Astronomers, Astronauts and Styles of Investing

One of my favorite parts of the film Jurassic Park III is when Dr. Alan Grant, played by Sam Neill, has a conversation with the adventurous 11-year-old Eric Kirby (Trevor Morgan):

Alan: I have a theory that there are two kinds of boys -- those that want to be astronomers and those that want to be astronauts. The astronomer, the paleontologist, gets to study these amazing things from a place of complete safety.

Eric: But you never get to go into space.

Alan: Yes. It's the difference between imagining and seeing.

One might think of investment managers as astronomers and CEOs as astronauts. The two roles are radically different with distinct personality traits. Like astronomers, investment managers tend to be introverted, skeptical and analytical. CEOs, like astronauts, are the exact opposite -- typically being extroverts, optimists and, well, leaders.

A subset of CEOs is that of entrepreneurs. And the classical definition of an entrepreneur is an individual who pursues opportunity without regard to the resources currently controlled. That sounds like a very different person from one might expect an analytical investment manager to be.

The essence of a good investment manager is one who studies a given business and extrapolates future cash flows the business will generate over the next several years. Using cash flow and asset assessment, they arrive at their expected rate of return if they bought a fraction of that business today at a given price.

Working With the Unpredictable

When I ran a small IT services business in the 1990s, it had strong recurring revenue, yet I couldn't accurately forecast cash flow for even the next few quarters. Small changes in the customer base or losing/hiring a few key employees could create massive swings in cash flow. And I have yet to meet a CEO who can look me in the eye and precisely forecast the cash flows their business will produce over the next several years.

It seems odd that "astronomers" looking at these businesses from a great distance can come up with these precise cash-flow forecasts when the CEOs who've been running the place for years on end can't do the same thing. Why is that?

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Mohnish Pabrai is the managing partner of Pabrai Investment Funds, an Illinois-based value-centric group of investment funds. At time of publication, Pabrai held a long position in Berkshire Hathaway, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. He appreciates your feedback at [e-mail]. You can access his Web site at www.pabraifunds.com.