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Many of you enjoyed my previous transcript of a talk Li Lu gave at Columbia University. Thanks to Joe Koster, you can now view a more recent lecture he gave to Bruce Greenwald¶s value investing class in April of 2010. Based on Berkshire¶s investment in BYD, the fact that Lu manages Charlie Munger¶s money, and that even Buffett would give money to Lu if he ever retired (according to Greenwald) makes me think Li Lu is an investor worth watching. With that in mind, I believe it is insightful to study whatever you can find about him and his approach. I think this lecture from 2010 is great. The recording has some audio issues making it difficult to hear and I thought that some of you might enjoy reading notes from the talk. This is not a true transcript, but an approximation of what was said. I think it comes pretty close, having listened to the lecture a few times. I think you will find it helpful and Lu¶s talk rewarding. Bruce Greenwald: Warren Buffett says that when he retires, there are three people he would like to manage his money. First is Seth Klarman of the Baupost Group, who you will hear from later in the course. Next is Greg Alexander of the Sequoia Fund. Third is Li Lu. He happens to manage all of Charlie Munger¶s money. I have a small investment with him and in four years it is up 400%. [Applause] Li Lu: Columbia is where my whole life in America started. I could barely speak the language. In Columbia it was where I had a new life. It was really in the Value Investing class where I got my career start. I was really worried about my student loan debt at the time and a friend told me about this class and said I need to see a lecture from Warren Buffett. What I heard that night changed my life. He said three things: 1. A stock is not a piece of paper, it is a piece of ownership in a company. 2. You need a margin of safety so if you are wrong you don¶t lose much. 3. In the market, most people are in it for the short term. It allows you a framework for dealing with the day to day volatility. Those were three powerful concepts. I had never viewed the stock market like that. I viewed it negatively as a place made up of manipulators who were lining their own pockets. I embarked on an intensive two year study learning everything about Buffett.
you can pretty much navigate. If you really know ² you will not pull triggers like Wall St. Warren says that if you only come up with 10 good investments in your 40 year career. If you could ever find something you can do well that you really like ² that will be your best investment. If you can really successfully know what you are getting into. The first year I managed money I lost 19%. . There are plenty of things I don¶t know but they don¶t factor into the purchase because I am using a huge margin of safety. If you are truly intellectually honest. you will not get crushed. but on the other hand. Everything affects an investment. the position turns against you. Sooner or later. Buying a dollar at 50 cents. This business is brutally competitive. This class teaches you to know what you are getting into. There are all sorts of ways you can fail. You need to build in a level of safety so that whatever happens. especially accepting what things you don¶t know. you need to have the guts and courage to back up the truck and ignore the opinions of everyone else. Back to the game of investing. To be a better investor. If you don¶t have any insights into the business. that really over time will add enormous value to you. The world is divided by those who know and those who don¶t know. If you can do it with intrinsic passion. You have to want to find a certain set up where you can know something that most people don¶t know. That is not easy. when it goes from $100 to $50 you aren¶t going to know if it will back to $100 or $200. The future is unpredictable. You need to examine who you are and see if you could be good at it. So this is really difficult. you would not do anything. You are not investing in the past but the accumulative cash flow of the future.Two years after that I bought my first stock. Most people are troubled by what they don¶t know. Being a value investor means you look at the downside before looking at the upside. it constantly changes. The game of investment is really continuous learning. you will always be dealt surprises. you will be okay. But when you find those insights along the road of study. the rewards are huge. I tried to start a fund but I didn¶t have a track record. traders. You just can¶t copy other people¶s insights. So if things turn against you. This concept of margin of safety is an essential concept to be a good investor. You will do better than competitors. some positive most negative. After I graduated I worked at an investment bank for a year and realized it was a mistake. you will be extraordinarily rich. Before becoming an investor you need to look at how you can fail at this game. you have to stand on your own. It is so impossible to know everything and know exactly what is going to happen to a business from now till the end that you really have to accept that what you don¶t know. That¶s really what it is. Finding an edge really only comes from a right frame of mind and years of continuous study. This shows how different value investing is than any other subject.
it would not stop at 50% but go to 0. It does not have to be a great business. 2/3rds of them will be gone. With that I am open to questions. you have to have a certain confidence in your own judgement and not be swayed by other people¶s views.So how do you really understand and gain that great insight? Pick one business. A few years later there was the Internet bubble. drugs. It¶s just the way it is. Letting the financial industry get too big is bad for the economy. there might be only a couple left. Capitalism rewards people who are talented at capital allocator. So avoid being harmful. they just transfer wealth. It happens to everyone. you would not be trading. By the time it goes to 100 years. That is really what Wall Street did. If you start with that. you will have a tremendous leg up against the competition. None of them are really useful. So if you have the aptitude and temperament. Every time it goes against you. If you don¶t have that then I urge you not to go and become a nuisance. By the time 20-40 years go by. When I started in the business in 1997. you will eventually know how much that business is worth. investing is a continuous learning process because your investments are constantly changing So for those of you that have curiosity and the temperament. it is the great game. You would really seek out knowledge on how it should be run. That is what I think happened on Wall Street over the last several decades. Most people don¶t take that first concept correctly and it is quite sad. and alcohol. Look at what happened to the once mighty General Motors. this game couldn¶t be better. You need to be able to get a feel for how you would do as a 100% owner. So thats why I¶m saying is. If you can do that. People view it as a piece of paper and just trade because it is easy to trade. your net worth or value of your investments might go down 50%. And truly understand it. Any business. Look at the top 50 companies in America every 10 years. If you really made a mistake. inside out. It is not easy. In a sense. But if it was a business you inherited. What are you going to do about it? That is the mentality to take when looking at any business. This is really where that insight and temperament comes in. They are billed as once in a century disasters but happen every few years. it could be any business. That is better than any training possible. It happens to everyone. it is just as bad as getting addicted to casinos. It is just a given. Berkshire had at least three times when the stock went down 50%. I tell my interns to work through this exercise ± imagine a distant relative passes away and you find out that you have inherited 100% of a business they owned. This happens to even mighty companies. It happened to Rockefeller. It happened to Carnegie too. . But that is life. A couple years ago was the Great Crash of 2007 ± 2008. how it works. it was in the middle of the Asian Financial Crisis. I strongly encourage you to start and understand 1 business. they don¶t really create anything they just move money around.
I learned a lot. Can you talk a bit about that? Li Lu: It goes back to understanding the business. you look at the most miserable failures of that industry to see whether you will invest in it. Every generation has a handful of great businesses that come from no where and come to dominate their fields. it is a tougher game than simply investing in securities because you have to evolve to the day to day changes in operations and it is just not as easy to build great businesses.Q: Mohnish Pabrai recently spoke about his reluctance about investing in China due to the multiple accounting books / the possibility of fraud. Everything has a reason. As I have said. So if you can understand a business inside out you can then eventually extend that to understanding an industry. That is not always the case but it is often the case. Also. It is much more rewarding as an investor to pick those. Automobiles are amazing. Q: I read that when you look at an industry. Every thing has an exception though. especially if you are investing for the long haul. How do you deal with this given your own investments in China? Li Lu: Well. If you can get that insight. That is one question to ask ² whether you can trust the accounting and people running the business. If you look at the early days it started with several players and concentrated with just a few players that became enormously profitable. don¶t copy other people¶s insights because it doesn¶t work. It really was a lot of fun. I suggest you spend a lot of time looking at these factors. I probably carried it too far ² I eventually ran one of the businesses and it was of course a mistake. A certain industry might have characteristics that make it different than others. And if the worst players perform reasonably well relative to the great players ² that tells you something about the characteristics about the industry. Q: Did you have any specific example? Li Lu: I have studied many over the years. I learned a lot in how businesses succeed and how businesses fail. That can have a huge impact on the business. Q: Why did you decide to go into venture capital? How is that different than your other investing? Li Lu: I always had this bent that I want to build a real business. look every 5 years and see how the . And see how they perform over time. it is enormously beneficial. Once you have that understanding you can extend it to understanding an industry. If you can then concentrate that on a business with superior economics in an industry with superior economics with good management and you get them at the right price ² the chances are that you can stay for a very long time. Overall. Certain industries are better than others. Find the best of the players in the industry and the worst players. You then see how the life cycle turns with new automakers in China and India. I started a venture and it was really a lot of fun. Just because a next door neighbor is a fraud doesn¶t mean you are. you are more likely to find managers much more capable than yourself. If you want a good idea ² look at General Motors from the early days. In certain industries you might have better prospects than others. Overall. you know I think he is right. Then they became miserable.
you know the key ² the heart and soul of the electric vehicle age the heart is the battery. Or if you say well those guys just unbelievable money machines ² that is not true either. Understanding this gives you a tremendous leg up. if you have a car that does all that. Henry Ford was able to make the internal combustion work even though it wasted 85% of the energy. Up and till then. I heard that you thought it was important for them to introduce a model to the US and wanted to know why you thought that. In the 1980s it was 9% in the 1990s it was 6%. The Graham and Dodd Center should collect all the data and perform some kind of commentary on it. 100 years before the Model-T was introduced. Bruce Greenwald: Do you want me to give you the answer to that? In the 1960s. we know that the way that oil is burned contributes to global warming. it will be sold everywhere. Q: Yeah ± but why BYD versus others? . Q: I wanted to ask you about BYD.performance metrics change. Li Lu: That might be a better question to ask the BYD chairman than myself. Battery development has advanced so much that it is now comparable to the price and performance of traditional cars. If it continues. Human beings have only been on the planet for a tiny bit of the earth¶s history. That is really what turns me on. their return on capital was 46%. The battery is really where you get the biggest appreciation and is what determines the value of the electric vehicle. If you are just talking about electric vehicles. So there are all sorts of good reasons for electric cars. So now with the help of companies like BYD. So instead of just accepting the conventional wisdom that the auto business is bad ² that is just not true. the competition between electric vehicles and gasoline was not nearly as optimistic. the planet might still be here but all the human beings might not. the amount of insight that would yield would be astonishing. If you have that data. In the 1970s their return on capital was 28%. Well. It wasn¶t until Rockefeller got oil extracted easily enough that it worked. 1/3rd of cars being produced were electric. That is where you find the real winners. control system is software that can be improved over time. So if you can really examine those statistics and understand it that will give you an advantage for analyzing new situations like in China and India. years later. There is the battery. Eventually. the balance is about to tilt towards where performance and price are getting to the level that makes them a desirable alternative. Q: What about BYD versus others in the industry? Li Lu: The market will determine that. The electric motor has been there for 100 years. He was able to build the engine and produce automobiles that were cheap enough for people to buy and it took off. You want to guess how negative it is now? Li Lu: So that is really fascinating. and the electric control control panel. electric motor. It will be desirable everywhere. Now.
I sold a small amount of shares because an investor of mine had an emergency redemption. Chuanfu and his team have this fabulous culture. He has demonstrated that . I saw that you sold a small amount of your BYD position at the end of last year. There is only one company. But I saw that automobile batteries are much more complex. It is amazing. now they have 160. With investing. Was it just rebalancing? Can I just wanted to get your thoughts on that. Whoever is leading the charge will have a major advantage. So he has this ability to adapt in a competitive environment. So why would you own it today? Li Lu: Well that is interesting. Q: Right ± but what did you look at to reach that view? Li Lu: There are a lot of people who have worked over 100 years making great cars. Q: So you went to BYD in 2005 and then you brought Berkshire as well. The place we are still seeing a curve of continuous rapid improvement is with the batteries for cars. It is not an easy process. I really did not have a better understanding till then.Li Lu: Well because we also studied all those other guys. That really causes you to question what it is before you make an investment. He raised money in an IPO and Buffett gave him $200M. So there is a point. He had no money. I did not think that the idea of a good consumer battery manufacturer + an automobile maker made much sense. He got into battery manufacturing in that particular way because he really had no other option. So far those two elements need to be put together. The technology for building a traditional car has been refined enough to where it can be learned in a short period. $500M in net profit. you have to work with imperfect information because you are buying a piece of the future. Q: We read your profile online. everything people thought they knew turned out to be a few years late. Li Lu: Actually I started my BYD position in 2002.000 in venture capital funding before IPO and that was it. When you get into situations like BYD. and I saw that BYD has a manufacturing advantage with consumer batteries. So the answer of the question is does that stop you from making the investment? No. We will see when the winner emerges whether we are right or wrong. Q: So I did some research on lithium ion batteries. $6-7B in revenues. I did not really see a factory plant at BYD until the end of 2008. So when Buffett looked at the stock maybe it was a better deal but today it is this dream of vehicles that is really priced in. where if you have enough margin of safety± that is why I kept coming back to the elementary concept of margin of safety± you can allow much more uncertainty and unknowns. To put this together you need a Ford to put that together. I had a question ± do you have any problems when trying to invest in China? Li Lu: Yeah I do have some difficulty. I did not really get a chance to get more information because the problem in Asia till much later but it did not stop me from making my investment decision. he only had $300. It does not feel like a good value investor stock. One of the most fascinating things about being an investor is that surprises are part of the game. you see lots of good surprises. There is really only one company that is a leader in battery manufacturing and automobile manufacturing.000 employees.
do I really know what I don¶t know? If you can¶t answer that question. The key to analyzing it is you have to ask: do I really know what I think I know. An almost unheard of speed. The scale is almost unparalleled. Their manufacturing capabilities will double soon. You can know about management teams without meeting with them.ability again again and again. 8 or 9 thousand engineers. He continues to surprise me with his ingenuity. actions speak louder. at such a large scale. So I come back to the point that if you know enough on other things that there is enough margin of safety. the better the situation is and the deeper the discount. At the end of the day. There is not set preparation. the more honest and upfront they are. chances are you are gambling. This investment is not easy to understand because it is changing so fast. Everything being equal. So this is why the study of history. the more motive they have. You could spend a lifetime studying a business or industry. you want to learn more and study it more. This year they will hire 10. I suggested that we start with GM and analyze its performance every 5 years for 100 years to understand at least one aspect of BYD¶s business. Because I usually am just curious about the business and don¶t know a lot. Jim Chanos gave us his thesis on the China Syndrome with there possibly being a bubble. Q: What kind of preparation do you do before meeting a management team? Li Lu: I don¶t really have a set method. When working at a hedge fund or mutual fund. of all the great corporations will give you a good insight in seeing what will happen with BYD. You have to analyze it all. 8 years ago I had no idea they would go into the automobile or laptop or cellphone battery business. Q: One investor came in and said talking to management is a waste of time. The key in investing is to know what you know and know what you don¶t know. So you are prepared and not prepared. Li Lu: Well. Obviously. It took me 10 years and I am still learning new things about BYD. you may not learn something. So how do you look at it as an investor with imperfect information? Well I suggest you look at what he has accomplished. to figure out ways to do something better than everyone else.000 college graduates. The way he does automation is far cheaper than anyone else and more reliable. What he is currently doing is very different than what everyone else has done. They will say what you want them to say. Q: Recently. you are expected to learn a business in one week. it is too big of a question for me. Obviously it sounds like you don¶t agree with that. You can¶t truly understand everything about a business in one week. you might look at what he has done. the more you know about management. You want to build knowledge by continually learning. It is a continuous learning process. but in a few seconds I can tell you whether or not I like it. If you are really curious. What do you think? Will you pay a premium for a business with a moat? Li Lu: There is no general rule. Every situation is slightly different. You want to see what they have done. Even if you meet with management. I don¶t know . So that demonstrates how he is.
You cannot afford to borrow money for 20 years. Its basically the three things: 1. If you have all that insight going into analyzing businesses I don¶t have any arguments with it. 20 years time. In the market. and this most recent financial crisis. the Internet Bubble. So therefor any intelligent investing is really value investing. most people are in it for the short term. 2. From time to time. In the long game. If time is not on your side. Your downside is 100%. The Asian Financial Crisis. the upside is unlimited. A short cannot be a fundamentally long term position. So you spend all your time chasing noise than studying a long term situation. You need a margin of safety so if you are wrong you don¶t lose much. and spend all your time thinking about the short term. So shorting is a short term game. you have a good opportunity and you can save money on taxes. you can be right but lose all your money. The best kind of short usually has some kind of fraud. in terms of value investing what do you challenge in the conventional wisdom? Li Lu: Well. This is why I closed long / short. Q: What is your point of view on long / short positions in value investing? Li Lu: The most profitable kind of investing is long term investing. That is really an intelligent approach. You know I went through three bubbles. It allows you a framework for dealing with the day to day volatility. You want to allow the time that it might take because you don¶t know when the market will catch on. 3. there is huge leverage that can utterly crush you. the fundamental philosophy of value investing is very sound. A stock is not a piece of paper. There is a certain level of intellectual honesty. long / short is okay. but if you are trading all the time you need to be in tune with all the things moving the market. In theory. Look at Bernie Madoff. In shorting it is opposite. you will lose some money on paper. If you can find a business with good management with good industry fundamentals blowing it forward. it is a piece of ownership in a company. None of them might be fundamental to the actual business. In those situations. Out of curiosity.Q: 20 years ago you said you challenged conventional wisdom in China. But it is just part of the game. The biggest mistake I made is not being able to pick up undervalued . management is determined to keep the fraud. If you cannot concentrate on things in the long term. When those positions go against you. so you need money and time on your side. Shorting is also essentially borrowing. you will not be able to develop the kinds of insights necessary to identify great investments.
how do you think about diversifying your investments regionally? Li Lu: First of all. after your teenage years you are out of the game. I invest in things that appear to be compelling values that continues. When I look back at everything I have done.companies where I had a unique insight but was tied up with this whole long / short thing. if you happen to have macro economic factors behind you. Q: In a bull market environment. that is just not my game. Your knowledge accumulates exponentially. but that is because I am better at it today. Most professions. how do you re-evaluate your thesis? Li Lu: I don¶t ever want to profit from a bubble. One of the great things about being an investor is you can look anywhere and find great pockets of opportunities. Q: How is your investment style different today than when you started the fund? Li Lu: A lot of things have changed. but it is not the driving force for a potential investment. This game looks to be easy but it is not easy. I would suggest that you don¶t take short cuts. That process and progression is like compounding money. if you are doing it the right way. you get out of the game. I don¶t profess any ability to understand how long a crowd will buy into a bubble. I don¶t think China considers me a criminal. I just find better bargains outside of it. I am still paying for those mistakes. What I think we are doing today with our investment in BYD in China is really helping China march towards a modern era of . So you can look anywhere for opportunities. I would have done it all slightly differently. If you truly love this game. Soros does that. as you mature. you become better and better. If you have your fundamental things right. So that is why this game is a continuous learning process ± because everything affecting the investment is constantly changing. you can run a great wave. as you get older. Q: Given your focus on international investments. Including the price. The money I left on the table is still adding up. So if you approach it in a fundamentally sound way. One bonus about this profession is you get better over time. You really do want to never stop learning. I did not really specialize in international investments. I have views towards certain countries and currencies. I do not take a regional approach to diversification. In recent years. you get better over time. I started off doing most of my investments in the US and Canada. It might take longer but it is more rewarding. Q: What is the difference between being a top political criminal in China versus a hedge fund manager today (referring to the ire directed at Wall Street)? Li Lu: I don¶t consider myself a criminal. With investing. Including the prospects and elements of business success. you can compound knowledge faster than money. If you are a figure skater or gymnast. You cannot do that as a venture capitalist as I experienced myself. In fact. Take the example of competitive sports.
Think about how Bill Gates started Microsoft. all originally come from the sun. while using batteries to store it. inexpensively ² will really make renewable energy power everything. so China is providing a great contribution to everybody with BYD. even fossil fuels (plants that die and then go into the ground).B) annual shareholder meeting. a questioner asked Warren Buffett about the status of Berkshire¶s CIO candidates. I don¶t think he knew up front that he would take the entire market ² at that time it did not exist. Ultimately. Li Lu: Berkshire Hathaway CIO Candidate? This past weekend was the Berkshire Hathaway (NYSE:BRK.A / BRK. to migrate from the past to a way that gets us out of the unsustainable carbon age that we live in. but more broadly our entire civilization. it just happened that way. Most of the energy. It is the same way with our investment in BYD. So if you can figure out a way to take energy from the sun and power vehicles. I think finding an inexpensive way to store energy that we harness from the sun will be a huge contribution for both China and the US. it only looks logical in retrospect. BYD is providing a solution to both China and the US. Global warming is a vital concern to every human being. America has had a great history of invention and here is a great company in China that is about to make a major contribution to human civilization with cheap electric vehicles and solar power. The combination of those things holds the key to the future of industrial civilization that we are about to embark on.prosperity. Ultimately we will have to get our energy from the sun. We didn¶t set out with BYD with this in mind. At one point during the Q&A. Charlie Munger remarked that one candidate who he is particular close with was up 200% in . With great companies.
Therefore. No money. especially with respect to improving your own abilities as an analyst and investor. and earned three degrees (BA. MBA) simultaneously from Columbia University. Some people think that the person Munger is referring to is Li Lu. Worried about making a living in the US. but I know he is a huge believer in taking concentrated. But I thought I would share some notes from a lecture he gave to Columbia Business School back in 2006. Below are my notes from Lu¶s lecture: Li Lu at Columbia Business School ± 2006 -15 years ago. the more he thought it was something he could do. which rose 400% in 2009. I don¶t know anything about his investments beyond that one position. he worked in an investment bank until 1997. a fund manager who turned Munger and Buffett onto BYD. Still. All of this is paraphrased. funds focused on publicly traded securities and venture capital. -In the middle of Buffett speech. He attended Nanjing University in China and later came to the U. which today manages both LL Investment Partners and Himalaya Capital Ventures. Lu personally owns at least 2% of BYD. Lu was accidentally brought in to a lecture by Warren Buffett. If that is the case here. fortunes are up and down with the . Even if Lu is not a Berkshire Hathaway CIO candidate. -Value investors see themselves as owners of a business. deep in debt.S.. -At the time. when he founded Himalaya Capital Management. Fortune: Barnstorm Green There isn¶t a whole lot of information about Lu¶s investing style out there. he is an investor with a tremendous work ethic that we could all learn from. JD. BYD¶s spectacular results must have contributed a lot to his returns for 2009 which may make a 200% for the year possible. Lu thought he could do something in the investment business. -The more Lu thought about it. so don¶t take anything as a direct quote and there may even be some inaccuracies. He is a member of Council on Foreign Relations and Young Presidents¶ Organization. Here is a brief bio on Lu: Li Lu was born in China in 1966.2009 with 0 leverage. and a Henry Crown fellow by the Aspen Institute in 1998. high conviction positions. I believe you will find these notes insightful. After graduation. made him think differently about the stock market. Lu had just escaped China. Li Lu was named a global leader for tomorrow by the World Economic Forum in 2001. Had epiphany moment. Did not know very many people.
You have to be comfortable being by yourself. You think of yourself as a real owner of the business. science. You only own a small piece of the business. so you demand a huge margin of safety. -Understand who you are. technology. -Occasionally you can find insights that will give you tremendous insights that other people don¶t have. P/Bs. not trading all the time. New low P/Es. -If you are a value investor. Market On Value Investing -Under 5% of all assets are run under value investors. -The more you know. -First looks at valuation. Emotionally very difficult to be in the 5%. everything can affect businesses and help you. You will be tested. Basically. -You will probably spend most of your time being an academic researcher rather than a professional. You are trying to figure out how everything works. Is the management good? What else? Why is the opportunity there? -Started fund in late 1997. You have to adopt the idea that you are right because your reason and evidence. etc. Got hooked on value line. Go through it page after page. ask ± What is in the book? How much is the book? . -You demand a margin of safety. doesn¶t go beyond it. -The stock market is created for the other 95% of people. -Biggest challenge: understand whether you are the 5% or the 95% -It is tempting to do what the other 95% of people do. that is where your opportunity and challenge is. but 95% of money probably always resides to somewhere else. This is unnatural to human beings. literature. loved to read the whole thing from beginning to end. The money is really for traders and they tend to amass more assets. The best kind of education. 3 Traits of a Value Investor: 1. it is enormously helpful.nature of the business. You are a researcher or journalist. you should do this if you want encyclopedic knowledge of companies. -Politics. you are probably genetically mutated and comfortable being in the minority. 3. If the valuation doesn¶t fit. -That was one lesson that stuck in Lu¶s mind when listening to Buffett¶s lecture. -Then you find if the business is cheap. -5% have a spectacular return. 2. you think everyone else is different ² like Ben Graham¶s Mr. Tech Bubble. -First thing Lu checks is new low list. Been through really traumatic events: Asian Financial Crisis. but value investors typically have better returns. -Does not care where something traded before. poetry. -If you see a low P/B ratio. not because others agree with you. Because you think of yourself as an owner. -Fall of 1998: Lu¶s search process is very general. You will have to ask yourself whether you are or aren¶t a value investor. the better you are as an investor. with insatiable curiosity. a real minority in the investment world. you don¶t think of yourself as a paper shuffler who constantly buys and sells securities.
You can do a quick data search. -How do you determine if they are good managers? Decent people? -Act like an investigative journalist. it takes a couple minutes to look over financials. So it was not about milking the business or fraud. their Synagogue. Most business owners leave a trail for you to follow and see how they deal with different situations. introduce yourself to their friends and neighbors. to find what these business people have done and what their neighbors say about them to accurately get an idea of their personality. -At the time. saw their sales falling off the cliff in Asia. It is worth it to spend as much time as possible. If you were a member of the other 95% of the investment business you might say maybe management is milking the business. Look at ROIC. Deployed capital is 200M with 100M return. did not need financial markets. You may not listen to their advice but you may want to know what other people are looking at. Owns 40% controlling 98% vote. was the height of the Asian Financial Crisis. . active mind to ask questions and find answers. Figure out how much capital is deployed in the business. -The first time. working capital. -Timberland had no other analysts covering it. -Download every court document lawsuit. annoying investors. -The father seemed like a simple. their Church. Family owned. Any thing with exposure to Asia was falling apart. -Immediately. but YOU are part of their 5%. Example: Timberland -Start by giving a 5 second look at the business. -Then check why the business fell apart and became cheap. consisting mostly of tangible liquid assets. -Look at pre-tax and pre-interest earnings. Try to check what other people are thinking about this. READ EVERYTHING. plus 100M in real estate. Then gather questions and do deep research. The business is trading around clean book value. decent guy. -Timberland had most of the vote. -You need to have a curious. no analyst coverage. Think if you had owned the entire business at that price. Look from an un-leveraged basis. visit people they know. Timberland. pretty profitable. -Why no coverage? -Look at business across years.-Encyclopedic knowledge is helpful when looking across different industries. Dig every single time. which annoyed the owner of the business. the son went to business school. You NEED a very curious mind to figure out WHAT is happening. Read it. that is a turnoff to most people. They were not crooks. Timberland has been growing. Most professional managers would not see this as part of their job. -Go to their community. -Most lawsuits came from Timberland missing guidance. just a high school graduate. They decided to stop talking to Wall Street. a bunch of shareholder lawsuits.
Own 13% of a department store recorded as 30M. The other 95% will take tiny positions. a $200 position. they own 100% of a hotel. The book. The only way to do that is by training yourself and reading page after page of financial report. saw the stock was still trading low. don¶t count on goodwill. -After all that. Decided he did not miss anything. Managed to get himself on the board with the son and became friends quickly. when looking at stock manuals. Use mental math. -Basically you see with 60M in market cap. -Use your brain. How much do we buy? Imagine having $900. roughly 2x pre-tax earnings. Example: Korean Company -60M market cap. -Of the 70M in current assets. it roughly has a market cap of 600M. -Most employees never went to business school. The working capital. reduced earnings by less than 5%. Came to realize these where high quality. it is all cash -Of 180M in fixed assets. -But we decide to buy. -Book value of 230M. don¶t think about per share information. you will never be a good investor. Do everything complete but do it fast. each page should really only take 5 minutes. 30M in pre-tax. The other 95% may not have done enough research to see this or have some kind of institutional imperative that prevents them from owning. -When opportunity presents itself you can smell it. Their asian business is tiny. very ethical businessmen. So the . Devote day and night so you can act quickly. Think of how much work you did. you have to seize it. look at: fixed assets. recorded 30M as book. Propelled by earnings. It adds up. Be a Learning Machine -When an investment opportunity comes. -Determine what the earnings is. You need to use concentration. -Look up the department store. and noticed that they had a mutual friend. 50 basis points. -Use common sense. Don¶t use calculators. Lu finds they are easier to train.was already COO of the company even though he was Lu¶s age. pre-tax earnings of 31M. -Uses S&P manuals for viewing foreign stocks. What happened after next 2 years? Stock went up 700%. 13% gives you roughly 80M. Lu saw what boards the son sat on. No real risk ± went from trading at 5x earnings to 15x with earnings growing 30% a year. $240M in book value ($180M in fixed assets) -It might be cheap. what constitutes book value? If you are an owner. working capital. -If you are not a good analyst. -Lu put a ton into Timberland. Lu visited all the stores to see how margins improved ± they had a fad going on where kids wanted the shoes. common logic and think about the business. You have to train yourself to jump on opportunity. -As an owner.
But take what is on the book anyway. . Trading roughly around cash and investments. good earnings. value is likely 2-3x what is on the book. They need to be buying it for the price to go up. -Value investing is not really about theory. but you need to look at how local investors see it. -They charge a percentage on the top line of all merchant sales. -If you decide your personality fits in with the mutated gene pool. -They own 15% of 3 cable companies and a whole bunch of real estate. and actually DOING IT. looked at hotel and department stores. -The department store has exactly the same profile. -Young analysts have energy and nothing to lose. listening. more like a shopping mall. -Checked recent transaction of properties in neighborhood. Most of the time you will stand alone against everybody else. You have to go to an extra length to get it done. another 100M in stock. 30M in hotel with a value that has not been changed in last 10 years while real estate market has gone up in 10 years. -Before you become a good investor. Add that to rest and you get 320M in assets that you are paying 60M for and earning 30M annually from operations. -Put it all together: Paying 60M. and own a whole bunch of assets. do not take inventory. so they should go and do the work. Do it. -You can make a lot of money if you are really interested. you cannot possibly take conviction positions when things go into free fall and everybody else is laughing at you. you need to be a good analyst. -Insiders own 50% -Many factors going in your favor. -Lu benefited from listening to his value investing class and then actually going out and doing the work required. it is about what works. Lu says you need two things to be a good analyst: 1. -This type of an approach is not natural to an investor. Provide accurate and complete information.book value undervalues it by another 50M. add 150M. -Department store used to trade at 22 went to 100 -This company was at 12 now trades around 70 -each went up 5-6x Don¶t just listen. there is a lot of money in it ² proven by Ben Graham to Buffett -You have to put in a lot of work into your analysis. Went to Korea. Turns out they are the second largest cable operator as well -The department store operates like a hotel. that this is something you might be looking to do. 70M in net cash. If you are not competent about what you know.
how it ticks. You only get it from continuous learning. be intensely curious -Eventually you will stumble into one big opportunity. Most money is not made in stocks from the examples. you may only have 5-10 key moments of insight. was working with Julian Robertson. They wanted to go up in down markets. They require a lot of factors to come together ± Charlie Munger¶s lollapalooza. not like once a week an idea. Investment Mistakes -Most mistakes come from inaccurate or incomplete information. economics. -In the meantime. It¶s like Charlie Munger says ² having your hands tied behind your back while getting into a fight. Wife has a PhD in biology. Some businesses studied for 15 years. law. Could not bring himself to buy it because of his mindset at the time. The business subsequently went up 50-100x. improving the .000x returns. -Learn from everything. Lu had maybe 3-4 great ideas. then years with a lot of opportunities. -You make a mistake when you have not finished your work but like it enough. -They do not come in a steady pace. -The biggest ideas can give 10. you will stumble into Timberland style investments which aren¶t bad. You need a whole bunch of things working together where you have the insight and are willing to bet. -In 6 years. even though Lu knew the management and had great insights. You start betting on probabilities instead of real analysis. -Lu started in physics. Your returns will come from a handful of stocks. You need tremendous insight by continuous intense curiosity and study. he has learned a lot from her. If you cannot do that you will not make huge out-sized returns. you will make 15-20% returns but you wont make the huge returns of Buffett. -Depends on what becomes available to you. -Missed the opportunity to buy a business below cash. -If you do what Ben Graham or Tweedy Brown does. -There might be years without opportunities. so you can swing with conviction. You can do the Tweedy Brown/Graham or the Buffett/Munger school.2. They do not provide out-sized returns. -Opportunities are not easy to find. Find an American business and then find the Asian counterpart. But you get progressively better and better. -Lu¶s biggest mistake was straying. started shorting ² have to think like a trader when you are shorting because your downside can be unlimited. Constantly search for ideas -In your life. mathematics. got interested in other subjects. -This is what drives Lu in business. You need to know what that business is. -Biggest mistake: most people wanted 2 week or monthly returns.
If you are truly think like a business owner. and spend your entire lifetime studying. -Selling makes you pay a huge amount of tax and you might not get that good buying price again. Now. If one idea jumps out. you will eventually leave the asset management business and run a real company. sometimes Lu feels he has insights about the business that allows him to believe the probabilities are in his favor for the business actually improving year after year. Human nature prevents it. it is all Lu does. Who is running it? 3. Three characteristics of a value investor: 1. µwhat did I miss¶ is greatly affected by psychology. Investment bankers use BS and project into infinity. -Caveat: you have to be very confident. -If a business can generate 50-100% ROIC. -The people who the stock market is designed for are fundamentally flawed people. The leaders perform spectacularly well. Business owner mentality 2. -If you are good. What did I miss? -Lu goes through the checklist. -When Lu reads biology. Demand a huge margin of safety Think like a Business Owner -It all comes from one thing. -Used to be strict about selling with great business. Rest of the time is spent with wife and kids and Lu learns from them too. the mathematics get interesting very quickly. history. Is it a good business? 2. it is all searching for ideas.amount of opportunities for you since you will be quicker at your analysis. Li Lu¶s Investing Checklist: 1. -That is the law of distribution in good businesses. -Go through every day by learning something. You cannot force management changes. You cannot project that long. In a year you have to learn a great deal. -You do not belong to the stock market but you have to understand its perspective to position yourself properly. This kind of cognition happens early on and Lu learns it from interacting with his girls. especially with seeing how human cognition develops which is enormously important. They will always make room for value investors. Is that cheap? 2. You have a long time horizon because you think like an owner. Difference in time horizon 3. -Or you become a private equity investor. Traders are bound to make mistakes due to fear or greed. That is why Buffett and Munger left it. That is why 95% of people never buy into value investing. -But why dabble with stock market? Stock markets are made for people who can dream. There are only a few opportunities where you can project that long. physics. so you demand a margin of safety. that you are a business owner. across 50 year career maybe 5-10 opportunities .
Suppose you know the inflexion point. By holding you don¶t pay the tax on capital gains. That is what you do. Study every business. how you use the system. -When you have a business like that. -Offices were using Windows. you don¶t need to sell. high switching costs -Bloomberg is a fabulous case study. How do you compete with that? -Lu doesn¶t know. -Suppose you have an opportunity to see how an industry evolves early on. the switching costs become to high so winner takes all. -You need insight. it came out of no where. they don¶t give you a manual -They want you visually hooked so it is a behavioral connection and you don¶t mind paying tens of thousands of years where you don¶t have a choice if they raise prices -They keep coming back to you because they know you are a trader and want to provide you with more services so you are hooked. Think about switching from that or a competitor coming up with a rival product. -Your job as a good financial analyst is to study that business ALL THE TIME. Observe those trends. so you are really compounding 40% interest free. -That is why Bloomberg is a fabulous business because you get hooked. -Why doesn¶t Bloomberg want to sell? He doesn¶t need to sell. At that point. -Once in your life. They all have more or less this type of dynamic. crossed a milestone point. Same . became a monopoly -At a certain point. -You have to identify businesses that are getting stronger and stronger every year. maybe you will find that opportunity. -Look for great businesses. -Why did Microsoft succeed over Apple? Little by little they eroded Apple¶s 100% market share.where you can confidently project the next 10-20 years. Do you want to invest? Lu would invest in Bloomberg at that point. not just businesses owned by Warren Buffett Example of a great business: Bloomberg LP -Product was superior to others. At a certain point they cross the line -Maybe when introduced to all businesses. Today ± do you have a choice of not using Bloomberg? -Bloomberg visits almost every month and asks what you do. which copies Bloomberg¶s business model. the business is deploying the capital at 40-100% a year in a tax efficient manner. ex: CapitalIQ. There is a time when that line gets crossed and a public company is poised to benefit by becoming a monopoly business. -Lu has made many private investments. Bloomberg terminals have tens of thousands of functions. you don¶t want to sell. after being highly relied upon for daily work. -Gained market share little by little. -What makes one business more successful than others? Why are they making more and more money compared to others? -The only way you can find that is by studying the ones that are established.
-Nothing is constant. He likes to be friends with people. Everything is changing that is why you have to keep learning. . -You need an active mind. -You can learn and observe from everyday business decisions and learn dynamics. -Businesses change. -Lu likes to know as much as he can. so you are prepared to act and you can seize opportunity due to your insights.method with an investment in an engineering service. Microsoft has threats now. with Timberland. the CEO and his son actually became investors in Lu¶s fund.
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