How to Minimize Risk and Thrive | MOHNISH PABRAI's 15-Minute Guide

In reality, entrepreneurs do everything they can to minimize risk.

The first thing you want to do is define the market that you're going after.

That it's not the size of the circle that matters, but knowing its boundaries.

So if you don't truly think it's something that you would yourself be a customer of, don't try to pitch it.

The single biggest advantage a value investor has is not IQ, It's patience and waiting.

Avoid the use of spreadsheets and avoid precision thinking.

And that's no fun. It's not fun to hit your head against a brick wall.

So what you want is a business that has a deep moat with lots of piranha in it and that's getting deeper by the day.

I'm flexible. I think it's very important in investing to be a learning machine.

Pay a lot of close attention to the feedback you get from the people who are listening to the pitch.

He's an Indian-American investor, businessman, and philanthropist. He sold his company TransTech Inc. in 2000 for $20 million. Today, he is the managing partner of Pabrai Investment Funds. He's Mohnish Pabrai, and here are his top 10 rules for success.

People think that entrepreneurs take risk and they get rewarded because they take risk. In reality, Entrepreneurs do everything they can to minimize risk. They are not interested in taking risk. They want free lunches and they go after free lunches. If you study any number of entrepreneurs from Ray Kroc to Herb Schultz at Starbucks and to even Buffett and Munger and so on, what you'll find is that they've repeatedly made bets which are low-risk bets which have high-return possibilities. So they're not going high-risk, high-return. They're going low-risk, high-return. And even with Bill Gates, for example, the total amount of capital that ever went into Microsoft was less than $50,000 between the time it started and today. That's the total amount of capital that went into the company. So Microsoft you cannot say was a high-risk venture because there was no capital deployed. But it had high uncertainty. Bill Gates could have gone bankrupt, or Bill Gates could have ended up the wealthiest person on the Forbes 400. And he ended up at the extreme end of the bell curve, and that's fine. But he did not take risk to get there. He was comfortable with uncertainty. So entrepreneurs are great at dealing with uncertainty and also very good at minimizing risk. That's the classic great entrepreneur.

If you look at any market, any product, any market, there will typically be 3 or 4 players at the most that control 80% of that market. And it could be making airplanes or it could be making, you know, hair clips. You can pretty much go across the board. It could be making software, anything you want. And And I found that stunning, and if you invert that, so one of my heroes, Charlie Munger, says every time you encounter something, always invert the logic to try to get some other place. So, if you invert that principle, first of all, if you agree with the principle, then the inversion would be that if you're starting a business and you say that this is a, $10 billion market and I just need 10% of it and I'll be a billion-dollar company, well, right there you're off because the inversion would be that if you're going after a market, your approach has to be how do I get 60% of that market? And so, if your starting point is that I'm going to take 2% of this market or 5% of this market, What you have not done is you have not segmented that market properly, and that is a fatal flaw. So, the first thing you ought to do is define the market that you're going after. And after you've defined it, if you don't get to very clear-cut game plan to get 50-60% market share, then don't even try. Because either you have not done your job correctly or you don't have anything to offer that is going to be that compelling to people.

I think another very important trait for successful investing is to stay within your circle of competence. So I think Buffett always says that it's not the size of the circle that matters, but knowing its boundaries. It's absolutely critical. Charlie Munger talks about that— he gives a couple examples. One is he says that if in a small town you bought the McDonald's franchise, you bought the Ford dealership— Ford dealership, gas station not so good. And gas station we leave for the Patels, low-cost operations. OK, and then you want the best. Class A office building, and you want the best residential building, right? So if you've got these 4 assets, and you don't need to own them completely. You could own 20% of each of them, right? So his perspective was that if in Peoria, Illinois, you owned these 4 assets and you just sat on them for your whole life, you would end up probably quite wealthy. And so if you think about it from a modern portfolio theory point of view, you would say, well, you're not diversified. Everything's in one geography, et cetera, et cetera. Yeah, but the odds are it'd probably still work out. And in fact, he has a friend here near Stanford, John Arriaga, who all he did was bought real estate within a mile of the Stanford campus. And I think Arriaga is a billionaire. And so what is Arriaga's circle of competence? It's this small. So the size of the circle is not relevant. Staying inside the circle is very fundamental.

Do not try to sell something that you wouldn't buy yourself. Okay? So if you don't truly think it's something that you would yourself be a customer of, don't try to pitch it. You know, don't be a used car salesman. So please make sure that whatever you're trying to come up with is compelling enough that you would yourself deeply be deeply interested in buying that product.

So, you know, Charlie Munger likes to say that you don't make money when you buy stocks. And you don't make money when you sell stocks. You make money by waiting. And so the biggest— the single biggest advantage a value investor has is not IQ, it's patience and waiting. Waiting for the right pitch and waiting for many years for the right pitch.

So what's that saying of Pascal that you like about just sitting there?

Yeah, all man's miseries stem from his inability to I can't sit in a room alone and do nothing. And all I'd like to do to adapt Pascal is all investment managers' miseries stem from their inability to sit alone in a room and do nothing.

The way to really look at investing is that when you look at, again, a business like Google or Microsoft or Berkshire, you really have to put yourself in the shoes of the people running the business. And you have to ask yourself, how do they run the business? Do they run it through a set of spreadsheets, or how do they run it? And I would bet that most of these businesses are run in a manner where the founders or CEOs are really looking at kind of 3 to 5 variables that dominate most of their thinking and outcome and direction. And so as an investor, you've got to hone in on those same variables. So if you can get to the same variables, if you're going to invest in Microsoft, you can get to the same variables that Satya Nadella is using. And if you— in Google, you get to the same variables that Larry and Sergey are using, then you're getting very close to trying to figure out what the business might do. And from there you can extrapolate whether it's underpriced or fairly priced and so on. So that's what I would suggest is avoid the use of spreadsheets and avoid precision thinking.

The stronger the marketing, the weaker the sales engine can be. Okay, so I do not consider myself a good salesman. I consider myself a poor salesman. I consider myself a pretty strong marketing person. And so if you have done your marketing homework, You can be a leper and make sales. And a standing example of that is someone in front of you. Because basically my approach to sales would be, you know, 180 degrees opposed to your traditional used car salesman schmoozing model and golf courses and all that. None of that is of much interest to me. The stronger the marketing, the less important the sales engine becomes. So it is very important, in my opinion, to spend incredible amounts of time on the marketing aspect of the business, because if you don't spend that time on that aspect of it, you will spend 50x that time on the sales end and hit your head against a brick wall. and that's no fun. It's not fun to hit your head against a brick wall. So it's good not to go there. So I just feel the stronger the marketing, the weaker the sales.

Now quickly define moats in terms of a business that keeps competition away.

Well, you know, if you talk to Michael Porter, he would give you 5 books on what is meant by, you know, strategy and competitive advantage and Durable competitive advantage. And if you talk to Warren and Charlie, they would just say it's a moat, and they'd break it down to one, one word. But basically it's the ability of a business to have some type of an enduring competitive advantage that allows it to earn a better than average rate of return over an extended period of time. And so some businesses have narrow moats, some have broad moats. Some have moats that are deep but get filled up pretty quickly. So what you want is a business that has a deep moat with lots of piranha in it and that's getting deeper by the day. That's, that's a great business.

I'm flexible. I think it's very important in investing to be a learning machine and to have flexibility and to be willing to look at the, the opportunity set and decide whether you need to do anything at all, or what is the best thing you can do based on the available opportunities.

Let's say you have come up with a compelling value proposition. Let's say you are absolutely truthful, you truly understand it, and your pitch is truthful and all of that. What I have found is that is that basically whatever you come up with, and you've come up with it in your lab and thinking about it, talked to a few friends, looks great, the service or product looks great. The real litmus test of that is when you put it in front of customers, right? So when you go out and make your pitch or create an ad or whatever else, and a very, very important thing for an entrepreneur to do is when they put that out there, be very, very— pay a lot of close attention to the feedback you get from the people who are listening to the pitch. And this is very important at the front end because what is probably the case is that whatever you came up with is off base. It's not exactly what your market wants. And You know, I'll give you an example. There's a friend of mine in Chicago, and he started this company called InstallShield. And many of you might be familiar with the company when you're installing different Windows products, InstallShield comes up. And Veeresh basically was like, I think, 19 years old or something when he came up with InstallShield. And he said, you know, he went to a trade show, he was going to go to a trade show, some software tools trade show, and he was trying to do a whole bunch of different things. He was trying to do Google Maps 30 years ago, you know, when there was no way that the computing could support that sort of thing. But he went to a trade show and he had created this kind of, you know, trade show booth with the different products, and he had 7 products, 7 different tools that he was pitching, and it wasn't balancing on that booth because he wanted to put 4 bullets on one side and 4 bullets on the other, and he was like 4 and 3. So, it was really bothering him, and so as an afterthought, this little tool he had which was to install software, for installing software, was his 8th bullet. He just put that in the end, at the bottom, the 8th bullet was software installation tool. And throughout the whole week, I think a couple of days he was at this trade show booth and all these people are coming by and all this stuff going on, and there was a guy across sitting across the aisle from him who spent 2 days looking at those 8 things because he was in the software business. And after 2 days he came up to him and said, you know, that product, I have an interest in that product. And this product did not exist. It was in Vireesh's mind. And so this was one of the only leads he picked up at the show, so he went back and created the product and gave it to the guy, and then he found that other people wanted it and so on and so forth. Okay, so bottom line is that if you study startups, you will find over and over that what actually works is not what you actually came up with. What actually works is, you know, some tangent or some kind of— you mentioned something to a customer in passing, and then they grab onto that and say, you know, I want that. And you say, oh, he's unusual, he wants an unusual thing, I should keep my core pitch. No, what you really have to do is pay really close attention to what is going on.

Thank you so much for watching. I made this video because Caesar V asked me to. So if there's a famous entrepreneur that you want me to profile next, leave it in the comments below and I'll see what I can do. I'd also love to know which of the top 10 rules had the biggest impact on you and why. Leave it in the comments, I'll join the discussion. Thank you so much for watching. Continue to believe, and I'll see you soon.