Heads I Win, Tales I Don’t Lose Much

The margin of safety, sort of!

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Dhandho — what the hell does it even mean?

Well, Google and you find out!

If you know the investor Monish Pabrai, I am sure you’ll know what that word means.

He is the guy who cloned Warren Buffett. “Heads I win, tales I don’t lose much” is the approach that has given him superb returns on his investments over his investing career. The foundation of this strategy is to consider the downside before investing in an idea. And only invest in the idea of high chances for success, and the expected downside isn’t too bad if you were wrong.

After winning the bid to have lunch with Warren Buffett for $650,000, along with Guy Spier, that two and half hour lunch was worth every penny.

Before he ventured into investing and copying the master of value investing, he ran a successful IT firm Trans Tech Inc. from 1991 to the 2000s. In 2000 he sold his IT firm to Kurt Salman Associates for $20 million. With the $20 million from the sale of his firm, he founded Pabrai Investment funds. Buffett partnerships inspired it. He followed how Buffett had set up his fund, the fee structure, philanthropy and investing style. He believed that you don’t have to re-invent the wheel when you can follow the individual who is best at something you like to do. And copy the hell out of him!

A few principles he followed to keep his investing style close to that of Warren Buffett’s

  • Focus on buying an existing business. A business with a well-defined business model and a long history of success that you can analyse. This is waaaay less risky than investing in a startup.
  • Buy simple businesses within an industry with an ultra-slow rate of change. Change can be fatal to investing if it’s kind that adds unnecessary complications to the business. Buy mundane businesses, the businesses that are crucial to everyday joe regardless of bull or bear market.
  • Buy distressed businesses in distressed industries—Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results. While lecturing a group of students at Columbia University at aged 21, Warren Buffett said, “I’ll tell you how to become rich. Close the doors. Be fearful when others are greedy and by greedy when others are fearful.”
  • Buy businesses with a durable competitive advantage (the moat) . The key to investing is not assessing how much industry will affect society or how much it will grow in the coming years. Rather, it determines the competitive advantage of a company and its durability. When speaking to the students at the University of Florida, Warren Buffett stated that “I don’t want an easy business for my competitors. I want a business with a moat around it. I want a precious castle in the middle, and I want the Duke who is in charge of that castle, to be honest, reliable and competent. Then I want a moat around that castle. The moat can be anything from large clientele, quality of service or brand identity, whatever makes it harder for competitors to enter and steal business from it.”
  • Bet heavily when the odds are overwhelmingly in your favour — Charlie Munger uses the horse racing pari-mutuel betting system as one of his mental modules when approaching investing in the stock market. Unlike a casino, in horse racing, you’re betting against other betters. The house takes a flat 17% of the total amount wagered. According to Munger, investing is betting against the pari-mutuel system. We look for the horse that gives us one in two chances of winning, which pays you three to one. You’re looking for a mispriced gamble. That’s what investing is. Bet heavily when the odds are overwhelmingly in your favour.
  • Exploit Arbitrage — Arbitrage is classically defined as an attempt to profit by exploiting price differences between identical or similar price instruments. For example: if Gold is trading at $1 per ounce and in New York at $1.1 per ounce, assuming low frictional cost, an arbitrageur can buy Gold in London and immediately sell it in New York, pocketing the difference.
  • Buy businesses at a big discount to their underlying intrinsic value — It is basically minimising downsize risk before even glancing at the upside potential. If you buy an asset at a steep discount to its underlying value, even if the future happens to unfold worse than expected, the odds of a permanent loss of capital are low.
  • Look for low-risk, high-uncertainty business — low-risk and high uncertainty in the business scenario is a wonderful combination. It leads to severely depressed prices for businesses, especially in a parimutuel system based stock market.
  • It is better to be a copycat than an innovator — Monish Pabrai himself got the idea for his IT firm from his previous employer Tellabs. Innovation is a Crap-chute where you innovate by trial and error over a long time, whereas lifting and scaling carries a far lower risk and pays decent to great rewards.

Entrepreneurs who focus on minimising the downside before even thinking about the upside often find themselves in the classic ‘Heads I win, tales I don’t lose much’ situation.

Check out other posts: The Jolly Investor

Check out the book for more: The Dhandho Investor



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