In The Dhandho Investor: The Low-Risk Value Method to High Returns Mohnish Pabrai explains his investment philosophy by drawing on examples from Indian culture and the wisdom of Warren Buffett. While some parts feel a bit lengthy, the book offers practical advice, especially on where to look for good companies to invest in.
Dhandho means “business” in Indian.
The Inspiring Example of the Patels
In the 1970s, Indian immigrants, including many members of the Patel family, ventured into the U.S. motel business during a challenging time marked by the energy crisis, which reduced travel. Despite these difficulties, the Patels recognized several advantages in this industry:
- The family could live on-site, reducing living expenses.
- Family members could provide affordable labor, enabling a highly efficient cost structure.
- The required down payments were relatively low, making it easier to enter the market.
In the event of failure, they knew they could fall back on regular employment to sustain themselves.
Today, the Patels own a significant number of motels across the U.S., exemplifying Mohnish Pabrai’s philosophy of “Heads I win, tails I don’t lose much.”
Finding Deals to Consider
The Goal: Buy at an Excellent Price
Warren Buffett famously said, “Never count on making a good sale. Have a purchase price so attractive that even a mediocre sale gives good results.”
While markets are generally efficient, they aren’t perfect. Stock prices can fluctuate when Mr. Market reacts emotionally to news. When these reactions are excessive, prices may dip below their intrinsic value, creating buying opportunities.
How to Find Deals
- Stay Informed: Regularly read business headlines to keep up with market trends and potential opportunities.
- Subscribe to Value Line: This publication provides a weekly summary of stock price drops. Review their bottom lists each week.
- Use PortfolioReports.com: This site publishes monthly updates on the investments made by prominent value investors, sourced from public filings.
- Read Public Filings: Access 13F forms and other filings directly through the EDGAR system for insights into what top investors are buying.
- Explore Joel Greenblatt’s Approach: Read The Little Book That Beats the Market and visit magicformulainvesting.com. Not all listed stocks are distressed, but some could be worth considering. More on this strategy will be detailed later.
- Value Investors Club: If a stock appears here and aligns with the magic formula, it’s a strong indicator of potential.
- Check 52-Week Lows: Focus on the NYSE’s 52-week lows. Skip unfamiliar stocks and prioritize those that catch your interest.
- Subscribe to Key Publications:
- Outstanding Investor Digest (oid.com) and Value Investor Insight for interviews with leading U.S. value investors.
- Portfolio Reports for recent activities of top value investors.
- Use Guru-Focus.com: This site provides comprehensive portfolio reports for various top investors.
- Follow Value Investor Publications:
- Value Investor Insight and Super Investor Insight, which track the 13F filings of leading investors.
- Read Major Financial Magazines: Subscriptions to Fortune, Forbes, The Wall Street Journal, Barron’s, and Business Week are essential for staying informed.
- Attend Conferences: Participate in the biannual Value Investing Congress to hear from industry leaders.
Invest Your Research Time Wisely: Filter out businesses that are complex or outside your circle of competence. Focus only on opportunities you understand well.
Interesting Characteristics
Buy Simple Businesses in Industries with a Slow Rate of Change
Invest in simple businesses that can be purchased below their intrinsic value. The ideal business should be straightforward and situated in an industry with a slow rate of change, enabling reliable cash flow projections.
Buy Businesses with Durable Competitive Advantages—The Moat
A business’s competitive advantage, or “moat,” is not always obvious at first glance. To identify it, closely examine the company’s financial statements. A strong moat supports a high return on capital. However, keep in mind that moats face continuous challenges from competitors and, like all great empires, will eventually erode over time. For this reason, when using John Burr Williams’ discounted cash flow formula, never project cash flows for a period longer than 10 years.
“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products and services that have wide, sustainable moats around them are the ones that deliver rewards to investors.” —Warren Buffett
Look for Low-Risk, High-Uncertainty Situations
Wall Street often mistakenly equates risk with uncertainty. When either is present, stocks are typically discounted. Situations where risk is low but uncertainty is high can present attractive opportunities, allowing for favorable purchase prices.
Timing
When to Buy
- Do you thoroughly understand the business—is it squarely within your circle of competence?
- Do you know the intrinsic value of the business today, and with high confidence, how it is likely to change over the next few years?
- Is the business priced at a large discount to its intrinsic value today and in two to three years? Over 50 percent?
- Would you be willing to invest a large part of your net worth into this business?
- Is the downside minimal?
- Does the business have a moat?
- Is it run by capable and honest managers?
You should only consider buying if the answer to all seven is a resounding yes.
When to Sell
- Wait at least two years after buying.
- Have a high level of certainty about the intrinsic value.
- Sell when the current price exceeds the present or future estimated intrinsic value.
Sizing each investment
Bet Fewer Times, But Heavily When the Odds Are in Your Favor
How to size your bet:
- Kelly Formula: Edge/odds = fraction of your bankroll you should bet each time.
- Visit cisinova.com/betsize.asp for a calculator.
Reading Advice by Mohnish Pabrai
Mohnish Pabrai emphasizes that The Intelligent Investor by Benjamin Graham remains the best book on investing. It encapsulates the only three ideas you need to succeed:
- Chapter 8—The Mr. Market Analogy: Use the stock market to your advantage. Think of it as your business broker, offering you prices daily that you can choose to accept or decline. As Warren Buffett puts it, “The C section of the Wall Street Journal is my business broker—it quotes me prices every day that I can take or leave, and there are no called strikes.”
- A Stock Is a Piece of a Business: Always remember that when you buy a stock, you are purchasing part of a business. Its true value is determined by the cash that flows in and out of it.
- Chapter 20—Margin of Safety: Ensure you are buying a business at a price significantly lower than your conservative estimate of its value. This margin acts as a cushion against potential errors in judgment or unforeseen events.