In his book The Dhandho Investor, Mohnish Pabrai discusses a strategic investment approach likened to pari-mutuel horse race betting, where success hinges on identifying mispriced opportunities that offer high rewards for minimal risk.
Papa Patel’s minimal risk motel venture and professional racetrack bettors who profit by selectively betting on undervalued horses exemplify this approach. Charlie Munger underscores this philosophy as essential to value investing—placing significant, well-informed bets only when odds are substantially in one’s favor, a strategy also employed by the Dhandho entrepreneurs who focus on highly favorable conditions to maximize returns while managing risks. Here’s an excerpt from the book:
There was a chance that Papa Patel’s motel could have failed. However, on two serial bets made over five years, the odds that both outcomes go against Papa Patel are slight.
Even when he loses both bets, since he did not have much to start with, his losses are pretty minimal. Societal safety nets help him get back on his feet. But when he wins—and the odds are over 99 percent that he wins at least once—he gets over 20 times his money back. It’s classic “Heads, I win; tails, I don’t lose much!”
Warren Buffett’s business partner and vice chairman of Berkshire Hathaway, Charlie Munger, uses horse racing’s pari-mutuel betting system as one of his mental models when approaching investing in the stock market. Unlike a casino, in horse racing you are betting against other bettors.
The house takes a flat 17 percent of the total amount wagered. Frictional costs, relative to the stock market, are very high. According to Munger:
To us, investing is the equivalent of going out and betting against the pari-mutuel system. We look for the horse with one chance in two of winning which pays you three to one. You’re looking for a mispriced gamble. That’s what investing is. And you have to know enough to know whether the gamble is mispriced. That’s value investing.
—Charlie Munger
To be a consistent winner at the race track, a person has to overcome the staggering 17 percent frictional cost of placing a bet. According to Munger, there are actually a few people who are able to make a living by betting at the race track after paying the full 17 percent. These folks watch all the horses and races, yet place no bets.
Then, when they encounter widely misplaced odds (in their favor) on a horse about which they know a great deal, they bet heavily on that one horse in that one race. After that, they go back to watching the horses and races indefinitely with no bets placed until another good opportunity shows up.
It is not too different from all five of our Dhandho entrepreneurs. They’ve all concentrated their capital and their bets. Most of the time they either do nothing or place miniscule bets (Branson). Every once in a while, they encounter overwhelming odds in their favor. At such times, they act decisively and place a large bet.
You can find a copy of the book here:
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