His volumes and capacity allow him to negotiate better prices than his competitors with both buyers and suppliers— driving his costs even lower. Nonetheless, Papa Patel intrinsi- cally understands the concept of minimizing downside risk before ever looking at upside potential. He had a huge margin of safety when he bought the motel. Ac- cording to Benjamin Graham:. However, the outcome had significant uncer- tainty 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. Even in the gloom and doom scenario, he comes out looking pretty good. If the economy booms and the gas prices moderate, he makes a killing. He has very low risk and relatively high uncertainty with the motel investment.
Low risk and high uncertainty is a wonderful combina- tion. It leads to severely depressed prices for businesses— especially in the pari-mutuel system-based stock market.
Dhandho entrepreneurs first focus on minimizing down- side risk. Low-risk situations, by definition, have low downsides. The high uncertainty can be dealt with by con- servatively handicapping the range of possible outcomes. The first few Patels paved the way for the thousands that followed.
Papa Patel had seen a few of the earlier Patels latch on to buying small motels. In conversations with these pio- neers, the no-brainer business model became 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. Innovation is a crap- shoot, but lifting and scaling carries far lower risk and de- cent to great rewards.
Treasuries, bonds, stocks, real es- tate, private businesses, gold, silver, platinum, oil futures— the list is endless. If you examine returns from the broad 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 overwhelm- ingly suggests that, over the long haul, the best place to in- vest assets is in common stocks. Humans have walked this earth for some fifty thousand years and the buying and selling of assets between humans has flourished for thousands of years.
The first stock mar- ket was formed in just in Philadelphia, followed by the New York Stock Exchange in A far better way, suggested by Benjamin Graham, is to think of them as an ownership stake in an existing business. If it were and you bought some of it, now you and Papa Patel are partners.
There are six big advantages that the stock market offers versus the buying and selling of entire businesses: 1. When you buy an entire business, like 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. When you buy a stock, you now have an ownership stake in the underlying business with one huge ad- vantage—the business is already staffed and run- ning.
You can share in all the rewards of business ownership without much of the effort. The stock mar- ket 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 clicks on your computer. 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. When humans buy or sell whole businesses, both sides have a good sense of what the asset is worth and a rational price is usually arrived at. Sellers usually get to time these sales to their benefit. As a result, you typi- cally end up with fair to exuberant pricing. The stock market operates like the pari-mutuel system in horse racing—prices are determined by an auction process.
Like in horse racing, the auction pro- cess 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-mutuel system is a market. Buying an entire business—even a small neighbor- hood gas station or laundromat—requires some seri- ous 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 years—is a huge advantage.
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. There is just no comparison. At the racetrack, the track owner takes 17 percent of every dollar bet. The frictional costs are very high. Ultra-low frictional costs are a huge advantage.
Having an ownership stake in a few businesses is the best path to building wealth. And with no heavy lifting required, bargain buying opportunities, ultra-low capital re- quirements, ultra-large selection, and ultra-low frictional costs, buying stakes in a few publicly traded existing busi- nesses is the no-brainer Dhandho way to go.
What is the intrinsic value of a busi- ness? 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. The definition is painfully simple. Are we better off buying the gas station or taking our virtually assured 10 percent return? Alternately, you could use Excel. As Table 7. If we did the DCF analysis on the 10 percent yielding low-risk invest- ment, it looks like Table 7.
In- vesting in the gas station is a better deal than putting the cash in a 10 percent yielding bond—assuming that the ex- pected cash flows and sale price are all but assured.
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. Table 7. I have been to its stores a few times over the years, and it has been a pleasant experience. It looks like BBBY is growing revenues 15 percent to 20 percent and net income by 25 percent to 30 percent a year.
What if we made some more conservative assumptions? We can run the numbers with any assumptions. The com- Table 7. We can compare November data to November data.
It looks like the top line is growing at only 10 percent annually and the bottom line by about 15 percent to 16 per- cent. If we made the investment, we would end up with an annualized return of a little under 10 percent.
If we have good low-risk alterna- tives where we can earn 10 percent, then BBBY does not look Table 7. I think of BBBY as a fairly straightforward, low-tech, and simple business to un- derstand.
Even with its simplicity, we end up with a pretty wide range on its intrinsic value. If we were to look at a business like Google, it starts get- ting very complicated. Google has undergone spectacular growth in revenues and cash flow over the past few years. If we extrapolate that into the future, the business appears to be trading at a big discount to its underlying intrinsic value.
If we assume that not only is its growth rate likely to taper off, but that its core search business monopoly may be success- fully challenged—by Microsoft, Yahoo, or some upstart—the picture is quite different. In that scenario, the current valua- tion of Google might well be many times its underlying in- trinsic value. What businesses are simple? Well, sim- plicity lies in the eye of the beholder. The motel had long histories of revenues, cash flows, and profitability available for analysis.
From that data, it is not too hard to get a ball park 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 ex- penses that were likely to be required in the future based on the historical data and the condition of the property.
Simplicity is a very powerful construct. It is the thinkers like Einstein and Buffett, who fixate on simplicity, who triumph. Everything about 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 a stock. I always write the thesis down. If it takes more than a short paragraph, there is a fun- damental 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.
And with frictional costs thrown in, the EMTs believe stock picking is not just a zero-sum game, but rather a negative-sum game. Here are Mr. 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 mostly and fully efficient. It is this critical gap that is responsible for Mr. Buffett not being a street corner bum. About EMTs, Buffett commented: Observing correctly that the market was frequently effi- cient, [academics and Wall Street pros] went on to conclude incorrectly that it was always efficient.
The difference be- tween these propositions is night and day. 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 are likely to fall below intrinsic value; ex- treme greed is likely to lead to exuberant pricing. In the meanwhile, the circumstances causing the fear may have abated or, more likely, rational thinking is likely to have prevailed over time. In the case of the stock market, an individual investor in the same doom-and- gloom mind-set would likely have unloaded his entire posi- tion 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 entire businesses.
Market, a creation of Benjamin Graham, lives in the stock market and is a very hyperactive and moody charac- ter. 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 price changes. With the rapid-fire trading of thousands of securities, every once in a while a few stocks might have a great deal of bad news come out. This sometimes leads to extreme fear and the wholesale un- loading of these stocks.
But when you sell a stock, 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 fixating on buying distressed businesses.
All we need to do is to first narrow the universe of candidate businesses down to ones that are understood well and are in a distressed state. How do we get a list of distressed businesses or indus- tries? There are many sources, but here are six to begin with: 1. Many of these news clips reflect negative news about a certain business or industry. More recently, Mr.
These were all headline stories. Value Line publishes a weekly summary of the stocks that have lost the most value in the preceding 13 weeks. It is another terrific indicator of distress. This list of 40 stocks routinely shows price drops of 20 per- cent to 70 percent over that period.
The ones with the largest drops are likely the most distressed. There is a publication called Portfolio Reports www. It lists the 10 most recent stock purchases by 80 of the top value managers.
Distressed situations are a subset of value investing, so some of their investments fall into the distressed category. Alternatively, www.
To get to the data, on the Nasdaq. You can do a Google search to get the name of the one ticker you need. I can use any one ticker on Nasdaq. 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 percent. We delve more into Greenblatt and his Dhandho approach later in the book.
Value Investors Club has about members—each of whom had to get approved for membership 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, he or she is likely to lose membership privileges. 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. After read- ing the book, visit www. We delve further into the Magic Formula later. Between these sources, there are now a plethora of candi- date distressed businesses to examine. How can we ever get our arms around all of them? We begin by eliminating all businesses that are either not simple busi- nesses or fall squarely outside our circle of competence.
We are now ready to apply the rest of the Dhandho framework to this select group. He is thus able to charge significantly more than the barbers in the neighbor- ing towns and make supernormal profits.
Capitalism is greed driven, and as barbers in the other towns get word of the spectacular opportunities in Town C, they rush to open up barbershops.
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.
All the other Mexican and fast-food restaurant owners in town are fully aware of the Chipotle phenomenon. It would be a significant uphill battle to replicate Chipotle.
When more players enter the market, they are likely to take customers away from other restaurants rather than Chipotle. From a standing start just 13 years ago, Chipotle recently opened its th restaurant. It could easily grow 10 times or more from its present footprint, not to mention its enormous prospects overseas. Chipotle has a durable moat. This durable moat causes customers like me to continue to go there regard- less of the wait. 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. Sometimes the moat is hidden. Take a look at Tesoro Corporation. It is in the oil refining business—which is a commodity. Tesoro has no control over the price of its prin- cipal raw material, crude oil. It has no control over the prin- cipal finished good, gasoline. Nonetheless, it has a fine moat. Over that period, the number of refineries has gone down from to , while oil demand has gone up about 2 percent a year.
The average U. Anytime you have a surge in demand, refining margins es- calate 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 cannot 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.
In the overwhelming majority of busi- nesses, the various moats are mostly hidden or only in par- tial 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 in- vested capital.
The balance sheet tells us the amount of cap- ital deployed in the business. The income and cash flow statements tell us how much they are earning off that capi- tal. Every three years it can take that cash flow and open another Chipotle. When it starts franchising, the re- turn on invested capital is exponentially higher. Throughout history, kings have sought to build heavily fortified castles with ever-widening and deeper moats.
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 is, no matter how many sharks or piranha are in that moat, eventually it is going to fall to the marauding invaders. Throughout history, every great civilization and kingdom has eventually declined. The businesses mentioned earlier as having narrow or nonexistent moats—Delta, Gateway, General Motors—all had pretty formidable moats at one time. 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 years ago, and amazingly both their moats are as robust as ever today. 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 large available universe. It takes about 25 to 30 years from forma- tion for a highly successful company to earn a spot on the Fortune 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 business is already past its prime by the time it gets on the list. We are best off never calculating a dis- counted cash flow stream for longer than 10 years or ex- pecting a sale in year 10 to be at anything greater than 15 times cash flows at that time plus any excess capital in the business.
John Larry Kelly Jr. Kelly came up with what is now known as the Kelly Formula. Poundstone describes the Kelly Formula beautifully. Papa Patel had likely never heard of the Kelly Formula. The odds in the aforementioned example are roughly the odds Papa Patel was offered—an 80 percent chance of having a 21 bagger, a 10 percent chance of a 7. In reality, Papa Patel was more conservative in his bet than the Kelly Formula suggested.
He bet 50 percent of his bankroll. He puts 50 percent of his bankroll at risk on 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 help and can buy a bigger motel. Even if the odds were simply a 50 percent probability of a percent return and a 50 percent probability of a total loss, the Kelly Formula suggests that he ought to bet 25 percent of his bankroll.
Historically, the motel business odds have been vastly superior than the aforementioned. The probability of a loss has likely been well under 25 percent and probability of a percent loss is well under 5 percent.
The Patels have not been shy about putting up large portions of their bankroll on these mouthwatering odds when they placed their sec- ond, third, and nth bet. They bet big when they have the odds. All have tried to place bets when the odds were heav- ily 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 overt proba- bilities 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 soundly with the house and playing blackjack at a casino is a losing proposition.
Thorp named the opti- mal play of cards Basic Strategy. He wrote the best-selling book, Beat the Dealer. In the s, casinos offered single-deck blackjack and dealt 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 in the favor of the player, the Kelly Formula suggested that the player bet 4 percent of his bankroll.
He started frequenting the Nevada casinos and cleaned up. When Thorp published Beat the Dealer,5 players the world over started cleaning up. Over the past four decades, the game has gone through numerous changes. Each time the casinos made a change, some smart gambler would figure out a way to beat the system. Then the casinos would figure it out and make another change. Today, most casinos deal from a shoe of six to eight decks. Aug 01, There are no reviews yet.
Be the first one to write a review. The Dhandho Investor www. Buy from Amazon. Inside this Book — Asian Indians make up about 1 percent of the population of the United States—about three million people.
Of these three million, a relatively small subsection is from the Indian state of Gujarat—the birthplace of Mahatma Gandhi. And a very small subsection of Gujaratis, the Patels, are from a tiny area in Southern Gujarat. Less than one in five hundred Americans is a Patel. It is thus amazing that over half of all the motels in the entire country are owned and operated by Patels.
What is even more stunning is that there were virtually no Patels in the United States just 35 years ago. They started arriving as refugees in the early s without much in the way of education or capital.
How did this small, impoverished ethnic group come out of nowhere and end up controlling such vast resources? There is a one word explanation: Dhandho. A comprehensive value investing framework for the individual investor In a straightforward and accessible manner, The Dhandho Investor lays out the powerful framework of value investing.
The Dhandho method expands on the groundbreaking principles of value investing expounded by Benjamin Graham, Warren Buffett, and Charlie Munger. Readers will be introduced to important value investing concepts such as 'Heads, I win! Tails, I don't lose that much! He is an unabashed admirer of Warren Buffet and Charlie Munger.
Members Only. Please Sign Up or Log In first. Most people think risk and return are related. All investors are told that if you want to earn high rates of return, you need to take on greater risks.
However, value investors like Benjamin Graham, Warren Buffett , and Joel Greenblatt have shown that it is actually possible to make great profits with relatively low risk levels. The Dhandho framework consists of nine core principles. File Name: dhandho investor pdf download free. Reading Notes - The Dhandho Investor.
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