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.
The Dhandho Framework:-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.