How To Beat The Odds When Buying Stocks (Mohnish Pabrai: The Dhandho Investor)

[Music] So there's been a lot of people trying to get into the stock market over the past year or so, and I actually just finished re-reading Monish Pabrai's book, "The Dondo Investor," which is a very good stock market book. But I've actually forgotten how good that book is at setting up your mindset to get started with investing.

There's a very good analogy in that book which describes how a new investor should think about making investments, and that's what I wanted to share in this video. Surprisingly, the analogy is that someone that is new to investing should think about investing as though they're gambling. Furthermore, with that mindset, they should see every investment as having odds. Right? There's odds of success and then there's odds of failure.

Because when you think about the world of gambling, really there's two types of gamblers out there. The first one is, you know, the person down at your local pub that's got a few teeth missing, that's shouting at the horse racing screen, that's just throwing, you know, 20 on Pink Gazebo, and they're rubbing their lucky charm and crossing their fingers that Pink Gazebo comes over the line in first place. But they don't really have any strategy; they're just really, they are purely gambling. These people do just do not make any money in the long run. In fact, these are the consistent losers over a long period of time.

But then there are the other type of gamblers. They're the gamblers that actually, over a long period of time, they do make money from their gambling. And the reason—and yes, these people do actually exist—and the reason that they are able to make money through their gambling is because they're not really gambling, as Pabrai says in his book. These are the people that, day after day, show up to the horse racing. They watch every single race and they learn about every single horse, but they don't really place any bets. They just continue to learn, they continue to see what the odds are offered by the bookies, and they wait until they find a golden opportunity where they can see a really good horse has been mispriced quite substantially by the bookie. Then they take a lot of their bankroll and invest or they bet heavily on that horse in that outcome.

With those odds, there's still some risk involved, don't get me wrong. But these people aren't really purely gambling; they're waiting patiently until they get those golden opportunities where they have a high probability that they're going to make money. Then, they're betting heavily on those golden opportunities. And then once that golden opportunity has passed, whether they made money or they didn't, they go back to what they were doing before—just watching, observing, learning about the horses, watching how their performances, watching what the bookies are offering in terms of odds, and waiting for that next golden opportunity.

Now, these two types of people are also found in the stock market. There are the people that, you know, go down to the pub and get a stock tip from Jono and bet heavily on it, where they really don't know anything about the company. Or, you know, they might take a tip from Motley Fool or they found some magic stock-picking formula in the back pages of a magazine, and they buy 10 stocks a week based on the magic formula. These people, they do not make money in the long run in the stock market, so please do not be one of these people.

But on the other hand, there are the value investors of the world. These are the people that learn a lot about each horse, or in this case, it's each company. Then they wait until the market presents these companies at a price that just seems absolutely ridiculous—a big bargain price where the likelihood is that we are going to make money. Then value investors bet heavily on those golden opportunities, and these people consistently make money in the stock market time and time again.

This is one of Charlie Munger's great analogies. He says 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.

Take the example used in "The Dondo Investor." He tells the story of Ed Thorpe, who was a MIT maths professor back in the 1960s. He used MIT's computers to figure out the optimal betting strategies in blackjack. Now, in blackjack, your odds consistently change with every card that is dealt. Thus, optimal play would mean that you would want to adjust your bet size with every card that gets flipped over. Now, Thorpe saw this was just merely a maths problem, which obviously it is. So he figured out what percentage of your bankroll you should be willing to bet in each situation in blackjack. He called this basic strategy and he actually published a best-selling book called "Beat the Dealer." In the process, he also went around to all the Las Vegas casinos and absolutely cleaned up.

However, eventually, the rules of blackjack were changed to take away Thorpe's edge. Not that this really meant much to Thorpe at the time because he had already been kicked out of all the casinos because he was just, he was just absolutely cleaning up. But a lot of gamblers around the world, a lot of blackjack players, had read his book and were also cleaning up. So they actually changed the rules of blackjack and how the cards were dealt and shuffled and whatnot, so that took away his edge.

But in any case, he still wanted to use this brilliant formula, so he just turned away from blackjack and instead he turned to the stock market. Which is actually a really good move for him because instead of making hundreds of thousands of dollars per year, now he was making millions of dollars a year. Because you see, there are two big advantages in the stock market. The first advantage is if you're wrong, it's rare that you actually lose a hundred percent. A lot of the times in the stock market, you can be very wrong but only lose 50 percent of your bet size. Whereas obviously when you're gambling, if you get it wrong, you just lose it all.

And then the second point is that in the stock market, there's very low frictional costs. So when you're betting in a casino, of course, or just at horse racing or whatever, you have to overcome the bookies' toll. Right? Just to make money, you first have to pay the bookies before you can start making money. Whereas in the stock market, you obviously don't have to pay this toll just to play the game. It's a much better environment for making money than, say, the casino.

But remember this, and I quote "The Dondo Investor" directly here: In investing, there's no such thing as a sure bet. Even the most blue-chip business on the planet has a probability of not being in business tomorrow. Investing is all about the odds, just like blackjack. When an investor approaches the equity markets, it has to be with the same mindset that Thorpe had when he played blackjack: If the odds are overwhelmingly in your favor, bet heavily.

So overall, our mindset as investors should be that of the sophisticated gambler. Right? We learn a lot about each company that we might be interested in. Then we wait for the market to give us a big mispriced gamble, right? When the odds are heavily in our favor, and then we have to bet heavily when those opportunities are given to us. That's how people should approach making an investment.

And throughout the book, Monish Pabrai summarizes this mentality with one simple phrase, and that is, "Heads, I win; tails, I don't lose much." Now, if I were you, I would write that down, print it out, whatever, and stick it up on your wall somewhere. We want to find situations in investing where, if it's heads, we make a lot of money, but it's never a sure bet with investing. So we also want to make sure that if it's a tail, we don't lose very much.

We're looking for low downside risk. And what this means is that means that when we're betting on companies, we bet on companies that have a low probability of bankruptcy, aka they don't have a massive debt load, and they still have strong cash flows. But most importantly, we only buy into these businesses when they offer a big margin of safety share price—a very big discount to the intrinsic value. The intrinsic value being what the stock, what the business is actually worth. So we want to be in the business of buying a dollar for 50 cents.

As Warren Buffett says, "Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results." And that's probably the biggest overarching message of Monish Pabrai's book: Successful investors are the ones that wait for the opportunities where, "Heads, I win; tails, I don't lose much." We don't want to be the people that are just taking the stock tips blindly from John at the pub. We don't want to be the people that are investing in the really risky up-and-coming thing, which, yeah, might go big one day, but is also extremely risky. That's not us. We're the ones that know what we know and wait patiently for those golden opportunities when the manic-depressive stock market offers fantastic businesses at massive discount prices where we can buy a dollar of value for 50 cents.

And that is a very important lesson to learn very early in your investing career. So that will do us for this video today, guys. All this stuff has come out of Monish Pabrai's "The Dondo Investor." So if you enjoyed today's video, I would highly recommend that you read that book. It's actually not a particularly stressful read; it's quite a short book, so it won't be a slog to get through. And some of the insights in there are just absolutely fantastic—completely follows the Warren Buffett style of investing. So I highly recommend it. If you wanted to, I might leave a link down in the description if you're interested in picking it up.

But that's it for this video. Leave a like on the video if you did enjoy it. Thank you very much for watching. Subscribe to the channel if you haven't done so already. If you'd like to learn more about the Warren Buffett style investing strategy, check out the links down in the description. I've made a full in-depth eight-hour course on how to run through the exact strategy. But that'll do me for today, guys. Thank you very much for watching, and I'll see you all in the next video. [Music] [Applause] [Music] So [Applause] [Music] [Applause] You.