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Notes from "Mosaic - Perspectives on Investing"

Notes from "Mosaic - Perspectives on Investing"

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Published by Anshul Khare
Personal Notes based on Reading this book (Mosaic - Authored by Mohnish Pabrai)

Caveat Emptor: This document is by no means a substitute for the book itself. The reason behind making these notes was to deepen my understanding of what I read in the book. And the purpose of uploading the document is to pique sufficient interest in the reader, so that he/she would buy the book and read it cover to cover.
Personal Notes based on Reading this book (Mosaic - Authored by Mohnish Pabrai)

Caveat Emptor: This document is by no means a substitute for the book itself. The reason behind making these notes was to deepen my understanding of what I read in the book. And the purpose of uploading the document is to pique sufficient interest in the reader, so that he/she would buy the book and read it cover to cover.

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Published by: Anshul Khare on Jun 14, 2013
Copyright:Attribution Non-commercial


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“Mosaic –
Perspectives on Investing“
by Mohnish Pabrai
Even the most seemingly resilient businesses are fragile and temporary creations and there isn’t
a single business whose future is assured. For any investment opportunity you need to first focuson the factors that can result in significant permanent capital loss
like war, terrorism, accountingfrauds, dishonest management, disruptive innovations and then assign probabilities to these
factors. There aren’t enough data points available to ascribe th
e exact odds for such events buthere are few guidelines
War, terrorism
Discovery of an accounting fraud or dishonest management (after having read the AR andfinancial statements of the company)
Significant loss of capital, after investing in well run, well understood business with price lessthan half of the IV
Maximum upside in shorting is 100%, but the maximum possible downside isunlimited. Your quality of life will go down drastically if you are forced to watch every wiggle in themarket
[There was wonderful post on this by Prof Sanjay Bakshi - here ] 
. It’s not worth shorting
even if a company is highly overpriced (like 1
0 times the IV), because you don’t know when the
market will realize and correct the price. Also, the management of the company can still takecertain actions to keep the price up in short term, and while you are waiting (after having shorted)for the price to drop, you are responsible for all the dividends that the stock pays out (and you
don’t even own the stock).
CEO’s can be compared to astronauts, typically extrovert, optimist and leaders. Investment
managers are like astronomers i.e. introvert,
skeptics and very analytical. CEO’s understand that
the business is very non-linear in nature and the future cash flow is affected by lot of internal and
external factors. So it’s almost impossible to forecast the future cash flow even for next 1 or 2
years. Investment managers look at the past of the business and based on the past performancedata they build linear models for future. So the best investment managers are those who have
run a business in past and the best CEO’s are those who understand the
intricacies of the capitalallocation, ROE and investment choices.
[As Warren Buffett says
I am a better investor becauseI am a businessman, and I am a better businessman because I am an investor].
Industry with one of the lowest rates of failure is the funeral homes. The morbid task of death careis a very good business. Similarly, "corporate death care" is a very lucrative industry. A samplingof such companies (low risk, high return)
Outplacement Services - They have far lower rate of failure or earning volatility than
Asset recovery services, merchandise liquidators - Specialize in purchasing andmarketing inventory from a variety of distressed situations (bankruptcy, buybacks, over production, cancelled orders etc.)Death and taxes are for sure. And it's always good to make bets that are for sure.
[I am not surehow these kinds of businesses exist in India. Haven't done any research on them, but it would bevery interesting to see their dynamics in Indian context] 
Retail innovation is crapshoot and comes with extremely low probabilities of widespread success.For every successful retailer there are hundreds of failed retail ventures. Another big problem withretail is the transparency of the business. You can't keep your processes secret. It's out in theopen to be copied by others.
Microsoft keeps 3 years of operating expense (50+ billion dollars) as cash reserves. Because of the unpredictability of the future (68% of MS revenue comes from 'office' and 'windows'). MSshould use this cash reserve on BRK model and appoint somebody like Buffett to make goodreturns by investing this cash.
[I recently found  this article about a fund manager named Michael 
Larsen. He manages Bill gates personal portfolio. I am sure Bill Gates has his own reason not toinvest Microsoft Cash in securities] 
Large businesses have their own upper limit to which they can grow. Pabrai law of large numbers- One would be best off never making an investment in any business that generates over USD 3-4Billion in annual cash flow and considered a blue chip. There businesses are very unlikely to beable to endlessly grow cash flow.
[This reminds me of one of the mental models that come frombiology. The size of biggest mammal on land/water is determined by a simple idea of heat loss.When size of an organism grows, its volume grows faster than the surface area and there comesa point where the heat generated by the body - which is proportionate to volume, cannot bedissipated by the available surface area - which is proportionate to heat loss. That's one of thereasons why the biggest mammal on land i.e. elephant is smaller than the biggest mammal inwater i.e. whale, since heat loss is faster in water, whale can afford more volume per unit of surface area] 
 A lot of useful information can be gained from decoding the DNA of a company andunderstanding what transpired during the very early stage of a given business. This can helpextrapolate business performance far into the future. Spend some time figuring out the geneticblueprint of a given business before making an investment. E.g. - Microsoft is a cloner notinnovator 
[MS bought its first software from another company, modified it a bit, renamed it MS-DOS and sold to IBM. Similarly Excel was originally developed by another company which MSbought later. X-Box takes its inspiration from Sony-PS and Nintendo etc.] 
Compared to nearly any other discipline, fund management is in many respects a bizarre fieldwhere hard work and intellect don't' necessarily lead to satisfactory results. Buffett and Munger need to satisfy their intellectual hunger without getting into actions that can get them into trouble.Buffett plays Bridge and Munger spends considerable time in applying perspectives gained fromone of study into other disciplines especially capital allocation.
[Investing is one field where luck  plays a significant role especially in short term. Micahael Mauboussin of Legg Mason Capital Management has written a wonderful book  The Success Equation which illustrates the idea that 
luck is a bigger factor than most people think. I think that's why even if you follow all the valueinvesting principals, you may do satisfactorily well in long term but it's highly unlikely that you will be next Warren Buffett] 
What Buffett calls 'Moat' - Harvard strategist Michael Porter describes as "sustainable competitiveadvantage". It should be painfully clear how a business generates cash today and how much it islikely to continue to generate into future and how much you are paying for that future cash flow.Think about width and depth of that moat, and think about the knight in charge of the castle(management). You will find that most of the investments that don't work out have less to do withfraud and more to do with an error in judgement in the all important Moat.
"How to think" is the most important skill to develop. One needs to have broad based view of theworld and build a latticework of mental models. In the rare instance where these mental modelsconverge on much large numbers for Intrinsic Value Vs Price, back up the truck!! Multidisciplinaryknowledge is fundamental to building a latticework of mental models. The cross pollinationimpacts of studying different disciplines are very helpful in getting a handle on the critical factorsthat are likely to control the future destiny of a given business. Getting the pulse of the factors thatmatter most is fundamental to investing success. And one of the only ways to getting to thosecritical drivers is to have very broad base of worldly wisdom and experience to develop alatticework of mental models. Investing is one of the broadest of all disciplines where allknowledge has a cumulative effect and essentially nothing is wasted.
 A simple back of the envelop calculation can give you a quick idea about the Intrinsic value of acompany. Use 10 year DCF of free cash flow (FCF) and add a terminal value at the end of 10years as 10X of FCF. If the price is more than "half of IV" then take a pass. The reason behindconsidering 10 years of FCF in DCF is that - An average fortune 500 company has a lifeexpectancy of 40-50 years. It takes about 25-30 years from inception for a highly successfulcompany to earn a spot on fortune-500 list. Typically many companies cease to exist in less than20 years after they get on to fortune 500. Book recommendations -

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