Li Lu (Trades, Portfolio) is a legendary value investor who is the founder and portfolio manager at Himalaya Capital Management, an investment firm with $2.38 billion in its U.S. 13F equity portfolio and more than $18 billion in total assets under management.
Charlie Munger (Trades, Portfolio) has previously called Li a “genius” and credits him with inspiring the investment in Chinese electric vehicle maker BYD Co. (SZSE:002594, Financial), which was one of Berkshire Hathaway's (BRK.A, Financial)(BRK.B, Financial) most successful investments, as it turned a $232 million stake into ~$5.6 billion (assuming Berkshire held the stake unchanged until recently; since it's not a U.S.-listed position, the company is not required to disclose minor changes to the position).
In an interview last year with Professor Greenwald of Columbia Business School, Li revealed insights into his investment strategy and life philosophy. The original interview is over one and a half hours long; here are my top eight takeaways from it.
1. How to handle a stock market crash
Last year, Li stated we are living in “unprecedented times” due to the Fed's liquidity injections, inflation and rising interest rates. He stated, “Money tends to promote the primal part of human nature... Our attitude is a financial crisis will happen all the time."
To survive the expected boom-bust cycle that results from people's approach to money, Li said he “looks for businesses which can get through crises and even thrive... If you hold through the ups and downs, your return will roughly equal the businesses return on invested capital.”
The quote above helps to keep perspective that in the long-term, the stock price should match the business' return on its invested capital, but in the short-term, it’s hard to see this.
Most people don’t have the temperament to be a great investor, as you need to be able to watch your portfolio fall by 40% and not making irrational decisions in reflex because of it. As Li said, “We’re good at rationalizing but not being rational."
2. When to buy stocks
Li has a disciplined value investing strategy and is happy to find a “great business” and then wait passively for the "price to come to our strike zone” before buying. This is very similar to Warren Buffett (Trades, Portfolio)’s style of “waiting for the right pitch."
“We buy stocks when they are trading at a discount to intrinsic value," said Li. During a crash, Li said he is happy to “buy more when the stock goes down.”
3. Characteristics of great businesses
When asked about his criteria for what constitutes a great business, Li replied:
“A great businesses has above average return on investing capital... Those businesses usually attract competitors, because everyone wants great returns on invested capital.”
The return on invested capital (ROIC) represents how much a company is getting back on its investments. For example, if a company owns five stores and earns a 15% return on each, they know by building more stores they can replicate that return. It is a good indicator of a sustainable business model and can be calculated by dividing net operating profit after tax by invested capital.
4. Competitive advantages
Li went on to explain that a “great business” doesn’t just need a high return on invested capital, but also the ability to “fend off competitors." To accomplish this requires an “enduring competitive advantage” and a “long runway of growth."
Buffett's investments strategy focuses heavily on companies with a competitive advantage, or moat. Types of competitive advantages range from network effects to brand recognition, pricing power or even economies of scale.
According to Li, it’s very difficult to find these “great businesses."
“They are really rare... Only a small slice of all businesses belong to that category... If you're lucky enough to find a long-term compounder, own them for a long amount of time.”
5. Great management
Investing into companies with great management is another key tenet of both Li's and Buffett's investment strategies. As Li said, “Management's ability to allocate capital pays an important role."
Li gave the example of Berkshire Hathaway as a company which has great management and an expert capital allocator (referring to Buffett and Munger). He said, “Berkshire started as a lousy textile business but Munger and Buffett took that capital and invested into businesses with better returns on capital.”
In a previous shareholder meeting, Buffett mentioned the worst investment he had ever made was the original “Berkshire Hathaway,” which was a money-losing textile mill. However, as Li points out, Buffett’s genius was to reinvest the profits from that business into other businesses with greater returns on capital.
Li also mentioned the importance of investors having a “business owner mentality” and exercising “intellectual honesty” in order to invest into your circle of competence.
6. Li and Munger's friendship
When asked about his relationship with Buffett's right-hand man, Li stated that Munger is "the most influential person in my life.” He was inspired by Munger's ability to "maintain rational composure and a commonsensical approach to all problems in business and life."
Li also talked about the importance of having a role model and somebody to learn from.
7. Generalist vs. specialist
Li believes investors should gain inspiration from many areas as a generalist, but when thinking about investing, we should aim to be a “specialist." He said that ideally, investors should be an expert in the company/industry that they are investing in and know more than others to give themselves an edge.
“We study the successful companies and ask if that success can continue,” said Li.
8. Investing in China
When asked about the prospects of investing in Chinese stocks, Li said he is bullish on investing in China, stating the "Asian economy will become a more important part of the global economy."
