The Dhandho Investor

This book is pretty small – just a little over 200 pages.And I love it.I am naturally a bargain hunter and love shopping in sales.I also love getting high quality goods at bargain-basement prices.So It’s small wonder that I am attracted to value investing.The danger of shopping in sales is that a person picks up things they don’t have any use for or items that are not a perfect fit just because they are cheap.Then there is a danger of buying poor quality stuff just because it seems to cost so little.The same applies to buying stocks cheap.Sometimes the whole market is beaten down and all stocks seem cheap, but if I buy stocks of companies I would not normally buy because of their poor returns to investors,just because they are cheap,I am left with the problem of selling them when the market and the stock recovers.This is a problem for me personally as I have a tendency to get married to my stocks.At other times a stock sells for low P/E multiples simply because there is something fundamentally wrong with the company. Stocking up on the shares and hoping for a turn-around is pretty foolish.But I am an optimistic type and I need to force myself to turn away from such situations.Over a period of time I have found ways to control my habits.When the markets are down,I first establish a budget and then try to make a list of likely stocks and arrange them in order of attractiveness depending on Buffett-style criteria and tell myself that I’m to invest over 80% of the budget on only the top 5 of my list.I find this stops me from stocking up on not so great businesses that I might find hard to sell later.Then I have accepted the fact that I am a speculator at heart.I no longer try to fight the urge but try to use the Dhandho Principles that come pretty naturally to me to gain out of my speculative tendencies.This is a book I recommend for all investors like me who like value investing but can’t overcome the urge to speculate.

Here is a round up chapter-wise of what is found in the book:-

Chapter 1

Pabrai starts the book by discussing the term “dhandho“which is a Gujarati word meaning “business”. Gujarat is a western coastal state in India that has served as a hotbed for trade with Asia and Africa. The Patels are a community of particularly entrepreunerial Gujaratis whose entrepreneurial ventures led to them forming a dominant part of the East African economy by the early 1970s. When Asians were thrown out of Uganda in 1972 on the basis of their race, a flurry of Patel immigrants landed in Canada, England and the United States.

The Patels now make up about 0.2% of the American population. Yet they own over half of the motels in the entire country. Pabrai attributes this to particular conditions which led the Patels to recognize and benefit from the minimal downside risk and upside potential that existed in the motel business when they immigrated to the United States.

The first Patels arrived during a recession. Motel owners were being foreclosed due to low occupancy rates. With just a few thousand dollars in hand, Patels could kill two birds with one stone by finding room and board for their families and a job at the same time by buying a motel. Since the assets are hard, banks would finance 80-90% of the purchase, so the initial investment required was low.

From here, Pabrai discusses some of the financial details that made these investments value investments: Low risk (the few thousand dollars initial investment) and high reward (with their low living expenses and hard-working attitude, Patels could make back their initial downpayment in the first four months!). This introduction to low risk / high reward sets the theme for the rest of the book.

Chapter 2

To dispel the idea that the story described in Chapter 1 was simply a matter of fortunate timing and luck, Pabrai describes another successful entrepreneurial venture where the risks were low but the potential upside was high. The story is that of Manilal Patel, a man who immigrated as an accountant, but could not land a job due to his broken English.

2) Participate in investment opportunities that have minimal downside risk but high upside potential: “Heads, I win; Tails, I don’t lose much.”

Chapter 3

In the first two chapters, Pabrai described how hard-working immigrants with few expenses managed to go from poverty to millions over the course of their lifetimes. Is this the only way to make money with little risk? Absolutely not.

In this chapter, Pabrai tells the story of Virgin, and how its founder Richard Branson is also a Dhandho investor. Branson has managed to take several business ideas that have come to him over the years, invest in them with minimal risk, and generate high rewards. How has he done this? Pabrai gives details about how Branson:

• Started Virgin Airlines with a one-year low-cost lease on a single airplane
• Developed Virgin Pulse with guaranteed distribution and outsourced manufacturing
• Launched Virgin Mobile with no cell-phone network
• Offered Virgin Mortgage without a banking infrastructure

In all of the cases Pabrai describes, the overriding theme continues to be: “Heads, I win; tails, I don’t lose much”. Branson’s businesses don’t take on the risk because they don’t require investment in infrastructure. Instead, they leverage existing infrastructure or outsource to other companies that have to take on the risk. What Branson does get, however, is the upside. With that risk-reward profile, Branson is crowned by Pabrai as a Dhandho investor.

Chapter 4

In 2005, Forbes listed Lakshmi Mittal as the third richest man in the world. Unlike many others on the rich list, Mittal operated in an industry with extremely poor returns on capital – steel mills. As an owner of a steel mill, you have no control over the selling price of your products, and in order to have the capacity to keep producing your end product, you need a constant supply of capital.

Mittal was able to transform his steel mills into efficient steel-producing machines. But if he had grown organically, he likely would never have managed to get his net worth to $20 billion. Instead, he grew by acquiring steel mills that were going under. In some cases, he was acquiring for 10 cents what other investors had built for $1. Once he applied his operational efficiencies to the plants, he had restored the value of the assets to $1 or more, thus generating incredible returns on investment. Once again, Pabrai’s “Dhandho” theme echoes through: the downside is minimal, and the upside is tremendous.

Pabrai also takes us the reader through his own experience applying “Dhandho”. When he started his business, he had $30K in cash, and $70K in credit card maximums. If his investment went south, he would have to declare bankruptcy and will have lost $30K and would simply have returned to his old job. In other words, his downside risk was minimal. But his upside was not. Within a few years, he had sold his business for several million dollars. This represents another example of Pabrai’s “Heads, I win; Tails, I don’t lose much” philosophy.

Chapter 5

While the low-risk / high-reward businesses described in the first four chapters were varied in type, they did share some commonalities. These commonalities form the basis for the rest of the book, where Pabrai discusses these features in detail:

// Chapter 6: Common stocks are best

Of all of the asset classes that investors have the option in which to invest, Pabrai argues that common stocks have proven to offer the best returns. While investors also have the option of buying (and selling) individual businesses, Pabrai offers the following advantages of the stock market: