Li Lu On Investing On Value Investing in China -- Part 1
Hello investors, welcome to my blog, where I study the best Investors and businesses from around the world. This week, we’ll learn from Li Lu, who is dubbed the title the “Warren Buffett of China”
He has a relationship with both Charlie and Warren, and every Tuesday evening, he has a phone chat with Charlie Munger because Munger allowed Li Lu to invest in him through the daily journal, and he is said to be the one who found BYD for Berkshire Hathaway. He’s the one that likely told Charlie Munger to invest recently in Alibaba and he doesn't speak often. So when he speaks, it's really important to listen. Since this is a long article, I will be breaking up this article into four parts. Here are the topics we will discuss in all the articles. This article will cover the first part.
His Investment philosophy,
Investing in China
His thoughts on New Technologies and also,
His thoughts on The 3 Key Things that you need to have if you want to become a value investor.
How Li Lu's Investment Philosophy Changed over 28 years?
The answer is very simple; it didn't. He said that the only thing that changed is his circle of competence expanded (compared to the Graham style Cigar Butt investing). When he started as a value investor, he was a Benjamin Graham Cigar Butt-type investor. He was really finding value in numbers then he expanded onto smaller businesses, into smaller niches that he could understand. Then he went to bigger businesses and technology, so the more you expand your circle of competence and your knowledge, the easier it is to find value investments. He was looking for great businesses with competitive durable moats, and long investment runways that will do really well.
Let's take a look at his thoughts on how his value investing has changed over the years:
What kind of businesses are we looking at as value investors?
This is what Li Lu looks for as a value investor:
Long-term durable moat, which can fend off new competitors
High return on invested capital and a long runway of growth
Businesses can come in all sizes, forms, and industries, so you have to study businesses from all angles
And must be able to buy it with a discount to intrinsic value.
A good business with a strong moat is needed but the key is a high return on invested capital. Such that capital invested into the business can yield a high return which can then be reinvested into the business growth or into another profitable business. This is what Warren Buffett always talks about - businesses that can keep compounding returns over the long term; such businesses come in all sizes and in all industries. So you don’t just have to find the business and the numbers, you also need to understand both the business and the industry.
As Warren Buffett and Li Lu say, “You only need a few of those businesses in your life to really do well. Also, the key here is patience; you need to wait for the right price in order to buy businesses below intrinsic value.” There are always crises or situations that allow you to buy businesses below their intrinsic value.
Let's take a look at his thoughts on how what he looks for in great businesses:
Moats
Let’s go deeper on moats. Li Lu says that a moat is created by the management's capacity of allocating capital. Warren Buffett turned Berkshire, the textile firm into what Berkshire is now because of his investment in moats and his great strength is capital allocation. So when you have management that knows when and where to put capital at work for a good return on invested capital that's a big moat and for Li Lu, it's really what makes a business great.
Let's take a look at his thoughts on how what he looks for in a MOAT:
In what other ways do you do things differently from most other value investors?
Here Li Lu talks about his 3 core investing factors:
Looking at businesses that are already successful. So you don't mess with businesses that are not doing well which makes it much easier to invest.
Being intellectually honest with yourself and knowing your circle of competence.
You need to know a business in and out in order to be able to predict outcomes for the next 10 years and predict the next 2 years of a business with a 90% degree of certainty. Keep in mind that most times you can't, so you keep learning until you can.
There are three principles that Li Lu covers, the first is called Ownership Perspective. One of his core principles is that if you own a stock, you own the company. This is what he calls having an Ownership Perspective
The first principle: Ownership Perspective (If you own, you think differently)
This is perhaps the most important lesson that Li Lu learned as a young investor. Li Lu focuses on knowing, knowledge, and knowing things so well, so detailed that you can predict the business over the next two years. He says that from his personal experience that is possible. He said:
“The more I look into a company the more I am able to see the trends, the cyclicality there and understanding. So value investing and investing is really about knowing more and more” This goes back to his two great insights. 1. that he has to know more about the business, more so than anyone else, and 2. is to have an owner's mentality.
When you think a little bit about how everyone is so focused on those stock prices going up and down. But you see, when you focus on stock prices, you don't have the right investing mentality because you are not focusing on ownership.
Li Lu says, “If you are given a business that has no stocks, that you own 100%. What do you do? You start learning about the business, understanding the business, see the competitors, see what can happen, and then you become a real business analyst, an investor.” But to have the right mentality, you have to think that you own 100% of the business.
Only a long-term ownership mentality, where you know the business very well, allows you to buy more of it when a stock crashes by 50%.
He says that in Today’s Market, you should invest in a business that can do good through thick and thin!
Li Lu says something different when everybody says this time is different. These are the three most dangerous words in investing. Li Lu says “every time it is different” and that's something very peculiar. In today’s markets, we are in uncharted territories. You never know what can happen but if you want to do well as an investor you have to find businesses that will do well through thick and thin, that's it. Then it makes investing simple.
Here are his thoughts on having an ownership perspective, and his advice to young investors.
The second principle: Human Irrationality (The more you know, the less the market will mess with you)
When it comes to crisis and human irrationality, he says that;
Every 5 to 10 years we have a once-in-a-century crisis. Human behavior will never change because it's driven by greed for easy money in good times, based on incomplete pictures of the environment. So, when things get rough, all the bad things surface, people panic, and due to the complicated irrational relationship with money people have, they usually do the wrong thing at the wrong moment in time.
Because I don't think that investors understand the real principles of investing. And the real things that they are doing but they are attracted by greedy money and when that incomplete picture turns around all those investors, then they start to panic, then they start to do irrational things. Because when you start losing money, you make decisions differently and that's normal human behavior in a cycle. That only by the knowledge we can solve and as he says;
Financial markets actually amplify human instincts. The way to deal with your instincts is to find businesses that will do well no matter the environment and know the businesses extremely well. To quote Li Lu, “If you just pretend you know a business well, you will be tested in difficult times.”
The third principle: Generalist or Specialist? (DO BOTH)
He says that if you want to be a true specialist in the company you chose to really invest in, you want to be a generalist always of business in general, so that your core competence, your circle of competence is constantly evolving and enlarging over time.
He says “Be generalist in the learning of the markets of the megatrends but be a specialist when you start looking at the business and the niche the business is operating.”
Thank you so much for reading, and if you like this article please share it with your friends and family, it’ll help the blog a lot! Leave in the comments section, your thoughts about this article and what company I should cover next.
Stay tuned for part two of Li Lu’s investing thoughts in China.