The Dhandho Framework
While the low-risk and high-reward businesses portrayed in the first four chapters differed in type, they did share common features. These similarities form the basis for the rest of the book, where the author talks about these features in detail:
1. Buy an existing business: Each of the businesses described in the first four chapters had defined business models and nothing new was invented. Each had a long history of operations that could be evaluated.
2. Buy businesses in simple industries with a low rate of change: All the businesses described were essential and were not getting replaced. Motels and hotels will always be in demand because travellers need a place to sleep and refresh themselves.
3. Buy distressed businesses in distressed industries: The most favourable time to buy a business is when it is unloved and hated. Under such circumstances, the odds are high that an investor can pick up assets at steep discounts to their underlying value.
4. Buy businesses with a durable competitive advantage- The moat: A company's moat refers to its potential to maintain the competitive advantages that help it repel competition and maintain profitability in the future. This advantage can come from being a low-cost brand to having captive customers. Papa Patel’s, Manilal’s, and Mittal’s moats were developed by being the lowest-cost producer.
5. Bet heavily when the odds are in your favour: In all the businesses described, the investor did not act for many years, but when the opportunity was clear and the odds in their favour, they acted decisively and placed a large bet.
6. Focus on arbitrage: Arbitrage is an attempt to make a profit by capitalizing on price differences in identical or related financial instruments. In all cases, the investors saw a disparity between price and value, which they exploited.
7. Buy businesses at big discounts to their intrinsic values: when an asset is bought at a steep discount to its underlying value, the odds of a permanent loss of capital are low, even if the future is worse than anticipated.
8. Look for low-risk, high-uncertainty businesses: The scepticism leads to severely depressed prices. Papa Patel’s motel purchase had low risks associated with it. However, the outcome had substantial uncertainty attributed to it. Even if the gas prices continued to stay high or the recession continued, Papa Patel would still be the low-cost provider. He’d still be proficient to charge less and get higher occupancy. He has a relatively high uncertainty compared to very low risk with the motel investment.
9. It's better to be a copycat than an innovator: Invention is a risk, but scaling carries a far lower risk and substantial to great rewards. Papa Patel simply followed what the other Patels did. He too did not innovate. He just minimized the cost naturally by using his family as employees.
To summarize, the Dhandho framework is to:
- Buy an existing business
- Invest in simple industries
- Buy distressed business in distressed industries
- Buy business with durable moats
- Bet heavily when the odds are in your favour
- Focus on arbitrage
- Look for low-risk, high-uncertainty businesses
- Invest in copycat than an innovator