I recently ran across an old interview from value investor Li Lu (Trades, Portfolio). The discussion was featured in the Spring 2013 Graham & Doddsville Newsletter. While it is now nearly 10 years old, the information Li imparted is just as important and relevant today as it was when the interview was first published.
Finding the niche
Whenever Li talks about investing, he always tries to make it exceptionally clear that finding one's niche is far more important than anything else when picking investments. In the 2013 interview, he said:
"Part of the game of investing is to come into your own. You must find some way that perfectly fits your personality because there is some element of a zero-sum game in investing. If you buy, somebody else has to sell. And when you sell, somebody has to buy. You can't both be right. You really want to be sure that you are better informed and better reasoned than the person on the other side of the trade."
This is a fascinating viewpoint, and it's something most investors appear to overlook. The stock market is like any other market. It is full of buyers and sellers. Buyers are buying something because they think they know more than the sellers. On the other hand, the sellers are selling because they believe they know more than the buyers.
Only time will tell who is right. Before buying an investment, investors need to understand why they are right, and the rest of the market is wrong.
This is something Howard Marks (Trades, Portfolio) calls "second-level thinking." Second-level thinkers don't take anything at face value. If a stock looks cheap, they ask why, and if a stock is outperforming the market, they ask if it can continue to do so. For a second-level thinker, nothing is ever taken for granted.
It seems that Li was trying to get across the same idea in 2013. Investors should never take anything for granted. They should always be asking why and questioning why an opportunity exists and how it has come about.
In his 2013 interview, Li also explained why it is vital for investors to understand what they are buying:
"You should understand every aspect of one business as if you own 100% but you don't actually run it. This causes you to be desperate to understand every aspect to protect your investment. That will give you a sense of a disciplined approach. That's how you truly understand business and investing."
It's challenging for the average investor to do enough research to know a business inside out. That's why I believe business owners have an advantage. If one has owned or owns a business, one knows the challenges companies may face and how to look for strengths, weaknesses, opportunities and threats firms may encounter.
Indeed, in a more recent interview with Bruce Greenwald, Li commented that his venture capital experience helped him develop a deep understanding of how businesses work. He said this experience also helps him identify the qualities that indicate a good company.
The only way to gain an edge in this business is to know more than the sellers and the rest of the market.
In 2013, Li stated that the only way to do this is to learn as much as possible about each opportunity and only act when one has the edge over others:
"Investing is about predicting the future, and the future is inherently unpredictable. Therefore the only way you can do it better is to assess all the facts and truly know what you know and know what you don't know. That's your probability edge. Nothing is 100%, but if you always swing when you have an overwhelmingly better edge, then over time, you will do very well."
If there's one thing we can take away from all of these comments is that Li believes the only way to be a good investor is to keep reading, studying and learning to be better than the competition.