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.
Dhandho 401: Margin of Safety – Always
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.
- The bigger the discount to intrinsic value the lower the risk.
- 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.
Good Business to Invest in Distressed business
Hello friends, in today’s article we see chapter 8 of the book the Dhandho Investor author by Mohnish Pabrai, In this chapter the author explains, we should invest in distressed businesses, which is a good business to invest in. so let’s start to understand distressed business in distressed industries.
Dhandho 201:- Invest In Distressed Business in Distressed Industries
In starting this chapter the author explains, how efficient market theories works and how to affect people’s opinion on that. so let’s see one by one
the author says, ” Efficient market theorists (EMTs) tell us that all known information about a given publically traded business is reflected in its stock price.
then they proclaim that there isn’t much to be gained by being a securities analyst and trying to figure out the intrinsic value of a given business. and with frictional costs thrown in, the EMTs believe stock picking is not just a zero-sum game, but rather a negative-sum game. (Good Business to Invest in Distressed business)
Here are Mr. Buffett’s replies to them.
I’d be a bum on the street with a tin cup if the markets were always efficient investing in a market where people believe in efficiency is like playing bridge with someone who has been told it doesn’t do any good to look at the cards.
It has been helpful to me to have tens of thousands of students turned out of business schools taught that it didn’t do any good to think.
Current financial classes can help you to do average. … Warren Buffett
Mr. Buffett has been Cherry-picking stocks for 56 years and from a standing start has a fortune valued at over $40 billion today.
nonetheless, I mostly agree with the EMTs. Stock prices, in most instances, do reflect the underlying fundamentals, trying to figure out the variance between prices and underlying intrinsic value, for most businesses, is usually a waste of time.
The market is mostly efficient. however, there is a huge difference between most and fully efficient. it is this critical gap that is responsible for Mr. Buffett not being a street corner bum.”
then the author explains, how Warren Buffett writes a wonderful section on EMTs.
the author says, ” Buffett’s 1988 letter to shareholders of Berkshire Hathaway has a wonderful section on EMTs. I strongly recommend reading it.
All the shareholder’s letters are archived on the Berkshire Hathaway website and they are a treasure trove of wisdom. about EMTs Buffett commented: observing correctly that the market was frequently efficient, (academics and wall street pros) went on to conclude incorrectly that it was always efficient, the difference between these propositions is night and day.
-Warren Buffett
The market isn’t fully efficient because humans control its action-driven pricing mechanism. Humans are subject to vacillating between extreme fear and extreme greed. When humans, as a group, are extremely fearful, the pricing of the underlying assets, is likely to fall below intrinsic value; extreme greed is likely to lead to exuberant pricing. (Good Business to Invest in Distressed business)
If a business owner is extremely pessimistic and fearful about the future of his business and decides to sell it, it is likely to take him several months to get a sale consummated.
In the meanwhile, the circumstance causing the fear may have abated or, more likely, rational thinking is likely to have prevailed over time.”
then author explains, how individual investor mindset work in the market
the author says, ” In the case of the stock market, an individual investor in the same doom and gloom mindset would likely have uploaded his entire position in a few minutes.
Hence, stock prices move around quite a bit more than the movement in underlying intrinsic value. Human psychology affects, the buying and selling of fractions of businesses on the stock market much more than the buying and selling of an entire business.
Mr. Market, a creation of Benjamin Graham, lives in the stock market and is a very hyperactive and moody character. He’s buying and selling tiny fractions of several thousand businesses every few seconds.
The price at which Mr. market buys or sells is not based on the intrinsic value of the underlying business. It is determined by his mood. changes in his mood immediately result in prices changes.
Mr. Market’s Pari-mutuel approach to setting prices could not be more different from the way prices are determined for the sale of the entire business with the rapid-five trading of thousands of securities, every once in a while a few stocks might have a great deal of bad news, come out. (Good Business to Invest in Distressed business)
This sometimes leads to extreme fear and the wholesale unloading of these stocks, but when you sell stocks, there has to be a buyer at the other end. the buyer is looking at the same bad news as you are.
the only way such a sale gets consummated is at a deeply distressed price. Papa Patel, Manilal, and Mittal all made their fortunes by a fixation on buying distressed businesses.
Most of the time they did it when the entire industry was severally wounded- the motel industry right after 9/11 or the bankruptcy-ridden steel industry in 1980, and 1990.
The advantage we have over them is that our playing field is much larger; there are thousands of stocks whose prices wiggle around all day long.
All we need to do is to first narrow the universe of candidate business down to ones that are understand well and are in a distressed state.”
then the author gives the 6 points that help us to find out the distressed business.
the author says, ” How do we get a list of distressed businesses or industries? there are many sources, but here are six to begin with.
- If you read the business headlines on a daily basis you’ll find plenty of stories about publicly traded businesses. Many of these news clips reflect negative news about a certain business or industry. for example, Tyco’s stock collapsed when the Dennis Kozlowski scandal was front and center. Martha Stewart’s prison sentence clabbered that stock. More recently, Mr. Spitzer’s adventures with H and R block have led to significant declines in its stock prices. these were all headline stories.
- Value line publishes a weekly summary of the stocks that have lost the most value in the proceeding 13 weeks. it is another terrific indicator of distress. this list of 40 stocks routinely shows price drops of 20% to 70% over that period. the ones with the largest drops are likely the most distressed. It also has a summary every week of the stocks with the lowest price to earnings ratio (p/e), widest discount to book value, highest dividend yield, and so on. Not all these businesses are distressed, but if a business is trading at a p/e of 3, it is worth a closer look.
- there is a publication called portfolio report (www.portfolioreports.com) that is published monthly it lists the 10 most recent stock purchases by 80 of the top value managers. it gleans this information from the various filings that institutional investors are required by laws to make, portfolio lists the buying patterns of such luminaries as Seth Klarman of Baupost, Lou Simpson or Geico, Marty Whitman of Third avenue, Peter Cundall of the Cundall group, Bruce Sherman of private capital management, and Warren Buffett. these managers aren’t 100% focused on distressed situations, but they are focused on value. Distressed situations are a subset of value investing so some of their investments fall into the distressed category. (Good Business to Invest in Distressed business)
- if you’d like to avoid the subscription price tag for portfolio reports, then much of that data can be gleaned by looking directly at the public filings ( e.g. SEC form 13-F ) that Institutional investors have to make. these can be accessed on the EDGAR system ( HTTP://access.edgar-online.com) Alternatively www.nasdaq.com, provides much of the data in condensed form. to get to the data, on the Nasdaq.com main page enter the anyone ticker symbol of a holding you think one of the values investing stars hold. I know Marty Whitman of Third Avenue has Owned Teson Ranch (TRC) for many years, so enter TRC and click on ” Infoquarters” then click ” holding/insiders” then click on ” Total Avenue Management ” and You get a listing of virtually everything the third avenue owns in U,S, stocks, you can do a google search to get the name of the one ticker you need. e.g. If i enter ” Longleaf 13F ” into the google search field, i get links to many of its holding. I can use anyone ticker on Nasdaq.com to get to virtually all its U.S. Holdings.
- take a look at Value investors club ( VIC; www.valueinvestorclub.com) it is a wonderful website started and managed by Joel Greenblatt of Gotham capital. Greenblatt has perhaps the best-audited record of any unleveraged investor on the planet over the past 20 years- a compounded annualized return of 40% we delve more into Greenblatt and his Dhandho approach later in the book. Value investor club has about 250 members by presenting a good investment idea. these members are required to post at least two ideas a year. the quality of these ideas is decent as they are peer-rated. If a member presents shoddy ideas a year. He or she is likely to lose membership privileges. Every week the best ideas ( judged by VIC management) get $5000. the primary benefit of membership is the ability to access ideas in real-time. however, as a guest, you can access the same content with a 2-month delay. it is very much worth looking through VIC for distressed situations. Start with the highest-rated ideas and work downward from there. (Good Business to Invest in Distressed business)
- Last, but certainly not least, please read the little book that beats the Market by Joel Greenblatt. after reading the book, visit: www.magicformulainvesting.com Like Portfolio reports or VIC, not all the stocks on the magic formula, website are distressed, but a meaningful number are we delve further into the magic formula later. Between these sources, there are now a plethora of candidates distressed business to examine how can we ever get our arms around all of them? well we don’t, we begin by eliminating all business. that are either not simple businesses or full squarely outside our circle of competencies. what’s left is a very small handful of simple well-understand businesses under distress we are now ready to apply the areas o the Dhandho framework to the select group.
so this is all about the good business to invest in from chapter 8 of the book the Dhandho Investor
Warren Buffett Books Recommandations
Hello friends, in today’s article we see Warren Buffett Favorite books on investing, and they recommend to everyone who wants to build a fortune in common stocks. This book is recommended by Warren Buffett in public speech and at the Annual Meeting of Berkshire Hathaway. If you really want to learn about investing and want to get rich like Warren Buffett, then you should mus read this warren Buffett’s best books on Investing.
Warren Buffett’s best books on investing:-
let’s start one by one
1) The Intelligent Investor by Benjamin Graham:-Warren Buffett Books
In many interviews so many times asked Warren Buffett about his favorite book, and that book is The Intelligent Investor book. This book he gets in the Omaha Public library, and then they started to read this book, then he realizes that buying stocks and selling stocks have to be reasonable. (Warren Buffett Books)
When he read this book, then forgot about the time and read very clearly and then he understands the Benjamin Graham quote on investment “ The best investment is done when they have done like a business.”
This means if you invest in any stocks, consider investing in the piece of Business. Warren Buffett also says about this books is that this book is all about the mindset of investing, and you required three things
- Patience
- Self-discipline
- Eager to learn attitude
From this book, warren Buffett learn the two basic principles is that 1) Mr. Market and 2) Margin of safety principle
Chapter 8 is about the Mr. market and chapter 20 is about the Margin of safety principle. These two chapters are most favorite subjects of Warren Buffett.
This book also explains the Defensive investor and Enterprising investor.
If you have time to do an analysis of stocks then you should have to become an Enterprising investor, and you don’t have so much time, then you should become a defensive investor by investing in Index funds.
For me, this book is the best best best of all-time Value Investing books. if this book is not written by benjamin graham, then there is no one like Warren Buffett and another value investor that doing badass in now market. they all are scattered with stocks and no one makes the fortune in the stock market. (Warren Buffett Books)
This is the best book on investing and those are beginners, that don’t understand the quantitative part, but they understand the Investment philosophy by benjamin graham.
Everyone should buy this book: click on the book image
Let’s talk about the second book of Warren Buffett’s best books on investing.
2) Common Stocks and Uncommon Profits by Philip A. Fisher:-Warren Buffett Books
Warren Buffett another favorite book from the other authors is Philip A. fisher.
One is meeting Warren Buffett says about his book is, ” I am the 85% of Benjamin Graham and 15% of Philip A. Fisher.”
Do some people say why warren Buffett only says about the 15% percent? the answer is in this book
This book is about growth investing and how to find growth stocks.
In this book, Philip A. Fisher explains the Scuttlebutt method. this method helps you to find a great company and develop the 15 points of an outstanding company that help you find a great company. (Warren Buffett Books)
3) Business Adventure by John Brooks:- Warren Buffett’s books
I don’t read this book, but this book, warren Buffett recommends in many speeches, this book warren Buffett recommend to Bill Gates.
4) Where are the Customers Yachts by Fred Schwed’s:-Warren Buffett books
5) The Little books of common sense investing by John C. Bogle:
This is one of my favorite books, this book is on the Index investing strategy, this strategy beat the top 10 fund managers.
On Index, warren Buffett owns the Million dollar bet, click here to see that bet.
so this strategy works well.
learn this strategy, and this strategy for those people who don’t know much about investing, this strategy makes them very wealthy.
6) Poor charlie Almanack: Charles T. Munger biography book
this book, definitely changes your life, This biography of Charlie Munger, ( vice-chairman of Berkshire Hathaway company). In one interview, Vishal Khandelwal ( value Investing teacher) asks Mohnish Pabrai ( Pabrai fund Manager, founder of Dhakshana foundation) , if you have the choice to keep one book, which book you keep for your lifetime, then he says, poor charlie’s Almanack.
7)
the Most Important Thing by Howard Marks:
8) The Clash of the Culture (Investment vs. Speculation) by JOHN C. BOGLE:
9) Security Analysis by Benjamin Graham and David Dodd:
Security Analysis is the book on Value Investing, in this book, you learn how businessmen buy bonds, stocks, or any other instruments, with the help of the real meaning of investing. (Warren Buffett Books)
So This is not for the beginner. this book is only for those people, who are very serious about investing and Value Investing.
So I am very serious about Value investing for this reason I write each and
every chapter books summary you can read by the following click
- Security Analysis book Introduction
- Security Analysis Chapter 1
- Security Analysis Chapter 2
- Security Analysis Chapter 3
- Security Analysis Chapter 4
- Security Analysis Chapter 5
- Security Analysis Chapter 6
- Security Analysis Chapter 7
- Security Analysis Chapter 8
- Security Analysis Chapter 9
- Security Analysis Chapter 10
10) The Conservative Investor Sleep well by Philip A. fisher:
this is all about the warren buffet favorites books, that help them to become 100 billion dollar man. Warren Buffett always, says, ” I love reading whatever Philip A. fisher wrote.” (Warren Buffett Books)
this type of sentence you also say, while reading their books, because, they are not magical books, they are Logical books.
If you want to read this book, you can buy this book by clicking this book image from the world-famous site Amazon.com
Some of the books show a cheap price, and those are real hard copies, that book is on this link, I hope you should buy this book only.
So this is all about the Warren Buffett books.
Intelligent Investor: Chapter 8
Hello friends, in today’s article we see chapter 8 of the intelligent investor. Investor and market fluctuations, this chapter explains how investors behave and also the market. Warren Buffet(the world’s greatest investor of all time says) ” In intelligent investor book, teach me the two lessons, in chapters 8 and 20.” So chapter 8 of intelligent investors is the most important chapter of all time in Value investing.
previous chapter: Click here
Investor and Market fluctuations:-Intelligent Investor: Chapter 8
In this chapter, the author says there are two ways to make a profit in the market.
- Pricing:
- Timing:
When you make money, you buy a cheap price of stock with a great company. It is the only way you can make money with our value investing philosophy.
When you make money, you time the market.
This job is horrible because you make a little profit of 100 times but you lose a single profit more than the value of 200 times.
So most of the time when you try to time the market,
you go to the speculation side, and the most interesting thing is that you think, you are doing the investment instead of speculation.
This is also called fooling yourself. (Intelligent Investor: Chapter 8)
the author gives us some pointers to remember about the market, they are as follows
When the market goes up:-Intelligent investor: chapter 8
When the market is going up, you are very happy and in that flow of happiness you lose control over yourself,
so the author gives us three important points to ask ourselves about the stock, they are as follows
- Should you sell now? If you ask this question, you get your answer to that.
- should you curse yourself for not buying more, when the price was low?
- Should you buy more now?
This type of question asks you yourself if you get the right answer this answer depends on your behavior and your philosophy.
In my opinion, when you try to sell this stock ask yourself if it’s important now to sell for your financial circumstances, and also the company’s financial circumstances and management.
After this Benjamin gram gives us the famous concept called the Mr. market, let’s see it in detail.
Mr. Market:-Intelligent investor: chapter 8
The author gives us the market is a living thing, and they have human behavior. Considering this concept author gives us some pointers to handle the Mr. market, which are as follows.
- Bipolar Disorder: Mr. market has a disease called bipolar disorder, in this disease Mr. market is happy sometimes and sad sometimes. This disorder is very much harmful to the investor. So this happens with the market at that time you can ignore the market for your protection.
- Mood Swings: Mr. market has two types of mood swings, one is good mood swings and other is bad mood swings, and they want you to behave like that. (Intelligent Investor: Chapter 8)
- Ignore Mr. market: To ignore Mr. market, you have to be very disciplined, and When you want to deal with the market. do when their mood is good, ignore when they have a bad mood.
- Make him your servant: You have to make Mr. Market your servant, not you the servant of Mr. market, This you can do only by ignoring Mr. market.
So dealing with Mr. market you have to control the following things
- Brokerage costs
- ownerships cost
- expectations
- Risk
- Tax bills
- Own behavior
Value investing means controlling your own behavior, If you can’t control the above point you have to the Index fund Investing daily month on month.
this also gives you the best return in the long run. (Intelligent Investor: Chapter 8)
So the author gives us the same point on controlling their own behavior, they are as follows
Advice:
- Our brains are designed to identify patterns: So many people do trading by analyzing the charts of trade and try to identify the pattern by using applied mathematics.
- Don’t check the value of your portfolio frequently: for this, you can consider the portfolio as your house.
- For this purpose you can follow three things: 1) Dollar-cost Averaging 2)Rebalancing 3) signing the investment contract. An investment contract is given in this book, you can see and understand the deep of that contract.
- Tax benefits: For this purpose, you can do the Index fun Investing, is this the best option for the tax benefit? (Intelligent Investor: Chapter 8)
Following this advice you can understand how the market fluctuates and what to do with investors, and also you have to understand the Mr. market.
This is all about chapter 8 of the intelligent investor.
to visit the book summary of one up on wall street book: Click here
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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.
Dhandho 302:- Fixate On arbitrage (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
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
Dhandho 301:- Few Bets, Big Bets, Infrequent Bets
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,
Steel Companies: Mittal Dhandho
Hello friends, in today’s article, we see the Steel Companies of Laxshmi Mittal Dhandho. This story is shared in the book the Dhandho Investor by author Mohnish Prabrai ( Prabrai Fund Manager/ World Famous Value Investor/ Shameless Cloner). so let’s understand maximum capital-intensive business in Dhandho Framework.
Previous Article:- Virgin Groups Case Study
Mittal Dhandho:-Steel Companies
In starting this chapter, the author Mohnish Prabrai gives the background of Lakshmi Mittal.
the author says, ” Bordering Pakistan is Rajasthan, the most colorful state of India, And Marwar is a small district within the state. The Marvaries is regarded by many as being the very best practitioners of the art of Dhandho. Their amazing Dhandho endeavors, in many cases, leave the Patels in the dust.
in the 2005 Forbes ranking of the wealthiest humans on the planet, Bill Gates and Warren Buffett took the usual top two spots. But nipping at their heels at number three is a Marvaris entrepreneur, Laxshmi Mittal.
Mittal, from a standing start, with virtually nothing 30 years ago, has a net worth of over $20 billion today.
He began his Dhandho journey at about the same time as Bill gates, As we knew Bill invested his energies in an industry that offers the highest returns on invested capital. (Steel Companies: Mohnish Prabrai on Mittal Dhandho)
He got a few engineers together, created MS-DOS and Microsoft word, then sold hundreds of millions of copies. Let’s investigate the amazing economics at work. A single copy of Microsoft Office is sent to Dell to load onto Dell PCs.
Each time Dell loads Office on any machine, it sends Redmond, Washington, a few hundred dollars. there are hundreds of millions of copies made all over the planet-yielding billions upon billions every year for Microsoft. the return on invested capital is out of sight and the gross margin approaches 100%. ”
then the author explains the opposite business of Bill Gates’s Software company Microsoft. the business of steel companies started by Laxshmi Mittal
the author says, ” What is amazing about Lakshmi Mittal’s Dhandho journey is that he invested all his energies and tiny capital base in an industry with terrible economics.- i.e. Steel Mills.
Unlike Microsoft, In a steel Mill, you have no control over the Selling price of the finished product and you have no control over the cost of raw materials.
Steel Mills are very Capital-Intensive Creatures, if that wasn’t a toxic-enough cocktail already the workforce is usually unionized. (Steel Companies: Mohnish Prabrai on Mittal Dhandho)
The steel industry has been one of the worst places to invest capital in the past 30 years. It is no wonder that all over the globe the players in space have encountered tremendous pain and a large number have ended up bankrupt.
Mittal Started in 1976 with a single, small nondescript steel mill in Indonesia. Despite having all the odds stacked against him, he ended up creating one of the largest and most profitable steel businesses on the planet.
More important ( for him) he ended up with a net worth of over $20 billion and growing. ”
then the author explains how he does it. they started the Steel Mill Companies.
the author says, ” How does he do it? there is a simple one-word Explanation -Dhandho.
Take the example of the deal he created to take over the gigantic Karmet steelworks in Kazakhstan.
The company had stopped paying its workforce because it was bleeding red ink and had no cash. The plant was on the verge of closure with its Soviet-era managers forced to barter steel for food for its workers.
The Kazakh Government was glad to hand Mr. Mittal the keys to the plant for nothing. Not only did Mr. Mittal retain the entire workforce and run the planet, but he also paid all the outstanding wages and within five years had turned it into a thriving business that was gushing cash.
The workers and townfolk literally worship Mittal as the person who saved their town from collapse. The same story was repeated with the Sidek-Steel Plant in Romania, and the Mexican government handed him the keys to the Sibalsa Mill for $220 million in 1992.
It had cost the Mexicans over $2 Billion to build the Plant. Getting Dollar bills at 10 cents – or less – is Dhandho-on Steroids. (Steel Companies: Mohnish Prabrai on Mittal Dhandho)
Mittal’s approach has always been to get a dollar’s worth of assets for far less than a dollar. And then he has applied his secret sauce of getting these monolith mills to run extremely efficiently.”
then the author explains, how Mittal got 3rd in Forbes magazine, across the world-famous Tech Companies Operators.
the author says, ” The people who founded Google, Oracle, Cisco, and Intel were all very talented, but they also had huge tailwinds propelling their net worth. Into the stratosphere.
They all focused on business with amazing economics and very high returns on invested capital. Amazingly, it is Mittal, facing massive headwinds, who has a higher net worth than all of them.
the Dhandho Framework helped him triumph over all but two members of the forces -400. and as we learn before we’re done, both the guys ahead of him are true connoisseurs and practitioners of the fine art of Dhandho.
Whether you hail from Seattle, Omaha, or Marwar, the Dhanho Framework to business pretty much trounces all others.”
then lastly author gives the final note on Marwaries Dhandho Framework (ways)
the author says, ” A final note on the Marwaris and their ingrained Dhandho ways.
Recently, I had dinner with a good Marwaries Friend of mine, and I asked him how the stereotypical Marwari approaches investing capital in a venture.
He said, quite nonchalantly, that Marwari business people, even with only a fifth-grade education simply expect all their invested capital to be returned in the form of dividends in no more than three years.
they expect that after having gotten their money back, their principal investment continues to be worth at least what they invested in it. (Steel Companies: Mohnish Prabrai on Mittal Dhandho)
They expect these to be ultra-low-risk bets. Now, folks, this is really good stuff- they don’t teach this at the Harvard Business School.
if you simply used this Marwari Formula before making any investments, let me assure you two things.
- You’d take a quick pass on most investments offered to you: and
- Starting with very little capital, after a few decades you’ll be very wealthy.
Enough said.”
so this is all about the Mittal Dhandho Framework on Steel Companies of Lakshmi Mittal from the book the Dhandho Investor written by Mohnish Prabrai.
the DHANDHO INVESTOR By Mohnish Pabrai
Hello friends, in today’s article, we see the new book on value investing from the world-famous and also greater value investor of all time i.e. Mohnish Pabrai. the book’s name is the DHANDHO INVESTOR. In today’s article, we only see the first chapter, which helps you to understand the motel business, and most important Low-risk high return philosophy, in Mohnish Pabrai, words, says, ” if Head: I win, if tail; I don’t lose much”.
so let’s start this book
Chapter 1:-the Dhandho Investor
In the introduction, the author ( Mohnish Pabrai) talks about, how this book, is invented.
the author says, ” this book, the DHANDHO INVESTOR, is a synthesis of ideas lived encountered in my readings, interactions with friends, and various experiences, both visceral and direct.
I have very few original ideas, virtuality everything has been listed from somewhere. if there wasn’t a warren buffet, there wouldn’t be Pabrai funds and there certainly wouldn’t be this book.
It is hard for me to overstate the influence warren buffet and charlie Munger has had on my thinking. their perspectives have, in one way or another, shaped virtually every page. I can never repay my debt to them for selflessly sharing priceless wisdom over the decade’s thanks, warren, and charlie.”
after his grand introduction, let’s start chapter 1 of this book, Patel Motel Dhandho.
Patel Motel Dhandho:-the Dhandho Investor
in this chapter, the author gives the history of Asian Indians and also how the DHANDHO word come, and most important how Patel enters the Motel business in America. so let’s start
the author says,” Asian Indians make up about 1 percent of the population of the united states about three million people. of these, there million, a relatively small subsection is from the Indian state of Gujarat. and very few small subsections of Gujraties, the Patels, are from a tiny area in southern Gujrat.
less than one in five hundred Americans is a Patel. It is this amazing that over half of all the motels in the entire country are owned and operated by patels. what is even more stunning is that there were virtually no patels in the united states just 35 years ago. they started arriving as refugees in early 1970 without much in the way of education or capital.
their heavily accented, broken English-speaking skills didn’t improve their prospects either. from that severely handicapped beginning will all the odds stacked against them, the Patels triumphed.
Patels, as a group, today own over $40 billion in motel assets in the United States, pay over $725 million years in taxes, and employ nearly a million people.
How did this small, impoverished ethnic group come out of nowhere and end up controlling such vast resources there is a one-word explanation: DHANDHO.”
After this, the author explains the Dhandho words,
the author says, ” Dhandho (pronounced dhundoe) is a Gujarati word. Dhan comes from the Sanskrit root word Dhana meaning wealth.
Dhan-dho, literally translated, means ” Endeavors that create wealth”. the street translation of dhandho is simply “Business.” which is business if not an endeavor to create wealth.
However, if we examine the low-risk, high return approach to business taken by the patels dhandho takes on a much narrower meaning. (the Dhandho Investor by Mohnish Pabrai)
We have all been taught that earning high rates of returns requires taking a greater risk. Dhandho flips the concept around. Dhandho is all about the minimization of risk while maximizing the reward.
The stereotypical Patel naturally approaches all business endeavors with this deeply ingrained riskless dhandho framework-for him it’s like breathing.
Dhandho is thus best described as endeavors that create wealth while taking virtually no risk.
Not only should every entrepreneur seek to learn from the Patel dhandho framework, but also the primary audience for this tone-investor and allocators of capital.
Dhandho is capital allocation at its very finest. if an investor can make virtually risk-free bets with 0utsized rewards, and keep making the bets over and over, the results are stunning.
Dhandho is how the patels have exponentially compounded their net worths over the past 30-odd years.
I am getting ahead of myself. sit back, relax grab a cool one, and mellow out. you’re about to begin a remarkable journey-one that I hope is as rewarding and profitable for you as it has been for me and a generation off Patel businessman.” (the Dhandho Investor by Mohnish Pabrai)
then the author gives the history of Patels, I hope you read his history in the book, for that buy this book from the following link(image)
then author explains why Patels choose the Motel business. by taking one the Patel example,
the author says, ” that still begs the questions, why did the first wave of patels who entered the united states go into the motel business? why not delis, laundromats, or drugs stores? why motels? and why not just find a job?
part of the answer lies in another demographic shift that was underway in the early 1970s in the united states. after world war II, there was a huge buildout of suburbia and the interstate highway system.
the automobile had become a middle-class stable and American family-owned motels popped up all along the newly built interstates.
the 1973 Arab oil embargo and misguided American economic policies ( price and wage controls) led to a deep recession across the country.
Motels are heavily dependent on discretionary spending. the recession coupled with rational and sky-high gas prices led to huge drops in occupancy, many small nondescript motels were foreclosed by banks or went or sold at distressed prices. (the Dhandho Investor by Mohnish Pabrai)
at the same time, the kids of their old motel-owner families were coming off getting and saw plenty of opportunity outside of the motel business and left in droves to seek their fortune elsewhere.”
then the author gives the most exciting part of this chapter is the psychology behind buying a motel by Patel.
for that author give papa Patel examples.
Papa Patel:-
the author says, ” it is 1973, papa Patel has been kicked out of Kampala, Uganda and has landed as a refugee in anywhere town, the USA with his wife and three teenage kids.
He has had about two months to plan his exit and has converted as much of his assets as he could into gold and other currencies and has smuggled it out of the country.
It isn’t much- a few thousand dollars. with a family to feed, he is quickly trying to become oriented to his alien surroundings.
he figures out that the best he can do with his strange accent and broken-English speaking skills will be a job bagging groceries at minimum wage.
Papa Patel sees the small 20 rooms motel on ale at what appears to be a very cheap price and starts thinking. if he buys it, the motivated seller or a bank will likely finance 80 percent to 19 percent of the purchase price. His family can live there as well, and their rent will go to zero. his cash requirement to buy the place is a few thousand dollars. Between himself and his close relatives, he raises about $5,000 in cash and buys the motel.
A neighborhood bank and the seller agree to carry notes with the collateral being a lien on the motel. As one of the first patels, in the united state, Dahyabhai Patel succinctly put it, “I required only a small investment and it solved my accommodation problem because ( my family and I could live and work there”
then author explains how the Dahyabhai Patel gets the success and behind their calculated risk.
the author says, ” Papa Patel figures the family can live in a couple of rooms, so they have no rent or mortgage to pay and minimal need for a car. (the Dhandho Investor by Mohnish Pabrai)
even the smallest motel needs a 24-hour front desk and someone to clean the rooms and do the laundry- at least four people eight our each.
Papa Patel lets all the hired help go. mama and papa Patel work long hours on the various motel chores, and the kids help out during the evenings, weekends, and holidays.
Dahyabhai Patel, reflecting on the modus operandi during the early days, said, “I was my own front-desk clerk, my own carpenter, mu own plumber, maid, electrician, washerman, and whatnot.”
with no hired help and a very right rain an expense. Papa Patel motel has the lowest operating cost of any motel in the vicinity. he can offer the lowest nightly rate and still maintain the same ( 0r higher) profitability per room than his predecessor and competitors.
As a result, he has higher occupancy and is making super-normal profits. his competitors start seeing occupancy drop off and experience severe pressure on rates.
their cost structure prohibits them from matching the rates offered by the Patel motel leading to a spiraling reduction in occupancy and profits.
the stereotypical Patel is a vegetarian and leads a very simple life. most restaurants in the united state in 1970. don’t serve vegetarian meals, so eating at home is all the more attractive and much cheaper for Patel families.
they are busy with the motel day and night, so they have little expenses for this family that are abysmally low. with a single beater car, no home mortgage, rent, or utilities, and zero commutes eating out or spending on vacations or entertainment of any type, papa patels family lives quite comfortably on well under $5000 per year.”
then the author explains, what if they don’t buy the motel and do the job and their living expenses
the author says, ” prices are lower in the 1970s, the minimum wage is just $1.60. the best papa and mama Patel could hope for are total annual earnings of about $6000 per year, if they both take up jobs and work full time.
If they buy a 20-room motel, at a distressed price of $50,000 with about $5000 in cash and the rest finances, even at rates of $12 to $13 per day and 50 percent to 60 percent average occupancy, the motel will generate about $50,000 in annual revenue. (the Dhandho Investor by Mohnish Pabrai)
In the early 1970s, with treasures yielding about 5 percent, the owner or most banks will be delighted to finances the motel purchase at a 10 percent to 12 percent of $5000 and another $5000 to $10000 in out of pocket expenses for motel purchase at a 10 percent to 12 percent interest rate with a lien on the property.
Mr. Patel has annual interest expenses of about $5000, principal payments of $5000 and another $5000 to $10000 in pocket expenses are thus under $20,000
even if the family spends another $5000 year on living expenses ( a grand sum in 1970), Papa Patel nets over $15,000 a year after all taxes and all living expenses. If he had borrowed the $5000 from a fellow Patel he has it full repaid in four months. he could even elect to pay off the mortgage on the motel in just three years.
the annual return on that $5000 of invested capital is a stunning 400 percent ( $20,000 in annual returns from the investment- $15,000 in cash flow and $5000 in principal repayment)
if he borrows the $5000 from a fellow Patel, the return on invested capital is infinite zero dollars, in and $20,000 a year out. that’s all fine and dandy you might say, but what if the business does not work out? what if it fails?”
then author explains what if the motel business is failing
author says,” For this first motel purchase, papa Patel not only has to give a lien on the property but most likely also a personal guarantee to the lender as well. however, papa Patel has only $5000 ( or less) to his name, so the personal guarantee is meaningless.
if he is unable to make the payments, the bank can take over the property but he has virtually no assets outside of the motel. the bank has no interest in taking over the motel and running it. it has no such competency.
it will be very hard for the book to sell a money-losing motel and cover their note.
it is very simple:- If a Patel can not make the motel run profitability, no one can. the bank’s best option is to work with papa Patel to make the motel profitable, so the bank is likely to renegotiate terms. and try to help papa Patel get back on trade. (the Dhandho Investor by Mohnish Pabrai)
It is net, net papa Patel still runs the motel; the family still lives there, and he works as hard and as smart as he can to make it- he has no choice. it makes it work or go bust and homeless.
Remember this is an existing business with a very stable business model and a long history of cash flow and profitability.
It is not rocket science. it is a simple business where the low-cost provider has an unassailable competitive advantage, and no one can run it any cheaper than papa pate.
the motel business ebbs and flows with the economy eventually, conditions are likely to become better, the bank is made current on payment, and everyone is happy most of all papa Patel.”
then the author talks about let’s look at this investment as a bet,
the author says, ” let’s look at this investment a bet, there are three possible outcomes.
First, the $5000 investment yields an annualized rate of 400 percent. let’s assume this continues for just 10 years and the business is sold for the same price as it was bought ($50,000)
This is like a bond that pays 300 percent interest a year with a final interest payment in year 10 of 900 percent. this equates to a 21 bagger on annualized return of well over 50 percent for 10 years.
Assuming a 10 percent discount rate, the discounted cash flow stream is shown in table 1.1
Table 1.1 Discounted Cashflow Analysis of the best case for Papa Patel
Year | Free Cash Flow ( $) | Present Value ( $) of future cash flow |
Excess cash | 0 | |
1 | 15,000 | 13,636 |
2 | 15,000 | 12,397 |
3 | 15,000 | 11,270 |
4 | 15,000 | 10,247 |
5 | 15,000 | 9,314 |
6 | 15,000 | 8,467 |
7 | 15,000 | 7,697 |
8 | 15,000 | 6,998 |
9 | 15,000 | 6,361 |
10 | 15,000 | 5,783 |
10 | Sale price 50,000 | 19,277 |
Total | 111,445 |
Second, the economy goes into a severe recession, and business plummets for several years. the bank works with Mr. Patel and renegotiates loan terms as described earlier.
Mr. Patel has a zero return on his investment for five years, and then starts making $10,000 a year in excess free cash flow when the economy recovers and booms (200 percent return every year after five years)
the motel is sold in year 10 for the purchase price. now we have a bond that pays zero interest for five years, then 200 percent for five years, and a final interest payment of 900 percent ( see. Table 1.2) (the Dhandho Investor by Mohnish Pabrai)
Table 1.2 Discounted Cashflow Analysis of the Below-Average case for Papa Patel
Year | Free Cash Flow ( $) | Present Value ( $) of future cash flow |
Excess cash | 0 | |
1 | 0 | 0 |
2 | 0 | 0 |
3 | 0 | 0 |
4 | 0 | 0 |
5 | 0 | 0 |
6 | 10,000 | 5,645 |
7 | 10,000 | 5,131 |
8 | 10,000 | 4,665 |
9 | 10,000 | 4,240 |
10 | 10,000 | 3,854 |
10 | Sale price 50,000 | 19,277 |
Total | 42,812 |
this equates to a seven-bagger on annualized return of over 40 percent for 10 years.
third, the economy goes into a severe recession, and business plummets.
Mr. Patel can not make the payments and the bank foreclose and Mr. Patel loses his investment. the annualized return is 100 percent. these three outcomes cover virtually the entire range of possibilities.
Assume the likelihood of the first option is 80 percent, the second is 10 percent and the third is 10 percent.
These are very conservative probabilities as we are assuming a one in five, chance of the motel performing for worse than projected-even though it was bought on the cheap at a distressed sale price and run by a best-of-breed, savvy, low-cost operator.
We have unrealistically assumed there is no rise in the model’s value or in nightly rates over 10 years. even then, the probabilities-weighted annualized return is still well over 40 percent.
the expected present value of this investment is about $93,400 (0.8 * $111,445 + 0.1 * $42,812)
from papa patels perspective, there is a 10 percent chance of losing his $5000 and a 90 percent chance of ending up with over $100,000 ( with an 80 percent chance of ending up with $200,000 over 10 years.
This sounds like a brainer bet to me.”
so some numbers are coming, please read carefully to understand the wonderful logic behind the motel business.
then the author gives simple race tract examples, on his best advice,
the author says, ” If you went to a horse race track and you were offered a 90 percent chance of losing your money, would you take that bet?
heck yes, you’d take that bet all day long, and it would make sense to bet a very large, portion of your net worth with those spectacular adds. (the Dhandho Investor by Mohnish Pabrai)
This is not a risk-free bet, but it is a very, low-risk high returns bet, Heads, I win; tails, I don’t lose much!
the skeptic in you remains unconvinced that the risk here, is low. you might say that there is still the very real possibilities of going broke if you bet all you have ( like papa Patel has done)
papa Patel does bet it all on one bet, but he has an ace in the hole. If the lender forecloses and he loses the motel, he and his wife can take up jobs bagging groceries, work 60 hours a week instead of 40, and maximize their savings.
At the 1973 minimum wage of $1.60, they earn $9,600 a year. after taxes, they can easily sock away $2,000 to $4,000 year
after two years, papa Patel could step up to the plate and buy another motel and make another bet. The odds of losing this bet twice in a row are 1 in 10. and the odds that it plays off, it’s over a 20-fold return, that’s on an ultra low-risk bet with ultra-high returns one very much worth making!
Heads, I win; Tails, I don’t lose much
with such high cash flow coming in, papa Patel is soon flush with cash. he still has a very modest lifestyle. His eldest son comes of age in a few years and he hands over the motel to him.
the family buys a modest house and goes hunting for the next motel to buy. this time, they buy a larger motel with 50 rooms, the family no longer lives at a motel, but still does not do most of the work, with little in the way of hired help.
the formula is simple: Fixate on keeping, costs as low as possible, charge lower rates than all competitors, drive up the occupancy and maximize the free cash flow.
finally, keep handling over motels to up and -coming Patel relatives to run while adding more and more properties.
there is a snowball effect here and over time we end up with these amazing statistics -half of all motels in the united states are under Patel ownership.
having fully corned the motel market the patels have begun buying higher-end motels and have derived into a number of businesses where they can apply their lowest-cost operations.
Dunkin donuts franchises, convenience stores (7-eleven), and the like. some have even bronched out into developing high-end time-share condominiums.
the snowball continues to roll down this very long hill becoming bigger over time.”
So this is all about chapter 1 from the book ” The Dhandho Investor” on Patels motel Dhandho.