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

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,

Business Moats:- The dhandho Investor Chapter 9

Hello friends, in today’s article, we see business moats from chapter 9 of the book the Dhandho Investor by author Mohnish Pabrai. In this chapter, we see investing in businesses with durable moats. By investing in this, you get a competitive advantage as compared to their competitor.

so let’s see how to find, that companies that have durable accounts.

Previous Chapter 8

Invest In Business with Durable Moats:-

Business Moat:- The dhandho Investor Chapter 9

In starting this chapter the author explains what is the moat, with his barbershop arbitrage

the author says, ” As we saw in the barbershop arbitrage example, our barber is initially the only game in town. he is thus able to charge significantly more than the barbers in the neighboring towns and make supernormal profits.

Capitalism is greed-driven, and as barbers in the other town, get word of the spectacular opportunities in town C, they rush to open up barbershops.

Over time, the price to get a trim in town C is no different from town A or Town B. Capitalists strive hard to capitalize on any opportunity to make outsize profits. the irony is that, in that pursuit, they usually destroy all outsized profits.

but every once in a while a business with a secret sauce for enduring outsize profits emerges.

take the example, of one of my favorite restaurants Chipotle. whenever I go there, there is usually a line all the way to the door. In spite of the fact that there is this long line and I live in southern California with a plethora of choices for Mexican food, I remain loyal to Chipotle. (Business Moat:- The dhandho Investor Chapter 9)

Why? Well partly it’s the fresh high-quality ingredients, partly it’s the tasty food, partly and ambiance, and partly the ability to precisely decide which ingredients I want and in what quantity.

All the other Mexican and fast-food restaurant owners in town are fully aware of the chipotle phenomenon. they hate it and want to do something about it, but they can’t – not easily anyway. It would be a significant uphill battle to replicate chipotle, I’m sure many will try, and eventually, a few might succeed but in the meanwhile chipotle is likely to continue to thrive for years on end.

when more players enter the market, they are likely to take customers away from other restaurants rather than chipotle.”

then author explains, the Chipotle business moat,

the author says, ” From a standing start just 13 years ago, Chipotle recently opened its 500th restaurant. it could easily grow 10 times or more.

Its present footprint, not to mention its enormous prospects overseas. Chipotle has a durable moat.

This moat allows chipotle to have the ability to earn supernormal profits. Best I can tell those profits are here to stay at least for the next decade or longer. (Business Moat:- The dhandho Investor Chapter 9)

There are businesses with deep moats all around US-American express. Coca-cola, H & R Block, Citigroup, BMW, Harley-Davidson, WD-40, Nabisco’s Oreo cookies- the list is endless.

There are businesses with shallow or nonexistent moats all around the US its well- Delta Airlines, General Motors, Cooper tires, encyclopedia Britannica, Gateway computers, and so on.”

then the author explains, how to find the moat, and most moats of companies are hidden

the author says, ” Sometimes the moat is hidden. take a look at Tesoro Corporation. It is in the Oil Refining business- which is a community. Tesoro has no control over the price of its principal finished good, gasoline, nonetheless, it has a fine Moat.

Tesoro’s Refineries are primarily on the west coast and in Hawaii. Refining on the west coast is a great business with a good moat.

There hasn’t been a refinery built in the United States for the past 20 years. Over that period. the number of refineries has gone down from 220 to 150, while oil demand has gone up about 2 percent a year. the average U.S. refinery is operating at well over 90 percent of capacity. (Business Moat:- The dhandho Investor Chapter 9)

anytime you have a surge in demand, refining margins Escalate because there is just not enough, Capacity. West Coast refiners also have a good moat because state EPA regulations in California and Hawaii are very stringent and require unique formulations.

Refining on the West Coast and Hawaii carries much higher margins than the rest of the country. A refiner in Texas can not easily serve the California market. the California refiner is the one that usually serves the California market, which means that when Tesoro has a refinery in California it has a very large captive market.”

then the author talks about how we know when a business has a hidden moat and what that moat is

the author says, ” In the overwhelming majority of businesses the various moats are mostly hidden or only in partial view. it takes some digging to get to the moat.

how do we know when a business has a hidden moat and what that moat is? the answer is, usually visible from looking at its financial statements. good businesses with good moats, like our barber, generate high returns on invested capital.

The balance sheet tells us the amount of capital deployed in the business, and the income and cash flow statements tell us how much they are earning off that capital. (Business Moat:- The dhandho Investor Chapter 9)

So If a chipotle, store costs $700,000 to open and it generates $250,000 a year in free cash flow, it’s a damn good business. Every three years it can take that cash flow and open another chipotle. when it starts franchising, the return on invested capital is exponentially higher.

throughout history, kings have caught to build heavily fortified castles with ever-widening and deeper moats. At the same time, the marauding invaders continued to attack unabated and endlessly improved the tools, techniques, and armies at their disposal to capture these prize castles, it is virtually a law of nature that no matter how well fortified and defended a castle is, no matter how wide or deep its moat, eventually it is going to full to the Marauding invaders.

Throughout history, every great civilization and kingdom have eventually declined.”

then the author talks about the narrow and nonexistent moats

the author says, ” The business mentioned earlier as having borrow, or nonexistent moats, Delta, Gateway, General Motors, all had pretty formidable moats at one time. (Business Moat:- The dhandho Investor Chapter 9)

they have all eroded over time, just like the moat well-defended castle eventually falls into the enemy’s hand. Here is Charlie Mungers on it:-

Of the fifty most important stocks on the NYSE in 1911, today only one, general electric remains in business…. that’s how powerful the forces of competitive destruction are. over the very long term, history shows that the chances of any business surviving in a manner agreeable to a company’s owner are slim at best.   – Charlie Munger

There are no such things as a permanent moat. even such invincible, businesses today like eBay, Google, Microsoft, Toyota, and American Express will all eventually decline and disappear.

Some moats are more durable than others. Wells Fargo and American Express were founded over 150 years ago, and amazingly both their moats are as robust as ever today. amazingly, as an aside, both American Express and Wells Fargo were founded by the same person, Henry Wells.

But here is the dilemma: if you were picking stocks a century ago, it would have been virtually impossible to pick these two out of the larger available universe, the odds are very high that even if the ones you picked were the bluest of the blue chips, they would eventually wither away. (Business Moat:- The dhandho Investor Chapter 9)

In 1977, Arie de Geus Wrote a Fascinating book called the Living company.

Geus studied the life expectancy of companies of all sizes and was very surprised to find that the average fortune 500 company had a life expectancy of just 40 to 50 years.

it takes about 25 to 30 years from Formation for a highly successful company to Earn a spot on the fortune 500.

Geus found that it typically takes many blue chips less than 20 years after they get on the list to cease to exist. the average fortune 500 business is already past its prime by the time it gets on the list.

Even businesses with durable moats, don’t last forever thus when using the John Burr Williams Intrinsic Value formula, We ought to limit the number of years, we expect the business to thrive. we are best off never calculating a discounted cash flow stream for longer than 10 years or expecting a sale in year 10 to be at anything greater than is times cash flows at that time ( plus any excess capital in the business.) (Business Moat:- The dhandho Investor Chapter 9)

so this is all about chapter 8 of the book the Dhandho Investor on Invest in business with durable advantages.

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.

Previous Chapter 7

Dhandho 201:- Invest In Distressed Business in Distressed Industries

Good Business to Invest in Distressed business

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.

  1. 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.
  2. 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.
  3. 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)
  4. 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.
  5. 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)
  6. 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

Intrinsic Value of Simple Businesses

Hello friends, in today’s article we see the intrinsic value of simple businesses, and how it is calculated from the book ” the Dhanndho Investor ” Chapter 7. In this chapter the author Mohnish Pabrai gives the intrinsic value of any business, to help in investing in simple businesses.

so let’s start, with how to invest in simple businesses.

Previous Chapter 6

the Dhandho Investor:- Chapter 7 (Intrinsic value)

Intrinsic value

in this author explain, how we can invest in any business by knowing its intrinsic value. so let’s understand this concept

the author says, ” the advantage of buying a fraction of an existing business is pretty clear, but before we buy, we must know its intrinsic value. how else would know it’s a good deal at a given price? What is the intrinsic value of a business is there a general formula? How do we figure it out?

Every business has an intrinsic value, and it is determined by the same simple formula. John Burr Williams was the first to define it in his theory of investment value. published in 1938.

For William, the intrinsic value of any business is determined by the cash inflows and outflows discounted at an appropriate rate – that can be expected to occur during the remaining life of the business.

the definition is painfully simple.”

then the author gives one example of a gas station, and how the intrinsic value of that gas station.

the author says, ” To illustrate let’s imagine that towards the end of 2006, a neighborhood gas station is put up for sale, and the owner offers it for $500,000. Further, let’s assume that the gas station can be sold for $400,000 after 10 years.

Free Cashflow- Money that can be pulled out of the business – is expected to be $100,000 a year for 10 years. let’s say that we have an alternative low-risk investment that would give us a 10% annualized return on the money.

Are we better off buying the gas station or taking our virtually assured 10% return? I used a Texas Instruments BA-35 calculator to do these discounted Cash Flow ( DCF) Calculations.

Alternatively, you could use excel. astable 7.1 demonstrate, the gas station has an intrinsic value of about %775,000

Table 7.1 Discounted Cash Flow (DCF) Analysis of the gas station

Year Free Cash Flow ($) Present Value ($) of Future Cash Flow ( 10%)
2007 100,000 90,909
2008 100,000 82,645
2009 100,000 75,131
2010 100,000 68,301
2011 100,000 62,092
2012 100,000 56,447
2013 100,000 51,315
2014 100,000 46,650
2015 100,000 42,410
2016 100,000 38,554
2017 Sale Price  400,000 154,217
Total 768,671

We would be buying it for $500,000 so we’d be buying it for roughly two-thirds of its intrinsic value. If we did the DCF Analysis it looks like Table 7.2

Table 7.2 Discounted Cash Flow ( DCF) Analysis of the 10 percent yielding low-risk alternative.

Year Free Cash Flow ($) Present Value ($) of Future Cash Flow ( 10%)
2007    50,000 45,454
2008     50,000 41,332
2009    50,000 37,566
2010    50,000 34,151
2011    50,000 31,046
2012    50,000 28,224
2013    50,000 25,658
2014     50,000 23,325
2015    50,000 21,205
2016      50,000 17,277
2017     Capital returned  500,000 192,772
Total 500,000

Not surprisingly the $500,000 invested in our low-risk alternative has a present value of exactly that – $500,000

Investing in the gas station is a better deal than putting the cash in a 10% yielding bond- assuming that the expected cash flows and sale price are all but assured.”

so above calculation, you see that buying the $500,000 is below the intrinsic value of a Gas Station. then the author gives the same example, in the stock market also.

the author says, ” The stock market gives us the price at which thousands of businesses can be purchased. We also have the formula to figure out what these businesses are worth, it is simple

When we see a huge gap between the price and intrinsic value of a given business – and that gap is in our favor – we can act and buy that business- and let’s take the of a well-known retail business, Bet, Bath, Beyond (BBBY).

I have to admit that I have never analyzed BBBY before. I have been to its stores a few times over the years, and it has been a pleasant experience.

As I write this, BBBY has a quoted stock price of $36 per share and a market cap of $10.7 billion.”

then the author calculates the intrinsic value of BBB Y’s company

the author says, ” What is BBBy’s intrinsic Value? let’s take a look at a few BBBY statistics a Yahoo finance, BBBY had $505 million in net income for the year ended February 28, 2005

Capital Expenditures for the year were $191 million and depreciation was $99 million. the ” Back of the Envelope.” net Free cash was about $413 million.

It looks like BBBY is growing revenues by 15% to 20% and net income by 25% to 30% a year. it also takes like it stepped up Capital expenditure (Opex) spending in 2005, let’s assume that free cash flow grows by 30% a year for the next three years and then grows 15 % a year for the following three years

then 10% a year after where. further, let’s assume that the business is sold at the end of that year for 10 to 15 times free Cash flow plus any excess capital in the business.

BBBY has about $850 million in cash in the business presently ( see table 7.3)

Table 7.3 Aggressive Discounted Cash Flow ( DCF) Analysis of Bed Bath and Beyond

Year Free Cash Flow ($MM) Present Value ($MM) of Future Cash Flow ( 10%)
Excess CASH    850
2006     523 475
2007    679 561
2008    883 663
2009    1016 693
2010    1168 725
2011    1340 758
2012     1478 758
2013    1625 758
2014      1787 758
2015     1967 758
2016 Sale Price 29,500 11,373
Total 19,130

so, the intrinsic value of BBBY is about $19 billion, and it can be bought at $10.7 billion. I’d say that’s a pretty good deal, but look at my assumptions – they appear to be pretty aggressive.

I’m Assuming no hiccups in its execution no changes in consumer behavior, and the ability to grow revenues and cash flows pretty dramatically over the years, what if we made some conservative assumptions?

We can run the numbers with any assumptions. the company has not yet released numbers for the year ended February 28, 2006, but we do have nine months of Data ( through November 2005)

We can compare November 2005 data to November 2004 data. Nine-month revenues increased from $3.7 billion to $4.1 billion from November 2004 to November 2005 and earnings increased from $324 million to $375 million. It looks like the top line is growing by 1% a year- going from 15% to 5% and its the final sale price is 10 times 2015 free cash flow the BBBY’s intrinsic Value looks like Table 7.4

Table 7.4 Conservative Discounted Cash Flow ( DCF) Analysis of Bed Bath and Beyond

Year Free Cash Flow ($MM) Present Value ($MM) of Future Cash Flow ( 10%)
Excess CASH    850
2006     469 426
2007    535 442
2008    604 454
2009    680 464
2010    751 466
2011    827 467
2012     901 462
2013    973 454
2014      1041 442
2015     1103 425
2016 Sale Price 11,030 4252
Total 9,604

Now, we end up with an intrinsic value of $9.6 billion.

BBBY’s Current Markt Cap is $10.7  billion. if we made the investment, we would end up with an annualized return of a little under 10%.

if we have good, low-risk, alternatives where we can earn 10%, then BBBY does not look like a good investment at all. so what is BBBY’s real intrinsic value?

My best guess is that it lies somewhere between $8 to $18 billion. And in these calculations, I’ve assumed no dilution of stock via option grants, which might reduce intrinsic value further.

With a present price tag of around $11 billion and an intrinsic value range of $8 to $18 billion. I’d not be especially enthused about this investment. there isn’t that much upside and a fairly decent chance of delivery under 10% a year. for me, it’s an easy pass.”

then the author comes the lesson of these examples,

the author says, ” We’re getting off track, the objective of this exercise is not to figure out whether to invest in BBBY stock. it is simply to demonstrate that while John Burr William’s definition of Intrinsic value is painfully simple, calculating it for a given business may not be so simple.

I think of BBBY as a fairly straightforward, low-tech, and simple business to understand. Even with its simplicity, we end up with a pretty wide range of its intrinsic value.

If we were to look at a business like Google. it starts getting very complicated. Google has undergone spectacular growth in revenues and cash flow over the past few years If we extrapolate that into the future, the business appears to be tracking at a big discount to its underlying and intrinsic value.

if we assume that not only is its growth rate likely to topper off, but that its core search business monopoly may be successfully challenged – by Microsoft, Yahoo, or some upstart – the picture is quite different. In that scenario, the current valuation of google might well be. many times it’s under intrinsic value.

The Dhandho way to deal with this dilemma is painfully simple: only invest in businesses that are simple- ones where conservative assumptions about future cash flows are easy to figure out.

What businesses are simple? well, simplicity lies in the eye of the beholder. Papa Patel bought a business that’s very easy to understand. the motel had a long history of revenues, cash flows, and profitability available for analysis.

From that data, it is not too hard to get a ballpark range of estimated cash flow that the motel is likely to generate in the future. Papa Patel also has a good handle on potential repairs and capital expenses that were likely to be required in the future based on the historical data and the condition of the property.”

then author explains the power of simplicity

the author says, ” simplicity is a very powerful construct. Henry Thoreau recognized this when he said, ” Our life Is frittered away by detail… simplify, simplify,” Einstein also recognized the power of simplicity, and it was the key to his breakthroughs in physics. he noted that the five ascending levels of intellect were, ” Smart, Intelligent, Brilliant, Genius, simple,”

for Einstein, simplicity was simply the highest level of intellect. Everything about, Warren Buffett’s investment style is simple. it is the thinkers like Einstein and Buffett, who fixate on simplicity who triumph. the genius behind E=mc2 is its simple elegance.

Everything about the Dhandho is simple, and therein lies its power. As we see in Chapter 15, the psychological warfare with our brains really gets heated after we buy stock.

The most potent weapon in your arsenal to fight these powerfully simple. there’s for why you’re to make a great, deal of money and unlikely to lose much. I always write the there down. if it takes more than a short paragraph, there is a fundamental problem. If it requires me to fire up excel, it is a big red flag that strongly suggests that I ought to take a pass.”

If you want to learn more about value investing, and finding great business, then buy this book from the following link

so this is all about the Intrinsic Value, from the book ” The Dhandho Investor” Chapter 7 written by author Mohnish Pabrai.

How much does it cost to Buy an Existing Business By Mohnish Pabrai

Hello friend, in today’s article we see how much it cost to buy an existing business from the book ” The Dhandho Investor” chapter 6 by author Mohnish Pabrai. In this chapter, the author explains that it’s better to buy an existing business than the Starting a new business.

so let’s understand the logic behind this

Previous Chapter 5

The Dhandho Investor:- Chapter 6 ( Buying an Existing Business)

How much does it cost to Buy an Existing Business By Mohnish Pabrai

In this chapter, the author explains that buying an existing business with the help of the stock market is way better than starting your own business. if you want to start a Value Investor career, then this chapter will change your life perspective to starting a business.

so let’s start with the author’s words,

the authors say, ” There are a plethora of asset classes you would choose to invest in – CDs U.S. Treasuries, Bonds, Stocks, Real estate, private businesses, gold, silver platinum, oil furniture. the list is endless.

If you examine returns from the Board of Stock Market indexes over the past one hundred years, it is pretty clear that stocks do better than virtually all other easily accessible asset classes.

the evidence overwhelmingly suggests that over the long haul, the best place to invest assets is in common stocks, let’s investigate this particular creation of mankind called the stock market.

The first stock market was formed in just 1790 in Philadelphia, followed by the new york stock exchange in 1972. A stock is seen by many as a cryptic piece of paper whose price wiggles around continuously, that’s one way to look at stocks. (How much does it cost to Buy an Existing Business By Mohnish Pabrai)

A far better way, suggested by Benjamin Graham, is to think of them as an ownership stake in an existing business. Papa Patel’s Motel is not publically traded on any stock exchange. if it were and you bought some of it, Now you and papa Patel are partners.”

then the author gives the Six big advantages of Stocks to buy the existing business that is traded on an exchange.

the author says, ” There are six big advantages that the stock market offers versus the buying and selling of an entire business.

  1. When you buy an entire business, as Papa Patel did, there is some serious heavy lifting required. you either need to run it or find someone competent who can this is no small task. Papa Patel did well but it required tremendous energy and dedication from his whole family for several years to make it work.
  2. When you buy a stock, you now have an ownership stake in the underlying business with a huge advantage- the business is already started and running. You can share in all the rewards of business ownership without much effort. the stock market enables you to own fractions of a few businesses of your choosing, over a period of your choosing with full liquidity to buy or sell that stake anytime with a few circles on Your computer. Humanity has given you a marvelous asset-compounding machine that’ is vastly superior to virtually all other alternatives and makes it all amazingly cheap and easy to use. Papa Patel does not have these advantages and we have a huge leg up on him with the stock market at our disposal. the key is to only participate in the stock market using the powerful Dhandho Investing Framework. (How much does it cost to Buy an Existing Business By Mohnish Pabrai)
  3. When humans buy or sell a whole business both sides have a good sense of what the asset is worth and a rational price is virtually arrived at. sometimes in these transactions, if the business or industry is distressed, buyers might get a bargain as papa Patel did, but those are anomalies. Sellers usually get to time these sales to their benefit. As a result, you typically end up with Fair to exuberant pricing. the stock market operates like the Pari-mutual in horse racing, the auction process occasionally leads to a wide divergence between the value of a business and its quoted market price in a few stocks. We can do very well by only placing an occasional bet when the odds are heavily in our favor. According to Charlie Munger:- If you stop to think about it, a pari-mutual system is a market everybody goes there and bets, and the odds change based on what’s bet. that’s what happens in the stock market.
  4. Buying an entire business- even a small/ neighborhood gas station or a laundromat- requires some serious capital. In the stock market, you can hitch your wagon to the future prospects of any business with what you have in your wallet right now. the ability to get started with a tiny pool of capital- and add to that pool over the year- is a huge advantage.
  5. There are thousands of publicly traded businesses in the united states, and you can buy a stake in any of them with a few mouse clicks. you can buy stocks in a plethora of other countries with ease as well. I’d estimate that the average individual investor could easily buy a stake in well over 100,000 businesses around the planet with a couple of brokerage accounts. In contrast, think about how many private businesses are on sale within 25 miles of your home, at any given time there is just no comparison.
  6. At the race track, the track owner takes 17% of every dollar bet. the frictional costs are very high. Even when you buy a tiny private business, transaction costs between the buyer and seller are usually between 5 percent to 10 percent of the purchase price which doesn’t include the considerable time and effort expended. You can buy and sell a stake in a publically traded company for under $10. with a $100,000 portfolio and even at a hyperactive 50 trades a year, frictional costs are 0.5% – and they keep getting lower ( as a percent) as the value of the portfolio rises over time.

ultra-low frictional costs are a huge business is the best path to building wealth. And with no heavy lifting required, bargain buying opportunities, ultra-low capital requirement, ultra-low frictional costs, buying stakes in a few publically traded existing businesses is the no-brainer Dhandho way to go.”

so you get the idea, the best way to make money or multiply money is to buy the existing business with a simple model with the help of the stock market.

so in the next chapter, we see which business we should invest in.

so this is all about how much does to buy a business existing business, from the book ” the dhandho Investor ” chapter 6

buy this book to learn more about value investing.

Picking Stocks By Mohnish Pabrai

Hello friends, in today’s article, we see the 9 principles of Investing in any business to get a multi-bagger return, by picking stocks on the Mohnish Pabrai Checklist. From the book ” The Dhandho Investor” written by Mohnish Pabrai. the 9 principles that constitute the Dhandho Framework, from chapter 5 of the book ” The Dhandho Investor”.

so let’s understand these 9 principles of the Dhandho framework.

Mohnish Pabrai First Business

The Dhandho Framework:-Picking Stocks By Mohnish Pabrai

Picking Stocks By Mohnish Pabrai

In starting this chapter, the author explains the previous chapter, how they define the Dhandho Framework, and get the maximum return, with very low risk.

so let’s start, the author says, ” On the Surface, the journeys are undertaken by Papa Patel, Manilal, Branson, Mittal and You’re truly are all pretty diverse. The roads we all took, however diverse, all led to a similar destination. Our journeys share a number of core principles. it is these nine principles that constitute the dhandho framework.”

then the author gives his own, checklist, that defines how is a great investor, gets continuously 26% return per year on his investment, continuously for the long term.

Friends, if you, understand this Dhandho Framework, then picking stocks, for your value investing purpose, is going to be very easy. so let’s see one by one What are the 9 principles of the Dhandho framework, we can use to pick stocks.

1) Focus on Buying an Existing Business:-Picking Stocks By Mohnish Pabrai

In this principle, the author explains, starting a business is more difficult than buying an existing business or pieces of business i.e. stocks.

in this principle some names are unknown to you, so for this, you can read their business in previous chapters, by clicking on their link to understand this principle

the author says, ” When Papa Patel ( Motel Patel Dhandho) decided to become an entrepreneur, he did not go out and start a brand new business. He bought an existing business with a well-defined business model and one with a long history of operations that he could analyze.

This is way less risky than doing a Startup. Manilal and Mittal did the same.”

to better understand this principle, read the above link article, to learn the power of focus on buying an existing business. (Picking Stocks By Mohnish Pabrai )

then the author gives the second principle of picking stocks in the Dhandho Framework.

2) Buy simple Businesses in industries with an ultra-slow rate of change:-(picking Stocks)

In this principle, the author explains, a simple business is giving more return than any complex business, which changes every time.

the author says, ” it is unlikely Papa Patel had ever even heard of Warren Buffett in the early 1970s. while being raised in environments that could not be more different, each reached the same conclusion: Buy a simple business with ultra-slow long-term change.

on this simple business, warrant Buffett gives the quote,

” We see change as the enemy of investments… so we look for the absence of change, we don’t like to lose money. Capitalism is pretty brutal. We look for mundane products that everyone needs.”

then the author explains, how the Motel business of Patels is great.

the author says, ” As long as humans travel long distances and have a need to sleep a refresh themselves, there will always be a need for motels and Hotels. My previous business, TransTech, appears to be in a rapidly changing industry, but it too is a simple low-tech business. (Picking Stocks By Mohnish Pabrai )

Motel business at its core is simply a service business. while information technology (IT) has changed dramatically over. the years, the underlying nature, and the economics of the services delivered are virtually the same.

IBM’s technology-centric business changes very quickly, but IBM Global services or Accenture’s  business stays in a pretty steady state,”

friends, this principle, is very simple but don’t take it casually, take it seriously

let’s see the third Principle

3) Buy distressed Businesses in Distressed Industries.

In this principle, the author explains, how we can get awesome opportunities, that can become multi-bagger. Because, those are distressed businesses, we are human, we don’t need trouble or any problem that may hurt us, so our brain, say, stay away from it. that’s why most financial fund managers, stay away from the distressed business,

so you can get the awesome opportunity. the author explains in a wonderful way, so let’s see

the author give Warren Buffett quotes and explain, how people get rich in distressed business

” Never count on making a good sale. have the purchase price be so attractive that even a mediocre sale gives good results.”    – Warren Buffett

“ The entrance strategy is actually more important than the exit strategy.” – Eddie Lampert

the author says, ” we discussed in Chapter 1, in early 1970, with the oil embargo, deep recession, and reduction in the consumer’s discretionary spending, highway motels were suffering.

They were being sold at very cheap prices- all based on their pathetic near-term prospects. Papa Patel knew he was buying during distressed conditions and getting a great price. (Picking Stocks By Mohnish Pabrai )

Manilal too made his move into the depressed travel industry right after 9/11.

Mittal loaded up on assets in severely distressed businesses in a severely distressed industry in severely distressed countries and geographies. That’s distressed to the power of three. No wonder he’s near the top of the Forbes 400.”

then author gives the Warren Buffett quote to understand this principle to become rich

While lecturing a group of students at Columbia University, at age 21, Buffett said,

” I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.”       – Warren Buffett

the author says, ” while Papa Patel, Manilal, and Mittal were not in that closed room in 1957, they intrinsically understand that the very best time to buy a business is when its near-term future prospects are murky and the business is Hated and Unloved.

In such circumstances, the goods are high that an investor can pick up assets at steep discounts to their underlying value. these things, no one knows that better than Lakshmi Mittal.

4) Buy Business with a Durable Competitive Advantage- The Moat.

In starting this principle the author gives Warren Buffett’s quotes

” The key to investing is not assessing how much an industry is going to affect society or how much it will grow, but rather determining the competitive advantages of any given company and above all the durability of that advantage the products and services that have wide, sustainable rewards to investors.            – Warren Buffett.

the author gives Papa Patel an Example to understand this principle

author says, ” With the fixation on running a low-cost operation, Papa Patel is able to charge much less than his competitors and still maintain healthy margins.

this leads to higher occupancy on a very perishable commodity that he is peddling- a motel room for tonight. this advantage has an enduring quality to it- are that has lasted several decades.

only when a Patel competes for head to head with another Patel is the advantage in Jeopardy. But with a large country and a small niche population, Patels are careful not to make their own lives, difficult by competing directly with another Patel. (Picking Stocks By Mohnish Pabrai )

Papa Patel’s, Manilla’s, and Mittal’s moats were created by being the lowest-cost producer. Branson only ventures into a business after he’s convinced it has a wide and deep moat.

part of the moat comes from extending his brand, part of the form from creating a truly innovative offering, and the rest from brilliant execution.

the IT Services business is a recurring revenue business. the relationships with clients and the knowledge of their business and systems are the deeply hidden moat in IT services.

As a company gets more familiar with a client’s business and technology infrastructure, the harder it is to be replaced by competitors and those recurring revenues keep pouring in.”

after this, the author gives the fifth principle of the Dhandho Framework.

5) Bet Heavily when the Odds are Overwhelmingly in your favor.

this is a very useful principle,

the author says, ” There was a chance that Papa Patel’s Motel could have failed. However, on two serial bets made over five years, the odds that both outcomes go against Papa Patel are slight.

Even when he loses both bets, since he did not have much to start with, his losses are pretty minimal. Societal Safety nets help him get back on his feet. But when he wins, and the odds are over 99 percent that he wings at least once, he gets over 20 times his money back. (Picking Stocks By Mohnish Pabrai )

it’s Classic ” Head, I win; Tails, I don’t lose much”

then author explains, how the great Investor thinker Charlie Munger use this principle.

the author says, ” Warren Buffett’s Business partner and Vice-Chairman of Berkshire Hathaway, Charlie Munger, uses horse racing Pari-mutuel betting system as one of his mental Models when approaching investing in the stocks market.

Unlike a casino, in horse racing, you are betting against other bettors. The house takes a flat 17% of the total amount wagered. Frictional costs, relative to the stock market, are very high, according to Munger.

to us investing is the equivalent of going out and betting against the Pari-mutuel system. We look for the horse with one chance in two of winning which pays you three to one. you’re looking for a mispriced gamble. that’s what investing is. and you have to know enough to know whether the gamble is mispriced. that’s value investing.

then author gives the 6th principle

6) Focus on Arbitrage

the author says, ” Arbritrase is classically defined as an attempt to profit by exploiting price differences in identical or similar financial instruments, for example, if gold is trading in London at $550 per ounce and in new york, at $560 per ounce assuming low frictional costs, on arbitrageur can buy gold in London and immediately sell it in new york, pocketing the difference.

Of course, as he or she ( and others) do these trades, the price spread collapses and the arbitrage opportunity eventually vanishes. while arbitrage spreads are small and sometimes only available for fleeting moments, they are virtually risk-free and it is free money while it lasts. (Picking Stocks By Mohnish Pabrai )

As, Warren Buffett said, speaking at Columbia law school: Because my mother isn’t here tonight I’ll even confess to you that I’ve been an arbitrageur.

Anytime you’re playing an arbitrage game, you end up getting something for nothing. it’s always very good, in various forms, to play the arbitrage game because wherever a clear-cut arbitrage spread is available you just can’t lose.

Papa Patel is playing an arbitrage game as well. his arbitrage endeavors aren’t risk-free but they sure are ultra-low-risk and have many of the same characteristics of classic arbitrage.

then the author gives a wonderful example, you can read this in the book, and buy a book from the following link.

after reading this story you know the power of arbitrage.

let’s see principle 7th

7) Buy Businesses at big Discounts to their underlying intrinsic Value.

in this principle, the author explains the margin of safety

the author says, ” it is unlikely, that papa Patel ever read. the intelligent Investor book by Benjamin Graham or even heard of Graham’s ” Margin of Safety”

Nonetheless, Papa Patel Intrinsically Understands the concept of Minimizing downside risk, before ever looking at upside potential. if You buy an asset at a steep discount to its underlying value even if the future unfolds worse than expected the odds of a permanent loss of capital are low. (Picking Stocks By Mohnish Pabrai )

That’s exactly what Papa Patel did, e has a huge margin of safety when e bought the motel, according to Benjamin Graham.

….the function of the margin of safety is in essence that of rendering necessary an accurate estimate of the future.       – Benjamin Graham

 

now let’s see the 8th principle

8) Look for low-risk High-uncertainty Businesses.

in this, the author says, ” Papa Patel’s Motel purchase did not ave much risk associated with it. however, the outcome had significant uncertainty associated with it.

What if gas prices continued to stay high or the recession continued on? even in that scenario, Papa Patel would still be the low-cost provider.

He’d still be able to charge less and end up with higher occupancy. Even in the gloom and doom scenario, e comes out looking pretty good, if the economy booms and the gas price is moderate, He makes a killing profit. he has very low risk and relatively high uncertainty with the motel Investment.

Low risk and high uncertainty is a wonderful combination. It leads to severely depressed prices for businesses- especially in the Pari-mutuel system-based stock market. (Picking Stocks By Mohnish Pabrai )

Dhandho entrepreneurs first focus on minimizing downside risk. Low-risk situations by definition, have a low downside. the high uncertainty can be dealt with by conservatively handicapping the range of possible outcomes.

You end with the classic Dhandho Tagline: Heads, I win; Tails, I don’t lose much!

let’s see the last principle of the Dhandho Framework.

9) It’s better to be a Copycat than an Innovator

the author says, ” The first few Patels Paved the way for the thousands that followed. Papa Patel had seen a few of the earlier Patel’s latch on to buying small motets

In conversations, with these pioneers, the no-brainer business model becomes painfully clear to him. He did not set out to innovate. He simply followed the path laid out by his peers. the thousands of subsequent Patels who followed did not innovate either; Neither did Manilal.

I, too, got the seed of the idea for Transtech from my previous employer, Tellabs. they weren’t interested in pursuing it, and I saw tremendous potential- so I left Tellabs and lifted and scaled the idea.

Innovation is a crapshoot, but lifting and scaling carry for lower risk and decent to great rewards.”

this is all about the 9 principles of the Dhandho framework, which you can also use for Picking stocks.

let’s summarize The Dhandho Framework,

  • Invest in an existing business.
  • invest in a simple business.
  • invest in the distressed business in distressed industries.
  • Invest in business with durable moats.
  • Few bets, big bets, and infrequent bets,
  • Fixate on Arbitrage
  • margin of Safety-always
  • invest in low-risk, high-uncertainty business
  • Invest in the Copycat rather than the innovators.

TransTech company Dhandho by Mohnish Pabrai

Hello friends, in today’s article, we see the TransTech company case study, this company is started by Mohnish Prabrai. Mohnish Prabrai explains his own Company business framework to Add to the Flavors of Dhandho. In this article, we learn how the author starts his own company while doing the job, how they value their own company, as well as how much percent return they get on the company’s invested capital.

so let’s start.

Laxshi Mittal Steel Company information

TransTech Dhandho:-

TransTech company Dhandho by Mohnish Pabrai

The author ( Mohnish Prabrai) explains, how is he start a part-time company, by applying the simple Dhandho Framework, so let’s understand, in his words.

the author says, ” To add to the Flavors of Dhandho, let’s exercise my own Dhandho Experience.

When I founded my first business, TransTech, Inc., I had virtually no money – there was about $30,000 in my 401(K) retirement amount at Tellabs and $70,000 available in credit card limits, on a number of credit cards that I signed up for in anticipation of starting my business.

I researched U.S. Bankruptcy laws and I found that they were not too onerous. if the business went south and I was unable to cover my debts, I could declare personal bankruptcy and start over.

It was a very similar situation to Papa Patel- there wasn’t much downside because there wasn’t much to lose. also, when I resigned, my boss told me that they’d have to have me back any time, and they were likely to give me a decent raise as well. (TransTech company Dhandho by Mohnish Pabrai)

All I had to lose was the $30,000 in my 401(K) retirement account. I was all of 25 years old; the last thing I was concerned about was depleting my retirement assets.”

then author explains how they start the company

the author says, ” I incorporated Transtech in February 1990, while continuing to work at Tellabs. I took 1/2 day off as vacation time, whenever I had client sales calls. I used to work on the business at home in the morning from 6:30 AM to 8:30 AM,

Be at work during the day and again work on the business in the evening from 6:00 PM to midnight. I had a paycheck coming in and every little in the way of business expenses.

When I had the first client and revenues over $200,000 a year in the bag, I resigned. If you look at the approach. the only downside I had was the Possible loss of my paltry $30,000 in 401(K) assets.

The upside was enormous easily several million dollars. Visa and Master Card were my venture capitalists funding the rest of it. I was single at the time. (TransTech company)

There was no family to worry about. Many lunches and dinners back then were comprised of a simple subway sandwich. my expenses were pretty low.

I considered staying at Tellabs to be a risky proposition. I thought that if I just stayed at the company, it was likely to be a boring and slow corporate path.”

then the author explains, why starting at age 25 is good than 35 or 45? and what is his game plan.

the author says, ” If I woke up when I was 35 or 45 and decided to go off on my own. it would be much more complicated. I would likely have a wife and kids by then, which would make it harder to break loose and make a risk-free bet. (TransTech company Dhandho by Mohnish Pabrai)

My game plan was very simple. I had an Arbitrage-based business model. the Value proposition was leveraging India’s deep expertise and available talent in client-server computing to satisfy the deep shortages of talent in the mid-western united states.

I had $100,000 of capital available to me and the business was already producing revenue and some profit when I resigned from Tellabs.

I knew that with the first two customers on Board, generating real revenue and profits, the downside was very limited.

it was classic ” Heads, I win, Tails; I don’t lose much”

then the author explains, how the company grows and how much return gets on his investment.

the author says, ” TransTech scaled nicely. In 1996, we were recognized as an Inc. 500 company- one of the 500 fastest-growing businesses in the united states.

As revenues went from nothing to over $20 million annually in 10 years, the business never took a dime off outside capital.

Cash Flows provided all the growth capital and then some. cash was always very tight as we were growing very rapidly and reinvesting all available capital to scale.

In late 1991 I found a terrific banker, Tom Harazim, who liked our story. He paid off all my credit cards, got us off the very expensive factoring of receivables I was doing to bring in cash as quickly as possible, and got TransTech set up with a hugely cheaper line of credit based on our pristine receivables.

We did a sale of some assets for about $2 million in 1994, which made me feel rich for the first time. And then the entire business was sold in 2000 for several million dollars. (TransTech company Dhandho by Mohnish Pabrai)

A $30,000 investment got me more than 150 times return over 10 years- an annualized return of well over 65%. I went from a salary of $45,000 a year(when I quit my job) to consistently having a salary of over $300,000 a year in a few years.

The magic word is Dhandho, baby- Huge upside with virtually no downside. it was a classic.

” Head, I win; Tails, I don’t lose much”   …. kind of bet.”

so, friends, the author start their first business, before starting Pabrai Funds.

from the above story, We should have to learn, to become very wealthy.

  • Take a Job to generate income for our monthly expense
  • Start a business, part-time. (TransTech company Dhandho by Mohnish Pabrai)
  • Take a calculated risk for business, like the author takes their retirement money to start a business
  • Work very hard(100 + hours a week), and live a Dual life, up until you don’t need a job for your regular monthly expenses
  • Start early, because, you don’t have much responsibility like family expenses, students’ education, etc. don’t worry if you have family expenses, then take a calculated risk.
  • Full focus on business, and in the job, do work as like above your firing level:- not more or not less to fire

for more understanding of this concept, see the following video of Mohnish Pabrai on Secrets of creating massive wealth

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

Steel Companies: Mohnish Prabrai on Mittal Dhandho

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.