Saturday, April 28, 2007

The Dhandho Investor

I'd heard a lot about this author through various online interviews and discussions with other high-profile value investors, so I decided to check out his book. This book is a very quick read, but contains some pretty powerful ideas. Whitney Tilson said that he read it in one sitting, it was that good.

Some of the major ideas in the book include the following:

  • "Few Bets, Big Bets, Infrequent Bets"
  • "Heads, I win; tails, I don't lose much"
  • Entrepreneurs as Arbitrageurs
This book is one of the first books I have seen to use the Kelly Criterion as a basis for position sizing. As highlighted by the first two bullets, it's advantageous to look for asymmetrical bets where the downside is limited, and the distribution of outcomes is very favorable. I would count my recent FTAR investment in that camp. In such a situation, with such a large edge and confidence, it does make sense to make significant commitments of capital. The approach is not to be riskier by betting on a few positions, but having incredibly stringent investment criteria, and only investing in those names that meet all those requirements.

The first chapter of the book details the rise of the Patel motel empire. He discusses all the competitive advantages and even does a basic DCF for a budding entrepreneur. Given the alternatives, there are situations such as these where it would make sense for someone to put their entire net worth on the line.

This book is also unique in that it is one of the the first books I have read that discusses a selling framework. Most investment tomes focus 90%+ on the selection and buying process and gloss over the details of exiting a position. One analogy he makes is to the Chakravyuh, an spiral-shaped Indian battle formation. One enterprising young warrior figured out a way to pierce the Chakravyuh. Once he entered however, he had no other option than to continue traversing deeper into the spiral. Once he arrived at the center, he had no way to exit and was eventually overcome. The main point is that investors should not purchase a security if they do not have a clear exit strategy or valuation planned out.

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