The Dhandho Investor

The Low-Risk Value Method to High Returns

--MOHNISH PABRAI

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.”

Pabrai has put forward the Dhandho Framework, which if followed one can earn
high returns with low risk. Pabrai gives us the framework (recipe) but we as an
investor have to determine the approach (ingredients) we need to follow to build
our portfolio (dish). Pabrai explains the Framework by giving few simple
examples. Wroth reading as the examples are interesting and simple to
understand.

The author is very much influenced by Warren buffett and Charlie Munger.
In his own words “It is hard for me to overstate the influence Warren Buffett and
Charlie Munger have had on my thinking. Thank you, Warren and Charlie.”

In the beginning of the book author has given examples of four personalities who
are now looked as a great entreprenuer – Papa Patel, Manilal Chaudhari,
Richard Branson and Lakmi Mittal. Pabrai discussed on their life and how they
have built their castle. I thought by giving such examples Pabrai tried to line up
the readers mind towards the later explained Dhandho principles. But since I am
not an author, so I thought not to bias our readers, so we will first look at the
Dhadho principles and then in next part we will see the examples that Pabrai has
given in his book.

The dhandho framework consists of nine core principles:

Dhandho 1: Focus on buying an existing business

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.

Dhandho 2: Invest in simple businesses

Only invest in businesses that are simple—ones where conservative
assumptions about future cash flows are easy to figure out.
Einstein also recognized the power of simplicity, for him simplicity was simply the
highest level of intellect. The psychological warfare with our brains really gets
heated after we buy a stock. The most potent weapon in your arsenal to fight
these powerful forces is to buy painfully simple businesses with painfully simple
theses for why you’re likely to make a great deal of money and unlikely to lose
much.
Here Pabrai gives example of retail business, Bed Bath and Beyond (BBBY).

Dhandho 3: Invest in distressed businesses

The share price of any company is not determined by its intrinsic value but by the
mood of humans trading in the market at that time. 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.
To pick the list of distressed businesses or industries, Pabrai mentined few points
as
Negative news about a certain business or industry
Stocks with the lowest price-to-earnings ratios (P/Es), widest discount to book
value and highest dividend yield
Look at the top Mutual Funds Managers buying. For example LIC and Reliance
MF Managers has increased stake in 3i Infotech. Why ???
Read good articles that are mentioning about the company. We have got the
previledge of Dr. Krishna’s articles.
Please read the book “The Little Book That Beats the Market” by Joel Greenblatt.
To prove this point, Parbai takes example of West Coast refiners in California
and Hawaii.

Dhandho 4: Invest in business with durable moats

This is one of the favorite concepts that Warren Buffet thinks before buying any
stock (Actually he thinks of buying the company ownership). Pabrai mentions
about Moats as an advantage particular company has. It can be due to licences,
government restiction to work in certain sector, people’s choice or a brand name.
Reliance brand led RPOWER pull heafty premium from its IPO listing compared
to Adani Power or Indiabulls Power.

Dhandho 5: Few bets, Big bets, and Infrequent bets

If we can determine the intrinsic value of a given business two to three years out
and can acquire a stake in that business at a deep discount to its value, profits
are all but assured. To prove this point Pabrai has used Kelly Formula very
effectively.
Pabria professes that betting heavily when the odds are overwhelmingly in your
favour is the ticket to wealth. Here Pabrai also gives example of American
Express Salas Oil crisis. When Amex stock price was hevily beaten up, Warren
Buffet invested 40% of the Buffet Partnership assest in single business (AmEx).
Dhandho 6: Fixate on Arbitrage
Arbitrage is simply eliminating the downside risk. In simple terms if one setup a
barbershop in a town and another shop is far far away may be in next town, then
this shop has an arbitrage.
Mr. Buffett is exceptionally good at buying businesses with enduring moats and
arbitrage spreads. Pabrai agrees that one day every arbitrage will vanish, but
that does not mean we can’t invest. It does mean, however, that we need to have
some perspective on whether the spread is likely to last 10 months or 10 years.
The wider the spread, the better it is.
For this Pabria gives example of CompuLink and GEICO insurance.

Dhandho 7: Margin of Safety – Always

This proverb is taken from the book “The Intelligent Investor” by Benjamin
Graham. Every investor should read this book as this an undoubtly the best book
ever printed. Thanks Benjamin Graham.
Graham’s perspective on the importance of margin of safety seems pretty
straightforward and simple. When we buy an asset for substantially less than
what it’s worth, we reduce downside risk. 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.

Here Pabrai given example of Washington Post and how Warren Buffet found the
Margin of Safety in the share price of Washington Post in 1973. Mr. Buffett hasn’t
sold a single share of the Washington Post over the past 33 years of holding the
stock.

Dhandho 8: Invest in Low-risk, High-uncertainty businesses

Fear and greed are very much fundamental to the human psyche. As long as
humans drive buying and selling decisions in equity markets, pricing will be
affected by these fear and greed attributes. When extreme fear sets in, there is
likely to be irrational behavior. Pabrai bets on Wall Street’s inability to distinguish
between risk and uncertainty.
Low-risk, high-uncertainty combination gives us our most sought after coin-toss
odds. Heads, I win; tails, I don’t lose much!
Pabrai gives example of Stewart Enterprises, Level 3 Communications and
Frontline.

Dhandho 9: Invest in the Copycats rather than the Innovators

According to Pabrai, innovation is a crapshoot, but investing in businesses that
are simply good copycats and adopting innovations created elsewhere rules the
world. He takes the case study of McDonalds and Microsoft.

In case of Microsoft, Pabrai tells how Microsoft world biggest software company
copied other products and scaled it further. Microsoft copied its flagship product
“MS-DOS” from a tiny outfit named Seattle Computer for $50,000