There’s a market-beater in your corner shop

By John Authers
Published: June 22 2007 15:26 Last updated: June 22 2007 15:26

After moving to London, at one stage I had lived in four different flats, in different neighbourhoods, in less than four years. That meant I had to order my newspapers from four different newsagents. And in each case, I had to write cheques to a “Mr Patel”.
All were well run, by families who worked exceptionally hard, but I did not pay much attention to them.
In the US it is hard to check in to a motel or an airport hotel without again dealing with Patels. Hardworking Patel families are ubiquitous behind the counters of US motels, as well as UK newsagents.
It never occurred to me that the Patel business model could be the basis for market-beating returns. But that idea did occur to Mohnish Pabrai.
Best-known as a disciple of Warren Buffett, Pabrai’s self-managed hedge fund has netted average annual gains of 26 per cent since he launched in 1999. This is phenomenal and he does it with a highly concentrated portfolio of rarely more than 10 stocks and without the aid of short-selling or any derivative contracts.
Instead, his fascinating new book* describes how he harnessed the wisdom of the Patels. The Patel clan, he says, hails from the Indian state of Gujarat, where they traditionally worked as landlords and tax collectors. Most of them arrived in the west after the dictator Idi Amin expelled all Asians from Uganda in 1973.
Pabrai (who was born in Mumbai and is not himself Gujarati), views the choices the Patels made when they reached their new countries in terms of risk analysis. They were looking for a good bet. Ideally, the odds would be: “Heads I win, tails I don’t lose much”.
The Patels arrived in the US during the oil crisis. The economics of motels seemed critically damaged and they could be bought easily.
As the Patels could move into the motel, eliminating their accommodation costs, and get bank finance for a chunk of the purchase price, it was easy to raise the cash needed to get started.
Their willingness to do all the work gave the Patels a critical advantage over the competition – they could undercut them on price. Even before the motel industry began to recover, Patel motels were performing profitably.
So, this was an affordable investment with a chance of big upside for someone who was prepared to work hard. The key, Pabrai realised on analysing the Patel business model, was the downside.
That downside was almost non-existent. The bank had little incentive to give up on its money and kick out the Patels. If it did, the Patels would lose their money – but in practice, they could earn that back, at the minimum wage, in about two years. This was a bet with almost nothing to lose: “Heads I win, tails I don’t lose much.”
They won. Patels now own motels worth more than $40bn in the US, with nearly 1m employees.
The key lessons Pabrai derives from the Patel experience can be applied to investing in public markets, by people who are not prepared to work 16-hour days. First, find a bet with the minimum downside possible and only then start to look at possible returns.
Second, make big bets (“Few Bets, Big Bets, Infrequent Bets”). The Patels, of necessity, had only one shot. But this improved the chance of a truly big profit. Similarly, Pabrai can go months without buying a new stock.
Concentrated bets are, of course, risky – unless you are sure the downside is truly limited.
The Patels’ approach to business has a word, Dhandho. In Sanskrit, it literally means “Endeavours that create wealth”.
When applying Dhandho to investment, Pabrai added a few more principles. One is to invest in companies with high uncertainty. If there are many possible outcomes for a company in trouble, its share price will suffer – even if in fact most of the outcomes are positive. Markets often in practice treat high uncertainty as a high risk of a big loss. The two are not the same.
Another point is to look for companies with, to use a Buffett term, a “wide economic moat”: a competitive advantage that will take a long time to erode. This applies to UK newsagents, which are mostly local monopolies.
Third, invest in simple businesses. “If it takes more than a short paragraph,” he says, “there’s a fundamental problem. If it requires me to fire up Excel, it is a big red flag that strongly suggests that I ought to pass.” He likes funeral homes: it is easy to show that demand for their services is consistent. The first Patels had no choice but to forego complex analysis tools.
Finally, buy distressed businesses in distressed industries, because they are the cheapest – like US motels in the early 1970s.
Who, beyond the Patels, is a true Dhandho investor? Warren Buffett is one. So is Lakshmi Mittal, who applied Dhandho to steel.
Pabrai even labels Virgin’s Richard Branson a Dhandho investor. For all his image as a risk-taker, his fortune stems from big concentrated bets with low downside. To start an airline, you need only lease an aircraft: the downside is low.
Perhaps Branson paid more attention to his newsagent than I did.
*The Dhandho Investor – The Low-Risk Value Method to High Returns by Mohnish Pabrai (Wiley, £18.95)
john.authers@ft.com