High Returns Without High Risk: The Pabrai Way

Mohnish Pabrai, one of the most successful investors and philanthropists in the world, reveals how he earns high returns without taking high risk in his book The Dhandho Investor originally published in 2007.

Reliable sources have suggested that Master of Dhandho Investing is vastly superior to Harvard MBA, writes Pabrai, who doesn’t have (and doesn’t need) any business degree. Pabrai is the founder of the Pabrai Investments Funds and the Dhandho Funds and manages over a $1 billion.

At the core of his Dhandho philosophy is the belief that stock market from time to time presents opportunities to make high returns with extremely low risk and that any investor who is willing to prepare and wait for such opportunities can build extraordinary wealth.

The Dhandho investors follow the nine-point framework when investing to minimize risk while maximizing returns:

1. They favor companies that have a simple business model with a long history, making such businesses easy to analyze.
2. They prefer stable industries (with ultra-slow pace of change).
3. They invest in businesses that are available at a huge discount to their intrinsic values. The discount offers crucial margin of safety from known and unknown unknowns.
4. They like stocks of companies that are in the eye of some storm. They are interested in the firms who will sooner or later ride out that storm.
5. They look for businesses that have durable competitive advantage. Such companies have protection from constant attacks by others in a capitalist survival-of-the-fittest world.
6. They often prefer copycats over innovators because innovation is typically a high-risk endeavor.
7. They seek companies facing high uncertainty but offering low risk. Wall Street often gets confused between risk and uncertainty. Risk has to with downside and uncertainty with future. When future is murky, stock price tends to crash to levels that make downside low, leading to attractive odds on such investments.
8. Once they find such opportunities, they invest big – sometimes even half of their portfolio – even if no one around them is optimistic on such companies.
9. They are constantly on the hunt for arbitrage opportunities.

How many such businesses do you need? Just 5 to 10 diverse stocks in your portfolio are enough to trounce the markets, Pabrai says.

After building the Dhandho portfolio, investors should be just as disciplined when selling as they are when buying. Pabrai suggests holding the stocks for two to three years as “most clouds of uncertainty will dissipate in two to three years”. Moreover, the three-year rule offers a clear exit in case our assessment of the business isn’t accurate. A disciple of Warren Buffett, Pabrai differs from his guru on this recommendation. Buffett prefers to hold stocks forever.

Whenever the stock price reaches within 10% of the intrinsic value, it’s a good time to start selling, according to Pabrai. He asks investors to sell when the stock price exceeds the intrinsic value. The only exception is when delaying sales saves taxes.

Finally, if becoming a Dhandho investor seems difficult, he suggests sticking to broad index funds. Active investing isn’t meant for most.

Pabrai, who is also founder of Dakshana Foundation, which helps bright and impoverished students make it to the top engineering and medical colleges in India, says while the book focuses on maximizing wealth, living for just money and comforts for self and family is sub-optimal. He hopes investors will use some of the Dhandho money to make the world a better place.

If you want to read more about Pabrai, please check out his website: https://www.chaiwithpabrai.com/

I’m Rahul Satija, and I’m on a mission to help you achieve your financial goals. If you liked the article, please take a moment to share it with your friends and family.

Disclaimer: Any view expressed in the article is my own. The article is meant for only educational purpose. Please share your feedback at [email protected].