Such deals are not common, but they do exist. In this case, the "tails, I don't lose much" was backstopped by the very wide margin of safety: The market price was just above $6 while the intrinsic value was about $25. Or, as he frequently wrote, "Heads, I win tails, I don't lose much." Buffett did not go that far, but Pabrai estimated Buffett invested more than 25% of his available cash he called this a case of Dhandho investing, taking a small risk for potentially high returns. The Kelly Formula would have recommended investing 98.7% of available capital to this opportunity. Just a brief reminder, this was well before the internet arrived, when newspapers and broadcast stations were considered pseudo-monopolies, i.e., protected by durable moats. Odds of a total loss after three years: 1%. Odds of 0% (breakeven) to 200% in three years: 4%. Odds of a 200% to 400% return in three years: 15%. Odds of a 400% or greater return in three years: 80%. Pabrai suggested applying these "conservative" odds to The Washington Post case: The Formula states: "Edge/odds = Fraction of your bankroll you should bet each time." Harkening back to chapter 10, Pabrai reintroduced the Kelly Formula, which provides guidelines for how much to buy given a set of odds (applicable to both gambling and investing). That would equal a return of about 70% per year. Applying that standard to the Post case, Pabrai argued his case for buying this way:īuffett paid about $6.15 per share for stock he valued at about $25 per share.Īssume the company recovers 90% of its intrinsic value in three years.Īssume that intrinsic value increases by 10% per year because of business growth.Īfter three years, the share price would rise to about $30 per share. Pabrai added that his own experience had shown that most gaps will close within three years, and that the vast majority of those will close in fewer than 18 months. Pabrai argued that Buffett expected the gap to close to his advantage. What Buffett saw in the margin of safety, between market value and intrinsic value, was a gap. And that did not include the modest dividend paid by the company. And why not keep holding them? After 33 years, their value had grown from $10.6 million to $1.3 billion, a "124 bagger" as Peter Lynch would have put it. As of 2007, when Pabrai's book was published, Buffett still held every share he had acquired. Buffett, of course, was not a believer, thanks, in part, to the tutelage of Graham.Īs a result, he bought a hefty batch of Washington Post stock for about 25 cents on the dollar. It holds that stock prices convey all relevant facts about all public companies and, therefore, expert knowledge is of no help in generating above-average profits.
Those other observers and investors found nothing attractive here after all, they were mostly believers in the efficient market hypothesis. At the same time, its market cap based on the share price was just $100 million.
Buffett had agreed with many market observers and experts that the company had an intrinsic value of $400 million to $500 million. To illustrate his point, Pabrai turned to Buffett's investment in The Washington Post in mid-1973. In their view, the only way to increase returns above the market average is to take on more risk, and the only way to reduce risk is to settle for lesser returns. That, of course, goes against the grain for many investors and experts because they believe risk and return must move in lockstep. The greater the discount to intrinsic value (margin of safety), the greater the return. The greater the discount to intrinsic value (margin of safety), the lower the risk. That business has an underlying value based on the amounts of cash flowing in and out.Īlways buy a business for much less than your conservative estimate of its value: Margin of safety.īuffett also argued that Graham focused on "two joint realities": Market and "Make the stock market serve you."īuying a stock means buying a piece of a business. He responds that his favorite book was written by his mentor and former employer, Graham: "The Intelligent Investor." Buffett tells the students there are three key ideas in the book: Inevitably, Buffett is asked which books he recommends. He began by noting that Buffett has hosted many university student groups in Omaha, Nebraska, events where students are allowed to ask Buffett any question. In chapter 12 of "The Dhandho Investor: The Low-Risk Value Method to High Returns," Pabrai used the two gurus to establish his case.