Friday, July 13, 2007

Mohnish Pabrai: 10 Questions & The Answers

How does your investment philosophy differ from Warren Buffett’s and Charlie Munger’s and why? As a follower of Warren Buffett you insist in buying into companies with a "moat"; nevertheless the kind of companies you tend to invest in do not appear to have wide moats as generally described by Warren Buffett and reflected in his holdings like Coca Cola, Gillette or American Express. Could you please expand on your definition of a moat and contrast it with Warren's definition? Warren Buffett stated that his ideal holding period is 'forever,' and that 20 investments in a lifetime are more than enough for any individual investor. Do you agree with these statements, or should one be more flexible in their investing strategy?

There are many different approaches that Buffett has applied over his long career. Even today, Buffett’s investing approach when investing for his own account differs significantly from his approach when allocating capital for Berkshire . Berkshire is a very inefficient vehicle for investing in stocks. Gains are taxed at 35%. In addition, shareholders are taxed when they sell Berkshire stock. Plus Berkshire is drowning in cash. With these realities, the best approach for Berkshire is to buy and hold stocks for a long long time.

If you’re a buy and hold forever investor, then having a very durable moat becomes extremely critical. Berkshire needs to invest in businesses that have very high returns on equity (Coke, Moody’s American Express), the ability to redeploy earnings at high rates of return and it needs to buy into these businesses below intrinsic value so that the annualized return is atleast the returns the businesses generate on their equity. Very very few businesses generate ROE exceeding 15-20% annually and have the ability to redeploy earnings at greater than 15-20% ROE. Thus it is unlikely Berkshire ’s stock portfolio can generate long term returns exceeding 15%. Their float helps then get higher effective returns. Buffett once said that float added about 7% to Berkshire annualized returns.

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