Super Investor: Monish Pabrai

Monish Pabrai achieved a return of 25.8% per annum in the first 18 years of running his fund. Monish achieved this by investing in low-risk, high-reward opportunities. He calls his approach the Dhandho framework and has written a book about it, called The Dhandho Investor. (Dhan-dho originates from the Sanskrit language and means “endeavours that create wealth”. In modern use, it means “business”).

Finance theory tells us that risk and reward are correlated. If you want higher returns, you have to take higher risks. Monish flips that with his Dhandho framework and seeks to minimise risk, while maximising reward. Here are the nine principles of the Dhandho framework:

1. Focus on buying an existing business.

2. Buy simple businesses in industries with ultra-slow rates of change.

3. Buy distressed businesses in distressed industries.

4. Buy businesses with a durable competitive advantage.

5. Bet heavily when the odds are overwhelmingly in your favour.

6. Focus on arbitrage.

7. Buy businesses at big discounts to their intrinsic value.

8. Look for low-risk, high-uncertainty businesses.

9. It’s better to be a copycat than an innovator.

(Monish is a disciple of Warren Buffett, so expect a few Buffett quotes to follow.)

Focus on buying an existing business

Monish focuses on established businesses with a long history of operations that he can analyse. The reason for this is simple – these businesses are much less risky than brand-new unproven start-ups.

Buy simple businesses in industries with ultra-slow rates of change

Warren Buffett said it best: “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”.

Investing is forward-looking, so businesses with ultra-slow rates of change are appealing because they are more predictable than fast changing businesses.

Buy distressed businesses in distressed industries

Warren Buffett said: “Be fearful when others are greedy. Be greedy when others are fearful”.

The best time to buy a business is when the near-term prospects are unclear. This creates negative sentiment toward the business and lower stock prices. At that time, it could be possible to buy companies at large discounts to their intrinsic value.

Buy businesses with a durable competitive advantage

Warren Buffett explains competitive advantage as follows: “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 advantage of any given company and, above all, the durability of that advantage. The products and services that have wide, sustainable moats around them are the ones that deliver rewards to investors”.

Bet heavily when the odds are overwhelmingly in your favour

Great opportunities are rare in the markets, but every once in a while an investment comes along where the odds favour the investor. At such times, it is important to act decisively and place a large bet.

Focus on arbitrage

Arbitrage means attempting to profit in price differences between similar financial instruments. For example, if gold trades in London at $500 and in New York at $510, an investor can buy it London and immediately sell it in New York at a profit.

As Monish puts it, when you play the arbitrage game, you end up getting something for nothing. You can’t lose.

Buy businesses at big discounts to their intrinsic value

Monish likes to buy assets at discounts to underlying value, so that if the future is not as rosy as expected, the chance of permanent capital loss is low.

Look for low-risk, high-uncertainty businesses

This is a “heads I win, tails I don’t lose much” situation. Monish is looking for depressed prices for businesses but where the actual risk is low. The low-risk means there is little chance of downside, whereas the high-uncertainty keeps other buyers away.

It’s better to be a copycat than an innovator

Innovation is risky, but copying and scaling an idea that already works, carries lower risk with decent rewards.

Conclusion

That’s Monish Pabrai’s Dhandho framework.

As with all investing strategies, on paper it sounds simple, but in practice, it clearly requires a lot of skill.

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