THE DHANDHO INVESTOR
The key takeaways from "The Dhandho Investor: The Low-Risk Value Method to High Returns".
The Dhandho Investor: The Low-Risk Value Method to High Returns
Why you should read this book?
The book is about value investing. The author, Mohnish Pabrai, a celebrated fund manager, is a disciple of Warren Buffet (he famously once bid $650,000 in an auction to have lunch with Mr. Buffett himself) and, in this book, he details the value investing principles that he advocates and adheres to. Mohnish calls his ‘brand’ of value investing ‘Dhandho’ investing (Dhandho is a Gujarati word that means ‘endeavors that create wealth’).
The book goes on to find the commonality between the successes – how identifying opportunities where if you win you win big, and if you lose, you don’t lose that much is the key to their successes. This, in essence, is the Dhandho philosophy – look for and study opportunities where the payoff for success is significantly higher (along with its probability) and the loss potential (both probability and magnitude) is significantly low. And when you find these opportunities, you bet big and wait to realize the value.
Things to Remember:
The Dhandho Investor Dhandho (pronounced dhun-doe) is a Gujarati word. Dhan comes from the Sanskrit root word Dhana meaning wealth. Dhan -dho, literally translated, means “endeavors that create wealth.” The street translation of Dhandho is simply “business.” What is business if not an endeavor to create wealth?
Dhandho is all about the minimization of risk while maximizing the reward.
Dhandho is thus best described as endeavors that create wealth while taking virtually no risk. The formula is simple: fixate on keeping costs as low as possible, charge lower rates than all competitors, drive up the occupancy, and maximize the free cash flow. Finally, keep handing over motels to up-and-coming Patel relatives to run while adding more and more properties. There is a snowball effect here and, over time, we end up with these amazing statistics—half of all motels in the United States are under Patel ownership. Now, that’s what I’d call Manilal Dhandho. He worked hard, saved all he could, and then bet it all on a single no-brainer bet. Reeling from the severe impact of 9/11 on travel, the motel industry was on its knees. As prices and occupancy collapsed, Manilal stepped in and made his play. He was on the hunt for three years. He patiently waited for the right deal to materialize. Classically, his story is all about “Few Bets, Big Bets, Infrequent Bets.” And it’s all about only participating in coin tosses where “Heads, I win; tails, I don’t lose much!”
Pretty much any business with minimal capital and virtually no risk—this is Dhandho on steroids.
Even today, Virgin Atlantic offers a very unique product in a very tough industry. The Virgin Atlantic business model is pure Dhandho. Heads, I win; tails, I don’t lose much!
Mittal’s approach has always been to get a dollar’s worth of assets for far less than a dollar. And then he has applied his secret sauce of getting these monolith mills to run extremely efficiently. Marwari approaches investing capital in a venture? He said, quite nonchalantly, that Marwari businesspeople, even with only a fifth-grade education, simply expect all their invested capital to be returned in the form of dividends in no more than three years. They expect that, after having gotten their money back, their principal investment continues to be worth at least what they invested in it. They expect these to be ultra low-risk bets.
The Dhandho Framework
1. FOCUS ON BUYING AN EXISTING BUSINESS.
2. BUY SIMPLE BUSINESSES IN INDUSTRIES WITH AN ULTRA-SLOW RATE OF CHANGE.
3. BUY DISTRESSED BUSINESSES IN DISTRESSED INDUSTRIES.
4. BUY BUSINESSES WITH A DURABLE COMPETITIVE ADVANTAGE—THE MOAT.
5. BET HEAVILY WHEN THE ODDS ARE OVERWHELMINGLY IN YOUR FAVOR.
6. FOCUS ON ARBITRAGE.
7. BUY BUSINESSES AT BIG DISCOUNTS TO THEIR UNDERLYING INTRINSIC VALUE.
8. LOOK FOR LOW-RISK, HIGH-UNCERTAINTY BUSINESSES.
9. IT’S BETTER TO BE A COPYCAT THAN AN INNOVATOR.
I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful. The very best time to buy a business is when its near-term future prospects are murky and the business is hated and unloved. In such circumstances, the odds are high that an investor can pick up assets at steep discounts to their underlying value. The products and services that have wide, sustainable moats around them are the ones that deliver rewards to investors. To be a consistent winner at the race track, a person has to overcome the staggering 17 percent frictional cost of placing a bet. According to Munger, there are actually a few people who are able to make a living by betting at the race track after paying the full 17 percent. These folks watch all the horses and races, yet place no bets. Then, when they encounter widely misplaced odds (in their favor) on a horse about which they know a great deal, they bet heavily on that one horse in that one race. After that, they go back to watching the horses and races indefinitely with no bets placed until another good opportunity shows up.
Arbitrage is classically defined as an attempt to profit by exploiting price differences in identical or similar financial instruments.
Ultra-low frictional costs are a huge advantage. Having an ownership stake in a few businesses is the best path to building wealth. And with no heavy lifting required, bargain buying opportunities, ultra-low capital requirements, ultra-large selection, and ultra-low frictional costs, buying stakes in a few publicly traded existing businesses is the no-brainer Dhandho way to go.
Markets aren’t fully efficient because humans control its auction-driven pricing mechanism. Humans are subject to vacillating between extreme fear and extreme greed. When humans, as a group, are extremely fearful, the pricing of the underlying assets are likely to fall below intrinsic value; extreme greed is likely to lead to exuberant pricing.
Edge/odds = Fraction of your bankroll you should bet each time.
According to the Kelly Formula, the edge is $0.50 =[(0.5 ×$2) + (0.5 × −$1)].
The odds are what you win, if you win, $2. So the Kelly Formula suggests you bet 25 percent ($0.50/$2.00) each time.
Dhandho is all about placing few bets, big bets, and infrequent bets; and the Kelly Formula supports this hypothesis. Looking out for mispriced betting opportunities and betting heavily when the odds are overwhelmingly in your favor is the ticket to wealth.
As stated by Mr. Buffett: The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.
The key to being a successful investor is to buy assets consistently below what they are worth and to fixate on absolutely minimizing permanent realized losses. Warren Buffett’s two main rules are:
Rule No. 1: Never lose money.
Rule No. 2: Never forget rule No. 1.
These seven Buffett Partnership nuances make it a very unique offering. When I studied them, my conclusion was that taken together, they accomplished three wonderful results for Mr. Buffett:
1. They attracted just the right kind of long-term investor for Mr. Buffett. The investor base was positively self-selecting based on the rules.
2. They created a wide moat that was virtually impossible for his competitors to cross—forever.
3. They made professional money management a very relaxed, blissful career to follow. Mr. Buffett tap-dances to work every single day.
Ben Graham’s genius was that he fixated on these two joint realities:
1. The bigger the discount to intrinsic value, the lower the risk.
2. The bigger the discount to intrinsic value, the higher the return.
Graham’s fixation on the margin of safety is understandable. Minimizing downside risk while maximizing the upside is a powerful concept. It is the reason Mr. Buffett has a net worth of over $40 billion. He got there by taking minimal risk while always maximizing returns.
Always look for arbitrage opportunities. They allow you to earn a high return on invested capital with virtually no risk. Exploit this Dhandho arbitrage spreads for all they are worth.
Innovation is a crapshoot, but investing in businesses that are simply good copycats and adopting innovations created elsewhere rules the world.
Here are seven questions that an investor ought to be thinking about before entering any stock market chakravyuh :
1. Is it a business I understand very well—squarely within my circle of competence? 2. Do I know the intrinsic value of the business today and, with a high degree of confidence, how it is likely to change over the next few years?
3. Is the business priced at a large discount to its intrinsic value today and in two to three years? Over 50 percent?
4. Would I be willing to invest a large part of my net worth into this business?
5. Is the downside minimal?
6. Does the business have a moat?
7. Is it run by able and honest managers?
A critical rule of chakravyuh traversal is that any stock that you buy cannot be sold at a loss within two to three years of buying it unless you can say with a high degree of certainty that the current intrinsic value is less than the current price of the market is offering.
What is a DCF model?
In a DCF model, things required are Discount Rate, Free Cash Flows, Growth Rates, and Terminal Value. The main aim is to arrive at free cash flows at different years so that they can be discounted to present value to calculate intrinsic value. Arriving at FCF will require determining growth rates future revenues and costs and so on. Once the growth rates are determined and future values of assets and cash are ascertained then they can be discounted back to their today value or present value using a discount rate.
"A lot of great fortunes in the world have been made by owning a single wonderful business. If you understand the business, you do not need to own very many of them."—Warren Buffett
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HAPPY INVESTING!
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