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The Dhandho Investor by Mohnish Pabrai

I read one book per week. Last week’s book was The Dhandho Investor by Mohnish Pabrai. Highly recommend reading it. If you are interested in the individual highlights that I made in the physical book, you can read those here. Hope you enjoy these notes every Wednesday morning.

Book’s main argument:

Mohnish Pabrai is the ultimate Warren Buffett disciple. He has replicated the Buffett partnership structure, the Berkshire investing methodology, and sometimes individual portfolio holdings. Through this journey, Pabrai learned that the best investors seek high-returns while taking very little risk. This book explains how that is possible, who has succeed because of it, and what you can implement in your own investing immediately. Minimize risk, maximize returns — the Dhandho way.

5 Big Ideas:

💡 Idea #1 — It does not take high-risk to obtain high-rewards. In fact, the best investors in the world obsess over minimizing risk while achieving outsized returns. Pabrai calls this " the Dhandho way." He explains where the term Dhandho comes from:

Dhandho (pronounced dhun-doe) is a Gujarati word. Dhan comes from the Sanskrit root word Dhana meaning wealth. Dhan-dho, literally translated, means “endeavors that create wealth.” The street translation of Dhandho is simply “business.” What is business if not an endeavor to create wealth?

Pabrai goes on to explain exactly what Dhandho means — minimizing risk, maximize reward.

"Dhandho is all about the minimization of risk while maximizing the reward."

"Dhandho is thus best described as endeavors that create wealth while taking virtually no risk."

"Dhandho is capital allocation at its very finest. If an investor can make virtually risk-free bets with outsized rewards, and keep making the bets over and over, the results are stunning."

💡 Idea #2 — True wealth is built by having a concentrated portfolio of great businesses. In a world of diversification, Pabrai and other Dhandho investors seek to own existing businesses that have advantages in the market. Not too many of them though:

"Having an ownership stake in a few businesses is the best path to building wealth. And with no heavy lifting required, bargain buying opportunities, ultra-low capital requirements, ultra-large selection, and ultra-low frictional costs, buying stakes in a few publicly traded existing businesses is the no-brainer Dhandho way to go."

The best businesses to put in a concentrated portfolio are the simplest. Pabrai explains:

"The Dhandho way to deal with this dilemma is painfully simple: Only invest in businesses that are simple—ones where conservative assumptions about future cash flows are easy to figure out."

💡 Idea #3 — Human psychology invalidates the efficient market hypothesis. Regardless of the academic awards that have been bestowed on the efficient market theory, it has failed to hold up in reality. Pabrai writes:

"Markets aren’t fully efficient because humans control its auction-driven pricing mechanism. Humans are subject to vacillating between extreme fear and extreme greed. When humans, as a group, are extremely fearful, the pricing of the underlying assets are likely to fall below intrinsic value; extreme greed is likely to lead to exuberant pricing."

This impact of human psychology is best understood when separating stock prices from the intrinsic value of a business.

"Human psychology affects the buying and selling of fractions of businesses on the stock market much more than the buying and selling of entire businesses."

💡 Idea #4 — Business moats do not last nearly as long as you think. Pabrai quotes Charlie Munger to explain:

“Of the fifty most important stocks on the NYSE in 1911, today only one, General Electric, remains in business…That’s how powerful the forces of competitive destruction are. Over the very long term, history shows that the chances of any business surviving in a manner agreeable to a company’s owners are slim at best.” – Charlie Munger

The moat is a competitive advantage while it lasts, but even the best businesses come under immense pressure eventually.

"Good businesses with good moats…generate high returns on invested capital."

"Even businesses with durable moats don’t last forever."

💡 Idea #5 — The best way to minimize risk and maximize rewards is to follow the mantra "Few Bets, Big Bets, Infrequent Bets." This is a key component of the Dhandho way. Pabrai explains:

"In investing, there is no such thing as a sure bet. Even the most blue-chip business on the planet has a probability of not being in business tomorrow. Investing is all about the odds—just like blackjack."

"Dhandho is all about placing few bets, big bets, infrequent bets; and the Kelly Formula supports this hypothesis. This approach works exceedingly well in making passive investments in the stock market."

You have to understand you are playing a game of odds. Most great investors are fixated on the idea of betting big when the odds are in their favor. Pabrai is no different:

"Investing is just like gambling. It’s all about the odds. Looking out for mispriced betting opportunities and betting heavily when the odds are overwhelmingly in your favor is the ticket to wealth."

Memorable quotes:

Having a moat that your competitors can see in broad daylight but never ever cross is just fantastic—and a rarity.
“Helping you makes me happy” – Abraham George
Have a crystal-clear exit plan before we ever think about buying a stock.
Value investing is fundamentally contrarian in nature.
Independence of thought is fundamental to sound investing.
Good cloners are great businesses. Innovation is a crapshoot, but cloning is for sure.
Rapidly changing industries are the enemy of the investor.
In investing, all knowledge is cumulative.
Whenever Wall Street gets confused, it means we likely can make some money.
If the odds are overwhelmingly in your favor, bet heavily.
To be a good capital allocator, you have to think probabilistically.

Pomp’s Takeaways:

This was an enjoyable, quick read. Mohnish Pabrai has spent a good amount of time investigating what makes a good investor, along with the best strategy to ensure a high probability of success. If you enjoy investing or financial markets, it is worth reading.

My first big takeaway was the concept of Dhandho itself — minimize risk, maximize rewards. This idea flies in the face of convention wisdom that requires high risk for high reward. The classic value investor is trying to buy businesses at prices that are less than what the business is worth, which would indicate (a) there is low risk in owning the company and (b) there is a high potential return if the market realizes the company is undervalued. Good reminder that conventional wisdom is not always right — question everything.

My second big takeaway was how different the advice of great investors tends to be from the advice given to the average citizen. For example, Buffett talks about concentration instead of diversification, Soros talks about betting big when the odds are in your favor, Thiel talks about competition is for losers, etc. While the average citizen does not have the experience or interest in becoming a professional investor, it is still shocking at the different ends of the extreme that the greats happen to arrive at compared to the regular joe investor.

My third big takeaway was a story that Pabrai opens the book with — Less than one in five hundred Americans is a Patel. It is thus amazing that over half of all the motels in the entire country are owned and operated by Patels. He uses this data point to highlight "the reason we end up with concentrations of ethnic groups in certain professions is because role models play a huge role in how humans pick their vocations." The morale of the story is that an entire generation of Patels were willing to work bad jobs to earn enough money to buy a small hotel, they moved their families into the hotels, fired the existing staff, and used their family to carry out the various daily tasks. This made the investments highly profitable and provided the cash-flow to buy a second and third motel. Do the unscalable things. Seek an advantage. Be willing to do the work that no one else will do.

My fourth big takeaway was the responsibility to create a positive impact in the world once you have achieved success. Pabrai writes:

"I do urge you to leverage Dhandho techniques fully to maximize your wealth. But I also hope that, well before your body begins to fade away, you’ll use some time and some of that Dhandho money to leave this world a little better place than you found it. We cannot change the world, but we can improve this world for one person, ten people, a hundred people, and maybe even a few thousand people."

Powerful message from a man who appears to follow his own advice.

My fifth and last big takeaway was how how timeless the great investing advice can be. It stands the test of time, regardless of what market or time period that you apply it to. Minimize your risks. Maximize your rewards. Buy great assets. Hold them forever. Dollar cost average into your positions. Don't try to time market movements. Understand what you own. If you wouldn't buy the whole company, then don't buy a single share. The list goes on. Great investors have nailed all the one-liner advice, but more impressively they continue to exert incredible control of their emotions. That may be the single most important and timeless skill.

As I mentioned, last week’s book was The Dhandho Investor by Mohnish Pabrai. Highly recommend reading it. If you are interested in the individual highlights that I made in the physical book, you can read those here. Hope you enjoy these notes. Reply to this email with your thoughts, including what you agreed or disagreed with. I will respond to as many emails as I can.

-Pomp