The Dhandho Investor:

The low risk value method to high returns

Author : Mohnish Pabrai
Book Summary

This handcra ed book summary will help you learn

• How an immigrant community dominated the motel segment in the US?
• What are the principles of dhandho inves ng?
• What is the common thread between Virgin Atlan c and Patel Motel?
• How to buy stocks that are high in intrinsic value, but at a discounted market price?

Thrown out, overnight.

From the southern part of Gujarat hails a community of landlords or pa dars, popular by their common
surname Patel. In the late nineteenth and early twen eth century, Patels migrated to East Africa as traders and
indentured labourers, especially to Uganda. With their strong entrepreneurial spirit and a sharp mercan le
sense, Patels became the dominant trading community in Uganda.

For Patels, trouble brewed in 1972 when Idi Amin took over as the dictator of Uganda and declared the “Africa
for Africans” policy. Overnight, the Patels lost all their wealth and assets in Uganda, and worse s ll, were asked
to move out of the country almost immediately.. The year1972 was a also a difficult me for the country of
origin for Patels from Uganda; India.

India was in a full-scale conflict with Pakistan, which lead to the crea on of Bangladesh. Besieged with millions
of Bangladeshis crossing over to India as refugees, the Indian government did not extend any support to the
Patels expelled from Uganda. Most Patels sought refuge in England and Canada, and a few made their way to
the United States. How did such a transforma on take place in just over three decades? How could a
community, evicted whimsically from an African country, build such a vast pool of resources in the US?

The answer lies in dhandho

Dhandho is the Gujara pronuncia on of the original word in Sanskrit dhan, i.e. wealth and dhan-dho is the
common Gujara speak for business. Why did the Patels, seeking refuge in the US, pick motels as their business
interest? How did they build scale and efficiency in a sector plagued with losses and poor margins? The answer
to the first ques on lies in the economic history of the US in the 1970s, while the answer to the second ques on
is one word – dhandho

A er the Second World War, the US spent a lot of money building long roads across the country. Consequently,
the automobile became a cri cal mode of transport for American families to travel across the country. This led
to a mushrooming of family-run motels across the key interstate highways in the US. However, by early 1970s,
just when the Patels were trickling into the US, the US economy got mired in a deep recession. As with all
recessions, consumers dropped their discre onary spends. High fuel prices meant lesser travel by car. Motels
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The Dhandho Investor:
The low risk value method to high returns
Author : Mohnish Pabrai
Book Summary

across the country started to cave in and went bust, or put themselves up for distress sale.

Crea vity in working capital management

In such a scenario, a Patel comes to the US, having been unfairly thrown out of Uganda. He has li le cash, does
not speak excellent English, and has a family to support. The most straigh orward op on for Patel would be to
take up a minimum wage job at a supermarket, packing groceries in bags. However, Patel sees an opportunity
in the distress sale of motels. If Patel buys a motel and runs it, there is no rental expense as his family will stay in
the motel itself. The family will also contribute, in terms of daily chores at the motel. So he will incur minimum
wages expenses in running the motel.

However, a fundamental ques on s ll remains- Patel does not have the money to buy the motel, even at a
distress price. But the sharp mercan le thinking Patel knows that the bank is also keen to get rid of the motel,
and will likely support any buyer interested in the motel. Patel is right; the bank is willing to finance 80-90% of
the distress sale price. So Patel has to arrange for the balance amount ($ 5000 in most representa ve cases). He
does so with the help of friends and family, and his own savings.

Patel is now the owner of a small motel, within a few months of arriving in the US, with very li le money, in the
early 1970s. His most significant concern of home rental expenses is now zero, as the Patel family stays in one of
the rooms of the motel that he owns. Work at the motel is divided among the family members, and all of a
sudden, the wage expenses of the motel go down, thanks to the Patel family.

The power of low price & high margin

With lower opera ng expenses, Patel now has the luxury to bring down the daily rental price for the customer.
Patel's motel starts offering the cheapest rates, thereby driving up occupancy. Since his wage bills are low, and
the Patel family stays in the motel itself, the margins for Patel are quite healthy even at the low daily rental
price. This is where Patel starts making more money (higher occupancy rates) and higher profits (lower
costs). Other motels in the vicinity of Patel motel start collapsing as they cannot match Patel motel rates.

Having ploughed in roughly $5000 of his savings into the motel, Patel can generate about $50,000 annual
revenue, even with a low rental rate of $12-13 per day and 50-60% occupancy rate at his motel. Inclusive of his
interest expense on the loan taken to buy the motel from the bank, his family expenses and other business
expenses, Patel's total expense would be about $20000 to $25000 annually. Which means that Patel can
generate a profit of about $ 15000 annually. This translates into an annual return of about 400 percent. This is
how Patels built their dominance in the motel business in the US.

What if Patel failed?

Now let's look at a scenario where Patel, having bought the motel with his $ 5000 savings, and the loan from the
bank, fails. His new motel just does not take off. In such a scenario, the bank that had extended the loan to
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The Dhandho Investor:
The low risk value method to high returns
Author : Mohnish Pabrai
Book Summary

Patel to buy the motel will take over the motel. But then banks are not interested in running motels, especially
when the motel has failed twice-once with an American owner and the second me with a recently immigrated
Patel.

So the bank knows that Patel is its only hope, and it renego ates the loan deal, with more benefits and support
for Patel, so that their best bet, Patel, gets the motel out of the crisis situa on. For Patel too, this is his best bet
to succeed in a new country. He has to ensure that the motel is profitable.

Scaling up

But Patel has made the motel a success story. He has steady cash flow and high margins because his motels
offer the lowest rental, and his labour expenses are negligible. The Patel family now decides to invest the
addi onal cash in another bigger motel, and this me, Patel's son manages the new motel, using the same
principles that Papa Patel has drilled into him.

Then more rela ves of Patel from India and other parts of the world, join the Patel family. Patel now has more
labour (at cheap rates). Patel's new extended family members are glad to find a place to stay for free in a motel
and manage its opera ons, just like Patel did a few years back.

This snowballs into a reality today where half of the motels in the US, are now owned by Patels.

The secret sauce

The secret sauce in Patel's success with motels is the concept of dhandho, which is about minimising risk and
maximising return. Contrary to common percep on, dhandho is fundamentally about crea ng wealth while
taking li le, or no risk. Dhandho is also about how well you manage your capital alloca on.

But dhandho is not about Gujarat or India. Dhandho is a philosophy that unites many, way beyond the Patel
community. One such dhandho investor is Sir Richard Branson. Richard Branson had built a successful music
catalogue business Virgin Records, having started his entrepreneurial journey at the age of 15.

Virgin Atlan c & the dhandho way

In 1984, Branson began evalua ng a business plan about star ng an all business class airline between London
and New York. There was a small problem, though. Virgin did not own any aeroplanes. Having decided to roll
out a dual-class London-New York service, Branson now went about looking to lease an aircra . He realised
that in this business, passengers pay for ckets about 20 days before the flight date, while the airline pays for
avia on fuel 30 days a er the flight, and salaries about 20 days a er the flight.

Branson understood that in the avia on business, the working capital requirement was low. He then called

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The Dhandho Investor:
The low risk value method to high returns
Author : Mohnish Pabrai
Book Summary

Boeing to figure out if they had an old 747 aircra to lease out. It turns out; they indeed had one. At this stage,
Branson calculated that if Virgin Atlan c failed, his liability would be about $ 2 million. In reality, Virgin Atlan c
made $12 million in its first year itself. Just like Patel did when he bought his first motel in the US. Both Richard
Branson and Mr Patel belong to this brotherhood of dhandho investor.

The core of dhandho investor is Heads; I win; tails, I don't lose much

The nine principles of dhandho framework

1. Focus on buying an exis ng business

When Patel bought his first motel, or when Lakshmi Mi al bought his first steel mill, they were buying into an
exis ng business with clear success metrics that could be analysed across an extended me period.
Richard Branson iden fied a new opportunity but within a well-defined and exis ng business. Unlike the
flavour of today's mes, start-up was not a hot word for these entrepreneurs. If you cannot own a business,
then owning a part of the business via shares is the smart thing to do. Building ownership across a por olio of
carefully selected companies via the shares route is the right wealth building tool. Just make sure that you
follow the Heads I win; tails I don't lose much dhandho investment logic while deciding your por olio.

2. Buy a simple business

If a dhandho investor is given a choice to invest in Google or in Patel's motels, the dhandho logic will guide
him towards the more straigh orward choice, i.e. the motel business. Yes, compared to motels, Google is far
more valuable currently with many exci ng prospects ahead in this fast-changing world.
However, the future cash flow assump ons for Google are difficult to predict given the high uncertainty of how
Google's business will evolve in the future. Motels, on the other day, have a very high predictability of revenue,
cash flow and profitability. There is a strong correla on between predictability of cash flow and the intrinsic
value of the business. The simplicity of the motel business and its inherent, intrinsic value makes it an obvious
choice for the dhandho investor.

3. Buy a distressed business in distressed sectors

Do you remember that when Patel decided to buy his first motel, he was a buying a distressed business? Bad
news in the steel sector was good news for Lakshmi Mi al, and he decided to buy more distressed steel plants
and companies. You can iden fy distressed businesses by reading the business headlines regularly or following
reports like Value Line or Por olio Reports or Value Investors Clubs, and many more.

4. Buy a business with a durable moat

Patel's motel had the moat of being the lowest cost player. Mi al's steel possibly also had the lowest
produc on moat. Low produc on costs make low prices possible, without eroding profitability margins. Once
this moat is in place, it becomes difficult for others to compete with your low prices and high profitability.
Richard Branson's moat with Virgin Atlan c was the Virgin brand itself, in addi on to low-cost opera ons. The
Mexican food chain Chipotle operates in the compe ve and fragmented Mexican fast food segment.

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The Dhandho Investor:
The low risk value method to high returns
Author : Mohnish Pabrai
Book Summary

However, Chipotle has built a moat with its ability to customise your Mexican meal, using fresh ingredients,
served in a pleasant ambience. Iden fying the moat of a business requires a deep dive into its financial
statements.

A high return on capital employed indicates a strong moat. But moats are not permanent. What used to be a
strong moat for companies like General Motors, eventually withered away, making GM suscep ble to
compe on.

5. Big & few bets; when the odds are in your favour
Keep in mind the dhandho adage of Heads, I win; tails, I don't lose much, when you bet. When Branson placed
his audacious bet on star ng Virgin Atlan c, he was placing a compara vely small bet, where the downside
would be about $ 2 million, if the first flight did not take off.

Warren Buffe has mastered the art of be ng few but be ng big, especially when the odds are in your favour.
In 1963, American Express announced a loss of $ 60 million, when it discovered that collateral of $ 60 million of
salad oil was actually just sea water. Pounded by the stock market, American Express share price halved. At this
stage, Warren Buffet invested 40% of his company's assets in American Express. Warren Buffet believed that
the intrinsic value of American express was much higher than its then share price, as the core asset of American
express was the trust of consumers and charge cards business and not salad oil.

In me, we now have the Kelly Formula which helps calculate the amount that you can theore cally bet across
a set of op ons available, and which is the one that you should place your biggest bet on. The Kelly Formula
reinforces the dhandho principle of be ng less o en, but be ng big, especially when your research tells you
that the intrinsic value of the bet is higher than its current value.

6. Focus on arbitrage
Arbitrage is about benefi ng from price difference on a commodity or instrument, basis geography, me or
other parameters. Like a moat, the power of arbitrage declines over a period of me, as more and more people
try to take the arbitrage advantage, thereby soon conver ng the arbitrage into a level playing field.

The low opera ng costs of Patel's motel leading to lower rentals was his arbitrage advantage over his
compe tors, who could not match Patel's rental rate without ea ng into their margins. In a tradi onal industry
like steel, Lakshmi Mi al plays the classic low-cost arbitrage advantage by buying his steel plants across
geographies.

7. Buy business at a discount to their intrinsic value

According to Benjamin Graham, the func on of the margin of safety is, in essence, that of rendering
unnecessary and accurate es mate of the future. Patel would have likely not read about Benjamin Graham's
margin of safety, but he prac sed the concept.

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The Dhandho Investor:
The low risk value method to high returns
Author : Mohnish Pabrai
Book Summary

Patel bought his first motel, which was a distressed asset, at a price far lower than its actual worth. This
minimised his downside and provided him a 'margin of safety'. Contrary to popular logic, the dhandho investor
believes that lower the risk, higher is the reward. Low risk generates high returns because when you buy an
asset whose price is far lower than its intrinsic value, you are bearing a lower risk. At the same me, because
you bought the asset at a discount to its intrinsic value, once the returns start coming in, they will be of much
higher magnitude.

8. Buy low risk, high uncertainty business

In the interplay of risk and uncertainty, there are four possible outcomes:
• High risk, low uncertainty
• High risk, high uncertainty
• Low risk, low uncertainty
• Low risk, high uncertainty

It is evident that low risk and low uncertainty is the best of both worlds. The stock market also believes so and
rewards companies which are in this quadrant with high trading mul ples. The dhandho investor is not
interested in this best of both worlds because the traded value is likely to exceed the intrinsic value.
The dhandho investor is interested in the third quadrant- low risk and high uncertainty. Stock markets do not
like high uncertainty, so they pull down the stock of companies that are in this quadrant. This low share price
does not reflect the high intrinsic value of these companies, thereby making it a lucra ve low-risk buy for the
dhandho investor.

Patel's motel is an example of a low risk (high predictability) and high uncertainty (possible economic
recession?) scenario. Even in the event of an economic recession, Patel's motel would con nue to be the
lowest cost operator, thereby garnering a significant market share, even in uncertain mes.

9. Be a copycat
Ray Kroc did not come up with the idea of McDonald's. He saw what the McDonald brothers had built, and
decided to scale it up. Similarly, Microso was not the first one to roll out an internet browser. Netscape did it
first, and Microso followed with Internet Explorer and completely dominated the internet browser space.

Li ing and scaling, or cloning, makes good business sense. The risk is lower in case of cloning, while
innova on carries a very high level of risk. The dhandho way is to li and scale. This is how Patels took the lion's
share of motels business in the US, within 30 years of se ng foot on American soil.

The art of selling stock

The dhandho principles help the investor pick companies or shares in companies by s cking to the adage ,
Heads, I win; tails, I don't lose much. However, what about exi ng at a profit? Like Abhimanyu in Mahabharata,
entering the chakravyuh was easy, it was the inability to exit the chakravyuh that killed Abhimanyu. An

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The Dhandho Investor:
The low risk value method to high returns
Author : Mohnish Pabrai
Book Summary
important mantra to keep in mind is that you should not sell at a loss within 2-3 years of buying a stock. This 3
year me period provides enough me for the stock to determine its intrinsic value. Any shorter and you would
risk selling at a loss. Any longer and your cost of wai ng to discover the intrinsic value will become prohibi vely
high. You must sell once the market price exceeds the intrinsic value, unless there is a tax imposed on the short
term sell. In which case, you should hold for the long term benefits to kick in.

This book summary captures key concepts from the original book. The original books carries detailed case
studies and analyses and is a highly recommended read.

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