The Dhandho Investor- Book Review

Book Review: The Dhandho Investor (by Mohanish Pabrai)

“Dhandho” is a Gujarati word for business, a similar word in Hindi is “Dhandha”. Mohnish Pabrai has discussed investment techniques to beat the market and earn super returns. The book introduces us to ‘Dhandho’ framework and challenges the highly established investment theory- ‘high-risk high return; low-risk low return’. The author discusses various ‘low-risk high return arbitrage’ businesses similar to coin tossing with the resulting outcome of ‘Heads, I win; tails, I don’t lose much!’

Mohnish highlights how, unlike others, Patels and Marwaris have managed to excel in their business without any formal business administration educational backgrounds. He discusses how Patels have been able to occupy 20% of all the motels in the United States of America. The author goes against standard sayings and elaborates his investment framework in a readable way to let you enjoy while building up the “Dhandho” techniques. Author’s convincing stories bring light to situations where lower risks don’t let you lose much; rather the brighter sides of winning situations are more likely. The odds of failures are lesser than the odds of success i.e. arbitrage situations do exist all around us and most of us fail to identify them.

Dhandho Framework

Dhandho 101: Invest in Existing Businesses

Dhandho 102: Invest in Simple Businesses

Dhandho 201: Invest in Distressed Businesses in Distressed Industries

Dhandho 202: Invest in Businesses with Durable Moats

Dhandho 301: Few Bets, Big Bets, Infrequent Bets

Dhandho 302: Fixate on Arbitrage

Dhandho 401: Margin of Safety

Dhandho 402: Invest in Low-Risk, High-Uncertainty Businesses

Dhandho 403: Invest in the Copycats rather than the Innovators

Invest in existing businesses: It goes well with the low-risk tolerance approach. New businesses have additional risk factors involved whereas existing businesses have the previous track records of operations to be analyzed.

Invest in simple businesses in industries with Ultra-slow rate of change: These businesses fulfill the basic needs and make mundane products that everybody needs. Change brings competition which can kill profit for the businesses in the long run. Dhandho investor invests in businesses where conservative assumptions about future cash flows are easy to figure out. Think Google vs. nearby petrol pump.

Invest in distressed businesses in distressed industries: The Dhandho framework is built on the principle that the entrance strategy is more important than the exit strategy. So, an investor should look for the businesses which are selling at a cheaper rate which happens to be the case with distressed businesses. If the businesses are in distressed industries then it is a bonus surplus. It is based on Warren Buffett’s quotation: “Be fearful when others are greedy. Be greedy when others are fearful.”

Invest in businesses with durable moats: The Dhandho investor should invest in the businesses which have a durable competitive advantage. The businesses should have moats which are difficult to replace. The moats could range from the lowest-cost producer to special knowledge of the product.

Few bets, big bets, infrequent bets: The author talks about that the Dhandho investor should place only a few bets in his lifetime. And when the appropriate opportunity arrives, when the odds are overwhelmingly in the favor of investors, then he should bet heavily. This principle goes against the diversification and supports concentrated portfolio in few businesses. As Warren Buffet had famously quipped that – “Diversification is protection against ignorance. It makes very little sense for those who know what they’re doing.” Remember Nicolas Taleb’s Black Swan?

Fixate on arbitrage: Arbitrage bets are completely risk-free and give riskless profit. These kinds of bets are available for a very short period of time. The investor has to keep looking and playing a waiting game for these and once the opportunity arrives, should take part in riskless profit making opportunity. Arbitrage opportunity can come because of innovation or a gap in available services. These opportunities like other arbitrage opportunities disappear over a time when the competition follows up. Read more about Richard Branson’s entry into aviation.

The margin of safety: Margin of safety is the most vital principle to follow in value investment. Benjamin Graham and Warren Buffett has been a proponent of it for a longer period of time. The author says that a Dhandho investor would invest in a business if it is getting sold at a considerable discount to its intrinsic value to reduce the chances of permanent loss of capital.

Invest in low-risk, high-uncertainty businesses: Dhandho investors focus on minimizing the downside risk by focusing on low-risk businesses. The high uncertainty leads to depressed prices and hence as the Dhandho tagline goes- ‘Heads, I win; tails, I don’t lose much!’ Yes, you read it right. Risk and Uncertainty are not the same.

Invest in the copycats rather than the innovators: According to the author, it’s advisable to invest in the copycats rather than the innovators. Copycats have a more competitive moat with lesser operational costs and faster lead time to market. The crowd follows the innovators making their prices quite high while the copycats present great opportunity to buy similar businesses at a discounted value.

Kelly Formula: The author talks about Kelly formula which calculates the optimal fraction of the portfolio to bet on a favorable bet. The optimal fraction can be calculated as Edge/odds = Fraction of portfolio you should bet each time. Assume that you are offered a coin toss where heads mean you get $2 and tails cost you $1. Kelly formula determined how much of the money you should bet if you are offered these odds? Expected payoff here is 0.5*$2 + 0.5*(-$1) = $0.50. Kelly Formula says you should bet 0.5/2 = 25%, each time to maximize your returns. One can here avoid the trap of investing too much in a particular bet. Suppose you have 10 bets and each demands 20% investment according to Kelly Formula. Then you can simply invest 10% in each of the bets.

The author also discusses art of selling- exiting from an investment. He takes a leaf from Abhimanyu in Mahabharata, who could not get out of the Chakravyuh. 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 holding unless you can say with a high degree of certainty that current intrinsic value is less than the current price the market is offering. The author says that generally good investments give returns within 2-3 years and cites various examples to illustrate what all should be taken into account while selling and in which all cases one hold for a longer period to avoid a loss.

The author discusses if a normal investor, bereft of investment acumen, should invest in an index fund and concludes that index fund investment generally beat 80% of the funds’ returns. So, it’s a wiser move to invest in an index fund and do the dollar cost averaging to minimize the cost price.

While concluding, the author gives an example of Arjuna and the investment art we can learn from the great warrior. He says that one should be focused on the target and market noises should be ignored. He gives the analogy of Mr. Market as well which gives us various opportunities and daily comes up with a price. We should be buying the stock when we feel that we are getting a good margin of safety.

Overall the book is a very nice read and is full of anecdotes and various successful investment stories. It teaches us why there are only a few investors who consistently beat the market and how they do it. Rather than learning from our losses, we can learn vicariously at an infinitely lower price by reading this book.



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A blog of the NYU Colloquium on Market Institutions and the Leipzig Colloquium on the Market Order

Fundoo Professor

Thoughts of a teacher & practitioner of value investing and behavioral economics

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