Published in: 2007
The value investor Mohnish Pabrai presents in the book what he calls a Dhandho framework for investing – how to get a high return at low risk. Since the launch of Pabrai Investment Funds, a copy of Buffett’s partnerships in the 1950s, Pabrai has outperformed all major indices and 99% of all funds. Dhandho means in Indian “endeavors that create wealth”, and with an annual return of 28% after fees, that is exactly what Pabrai has done.
Einstein has said: “Compounding is the 8th wonder of the world.”… “We, the compounders, agree with Einstein. It is all about the doubles. How long does it take to get a double and how many doubles can I get in a lifetime?” – Pabrai
HEADS I WIN, TAIL I DON’T LOSE MUCH. Pabrai sums up his investment philosophy as a constant pursuit of situations with minimal risk and maximum return: ”Heads I win, Tails I don’t lose much”, as oppose to the maxim ”high risk, high reward”.
”A classic heads I win tails I don’t lose much. Except that the odds of getting heads was way over 50 percent, and if it came up tails, it simply meant that we either broke even or made a little money. When extreme fear sets in, there is likely to be irrational behavior” – Mohnish Pabrai
LOW RISK, HIGH UNCERTAINTY. Risk and uncertainty are two different concepts. A company’s future may be uncertain. But when you have carefully thought through possible future outcomes and come to the conclusion that the risk of permanent loss of capital is very low, you may have found a lucrative low-risk / high-uncertainty situation. When extreme fear strikes, stock markets can act irrationally. Bad news leads to extreme fear and low valuation as a result. Look for simple businesses that have temporary problems. Look for companies with low valuations and previous profit warnings. Lower expectations may actually mean lower risk of losing your money on the investment.
BUY EXISTING BUSINESSES. Pabrai believes that owning a few listed companies is the best way to build wealth. No major effort is required and in the stock market, a patient investor can occasionally find big discounts. There is also no need for a large amount of capital and there is a gigantic supply of investment opportunities. In addition, the transaction fees are relatively low.
SIMPLE BUSINESSES. “The Dhandho Way” is simple, which is also its power. To fight against your own psychological forces, you must, according to Pabrai, buy businesses that are so painfully easy to understand that in tough times you can remind yourself why you bought the stock. If you need a cumbersome spreadsheet and more than a short paragraph for your thesis, you should look for another investment opportunity.
SUSTAINABLE MOAT. Only businesses with a sustainable moat – ie sustainable competitive advantages – can earn an above average return on invested capital. Over time, the moat tends to shrink. Charlie Munger has said that of the 50 most important companies on the NYSE in 1911, there is only one left today – General Electric. The average life expectancy of a company on the S&P 500 has decreased from just over 60 years in the 1960s to 15-20 years in the last ten years.
FEW BETS, BIG BETS, INFREQUENT BETS. Warren Buffett has said that diversification can be seen as protection against ignorance. Having a portfolio of 100 companies makes it difficult to beat the indices. According to Pabrai, investing as well as gambling is: ”looking out for mispriced betting opportunities and betting heavily when the odds are overwhelmingly in your favor is the ticket to wealth”.
MARGIN OF SAFETY. The larger the discount to the intrinsic value, the lower the risk. And the bigger is also the upside. Stocks are often valued at or above the intrinsic value. Investors should be patient and wait until they find cheap stocks with a large margin of safety, low risk and potentially large upside. In the long run, the cost of permanent losses is high due to the interest-on-interest effect.
COPYCAT RATHER THAN INNOVATORS. According to Pabrai, innovation is a gamble while cloning is safe. Therefore, successful cloning is the best business. Look for businesses run by people who have demonstrated that they can learn and copy from the innovators time and time again.