I’m positive you've never read before this book before, but you should. Here is the opening paragraph:
The book is The Dhando Investor: The low-risk Value Method to High Returns by Moohnish Pabrai, John Wiley & Sons Inc, 2007 All credit for the ideas in this post goes to the author Moohnish Pabrai. I’ll limit this post to talking about chapter five, The Dhando Framework. Even though I want you to read the actual book, I’m not giving much away by revealing the following nine points. I’ll even add one of my own to round them out for an even ten. Please note, the nine points below are taken directly from the book but the explanations provided are really adaptations because they were created by me to make the Dhando Framework more directly applicable to real estate investing. 1. Invest in existing businesses.Pabrai says it’s much less risky to buy an existing business with a well-defined business model than doing a startup. My thoughts: True. But this all depends on how you view risk. Most people see risk as something to be avoided because it represents pain, suffering and financial loss. I view risk as an opportunity. It involves an ill-defined problem that I need to think through. I allocate percentages to my chances of success and failure. There is often safety in sticking with the tried and tested, but it is on the frontier of the unknown that immense success and financial reward can be found. But remember: risk is double-edged. The line between great profit and life-altering failure is thin. Do you have the emotional and financial resilience to bounce back if your analysis is wrong or an unexpected event wipes you out? That’s a question between you, your mirror, and your life partner. 2. Invest in simple businesses. Pabrai advises buying simple businesses which experience ultra-slow, long-term change. He cites the Patel’s purchase of roadside motels as an ideal example. Computers have made the travel industry more IT-centric, but motels/hotels are at their core still a basic service business. As long as humans travel long distances, they will always need a place to sleep and refresh themselves. The fundamental economics of the business and the basics of good service are universal and unchanging. My thoughts: True. Air BnB and VRBO are simply new spin on an old problem. They monetize latent supplies of accommodation that no-one even knew existed: empty bedrooms in people’s homes. At the end of the day, a nice room in a nice hotel with nice amenities is all most people desire. 3. Invest in distressed businesses in distressed industries. Pabrai says, “the very best time to buy a business is when its near-term future prospects are murky and the business is hated and unloved. In such circumstances, the odds are high that an investor can pick up assets at steep discounts to their underlying value.” He uses Lakshmi Mittal, the Indian entrepreneur, as an example. Lakshmi built a global steel manufacturing empire by buying unwanted steel mills around the world when the steel prices were in the doldrums and the mills were being got rid of at fire sale prices. My thoughts: There are many ways to make money on a real estate deal. The first one is your purchase price. If your entry strategy is lousy and you pay too much, it doesn't really what your exit strategy is; you’ll still lose. Or as Warren Buffett wrote, “Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.” 4. Invest in businesses with durable competitive advantage – a moat to keep away the competition. Pabrai leans on Warren Buffet completely for this one. He even quotes him: “The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products and services that have wide, sustainable moats around them are the ones that deliver rewards to investors. I don’t want an easy business for competitors. I want a business with a moat around it. I want a very valuable castle in the middle and then I want the duke who is in charge of that castle to be very honest and hardworking and able. Then I want a moat around that castle. The moat can be various things: The moat around our auto insurance business, GEICO, is low cost” My thoughts: Nothing to add. 5. Few bets, big bets, and infrequent bets. Pabrai says Dhando is about taking low risk, high return bets. 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? However, if we examine the low-risk, high-return approachto business taken by the Patels, Dhandho takes on a much narrower meaning. We have all been taught that earning high rates of return requires taking on greater risks. Dhandho flips this concept around. Dhandho is all about the minimization of risk while maximizing the reward. The stereotypical Patel naturally approaches all business endeavors with this deeply ingrained riskless Dhandho framework - for him it’s like breathing. Dhandho is thus best described as endeavors that create wealth while taking virtually no risk.” Pabrai uses the example of Papa Patel to explain: “It is 1973. Papa Patel has been kicked out of Kampala, Uganda, and has landed as refugee in Anywheretown, USA, with his wife and three teenage kids. He has had about two months to plan his exit and has converted asmuch of his assets as he could into gold and other currencies and has smuggled it out of the country. It isn’t much—a few thousand dollars. With a family to feed, he is quickly trying to become oriented to his alien surroundings. He figures out that the best he can do with his strange accent and broken-English speaking skills will be a job bagging groceries at minimum wage. "apa Patel sees this small 20-room motel on sale at what appears to be a very cheap price and starts thinking. If he buys it, the motivated seller or a bank will likely finance 80 percent to 90 percent of the purchase price. His family can live there as well, and their rent will go to zero. His cash requirement to buy the place is a few thousand dollars. Between himself and his close relatives, he raises about $5,000 in cash and buys the motel. A neighborhood bank and the seller agree to carry notes with the collateral being a lien on the motel. As one of the first Patels in the United States, Dahyabhai Patel succinctly put it, “It required only a small investment and it solved my accommodation problem because [my family and] I could live and work there.” 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. His competitors start seeing occupancy drop off and experience severe pressure on rates. Their cost structures prohibit them from matching the rates offered by the Patel Motel - leading to a spiraling reduction in occupancy and profits.” p. 6-7 My thoughts: Place the odds in your favour and you are sure to win over the long term. The hard part? Being patient. Waiting until you find investments that offer you great odds. Papa Patel is a classic story of the tools we still use to create wealth through real estate: house hack (live in your investment property while also renting out part of it; managing the property yourself. Use family values to offer a clean establishment with attentive service. Outmuscle the competition by maintaining standards high and expenses low so that rental prices are always competitive. Succeed at all these things and you will create strong cash flow that will provide a good living and help you accumulate savings large enough for a down payment on a new property. So, the hotel/real estate growth cycle goes, slowly, on and on. Part 2 of this post will include the remaining four recommendations made by Moohnish Pabrai (seen above) plus one of my own.
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Cameron MorrellBusiness Educator Archives
November 2024
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