Review: The Dhandho Investor, by Mohnish Pabrai

The Dhandho Investor: The Low-Risk Value Method to High Returns, by Mohnish Pabrai. Hoboken, NJ: John Wiley & Sons, 2007. 208 pp. $27.95 (hardcover).

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“From a standing start as refugees with virtually no capital, a person with the last name Patel today owns one out of every five motels in the United States” (p. 132). According to hedge fund investor Mohnish Pabrai, one word identifies how these Indian immigrants have achieved this extraordinary success in a little more than thirty years: Dhandho.

Dhandho (pronounced dhun-doe) is a Gujarati word. Dhan comes from the Sanskrit root word Dhana meaning wealth. Dhan-dho, literally translated, means “endeavors that create wealth.” The street translation of Dhandho is simply “business.” What is business if not an endeavor to create wealth? (p. 2)

In The Dhandho Investor: The Low-Risk Value Method to High Returns, however, Pabrai uses the word more narrowly to describe the low-risk, high-return approach to business taken by the entrepreneurial Patels.

According to Pabrai, the first Patels arrived in America in the mid-1970s with strange accents and nowhere to live. At the time, owing to a recession and gasoline rationing, the motel industry was suffering from drastically low room occupancy, and many motels were either for sale or in foreclosure. To the Patels, who saw that the banks would finance motel purchases for anyone with roughly $5,000, this circumstance represented an opportunity. According to Pabrai, the average “Papa Patel” sized up the situation this way:

Papa Patel figures the family can live in a couple of rooms, so they have no rent or mortgage to pay and minimal need for a car. Even the smallest motel needs a 24-hour front desk and someone to clean the rooms and do the laundry—at least four people working eight hours each. Papa Patel lets all the hired help go. Mama and Papa Patel work long hours on the various motel chores, and the kids help out during the evenings, weekends, and holidays. Dahyabhai Patel, reflecting on the modus operandi during the early days, said, “I was my own front-desk clerk, my own carpenter, my own plumber, maid, electrician, washerman, and what not.” With no hired help and a very tight rein on expenses, Papa Patel’s motel has the lowest operating cost of any motel in the vicinity. He can offer the lowest nightly rate and still maintain the same (or higher) profitability per room than his predecessor and competitors. As a result, he has higher occupancy and is making super-normal profits. (p. 7)

Before those profits, Pabrai notes, all Papa Patel had was $5,000 and the knowledge of possible outcomes that could follow if he invested it in a motel. For instance, one possibility was that by drastically cutting expenses to $30,000 per year and cutting rates to achieve at least 50 percent occupancy, he would generate $50,000 in annual revenue—leaving $20,000 in profits, or a 400 percent return on his $5,000 investment. Another possibility was that, if the recession got much worse and Papa Patel could not convince the bank to work with him to avoid foreclosure, he would lose his investment of $5,000, much—if not all—of which would have gone to rent and other associated expenses anyway, had he not purchased the motel.

After considering his alternatives, Papa Patel thinks a successful outcome is likely and the second option, foreclosure, extremely unlikely. So he purchases the motel. With the obvious benefit of hindsight, Pabrai cheers the move. “This is not a risk-free bet,” he says, “but it is a very low risk, high return bet. Heads, I win; tails, I don’t lose much!” (p. 12). Or, in a word: Dhandho.

Pabrai shares stories of other businessmen—including Lakshmi Mittal and Richard Branson—who became very wealthy by making investments with minimal downside risk and huge upside potential. Pabrai then follows these stories with nine principles that constitute “the Dhandho framework,” which he says also apply to buying shares in the stock market.

One of these principles calls for investing “in businesses that are simple—ones where conservative assumptions about future cash flows are easy to figure out” (pp. 56–57). Hearkening back, Pabrai explains:

Papa Patel bought a business that’s very easy to understand. 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 ballpark 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 expenses that were likely to be required in the future based on the historical data and the condition of the property. (p. 57)

The benefit of buying shares in simple businesses, Pabrai says, is that one can more easily see both what such businesses are worth and what risks are involved in owning them.

With this in mind, Pabrai turns to another principle: Always buy with a “margin of safety” between what you understand a business to be worth and what you pay for it. Paying less for a business than it is worth reduces your downside risk and increases your upside potential. This view of risk is consonant with that of the world’s top value investors—including Warren Buffett and Charlie Munger, two men from whom Pabrai quotes extensively and often. In fact, as The Dhandho Investor progresses, it becomes increasingly clear that Pabrai has embraced and is elucidating the principles of value investing that he learned from those great investors.

For the most part, Pabrai writes clearly, provides interesting examples, and gets these principles right. But the book does have several notable flaws.

For example, on page 1 Pabrai says that the Patels own half of all the motels in the United States. This contradicts the accurate figure of 20 percent he gives later in the book and may cause readers to question some of the seemingly outlandish but true claims that Pabrai makes elsewhere. For example, he correctly points out that Richard Branson bought Necker Island for just 7 percent of its listed price of £3 million and that the Kazakh government handed Lakshmi Mittal the keys to a gigantic steel plant for nothing (pp. 28, 30). Pabrai’s inaccuracies elsewhere taint his credibility when making such claims—claims that are crucial to supporting his theme.

Pabrai also misleadingly speaks of investments as “bets” and justifies this “betting lingo” by saying, “To be a good capital allocator, you have to think probabilistically” (p. 74). There is certainly nothing wrong with pointing out that being able to consider a range of possible outcomes is crucial to investing as well as to gambling. However, Pabrai’s description of an innovative company as “a crapshoot” or his claim that investing is “all about the odds” obliterates an important distinction between making a calculated investment and betting on the outcome of a coin toss (pp. 132, 84). The prospect of purchasing a debt-free, innovative company selling for less than the value of its main research facility is not a crapshoot; rather, it is an investment that promises both safety of principal and quite possibly a decent return.

If you are aware of such flaws and on the lookout for others, they will not detract much from the value of The Dhandho Investor. In general, Pabrai explains clearly and accurately how the same principles that lead to success in business apply to investing as well. Anyone who reads the book carefully and applies its principles thoughtfully should profit.