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Pabrai 2010 Annual Meeting Transcript — Net-Nets And Berkshire's Put Options


biaggio
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So we have these perfect symmetry events where 1982 to 1999 the market ran a lot. And from 1999 to 2016 let’s say it does nothing or did nothing. So all we have to do is get to 2016 with a pot of cash and then we climb again until 2033.

 

He sounds so f'n stupid here.  I'll never listen to another word this guy says.  That being said, he's absolutely right about his opinion of most net-nets. 

 

 

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So we have these perfect symmetry events where 1982 to 1999 the market ran a lot. And from 1999 to 2016 let’s say it does nothing or did nothing. So all we have to do is get to 2016 with a pot of cash and then we climb again until 2033.

 

He sounds so f'n stupid here.  I'll never listen to another word this guy says.   That being said, he's absolutely right about his opinion of most net-nets.  

 

 

 

Isn't that a tad drastic?

 

Think about it - we're in a Japan-style deflationary environment (think Watsa's UST bet) that could extend for several more years even if we continue to run deficits, but if we let the Paul Ryans of the world scare the country into a balanced budget we'll be dealing with a Japan environment for even longer. The US Congress does not have the financial/economic brainpower to understand that the worst possible fiscal policy in this environment is a balanced budget, thus I don't believe we as a country have the political will power to do what is necessary to thwart underlying deflation.

 

All that to say, it appears perfectly reasonable to say that after the next five years the environment will be ripe for a secular bull market. Just because Buffett does not come out and say he thinks this, I guarantee you he has a strong opinion on when the next secular bull market will appear.

 

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He wasn't saying that.   He was saying that we had a 17 year bull market and then we have to have a 17 year bear market.  This will be followed by another 17 year bull market.   At least that's how I interpret it. 

 

That's my bad, I was focused on the last sentence thinking that he meant the market would be flat for awhile, which makes sense given the environment we're in. Let's hope that he does not truly believe in that perfect symmetry - I'm going to assume he uses that outline as an extremely rough general market roadmap.

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He wasn't saying that.   He was saying that we had a 17 year bull market and then we have to have a 17 year bear market.  This will be followed by another 17 year bull market.   At least that's how I interpret it. 

 

Ok thats a bit much. If so then I slightly agree with you that its a bit much. I interpreted it as we would be rangebound for another 5 years or so and then would be able to move into a bull market. I assumed probably incorrectly, that the range bound was caused by macro issues....

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It sounds somewhat like Katsenelsons' Active Value Investing. Making money in range bound markets. Only this is about the before and after story.

 

Thats what I assumed (again incorrectly). It made sense to me because I do believe we are range bound.

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His statements on net nets also make no sense whatsoever.  I am surprised a value "guru" would make such statements.  From Ben Graham to Tweedy Browne net nets have been shown to outperform the market time after time.  Combined with his views on bull and bear cycles, I am wondering what exactly it is he is thinking.  

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His statements on net nets also make no sense whatsoever.  I am surprised a value "guru" would make such statements.  From Ben Graham to Tweedy Browne net nets have been shown to outperform the market time after time.  Combined with his views on bull and bear cycles, I am wondering what exactly it is he is thinking.  

 

I think his point that most net nets are extremely overcapitalized companies where even if the EV were to double you wouldn't make a great return on your invested capital.  That's something I generally agree with.

 

 

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His statements on net nets also make no sense whatsoever.  I am surprised a value "guru" would make such statements.  From Ben Graham to Tweedy Browne net nets have been shown to outperform the market time after time.  Combined with his views on bull and bear cycles, I am wondering what exactly it is he is thinking.  

 

My (admittedly shallow) understanding of Pabrai's investing style is that he doesn't care much for cigarbutts. In his fund he often loads up on natural resource producers and other more cyclical stocks. There are many ways to skin a cat; Pabrai's way is different than Graham's net-net investing, hence the disagreement.

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I pretty sure Pabrai took his 17 year market cycle idea from Buffett.

 

Maybe.  But then it seems like Pabrai's either didn't mention the salient point from Buffett, or isn't aware of it.  It has nothing to do with specific time periods; the symmetry Buffett noted was simply a way of bringing attention to the underlying forces at work.

 

Here's Buffett:

 

http://money.cnn.com/magazines/fortune/fortune_archive/2001/12/10/314691/

 

"I concluded that the market's contrasting moves were caused by extraordinary changes in two critical economic variables--and by a related psychological force that eventually came into play."

 

The first variable he mentions is interest rates:

 

Interest rates, Long-term government bonds

• Dec. 31, 1964: 4.20%

• Dec. 31, 1981: 13.65%

• Dec. 31, 1998: 5.09%

 

The second economic variable he mentions is corporate profitability.  Finally, the "psychological force" was speculative trading that gained popularity.

 

So to talk as if there is some kind of predictive power to the 17 year time frame (and it sure sounded like that is what Pabrai is doing) is to confuse the causes of market returns.  He's either being obtuse or coy, I can't tell which.

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I was there when that question was asked.  He wasn't saying that markets ran in perfect 17 year runs.  All he was saying, in response to the question about the S&P contracts Berkshire insured, was that if markets run flat for the next few years because of the deleveraging process and then a new bull run starts as many people expect, including Munger, then Berkshire would not incur much in losses...if any...as the coverage dates were well out!  That's all he was saying there. 

 

In regards to the net-net question, again all he was saying is that a net-net with little in the way of recurring income, is of little interest to him.  He's not an activist, so he isn't going to buy the net-net and reinvest the excess cash.  For someone else, this may be a much more attractive investment, such as Sardar or myself, where I would be happy to get my hands dirty and redistribute the cash.  If the cash is redistributed, then that changes the intrinsic value of the investment based on the recurring income.  If the cash sits there like an anchor, and does nothing, then that business is of no interest to him. 

 

Not sure why this is so difficult to grasp for some.  Cheers! 

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I was there when that question was asked.  He wasn't saying that markets ran in perfect 17 year runs.  All he was saying, in response to the question about the S&P contracts Berkshire insured, was that if markets run flat for the next few years because of the deleveraging process and then a new bull run starts as many people expect, including Munger, then Berkshire would not incur much in losses...if any...as the coverage dates were well out!  That's all he was saying there. 

 

That's not at all what it sounded like he meant in that article, for what it's worth.  It sounds like he believes in 17 year cycles.  Why else would he have said the next bull market will end in 2033? 

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I was there when that question was asked.  He wasn't saying that markets ran in perfect 17 year runs.  All he was saying, in response to the question about the S&P contracts Berkshire insured, was that if markets run flat for the next few years because of the deleveraging process and then a new bull run starts as many people expect, including Munger, then Berkshire would not incur much in losses...if any...as the coverage dates were well out!  That's all he was saying there.  

 

That's not at all what it sounded like he meant in that article, for what it's worth.  It sounds like he believes in 17 year cycles.   Why else would he have said the next bull market will end in 2033?  

 

He's giving an analogy:

 

So we have these perfect symmetry events where 1982 to 1999 the market ran a lot. And from 1999 to 2016 let’s say it does nothing or did nothing. So all we have to do is get to 2016 with a pot of cash and then we climb again until 2033. So when those puts expire, which is way after 2016, my view is that Berkshire will be just fine. They will have no pay out on those. But if you’re concerned you should ask Warren at the annual meeting and maybe he’ll give a better answer.

 

He's saying suppose we have this perfect symmetry of events (there is no such thing as perfect, thus he's using the analogy) and markets ran alot from 1982 to 1999.  From 1999 to say 2016 they do nothing.  Now you have another bull market for simplicity's sake running to 2033.  Berkshire's contracts would have no losses as the bull market would be a few years under way.  He was simplifying it for the idiot who asked the question!  He's just too polite to say that, whereas...well you know me!  ;D  Cheers!

 

 

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I was there when that question was asked.  He wasn't saying that markets ran in perfect 17 year runs.  All he was saying, in response to the question about the S&P contracts Berkshire insured, was that if markets run flat for the next few years because of the deleveraging process and then a new bull run starts as many people expect, including Munger, then Berkshire would not incur much in losses...if any...as the coverage dates were well out!  That's all he was saying there. 

 

That's not at all what it sounded like he meant in that article, for what it's worth.  It sounds like he believes in 17 year cycles.   Why else would he have said the next bull market will end in 2033? 

 

It looks like there was a loss of accuracy in translating what was said to what was written. The transcript was written by another party. It never occurred to me that he could mean that there would be a market cycle lasting exactly 17 years. I dont think he thinks that way. I think every one here would agree with you if that were the case.

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For what it's worth, whether his views on net nets are that he isn't interested in one with little in the way of recurring income, it shows he doesn't fully grasp the concept of a basket approach to net nets.  The "cigar butt" concept isn't one of recurring income but of a misunderstanding by the market of the value that's there based on assets in hand.  For example, if the company is never going to earn another dime, but is selling for 2/3 of it's NCAV, it should liquidate.  Since, per Graham, NCAV is a rough index to liquidation value, you've just made 50% on your investment in this hypothetical should the company liquidate.  Or someone could buy them and put the assets to better use.  Or new management might come in or present management find religion. 

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For what it's worth, whether his views on net nets are that he isn't interested in one with little in the way of recurring income, it shows he doesn't fully grasp the concept of a basket approach to net nets.  The "cigar butt" concept isn't one of recurring income but of a misunderstanding by the market of the value that's there based on assets in hand.  For example, if the company is never going to earn another dime, but is selling for 2/3 of it's NCAV, it should liquidate.  Since, per Graham, NCAV is a rough index to liquidation value, you've just made 50% on your investment in this hypothetical should the company liquidate.  Or someone could buy them and put the assets to better use.  Or new management might come in or present management find religion.  

 

I would re-read his comments.  He was stating that the primary benefit of a net-net is that it provides down-side protection.  His example was one of which the net-net was trading at a discount of 10% to cash, and perhaps 80% of intrinsic value ($100M in cash and recurring income valued at $15M - trading at $90M total).  If you liquidate that, you get a 25% return.  The same thing if the cash was at $110M and the market cap was $90M.  The bang for the buck is not worth it to him.

 

He looks for companies that go up 2-3 fold plus over a few years.  I personally look for those 20-50% returns over shorter time frames with that downside protection, but he looks for multiple-baggers over several years.  He isn't going to find that in the stuff I'm looking for...thus the volatility in his fund as well.  Again, he's trying to explain this to the person who asked the question.  

 

Incidentally, before you ask, he isn't saying he wouldn't buy net-nets.  Only that the return on them be commensurate with what he is aiming for.  For example, he bought Fairfax at 50% of book, but it was a business that could also generate a signficant stream of income over time.  He's bought other net-nets as well.  His point was that a net-net in and of itself, does not mean he would be a buyer.  Cheers!  

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I was there when that question was asked.  He wasn't saying that markets ran in perfect 17 year runs.  All he was saying, in response to the question about the S&P contracts Berkshire insured, was that if markets run flat for the next few years because of the deleveraging process and then a new bull run starts as many people expect, including Munger, then Berkshire would not incur much in losses...if any...as the coverage dates were well out!  That's all he was saying there. 

 

That's not at all what it sounded like he meant in that article, for what it's worth.  It sounds like he believes in 17 year cycles.   Why else would he have said the next bull market will end in 2033? 

 

It looks like there was a loss of accuracy in translating what was said to what was written. The transcript was written by another party. It never occurred to me that he could mean that there would be a market cycle lasting exactly 17 years. I dont think he thinks that way. I think every one here would agree with you if that were the case.

 

OK, that makes more sense.  I take back my initial comment if the quote was taken out of context. 

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OK, that makes more sense.  I take back my initial comment if the quote was taken out of context.

 

You know the smartest thing to do would have been for the writer to fact-check the article with Mohnish before printing.  Especially, when you are quoting someone in an article and then you are critical of their comments.  You see this all the time with Buffett or whoever else.  A very specific quote is taken out of context, or perhaps Buffett hasn't clarified the response appropriately.  

 

Example:  Buffett - "I don't understand technology" comment from years ago.  How many people reamed him for it, including Jim Cramer in that famous challenge where he listed ten stocks that would outperform Berkshire Hathaway.  Over the next five years that portfolio was down 95%!  It was never that Buffett didn't understand technology, but only that the outcome of technology companies were harder to determine and that would directly affect any calculation of intrinsic value.  Cheers!

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