The Dhando Investor: the Low-Risk Value Method for High Returns

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  • “It is these nine principles that constitute the Dhandho framework: 1. FOCUS ON BUYING AN EXISTING BUSINESS. When Papa Patel decided to become an entrepreneur, he did not go out and start a brand-new business. He bought an existing business with a well-defined business model and one with a long history of operations that he could analyze. This is way less risky than doing a startup. 2. BUY SIMPLE BUSINESSES IN INDUSTRIES WITH AN ULTRA-SLOW RATE OF CHANGE. 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 good results. Be fearful when others are greedy. Be greedy when others are fearful.4. BUY BUSINESSES WITH A DURABLE COMPETITIVE: 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.To us, investing is the equivalent of going out and betting against the pari-mutuel system. We look for the horse with one chance in two of winning which pays you three to one. You’re looking for a mispriced gamble. That’s what investing is. And you have to know enough to know whether the gamble is mispriced. That’s value investing.
    6. FOCUS ON ARBITRAGE. Warrent Buffett once said: Because my mother isn’t here tonight, I’ll even confess to you that I’ve been an arbitrageur.7. BUY BUSINESSES AT BIG DISCOUNTS TO THEIR UNDERLYING INTRINSIC VALUE 8. LOOK FOR LOW-RISK, HIGH-UNCERTAINTY BUSINESSES.
    7. BUY BUSINESSES AT BIG DISCOUNTS TO THEIR UNDERLYING INTRINSIC VALUE.
    8. LOOK FOR LOW-RISK, HIGH-UNCERTAINTY BUSINESSES. 9. Invest in the copycats rather than the innovators.”
  • “If we were to look at a business like Google, it starts getting very complicated. Google has undergone spectacular growth in revenues and cash flow over the past few years. If we extrapolate that into the future, the business appears to be trading at a big discount to its underlying intrinsic value. If we assume that not only is its growth rate likely to taper off, but that its core search business monopoly may be successfully challenged—by Microsoft, Yahoo, or some upstart—the picture is quite different. In that scenario, the current valuation of Google might well be many times its underlying intrinsic value. 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. What businesses are simple? Well, simplicity lies in the eye of the beholder.”
  • “Simplicity is a very powerful construct. Henry Thoreau recognized this when he said, “Our life is frittered away by detail … simplify, simplify.” Einstein also recognized the power of simplicity, and it was the key to his breakthroughs in physics. He noted that the five ascending levels of intellect were, “Smart, Intelligent, Brilliant, Genius, Simple.” For Einstein, simplicity was simply the highest level of intellect. Everything about Warren Buffett’s investment style is simple. It is the thinkers like Einstein and Buffett, who fixate on simplicity, who triumph. The genius behind E=mc2 is its simplicity and elegance.”
  • “As an aside, Mr. Buffett hasn’t sold a single share of the Washington Post over the past 33 years of holding the stock. That original $10.6 million dollar investment is now worth over $1.3 billion—over 124 times the original investment. The Washington Post pays a modest dividend that is not included in the 124-times number. That modest dividend, now paid by the Post to Berkshire every year, exceeds the amount Mr. Buffett paid for the stock in the first place.”
  • “It is instructive to note that Mr. Buffett bought his Washington Post stake at a 75 percent discount to intrinsic value. As Benjamin Graham told Senator Fulbright, all discounts to intrinsic value eventually close. Mr. Buffett knew that this gap was likely to close in a few years. 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.”
  • “Wall Street sometimes gets confused between risk and uncertainty, and you can profit handsomely from that confusion. The Street just hates uncertainty, and it demonstrates that hate by collapsing the quoted stock price of the underlying business. Here are a few scenarios that are likely to lead to a depressed stock price: High risk, low uncertainty High risk, high uncertainty Low risk, high uncertainty The fourth logical combination, low risk and low uncertainty, is loved by Wall Street, and stock prices of these securities sport some of the highest trading multiples. Avoid investing in these businesses. Of the three, the only one of interest to us connoisseurs of the fine art of Dhandho is the low-risk, high-uncertainty combination, which gives us our most sought after coin-toss odds. Heads, I win; tails, I don’t lose much! American Express, ADP, Paychex, Procter & Gamble, and Costco are all examples of low-uncertainty businesses. Their stock prices rarely get to bargain basement prices. When uncertainty does cloud their future, as it did for American Express in the 1960s, their stock price will dutifully tank.”
  • “Despite our policy of candor, we will discuss our activities in marketable securities only to the extent legally required. Good investment ideas are rare, valuable and subject to competitive appropriation just as good product or business acquisition ideas are.”
  • “Value investing is fundamentally contrarian in nature. The best opportunities lie in investing in businesses that have been hit hard by negativity. Even the pundits of the efficient market theory, Eugene Fama and Ken French, concluded that stocks in the lowest decile of price/book ratios outperformed stocks in the highest decile by over 11 percent a year from 1963 to 1990. If you had invested $10,000 consistently in stocks with the highest price/book ratios (the Googles of the world) in 1963, it would have grown to about $72,000 by 1990. Not bad. However, if you had invested those same dollars in the cheapest businesses, you’d have $915,000 by 1990. I’d say that’s a statistically significant difference. The problem is that the businesses in the lowest deciles are ones “with the most hair on them.” Investing in them is clearly the ticket to wealth, but trying to get any type of active.”
  • “A critical rule of chakravyuh traversal is that any stock that you buy cannot be sold at a loss within two to three years of buying it unless you can say with a high degree of certainty that current intrinsic value is less than the current price the market is offering.”
  • “The key to being a successful investor is to buy assets consistently below what they are worth and to fixate on absolutely minimizing permanent realized losses. Warren Buffett’s two main rules are: Rule No. 1: Never lose money. Rule No. 2: Never forget rule No.”
  • “The three-year rule also allows us to exit a position where we are simply wrong on our perception of intrinsic value. If we didn’t have an out and always waited for convergence to intrinsic value, we may have an endless wait. There is a very real cost for waiting. It is the opportunity cost of investing those assets elsewhere. Hence, there is a balance between allowing a sufficient time frame for a stock to find its intrinsic value and waiting endlessly.”

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