The Dhandho Investor:- Chapter 12

Hello friends, in today’s article, we see The Dhandho Investor:- Chapter 12, this chapter is all about the margin of safety while you invest in the stock market. so let’s understand this concept in the author’s words.

Previous Chapter 11

Dhandho 401: Margin of Safety – Always

The Dhandho Investor:- Chapter 12

In this chapter, the author refers the Benjamin graham’s book, the intelligent investor, the key idea of investing, and also the importance of the Margin of Safety. the author also gives examples of Warren Buffett’s investments.

so let’s understand it

the author says, ” Mr. Buffett hosts business school students from over 30 universities every year. The schools represent a wide range from Harvard and Yale to the University of Tennessee and Texas A&M.

the students get to ask him questions on almost any subject for over an hour before heading out to have lunch with Mr. Buffett at his favorite Steakhouse.

virtually every group asks Mr. Buffett for Book Recommendations. Mr. Buffett’s Consistent Best Book recommendation for several decades has been Benjamin Graham the “Intelligent Investor”

As he stated to students from Columbia Business in Omaha, Nebraska On March 24, 2006

The Intelligent Investor is still the best book on Investing, it has only three ideas you read need

  • Chapter 8 – the Mr. Market analogy. Make the Stock Market Serve you. the C section of the Wall Street Journal is my business broker it quotes me prices every day that I can take or leave and there are no called strikes.
  • A stock is a piece of a business. Never forget that you are buying a business that has an underlying value based on how much cash goes in and out.
  • Chapter 20 – Margin of Safety, Make sure that you are buying a business for way less than you think it is conservatively worth.

— Warren Buffett

Graham’s perspective on the importance of the margin of safety seems pretty straightforward and simple. recall that Einstein’s five ascending levels of intellect were ” Smart, Intelligent, Brilliant, Generous, simple.”

When we buy an asset for substantially less than what it’s with, we reduce downside, risk, Graham’s Genious Was that he fixated on these two joint Realities.

  1. The bigger the discount to intrinsic value the lower the risk.
  2. the bigger the discount to intrinsic value, the higher the return.

Then the author talks about, papa Patel and Manilal and Branson’s Dhandho with Margin of safety

the author says, ” Papa Patel, & Manilal have likely never heard of Benjamin-Graham. Branson too has likely never read any of Graham’s books.

Their Dhandho journeys have always been all about the Minimization of risk. They’ve always fixated on the seemingly bizarre notion of ” the lower the risk, the higher the rewards.” (The Dhandho Investor:- Chapter 12)

Most of the top-ranked business schools around the world do not understand the fundamentals of margin of safety or Dhandho. for them, low risk and low returns go together as do high risk and high returns.

Over a lifetime, we all encounter scores, of low-risk, high-return bets. they exist in all facets of life. Business schools should be educating their students on how to seek out and exploit these opportunities.”

then the author gives, the example of Margin of Safety

the author says, ” One of the most vivid examples of margin of safety at work in the equity markets is Warren Buffett.

Observations about his purchase of the Washington Post in 1973.

We bought all of our { Washington Post ( WPC)} holding in Mid-1973 at a price of not more than one-fourth of the then per-share business value of the enterprise.

Calculating the price/value ratio required no unusual insights, most security analysts media, brokers, and media executives would have estimated WPC’s intrinsic business value at $400 to $500 million just as we did, and if $100 million stock market valuation was published daily for all to see.

Our Advantage, rather, was attitude; we had learned from Ben Graham that the key to successful investing was the purchase of shares in good businesses when market prices were at a large discount from underlying business values.

— Through 1973, and 1974, WPC continued to do fine as a business, and its intrinsic value grew. Nevertheless, by year-end 1974 our WPC holding showed a loss of about 25% with a market value of $8 million against our cost of $106 million. (The Dhandho Investor:- Chapter 12)

What we had bought ridiculously cheap a year earlier had become a good bit cheaper as the market, in its infinite wisdom, marked WPC stock down to well below 20 cents in the dollar of intrinsic value.

….. Warren Buffett

then author explains, how warren Buffett, gets this company at discounted prices

the author says, ” As inside, Mr. Buffett hasn’t sold a single share a Washington Post over the past 30 years of holding the stock.

that’s original $10.6 million dollar investment is now worth over $1.3 billion over 124 times the original investment. the Washinton post pays a modest dividend, now paid by the past to Berkshire Every year, exceeding the Amount Mr. Buffett paid for the stock in the first place.

Why was the Washinton Post Trading at such a large discount to intrinsic value in 1973/1974?

Mr. Buffett goes on to offer an explanation. Most institutional investors in early 1970, on the other hand, regarded business value as only mirror relevance when they were deciding the prices at which they would buy or sell.

this now seems hard to believe however these institutions were then under the spell of academics at prestigious business schools who were preaching a newly fashioned theory;

the stock market was totally efficient and therefore calculations of business value and even thought, itself, were of no importance in investment activities.

Warren Buffett says, ” We are enormously indebted to those academics what could be more advantageous in an intellectual contest – whether it be a bridge, chess, or stock selection than have opponents who have been taught that thinking is a waste of energy?”

Over the past 20 years, there hasn’t been much change in the thinking of institutional investors with regard to market efficiency as stated by charlie Munger when speaking at the 2004 Wesco annual meeting.

Charlie Munger:- Very few people have adopted our approach… maybe two percent of people will come into our corner of the tent, and the rest of the ninety-eight percent will believe what they’re been told ( p.g. that markets are totally efficient.)

It is instructive to note that Mr. Buffett bought his Washinton post stake at a 75% discount to intrinsic value.

As Benjamin Graham told Senator Fulbright, all discounts, to intrinsic value eventually lose.

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. (The Dhandho Investor:- Chapter 12)

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.

Mr. Buffett has his Washinton Post stake for about $6.15 per share in $25 per share. let’s assume that the Washington Post got to at least 90% of its intrinsic value increased by a modest 10% a year.

So, in 1976, the business would be worth over $33.28 per share ( $25 * 1.1 * 1.1* 1.1), and 90% of that is about $30. If a person bought the Stock in 1973 and sold it in 1976, the annualized return would be about 70% a year. Let’s the kelly Formula and this one, let’s assume the following conservative odds.

Odds of making 4 times or better return in three years – 80%

Odds of making 2 times to 4 times or better return in three years  – 15%

Odds of Breakeven to 2 times – 4%

Odds of a Total loss  – 1%

In this case, the Kelly formula suggests that an investor bet 98.7% of the available bankroll on this mouthwatering opportunity.

At the time, Berkshire Hathaway had a total market capitalization of about $60 million.

Available cash was likely a small fraction of this member. I’d estimate that Mr. Buffett likely used well over 25% of hrs available bankroll on this bet.”

then author explains, Graham’s Fixation on the Margin of Safety

author says, ” Graham’s fixation on the Margin of Safety is understandable. Minimizing downside risk while maximizing the upside is a powerful concept. It is the reason Mr. Buffett has a net worth of over $40 Billion. he got there by taking minimal risk while always maximizing returns.

Most of the time, assets trade hands at or above their intrinsic value. the key, however, is to wait patiently for that super-fast pitch down the center. (The Dhandho Investor:- Chapter 12)

it is during times of extreme distress and pessimism that rationality goes out the window and prices of certain assets go well below their underlying intrinsic value.

Extreme Distress can be caused by macro-events like 9/11 or the Cuban Missile Crisis. or they can be company-specific- for example, Tyco’s Stock Price collapse during the Dennis Kozlowski Corruption Scandal. We can not predict which asset classes are likely to get distressed next. however, if we only focus on a single asset class of Stocks, that encompasses thousands of businesses.

Virtually every week, specific businesses that trade on public markets see their prices collapse. At other times it might be an entire sector that gets written off. More rarely it might be an entire market sells off due to a macro-shock like 9/11

Papa Patel, Manilal, Branson, Graham, Munger, and Buffett have always fixated on a large Margin of Safety and gone to great lengths to seek out low-risk, high-return bets.

it is truly a fortunes’ Formula.”

So this is all about the Dhandho Investor Chapter 12.

The Dhandho Investor Chapter 11

Hello friends, in today’s article, we see The Dhandho Investor Chapter 11 Summary. this chapter is all about fixating on Arbitrage. so let’s understand, how value investors can take benefit from this arbitrage.

Previous Chapter 10

Dhandho 302:- Fixate On arbitrage (Chapter 11)

The Dhandho Investor Chapter 11

In starting the author explain, what is the arbitrage, and how value investor take benefit from that

the author says, ” Arbitrage is a powerful construct and a fundamental tool in the arsenal of any value investor. with arbitrage, we get decent returns with virtually no risk.

The elimination of downside risk, even if the upside is limited, is awesome -& that is exactly what arbitrage gives us. With arbitrage, the appeal is ” Head, I win: Tails, I breakeven or win!”

Although many different forms of Arbitrage exist, compare these four:

1) Traditional Commodity Arbitrage:-The Dhandho Investor Chapter 11

in this, the author explains, Commodity Arbitrage

the author says, ” If gold is trading in London at $600 per ounce and is changing hands at $610 per ounce in new york city, an arbitrageur can buy in London and immediately sell in new york capturing the spread.

Over time, these trades will lead to the special being dramatically narrowed or eliminated.

2) Correlated Stock Arbitrage:-

In this arbitrage, the author gives the example of Berkshire Hathway

the author says, ” Berkshire Hathaway has two Classes of -BRK-A and BRK-B – which trade on the New York stock exchange ( NYSE). BRK-B is economically worth 1/30 of BRK of BRK-A.

One BRK-B share has 1/200 the voting rights of a BRK-A share. so it is slightly inferior as it has less than one-sixth of the voting power for the same dollar and invested, other than that, these two stocks are virtually identical. also, since Mr. Buffett, these close friends have large enough BRK-A Holdings. (The Dhandho Investor Chapter 11)

To control the company, these voting rights differences are mostly irrelevant. BRK-A shares can be converted into BRK-B shares at the discretion of the holder at any time however, the holder can not do the reverse.

Based on these facts, these two stocks should trade in lockstep with each other- or perhaps BRK-B ought to trade at a very slight discount due to its inferior voting rights and one-way conversion features.

However, the reality is different. As figure 11.1 shows, during a recent 3 month period. BRK-B traded mostly at a discount to BRK-A for a few weeks and then traded at a premium for a few weeks.

On some days, the two stocks, differed by up to 1 percent. Assuming minimal frictional costs an arbitrageur could endeavor to capture that spread.

This type of arbitrage exists in a variety of stocks, sometimes holding company stocks, trade at a discount to a sum of the parts even if the parts are individually publically traded.

sometimes the same stocks on different exchanges can have price differences. Closed-end-funds from time to time trade at significant discounts to their underlying assets, all are candidates for arbitrage plays.”

then author explains the merger arbitrage, between two companies

3) Merger Arbitrage:-

the author says ” Public company A announces it is to buy public company B for #15 a share, prior to the announcement B was trading at $10 a share; immediately after the announcement B goes to $14 a share.

if an investor buys B at $14 and holds the Stock until the deal closes; then the $1 spread can be captured for a tidy profit in a few months. (The Dhandho Investor Chapter 11)

However, there is always some risk that the deal does not close. In that case, Company B’s Stock price might head back down to $10 ( or lower). Unlike other forms of arbitrage discussed earlier, this is not risk-free. this is sometimes called risk arbitrage.

There are well-downside statistics on the percentage of announced mergers that never close. don’t get government approval, don’t get shareholder approval, or the like. if you understand the business and these dynamics, you can handicap the odds of the deal closing and decide to place a bet ( or not ) accordingly.”

then author explains, his famous Dhandho arbitrage

4) Dhandho Arbitrage:-

the author says, ” Virtually all startups engage in Dhandho arbitrage. An example of this is presented in chapter 5.

Our barber set up shop in town C and had a 17-mile arbitrage likely was reduced to a few blocks and the arbitrage mostly disappeared. However, while it lasted, he had Super-normal profits.

He got these profits by taking very little risk. It was low risk and high uncertainty that got him his bounty. the barber is a classic Dhandho arbitrageur.

Head, He wins, Tails, he doesn’t lose much!

the overwhelming majority of entrepreneurs are not risk-takers. they are Dhandho arbitrage players. one of the most vivid examples of this dhandho arbitrage. entrepreneurial journeys is the story of computing, documented by Amar Bhide in his wonderful book ” the origin and evolution of new businesses.”

then the author gives a detailed story,

the author says, ” In 1994, computing, was founded by two 20-year-olds- steve Shevlin and Robert Wilkin.

Shevlin was the main driver of the business. A college dropout, Shevlin, entered the army where he trained and worked as an electronic technician. (The Dhandho Investor Chapter 11)

he didn’t care too much for the military’s uptight attitude. After a brief stint, he left the army. Shevlin was unemployed and without much money. He lived in a tiny studio apartment in Florida.

it was the very early days of the personal computer business, and Shevlin being a hacker type, had a computer and a printer in his studio.

The Ideal setup required the printer to be placed away from the PC and he needed a 20-foot cable to connect them. he went to a shop that sold printer cables and computer accessories and asked if they had the long cable he needed.

at that time, when PCs were very few the interfaces for all these cables were not Universal or standard as they are today. there was a hodgepodge of different cabling and socket standards.

The retailer said he had the cable but it was only seven feet long. he suggested daisy-chaining three cables and adding some special connectors to make it all work.

Shevlin was not happy with the total price or nature of the proposed solution. He went back to his studio and thought about the situation. he come back to the retailer and said that he adds been a tech in the army and knew how to make PC cables.

he offered to make and sell cables in a variety of lengths to the retailer. the retailer said that he was used to getting all sorts of requests for cables of different lengths that he did not have the ability to procure or provide. Nonetheless, the retailer was hesitant about taking inventory risk on unbranded cables as some of the different lengths that he did not have the ability to produce or provide.

Nonetheless, the retailer was hesitant about taking inventory risks and unbranded cables as some of the inventory might become obsolete quickly.

Shevlin offered to give it to him on consignment the retailer said that on a consignment basis, he’d stock anything.

so Shevlin was in business with the first customer lined up. Shevlin and Wilkin carefully noted all the missing cable lengths and connections that people might want. (The Dhandho Investor Chapter 11)

They bought 300 free cables and all the hardware to make the various connectors and want to work.

they made various odd-length cables and delivered them to the retailer who was elated. these cables cost about two to three dollars apiece which was very competitive with the other shorter lengths.

the retailer put them for sale at over $30. everyone was happy with the healthy margins.

They started to get more retailers to carry their cables and sales grew significantly over the next few months. then sales started falling.

The retailer put them for sale at over $30. everyone was happy with the healthy margins.

they started to get more retailers to carry their cables and sale grew significantly over the next few months. then sales started falling. the retailers said that they no longer needed the CompuLink cables as their primary vendor had come up with these lengths, and the incumbent had a better brand and packaging.

Shevlin was very disappointed and spent some time thinking. he realized that PC and printer manufacturers are continuously coming up with new models of printers and new models of computers and other devices that need to be connected.

Every few months, CompuLing changed large portions of this product line as competitors entered the fray. Shevlin was always running about three to six months ahead of his big competitors in intraday cables because he was nimble and focused. the competitors were slower because they were larger companies, and it took time to roll out new products.

Shevlin would get the new cables into distributor channels, scoop, in all the super-normal profits as a monopolist, milk it for three to six months, and then be told that he was either being replaced by the mainstream vendor or had to drop prices.

They did exceptionally well with their lowly Dhandho arbitrage and become an Inc.500 company in 1989- one of the fastest-growing businesses in the United States.

They literally were the Ultimate business arbitrage model- one where supernormal profits were totally free but lasted just a few months.

They were good at dealing with uncertainty, low-risk high uncertainty and arbitrage are the core fundamentals of how good entrepreneurs operate. (The Dhandho Investor Chapter 11)

As computer interfaces began to get standardized computing original arbitrage spread all but vanished. it continued to evolve and always looked to exploit on offering gap.

It did find such a gap in complex cable installation today, CompuLink has 600 employees doing mostly cable installation services.

This spread, too, has narrowed, but in the meanwhile, it has built brand and reputation. it’s likely CompuLink Will continue to strive -at least for several more years before this gap closes.

Due to technology changes or more intense competition. ”

then the author gives the examples of GEICO Insurance, the arbitrage spread is its focus on selling auto insurance policies without agents or a branch office Network.

so this is a summary of chapter 11, from the book ” The Dhandho Investor” written by Mohnish Pabrai

problems with cryptocurrency like Bitcoin

Hello friends, in today’s article, we see the problem with cryptocurrencies like bitcoin. so if you know this problem, then you understand the whole technology, and how it works. so let’s start

Bitcoin Story

Problems with Bitcoin:-

problems with cryptocurrency like Bitcoin

let’s understand one by one

1) Scalability:-problems with cryptocurrencies like Bitcoin

In Bitcoin 1 block size is 1 MB means in 1 block we fill that many transactions we have that much capacity. In 1MB 2000-2500, transactions in 1 block and so 1 block created after 10 minutes means the transaction speed is about 34 per second.

But in VISA and Master Card, the transaction speed is about 5000-10,000 transactions per second.

In Bitcoin, transaction speeds are overly slow than existing technology. So what’s the benefit of new technology that has less speed than a current transaction?

and also 3-4 transactions per second are only the virtual number. In bitcoin, nothing happens in a second. On block transaction put after 10 minutes. so whatever 2000-2500 transaction is executed after 10 minutes.

and also said that after the transaction needs 1 hour. means 10 minutes for your 1 transaction and waiting for 4 to 5 other transactions is equal to 1 hour. (problems with cryptocurrency like Bitcoin)

So transaction is very slow on those day trading volume are more than day one transaction takes up to 16 hours to add in the block.

let’s talk about Transaction Fees:-

Normally a bitcoin transaction fee works like this, If I want to sell a bitcoin, I put a transaction and give some bitcoin as a transaction fee to a minor.

and minor only do transactions of those people they give maximum bitcoin as transaction fee.

when lots( 1 million) of transactions come at a time, and in the block, we can add only 2000-2500 transactions. in this scenario, those give the maximum transaction fee that only transactions add to the block at first.

Normally fees for bitcoin transactions are 50 cents to 1 dollar, but the trading volume is big. then the fee is about 55 dollars at this time giving a transaction fee is not possible.

e.g. For 50 dollar transaction amount, I can’t do 30 dollars as a transaction fee and not wait for 16 hours.

so this is a big problem in bitcoin.

Lack of Privacy:-

Bitcoins don’t have privacy.

Blockchain technology is public:- so any new person a see the history of all transactions happening in the bitcoin chain.

and also see which account has the maximum bitcoin, but the account number is kept secret. but if a powerful person wants to see, this account has that much bitcoin, which person has this account?

e.g. in the USA, the Income Tax department takes the personal data of the person, their account number their main address from the crypto exchange.

On Exchange, we do KYC, so they have our data. If any person can hack the exchange, they can get all information of the account number of bitcoins, the person’s name, etc.

or Exchange employee can steal their data, or an outside person by pressuring the exchange can steal the data.

Blockchain is like a Glass locker( like a transparent safe), anyone can see how much bitcoin has ( in their account) but not a personal name, that has their locker, they only know by the private key. (problems with cryptocurrency like Bitcoin)

So in this problem, if someone knows in your locker, and has 100 bitcoin, then a bad person come to your home and by pressurizing you, can take your all bitcoin by using your private key,

3) Hidden Centrality:-

by seeing as an outsider, you see bitcoin is actually decentralized, ( you can read this blog)

4) Harsh Security Model:-

The bitcoin security model is very harsh because on security we use only private keys.

private keys like an ATM pin so those know the ATM pin. those who have an ATM pin can withdraw all money.

But in a bank case, if you forgot the pin then the bank gives you another pin.

if you forgot the private key, then all your bitcoins are permanently gone means you can’t trade them without your private key. (problems with cryptocurrency like Bitcoin)

One reports says, 30% of Bitcoin’s private key is forgotten by people.

5) Harsh Costs:-

Bitcoin mining really expensive

to solve the hash puzzle is expensive because it takes high electricity to run big hardware to solve the easy hash puzzle.

this electricity per year, is more than the more countries, that required electricity in one year, countries like Newzealand, Geese, Portugal

But the hash puzzle is the only thing that makes bitcoin safe and secure

So to solve the hash puzzle, you have to repeat things to get a particular hash value.

so people increase their hash power and upgrade their hardware.

so that effect, they take maximum electricity to run that hardware in the previous 3 years, the power required  9X more as compared to 2017. (problems with cryptocurrency like Bitcoin)

so these are the problems, we have with bitcoin.

Crypto:- Is bitcoin really decentralized

Hello friends, in today’s article, we see the Crypto:- is bitcoin really Decentralized. so the aim of blockchain technology is to become a decentralized system of transactions, that no one can track, or hack. So let’s understand this bitcoin/blockchain technology control.

Previous Article on Bitcoin

Is Bitcoin Really Decentralized?:-

Lots of People say, Bitcoin is decentralized, so after reading this article, you can decide.

so let’s start

First, understand the what is the meaning of the centralized and decentralized system.

  1. In a centralized System:- Have full control in one center component. if you destroy the center components, then all system is shut down.
  2. A Decentralized system, Doesn’t have any central system. if you destroy 2-4 components, then other components run the whole system. (Crypto:- Is bitcoin really decentralized)

In Bitcoins, components called nodes

Nodes:- Nodes have Independently validated all transactions and updated the ledger/blockchain with new valid blocks

Miners are those special nodes

Minors:- Special nodes that bundle valid transactions into blocks to solve the hash puzzle and distribute the new blocks to other nodes.

Nodes and Miners have to download software on the computer to do the mining

that software is called Bitcoin Software, when you run the software, then you work as nodes. work is like checking whether transactions are valid or not.

So some of you as this question is there a home desktop computer that can do minings and get bitcoin by solving hash puzzles?

In 2009, bitcoin come, At that time normal computers also do the mining because very few people know about this, and hash puzzles have less difficulty when competition increases. (Crypto:- Is bitcoin really decentralized)

e,g, First people do mining with a knife, then some people buy a gun, and then some people buy a rifle and do mining, after this, some people buy a machine gun and do mining, and some people buy a tank and do mining.

so just like this, minor update, their hardware now a day bitcoin Hardware are ASICs (Application-specific Integrated Circuits)

Normal computers do lots of work at one time. but ASICs do only one work. and that work does a better way.

ASICs software, after this software no new update comes into the market.

Now a day also we use ASICs software for mining the bitcoin

So nowadays, lots of minors find, so for a person to solve a hash puzzle is difficult. to solve this problem, one concept come is Mining Pools.

Mining Pools means, lots of minors come together and start mining in groups. by using their hash Power and contributing to a mining pool.

by contributing hash power, to the mining pool then these groups’ hash power increases, and the chance of solving the hash puzzle is easy. (Crypto:- Is bitcoin really decentralized)

By solving the hash puzzle, the reward in form of bitcoin is distributed in groups, that give the hash power.

so this system works like this,

so come to our main question is, Is bitcoin really decentralized?

The answer is ya, Bitcoin is Decentralized,

there are no central components that control the system like a person or company. there are only 10,000 nodes available and anyone can become a Node.

rules endorsed in bitcoin software:- by design Bitcoin is decentralized but for some points comes as centralization

so let’s see what are the points,

  1. Bitcoin Software:- 97.5% of nodes use the Bitcoin core software (block system company developed) of 10,000 computers (nodes)  almost everyone uses this software. those who develop this situation got the fund from the Block system company. and also give employment.

By seeing this we can say the Block system controls the ” Bitcoin Core” software, bitcoin software used.

2) Mining Hardware:- 70-80% ASICs, made by Bitmain Company

so mining hardware also has centralization

3) Mining Pools:- Top 4 pools control = 50% Hash power

if the top 5 pools got together then they can attack the blockchain system called a 51% attack

In these 4 pools, 2 pools are owned by one company i.e. Bitmain

if their company decides to change, then bitcoin’s longest chain also changed. Mining pools also have centralization.

4) Chinese Control:- 70-80% of ASICs are made by a Chinese company.

80% of hashing power is controlled by Chinese pools.

You know the Chinese government, this government controls all companies. so this one side says, the Chinese government has centralization. (Crypto:- Is bitcoin really decentralized)

5) Few Nodes:- Blockchain size is 250 GB and growing at 50 GB per year.

In 2018, nodes do not increase in number, with only 10,000 nodes available. In the future may be nodes also go centralized.

Blockchain size is 250 GB and growing at 50GB per year, for blockchain storage facility required.

so when the blockchain, size increases, then small minors live the work of mining, and then only big companies do the mining over time.

Because, any person, in his computer space not give to that thing that gives any reward.

Lastly, in theory, Bitcoin is decentralized but in the real world, it’s centralized.

means not that much is decentralized and some points they go to centralized.

so, friends, this is all about the is that bitcoin is decentralized. (Crypto:- Is bitcoin really decentralized)

so now you can decide if is bitcoin decentralized or not.

Start your blogging Career in Bitcoin:- Link for cheap Hosting:- Click here

The dhandho Investor chapter 10 Summary

Hello friends, in today’s article, we see a summary of the hand Investor chapter 10, this chapter is on Few bets, Big bets, and infrequent bets. if you understand this chapter then you learn how to bet on a company.

so let’s start

Previous Chapter 9

Dhandho 301:- Few Bets, Big Bets, Infrequent Bets

The dhandho Investor chapter 10 Summary

In this chapter, you learn the kelly formula to bet on companies, that win. so let’s understand, how Mohnish Pabrai, learn and use these few  bets, big bets, and infrequent bets, in the author’s words

the author says, ” Let’s assume you were offered the following odds on a $1 bet:

  • 80% chance of winning $21.00
  • 10% chance of winning $7.50
  • 10% chance of losing it all

Let’s further assume that you had $10,000 to your name and you were allowed to bet as much of that bankroll as you wanted. How much of that $10,000 would you be willing to that $10,000 would you be willing to put at stake to play this game once? The answer is clearly not $10,000 as there is a solid 10% chance of being in a poor house.

Betting $1 seems too conservative it isn’t going to move the needle. the good news is that exactly 50 years ago a researcher at Bell Labs in new jersey, in john larry kelly, jr. Pondered this question and published these findings.

Kelly comes up with what is now known as the kelly formula.

The optimal fraction of your bankroll to bet on a favorable bet is:

Edge/odds = Fraction of your bankroll you should bet each time

There is a wonderful book written by William Poundstone entitled fortune’s formula that is well worth reading pounded stone describes the kelly formula beautifully Michael Mauboussin of leggMason recently wrote a paper on the kelly formula where he used the following illustration.” (The dhandho Investor chapter 10)

then the author gives the example to understand the kelly formula

author says, ” Assume you’re offered a coin toss where head means you get $2 and tails cost you $1. how much of your bankroll should you bet if you’re offered these odds?

A/c to the kelly formula. the edge is $0.50 { ( 0.5 * $2 )  + ( 0.5 * -$1)}

the odds are what you win if you win, or $2. so the kelly formula suggests you get 25% ( $0.50 / $2.00) each time.

The first example involves more than 2 outcomes for a detailed treatise on how to calculate the kelly bet size for such bets, go to www.cisiova.com/betsize.asp.

this website not only gives the general case kelly formula, but the author has generously programmed the formula for use by anyone at no charge.

The interested reader may also wish to read Edward thorp’s paper, ” the kelly criteria in blackjack, sports betting, and the stock market

for the first example, the answer is 89.4% of your $10,000 bankroll or $8,940

Papa Patel had likely never heard of the Kelly formula, in chapter 1, we noted that when papa Patel invested $5,000

in his first motel.

He pretty much bet it all on his investment the goods in the aforementioned example are roughly the goods papa Patel was offered an 80 percent chance of having a 21 bagger. (The dhandho Investor chapter 10)

A 10% chance of a 7.5 bagger, and a 10% chance of going broke. In reality, papa Patel was more conservative in his bet than the kelly formula suggested.

He bet 50% of his bankroll. he did have $5,000 to his name and ” bet it all ” but, he had that ace in the hole. the ability to go back, take a job, save $5,000, and try again in a few years. he likely would not to this endlessly because each time he gets older and gets dissuaded from the endless bitter experiences.

Because Dhandho is so deeply rooted in his psyche,

He’s got at least two bets in him. He puts 50 % of his bankroll at risk of the first bet. if it works he does not place a second bet. if it fails, he places a second bet.

Winning the first bet changes the world around him his family no longer lives in the motel. they have hired HDP and can buy a bigger motel. when the now buys another motel ( and hence places his second bet ) it’s with a smaller percentage of his bankroll because the odds are no longer as good.

Even if the odds were simply a 50% probability of a 200% return and a 50% probability of a total loss, the kelly formula suggests that he ought to bet 25% of his bankroll.

historically, the motel business odds have been vastly superior to the aforementioned. the probability of a 100 % loss is well under 5 percent.

the Patel has not been shy about putting up large portions of their bankroll on these mouthwatering odds when they placed their second, third, and nth bet.

they hadn’t heard of kelly or his formula, but it makes perfect Dhandho sense to them, the result is that Papa patels as a group. today own over $40 billion in motel assets, pay over $725 million a year in taxes and employ nearly a million people.

In a speech at the university of southern California’s marshall school of business, Charlie Munger said:

the wise ones bet, heavily when the world offers them that opportunity. they bet big when they have the odds. and the rest of the time they don’t. it’s just that simple.”

then the author explains, how papa Patel, manilla Mittal and you also make a few bets that are given pretty well.

the author says, ” papa Patel, Manilal, Mittal, and Yours truly have always fixated on making very few bets and each bet is pretty large. (The dhandho Investor chapter 10)

All have tried to place bets when the odds were heavily in our favor. this betting lingo is deliberate. to be a good capital allocator, you have to think probabilistically.

the most obvious business model entirely based on over probabilities is a casino. Connoisseurs of blackjack know that the odds change with every card that is dealt. they are always fixating on trying to figure out when the odds are with them and raising their bets accordingly.

As blackjack is played today in casinos, the overall odds are sound with the house, and playing blackjack at a casino is a losing proportion. I have to admit that this hasn’t stopped me.

But it wasn’t always a losing proposition, in 1960, an MIT math professor, ED thorp, used MIT’s computers to run a variety of calculations and come up with optimized blackjack play.

Thorp named the optimal play of cards a basic strategy. he wrote the best-selling book Beat the Dealer. it is, even today regardless of classic work, blackjack players, the world over rely on basic strategy to optimize their card play.

In the 1960s casinos offered single-deck blackjack and dealt with the entire deck. thorp calculated that players who counted cards and scaled their bets based on the residual cards/ left in the deck had an edge over the casinos.

he used the Kelly formula to figure out how much of your bankroll you ought to bet each time based on how favorable the odds were.

for example, if the deck had an overrepresentation of tens and aces, that was good for the player

If the odds were 52:48 in the favor of the player the kelly formula suggested that the player bet 4 percent of his bankroll. that’s what thorp would endeavor to do with every hand.

For thorp, this wasn’t an academic exercise he started frequenting the Nevada casinos and cleaning up. the casinos didn’t understand why he was consistently winning, but, with the mob running the casinos they didn’t wait to understand.

they simply showed him the door and made it very clear that if he ever returned, the reception wouldn’t be so civil.

when Thorp published beat the dealer, players the world over started cleaning up. Casino owners also read thorp’s book and began to make changes to the game over the past four decades, the game has gone through numerous changes.

Each time casinos made a change, some smart gambler would figure it out and make another change. today, most casinos deal from a shoe of six to eight decks. They don’t play the last couple of decks and pit bosses watch the action like hawks. In some casinos, auto shufflers recycle the used cards back in real-time – ensuring that the card pool never has an over or underrepresentation of specific cards. (The dhandho Investor chapter 10)

Thorp related to this changing reality( along with the demanding threats ) and decided that he’d be better off if he applied his talents to  a casino where

  • There were no table limits
  • the offered odds were vastly better
  • the house was civil about taking large losses
  • the mob wasn’t running the casino

He found that such a casino existed and it was the new york stock exchange ( NYSE) and the fledgling options market. rumor has it that Thorp figured out something along the lines of the Black-Scholes formula years before black and Scholes did.

He decided not to publish his finding that the Black-Scholes formula is effective, basic strategy for the options market. it dictates what a specific option ought to be priced at.

Because he was one of the only players armed with this knowledge, thorp could buy underpriced options and sell overpriced ones- making a killing in the process.”

then the author talks about the Thorp

the author says, ” thorp set up a hedge fund, Princeton-Newport partners over a 20-year span, the professor delivered 20% annualized returns to his investors with ultra-low volatility. One of his potential investors was actor Paul Newman.

Newman once asked Thorp how much he could make playing blackjack full-time. thorp could still beat the casinos with his skilled card counting and replied that it would be about $300,000 a year.

Newman then asked him why he wasn’t pursuing it. thorp looked at him and said that the NYSE and options market casinos made him over $6 million a year with minuscule risk. Why pursue $300,000 and take on added risk to life and limb?

In investing, there is no such thing as a sure bet. Even the most blue-chip business on the planet has a probability of not being in business tomorrow. (The dhandho Investor chapter 10)

Investing is all about the odds- just like blackjack thorp is the most vivid example of a human who has mastered these concepts fully. He has repeatedly played the odds on the strip of wall street over the decades and won handsomely on both fronts – creating a huge fortune for himself and his investors. when an investor approaches the equity markets, it has to be with the same mindset that.

Thorp had when he played blackjack; if the odds are overwhelmingly in your favor, bet heavily.

Let’s assume that you have adopted the Dhandho framework and have found an existing publicly-traded company with a simple business model.

further, it happens to be a business under temporary distress, and this has led to a collapse in its stock price. the best part- is it’s a good business with a durable moat. the business is squarely within your circle of competence, and you’ve figured out its intrinsic value today and two to three years out. you’ve found that

the current stock price is less than half of the expected intrinsic value in two to three years. what would cause your stock to reach its intrinsic value in a few years at most? senator William Fulbright fixated on this question and asked benjamin graham about it during one of the more interesting exchanges in a U.S. Senate banking and Commerce Committee hearing on March 11 in 1955.”

then the author gives their conversation about finding undervalue in the company

Fulbright:- One other question and I will desist. when you find a special situation and you decide, just for illustration, that you can buy for $10 and it’s worth $30, and you take a position and then you cannot realize it until a lot of other people decide it is with $30 how is that process brought about by advertising, or what happens? what causes a cheap stock to find its value?

Graham:- that is one of the mysteries of our business and it is a mystery to me as well as to everybody else. but we know from experience that eventually the market catches up with value. (The dhandho Investor chapter 10)

Whenever there is a dislocating event like 9/11 or pearl harbor, stock prices can be severely impacted in the short term, but they tend to bounce back over time. table 10.1

Table 10.1:- DJIA Decline and subsequent Performance after crisis Events

DJIA Loss DIJA Percentage  Gain
Days  After Reaction Dates
Event Reaction Dates Gain/loss (%) 22 63 126
Fall of France 05/09/1940 – 06/22/1940 -17.1 -0.5 8.4 7.0
Korean War 06/23/1950 – 07/13/1950 -12.0 9.1 15.3 19.2
U.S. Bombs Cambodia 04/29/1970 – 05/26/1970 -14.4 9.9 20.3 20.7
Arab oil Embargo 10/18/1973 – 12/05/1973 -17.9 9.3 10.2 7.2
Nixon resigns 08/09/1974 – 08/29/1974 -15.5 -7.9 -5.7 12.5
Hunt Silver Crisis 02/13/1980 – 03/27/1980 -15.9 6.7 16.2 25.8
Financial Panic 1987 10/02/1987 – 10/19/1987 -34.2 11.5 11.4 15.0
Asian stock market Crisis 10/07/1997 – 10/27/1997 -12.4 8.8 10.5 25.0
Russian LTCM Crisis 08/18/1998 – 10/08/1998 -11.3 15.1 24.7 33.7
Mean -16.7 6.9 12.4 18.5
Medium -15.5 9.1 11.4 19.2

 

The nine events outlined in Table 10.1 all led to double-digit declines in the Dow in a Few days a week. However, a few months later, the dow had recovered most, if not all of the fall.

Business-specific micro-events for business, like the Tylenol scare, the Exxon Valdez oil spill, or the American Express ” Salad oil Crisis” in the 1960s have similar traits. they all led to big instantaneous drops as panic and fever set in.

over time, as rationality prevailed prices did recover to more rational levels. similarly, if you invert, in any under or overpriced business, it will eventually trade around its intrinsic value- leading to an appropriate profit or loss.

We can pretty much treat this as a low of investing and hang our hat on it. thus, if we can determine the intrinsic value of a given business for two to three years but can acquire a stake in that business at a deep discount to its value profits are all but assured.

In determining the amount to bet, the kelly formula is a useful guide.”

then the author gives the example of the American Express Salad Oil Crisis

The American Express Salad Oil Crisis:-The dhandho Investor chapter 10

In this, the author says, ” Betting heavily when the odds are overwhelmingly in your favor is something to which warren buffet and Charlie Munger have always subscribed.

In November 1963, Mr. Buffett invested 40% of the Buffett partnership’s assets into a single business, American Express (AmEx)

Where he had no control or say. Because virtually his entire liquid net worth was in the Buffett partnership, he had effectively put 40% of his personal liquid net worth into Amex. (The dhandho Investor chapter 10)

All the time, the buffet partnership had about $17.5 million under management. thus about $7 million was invested in buying the stock of American Express – which had seen its stock price cut in half just before Buffett’s large purchase.

American Express had been hit hard by the Salad Oil Crisis. the company had lent $60 million Against collateral that consisted of a warehouse full of vats of Salad Oil.

It later found that the vats contained mostly seawater and its shady borrower was bankrupt. American Express announced the $60 million loss, and its stock price was instantly cut in half.

At the time, with a total market capitalization of about $150 million, the $60 million was a huge hit to Amex’s fledging, Balance sheet.

Mr. Buffett analyzed the situation carefully and concluded that as long as the trust associated with American Express travels’ checks and charge cards was unaffected, the company’s intrinsic value was significantly higher than the current price at which it was being offered. Seeing virtually no downside and a massive upside, he placed the largest bet he’s ever placed.

he effectively bet 40% of his net worth on a scandal-ridden business making negative headlines daily. What were the odds that this bet offered? if we knew the odds we could pay the kelly formula and see if the bet made sense.

I don’t believe that question has ever been answered directly by Mr. Buffett, but there are some clues in his letter. to partners from 1964 to 1967:

We might invest up to 40% of our net worth in a single security under conditions coupling an extremely high probability that our facts and reasoning are correct with a very low probability that anything could change the underlying value of the investment.

We are obviously only going to go to 40% in very rare situations- this rarity, of course, is what makes it necessary that we concentrate so heavily. (The dhandho Investor chapter 10)

When we see such an opportunity. we probably have had only five or six situations in the nine-year history of the partnerships where we have exceeded 25% any such situations are going to have to promise very significant superior performance.

. … They are also going to have to possess such superior qualitative and/or quantitative factors that the chance of serious permanent loss is minimal….. In Selecting the limit to which, I will go in any one investment, I attempt to reduce to a tiny figure the probability that the single investment can produce a result for our portfolio that would be more than 10% points poorer than the dow.

— Warren Buffett

Note that the language that Mr. Buffett uses is not talking about Surebets- every investment has a probability of a loss. he is not talking about sure bets – every investment has a probability of a loss. He fixated on the odds and did not hesitate in placing large bets when the odds were overwhelming in his favor.

Mr. Buffett generated a three or four-bagger return on his American express investment over three years.

Based on the available facts, let’s assume the conservative odds of this bet are as follows:-

  • Odds of a 200% or greater return in three years      90%
  • The odds of a breakeven return in three years are           5%
  • Odds of a loss of up to 10% in three years                   4%
  • Odds of a total loss on the investment of                     1%

Based on these odds, the Kelly formula would suggest betting 98.3% of the partnership’s assets on the fund.

Mr. Buffett stayed well within the maximum suggested and placed a few other highly favorable bets with the rest of the assets.

then the author gives the logical facts, you can read this in the book, buy this book from the following link

let’s summarize this chapter,

  • learn about the kelly Formula
  • Bet when odds are in our favor
  • Warren Buffett’s partnership investment in SalaD Oil Crises

so this is the all about The Dhando Investor Chapter 10 summary,