A few years back, I read Monish Pabrai’s book The Dhando Investor which explains risk and the basic concepts of investing in a very reader friendly fashion.
One of the main ideas from the book is that low risk investing can equate to high returns.
The Casino Example of Risk
It is obvious that the odds are against you in any casino.
However, if there is at least one table in the whole casino offering odds where you had just a 1% advantage in odds, you would be crazy to be sitting and gambling your money on a different table.
The high risk and huge payout of games such as roulette will draw the crowd and make you look good when you win, but in the end,the house always wins.
Gurus Teach You to Focus on Low Risk InvestmentsWhat Pabrai preaches in his book is to go after the low hanging fruit. The investments where the downside risk is protected.
As Monish Pabrai puts it;
Heads, I win; tails, I don’t lose much!Seth Klarman pounds the table on the same topic in his book, Margin of Safety where he emphasizes the importance of reducing risk in an investment because then the upside will take care of itself.
Phil Town even wrote a book dedicated to Buffett’s rule;
Rule # 1: Don’t lose money.Buffett wrote a paper a while back called The Superinvestors of Graham and Doddsville which discusses the value investing strategies of Benjamin Graham, Warren Buffett and his coalition of “The Superinvestors of Graham and Doddsville” that shows it is indeed possible to keep risk low while producing staggering returns.
Rule #2: Don’t forget rule number 1.
7 Ways to Find Stocks using Low Risk Investment Strategies1. Focus on an existing business – Look at businesses with long history of operations that you can analyze. This is less risky than trying to figure out a startup.
2. Buy simple businesses in industries with an ultra slow rate of change – Buffett tells us
“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.”3. Buy distressed businesses in distressed industries –
“Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives it good results.”4. Buy businesses with a moat –
“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products and services that have wide, sustainable moats around them are the ones that deliver rewards to investors.”5. Bet heavily when the odds are overwhelmingly in your favor – if the market is offering you 10 to 1 odds in your favor for a particular company, would you bet on something else or bet heavily on that one bet and look to do it again and again?
6. Buy businesses at big discounts to their underlying intrinsic value – Minimize downside risk before ever looking at upside potential. If you were to buy an asset at a steep discount to its intrinsic value, even if the future turns out completely unexpected and worse, the odds of loss in capital are low. Ben Graham first brought this concept by stating that
“…the function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future.”7. Look for low risk, high uncertainty businesses – This is a great combination. It produces severely depressed prices for businesses. Think back to the tech bubble. Had you bought great businesses such as Adobe, Apple, Cisco etc at the depressed prices, I’m sure you would be a millionaire right now.