05 May 2019

On today’s show, we talk to value investor, Mohnish Pabrai. Mohnish is the founder of Pabrai funds and an avid scholar of the Buffett and Graham style of investing.

Subscribe through iTunes
Subscribe through Castbox
Subscribe through Spotify
Subscribe through Youtube


Subscribe through iTunes
Subscribe through Castbox
Subscribe through Spotify
Subscribe through Youtube


  • How Mohnish Pabrai is reading Warren Buffett’s letters to shareholders.
  • Who is Mohnish Pabrai cloning?
  • How Mohnish Pabrai is evaluating the performance of his investments.
  • Why Mohnish Pabrai will never own an insurance company again.
  • Ask The Investors: How do you determine the expected future growth of a company?


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

Preston Pysh  0:02  

On today’s show, we bring back one of the most requested guests we hear about from our audience. And that’s Mr. Mohnish Pabrai. As many people know, Mohnish is a value investor, an avid scholar of the Benjamin Graham and Warren Buffett style of investing. Mohnish got his start as a successful tech entrepreneur in the 1980s. And after selling his business for a huge gain, he started his own Pabrai Investment Fund in the late 1990s. He established his firm after the same principles that Buffett had for his partnership before acquiring Berkshire Hathaway. And nearly 20 years later, Mohnish continues to outperform and run his hedge fund. So without further delay, we bring you the crowd favorite, The Dhandho Investor, Mr. Mohnish Pabrai.

Intro  0:48  

You are listening to The Investor’s Podcast while we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.

Stig Brodersen  1:09  

Mohnish, welcome to The Investor’s Podcast. We are so honored to have you with us today.

Mohnish Pabrai  1:14  

It’s such a pleasure. It’s been a while. I love you guys. I love the work you guys do. I’m looking forward to our session together.

Read More
Preston Pysh  1:20  

Oh, Mohnish. It’s always awesome to have you here. And since we announced that you were coming back on our podcast just a few days ago, we had more than 100 people submit questions. We have some very passionate listeners. In fact, we even had a listener from Sweden. Mateus who was such a big fan of yours that he wanted you to become the emperor of India.

I can comfortably say that you’re definitely among good friends here. But Mohnish, don’t worry. We’re not going to ask you 100 questions. We’re going to cover some of the most frequently asked ones, and add a few of our own. We recorded this on the 25th of April but it’s going to be released on May 4, 2019. And so for anybody that knows that date, they know that that’s the same same day as the Berkshire Hathaway Annual Shareholders Meeting. Mohnish, that brings me to my very first question. What are your plans for the Berkshire weekend? 

Mohnish Pabrai  2:10  

At about 5:30 in the morning, on the 4th of May, I will be at the south entrance in line. Hopefully the weather will cooperate to get into the Berkshire Hathaway meeting or reuniting they’ll open doors at 7:00 AM or so. I get a number of requests from people who want to meet in Omaha from all over the world actually. Omaha is usually a pretty packed schedule. So I tell all of humanity to come to the south entrance at 5:30 AM, on the 4th of May. Usually, there’s a decent number of diehards who show up and we have a good time in the morning. So if you’re so inclined, please feel free and I would love to meet you.

Stig Brodersen  2:46  

Mohnish, we recently had a great interview with Professor Sanjay Bakshi. He talked about how he read Warren Buffett’s letters and how he learned about different topics from him. For instance, for share buyback, what he would do is to put all the letters into one PDF, and then simply search for instance, buyback and then see how Buffett’s approach changed over the years in his augmentation. Do you have a specific technique for reading Buffett’s letters?

Mohnish Pabrai  3:14  

I remember the first time I wrote to Warren. It was to get the annual letters. At that time, they were not on the net. I got a letter back from Debbie. Warren have signed it. But basically, they sent the bound letters, but they also referred me to Larry Cunningham’s book. The rearranged letters by subject. Buffett very strongly endorsed Larry’s book. And that book is a godsend for all of us because it is a lot of work to rearrange Buffett’s parts in so many different letters by topic. 

I have sent that book to a number of folks. In fact, in the last year, I sent it to a lot of Indian public company CEOs. I said: “Look, anytime you’re thinking about or getting stupid thoughts like stock splits, issuing options or any of those sort of things, just go to the relevant section and read it before you do that.”  

A couple of weeks ago in Toronto, I told Larry, “The problem is you haven’t updated that book in so many years, and we need an updated edition which again rearranges it by letter.” The other upload, which Sanjay has taken, put it in a single PDF and say though it is as effective. That works pretty well. I do want to say that Sanjay runs a tremendous value investing course at one of India’s best business schools. And very few business schools on the planet focus on value investing. 

Sanjay’s course is excellent. He’s doing some great work. And Stig, one of the most interesting things that happened to me. About a year ago, Buffett posted all his annual meeting videos, going back to all the way to 1994 online. The best things in life are free. One can go to buffett.cnbc.com. All the annual meeting videos from 1994 to 2018 are posted. 

Besides the videos, they’ve actually annotated and then a whole bunch of other stuff to them. What I have been doing is, every day, when I get ready, or when I’m shaving and showering, etc, I have a waterproof Bluetooth speaker. I play about 30 minutes of audio. I started in 1994. For most days, those 30 minutes are the most productive 30 minutes of the day. Usually the learning in those 30 minutes, far exceeds what happens in the rest of the day. So it’s been really good. 

It’s kind of like, you go on a car ride every day where Warren and Charlie are your carpool buddies. They’re talking for 30 minutes in the car. Many times, I’ve had to play back certain sections because it was just so filled with priceless wisdom. One of the differences between Buffett’s letters and the annual meeting videos is that the letters are exceptional, but they are premeditated. 

So Buffett starts writing the letters. He starts in November. He said that in March, they kind of snatched away from him. He decides what topics he wants to focus on in the letters. In the videos, they have no idea what questions come at them. They get this very wide range of questions. In many cases, they convert lemon questions into lemonade answers, which is great. But we hear thoughts on subjects that I’m sure they would never ever talk about because they haven’t prepared. 

I have attended every meeting since 1998. Even though I’ve attended every meeting since 1998, I have learned so much. So now I am in the year 2013. In the next 2 to 3 days, I’ll be finished with the year 2013. And I have now 2014 to 2018 to listen to. But somebody recently sent me a PDF. I think it’s a 3000-page PDF of the transcript of all these meetings in a PDF file. 

What I was intending to do is after I finished all the audio through 2018, I’m going to go and read the entire 3000-page PDF because we are basically taking in the data in two different formats into our brain. One is we’re taking it to our audio. And the second is we’re taking it through reading. 

Preston Pysh  7:15  

Mohnish, you’re well-known for being a very humble investor. One of the things you’re often talking about is this idea of cloning your investment approach after great investors like Warren Buffett. So I’m curious, who else have you modeled your approach after, and what were some of those guidelines? 

Mohnish Pabrai  7:33  

When we latch on to certain mental models, we get a huge advantage in life versus other people who might be smarter than us, or who might be even much harder working than us, we will end up doing a lot better than them. So mental models in general, especially the right mental models carry a lot of freight to make us a lot more effective than we would be otherwise. A lot of these mental models, someone else has already figured them out. All we have to do is reach out and grab them. 

They’re on a shelf user society, I’ll take this one. Cloning is a very unusual mental model. It is one of the most powerful mental models. I think that cloning has had a significant impact on me for more than 30 years. It is one of the first mental models, even before I heard a word on Charlie, I adopted cloning. 

There was a McKinsey consultant, Tom Peters in the ’70s and ’80s. He wrote a bunch of best selling books such as, “Passion for Excellence”, “In Search of Excellence”, and so on. In one of those books, he had this story of this California gas station. Two gas stations, actually. That story is etched in my brain. It had a huge impact. I actually didn’t believe the story. 

What Tom Peters said was, they were these two gas stations that were on this busy intersection in California diagonal from each other. They were both self-serve, and you go in and get your gas. In one of the gas stations, the owner would come out every so often. Maybe every hour or so. Pick a random car and tell the owner: “Listen, sit in the car, and I’m going to give you a full service”. Which means, I’ll pump the gas and clean your windshield. I’ll check your oil and so on. No additional charge, just extra service. 

His competitor who was diagonal across the street could see this very clearly. He could repeatedly see this going on. His perspective was, “Well, this is really dumb because if you can’t provide the service for everyone, why do it for anyone.” And the second is you actually cannot provide the service to everyone because it will be too expensive, and then you lose money and so on. So the competitor never cloned his competitor’s approach on customer service.

Of course, we know over time, the guy providing the random greater service was getting more business. More and more of the cars went to him versus his competitor. Even after losing the gas station, the owner saw that his business went down. He knew the reason the business went down. He still did not make any change in behavior. I found this really puzzling. And then Tom, Peter said: “That you can sit down with your most fierce, direct competitors and just tell them all your trade secrets.” What will happen is they will listen to you, but they won’t make any change, and they won’t follow any of those secrets. 

When I read that, I said, “Well, Tom Peters is stupid”. This is not how the world works. If I tell somebody how to make more money, of course, they don’t listen. And so what I decided to do was, I decided to do two things after I read this. When I started a business, I said, “First of all, when I see someone else doing something smart, I am going to force myself to copy that. And the second is, I am going to carefully observe this idea that Tom Peters had that humans are bad at cloning, to prove them wrong.” 

And what actually happened over the last three decades is I found that Tom Peters is absolutely right. Humans have a lot of difficulty with cloning. I still don’t know why. I have not yet figured out why. Something in our genetic makeup, or our history as humans makes us have difficulty with cloning. But the second thing that I did, which is I forced myself to copy things that were exceptional. 

What I found is, for a small sliver of humans. Maybe 1% or 2% of humans will be good cloners. For this small sliver of humans, they get a massive advantage over humanity. And so I have been a cloner for 30 years. I have cloned small things. I’ve learned big things. It’s been a huge advantage. 

For example, we would not have a Walmart if Sam Walton was not a cloner. We would not have a Microsoft, if Bill Gates was not a cloner. We would not have an Apple if Steve Jobs was not willing to lift from Xerox Parc. 

Cloners are all over the place. They’re everywhere but they’re very small sliver of humanity. My whole investment philosophy was cloned from Warren and Charlie. I would be a useless third-rate investor if I did not pick up their principles and copy them. I’ve not just done that. I’ve actually looked at “The Great Investors”. I have shamelessly copied those topics. It’s made me wealthier. Those guys still continued to be my friends. What a wonderful world.

Stig Brodersen  12:27  

What an amazing world. Why do you think that you’re a good cloner? You said that so many people have problems doing that because it seems so counterintuitive. What is it specifically about your brain that’s wired that you can go in and do that?

Mohnish Pabrai  12:42  

It’s something I have actually not been able to figure out. All I have been able to figure out is that Tom Peters is correct. So many young investment managers or aspiring investment managers come to me. They want advice on setting up their investment fund, and etc. I tell them, “Listen clone the Buffett fee structure, 0/6/25. Clone the fee structure. Don’t question it. Don’t have intellectual debates with me about it. Just clone it.” 

Six months to a year later, I look at the operation. It’s 1/20 or 2/20. So then, I meet the guy. I said, “Listen, didn’t I tell you to do this?” Yes, but more or less, you don’t understand. I need the cash flow. I said, “You have less than $10 million in assets. The 1% is not that big an amount. You can live without it. It’s not like you have a billion dollars that you’re getting 1% on. Instead, you have $5 million/ $7 million/ $3 million. It’s an irrelevant number. 

What is happening is by having that structure, you have taken away competitive advantage. Some people who would have invested with you will now not invest with you. So when I gave you this piece of advice, it wasn’t Mohnish advice. This is coming from Buffett.” 

Even after the second conversation, there is no change. And even after the third conversation, there’s no change. So these are very good, high quality people. I like them. That’s just the way it is. Tom Peters will forever be right.

Stig Brodersen  14:09  

That’s so interesting. I remember this story, you’re telling the last time in the podcast that you had a young analyst coming to you and said, “You need to tell me what’s the best railroad stock guess.” And you said, “That’s just not interesting”. He was like, “That’s the only thing I cover. I need one.” This is so interesting. It’s kind of like the financial sector is wrecked against thinking freely in a way. 

My next question is about how you evaluate your own investment process. For instance, say that you think there is a 70% chance or probability of a catalyst to happen, which will significantly influence the price and the value of the stock. Now, you don’t want to fall into the trap of resulting and then only look at the result, like what happened. After all, if there is a 70% probability, there’s still a 30% probability that it’s not going to incur. Keeping that in mind, how do you evaluate your own decisions and your results?

Mohnish Pabrai  15:01  

You can segment investments into two different classes. Value investing is let’s say broadly is in two different buckets. One is a company that’s trading at a very significant discount to what it’s worth. So you’re buying a pie at a third of the value of the pie. The second is, that is a pie. It’s likely to grow a lot. But the discount that you get for buying that pie is not 70%. Maybe it’s 20% or 30%. 

So you have a growing pie with a smaller discount, or you have a constant pie with a large discount. Usually, catalysts tend to come into play in these constant pies. They tend to be more prevalent or predominant in constant pies where you will say, “Hey look, this company has a lot of real estate, and in the next two years or three years, they’re going to monetize it. The real estate is not being valued by the market but it would double the stock once they monetize it.” 

The thing that I’ve learned and is still trying to learn is to not focus on the pies at a discount. Focus on the growing pies. The growing pies is where the game is at. What we really want, if you really want to get to the promised land is you want great businesses run by great managers. It would be awesome if they are available at huge discounts if you can get that. You would still do well if you bought the great business with a great manager at a not so great discount with no catalyst than looking at some business where the sum of the parts is a lot bigger. There are some potential catalysts in place. 

First of all, in both styles, I never focus on catalysts. Ben Graham said, “Value is its own catalyst.” And so, that’s one of those core mental models that you have to adopt. Whenever we add value investors making in investment, we are implicitly agreeing with Ben Graham that in the long run, the stock market is a weighing machine. And in the long run, things will get weighed appropriately. 

One doesn’t need to focus on catalysts or value to be unlocked. I think that if one shifts, it’s very tempting to buy discounted pies, especially heavily discounted pies. The bargain hunter in us loves that. But what I’ve learned is that what you want is these great franchises. The most important thing is to find these great franchises with what I would call hidden moats. These are businesses. 

If I look at a business like, let’s say, I look at MasterCard. It is maybe followed by 30 analysts on the street. Most people who understand the competitive advantage of buying off MasterCard which is a very strong franchise, has huge returns on equity, has great management, continuously buying back shares since the IPO it delivered almost 40%, annualized. What’s not to like about that. 

But the thing about MasterCard is, if you buy that, you’re probably buying it at 30 times earnings or something. At least from my vantage point, there are two problems. The first is, you’re paying a significant multiple. *inaudible* turnout be okay, but you’re paying a significant multiple. The second is, there is nothing hidden about the moat. This means, humanity has a good grasp on Microsoft. 

But the best investment ideas are the ones where you have figured out something about the business that the market has simply got no idea about. When you figure that thing about that business, the moat can be subtle, the moat can be hidden, and the moat will eventually reveal itself. And so at some point, the market will say, “Oh, yeah, I get it now. I can now go buy this”. That’s fine. You want to be bought and taken by the three times the price you bought it, no problem. That’s okay. 

I think that the key mantra is, “focus on the index.” Any index we look at. The S&P index or any index. Most investment managers, active managers have a hard time beating the index. Why do they have a hard time beating the index? The reason they have a hard time beating the index is because the index owns the haystack. In the haystack are several needles. The index would not go hunting to find needles in haystacks. They just bought the entire haystack and all those needles came with it. 

So in the S&P 500, Apple just comes with it. Microsoft comes with it. Google comes with it. Facebook comes with it. All kinds of businesses that have incredible economics and tailwinds are just part of that haystack. An active manager goes and tries to find the needles in the haystack, and just buy those. What ends up happening in many cases is they also end up owning haystacks. Many times their haystacks have no needles in them because the index is too dumb to know that it owns Amazon. The active manager is too smart to pay up for Amazon. This is one of the reasons why indices are not the easiest thing to be.

Stig Brodersen  20:26  

Say that you already own the stock, which steps to go through as you track the performance of the company?

Mohnish Pabrai  20:32  

This is one of the, I would say, the strangeness about investing. The rate at which change occurs in companies. Progress occurs in companies that one can look at and measure. It is a lot slower than the rate at which our brains process information. The human brain can process information pretty quickly. Meaningful change in businesses that you invest in may come after one year, three years, nine months, or five years. It could take a while. They’ve got to make their moves. Those moves take time. 

Only a few businesses can have a lot of change happening in them every few weeks. And even every few weeks is much lower than the human brain. There is constant data coming out of all of these entities. Most of the data that is coming out of these businesses, I would classify it as noise. It’s irrelevant data. But the brain can be many times tricked into thinking that this irrelevant noise is actually very relevant data. 

We, as investors, our jobs are to make sure that we hopefully have figured out that we have latched on to the right variables. If I go back to the example of MasterCard. They’re in the payments business. We live in a world where payments is an area of very significant change. There’s a lot of change happening across the world in how people are paying for transactions. At the same time, MasterCard or American Express or VISA have extremely dominant franchises. 

They face threats, but they also have dominance. If you follow the industry, almost daily, you’re gonna have noise coming at you all day. There’s this FinTech startup. There’s this different way for payments. PayPal is doing this and that, and all these different things going on with payments. One needs to have clarity. I have no investment in MasterCard, probably because I could never get it at three times earnings. 

But if I did have investment in MasterCard, before making the investment I would need to have clarity and think, “Hey, listen, Mohnish, you’re investing in MasterCard now. For the next five years, when you try to own this thing, you’re going to be clobbered with data coming at you which will contradict your thesis and that data could be correct, or that data could be incorrect. But you need to have some conviction about why five years from now, MasterCard is more valuable than it is today. And why they are not going to get affected by these very strong different kinds of headwinds that they’re going to encounter.” So what I’m saying is, it’s a noisy world. That’s what makes investing not so easy.

Preston Pysh  23:34  

So Mohnish, you’re a lifelong learner. I’ve seen your reading list, and it’s absurdly long. We’ll have a link to that in our show notes if people want to check out Mohnish’s reading list. But my question is based on changing mental models. What is something you’ve changed your mind about in the last five years based on your learning and your reading?

Mohnish Pabrai  23:56  

When I was young and naive, let’s say five years back I used to think insurance was a great business. Why would I not think that? Warren Buffett became a billionaire. But insurance frameworks have become a billionaire. What’s not to like about insurance? What’s not to like about having other people’s money, and they pay you to hold that money? It is such a wonderful concept. 

I think about five years ago, I decided that I wanted to set up a permanent capital structure, which in that structure, owned an insurance business. That is using the surplus, capital or equity, and float to make investments and ride off into the sunset. I did that. I set up an entity calle, Thunder Holdings. I realized after hitting my head against a brick wall for a few years that insurance is a terrible business. One should never be in the insurance business. 

I did not read the fine print. The fine print God read to me after I bought the business. In fact, I bought the insurance company. I agreed to buy it in kind of early 2014. And by early 2015, we owned it. I think even before the deal closed, I was getting doubts in my head that this was a mistake. But I said I think it can still work out. I was kind of delusional. I was going down this path. We had raised so much money, and we agreed to buy the business from the seller and all of that. I wasn’t brave enough to pull the plug. 

But almost immediately after we closed on the business, it started becoming clear to me that I had made a mistake. Another mental model which is a very important model to follow is if you make a mistake, you need to see how quickly you can unwind that mistake. If your ship is burning, you don’t need to wait until it’s all burnt and drowned. You need to start taking action before that. 

That’s another thing where a lot of people make a decision. In my case, this was a very significant public decision. I had raised $150 million. I had told investors we would be following a certain game plan. Investors had confidence in giving me that money. They were expecting that game plan. I now had to go back to them and say, “Hey, listen, guys. I think we are kind of hosed over here. We need to unwind.” But I said that was the right thing. 

I went back to my investors and said that we’re going to unwind. I said that they would at least get their money back. I’ve learned to own mistakes. If you make a mistake in investing, and you get your money back, that is an exceptional outcome. Anytime we make these bets, and the bets don’t work and we get to take our principal back, hallelujah. That’s a great outcome. 

I looked at that business, and I said, “Okay, we need to unwind.” I know it’s ugly and painful. When everything else needs to unwind because unwinding means you have to layoff people. You have to let go. There’s a lot of things that are unpleasant to work with. But now, we are quite *inaudible* into that unwinding.

We were able to sell it at a slight profit to what we bought it for, which I was surprised at. I was willing to let it go at 30% less than what we bought it for. Why is insurance a bad business? I think if you listen to these Buffett videos. There’s an example of what doesn’t show up in the letters. But it does show up in the annual meetings. 

Simplistically speaking, let’s say there’s an insurance company that has $100 million of capital and $100 million of float. They’ve written a bunch of policies and they’re paying claims. $100 million is sitting in [the] float. There are two entities that oversee these insurance companies. There’s your regulator, which is usually a state regulator. They are the rating agencies *inaudible*, which assigns a rating to the insurance company. 

The rating determines how easy or difficult, and the kind of pricing you can get in the market. So high ratings are very important. The regulator is very binary. They’re going to allow you to do certain things and not allow you to do certain things. The regulator’s most important task is to make sure that anyone who bought a policy when they have claims, that those claims are paid. 

In some cases, when you’re writing these long tail policies, you might write a policy in the year 1980. The claim price through being paid. The ability for the business of the insurance company to be around to pay the claims for decades is the primary concern of the regulator. Neither the regulator nor the rating agency are concerned with the returns that the insurance company generates. It is completely irrelevant to them. It’s very relevant to you, but it’s irrelevant to them. 

What you’re going to do with the float is you’re going to buy investment grade bonds, or a high percentage of investment grade bonds. The float is restricted in what it can be invested in. One can typically invest the $100 million of equity in equities, in stocks and so on. But they need to follow certain guidelines. They’re not going to allow you to put it into three stocks. They want to see wide diversification. They want to not see a lot of current risk. If you put it into a foreign stock, they *inaudible* you in terms of your ratios, and so on. 

At the end of the day, when you have these restrictions on float and on equity. Let’s say, I bought an insurance company for $100 million. I end up with $100 million of surplus and $100 million of float. Actually, I’m better off not buying the business at all, especially in a zero interest rate environment. If interest rates are decent or too high without inflation being that high, then I can make some money on the float with fixed income. But in this environment, you cannot make much money on fixed income. 

This revelation, which should have been obvious before 2014 to me was not obvious. I made a mistake. And I got a huge lesson on insurance in the few years that I owned the insurance company. I’m very grateful for all those lessons. I know insurance really well now compared to what I was in 2013. It is one of the learnings of the last few years that I’m so grateful for.

Stig Brodersen  31:09  

Lesson learned. 

Mohnish, thank you so much for making yourself available for The Investor’s Podcast. Before we let you go, where can the audience learn more about you?

Mohnish Pabrai  31:18  

I do a few talks and such. Like with you, the value investing community, primarily because of Buffett and Munger, has an ethos of sharing. That ethos is very deeply embedded in the community. I have learned a lot because these two gentlemen and Ben Graham were so selfless. They’re willing to educate people like me to the extent that I can help others. I’m more than willing to do that.

Stig Brodersen  31:45  

Fantastic. Mohnish, thank you so much once again for making yourself available. I think I can speak for everyone when I say that all of us learned a ton from you here today.

Mohnish Pabrai  31:53  

Stig, you and Preston are doing human service to the community. I love your podcast. East or West, The Investor’s Podcast is the best.

Stig Brodersen  32:05  

I like that there’ll be a new slogan from now on.

Mohnish Pabrai  32:08  

All right, make sure you clone it. It is hard. But make sure you clone it.

Preston Pysh  32:14  

Oh, we definitely will. I love it. Thanks so much, Mohnish. Coming from you, we will absolutely take that. Thanks so much for coming on the show, Mohnish. Always awesome to have you. 

Alright, so at this point in time, we’re going to play a question from the audience. This question comes from Evan.

Evan  32:34  

Hey, Preston and Stig This is Evan from Dallas. You guys often talk about the probability that a company would grow at a certain percentage, say 60% or 30% or 10%. My question is, how do you assign probabilities of different growth rates in your assessment of various companies? Thanks for your time, guys. I love the show and keep up the good work.

Stig Brodersen  32:57  

Great question, Evan. 

So what you refer to is when you estimate the intrinsic value of a stock pick. The traditional approach is that it might grow with say, 6% annually. What Preston and I do, and the tool we created around that, which we’ll give to you for free for asking this question is to make this applicable to real life investing. Instead, we’re saying that we assign probabilities to three different scenarios that could happen. A most likely scenario, and then a positive and a negative scenario deviating from that. 

For the most likely scenario, I typically assign at least 50% probability. I look into the outlook of the industry as my starting point. For instance, if I was looking at the airline sector, the huge underlying factor for the growth is economic growth. Even though I’m looking at a higher performing company with a strong moat. So much is still determined by the sector and the general tailwind and head when it faces. 

Of course, it’s not as simple as just saying, “Whatever the industry is growing with that is just what I would use.” But again, it would be a good starting point for you. Of course, this is more tricky when you deal with a company like Google and the other monopoly kind of business that is almost its own industry. But for most businesses, it’s typically simpler to look at the industry as a whole. Then to make it more specific to depict that. I’m looking into my assessment. I also look at the organic revenue growth. 

Revenue is the starting point for all businesses. I would like to ensure that more potential free cash flow is not coming from cost cutting, for instance. We can continue to cut costs and use that in the growth assumptions. As Mohnish was talking about here in this interview, it has to come from growing revenue. 

Keep in mind that even though the company you’re looking at has a strong moat. I’m typically reluctant to use a high growth rate. I always like to be conservative, especially in the most likely scenario. And again, perhaps I missed just the size of the moat. The first scenario we looked at which was the most likely scenario is the base case scenario. 

For the more positive scenario, I’m looking at which catalyst can positively impact the company. Often, I find that analysts look at catalyst and say, “This is how the company would grow with, for instance, 10%.” And then they would use that as the growth. For instance, if I looked at an airline, like Southwest Airlines. I might assume that the new routes to Hawaii will be profitable and very successful. I also argue that all price will stay low, which will provide another boost to the profit. Of course, this could happen. But I would rather assign a probability to the most positive scenario, which I think and hope will happen. 

But as a conservative value investor, I typically do not assign more than 25% to that scenario. In the long run, you will find that your own biases from picking that stock will just blind you. And you will find that the positive scenario is often way less likely than you thought. I’m sorry to say that, I learned that from bitter experience myself. We talked about the base case scenario and the positive scenario. But let’s talk also about the most pessimistic scenario.

For this scenario, I often do not use any growth at all in my assessment, perhaps even a negative growth rate. I especially pay attention to whether or not it’s a cyclical business and where I think we are in the cycle. And again, I could be wrong. I typically assume that the stock will perform worse than the sector and one or two negative events will happen. For many stocks. I don’t even shy away from using up to a minus 10% growth rate, even for a company that has performed okay in the past.

Preston Pysh  36:54  

So Evan, the best way I can describe the probability approach is thinking about the map of a hurricane projection. For anybody that’s watched “The Weather Channel” during a hurricane event, you’ll see that they have a projection array of where that hurricane might go. Let’s say the hurricane is three days from making landfall. There’s the point of where it’s at right now. And then, the array of potential outcomes of where it can go. And in the middle is the “most likely”, and then on the left and the right of the approach is this cone. The potential array and maybe the probabilities of it hitting that outer line of that array is 5%, or 15%, or whatever. 

I think of future cash flows in a similar way, that we’re making a projection about what the future is going to be or with those cash flows might be. Where our center line is our “most likely” and then on the left or the upwards angle, you could say is the optimistic view and then on the line underneath of that would be your pessimistic view. 

And so, now that people can visualize what we’re talking about here, let me get to the heart of your question, which is: “How do I assign a value for the most likely path versus the worst case or the best case path?”. And for that, I can’t really give you a concrete answer. But instead, what I’ll tell you is I tend to err on the side of caution whenever I’m doing this. If I see a company that has very inconsistent earnings, they’re very volatile in the past and then in the future, they’re equally variable as my expectation, then I’ll be much more likely to heavily wait the downside portion of my projection, regardless of where the most likely trend is pointing. 

On the contrary to that, if let’s say I have a company that’s top line. It’s growing like crazy. It’s a large cap business, which means that those revenues are, I guess, more of a solid foundation. The past results are very steady, and the future results that I can tell from all my research is also projecting an upwards direction. 

In this scenario, I know it’s very generic. I might provide a slightly higher weight to the upside. But in that scenario which I would describe as the best case scenario, I’m still going to have a heavyweight, the most likely expectation of whatever that the trend has shown and what the trend would be moving towards in the future. 

So at the end of the day, this is where estimates really kind of become an art form. You’re mixing qualitative and quantitative factors. It’s the reason that Buffett and Munger always say that they come up with two different intrinsic values for the same business. My best advice for you is to build a margin of safety and always have a deep appreciation for what it is that you do not know, as opposed to what it is that you do know when you’re conducting these weights and whenever you’re estimating what that trend might continue to look like moving into the future. 

Alright Evan, as a token of our appreciation for leaving your great question, we’re going to give you access to one of our paid courses on the TIP Academy page of our website. The course that we’re going to give you is our Intrinsic Value Course. Our Intrinsic Value Course teaches people how to determine the value of an individual stock. It also teaches you how to think about the market cycle and when you’re buying your stock. It also teaches you some stuff about options trading. 

So we’re really excited to give you this course. If anybody else out there wants to check out the course, you can go to tipintrinsicvalue.com, or you can just go to our website and click on the [TIP] Academy link at the top of the page. The course is right there. If anyone else wants to leave a question on the show, go to asktheinvestors.com. If your question gets played on the show, you’ll get a free course.

Stig Brodersen  40:42  

Alright guys, thanks for joining us today. And thank you for helping us with all the questions to Mohnish. The Investor’s Podcast is really all about empowering the TIP community. Thank you for making that happen. This is the weekend of the Berkshire Hathaway’s Shareholders Meeting. Before our traditional outro, we will instead play the “Mr. Market” song by the ever talented, Brittany Collins. Brittany is an avid listener of The Investor’s Podcast. He’s president of our local chapter in Houston. And more importantly, she’s just a wonderful human being. Enjoy.

Britanni Collins  41:18  

“Good morning, Mr. Market! Well, what do you say? What do you say about your price today? Does it fit within my requirements? That means it provides a high margin of safety to protect my principle when things get crazy. I’ll minimize risk to prepare for retirement.

Through my research and reviews, I can identify the intrinsic value.

When the market’s overvalued and the stocks are under-valued, it’s still a go. Well, Buffett taught me it’s okay to buy with a low P/E ratio. Of course, there’s no guarantee, but it works with my buy and hold strategy. So, Mr. Market I’ll give you this opportunity to just go low, or I’ll say no to you.

I won’t buy a company just because of your quote. I must understand it, and it must have a moat. Let’s not forget the trustworthy management team.

If your price hasn’t decreased from yesterday, what makes you think I’m going to buy today? I’m okay waiting for the perfect opportunity.

Through my research and reviews I can identify the intrinsic value.

When the market’s overvalued and the stocks are under-valued, it’s still a go. Well, Buffett taught me it’s okay to buy with a low P/E ratio. Of course, there’s no guarantee, but it works with my buy and hold strategy. So, Mr. Market I’ll give you this opportunity to just go low or I’ll say no to you.

Because you work for me, Mr. Market, Mr. Market. Because you work for me, Mr. Market, Mr. Market!”

Outro 44:38  

Thanks for listening to TIP. To access the show notes, courses or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to asktheinvestors.com and win a free subscription to any of our courses on TIP Academy. This show is for entertainment purposes only. Before making investment decisions, consult a person This show is copyrighted by the TIP Network. Written permission must be granted before syndication or rebroadcasting.


What do you love about our podcast? Here’s our guide on how you can leave a rating and review for the show. We always enjoy reading your comments and feedback!



P.S The Investor’s Podcast Network is excited to launch a subreddit devoted to our fans in discussing financial markets, stock picks, questions for our hosts, and much more! Join our subreddit r/TheInvestorsPodcast today!


Disclosure: The Investor’s Podcast Network is an Amazon Associate. We may earn commission from qualifying purchases made through our affiliate links.






Check out our latest offer for all TIP listeners!

WSB Promotions

We Study Markets