- This is one of my favorite investing books.
- I discuss what has been most applicable for me at Rangeley Capital.
- The author explains his investing philosophy of "heads, I win; tails, I don't lose much".
In The Dhandho Investor, Monish Pabrai tosses out the notion that to achieve high investment returns, one must take incrementally greater amounts of risk, common in modern portfolio theory (MPT). Instead, he lays out a low risk, high return approach that is within the value investing canon, but with a fascinating Indian migrant perspective. The book tracks the investing strategy of a tiny Indian community, the Patels, who have prospered magnificently in the United States since their arrival about thirty-five years before the writing of this book. Fewer than one out of five hundred American belong to this group, yet they own a majority of the motels operated in the US.
The first key to the Patels' success is that they are extremely frugal. While different investments have differing probabilities of success, cost savings essentially always work. Saving money has 100% odds of leaving you richer. Without even knowing it, the Patels were value investors.
What was applicable? There are two lessons I pulled from these stories that were the most impactful for me. First, only make "heads, I win; tails, I don't lose much" bets. Second, make "few bets, big bets, infrequent bets."
"Heads, I win; tails, I don't lose much"
A fun and exhilarating attribute of the business leaders in this book is that they did not succeed based on meticulous precision or certainty about predicting the future. They didn't necessarily even have a high probability of success in any one venture. Instead, they started with minimal capital but invested such that they would not lose much when they failed. This was true to the Patels, for Sir Richard Branson and Virgin, and it is true for Mohnish Pabrai and his management of both his start-up operating companies and, later, the Pabrai funds.
"Few bets, big bets, infrequent bets"
This ignores conventional wisdom about extreme diversification. How does one get comfortable with big bets? It does not happen frequently. One can quickly toss out the prospect of concentrating in most investment opportunities that arise. Wait until the odds are overwhelmingly favorable and then make a big bet.
Pabrai's confidence in concentrated portfolios is backed up by the Kelly formula, which he discusses in Chapter 10 (p. 72). He advocates thinking probabilistically as a capital allocator. In so doing, it is helpful to have a moderate level of diversification - ten independent variables is better than five. However, the value of diversification beyond that diminishes significantly.
In a straightforward and accessible manner, The Dhandho Investor lays out the powerful framework of value investing. Written with the intelligent individual investor in mind, this comprehensive guide distills the Dhandho capital allocation framework of the business-savvy Patels from India and presents how they can be applied successfully to the stock market.