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

The Dhandho Investor is an absolute feast for value investors! Mohnish Pabrai sets out an atypical approach for low risk, high return investing. Warren Buffett said to be greedy when others are fearful, but for the Dahando investor, the motto should be: Be very greedy when others are fearful!


Book notes

Dhandho investing

Dhandho investments are “endeavors that create wealth while taking virtually no risk.”

“Heads, I win; tails, I don’t lose much!”

Make “Few Bets, Big Bets, Infrequent Bets.”

Keep costs low.

Lowball offers may be accepted: Branson first offered £150,000 for Necker island, and he bought it a few weeks later for £180,000. The asking price was £3m.

Dhandho returns

Investments should return all of your invested capital within three years.

“Getting dollar bills at 10 cents—or less—is Dhandho on steroids.”

“Buy distressed businesses in distressed industries.”

“Bet heavily when the odds are overwhelmingly in your favor.”

Risk and uncertainty

Target investments with low risk but high uncertainty.

Minimise your downside.

Be conservative when assessing the impact of different possible outcomes.

“Only invest in businesses that are simple”

Avoid making cash flow forecasts more than 10 years out.

Avoid the endowment effect. Understand that it is harder to be objective once a stock is purchased.

Be prepared to accept large downside. Buffett saw a 50% decline in the stock price of the Washington Post after he bought a large stake. He took his stake in American Express up to 40% after the share had fallen by a half.

Portfolio construction

Use the Kelly formula to guide portfolio weights. With a 50% chance each of either a 200% return or a 100% loss, Kelly bet is 25% of the bankroll.

Only take a big position when “the chance of serious permanent loss is minimal”

Joel Greenblatt and Eddie Lampert run concentrated portfolios. Greenblatt’s top five ideas typically make up 80% of his portfoli0.

Pabrai initiates positions at 10% of his portfolio.

Timing

Most gaps to intrinsic value close in under 18 months, although it may take three years or longer. But don’t wait forever.

Don’t sell at a loss within three years, unless you are very sure that the intrinsic value is below the market price.

If the position has been profitable, “sell once the market price exceeds intrinsic value”.

Case studies

Motels case study: Buy a motel with a 10% cash deposit, 90% mortgage. Purchase price equals annual revenue. Net cash flow after expenses is 40% of revenue. Annual return on equity invested is 400%.

Best Western case study: Buy a motel at time of distress for $4.5m with a $1.4m deposit. Gross revenues are under $1.6m. Free cash flow is approximately $0.5m (36% of original equity investment). Four years later, the motel is worth $9m. Assuming $0.8m of the loan note has been repaid, the equity is worth $6.7m. Compound annual return is 48%.  Revenues are now $2.1m.  Assume free cash flow generated each year of $0.8m (57% of the initial equity investment).

Funeral homes case study: Consolidation of the funeral homes sector had left many companies with large debt burdens. When one went bankrupt, the sector sold off sharply.  Stewart had $930m of debt, with $500m due in two years. Stewart traded at around half book value that was probably understated due to land holdings. Stock traded below three times cash flow and at a quarter of revenue.

Level 3 convertible bonds case study: In 2001, Level 3 convertible bonds paying a 6 percent coupon were offered at 18 cents on the dollar. Company was expected to meet the interest payments over the next three years.


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