In his book – The Dhandho Investor, Mohnish Pabrai discusses the power of simplicity in investing, which focuses on businesses that are easy to understand with predictable cash flows.
He highlights the importance of conservative assumptions and straightforward analysis, citing Papa Patel’s purchase of a motel as an example. Pabrai references the wisdom of Henry Thoreau and Albert Einstein, noting that simplicity is a hallmark of genius.
He advises investors to develop clear, concise investment theses and warns against complex analysis, suggesting that if a business requires intricate calculations, it’s likely not worth pursuing.
Here’s an excerpt from the book:
The Dhandho way to deal with this dilemma is painfully simple: Only invest in businesses that are simple—ones where conservative assumptions about future cash flows are easy to figure out. What businesses are simple? Well, simplicity lies in the eye of the beholder.
Papa Patel bought a business that’s very easy to understand. The motel had long histories of revenues, cash flows, and profitability available for analysis. From that data, it is not too hard to get a ball park range of estimated cash flow that the motel is likely to generate in the future.
Papa Patel also has a good handle on potential repairs and capital expenses that were likely to be required in the future based on the historical data and the condition of the property.
Simplicity is a very powerful construct. Henry Thoreau recognized this when he said, “Our life is frittered away by detail . . . simplify, simplify.” Einstein also recognized the power of simplicity, and it was the key to his breakthroughs in physics. He noted that the five ascending levels of intellect were, “Smart, Intelligent, Brilliant, Genius, Simple.” For Einstein, simplicity was simply the highest level of intellect.
Everything about Warren Buffett’s investment style is simple. It is the thinkers like Einstein and Buffett, who fixate on simplicity, who triumph. The genius behind E=mc² is its simplicity and elegance.
Everything about Dhandho is simple, and therein lies its power. As we see in Chapter 15, the psychological warfare with our brains really gets heated after we buy a stock. The most potent weapon in your arsenal to fight these powerful forces is to buy painfully simple businesses with painfully simple theses for why you’re likely to make a great deal of money and unlikely to lose much.
I always write the thesis down. If it takes more than a short paragraph, there is a fundamental problem. If it requires me to fire up Excel, it is a big red flag that strongly suggests that I ought to take a pass.
You can find a copy of the book here:
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