How to profit from uncertainty

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By Larissa Fernand |  15-11-16

Would you like to have lunch with Warren Buffett?

Around a decade ago, a 43-year old investor of Indian origin was determined to make it happen.

Buffett holds an annual charity lunch auction. The winner and up to seven friends can dine with him and the proceeds go to charity. The 43-year old decided to blow everyone out of the water with his bid. (He had been outbid in four previous instances.) In 2007, he, along with a friend, put up $650,100 and were selected as the highest bidders.

Say hello to Mohnish Pabrai of Pabrai Investment Funds. Pabrai’s investment style is heavily influenced by Buffett's investing philosophy and he refers to himself as a "humble disciple" and "shameless cloner" of the Oracle. Instead of chasing diversification, Pabrai believes in being selective (few bets, big bets, infrequent bets). His investing is largely moat based. He also looks at the intrinsic value of the company to ensure that he is buying at a great price. Little wonder that he wanted to break bread with Buffett.

In a Forbes post titled How Mohnish Pabrai crushed the market by 1100% since 2000, the writer points out that Pabrai has nerves of steel and invests with unshakable conviction. He reaches out and grabs a stock falling like a dagger and then keeps buying while it plummets into the abyss.

I remember seeing him in September 2008 when his fund was down 60% and the global financial system was coming off the rails.  These facts bounced off him like a pea-shooter. His only concern was finding cash to buy stocks while they were still cheap.

This behaviour ties in with his idea of “low risk, high uncertainty” investing.

Pabrai claims it is something he learnt from entrepreneurs. People are under the misconception that entrepreneurs take risks and get rewarded for it. In reality, entrepreneurs do everything they can to minimize risk. They are not interested in taking risk and go after free lunches. They focus on low-risk bets which have high-return possibilities.  Not high risk-high return. But low risk-high return.

He cites the example of Bill Gates in this context. The capital he put in was meagre. It was high uncertainty (Gates could have gone bankrupt) but not high risk (no capital deployed). Gates was comfortable with uncertainty but did not take any risk.

In his book The Dandho Investor, Pabrai says that low risk and high uncertainty are a wonderful combination. Risk is the potential for capital loss, while uncertainty is a wide range of possible outcomes.  When The Street gets confused between risk and uncertainty, it is time to profit handsomely from that confusion.

Next: How Pabrai made money on these two stocks using this principle

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