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

by Mohnish Pabrai

1. FOCUS ON BUYING AN EXISTING BUSINESS.

well-defined business model and one with a long history of operations

BUY SIMPLE BUSINESSES IN INDUSTRIES

WITH AN ULTRA-SLOW RATE OF CHANGE.

buy simple businesses with ultra-slow long-term change.

We see change as the enemy of investments ... so we look for the absence of change. We don’t like to lose money. Capitalism is pretty brutal. We look for mundane products that everyone needs.1 —Warren Buffett

4. BUY BUSINESSES WITH A DURABLE COMPETITIVE ADVANTAGE—THE MOAT.

Part of the moat comes from extending his brand, part of it from creating a truly innovative offering, and the rest from brilliant execution.

I don’t want an easy business for competitors. I want a business with a moat around it. I want a very valuable castle in the middle and then I want the duke who is in charge of that castle to be very honest and hardworking and able. Then I want a moat around that

castle. The moat can be various things: The moat around our auto insurance business, GEICO, is low cost.6 —Warren Buffett

5. BET HEAVILY WHEN THE ODDS ARE OVERWHELMINGLY IN YOUR FAVOR.

To us, investing is the equivalent of going out and betting against the pari-mutuel system. We look for the horse with one chance in two of

winning which pays you three to one. You’re looking for a mispriced gamble. That’s what investing is. And you have to know enough to know whether the gamble is mispriced. That’s value investing.7 —Charlie Munger

Every once in a while, they encounter overwhelming odds in their favor.

Arbitrage is classically defined as an attempt to profit by exploiting price differences in identical or similar financial instruments. For

Because my mother isn’t here tonight, I’ll even confess to you that I’ve been an arbitrageur.9 —Warren

Humans are creatures of habit.

Branson’s arbitrage is his innovative offerings in the industries he plunges into. Eventually, many of his innovations get copied by competitors, the moat shrinks, and the arbitrage spread collapses. But again, that spread can last for well over a decade or two.

7. BUY BUSINESSES AT BIG DISCOUNTS TO THEIR UNDERLYING INTRINSIC VALUE.

. . the function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future.11 —Benjamin Graham

8. LOOK FOR LOW-RISK, HIGH-UNCERTAINTY BUSINESSES.

Low risk and high uncertainty is a wonderful combination.

9. IT’S BETTER TO BE A COPYCAT THAN AN INNOVATOR.

And that’s the Dhandho framework. To summarize: • Invest in existing businesses. • Invest in simple businesses. • Invest in distressed businesses in distressed industries. • Invest in businesses with durable moats. • Few bets, big bets, and infrequent bets. • Fixate on arbitrage. • Margin of safety—always. • Invest in low-risk, high-uncertainty businesses. • Invest in the copycats rather than the innovators.

there is some serious heavy lifting required.

When you buy a stock, you now have an ownership stake in the underlying business with one huge advantage—the business is already staffed and running.

If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based on what’s bet. That’s what happens in the stock market.2

—Charlie Munger

buy a stake in well over 100,000 businesses around the planet with a couple of brokerage accounts.

Ultra-low frictional costs are a huge advantage.

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.

Per Williams, the intrinsic value of any business is determined by the cash inflows and outflows—discounted at an appropriate interest rate—that can be expected to occur during the remaining life of the business. The definition is painfully simple.

Only invest in businesses that are simple—ones where conservative assumptions about future cash flows are easy to figure out.

“Our life is frittered away by detail ... simplify, simplify.”

noted that the five ascending

levels of intellect were, “Smart, Intelligent, Brilliant, Genius, Simple.”

Efficient market theorists (EMTs) tell us that all known information about a given publicly traded business is reflected in its stock price.

Trying to figure out the variance between prices and underlying intrinsic value, for most businesses, is usually a waste of time. The market is mostly efficient. However, there is a huge difference between mostly and fully efficient. It is this critical gap that is responsible for Mr. Buffett not being a street corner bum.

Markets aren’t fully efficient because humans control its auction-driven pricing mechanism. Humans are subject to vacillating between extreme fear and extreme greed.

Hence, stock prices move around quite a bit more than the

movement in underlying intrinsic value.

Papa Patel, Manilal, and Mittal all made their fortunes by fixating on buying distressed businesses.

Value Line

but if a business is trading at a P/E of 3, it is worth a closer look.

It lists the 10 most recent stock purchases by 80 of the top value managers.

look at Value Investors Club

Value Investors Club has about 250 members—each of whom had to get approved for membership by presenting a good investment idea. These members are required to post at least two ideas a year. The quality of these ideas is decent as they are peer rated. If a member presents shoddy ideas, he or she is likely to lose membership privileges. Every week the best idea (judged by VIC management)

gets $5,000. The primary benefit of membership is the ability to access ideas in real time. However, as a guest, you can access the same content with a 2-month delay. It is very much worth looking through VIC for distressed situations. Start with the highest rated ideas and work downward from there. 6. Last, but certainly not least, please read The Little Book That Beats the Market by Joel Greenblatt. After reading the book, visit www.magicformulainvesting.com.

We begin by eliminating all businesses that are either not simple businesses or fall squarely outside our circle of competence.

Capitalism is greed driven,