Boganmeldelse af Mohnish Pabrais "The Dhandho Investor"

Book Summary

The Dhandho Investor: The Low-Risk Value Method to High Returns

June 4, 2017

This post is also available in: Dansk


  • The Dhandho mantra “heads, I win; tails, I don’t lose much” captures Mohnish Pabrai’s investment strategy whereby one acquires securities with substantial upside potentiale while minimizing downside risk.
  • Dhandho is the discipline of scouting for businesses with low risk and high uncertainty. Risk is the likelihood of capital losses. Uncertainty deals with the number of outcomes and the unpredictability of the future. Wall Street considers these terms as synonyms, which can create buying opportunities for value investors who understand the distinction.
  • Stocks, which adhere to the Dhandho mantra, are often found on the lists of low price-to-fundamentals, e.g. low P/E or P/BV.

Forget the dogma that “high returns require high risks.” It’s a mental cloak one dives into when trying to justify inconsiderate and speculative ‘investments’. Instead, you should learn from the Patel Cartel. From a small sub-region in India, Gujaratis, originates a group of people who migrated to the US in the 1960-1970s. They make-up 0.20% of the American population, but they own more than 50% of the US motel industry; hence the catchy phenomenon Patel Motel Cartel. “How on earth is this possible?!”, I wondered. The answer, explains the author, can be boiled down to one word: Dhandho.

Heads, I win; tails, I don’t lose much
The Patel story was the starting pistol to The Dhandho Investor. Mohnish Pabrai, the investing guru who has ensured an annual return of 28% for its partners since 1999, has written a book that seeks to imprint the following mantra in the reader’s mind: “Heads, I win; tails, I don’t lose much.” The metaphor emphasizes that investing is a large-scale game of heads-or-tails. The outcome of each investment is uncertain, but you can turn the odds in your favor by adopting a Dhandho mindset. In its essence, it’s all about securing a substantial upside potential while minimizing downside risk.

Creating an airline without assets
Mohnish introduces various examples to illustrate this philosophy in praxis. The first of which is Richard Branson’s venture into the airline business. When Richard founded Virgin Airlines, it happened basically without taking on any risks. He did not allocate the otherwise necessary $200 mio. in assets to get started. No, instead he leased a 747 for $2 mio. He received payment for the tickets 20 days before lift-off while gas and personel weren’t to be paid until 20 days after the airplane landed. This structure and the maximum loss of $2 mio. dollars (relative to Virgins $12 mio. earnings that year) constituted a low-risk foundation to accelerate a high-return business. Heads, Richard wins; tails, he doesn’t lose much.

Outsmart Wall Street: Understanding the difference between risk and uncertainty
In chapter 5, the reader is introduced to the Dhandho Framework. It’s essentially 9 principles that constitute the Dhandho mindset. For the sake of simplicity, I’ll only highlight the one principle that had the greatest impact on my thinking: Be on the look-out for opportunities with low risk and high uncertainty. Mohnish explains that Wall Street is often confused about the distinction between risk and uncertainty. These traders regard the terms as synonyms. Mohnish, on the other hand, regards risk as the likelihood of loss of capital. Uncertainty revolves around the amount of outcomes and the unpredictability of the future. Wall Street often rushes to sell their positions when the future is uncertain, which drives prices to depressed levels. This creates opportunities, as the levels can be driven so low that there’s practically no risk. For instance, when Buffett went shopping in Washing Post’s stock in 1973, the entire business was valued at just $100 mio. by the market. However, the balance sheet revealed more than $500 mio. in assets. Assets, which could easily bring in well-above $100 mio. dollars in case of liquidation. Washington Post was in trouble, just as all other businesses during the crash of 1973-1974. The future was uncertain, indeed, but there was no risk. In 2006, Buffett’s initial stake of $10.6 mio. was worth $1.3 billion. The annual dividend payment exceeds the price Buffett paid back in the day. Heads, Warren wins; tails, he doesn’t lose much (or nothing in this case due to the substantial discount to liquidation value).

Dhandho in praxis
You probably noticed the resemblance between the book’s title and this blog’s domain. It seeks to underscore this framework’s influence of my view on risk. Since I formed a relationship with the Dhandho philosophy, I’ve attempted to hunt-down stocks whose prices for some reason have fallen to depressed levels, e.g. by scouting for low P/E and P/BV stocks. Legendary value investor Walter Schloss says it best when he exclaims that he sleeps better knowing that if there’s a cliff out there, his stocks have already fallen off it. Dhandho is about finding relatively healthy businesses at give-away prices. This is the art form I wish to master – and document her on the blog.

How did those Patels do it, by the way?
Mohnish portrays an immigrant, Papa Patel, who landed in the US with his wife and three teenage children. He spots a 20-room motel with a sharply reduced price. He wonders, a seller that motivated would probably finance 80-90% of the purchase price. The family could live there, and thus reduce their living expenses to nill. He could dismiss the current personal and make it a family-run business with a negligible cost base. Papa would hence be able to offer the lowest prices and achieve the same level of profitability as the competitors. He decides to strike at the opportunity. Papa ties $5,000 in the motel; the bank and the seller finances the rest against mortgages in the assets. The motel ends up generating $50,000 in yearly revenue, of which $20,000 finds its way to the bottom line. That’s a 400% annual return on invested capital – not too shabby! There was an undeniable upside. But what about the downside risk? In the unlikely scenario that a recession or the like force the motel to shut-down, Papa would have lost a maximum of $5,000 – an amount that the family could earn back in a year or two. Heads, Papa wins; tails, he doesn’t lose much.

With these stories, probability scenarios, DCF analyses and a lot of stolidity, Mohnish puts forth a strong argument for ‘the Dhandho way’. An extremely recommendable book, which convincingly challenges traditional thinking regarding the relationship between risk and reward.

This post is also available in: Dansk


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