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Grahamites
Grahamites
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Notes From Li Lu's Recent Interview - Part I

The link between modernization and value investing

July 12, 2020

Li Lu's new book, "Civilization, Modernization, Value Investment and China," has been published recently and is worth reading repeatedly. Unfortunately, the book is only available in Chinese at this point to my knowledge. More than half of the book focuses on his systematic thinking on China's modernization process, and the rest is about value investing.

In an exclusive interview with Barron's China during the Dragon Boat Festival holiday, Li talked about the link between the two topics. Below are the first part of my notes from the interview.

Connection between modernization of China and value investing.

Li has been obsessed with the modernization of China since he was a teenager. He had always wanted to understand why the country's modernization was so difficult. In fact, over the past 200 years, Chinese and foreign intellectuals have tried to understand this great puzzle.

Value investing is another interesting topic which he stumbled upon after coming to the United States and hearing one of Warren Buffett's speeches by accident.

Li formed the connection between the modernization of China and value investing later in his life. He found out that, in the end, “the fundamental research required in value investing allows an investor to invest in the most righteous way by sharing the value creation by the companies we invest in and grow with them, instead of merely discovering the disparities in valuation. This is the core of value investing.”

This naturally led him to ask some new questions: Why can outstanding companies achieve sustainable growth over a long period of time? What are the reasons for the growth? Is there a limit to such growth? And what kind of economic environment will cultivate companies with such growth?

He then found out that “not only for these outstanding companies, but also for the whole global economy and the whole human society, a strange phenomenon has happened in the past two years. That is, the economy had begun to enter a sustained and progressive growth stage.”

This is what we call the power of compound interest, the most important force in value investment. However, compound interest only existed in the past 200 years in human society. Before that, it hadn’t existed in the whole human society or in nature.

After he had studied the concept of value investing and compound interest, and found out about the above phenomenon, he began to synthesize the two topics.

As Li wrote in his book, “The whole process of modernization itself is actually a process of compound interest.” According to his definition, “modernization is the phenomenon that the whole economy begins to enter a state of continuous progress and unlimited growth.” He called it the "law of modernization."Iit may take several decades to look back before we know whether it is right or not. Like "Moore's law" in the early years, observation can only lead to induction.

Li’s investment style is closely related to this observation because the essence of value investing is to explore and discover opportunities for compound interest, which is only a product of the phenomenon of modernization. He said during the interview that “whether this observation can be summed up as 'Li Lu's law' in the future can be slowly tested by time. However, the two phenomena can be thought of as the same modern phenomenon. This phenomenon of compound interest has only really appeared in the past two hundred years, that is, a very short period of time in human history. It will be several hundred years before we know whether the summary and explanation of this phenomenon can be verified. This is just like the ‘Malthusian trap.’ When Malthus put forward his theory, he actually wanted to predict the future. It turns out that his prediction of the future is not very good and almost completely wrong. But his summary theory of the past agricultural society is correct.”

Therefore, the main topic of his book is to summarize the phenomenon (of modernization) of the past 200 years. And the practice of value investing is proof that such an idea can really produce a real return on investment, so it is also a kind of unity of knowing and practicing.

To sum up, the modernization process itself is a compounding process and, in this sense, the essence of value investment is the same as modernization. Although the recent coronavirus crisis has posed great challenges to China and the rest of the world, Li is still confident about the future of China's economy. He believes that Chinese traditional culture is very suitable for the modern market economy, and China will still provide plenty of investment opportunities in the future. It is important for investors to keep their intellectual honesty so as to withstand the test of human nature by the market.

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About the author:

Grahamites
A global value investor constantly seeking to acquire worldly wisdom. My investment philosophy has been inspired by Warren Buffett, Charlie Munger, Howard Marks, Chuck Akre, Li Lu, Zhang Lei and Peter Lynch.

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