By IntrinsicValueFormula. Originally published at ValueWalk.
The Dhando Investor, the low-risk value method to high returns is a wonderful book written by hedge fund manager Monish Pabrai. In it, he gives a comprehensive value investing framework for the individual investor.
The book is written in a straightforward style that is easy to read and comprehend. The Dhando Investor lays out the amazingly powerful value investing framework. Written with the intelligent individual investor in mind.
The Dhando method expands on the value investing principles expounded by Benjamin Graham, Warren Buffett, and Charlie Munger. In this book, we will come across phrases like “Heads I Win! Tails, I don’t lose much”, “Few bets, Big bets, Infrequent bet.”
Other concepts discussed are Abhimanyu’s dilemma, a detailed breakdown of the Kelly formula to invest in undervalued stocks.
So who is Monish Pabrai? I can hear you asking who is this guy and why are we talking about his book?
Let’s dig in a little and learn more about Monish.
Monish was born in 1964 in Mumbai, India and he moved to the US in 1983 to study at Clemson University. After graduation, he worked in the tech world until branching out on his own.
He started his own tech company with $30,000 from his 401k and $70,000 in credit card debt. In 2000 he sold the company for $20 million.
In 1999 he started Pabrai Investment Funds, that he still runs today. Since the fund’s inception, he has generated net returns of 517% versus the 43% return of the S&P 500 for the same time period. We are talking 16 years that he has made these returns.
His focus is long-only equities that are deeply distressed. He looks for two to three ideas a year, which he feels is enough. His portfolio is highly concentrated in that he generally only holds 10-20 stocks at one time. Currently, he has seven positions.
Buying and holding are only part of his strategy, he also looks very closely at his mistakes as well. Investing is a field where mistakes can be very costly and they must be looked into. He is unusual in that he doesn’t gloss over mistakes but rather spends time breaking down what happened so he can learn from the mistake. So he doesn’t repeat it in the future.
He uses a checklist of what not to do in the markets. Pabrai built this list by analyzing investors that he admires and deconstructing their mistakes. As a result, he ended up with hundreds of checkboxes on his investing checklist. This is not his exact checklist but rather an outline of his checklist and how he things about constructing his. He feels that each individual investor should come up with their own checklist as they learn more about investing.
Monish Pabrai’s primary source of investment ideas come from the 13F SEC filings from other value investment managers that he admires. 13F SEC filings are a quarterly filing required of all institutional investment managers with over $100 million in assets. In this filing, they will list all the current holdings for each fund. It will also list the prices purchased or sold as well.
This is a great source of investing ideas and is a whole investment strategy in and of itself. We will dig into this topic in a future post.
To illustrate how simple his holds are. He currently has these seven stocks in his portfolio.
- AerCap Holdings NV (AER)
- Fiat Crysler Automobiles NV (FCAU)
- General Motors (GM)
- Alphabet (GOOG)
- Berkshire Hathaway (BRK.B)
- Seritage Growth Properties (SRG)
- Ferrari NV (RACE)
Of these, Fiat, GM, and RACE hold 63% of his portfolio. So three automakers hold that much of his portfolio. Pretty simple stuff.
Ok, we have established that Monish knows his stuff and has some great results in his portfolio.
Let’s talk about the book.
Dhando Investor
Pabrai starts the book by discussing the term “dhandho” (pronounced “dhun-doe”), which is a Gujerati word meaning “endevours that create wealth” or “business”. Gujerat is a coastal province in India that has served as a hotbed for trade with Asia and Africa.
Most people think that risk and return are intertwined. Investors are told if you want high returns you must take on high risk. However, value investors like Warren Buffett, Benjamin Graham, and Joel Greenblatt have shown that it is possible to achieve incredibly high returns with very low risk.
Monish Pabrai shows that his Dhando investing framework is low risk with high returns. His framework contains nine principles.
Principle #1. Focus on Buying an Existing Business
Pabrai states that the path to wealth is investing in existing businesses through the stock market. His view is to find a few great bets that you can buy and hold, at least for 2 to 3 years.
There are few reasons to do this. First, there is little to no heaving lifting required. Secondly, you can find a multiple of bargain basement stocks to invest in. And finally, you don’t need a lot of money to start investing in the stock market. With the ultra-low transaction costs, there are very low friction costs.
As we have said before stay away from IPOs. They are extremely risky and they make money for one person and one person only. The owner of the business, not YOU!
Principle #2. Invest in Simple Businesses
Simplicity is an extremely powerful idea. After all, Einstein stated that simplicity was the highest level of intellect. Pretty smart guy.
The Dhando framework is simplicity itself. This is the power of this style of investing. Only after we buy a stock does the battle with our brain begin. This is when the yin and yang of self-doubt starts to creep into our decision-making basis.
To help fight this psychological battle with ourselves. We need to buy painfully simple businesses with painfully simple ideas. This will help you make a decent profit and reduce the need to create complicated spreadsheets to track all the data about the stock.
The framework is simple. Find a company you can understand. Buy it for a discounted price. Hold on to it until it is no longer a reasonable price or the story changes about the company. Rinse and repeat.
Principle #3. Invest in Distressed Businesses
Stock prices do not always reflect the fundamentals of the underlying business. In other words, price does not equal value of the company.
Pabrai states that the human psychology affects the buy and selling of stocks much more than the buying and selling of entire businesses. Bad news can lead to extreme fear, stock dumping, and a very low valuation as a result. Sell the news, is a phrase that is used in the market.
In other words, the stock you are looking at will rise and fall based on a piece of good/bad news.
You should look for simple businesses that are under duress. So you can buy them at incredibly low prices. If you see bad news about a company you are interested in this could be great news for you. If the underlying businesses fundamentals have not changed but the bad news has driven the price down out of fear. Then step up to the counter and buy all you can at the
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