During the past month, I've written extensively about two of the best value investors in the world – Himalaya's Li Lu and Hillhouse's Zhang Lei. From their case studies, it is clear that they are very different investors, although both place deep fundamental research at the core of their investment process.
Li Lu is very much like Warren Buffett (Trades, Portfolio). He started with the classic Benjamin Graham style investing, looking for cheap securities, and he believed that it was the only choice because when you first start investing, you don't have enough experience and you don't want to lose money. Later in his career, Li evolved from the Ben Graham style to the Buffett-Munger style.
Zhang Lei's style is very different from that of Warren Buffett (Trades, Portfolio). When Hillhouse made a big bet on Tencent (HKSE:00700, Financial) almost 15 years ago, Tencent's business model was still unproven. There wasn't much, if any, margin of safety from a traditional value investing perspective. Even today, Hillhouse invests substantially in pre-earnings or even pre-revenue businesses. In a sense, he leapfrogged the Ben Graham phase of looking for cheap securities. Outside of China, few value investors would associate Zhang with Warren Buffett (Trades, Portfolio), not to mention Ben Graham. Many are doubtful of the claim Zhang Lei made that he is a "true value investor."
I, too, had doubts a few years ago when I first heard about Hillhouse and Zhang Lei. I remember back in 2014 and 2015 when I saw Hillhouse investing in companies with no current earnings such as JD.com (JD, Financial) and sometimes even without current revenue such as BeiGene (BGNE, Financial), I couldn't reconcile such investments with the value investing methodology.
Incidentally, it was Li Lu's partner, Chang Jing, who helped me realize why Zhang Lei is a true value investor. Last year, I had the honor and pleasure to attend the value investing class taught by Chang at Peking University. A key topic of the class was the constitution of intrinsic value. During one lecture, Chang discussed the breakdown of intrinsic value components, i.e., sources of value.
The idea of "sources of value" is actually detailed in Bruce Greenwald's classic book "Value Investing: From Graham to Buffett and Beyond." Faced with the shortcomings of discounted cash flow (DCF) intrinsic value calculations, Graham and Dodds investors have developed a three-element approach to valuation: assets, earnings power and profitable growth. The benefits of this approach, as outlined in the book, are:
- "It segregates information affecting valuation by reliability class, so that good information is not contaminated by poor information."
- "It puts more emphasis on information about the firm that is solid and certain."
- "It is based on a thorough grasp of the economic situation in which a company finds itself."
- "It values the company's future prospects with more realism and less optimism than is customary on Wall Street."
- "It refuses to pay anything for even the rosiest prediction that has no current or historic foundation."
Obviously Greenwald and Li Lu think assets are more reliable, more predictable, solid and certain.
If we look at Li Lu's early investment case studies, his margin of safety came from buying a company at a price much below a combination of asset value and discounted value of earnings power. He didn't pay anything for growth. Instead, he used future growth as protection to downside. To be fair, when he invested in Timberland (now part of VF Corp. (VFC, Financial), he had high conviction that its earning were very likely to grow, but the price he paid didn't reflect such expectations.
Now if we look at Hillhouse's investments, we can see that they couldn't be more different from Himalaya's portfolio companies. Many Hillhouse portfolio companies, especially technology companies, inherently have asset-light business models. They could be in the very early stage of business development, so their intrinsic values inevitably depend upon profitable future growth. Is this less reliable? It depends on how much you understand the business and how sure you are about the future of the industry. Many of Hillhouse's portfolio companies are riding big mega trends, so the future growth is highly certain, but whether they can generate profitable growth and how fast they can grow is less certain.
Interestingly, the more I research, the more some of Hillhouse's investments are starting to remind me of the Buffett style, such as Gree Electric (SZSE:000651, Financial) and Conch Cement (SHSE:600585). Some of Li Lu's investments, such as Alibaba (BABA, Financial), are more like the Hillhouse style.
Conclusion
Li Lu once said, "Part of the game of investing is to come into your own. You must find some way that perfectly fits your personality. The game of investing is a process of discovering who you are, what you are interested in, what you are good at, what you love to do, then magnifying that until you gain a sizable edge over all the other people."
I think it's safe to say that both Zhang Lei and Li Lu have found who they are, what they love and what they are good at. In that sense, they are both admirable value investors.
Read more here:
- Why Li Lu Is 'The Warren Buffett of China'
- Case Study: Li Lu's Investment in a South Korean Company
- Case Study: Li Lu's Investment in Timberland
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
