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Checklist - Mohnish Pabrai PDF

The document discusses the development and importance of checklists, using examples from aviation and healthcare. Some key points: 1) Checklists were developed for aviation after crashes revealed the complexity of operating planes exceeded a pilot's memory. Their use eliminated accidents. 2) A checklist for ICU line insertions reduced infection rates close to zero, even though the steps seemed obvious. Doctors often skipped steps without checklists. 3) Checklists are effective because our brains take shortcuts and make emotional decisions instead of thoroughly analyzing options. Checklists overcome these limitations. 4) Investors can use checklists to learn from others' mistakes and avoid investment losses by systematically evaluating potential downside issues.

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6K views21 pages

Checklist - Mohnish Pabrai PDF

The document discusses the development and importance of checklists, using examples from aviation and healthcare. Some key points: 1) Checklists were developed for aviation after crashes revealed the complexity of operating planes exceeded a pilot's memory. Their use eliminated accidents. 2) A checklist for ICU line insertions reduced infection rates close to zero, even though the steps seemed obvious. Doctors often skipped steps without checklists. 3) Checklists are effective because our brains take shortcuts and make emotional decisions instead of thoroughly analyzing options. Checklists overcome these limitations. 4) Investors can use checklists to learn from others' mistakes and avoid investment losses by systematically evaluating potential downside issues.

Uploaded by

PradeepKanwar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Th Ch

The Checklist
kli t

www.pabraifunds.com
Munger & The Checklist

B-17 Bomber

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“Too Much Plane for One Man to Fly”
¾ After
Afte the B-17
B 17 c
crash,
ash Boeing’s s
survival
i al was
as in
question.
¾ The aviation checklist was born.
born
¾ Too complex for one man’s memory
¾Four checklists
h kli – takeoff,
k ff fli
flight,
h llanding,
di after
f
landing.
¾ Zero accidents – govt.
govt ordered 12,731
12 731 B-17
B 17 bombers

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The ICU Checklist
¾5 Million Lines put
p t into
patients annually in ICUs
¾ 4% infected after 10
days; 80,000 people.
¾ Fatal 5
5-28%
28% of time.
Increased ICU time.
¾ The Line Insertion
checklist.

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The ICU Line Insertion Checklist
1.
1 Wash hands withith soap.
soap
2. Clean patient’s skin with chlorohexide antiseptic.
3. Put sterile drapes over entire patient.
4. Wear a sterile mask, hat, gown and gloves.
5. Put sterile dressing over catheter site after line in.

¾ Very obvious; well-known; taught to all for ages.


¾ At least one step skipped in 1/3 of all insertions.
¾ Infection rate after checklist – approached zero!
¾ Doctors learning to appreciate checklists.

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Why are checklists so effective?

¾ O
Our bbrains
i are designed
d i d tto take
t k short-cuts
h t t and
d
arrive at answers quickly.
¾ When you see the lion, you run. You don’t
process your options, you just run.

¾ We are also a mix of rationality and emotions.


¾ When we notice a great business is
undervalued, we read up on it, run through a
n mbe of conce
number concerns/questions
ns/q estions and arrive
a i e at a
decision – not as effective as a checklist.

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The FAA’s Approach to Aviation Safety

¾ Very
Ve effective;
effecti e Lower
Lo e probability
p obabilit of dying
d ing in an
airplane than crossing the street.
¾ A human life is worth $3 Million.
Million
¾ Aviation safety comes from carefully studying each
and every plane crash worldwide.
¾ Changes to Checklists, pilot training, equipment,
procedures,, ATC etc.
p
¾ Results are extremely compelling.

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Investing and The Checklist

¾ Not rocket
ocket science.
science Pretty
P ett obvious.
ob io s
¾ Start with stuff we’ve learned from Graham, Buffett,
Munger Klarman
Munger, Klarman, Fisher,
Fisher Templeton etc.
etc
¾ Margin of Safety, Moats, Simple Businesses …
¾ Make
k a reall checklist.
h kli
¾ Examine all your mistakes that led to a
permanent loss of capital – the plane crashed.
crashed
¾ Add to the checklist.

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Visceral vs. Direct Experience

¾ Look at all the great


g eat investors
in esto s and their
thei mistakes.
mistakes
¾ Why did a given investment fail?
¾ Could one have looked at that factor and known
of a possible problem before investment was made?
¾ Muchh muchh cheaper
h to llearn ffrom the
h mistakes
i k off
others than your own.
¾ In 2000,
2000 Munger bought Cort Furniture for Wesco,
Wesco
Poor investment result. Why?

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Add to the Checklist

¾ Wesco makes very


e few
fe investments
in estments and even
e en fewer
fe e
acquisitions.
¾ Cort was acquired in Feb
Feb. 2000 by Wesco after a
long hiatus.
¾ Munger compares it to Enterprise Rent
Rent-acar,
acar,
which is a fantastic company/culture/business.
¾ Cort had abnormally y high
g revenues/FCF
/ as a
result of internet bubble. Buffett/Munger clearly
knew the internet was a bubble.

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Add to the Checklist

¾ Checklist query:
q y
¾ Are the revenues and cash flows of the business
sustainable or overstated/understated due to boom
or bust conditions? (e.g. Cort)
¾ Are there temporary tailwinds enhancing FCF?
¾ Need to appreciate that this is easy to miss with
many businesses that have temporary tailwinds that
can be hard to detect as being temporary
temporary.
¾ Minds as sharp as Munger and Buffett missed it.

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Buffett’s Rare Mistakes
¾ Berkshire Hathaway y turned out to be a great
g
investment. Buffett calls it a mistake. What was the
mistake?
¾ Was a Graham net net. Bought below net working
capital.
¾Ih
have made
d this
hi specific
ifi mistake
i k numerous times.
i
¾It’s now on the checklist. No more!

www.pabraifunds.com
Learning from Buffett

¾ A good investment needs two facets to be in place:


¾ Downside protection – Margin of Safety
¾ Upside earnings engine – Moat
¾ I’ve often been mesmerized by the strong downside
protection and overlooked the all-important moat.
moat

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The Evaporating Moat

“I liked and admired Ed Colodny, the company's then-CEO, and I


still do. But my analysis of USAir's business was both superficial
and wrong. I was so beguiled by the company's long history of
profitable operations, and by the protection that ownership of a
senior security seemingly offered me, that I overlooked the
crucial point: USAir's revenues would increasingly feel the effects
of an unregulated,
e l ted fie
fiercely-competitive
el o etiti e market
ket whereas
he e its
it cost
o t
structure was a holdover from the days when regulation
protected profits. These costs, if left unchecked, portended
disaster however reassuring the airline
disaster, airline's
s past record might be.
be ”
1996 Letter to Shareholders, Warren Buffett

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Add to the Checklist

¾ Checklist additions:
¾ Is there a solid moat? (e.g. Berkshire Mills)
¾ Could the moat be shrinking/evaporating?
(e.g. US Air, Dexter Shoes)
“The business world is divided into a tiny number of
wonderful businesses--well worth investing in--
and a huge number of bad or mediocre businesses
that are not attractive as long-term
long term holdings.””
- Warren Buffett (in Money Masters of our Time)

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Using the Checklist

¾ I went through every investment mistake I’ve made


and am in the process of gathering mistakes made by
other great investors.
¾ 60 items on checklist so far. Not done yet.
¾ No company will get past all 60 with a clean bill
of health.
¾ Different from healthcare or aviation.
¾ Investments will have one or more issues.

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Using the Checklist

¾ Wells Fargo is a great business.


business

¾ Checklist “failure issues”:


¾ Highly leveraged assets to equity.
¾ Could be subject to run on the bank.
¾ Could make/have made bad lending decisions.
¾ High unemployment, recession will hurt.

¾ All businesses will fail on some items on the


checklist.

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What is one to do with Wells Fargo?

¾ The events of 1929-33,, 1937,, 1973-74,, 2000-02 and


2008-09 have taught us that the ride can be quite
rocky.
¾ Likely to hit these major dislocating events at least a
few times in an investing lifetime.
¾ Any number
b multiplied
l i li d by
b zero is
i zero.
¾ All businesses fail on some checklist items.
¾ Run a diversified portfolio. At least 20-30 names that
do not correlate on the same issues (e.g. leverage).

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Checklist shows possible failure points

¾ I used to believe in a 10x10 p


portfolio until Q
Q308.
¾ The drubbing of Q408 exposed clear weaknesses in
some portfolio holdings. Size was key issue.
¾ Moved to a 2, 5 or 10 model.
¾ 2% bets are part of a basket or cases like Wells
Fargo.
¾ 5% bets are typical.
yp
¾ 10% bets are made when 7 moons line up.

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Lessons Learned from 2008-09

¾ Graham’s entire framework emerged


g after the 1929-
1933 Great Depression and collapse in equity prices.
¾ Since mistakes are inevitable and businesses always
fail on some checklist items, best to go back to
Graham 101 and diversify.
¾ No need
d to h
hold
ld 100 names, b
but unwise
i to h
hold
ld 4.
¾ 20-30 names seems just right.
¾ Believer in the power of the simple checklist.

www.pabraifunds.com
Thank You.

Mohnish Pabrai
Managing Partner
P b i Investment
Pabrai I t t Funds
F d
Irvine, California, USA

[email protected]

Tel. +1949.453.0609

www.pabraifunds.com
www.pabraifunds.com

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