By Rupert Hargreaves. Originally published at ValueWalk.
Mohnish Pabrai is one of the world’s most respected value investors. However, few outside the world of value investing know his name.
Still, the lack of notoriety hardly matters because Pabrai’s returns speak for themselves. His leading Pabrai Investment Fund II, which evolved out of PIF I has produced an annualized return of 13.6% since PIFI was founded on July 1, 1999. A $100,000 investment in PIFI at inception on July 1, 1999, and rolled over into PIF2 on 12/31/02 ($197,900) was worth $936,600 net as of December 31, 2016.
The returns have continued to grow with Pabrai writing in the funds’ annual report that during the first four months of 2017, PIF3 added a staggering 28.8%, versus 7.1% for the S&P 500.
As well as the yearly returns for the funds’, Pabrai also gives a fascinating insight into his investment process in his newly released 2016 annual report to investors, a copy of which was reviewed by ValueWalk.
Mohnish Pabrai On The Mistake Of Selling Ferrari
Enzo Ferrari once said about his luxury car brand, “the Ferrari is a dream – people dream of owning this special vehicle, and for most people, it will remain a dream apart from for those lucky few.” Mohnish Pabrai was able to realize this dream with his holding of Ferrari shares, but unfortunately, he cut his own Ferrari experience short.
Pabrai spends a portion of the Pabrai Investment Funds’ 2016 annual report lamenting the premature sale of his stake in Ferrari received when the luxury carmaker was spun off from its parent Fiat Chrysler in early 2016. PIF-owned around 13.8 million shares of Fiat amounting to $70 million and received one Ferrari share for every Fiat share owned at the time of the spin. PIF was left with 1.4 million shares in Ferrari.
Mohnish Pabrai continues to hold Fiat, and continues to believe that the shares are undervalued even after the stock has more than doubled, but rather than hold onto the Ferrari stake, PFIs divested the majority of this (at the time) unwanted asset.
Today, the shares are worth (including the initial Fiat stake) a total of $269.1 million compared to a purchase price of $69.6 million. A large part of this gain has come from Ferrari, which Pabrai unfortunately missed. But why did he miss this once-in-a-lifetime opportunity?
Part of the Ferrari stake was sold to meet redemption requests, but the rest Mohnish Pabrai writes was sold because “I am a cheapskate.”
“The sin I committed was selling 700,662 shares to buy something else. And therein lies the problem. I am a cheapskate. I try to buy assets on the cheap and sell them when they approach 90% of intrinsic value. But sometimes, this is not a good way to go.”
He goes on to explain that sometimes, it’s better to hold on to a wonderful business at any price, rather than sell a wonderful business in an attempt to profit buying a cheaper one.
“Ferrari is a unique asset. It is one of the widest moat businesses on the planet. The cars appreciate after they are sold. Incremental margins on their higher-end cars likely exceed 70%. More importantly, Ferrari is led by Sergio Marchionne, who is simply one of the best CEOs on the planet. May god give me the wisdom to not sell another share of Fiat Chrysler or Ferrari as long as Sergio runs them. Ferrari is an incredible asset, and when it is managed by one of the top 100 all-time greatest CEOs to come along, it is pure stupidity to sell.”
The company that looked so attractive it inspired Pabrai to sell Ferrari is Southwest Airlines. $4 million from the sale of Ferrari was devoted to a Southwest position, while $1.4 million was used to “buy small stakes in four obscure undervalued Korean stocks”.
How have these investments done today? Well at the time the letter the Southwest and Korea positions were worth $8.1 million, which isn’t bad but is $2.4 million less than the $10.5 million the Ferrari were worth. Cheapness is no match for a strong business moat:
“Why did I do it? Well, Southwest Airlines was very cheap (it was trading at less than 7 times cash flow) while Ferrari sported a robust double digit multiple. From a strictly moat perspective, there is no question that Ferrari’s moat is vastly superior to Southwest. I love Southwest, but it ain’t no Ferrari. And on top of that, Ferrari has a super-human CEO in Sergio. I should simply have either passed on Southwest (very hard to do that!) or looked for other stocks to sell. While the Southwest narrower moat plus lower P/E may have made me feel it was better than the wider moat, however, more expensive Ferrari, there is no justification for me to sell Ferrari to buy the Korean or Indian stocks. I have a good understanding of the Korean and Indian businesses. They are cheap. However, they cannot hold a candle to Ferrari from a moat perspective.”
And even though shares in Ferrari have doubled since being spun off, Pabrai sees further upside:
“The reason I wanted to include my adventures with Ferrari in this letter was to try to reinforce in my brain the importance of just sitting on your ass when you own great businesses run by great managers. It is not a good idea to sell them unless they are egregiously overvalued. I may have felt Ferrari was fully priced at $44, but by no means was it egregiously overpriced. And today, at $84, I can see actions that Sergio can take that may make $84 look cheap in a few years.”
[Pabrai did not see out of Ferrari entirely and funds in the group still own shares valued at $33.5 million of the auto maker.]
The post Mohnish Pabrai On The Mistake Of Selling Ferrari appeared first on ValueWalk.
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