The Dhandho Investor — Highlights/Summary
The Success Stories
A. Patel Motel
Papa Patel migrated to the USA. He didn’t have shelter and jobs. All he had was a few thousand dollars which he invested on to buy a motel and also took a loan from relatives. He collected $5000 in total and bought the 90-room motel. He used to work there himself as receptionist, clerk, plumber and his wife used to help him in daily chores. They got a rent free accomodation.
As their expenses were too low. They could earn $5000 yearly. They were successful because they had good free cash flow from the business and their annualised return was 400 percent.
It was a huge one time opportunity in the 1970s.
An existing business with a very stable business model and a long history of cash flow and profitability.
B. Manilal Chaudhary
After working at a gas station, Mr. Manilal wanted to do his own business. In 2001, after 9/11 attacks, travel industry was distressed. Prices declined significantly. He bought a motel for $4.5M with $1.4M down payment.
Fast forward 4 years, the motel’s market value is worth $9M. An annualised return of 48%.
C. Virgin Dhandho
Richard Branson started Virgin Atlantic by renting a boing aircraft and spent money on marketing (instead of buying the aircraft).
In the airline business, You got to pay for the fuel prices after 30 days and staff wages after 15–20 days. And you got to get advance for bookings at least 20 days before. the plane took off.
D. Mittal Dhandho
Mittal bought steel factories in different countries for nearly FREE. Why? Because the steel factories were in a distress. The former employer (or the govt) were not able to pay for the wages. Therefore, his investment was almost zero and all he had to do was manage the business efficiently. Not only he paid the outstanding wages but also run the mills profitably.
The Dhandho Framework
A. Invest in Existing Businesses
The intrinsic value of any business is determined by the cash flows — discounted at an appropriate interest rate — that can be expected to occur during the remaining life of the business.
Buy an existing business at a value lower than its intrinsic value. You can choose to buy a company’s stocks.
B. Invest in Businesses in Distressed Industries
How do you get a list of distressed businesses or industries? There are many sources:
a) Newspapers — Negative news about a company or industry.
b) A screener showing lowest PE ratios, widest discounts to book value, highest dividend yield and so on.
C. Invest in Businesses with durable Moats
There are businesses with deep moats all around us — Coca-Cola, Harley Davidson, WD-40, Oreo Cookies, Nestle Maggi and the list goes on.
How do we know whether a business has a hidden moat?
Ans: Look at its financial statements. The businesses which generate high returns on invested capital. The income and cash flow statements tell us how much they are earning off that capital.
Remember No matter how well fortified and defended a castle is, no matter how wide or deep its moat is, eventually it is going to fall to the marauding invaders. There is no such thing as a permanent moat.
D. Few Bets, Big Bets, Infrequent Bets
Kelly Formula: Edge/odds = Fraction of your bankroll you should bet each time.
Example: Coin toss — Heads gets you $2 and Tails costs you $1.
According to Kelly Formula, the edge is $0.5 [(0.5x2)*(0.5x1)]
So edge/win = $0.5/$2 = 25%. You should bet 25% each time.
Charlie Munger’s Quote:
“The wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t.”
Here’s when you should bet heavily:
A business is under temporary distress. Price collapsed. It’s a good business with a durable moat. The business is squarely within your circle of competence. And you have calculated its intrinsic value today. And the current stock price is less than half of the expected intrinsic value in two-three years.
E. Fixate on Arbitrage
The elimination of outside risk, even if upside is limited.
a) Traditional Commodity Arbitrage: A sight price delay of a commodity in different countries.
b) Correlated Stock Arbitrage
c) Merger Arbitrage
d) Dhandho Arbitrage: That barber example. The barber had super normal profits until others opened barbershops in town C.
Warren Buffet: “We think in terms of moats that are impossible to cross, and tell our managers to widen their moat every year, even if profits do not increase every year.”
F. Margin of Safety
Make sure that you are buying a business for way less than you think it is conservatively worth.
a) The bigger the discount to intrinsic value, the lower the risk.
b) The bigger the discount to intrinsic value, the higher the return.
G. Invest in Low-Risk, High Uncertainty Businesses
Industries with rapid change are bad for its investors. Always take advantage of a situation where market gets confused between risk and uncertainty.
A high dividend yield is sometimes indicative of a stock being undervalued.
H. Invest in the Copycats Rather than the Innovators
McDonalds, Microsoft, Pabrai Investment Funds are the good examples of copycats that surpassed the original innovators.
a) Innovation is crap-shoot, but cloning is for sure.
b) The manager’s stake in his own fund is of critical importance to some investors.
c) Stocks in the lowest decile of price/book value ratio outperformed stocks in the highest decile.
Art of Selling Abhimanyu’s Dilemma
The lesson Abhimanyu has for us is to have a crystal-clear exit plan before we ever think about buying a stock.
To Enter of Not to Enter
- Is it a business I understand very well — squarely within my circle of competence?
- 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?
- Is the business priced at a large discount to its intrinsic value today and in two to three years?
- Would I be willing to invest a large part of my net worth into this business?
- Is the downside minimal?
- Does the business have a moat?
- Is it run by able and honest managers?
One should only consider buying if the answer to all seven is a YES.
The key to being a successful investor is to buy assets consistently below what they are worth and to fixate on absolutely minimising permanent losses.
“One year is a very good time frame, but if you understand the business well before buying it, A longer time frame is fully warranted and justified.”
- Don’t hesitate to take a realised loss once three years have passed.
Exiting the Chakravyuh
- Within three years of buying, there is likely to be convergence between intrinsic value and price.
- You must sell once the market price exceeds intrinsic value.
To Index or Not to Index
- As long as there are frictional costs, the vast majority of actively managed assets will underperform the broad indexes.
- An individual investor running a focused portfolio is likely to do better than the broad indexes.
- Buying good businesses when they are cheap is likely to generate vastly better returns than any broad index.
