Saturday, August 22, 2009

The Dhandho Investor: Chapter 4

Mohnish Pabrai is an Indian-American businessman and investor. For a number of years, he turned heads with the performance of Pabrai Investment Funds since its inception in 1999. Pabrai has high regards for Warren Buffett and admits that his investment style is copied from Buffett and others. Over the next few weeks, we'll be exploring the topics in his book about value investing.

In 2005, Forbes listed Lakshmi Mittal as the third richest man in the world. Unlike many others on the rich list, Mittal operated in an industry with extremely poor returns on capital - steel mills. As an owner of a steel mill, you have no control over the selling price of your products, and in order to have theh capacity to keep producing your end product, you need a constant supply of capital. As a result, the steel industry has been one of the worst places to invest over the last few decades, with bankruptcies abound around every corner.

Mittal was able to transform his steel mills into efficient steel-producing machines. But if he had grown organically, he likely would never have managed to get his net worth to $20 billion. Instead, he grew by acquiring steel mills that were going under. In some cases, he was acquiring for 10 cents what other investors had built for $1. Once he applied his operational efficiencies to the plants, he had restored the value of the assets to $1 or more, thus generating incredible returns on investment. Once again, Pabrai's "Dhandho" theme echoes through: the downside is minimal, and the upside is tremendous.

Pabrai also takes us the reader through his own experience applying "Dhandho". When he started his business, he had $30K in cash, and $70K in credit card maximums. If his investment went south, he would have to declare bankruptcy and will have lost $30K and would simply have returned to his old job. In other words, his downside risk was minimal. But his upside was not. Within a few years, he had sold his business for several million dollars. This represents another example of Pabrai's "Heads, I win; Tails, I don't lose much" philosophy.


Anonymous said...

Yikes, I can't believe this is being posted as something to look up to. If bankruptcy is "tails I don't lose much".. then I don't know what is?

What would "lose much" be for this guy? Getting castrated after going bankrupt? You don't take your savings of 30k, and then max out your credit limits, and regard that risk as "not losing much". That's how you make a homeless person, that's not financial or entrepreneurial advice.

Anonymous said...

As a follow up,

There's an ethical side to this level of risk taking with borrowed money. This Monish individual could have easily leaked his way into the employment food chain at a pension fund - in the role of an investment manager - and done this kind of "minimal risk taking" with other perople's pension money. Apparently, his world view regards complete personal bankruptcy as "tails I don't lose much", which is not a view shared by 99.999% of sane humans.

Books like this inspire illogical risk taking, and label them "tails I don't lose much", to dangle the "heads I win" carrot. One can easily see through the invalidity of the argument by reading these excerpts through the lens of margin of safety.

Finally, there is no proposition in life as heads I win, tails I don't lose much, that is sustaining over the long-term, and if anybody claims to find such a pill, the first response should be strong suspicion.

Saj Karsan said...

Hi Anon,

I agree. Pabrai's view that going bankrupt is not much of a downside is a lot different than our viewpoint.

I'm not sure if it's an ethics issue though, as presumably credit card companies know that people are doing this and as far as I know don't try to stop it, as they just make it back by charging 18% to the people (like Pabrai) that are able to successfully pay it back.