In my previous article, I shared my notes for the lecture part of Chang Jing's first lecture, given as part of the Value Investing Course at Peking University. Below are my notes from the question and answers section that followed the lecture.
Q1: Hillhouse's Zhang Lei has said that moat should be dynamic and the only moat is the dynamic creation of long term value. What do you make of this?
There's some truth in this statement in that moats should be dynamic. But whether the moat should be crazy value creation and whether a business can create long term value sustainably is debatable. All companies should create value. What matters (for investing) is whether the business possesses sustainable competitive advantages. A business might be lucky because it is in an industry on a cusp of rapid growth. But it may not be sustainable in the future. It may be subject to technological disruption. It may be disrupted by its competitors. Also, you can create value for the society but you may not create value for the shareholders because the cost of value creation could be high.
Q2: Can you expand on how to think inversely?
It's quite simple. You just inverse. For instance, if you like a business, then the way to inverse is by asking yourself what you don't like a business. It's very easy to apply it in life. It's a habit.
Q3: Intangible assets are becoming more important, especially for technology companies. How to think about margin of safety for tech companies?
You have to be clear what margin of safety represents. The margin of safety for buying is different from the margin of safety for holding. When buying a company, margin of safety means a discount between the purchase price and the value of the business. But with technology companies, it's hard to know what the value is. Ten years ago, it was hard to predict Tencent's (HKSE:00700, Financial) future prospects. But as the company grows and more users use its products, Tencent's network effect strengthens. And its competitive advantages become clearer. Now it's more predictable and you may now require a smaller margin of safety for Tencent. The other thing is that technology itself isn't necessarily a competitive advantage. Technology is an advantage only when it fits the business model.
Q4: How can you tell whether a manager is reputable or not?
Performance is part of the reputation and is secondary. It should be all about the values because a great investor may not place the interests of his clients first.
Q5: When faced with a temptation to learn something outside of your circle of competency, what should investors do?
In the beginning, it's difficult to choose an area to build your competency. First of all, you need to focus. For instance, in the beginning, you might want to focus on a business you really like. You like the products of the company or the service of the company. You can test whether you understand the business yourself such as debating with yourself. What you don't like about the business. You can ask others to help you. For instance, if you say you really know about Metituan Dianping (HKSE:03690, Financial), find some friends and see if you can really explain it to your friends, then you can speak to experts, management team, the founder. Thirdly, you can compare your projections with realities. For instance, you project daily order for Meituan can reach 50 million, if it turns out to be 50 million you might be right.
Q6: For minority shareholders, should they apply a discount for corporate governance? For instance, a dividend paying company suddenly stops paying dividend. Should that raise concern for minority shareholders?
It depends on your understanding of the business. In the case of dividend, a business might not generate better returns by reinvesting its capital back into the business. But as a minority shareholder, you should require a larger margin of safety than the controlling shareholder because you face a higher risk and the damage is larger if risk events happen.
Q7: Can you expand on grey rhino events?
Grey rhino events can be very significant. When it happens, it can be detrimental to a company's value. Rhino events mean they can happen anytime, and they are likely to happen. For instance, if you think regulation is a big risk, you have to incorporate it in your thinking.
Q8: should you hedge or diversify as a value investor?
Yes you can hedge, but you have to figure out what you are hedging against. If you don't know what you are hedging against you are in danger. You can't hedge to make money regularly. If you invest in net-net companies you want to diversify. You have to be open-minded. You have to stick to margin of safety. You have to be careful about leverage.
Q9: Li Lu has said that the biggest market is the only market. With what's happening today, does it still hold?
The global market has the economy of scale. The bigger the market, the more efficient the market is and the more participants want to be part of the market. For China, this means China cannot stay closed to the world and has to participate in the global market. But it doesn't mean China should lead the global market. Currently China should not try to act like it's the No.1 in the world.
Q10: What is the difference between speculating and investing? Would you consider taking advantage of the market mispricing? Do you use technical analysis and any position weighting techniques?
Of course you shouldn't use technical analysis. We don't care about prices but we care about the discount. The discount itself could be the arbitrage. There's an element of arbitrage in value investing but it shouldn't be your primary source of returns. It should be the fundamental growth of the business that is your primary source of return. Value investing should be based on the basis of continuous value creation, as opposed to the mispricing.
Q11: Warren Buffett (Trades, Portfolio) has said that it's better to buy a great company at a reasonable price. How's this related to margin of safety?
A great company itself can provide protection for your capital. If you buy it at a reasonable price you can expect pretty decent long term returns. This means you can require a lower margin of safety for such companies. In essence, it's about how much of a discount you need for different businesses. A company that can compound 15% a year with no valuation change can be much better than a valuation reversal.
Q12: In the face of negative interest rates, should you use a lower discount rate?
You should use a normal discount rate at least. It might last for a while but it's not a normal state.
Q13: If you really know something about an industry as an investor, is the knowledge different from the knowledge of the owner?
You may have a broader view than the owner because you come from a different perspective. The owner may not have an outside point of view. He knows the operation better.
Q14: When you conduct deep research, is there a point you should stop?
You have to ask why you are researching the company. Then you ask how much the owner of the company may want to know. How deep would the owner go?
Q15: There's study done that says it may take five years for the price to converge with intrinsic value? How do you know whether you are right or wrong?
It boils down to margin of safety. If you have enough margin of safety, you wouldn't worry about it. And you will be more excited if the price goes down. That's how the market tests you. It throws you surprises and tests your knowledge. If it puzzles you, it means a) your understanding might not be enough b) your margin of safety is not sufficient.
Q16 How do you value early stage companies? DCF can't be applied. Can you use PS ratios?
Usually value investors have to stay away from this type of companies. Even a complete discount might not justify the price. You may want to ask the leading PE VC funds. But value investors can learn something from VC and PE funds and vice versa.
Q17: Which concept is the most important concept in value investing?
Margin of safety is the key concept. If an investor doesn't talk about margin of safety, he's not a real value investor. Also circle of competency is key, you can think of as complementary to margin of safety.
Read more here:
- Notes From Peking University's Fall 2020 Value Investing Course - Lecture 1
- Li Lu and Zhang Lei's Differences
- Why Li Lu Is 'The Warren Buffett of China'
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