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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Charlie Munger: The Complete Investor by Tren Griffin

I start with a book about one of my favourite investors: Charlie Munger. Charlie Munger: The Complete Investor is packed full of Munger quotes, cleverly weaved together by Tren Griffin. For anyone new to Charlie Munger, or for those who simply want a refresher in his unique brand of common sense, this book is well worth reading.


Book notes

Temperament

Munger is almost unshakeable:

Being a true contrarian takes supreme courage and implacable calm. Buffett talks constantly about the “emotional framework” Graham provides; […] I like to use a word from ancient Greek philosophy to describe this: ataraxia, or perfect imperturbability. You see it when Socrates goes on trial, when Nathan Hale is hanged, when Buffett invests in Goldman and when Charlie buys Wells Fargo the day before the bottom tick in March 2009.
—JASON ZWEIG, EMAIL TO AUTHOR, OCTOBER 2014

Be prepared to react to falling share prices with equanimity.

Be both patient and aggressive:

Experience tends to confirm a long-held notion that being prepared, on a few occasions in a lifetime, to act promptly in scale, in doing some simple and logical thing, will often dramatically improve the financial results of that lifetime. A few major opportunities, clearly recognizable as such, will usually come to one who continuously searches and waits, with a curious mind that loves diagnosis involving multiple variables. And then all that is required is a willingness to bet heavily when the odds are extremely favorable, using resources available as a result of prudence and patience in the past.
—CHARLIE MUNGER, WESCO ANNUAL MEETING, 1996

Be rational and objective.

Learning

Munger and Buffett deliberately spend much of their day reading and thinking.

Investors need to be “learning machines”, and should “go to bed every night a little wiser than they were when they got up”.

Munger’s children describe him as a “book with legs sticking out.”

“If you cannot write it down, you have not thought it through.”

Wisdom

Avoid stupidity:

It’s remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent. There must be some wisdom in the folk saying, “It’s the strong swimmers who drown.”
—CHARLIE MUNGER, WESCO ANNUAL REPORT, 1989

If you cannot value a company, then move on.

Learn from the failures of others and from your own mistakes:

I like people admitting they were complete stupid horses’ asses. I know I’ll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn.
—CHARLIE MUNGER, BERKSHIRE ANNUAL MEETING, 2011

Fix your own mistakes quickly.

“Seek out wise people who are not afraid to disagree with you.”

Making decisions

Don’t think all problems are solved in the same way:

You know the old saying: to the man with a hammer, the world looks like a nail. This is a dumb way of handling problems.
—CHARLIE MUNGER, WESCO ANNUAL MEETING, 2000

The more models you understand, the better your decisions are likely to be.

Minimise the need to make difficult decisions. Stick to your circle of competence. “You have a limited amount of time and talent and you have to allocate it smartly.”

Think about opportunity costs.

To solve a problem, invert it. In order to achieve success, look at how others have failed.

Investing

Make a bipolar Mr. Market your servant rather than your master.”

Margin of safety is simply “the difference between the intrinsic value and the current market price.” Redundancy in engineering is an example of the margin of safety principle.

Risk to Munger and Buffett is: “1) the risk of permanent loss of capital, or 2) the risk of inadequate return.”

Having a concentrated portfolio or practising “focus investing” reduces the number of decisions to make.


Buy Charlie Munger: The Complete Investor on Amazon (affiliate link)