The Great Investors - Li Lu: The World's Best-kept Secret Investor

Hello investors, welcome to my blog, where I study the best Investors and businesses from around the world. Today, we will be looking at Li Lu - one of the world's best-kept secret investors. Although he gives very limited interviews and lectures, I’ve researched all that I could about him, and it’s hard not to be impressed. 

Here is how the article is broken down:

• Early Life and his Escape from China

• First Introduction to Warren Buffett

• His Value Investing Career to Date

• Lu Lu's relationship with Charlie Munger 

• My takeaways as a value investor from Li Lu’s investing style

Li Lu is one of the world's best-kept secrets as an investor, a hugely successful value investor who consistently outperforms the market.

Since its inception in 1998, Li Lu's value investment firm, Himalaya Capital Investors, has reportedly produced a 30 percent compound annual return, putting this little-known investor in the same league as Warren Buffett, Charlie Munger, and Peter Cundill.

A $1000 investment with Himalaya Capital and Mr. Li Lu would yield a total return of $321,000 over the same time period, compared to $6600 for the S&P 500. It's no surprise, then, that Charlie Munger has entrusted Li Lu with his own money. But how did Li Lu achieve such incredible results? Let's take a trip down memory lane and learn more about his early years.

Li Lu’s life didn't start as well as it turned out. During the Chinese Cultural Revolution, Li Lu's mother and father were sent to labor camps, so he spent his early years rotating between adoptive families. He was born in Tangshan, China, and studied Economics at Nanjing University before fleeing to Columbia University to further his education.

He grew up with no direction and spent his free time-fighting in the streets. His life trajectory changed when his grandmother, one of the first women in her city to attend college, inspired him to begin studying and reading. This was a turning point in Li Lu's life, and it was here that he began his path to a chance meeting with a young Mr. Buffett.

He became one of the student leaders at the Tiananmen Square student protests, organizing and participating in hunger strikes, during his time at a university in China. Lu was eventually chased out of the country and fled to America. France as a result of this.

Mr. Li arrived in America knowing little English but was greeted as a hero and given scholarships, which he took full advantage of, learning English while simultaneously earning three degrees in Economics, Law, and a graduate degree in business, which is impressive, to say the least.

“When I first came to Columbia University, I was dirt poor. I did not choose to come here - I just ended up here because I had nowhere else to go, having just escaped from China after Tiananmen.”  - Li Lu

Li Lu founded Himalaya Capital Management in 1998, shortly after graduating and being inspired by Warren Buffett. He embraced the value investment principles of Benjamin Graham, Warren Buffett, and Charles Munger.

Li Lu's First Introduction to Warren Buffett

Warren Buffett met Li Lu for the first time at a guest lecture at Columbia Business School in 1993, which Li Lu almost missed. In an interview, Li Lu explained that during his second year of study, a friend invited him to a guest lecture by Warren Buffett, knowing that Li Lu was looking for ways to make money.

Li Lu, on the other hand, misinterpreted his friend's statement and assumed that there was a free lunch buffet as well as an opportunity to learn how to make money, which was a good enough reason for Li Lu to attend. Thankfully, he did, and it completely changed his life.

There was no free lunch, much to Li Lu's dismay. Mr. Warren Buffett, on the other hand, gave a speech. This talk smacked him in the face and flipped the switch to a life of value investing and, eventually, a life of learning with wealth as a byproduct.

The lesson here is to never turn down a free buffet...or a Warren Buffett guest lecture!

Li Lu Launches His Value-Investing Career

Due to historic stock market valuations, the late 1990s were one of the most difficult periods for value investors. Despite the challenges, Li Lu went on to have a successful career. Unfortunately for Li Lu, he launched his fund just as the Asian Financial Crisis (AFC) was kicking in, and he lost a whopping -19% in his first year.

He said about this time -  

“In my view, the biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. Not only is the mere drop in stock prices not a risk, but it is an opportunity. Where else do you look for cheap stocks?”  - Li Lu

Lu's character was forged in part by his Grandmother's example and in part by his difficult escape from China, and it helped him stay on track after a rocky start. His perseverance would soon pay off, as he discovered what would turn out to be one of his most profitable investments.

Li Lu followed sound investment principles from the start, which a young Warren Buffett would have admired. The search for extremely low-cost stocks in terms of net asset value was one of the most important.

Li Lu believes that if you know where to look and are willing to do the research, the market's irrationality will always provide opportunities for deep-value investors. His interest in Russian stocks, particularly oil stocks, in the 1990s is one example he has mentioned.

A deep value opportunity is frequently born in a time of crisis. The Soviet Union had just collapsed, and the newly formed Russian Federation was undergoing capitalist "shock therapy," rapidly privatizing previously state-owned conglomerates. Because there was no such thing as a stock exchange at the time, ordinary citizens and employees of these massive state conglomerates were given issues that could be converted into shares. The problem was that most people had no idea what a stock share was, so they thought they had been given worthless paper.

Due to a lack of liquidity, a lack of a market, and the general uncertainty surrounding Russia during this tumultuous period, these companies were forced to trade at deep discounts. 

Li Lu explains: “Forget about earnings, just consider the assets on the balance sheet. At the time, the five-year average for oil prices was about $20 per barrel and on a per-share basis, they were trading for as low as 1 cent on the dollar, sometimes half a cent on the dollar, so about 10 cents to 20 cents per barrel of crude oil. And that's not even counting the earnings from the company! It was ridiculous."

What attracted value investors like Li Lu to these dirt-cheap stocks was the fact that the huge discount did not even take into account the companies' earnings. At the end of the day, these were still massive corporations with monopolies in the Russian oil and gas industries, further bolstering their moat and safety margin.

Li Lu invested in Lukoil (LUKOY), a newly formed Russian government entity that later sold shares to the general public. Those who recognized the opportunity and acted quickly saw their money grow tenfold by 1998. In 1999, the stock was listed over the counter for $8, a huge increase from just a few years before.

We can see how investors in these oil companies would have done during the AFC, when Russia devalued its currency by 90%, to really emphasize the margin of safety that very cheap stocks provide. After the severe market decline, investors who bought shares in 1993 were still up tenfold on their investment!

After hearing Warren Buffett speak and implement his approach, Li Lu's investment returns were so good during college that he was able to retire. So, how did Li Lu make such a large profit?

The simple answer is a sound investment philosophy based on buying dirt cheap but solid companies, similar to Warren Buffett's classic Cigar Butt strategy. When Li Lu is looking for investment opportunities, the first place he goes is to the new low list, where he looks for stocks that are extremely cheap in comparison to their net asset value.

It's no secret that investing in extremely low-cost stocks that trade below their liquidation value has outperformed the market over time.

This is demonstrated by super investors such as Buffett, Cundill, and Schloss in practice, as well as academic research by Montier, Oppenheimer, Oxman, and Vu. Graham, Buffett, and Li Lu all passed down the wisdom of this investing style to Li Lu, who masterfully applied it.

Like Buffett during his partnership days, Li Lu's early investment philosophy was to buy dirt-cheap stocks. Li Lu was drawn to the fundamental principle of value investing: buying good securities at a low price. Lu says in a Graham and Doddsville interview that this approach appealed to him because “if you're wrong, you won't lose a lot, but if you're right, you'll make a lot.” Monish Pabrai, a self-described Warren Buffett clone, takes a similar approach and outlook: "Heads I will, tails I don't lose much"

Li Lu believes that the market is irrational and that value investors will find plenty of opportunities if they are willing to put in the effort and do their homework.

Another of Lu's early investments, Timberland, a shoe manufacturing and apparel company, demonstrated this. The company was trading at a ‘clean' book value, consisting primarily of tangible liquid assets, working capital, and $100 million in real estate, according to Li Lu. Timberland did not offer a discount to tangible liquid assets at the time, but it did offer an interesting and eventually profitable investment opportunity.

According to the Wall Street Journal, in 1998, shares were trading at 5 times earnings, or $28 per share, with 11.4 million shares outstanding, resulting in a market capitalization of $319 million. The company's assets were $387 million at the time, and the entire company could be purchased for less than the current assets. With total liabilities of $203 million, the stock had a positive net current asset value and was cheap in relation to tangible book value.

Furthermore, Timberland had been steadily paying down debt since 1996, lowering its debt-to-capital ratio from 53.4 percent in 1996 to 27.3 percent in 1998. The company was also family-owned and controlled, with the company buying back shares when they were statistically cheap.

The company, like many other value investments, was out of favor with the market in this case due to a slew of lawsuits. However, the stock rose 700 percent in just two years, fueled by 30 percent annual earnings growth. Li Lu invested 20% of his portfolio in the stock and saw a significant return with little risk.

This exemplifies Li Lu's approach to investing while also demonstrating several key concepts of value investing: markets can be extremely inefficient, presenting opportunities for the informed investor to profit significantly in such circumstances.

So it's no surprise that Li Lu joked about being able to retire after college!

Charlie Munger Takes Li Lu Under His Wing 

Charlie Munger has previously stated that he prefers to work with people and businesses that can be dropped into an entirely new country or environment with no resources and still make a fortune.

It's easy to see why Charlie Munger chose Li Lu to manage his money after learning about his investor background, ability to thrive in a foreign environment, outstanding results, temperament, discipline, and outlook. Because they didn't want anything to do with the new tech darlings and their sky-high valuations, Warren Buffett and Charlie Munger always invested in businesses they knew and understood, avoiding much of the pain of the dot-com bubble bursting. Li stuck to his circle of competence as well, but instead of focusing on industry, he broadened it to include geography.

Li, like Buffett decades ago, saw a dearth of deep value opportunities in American stocks and realized he needed to look elsewhere. Fortunately, Li was born in China, spoke fluently in the language, and was well-versed in the culture.

Munger revealed in 2017 how important Lu has been to the Munger family.

"I’ve read Barron’s for 50 years. In 50 years I found one investment opportunity in Barron’s, out of which I made about $80 million. For almost no risk. I took the $80 million and gave it to Li Lu, who turned it into $400 million or $500 million. So I have made $400 million or $500 million out of reading Barron’s for 50 years and following one idea…I didn’t have a lot of ideas. I didn’t find them that easily, but I did pounce on one." - Charlie Munger, 2017, Daily Journal Shareholder Meeting

Munger and Lu met through mutual friends and quickly became friends, discussing business, life, and investing. Charlie Munger was first introduced to BYD, a Chinese battery manufacturer and automaker, by Li Lu. According to the Wall Street Journal, Berkshire Hathaway's stake in BYD has increased more than sixfold since its initial $230 million investment in 2008, generating $1.2 billion in profits. Mr. Li's $40 million investment in BYD was worth around $400 million after two years, not a bad return.

Their relationship grew into a mentor-mentee partnership and even friendship over time. As with Warren Buffett, Charlie aided in the introduction of the concept of buying a great company at a reasonable price, which is essential when managing large sums of money (anything over $10-15 million). Munger explained,

“He’s partly a Chinese Warren Buffett. That really helps, partly because he’s fishing in China. Not in this over-searched, over-populated, highly competitive American market.” - Charlie Munger

Like me, if you don't have any mutual friends with Munger, we’ll have to just learn to replicate his strategies through his writing, interviews, and the annual Berkshire Hathaway Annual Meeting. 

Himalaya Capital Proves a Major Winner 

Mr. Li Lu founded Himalaya Capital in late 1997. Himalaya Capital Investors manages only one fund, which Mr. Li Lu has been managing since its inception on January 1st, 1998. Himalaya Capital follows the value investment principles of Benjamin Graham, Warren Buffett, and Charlie Munger, and focuses on publicly traded Asian companies, with a particular focus on China.

Himalaya Capital's goal is to generate superior returns as long-term owners of high-quality companies with a significant "economic moat," significant growth potential, and management that is trustworthy. Since Lu's Timberland days, a lot has changed.

Himalaya Capital Management has grown its portfolio from Li Lu's initial $300,000 to over $9 billion since its inception, achieving a 30 percent annualized compound return. Although this may only be the American holdings disclosed in Himalaya Capital's 13F filing, the fund manages a concentrated portfolio of only six companies. 

Mr. Li once recounted that he even took a valuable lesson from watching the Soccer World Cup. “You may very well work extremely hard and seldom score, but occasionally - very occasionally - you get one or two great chances and you make decisive strikes that really matter.” - Li Lu certainly concentrates on his best opportunities. 

And, as Warren Buffett says: "When it's raining gold, reach for a bucket, not a thimble.”  - Warren Buffett, Berkshire Hathaway Annual Letter, 2009.

Himalaya Capital, like Li Lu, is always evolving, learning, and trying to improve — a habit that everyone should adopt. Himalaya's roots were in buying dirt-cheap stocks and traditional value investing, but as the firm's assets under management grew, Li Lu's focus shifted to great companies at reasonable prices, following in Warren Buffett's footsteps.

Himalaya Capital, on the other hand, did not always have it easy; in its first year of operation, the fund was down 19 percent, and the Asian Financial Crisis had only just begun. Li Lu evidently persevered and has established himself as one of the world's best investors, with Himalaya Capital emerging as a major winner.

Li Lu used a very cheap stock strategy early in his career before Himalaya Capital Management became a significant investment fund. The success of this strategy is demonstrated by Li Lu's investor returns, however, an individual small investor can achieve similar, if not better, long-term results and emulate Li Lu's success.

Those who are or are considering investing in a deep-value strategy should learn from those who have successfully implemented this market-beating strategy.

Li Lu uses a quantitative and qualitative approach, combining a young Buffett/Graham value investing strategy with a modern Buffett wonderful companies quality business style. Li Lu provides additional evidence of the power of value investing, and these key takeaways:

• Understand yourself: A value investor must be willing to be in the minority. You'll have to believe that you're correct because of your logic and evidence, not because others agree with you.

• Small and Concentrated: The small-cap advantage has shown that small-cap companies have outperformed larger caps over the long term. Part of the reason for outperformance is a lack of coverage. No analysts were covering the company, as was the case with Timberland and Li Lu, but it performed spectacularly. At Himalaya Capital Management, Li Lu manages a concentrated portfolio and only invests in his best ideas.

• Think Differently from the Market and Long-term: Investors must think differently to achieve outperformance, which includes looking at the beat-up, downtrodden, and unloved companies. Li Lu still prefers the quality variety of the downtrodden, but in these situations, a contrarian outlook is beneficial. The key to small investor success is identifying areas of the market where investors are selling for reasons other than a fundamental valuation. “The single greatest edge an investor can have is a long-term orientation.” – Seth Klarman. 

• Demand a Margin of Safety: What you pay for is what you get, and what you get is what you pay for. Buying companies for less than their liquidation value, as well as buying great companies at reasonable prices, provides a huge margin of safety. Again Seth Klarman provides a great definition: “A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable, and rapidly changing world.”

• Be patient but decisive: Warren Buffett often says "be fearful when others are greedy and be greedy only when others are fearful." This is undoubtedly Li Lu's approach to investing, and it has been proven true over time with the examples provided in this video.

Li Lu's strategy as an investor is simple but difficult to implement: find undervalued securities and bet large on those stocks. His investment strategy, like Buffett's, had to develop and evolve over time, but he began by buying very cheap stocks and outperforming the market, amassing wealth along the way.

So, do you think Li Lu is one of the best investors in the world? Few can deny that he has lived an extraordinary life, that he has generated extraordinary returns for his investors, and that he is deserving of the title. The best way to get started on the path to becoming a Li Lu investor is to invest in yourself and begin your education now!

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