Book Notes: Mohnish Pabrai - The Dhandho Investor

The Dhandho Investor - Mohnish Pabrai

Acknowledgments

• “I have very few original ideas. Virtually everything has been lifted from somewhere”. He says that there is no shame in cloning and that there are plenty of very talented people out there from which you can take a lot of ideas.

Chapter 1: Patel Motel Dhandho

• Dhandho is roughly translated to “endeavors that create wealth” and he suggests that the more correct, complete definition for him would be “endeavors that create wealth while taking virtually no risk” (p. 2).
• “role models play a huge role in how humans pick their vocations” (p. 5).
• A saying that is repeated numerously throughout the book and embodies the Dhandho approach to investing is: “Heads, I win; tails, I don’t lose much!” (p. 12).

Chapter 2: Manilal Dhandho

• A common trait across Dhandho entrepreneurs in the early chapters of the book is that despite their improving economic situation, all of them continued to live quite simply, keeping expenses low and not splurging on unnecessary stuff. They also were really hard workers (p. 17).
• Recipe for wealth: “[…] worked hard, saved all he could, and then bet it all on a single no-brainer bet” (p. 21). This recalls the principle “Few Bets, Big Bets, Infrequent Bets”.

Chapter 3: Virgin Dhandho

• “With minimal downsides, failure rates don’t matter to Sir Richard Branson” (p. 28).
• Mohnish suggests that this model of the ventures of Virgin should be the model for the VCs of the future.

Chapter 4: Mittal Dhandho

• “Getting dollar bills at 10 cents—or less—is Dhandho on steroids” (p. 31).
• Mohnish places a lot of emphasis on quick passes on many opportunities. If it doesn’t meet most/all of the things he is looking for he will pass quickly on that opportunity.
  

Chapter 5: The Dhandho Framework

• In this chapter Mohnish introduces the 9 pillars/principles of the Dhandho framework, not only for investing but also for life and business in general.

1. Focus on Buying an Existing Business: This is waaaay less risky than doing a startup (p. 35). 
2. Buy Simple Businesses in Industries with an Ultra-Slow Rate of Change: He got this from Warren Buffett’s approach (p. 35). 
1. In a Motley Fool article they reference a Warren Buffett saying that goes like this: “We see change as the enemy of investments… so we look for the absence of change. We don’t like to lose money. Capitalism is pretty brutal. We look for mundane products that everyone needs” (p. 36). 
2. An interesting thought Mohnish mentions is that within tech, while the competitive landscape for IBM probably changes a lot, for a company like Accenture, it doesn’t as it is a services and not tech business.
3.  Buy Distressed Businesses in Distressed Industries (p. 36). 
1. “Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results” — Warren Buffett in the 1974 Berkshire Hathaway annual letter.
2.  “Be fearful when others are greedy. Be greedy when others are fearful” — Warren Buffett
3. This thought from Mohnish reminded me of Intel in 2021: “[…] the very best time to buy a business is when its near-term future prospects are murky and the business is hated and unloved. […] odds are high that an investor can pick up assets at steep discounts to their underlying value”.
4.  Buy Businesses with a Durable Competitive Advantage - The Moat (p. 37).
1.  Don’t just evaluate how great (wide) the moat is, it is perhaps more important how durable it is.
2.  With regards to IT services businesses: “As a company gets more familiar with a client’s business and technology infrastructure, the harder it is to be replaced by a competitor” —> this reminded me on how Qlip relied on companies like Hubspot and these softwares were very ingrained in their processes, creating switching costs. Switching costs + recurring revenue is a good combo.
3.  Lots of Berkshire Hathaway businesses gained its moats by providing lower prices, for example the GEICO vs State Farm model. Maybe low-cost strategies are not bad after all.
5.  Bet Heavily when the Odds are Overwhelmingly in Your Favor (p. 39)
1.  Here Mohnish references Charlie Munger’s comments on a pari-mutuel system on the horse-racing track and how when you find a mispriced gamble you have to bet heavily.
6.  Focus on Arbitrage (p. 40) 
1. I didn’t understand this principle really well, to me it seemed as a blend between principle 4, 5, and the “Few Bets, Big Bets, Infrequent Bets” concept. 
7. Buy Businesses at Big discounts to their Underlying Intrinsic Value
1.  “[…] the function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future” — Benjamin Graham on The Intelligent Investor
2.  Even if our cash flow estimates are not accurate at all, the fact that we employ a margin of safety provides us with a safety net for that. If our estimates end up being 25% too optimistic but we bought at a 50% margin of safety then we will still be more than fine. However, if we buy without a margin of safety we will have screwed up.
3.  Very simple, yet powerful idea. Charlie Munger emphasizes it a lot and applies the idea from engineering for building bridges. 
8. Look for Low-Risk High-Uncertainty Businesses (p. 45)
1.  The high uncertainty usually leads to depressed prices
9.  It’s Better to be a Copycat than an Innovator (p. 46)
   

• Summarizing:
1. Invest in existing businesses
2. Invest in simple businesses
3. Invest in distressed businesses in distressed industries
4. Invest in businesses with durable moats
5. Few Bets, Big Bets, and Infrequent Bets
6. Fixate on arbitrage
7. Margin of safety, always
8. Invest in low-risk, high-uncertainty businesses
9. Invest in the copycats rather than the innovators

Chapter 6: Dhandho 101: Invest in Existing Businesses

• The public markets for shares of companies are very cheap, easy, and amazing compounding machines that we should use all the time.
• 50 trades per year is “hyperactive” (p. 50).
• “buying stakes in a few publicly traded existing businesses is the no-brainer Dhandho way to go” (p. 50).
  

Chapter 7: Dhandho 102: Invest in Simple Businesses

• He uses Yahoo Finance for many of his tasks.
• He doesn’t use CAPM or WACC to determine his discount rate for DCF models. He uses the opportunity-cost method, which is consistent with what Warren and Charlie do (p. 55).
• In the example he gives in page 55 he uses a 10% discount rate as a low-risk alternative.
• “Only invest in businesses that are simple—ones where conservative assumptions about future cash flows are easy to figure out” (p. 56-57).
• He insists on writing down the investment thesis: “I always write the thesis down. If it takes more than a short paragraph, there is a fundamental problem. If it requires me to fire up Excel, it is a big red flag that strongly suggests I ought to take a pass” (p. 57).

Chapter 8: Dhandho 201: Invest in Distressed Businesses in Distressed Industries

• “I’d be a bum on the street with a tin cup if the markets were always efficient” — Warren Buffett
• The cognitive and psychological mistakes of humans affect the buying and selling of pieces of businesses in the stock market much more than the buying and selling of entire businesses. Mohnish gives the example of the many weird effects quants try to find in stock prices, such as the monday effect, the friday effect, the january effect, etc. When people are buying entire businesses they do not care if it’s a Friday, Monday, rainy day or sunny day (p. 61).
• Our investable universe should be narrowed down to those businesses within our circle of competence and are in a distressed state (p. 62).
• Ways to find distressed businesses and/or distressed industries: Value Line’s lists of low P/Es or high dividend yields (also recommended by Charlie Munger), Portfolio Reports, 13-F filings which you can get from Guru Focus or Edgar etc., Value Investors Club, and Joel Greenblatt’s magic formula from his book The Little Book that Beats the Market (p. 62-64).

Chapter 9: Dhandho 202: Invest in Businesses with Durable Moats

• In many businesses the moats are not available at plain sight, you have to do some digging to find them (p. 67).
• Good businesses with good moats generate good returns on capital (p. 67).
• Moats are not permanent, even the widest and deepest moat will eventually be conquered (p. 68) —> we just have to assess how likely this is to happen within our investment horizon.
• For DCF models “We are best off never calculating a discounted cash flow stream for longer than 10 years or expecting a sale in year 10 to be anything greater than 15 times cash flows at that time (plus any excess capital in the business)” (p. 69).
  

Chapter 10: Dhandho 301: Few Bets, Big Bets, Infrequent Bets

• Here Mohnish first introduces Kelly’s Formula. I haven’t grasped this concept entirely yet, but it’s just a guide, in the end he mentions that he doesn’t really employ it literally.
• Website to calculate bet size: www.cisiova.com/betsize.asp —> doesn’t seem to work anymore ☹️
• Reading recommendation: “The Kelly Criterion in Blackjack, Sports Betting, and the Stock Market”, a paper by Edward Thorp.
• Warren and Charlie also follow this approach of betting heavily when you have good odds.
• There is no particular law why prices eventually catch up to intrinsic value, even Benjamin Graham stated this (p. 77).
• Whenever there are dislocating events like 9/11 or Pearl Harbor stock prices move heavily but eventually bounce back. After 126 days the stock market usually is at a similar or higher level than at the one to which the dislocating event sent it to (p. 77-78) —> interesting table on page 78.
• “In my own portfolios at Pabrai Funds, I adjust for this by simply placing bets at 10% of assets for each bet. It is suboptimal, but it takes care of the Bet 6 being superior to Bet 2 problem” (p. 83). In the end he uses equal weights in his portfolios.

Chapter 11: Dhandho 302: Fixate on Arbitrage

• His definition of arbitrage in this context focuses on finding risk-free situations that, for some reason, are not being exploited, and then taking advantage of them. For example the barber from Town B that opens his own barbershop in Town C before anyone else opens a barbershop there.
• Similar theme to moats: you have to find not only what the moat is and how wide it is, but perhaps even more important is how durable it is (p. 96).
• Chapter 12: Dhandho 401: Margin of Safety—Always!
• For decades Warren Buffett has recommended The Intelligent Investor as the best book you can read about investing. He highlights that this book has the three key concepts you need (p. 100):
• The Mr. Market Analogy
• A stock is a piece of a business
• Margin of Safety
  
• Two rules (p. 100):
• “The bigger the discount to intrinsic value, the lower the risk”.
• “The bigger the discount to intrinsic value, the higher the return”.
  
• Holding period recommendation: “Whenever I make investments, I assume that the gap is highly likely to close in three years or less. My own experience as a professional investor over the past seven years has been that the vast majority of gaps close in under 18 months” (p. 103).
• Same observation as Phil Fisher’s 3-year rule.
• The biggest opportunities arise in times of distress, which can be a macro event (9/11, Covid Outbreak, Cuban missile crisis, etc.) or company-specific. It is during these times that you should be actively looking to invest in a business (p. 104).

Chapter 13: Dhandho 402: Invest in Low-Risk, High-Uncertainty Businesses

• Look for opportunities where the “odds of a permanent loss of capital are extremely low” (p. 107).
• A type of company that Wall Street loves are the low-risk, low-uncertainty companies. These carry very low risk and are fairly predictable, hence they carry high multiples. Mohnish suggests avoiding investing in these companies (p. 108). This goes a bit against the quality focus of paying up for good companies but makes sense that if you are looking to achieve the lowest possible risk with the highest possible return you should look for the low-priced stocks and these are not usually the quality companies.
• Mohnish says that he has been looking at Value Line lists for several years, this is a universe of over 1,600 stocks and he mentions that seeing a stock below a 3 P/E ratio is a rarity (p. 109). He then looked at this business, which seemed to be simple and decided to dig deeper.
• “Always take advantage of a situation where Wall Street gets confused between risk and uncertainty” (p. 114).
• “Rapidly changing industries are the enemy of the investor. That’s why all the Dhandho entrepreneurs fixate on industries with minimal long-term change” (p. 116).
• “A high dividend yield is sometimes indicative of a stock being undervalued. So like low P/E or 52-week low lists, it’s a worthwhile screen” (p. 123). This reminded me of Imperial Brands in 2021.
• You never waste time researching certain company or topic. In investing “all knowledge is cumulative” and whatever you don’t find useful this time around might be key next time (p. 126).
• * Seeing a Chairman, CEO, or executive buy the company’s stock “hand over fist” in the open market is always a good sign (p. 128).
• * “Read voraciously and wait patiently, and from time to time these amazing bets will present themselves” (p. 129).

Chapter 14: Dhandho 403: Invest in the Copycats rather than the Innovators

• By copycat he means companies that are able to take the innovations of other companies and use them to their advantage in a way that is not available to others. For example McDonald’s lifting the Kid’s menu from BK and rolling it out to all their stores or Microsoft purchasing a company for certain tech and packaging it with their Office products (p.  132-136). 
• “Innovation is a crapshoot, but cloning is for sure” (p. 136). 
• He mentions we should look for management teams that are able to successfully clone products. 
• He explains in detail how he copied the superior structure of the early Buffett partnerships in order to set up his own Pabrai Funds. 
• “Independence of thought is fundamental to sound investing” (p.  140). He mentions this with respect to how Buffett barely discloses anything about his positions above the minimum legal requirements. Talking about your positions is not good most of the time. 
• He explains that a single mind without a team of analysts is perfectly capable of running hundreds of millions, in fact it can be better since there is no consensus to reach in order to make decisions (p.  140). 
• “If there were such a thing as the Laws of Investing, they would have been written by Graham, Buffett, and Munger. A small team size (ideally one) would be one of these laws” (p.  142).
  

Chapter 15: Abhimanyu’s Dilemma—The Art of Selling

• When to sell is a harder decision to make than when to buy (p.  147). 
• Mohnish recommends having a crystal-clear exit plan before ever investing into a company (p.  150). 
• 7 questions (not exhaustive) an investor must ask him/herself before entering any “chakravyuh” (p.  150): 
• Is the business within my circle of competence? 
• Do I know its intrinsic value? Is it going to change a lot during the investment horizon? 
• Can I buy it at a large discount to intrinsic value? 
• Would I be willing to invest a large part of my net worth in this business? 
• Is the downside minimal? 
• Does the business have a moat? 
• Is it run by able and honest managers? 
• His personal rule for selling (p.  153): 
• “[…] any stock that you buy cannot be sold at a loss within two to three years of buying unless you can say with a high degree of certainty that current intrinsic value is less than the current price the market is offering”. 
• He recommends always focusing/fixating on buying assets for less than they are worth in order to minimize permanent loss. He refers to Buffett’s “Never lose money” rule (p.  155).
•  You have to allow enough time for the clouds hanging over the business to clear (previously mentioned that around 18 months). “Once the three years have passed, all the shackles are off. At this point, I would be open to selling at any reasonable price—even if it means a big loss on the investment” (p.  155). 
• “IT IS VERY HARD TO MAKE UP THE LSOT NON-COMPOUNDING YEARS” (p.  156) = “Time in the market beats timing the market”. 
• His reasoning for allowing a longer investment horizon on businesses that you really know about is that since Joel Greenblatt’s Magic Formula calls for a 1-year holding period for a business that you don’t know really well then you should be comfortable holding these businesses you know really well for longer (p.  157). 
• Mohnish mentions that if after three years the investment is still losing money then, virtually always, there was some kind of misjudgment in the beginning regarding intrinsic value or the drivers of value —> “Don’t hesitate to take a realized loss once three years have passed. Such losses are your best teachers to becoming a better investor” (p.  164-165). 
• He mentions that you don’t have to get back to 100% of value, even if you are within 10%, sell. 
• “If you can get to holding 5 to 10 diverse, well-understood value stocks in your portfolio, you’re well on your way to trouncing the markets and decimating one chakravyuh after another” (p.  167).
  

Chapter 16: To Index or Not to Index—That Is the Question

This chapter is full of pearls of investment advice

• “As long as there are frictional costs, the vast majority of actively managed assets will under-perform the broad indexes. This will always be true” (p.  169). 
• Book recommendations (p.  171). 
• David Swensen’s Unconventional Success: A Fundamental Approach to Personal Investment 
• Joel Greenblatt’s The Little Book that Beats the Market 
• Mohnish mentions that the key of Joel Greeblatt’s approach is buying good businesses when they are cheap, which is “vastly better […] than any broad index” (p.  172). 
• Mohnish mentions that Greenblatt himself does not follow strictly the Magic Formula’s 1-year approach. He says that Greenblatt uses the formula to screen, then checks which businesses he likes most, and then “loads up big time when he buys” (p.  173). 
• Picking stocks out of the Magic Formula screener is already a huge step to outperforming the broad indexes. 
• Potential sources for ideas (p.  175-177): 
• Value Investor’s Club 
• Value Line
• 52-week lows on the NYSE/NASDAQ: most stocks you will have never heard off, focus on familiar names and check any that draws your attention.
•  Portfolio Reports OR GuruFocus: let’s you check what big value investors are holding 
• Super Investor Insight 
• Business news: FT, Barron’s, WSJ, etc. 
• Attend the biannual Value Investing Congress (NYC & Hollywood).
  

Chapter 17: Arjuna’s Focus: Investing Lessons from a Great Warrior

• “when something jumps out, focus intently in it until it’s either rejected as an investment or passes all the Dhandho filters and you make the investment” (p. 181).
• “Do not make the fatal mistake of looking at five businesses at once” —> FOCUS ON JUST ONE BUSINESS ANALYSIS AT A TIME (p. 181).
• Same focus as many other great investors of GIVING BACK and not only hoarding wealth for wealth’s sake (p. 183).