Mohnish Pabrai  6:03  

Actually, I’ve had some detailed conversations with Charlie, specifically on this. I can’t go into more detail because it touches on things that I don’t think I want to talk about publicly and I don’t think he’d want to talk about publicly. Though I can tell you this, that what you see is what you get. 

So, Charlie and Warren have a very simple system. The simple system is they are not trying to hoard cash. That is not part of the system. Their system is if an opportunity shows up, and that opportunity makes sense, they will put cash to work. They are not going to be particularly concerned, if 911 happens next day, or the Fed is at zero or what’s going to happen in the next 10 years. They truly run their affairs with the understanding that you really have to understand the business and you have to invest based on the understanding the business.

I mean, if you analyze Warren’s purchase of Burlington Northern Railroad, I think he gleaned some insights into railroads that were not at all understood by the public, not even understood by railroad analysts. I think he understood a number of things about the irreplaceable nature of that infrastructure. The fact that all these bridges and underpasses in the US had been redone to allow double decker trains over a long period of time, the fact that labor relations have changed, the fact that trains have become more efficient, and the fact that versus trucking, they were many times more efficient in moving a ton of freight and so on. 

So there were a number of *inaudible effects that came about the Northern decision, just like the Coca Cola decision. They were so overwhelmingly in his favor in terms of the intrinsic value of the business being so much higher than where it was. They’re, quite frankly, it didn’t matter that much in what happened in the next few years the economy.

If you look at the Burlington Northern value today, it may be four times what they paid for it three or four times or they paid for it. How could you have such a wide mispricing on such a large asset? So the area that they spend their time on is exactly that, which is figure out the business. I mean, Precision Castparts, they have to figure out the business. Warren did mentioned that if interest rates were higher, they may not offer that much money. So Precision Castparts is one of those that they were sitting on the edge, right? Right on the edge of the precipice of whether to go or no go, if you will, but they love the manager, and they went for it because of the manager. The manager was a huge part of the equation. 

So I truly believe that they understand a lot of things about macro, but my reading everything in the public domain and our private interaction, I’d be able to make a pretty sizable bet that micro trumps macro for Warren and Charlie in a very major way. They are looking to buy businesses well below the intrinsic value where those businesses will have staying power for decades, because they have lots of capital, they can go sloshing in and out of different things. They have staying power for decades, and they will deliver good returns for decades. Then the rest of it is just noise. They don’t care about the rest.

Preston Pysh  9:33  

The thing like when I look at the current US market, if we’re using a Shiller PE, it might be priced at a 4% right now. If you look at a 10-Year Treasury, I mean, it’s what? 2.6 now? I know it’s come up a lot in the last a little bit of time, but he’s not investing in just the S&P 500 at that call it 4% return. He’s deciding to sit on a tremendous amount of cash. I guess this is the magic question is where is he drawing that threshold of I have to have an 8% return or a 9% return that I’m expecting to get in order for me to employ that cash and not go after a measly 4% return? I guess that’s the thing that I just constantly think of where are they drawing that threshold? How are they making that determination that I’m going to value liquidity over 4% return if you were going to take the S&P 500?

Mohnish Pabrai  10:27  

I think the way they’re making those decisions is they want the decision to be a no brainer. So what they are looking to do is I don’t think they are sweating the details on the S&P versus the 10-Year Treasury and all those sorts of things. I don’t think that’s really the driver. 

What they’re looking for is can they land an exceptional asset in the hands of an exceptional manager with a moat that is getting deeper by the day. That is the key. Those are the facts that matter more than anything else. If you look at the Coke purchase from 1988 to 2016, how many economic cycles have we had? How many Fed loosening and tightening cycles we had? All of that is irrelevant. It’s the business and what the business does that trumps everything else. 

So I think investors basically should take them at face value. I think investors are just doing themselves a huge favor, if you just eliminate any macro thoughts from their brains. I mean, it is hard enough to figure out the future of a business. Don’t try to figure out the future of the world. Don’t try to figure out the future of a country. Just try to figure out the future of a business. That is hard enough. Don’t go beyond that.

Stig Brodersen  11:49  

So speaking of macro, and more on Buffett, one thing that comes to mind is Berkshire Hathaway’s new holdings of four airline companies. I think some people definitely were highly surprised by this since Buffett’s several times has warned about the industry, and he even called them a deathtrap for investors. 

Now, their positions were somewhat small and given the size of them, it’s probably performed by *inaudible his portfolio managers. However, the interesting thing about this is that based on the enterprise, most of all, the companies actually looked very attractive before Berkshire scooped them up. So my question is basically, twofold here. I’m curious to hear your thoughts about airlines specifically. Also how much emphasis you put on valuation metrics, like the enterprise multiple for tricky industries, like the airline business?

Mohnish Pabrai  12:43  

Actually, the airline investment is a really good example of how Warren only selects the manager and does not interfere with what they do. So I’ll get to airlines in a second but there’s a story I remember about many years back. Geico did not accept the American Express card. Berkshire had a large position in Amex. So the Amex CEO I forget, Ken Chenault or Harvey Golub, called Warren and said, “Hey, Warren, I tried calling the of CEO Geico and he won’t even return my call. Can you ask him to just take my call, not to accept Amex, just take my call?”

Warren told him that I can’t do that. He said, “The reason I can do that is because if I call the guy and say, ‘Hey, take the Amex CEO’s call.’ He’s going to read more than that into that sentence and he’s going to think that there’s a mandate of some kind to maybe accept the Amex card. Whatever I feel about whether Geico should accept Amex or not, is irrelevant. That decision rests with the CEO of Geico.”

So he told the Amex CEO, keep calling and be a pest and pound him every day. But do not ever utter my name, you’re on your own and all the best and I hope you make the sale. So the *Todd and Ted relationship with Warren is one where Warren is not going to tell them do this and don’t do this. Now, clearly to our very smart people, it’s clearly one of them who bought this, I would guess it’s *Ted because he’s had some history in the past of making airline investments. So I think if you go look in *inaudible, he’s done some things with airlines. I think that Ted is very well aware of his boss’s extreme hatred for airlines. But he also understands his boss has given him a mandate to deliver returns without taking ridiculous risks. So the good news is, he’s exercised his freedoms in such a way that which is which is great. 

Now, why did he do that? Well, I think that what happened is, I think the airlines situation is similar to the railroad situation. Basically, you have an industry, which has really bad economics. Your dumbest competitor sets your price and you have a duopoly from where you need to buy your airplanes. Your workforce is unionized, and you’re selling a commodity on all fronts. Then you have no control or fuel prices, so something like one third of your cost, of your operating expenses is out of your control, what a great business to be in. 

But the thing is that one by one, many of these things are no longer true. So for example, I don’t think we are going to see high fuel prices for any sustained period of time, maybe ever. The reason is because the United States is a swing producer and the United States was not a swing producer before. Also, the United States production cannot be controlled, because it is 10,000 independent entrepreneurs making those decisions. It’s not Saudi Arabia making those decisions. 

On top of that, we have a Interior Secretary whose three most beloved words are “drill, baby drill.” So we have an EPA where the head of the EPA wants to abolish the EPA. We have the head of the Energy Department coming in who wants to abolish the Energy Department. So the United States is going to take the shackles off the frackers in a very major way. 

Even the technology that existed for fracking three years ago, versus today is night and day. I mean, just the other day, I was reading that Chesapeake digged some well, which went two miles for the first time ever, and then the horizontal runs were huge. I mean, on a number of fronts, it broke all kinds of records and it’s going to drop the per barrel costs significantly. That trajectory is going to keep continuing.

The entirety of oil went to 75 or 100, you would see far more innovation come in into the fracking area. So I think that it’s a safe bet that for any sustained period of time, unless we had weird things going on, like you shut down the Strait of Hormuz or something, we are not going to see high oil prices. So that takes away one big huge monkey that is on the back of the airlines. 

The second is that it used to be a brutally competitive industry with more than a dozen players. They all kind of merged with each other. Then we were left with five or six players of any meaningful size in the US. The top three or four, in fact, have somewhat oligopolistic positions. So for example, if you know when you have hubs in places like Dallas Fort Worth as American does, then if your travel takes you around that area, American has pricing power because of those hubs and gates. So just like United has power in Newark, and Southwest has power at Las Vegas and so on, and a number of California airports. 

So the different pieces are getting to the point where there is rationality and these airlines have all been through such a bloodbath in the past that the CEOs of almost all of the major airlines now have seen the movie before, and are not interested in going there again. So they’re not focused on market share. They’re focused on profits. At the core, they have tail winds because air travel is growing. I mean, I don’t know if you’ve been on a flight lately, but there are no empty seats. I mean, their load factors are through the roof. The fares aren’t really that cheap, even though fuel prices are cheap. So I think that these guys are in great shape and many of those things are unlikely to change for a while.

Stig Brodersen  18:57  

I know that you recently took a position in Southwest Airlines. I did too by the way. Could you explain to us why you recently decided to invest in Southwest and not say in Delta, American, United, or any of the other airlines?

Mohnish Pabrai  19:11  

First, I mean, I looked at all the airlines. Southwest is an extremely unusual company. It is like no other airline company that I know of. I mean, I think that for the longest time, if you had put up the Berkshire Hathaway stock chart next to the Southwest stock chart, the stock performance blew it away. This was an airline operating in environments where fuel went up and fuel went down and everything in between and they still blew out Berkshire Hathaway. 

I have a person who was one of my first employees in one of my first businesses, TransTech, and he came to work for me 25 years ago. He’s a very talented IT person, obviously, he’s become very senior guy. He was a senior employee at United for a while and now he’s an independent consultant. So for a few years, he was flying in and out of Southwest headquarters because he was working on an IT project for them because they’re going through a lot of system changes. My conversations with him are not related to the investment. I’ve had conversations with him about Southwest, just shooting the breeze for several years. 

However, just to give you some examples of what he said that it’s the only place where he would go into a meeting with a bunch of Southwest employees, and he’s one of the only people who was not a Southwest employee. Before the meeting started, everyone would hug him. Okay, they all have hugs, and then they’d get down to business right? The ticker of Southwest is LUV. He said, “Mohnsish, at United, united, no one ever hugged me.” And no other business that he ever worked at did anyone gives hug. 

So Southwest has an extremely unusual culture if you walk into their headquarters. They do not allow any type of art on the walls. The only thing you can put up on walls are pictures of friends and family. I think they’ve given license for any employee to take any picture of their friends and family and put it anywhere in the headquarters where they want to. So when you walk in there, it’s like a place like no other place you’ve seen.

Also, the way Southwest hires its people. I already told you that humans are hardcoded at the age of five, you are not going to change humans after the age of five. All you can do is try to make sure you bring in the right humans. So what Southwest does is in their hiring processes, they are far more concerned with the psychological makeup of the person than the capabilities of the person. They believe they can teach capabilities, but they cannot change the psychology so they are looking for people who have a certain psychic makeup.

Have youflown Southwest lately? 

Preston Pysh  22:01  

Yeah, I have.

Mohnish Pabrai  22:03  

They have that Harvard Baltimore. So you can you can avoid them. When you die and go to heaven, you’re going to change planes in Baltimore. So you have that huge Southwest hub in Baltimore, and you’re going to use that. But when you go on a Southwest aircraft, so here’s how I feel. I go on a United Aircraft or an American aircraft, and I’m in business class, and it’s fine. I go on a Southwest aircraft, and I’m a coach, and I usually find them happier. I’m in a happier state of mind in coach in Southwest versus business on American. 

Why is that? I don’t know, why is that I still haven’t figured out I keep asking myself the question. Why do I feel happy being in Southwest? I don’t know exactly why, but the thing is, it’s a happy place. They’ve made that narrow cue to a very happy place. 

Why is it a happy place? Because they’ve had certain type of people, and they’ve given them a lot of flexibility. The other airlines have tried repeatedly. They’ve tried repeatedly to clone Southwest. So United setup Head, and they shut it down. Selta set up song and they shut it down. All these guys would do… They thought all the formula is you have one airplane 737, you fly from point to point, and you fly the airplane nonstop and the time between takeoffs and landings is 25 minutes or something. They cloned all of that. They still couldn’t make it work because the thing that is the hardest to clone, and the thing that none of the airlines can ever clone about Southwest is the culture.  American can try as hard as it wants. It can never clone the culture in 100 years. United can never clone the culture. Delta can never clone the culture. They’ve tried and fallen flat. 

If you read there’s a book called “Nuts!”, which is a biography of Southwest. There’s a number of books on Southwest, a number of HBS cases on Southwest. I think if you just drill down on the company, this is a very unusual company. This is the company with a very happy workforce. This is a company which has a very unique culture. This is a company where twice a month, the management loads bags on airplanes, on and on. I mean, it had a level five leader Herb Kelleher who’s left the scene a long time ago, and even though he’s left the scene, the culture has not changed at all. Just like Berkshire’s culture, even 20 years after Warren is gone, the culture will be intact. So did I answer your question on Southwest?

Stig Brodersen  24:41  

Definitely, definitely. I’m really happy that you also brought in the term level five leader because that was actually something that we just covered on the podcast. So very, very important. Also in continuation of talking about leadership, management and what’s important.

Preston Pysh  25:17  

You know we all learn the most from our blunders and our mistakes and so on. People on Twitter we’re really curious what you would say was one of your biggest it can be an investing mistake life lesson. It doesn’t matter, however you want to take this, but what would you say is one of your biggest learning lessons from a mistake that you’ve made?

Hari Ramachandra  26:13  

First of all, mistakes are a blessing. Adversity is a blessing. I truly believe in what Marcus Aurelius says that to have misfortune and prevail is good fortune. If we were really wise, we would hope and pray for lots of misfortune because when I look back, when I look back on my on my life, and I look back on some of the critical points, what I found is that the points at which I took a leg down, were the points of greatest learning. We don’t learn when we do well, because there’s nothing to learn. Things are great. 

Mohnish Pabrai  26:56  

So I think that from my vantage point, I think mistakes are wonderful because the mistakes are great teachers. I find myself making mistakes all the time. After I have a few mistakes I’ve made even the last few years, and I look at those and say how dumb were you to make these mistakes, but I also know that I will not make those mistakes again. That is a tremendous advantage to basically reduce the error rate, if you will, as you go on in life.

I think when you look at the… When I think about the… I haven’t thought about in terms of the greatest mistake… One of the biggest mistakes I had happened just before the Pabrai Fund started. The dot-com boom was on in a big way. I thought I’d found a way to ride the wave, if you will, upside or downside. They will they some of the incubators that were coming up at the time. They had raised about I think about 4 million or so in capital for the ad and what 2.2 million of that all was my own money. The entire amount went to zero. So the outside investors who had put in money all saw it go to zero, and I saw it go to zero. So we lost that 4 million. We felt terrible. I felt terrible about the money loss of these people who had put in money were some of the nearest and dearest people to me. They were longtime friends and family and so on. 

However, there was a lot of success that came to the Pabrai Fund in the next several years. That would not have come if that mistake had not happened. So if I look on absolute dollars, there was more than 100 million couple of hundred million made that wouldn’t have been made, if that 4 million hadn’t been lost. 

Now, the same people didn’t make that. So there is an asymmetry there, but I couldn’t see it then. I just felt terrible about it at that time. A few years later, I look back and I say, “Wow, that was really good. That was a good thing for me to get hit that hard at that time because the lessons don’t sink in very well, if there are other people’s mistakes.” It’s unfortunate and this is one of Munger’s and Buffett’s great strengths is they actually are really good at learning from others mistakes. So they try to avoid most of them. I’m not as good as I have to do them on my own more than I’d like. I hope I get better at learning from other people’s mistakes. It will be so much cheaper. 

I would say that clearly the 99 timeframe, we had that mistake, 1999-2000. Then we’ve had we have others in the financial crisis. We had a company Delta Financial that went bankrupt. We had Horsehead Holdings that went bankrupt earlier this year. Very tough things because that was 100 million dollars that we earned. We invested 70 and had gone up to more than 100 and in the end it was zero. Tough things to deal with. Tough lessons. But the good news is that we’ll learn and my investors have been very gracious for the most part about these things. I think we will do better in the future as a result of the mistakes. 

Preston Pysh  30:12  

Absolutely. 

Mohnish Pabrai  30:13  

I believe that Buffett’s code: rule number one, don’t lose money. Rule number two, don’t forget rule number one. Going back to your question about him keeping cash, him keeping cash is because of that, quote. It’s not for macro, what they want to do is they want to make sure bets or as close to shore bets as you can get, and keep that error down. So that’s really what is driving the cash more than anything else.

Stig Brodersen  30:41  

Very, very interesting. The last question I’d like to ask you is about a really good resource for our listeners out there. If you could endorse up to three investing books, not including Graham’s books, and not including Buffett’s shareholder letters, which I can see that you’re smiling now, because that was probably what popped into your mind right away.

Hari Ramachandra  31:05  

The reason I was smiling is because you left me a wide opening, which was great, because you didn’t mention “Poor Charlie’s Almanac.” First of all, I would say that if you’re excluding the Graham one and Buffett books, I would say, “Poor Charlie’s Almanac” is a book that I try to reread every year. Every year when I reread it, I find brand new things that I can swear whenever in the book before, somebody just put them in there. So I pick up more insights and just his speech on the psychology of human misjudgment. 

Mohnish Pabrai  31:36  

That speech, every time I read it, I pick up more insights. So I would say that that one book, in my opinion is better than a college degree. I think if someone just imbibed that book and read and reread it a few times, you would do quite well. 

The other insight that I’ve learned is that business autobiographies are really good. I mean, if you read, Sam Walton’s “Made in America,” for example. I mean, I think the business autobiographies are really good because they really help you get in the mind of these phenomenal entrepreneurs. If you can read some of those, there’s one that was written by Harvey Firestone a long time ago. It’s a book that was recommended by Peter Kaufman. It’s in “Poor Charlie’s Almanac.” I think it’s men and rubber or something along those lines. It’s a phenomenal book. That was written, I don’t know, close to 90 years ago? I think those insights are very valuable today. So I think that if you’re interested in airlines, studying Ryanair, Michael O’Leary, Southwest and such, is going to be really, really helpful in helping you figure things out. You don’t need too many of these insights to do well. I think the thing is that just a couple of these insights can be enough to give you a significant tailwind on the portfolio.

Preston Pysh  33:04  

Alright, Mohnish, I know I speak for our entire audience, when we just say thank you for coming on the show your insights, just amazing. It’s just so much fun to talk to you. If people want to learn more about you, and they want to go to your website, or go to your Twitter feed, if they want to see your book, “The Dhando Investor” or whatever, where is the best place for them to find you on the internet?

Hari Ramachandra  33:29  

First of all, its been a pleasure. I think both of you do a great job and great service to the community. I wanted to say that I was living under a rock for a long time. I had never been on Twitter. I didn’t even understand Twitter. But then when we got a Twitter President, I decided that if we can elect a president of these ways, United States, that I should kind of go on to Twitter land. So very recently, in the last few weeks, I set up a Twitter account and actually, it surprised me. I had very quickly more than 5000 followers, which is great. I’m having a lot of fun because I set up a blog recently called Chai with Pabrai. So anytime you want to have a good cup of tea, just come to the blog, and that’d be great.

Preston Pysh  34:15  

You know what I like about your Twitter feed is so many people that are really accomplished like yourself, they stand up a Twitter account, but it’s not them that you’re like interacting with, it’s some person that they hired or whatever. So huge kudos to you, Mr. Pabrai, I because I know I’ve had a couple interactions with you. Jist so our audience knows, go on Twitter and follow Mohnish because he will respond to some of the tweets that you send him and it’s just an amazing opportunity.

Stig Brodersen  34:44  

All right, good stuff, guys. This was all that we had for this week’s episode on The Investor’s Podcast. We’ll see you again next week with a new episode.

Outro  34:53  

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