Circle the wagons investing
Mohnish Pabrai on watering your flowers and your weeds
In episode 550 of The Investor’s Podcast, Mohnish Pabrai describes an investment strategy that he calls “circle the wagons”.
Historically the term was used to describe a defensive maneuver which was employed by the Americans in 19th century. The "circle the wagons" strategy was used by pioneers and settlers moving west to stake out land and start farming. When attacked by American Indians, they would put everything, their crown jewels, in the center of the circle, and fight to protect the center.
Pabrai relates this concept to investing by providing several examples of how protecting a few small (less than 10% of an investor’s portfolio), exceptional ideas can lead to outsized returns.
Below are what I deem to be the best bits of the episode. Specifically, it is where Pabrai drills down into this “circle of wagons” framework by providing some illustrative examples.
“In his letter this year, Warren Buffett mentioned that Berkshire Hathaway has a few truly extraordinary businesses, many pretty good businesses, and a very large number of mediocre or below average businesses. He also noted that, over the course of 58 years, it's really been 12 decisions that have created most of the great outcomes for Berkshire. Most of the other decisions have just been at best so-so, with a hit rate of about 4%. Charlie Munger has said many times that, if you took out our top 15 decisions, our record would be useless. If you look at something like Berkshire Hathaway, Warren has bought more than 80 companies over 58 years. In that period, he's probably made at least 10 key hires and bought at least 210 stocks over that period. Collectively, that's well over 300 decisions. When he says that 12 stand out, it's like one in 25 (4%).”
'“If you look at the Nifty 50 in the early 1970s, which was composed of 50 blue-chip stocks, and assume that Walmart was part of the Nifty 50 with a 2% weight, and that the other 49 stocks went to zero, you would end up with a 13.3% annualized return if you had bought Walmart at the IPO in 1970 and held it until today. The S&P achieved 10.3%. So with just 2% of the portfolio surviving and being there for the entire 52-year period, you still significantly outperformed the S&P. And of course, 49 of the other names didn’t go to zero. They were companies like McDonald’s, Coke, and Procter Gamble. There were a lot of good companies. There were some bad companies like Polaroid, Xerox, Kodak, and Burrows, and a lot of these companies basically went to zero. But you can see that the one decision of whether Walmart is part of the group and whether you keep it or not has such an outsized impact. Now, let’s assume that Walmart is not part of the Nifty 50, and you assume that you invest in the Nifty 50 at the all-time high in 1972, just before the big crash of 1973, 1974, and you run it till today. What you find is that the annualized return is 10.2%, and the S&P is 10.3%. Even with buying at ridiculous valuations and just holding them. Of course, what happened in 1973, 1974, is that the Nifty 50 went down 50%. Nobody was in the Nifty 50 by 1975, everyone exited. But if they had held on and if they had held on to until today, they would pretty much be toe to toe with the S&P.”
“This lesson plays out again with Rakesh Jhunjhunwala, a great investor in India who passed away in 2022. Rakesh Jhunjhunwala never managed money professionally. He was an individual investor, and maybe close to the end of his life, he was starting a business. So basically, he was all passive investing, and he started with $400 when he was 25 years old. And at 62, when he passed away, it was $5.8 billion. In 2003, Rakesh put 4% of his portfolio into a company in India called Titan Industries, and it was a $3.4 million bet on Titan. He had about $85 million in total assets at that time. Rakesh put in $3.4 million. If you take everything he had in 2003, except for Titan, and assume he owned 5% of Titan, then ran it until his passing, it would be worth $1.4 billion today, not including dividends. If you reinvested the dividends, it would be even higher. Therefore, the return on his investment was 400 times, even if everything else went to zero.”
“It's important to note that these were not venture investments like early-stage Amazon, but rather mature businesses like Coke or Sees candy that Warren Buffet invested in. The same applies to Nick Sleep's investment in Amazon. Without Amazon, his record isn't that great, but when you include it, it's exceptional.”
“The most extreme case is Naspers in South Africa. In 2001, they invested $32 million in Tencent, receiving a 46% stake. They never sold most of the stake, and in 2018 they still owned 36% of the company. In 2018, their stake was worth $170 billion, and in 2021, at the peak of Tencent, their stake was worth $270 billion. This sleepy old media company in South Africa suddenly saw a Chinese company become more than 99% of their total assets, and they didn't trim or hedge it, but kept it. As a result, they ended up with an astronomical return on investment over the last 20 years. If you look at the Tencent bet, it was approximately 6% of the value of Naspers at that time, which made hundreds of bets. Buying Tencent was crucial, but more importantly, not selling Tencent was even more important.”
To conclude, Pabrai explains that in investing, it is important to recognize two things. First, as investors, we are going to make a lot of mistakes. Second, this is a forgiving business. Even if we're wrong 98% of the time, we can still come out smelling nice. However, this only happens if we purchase businesses with great economics at reasonable valuations and hold onto them forever. Only when they become egregiously overpriced should we consider selling.
This framework of "circle the wagons" is fundamental to success in the market. Without it, we risk cutting the flowers and watering the weeds. Our goal is to avoid cutting the flowers, and it's okay if we water the weeds.