Monday, November 20, 2006

Mohnish Pabrai's Words of Wisdom: Excerpts from the 2006 Value Investor Congress

Mohnish Pabrai, Managing Partner of Pabrai Investments, gave an illuminating presentation at this year's 2nd Annual VIC in New York City. Titled, "Dhandho! Low Risk+High Uncertainty = Ultra High Rewards," Mohnish brilliantly illustrates the rise of the Patels in the U.S hotel industry.

Coming as refugees from East Africa, the Patels were filled with entrepreneurial spirit and nothing to lose. By buying small motels, living in the motels, and staffing the motel with family members, the Patels were able to reduce overhead costs down to the bare minimum (low risk).

This low cost structure gave the Patels one of the most prized attributes in all of business: a sustainable competitive advantage. Patels had no idea how their model would work out (high uncertainty), but they did know that they had no downside (the hotels were highly leveraged).

Mohnish referred to this as The Patel Motel Dhandho model (clever choice of words).

So how did this model turn out? Collectively, Patels own over 33% of all U.S hotels (about 20,000) or so worth over $40 billion.

Essentially what Mr. Pabrai is illustrating is the arbitrage spread that exists due to a gap that start ups step in to fill. In the Patel case, because they were able to operate with the lowest costs, they were able to provide the lowest prices and so they generated super sized returns.

Like all arbitrage opportunities, however, over time the gap diminishes. As Patels applied their model on a larger scale, the profits eroded and the gap diminished. In this situation the gap persisted long enough for a lot of Patels to make a lot of money.

I found Mohnish's talk to be brilliantly refreshing. Before his discussion, I was puzzled with the title of his topic, but as I have come to discover about Mr. Pabrai, give him a few minutes and he will explain his thoughts in such a way that you taken by thier combination of simplicity and potency (I am often reminded of Warren Buffett's responses to shareholder at annual meetings in much the same way)

This talk contained valuable nuggets of information that are essential to any long-term investment philosophy: seek out companies with sustainable advantages and you don't need to take on higher risk to generate higher returns.

Mohnish's Dhandho model is a powerful frame work for all equity investors to use.

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