Whatever you do, don't follow the investing framework laid out in this book. It will make my job as an investor that much more difficult because you'll be much more competitive.
OK, that's not completely fair. After all, one of the goals at The Motley Fool is to help you become a better investor. And that's exactly what The Dhandho Investor by money manager Mohnish Pabrai can do. But be forewarned: Pabrai gives us the recipe, but we have to determine the ingredients we'll need to make the dish.
Before we begin, let's learn a bit about Mohnish Pabrai. He manages Pabrai Investment Funds and, since 1999, has "delivered annualized returns of over 28% (net to investors)." With a track record like that, he's worth listening to.
As of March 31, 2007, Pabrai registered 13 holdings in his portfolio. Steel producer IPSCO (NYSE:IPS) makes up 18.4% of the portfolio. Independent energy company Harvest Natural Resources (NYSE:HNR) and financial services company Fairfax Financial Holdings (NYSE:FFH) round out the top three. These may not be household names, but when you read the book, you'll see why Pabrai likes them as investment opportunities.
Low risk, high return
That's how he does it. That's the message of the book. As an investor, Pabrai says stick to opportunities that have huge return potential with as little risk as possible. Intuitively, that makes perfect sense. Unfortunately, as humans, we're not wired that way, and we haven't really been taught to think that way.
Humans love action. We want to make things happen. We want every day to be filled with activity. Pabrai says, not when it comes to investing! The title of Chapter 10? "Few bets, big bets, and infrequent bets." What kind of fun is that? Pabrai isn't looking to make investing fun -- he's looking to make you a better investor.
I think one reason we do this is because we've been taught that higher risk is the way to generate higher reward. We have to take risk to earn a higher return. Think about Dendreon (NASDAQ:DNDN) and the ups and downs associated with the trials of Provenge. There are lots of people looking to make money there, and some investors can do it. Under his framework, outlined in Chapter 5 with details following in each chapter, I don't think Pabrai would consider Dendreon as an investment opportunity. The return potential is high, but the risk of loss is high as well. That's not the Dhandho way.
What I liked most
I think many of you are likely to disagree with what I'm about to say. I like the fact that Pabrai only gives the framework and leaves out lots of details, instead giving examples of how he has used this framework in the past.
Every investor is different. Everyone looks at things through his or her own lens. Everyone assess the odds differently. Everyone defines a moat differently. Some don't know what a moat, or sustainable competitive advantage, is, much less how to assess one. Guess what? If you want to be an investor, you have to put in the time to learn what a moat is, what margin of safety is, or what the Kelly Formula is. Pabrai gives readers the roadmap, and it's up to us to chart the path we want to take.
I'm fortunate. I have a Dhandho-type investment in my portfolio, AES (NYSE:AES), and I've written about it several times. Now not everyone is going to find AES as an opportunity. But with Pabrai's framework, you're more likely to recognize one going forward, giving you a leg up on the competition. "That's exactly why I don't want you following Pabrai's framework," he says tongue in cheek.
What I didn't like
I don't completely agree with principle two: Buy simple businesses in industries with an ultra-slow rate of change. On the surface, I see how you'd be able to find low-risk, high-return types of opportunities there. However, risk can be mitigated with knowledge. If you can recognize a business with an innovative or disruptive technology, then you can determine if it meets the low-risk, high-return criteria.
Take, for example, a business with strong network effects like eBay (NASDAQ:EBAY). When the company was changing its listing policies and fee structures, you would have thought the world was coming to an end. In a business with lots of change, lots of innovation, and lots of competition, I think that could make for a Dhandho-type investment. It's why I put eBay in my CAPS portfolio.
The Foolish bottom line
Admittedly, there's nothing new about investing in this book. Lots of great lessons have been packaged together to form a very nice framework that Pabrai uses. That's not a knock on the book. Rather I think that's the beauty of it.
Granted, I admit I'm biased, because this happens to be similar to the way I invest my personal portfolio. But even if you don't want to run a concentrated portfolio, the book contains plenty of powerful messages to help you assess investment opportunities and make you a better investor.
For more on things that can help make you a better investor, check out:
Retail and Consumer Goods editor David Meier is ranked 6,388 out of 31,195 in CAPS. He owns share of AES but does not own shares in any of the other companies mentioned. You can view his TMF profile here. The Fool takes its disclosure policy very seriously.