The Dhandho Investor: Pabrai's Investing Framework

A Dhandho investment is one which involves low risk and potentially high returns, or “Heads I win; tails, I don’t lose much.” Those words came from Mohnish Pabrai (Trades, Portfolio), the founder of Pabrai Funds and author of “The Dhandho Investor: The Low-Risk Value Method to High Returns.”Â

In the first chapter, he explained how one extended family, the Patels from the state of Gujurat in India, managed to buy up more than half of all motels in the United States using this investment philosophy. He followed up with another Indian-American, also from Gujurat, who had built his own empire using these principles and his extended family.

To show that you need not come from Gujurat or have a big family to succeed with Dhandho methods, the author offered the example of Richard Branson and Virgin Atlantic. Similarly, an unrelated entrepreneur in Pakistan, Lakshmi Mittal, used this approach to build a steel mill empire from “a tiny capital base” (it became part of ArcelorMittal (MT, Financial)). And Pabrai cited his own success with TransTech, a tech company he founded in 1991 with $100,000, including $70,000 of credit card debt. Nine years later, he sold it for “several million dollars.”

So how do the rest of us use the Dhandho method? How do we invest in companies with low risk and high returns? To answer that, Pabrai offers his nine-point framework:

1. Focus on buying an existing business rather than starting a new one. An existing business has a financial history that can be analyzed.
2. Shades of Warren Buffett (Trades, Portfolio): Buy a simple business in an industry that is changing very slowly. The motel business is an obvious example, as are most of the companies Buffett has bought.
3. Look for distressed companies in distressed industries. Mittal, for example, “loaded up on assets in severely distressed businesses in a severely distressed industry in severely distressed countries and geographies.”
4. Buy companies with competitive moats. In the case of the Patel motels, that meant a low-cost advantage. For Branson, the moat is made up of his brand, which promises an innovative product or service, and from his ability to execute “brilliantly.”
5. When the odds are in your favor, bet heavily. As we saw in the case of Papa Patel and his motel, he was working with very good odds. If he had failed, he would have lost a few thousand dollars, but if he won, he would get more than 20 times his money back.
6. Focus on arbitrage. This practice generally involves exploiting price differences between two places or among financial instruments. In the case of Lakshmi Mittal, this involved buying steel companies assets for practically nothing, streamlining their operations and becoming a low-cost producer (for a low-cost moat).
7. Classic value investing: Buy companies that are selling for far less than their intrinsic value. This provides powerful protection against buying at a less than optimal price and surprises that may emerge after buying.
8. Watch for low-risk, high-uncertainty businesses. Note here the switch from “high returns” to “high uncertainty.” Pabrai wrote, “Dhandho entrepreneurs first focus on minimizing downside risk. Low-risk situations, by definition, have low downsides. The high uncertainty can be dealt with by conservatively handicapping the range of possible outcomes.”
9. Be a copycat, not an innovator. The author observed that only one Patel family had to be innovative, the rest could take up the original business model by simply copying the first family in the motel business. Even in his own TransTech business, he said he got the idea from his employer at the time, but the company had declined to pursue it.

Not listed among the items in Pabrai’s framework are patience and discipline, an extension of the idea that when the odds are in your favor, you should bet heavily:

“It is not too different from all five of our Dhandho entrepreneurs. They’ve all concentrated their capital and their bets. Most of the time they either do nothing or place miniscule bets (Branson). Every once in a while, they encounter overwhelming odds in their favor. At such times, they act decisively and place a large bet.”

Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.

Read more here:

• The Dhando Investor: Why the Patels Owned So Many Motels
• Buffett on Financial Statements: Which of These 3 Retailers Has the Best Moat?
• Buffett on Financial Statements: When to Buy and When to Sell

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