Mohnish Pabrai couldn’t figure out how on Earth the Patels – an small immigrant community that only arrived in the US a few decades ago with barely any assets to their name – managed to acquire $40bn worth of American motel and hotel assets. He came to realise that the answer is in their approach: low risk, high return. In fact, they had no other option than to be low risk, but how did they get that high return? Here are the principles.
Principles with my own interpretation added
1. Buy an existing business
The Patels bought motels with an existing business model. The fact that a business model already existed is lowering risk.
2. Buy a simple business in industries with an ultra slow rate of change
Also synergies with Warren Buffets approach: change being the enemy of investment so mundane products (e.g. Gilette) that everyone needs are desirable. Worth considering: Pabrai says that some underlying businesses that appear to have high change (like high tech firms) have essentially the same business model at their core even though the ‘front end’ might change rapidly.
3. Buy distressed businesses in distressed industries
Fairly self-explanatory. ‘Be fearful when others are greedy. Be greedy when others are fearful’ Buffet
4. Buy a business with a durable and competitive advantage – the moat
Richard Branson only ventures into a business once he’s convinced that it has a wide and deep moat. Part of the moat comes from extending his brand, part of it from creating truly innovative offering, and the rest from brilliant execution.
5. Bet heavily when the odds are in your favour
This was probably the newest concept for me. This is when the odds are so in you favour and the loses are minimal, that one can bet heavily. This is the basis of the ‘heads I win, tails I don’t lose too much’. This has radically changed my perception of some investments. Buffett says that these opportunities are rare – maybe only ‘twenty in a lifetime’ but this where the high upside comes from.
6. Focus on arbitrage
Someone was telling me that a friend, whilst working at his day job was also, on the side, buying stuff at Costco (bulk discount) and selling it on amazon at a higher price. This is arbitrage – exploiting price differences between markets. This friend made enough from these price differences to make this his full time income. Arbitrage is usually risk free! Although I don’t fully understand this, motels were an ‘arbitrage spread’ by reducing operating costs.
7. Buy business at a big discount to their underlying intrinsic value
Here we are reducing the downside before even working on increasing the upside! In other words, focussing on the ‘tails I don’t lose to much’ by ensuring that loses are as low as possible. This is constantly looking for opportunities with a large margin of safety.
8. Look for low risk high uncertainty businesses
Another bit of common sense that stares us right in face but we overlook. The motels that the Patels bought were low risk in a high uncertainty business. They were distressed businesses in the 70s (see principle #3) due to the oil shock (i.e the uncertainty). Because the businesses (principles #1, 4, 6 & 7), they were low risk, so then the Patels had the classic ‘tails I don’t lose too much, but if it’s heads (the situation changes and oil price recovers) then, I win!
9. It’s better to be a copycat than an innovator
Whilst many will, I’m sure, disagree about this principle, the point is to remember that we are talking about low risk. Innovation (innovator’s dilemma) has extra risk attached.
So what when other Patels arrived who were also low risk, why would they innovate when they can copy someone else’s success?
I hope that explains the nature of a low risk investment with a high return.
Originally posted in Personal Antifragility: https://personalantifragility.com/summary-dhandho-investor-the-low-risk-method-to-high-returns/