My Learning from "The Dhandho Investor"

"Heads I win, Tails I don’t lose much" - Mohnish Pabrai In the book 'The Dhandho Investor', Mohnish Pabrai describes his Dhandho investment framework through the example of business savvy Patels, which can be applied by retail investors to earn high returns with low risk. The Patels are a small ethnic group from India, who first began arriving in the United States in the 1970s as refugees with little education and capital. Today, they own more than half of the Motel assets in the United States, employing nearly a million people. The Patels simply outcompeted everyone using the principles of what Mohnish Pabrai calls “Dhandho”; a low-risk, high-return approach to business.

The Dhandho method expands on the groundbreaking principles of value investing expounded by Benjamin Graham, Warren Buffett, and Charlie Munger. The literal translation of the word 'Dhandho' means business, but the way the Gujarati's uses it is -the way of doing business where there is an upside with a non existing downside. The book explores the notion that the market often confuses people between high uncertainty and high risk. Value investors should look for such low risk, high uncertainty situations to earn stellar returns. Dhandho is about the maximisation of rewards and minimisation of risks. In this blog, I have tried to summarize my learning from the book which has helped me in value investing.

The Nine Principles of Dhandho Framework:

1. Focus on Buying an existing business: Focus on a well defined business, where the rate of change of industry is very slow. New businesses have additional risk factors. Stocks are an easier method of buying a business. 2. Invest in Simple business: Business that fulfill basic needs and make mundane products that everybody needs. Change is the enemy of investments. 3. Invest in distressed business: Entry strategy is more important than exit strategy. Look for businesses which are selling at cheaper rate. Mr. Laxmi Mittal bought distressed steel mills very cheaply ( for example: Sidek Steel in Romania ), he then turned around the mills to get them to run extremely efficiently. 4. Invest in business with durable moats: The products or services that have wide sustainable moats around them are the ones that deliver rewards to the investors. Patels created moat for their Motel business by keeping the cost very low, as they did all the maintenance and running themselves. 5. Few bets, big bets, and infrequent bets: Look for mispriced betting opportunities and betting heavily when the odds are overwhelmingly in your favour. Don't go for stocks where the return potential is high, but the risk of loss is also very high. 6. Fixate on arbitrage: Always look for arbitrage opportunities, they help you earn a high return on invested capital with low level of risks. 7. Margin of Safety: The bigger the discount to intrinsic value, the lower is the risk, the higher will be the return. Wait patiently for finding cheap stocks with large margin of safety, a low risk and high upside potential. 8. Invest in low risk, high uncertainty business: High uncertainty leads to depressed prices. Minimize downside risk by focusing on low risk business. Even if the result turns out to be really bad, you will still come out okay, but if the result turns out to be good, you can make a killing. 9. Invest in the copycats rather than the innovators: Good cloners are great business. The Patels copied the other Patels and executed a proven business model which was risk free. Microsoft copied the graphical user interface (GUI) and mouse combination from Apple in 1981 after seeing the Macintosh mockup. Innovation is a gamble, but cloning is for sure. Abhimanyu's Dilemma To be a good investor, we need a robust framework for both buying and selling of stocks. Mr. Pabrai uses the example of the mighty warrior Abhimanyu (from the epic Mahabharat) to explain the same.

On the 13th day of the battle, the Kauravas (the bad guys) had got their army into the in-penetrable chakravyuh formation (Archimedes Spiral), thereby wreaking havoc on the Pandavas (the good guys) Abhimanyu was an accomplished warrior who knew how to enter the chakravyuh but did not know how to exit out. When he saw the Pandava army sustaining major losses, he offered to penetrate the chakravyuh, even though he did not know how would he exit once he reached the center. Abhimanyu was able to penetrate the chakravyuh, but he could not exit, as a result the brave warrior killed at the center. This Likewise in stocks, you should know not only when to enter, but also have a framework in place for exiting out. Everyday in stock market, investors are face with this dilemma, the decision to buy, hold or sell a given stock. The lesson from the Abhimanyu story is that all investors should have clear framework/ exit plan before we ever think about buying a stock. 7 questions investor should think before entering a stock:

1. Is is 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 or three years? over 50%?

4. Would I be willing to invest a large part of my networth into this business?

5. Is the downside minimal?

6. Does the business have a moat?

7. Is it run by able and honest managers?

One should only consider buying if the answer to all the above seven questions is a resounding YES. This books has helped me with very valuable investment knowledge. The case study of the Patels, Richard Branson (Virgin) and Laxmi Mittal (Arcelor Mittal) are inspiring and helped me understand the Dhandho framework. I strongly recommend all investors to buy and read this fantastic book. "The best part about investing is that one can never reach a plateau where the learning stops. It is one of the broadest of all disciplines where all knowledge has a cumulative effect and essentially nothing is wasted...if one continues to delve into diverse range of disciplines, the latticework of mental models only get richer". - Mohnish Pabrai