Th Ch

The Checklist
kli t

www.pabraifunds.com
Munger & The Checklist

B-17 Bomber

www.pabraifunds.com
 “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

www.pabraifunds.com
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.

www.pabraifunds.com
 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.

www.pabraifunds.com
 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.

www.pabraifunds.com
 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.

www.pabraifunds.com
 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.

www.pabraifunds.com
 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?

www.pabraifunds.com
 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.

www.pabraifunds.com
 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.

www.pabraifunds.com
 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

www.pabraifunds.com
 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

www.pabraifunds.com
 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)

www.pabraifunds.com
 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.

www.pabraifunds.com
 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.

www.pabraifunds.com
 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).

www.pabraifunds.com
 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.

www.pabraifunds.com
 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

mp@pabraifunds.com

Tel. +1949.453.0609

www.pabraifunds.com
www.pabraifunds.com