The Dhandho Investor: The Low - Risk Value Method to High Returns
by Mohnish Pabrai
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Book Summary Information
Author: Mohnish PabraiEdition: Hardcover
Audio: English (Original Language); English (Unknown); English (Published)
Published: 2007-04-06
ISBN: 047004389X
Number of pages: 208
Publisher: Wiley
Book Reviews of The Dhandho Investor: The Low - Risk Value Method to High Returns
Book Review: Buffett and Munger would be proud
Summary: 4 Stars
2007 Wiley, 196 pages (of which 183 pages form the main body of the book)
On the back of the Dhandho Investor is some blurb by Whitney Tilson saying that he read the book from start to finish in one sitting. The Dhandho Investor is that kind of book: it is short and engaging.
Pabrai's book is about what he calls high uncertainty, low risk investment. The main idea is that there are certain types of situations, which - though heavily shrouded by uncertainty and thus apparently very risky - actually offer very low risk of capital loss and good odds of a decent return. I like the way Pabrai puts it when discussing Stewart Enterprises:
"Wall Street could not distinguish between risk and uncertainty, and it got confused between the two."
Pabrai's book is basically an exposition of the key ideas from Warren Buffett and Charlie Munger in the form of a usable framework to produce really significant stock market outperformance. I would like to emphasise that last point: really significant outperformance. Pabrai understands very well that the long-term buy-and-hold strategy Buffett and Munger espouse publicly literally cannot produce returns that are very significantly above the market (over the long term and without use of leverage or insurance float). Here is what Pabrai said on the subject in a recent Q&A with Gurufocus (a US financial website):
"Very, very few businesses generate ROE [return on equity] exceeding 15-20% annually and have the ability to redeploy earnings at greater than 15-20% ROE. Thus it is unlikely Berkshire's stock portfolio can generate long-term returns exceeding 15%. Their float helps them get higher effective returns."
(I had to remove the links to the two Q&A sessions with Pabrai as Amazon.co.uk refused to publish them. This is a shame as they are particularly useful: I could not find these explicit comments on why Pabrai does not follow Buffett's buy-and-hold-forever philosophy in The Dhandho Investor - though it is implicit in the book's content. If you wish to read them please either contact me via Amazon.co.uk or find the same review on Amazon.com (who were happy to publish the links). Alternatively, Pabrai's exemplary reasoning is explained in an interview with him published in James Altucher's book, Trade Like Warren Buffett.)
Pabrai's book is entirely successful when looked at from the point of view of providing the framework I referred to above for major stock market outperformance. It is less successful when Pabrai goes into using the Kelly Formula for calculating optimum position sizes. (The Kelly Formula is a mathematical formula for calculating the optimum percentage of your bankroll to bet on a favourable bet, if you know the correct odds compared to the actual odds being offered on the bet.)
Pabrai's use of the Kelly Formula in The Dhandho Investor reads as an afterthought. For example, in his Stewart Enterprises case study Pabrai states:
"I hadn't heard of the Kelly Formula back then, but I didn't need anything beyond third grade math to know that this is a very favourable bet to make."
He then goes on to state that the Kelly Formula indicates he should have bet 97% (sic) of his bankroll, but that Pabrai Funds actually invested 10% of its assets in Stewart Enterprises.
However, now that Pabrai does know about the Kelly Formula he still invests 10% of assets in each investment and does not attempt to change the position sizing according to his assessment of the odds of each bet (investment).
As the answers produced by the Kelly Formula bear little resemblance to Pabrai's actual positions, his entire use of the Kelly Formula reads like an ex post attempt to explain what he was already doing.
To be fair, Pabrai does try - though not entirely convincingly - to reconcile the differences between his actual position sizing and the results dictated by the Kelly Formula. For example, he explains that the situations are too uncertain for him to be sure which potential investments will actually produce the best result. However, this seems to argue against any attempt at exact use of the Kelly Formula - rather than plugging in the numbers and then disregarding the answer.
His much better explanation of his sub-Kelly position sizing is that he has an overabundance of roughly equally good ideas and thus wishes to buy them all. However, he doesn't say what he would do (or has done) if he found a dearth of clearly good ideas: would he hold cash or increase the weighting of his best ideas? (This would surely be the test of whether he actually uses the Kelly Formula, rather than just talks about it.)
That carping aside, I really enjoyed The Dhandho Investor and thought it was an excellent reminder of how important it is to load up on a few best ideas if you want really good results. There are also odd bits of other very good advice throughout the book, as when he advises strongly to focus on one potential investment at a time before investing or discarding and then moving on. Highly recommended.
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