Bruce Greenwald: Warren Buffett (Trades, Portfolio) says that when he retires, there are three people he would like to manage his money. First is Seth Klarman (Trades, Portfolio) of the Baupost Group, who you will hear from later in the course. Next is Greg Alexander of the Sequoia Fund. Third is Li Lu. He happens to manage all of Charlie Munger (Trades, Portfolio)’s money. I have a small investment with him and in four years it is up 400%.
[Applause]
Li Lu: Columbia is where my whole life in America started. I could barely speak the language. In Columbia it was where I had a new life. It was really in the Value Investing class where I got my career start. I was really worried about my student loan debt at the time and a friend told me about this class and said I need to see a lecture from Warren Buffett (Trades, Portfolio).
What I heard that night changed my life. He said three things:
1. A stock is not a piece of paper, it is a piece of ownership in a company.
2. You need a margin of safety so if you are wrong you don’t lose much.
3. In the market, most people are in it for the short term. It allows you a framework for dealing with the day-to-day volatility.
Those were three powerful concepts. I had never viewed the stock market like that. I viewed it negatively as a place made up of manipulators who were lining their own pockets. I embarked on an intensive two-year study learning everything about Buffett.
Two years after that I bought my first stock. After I graduated I worked at an investment bank for a year and realized it was a mistake. I tried to start a fund, but I didn’t have a track record. The first year I managed money I lost 19%.
Being a value investor means you look at the downside before looking at the upside. Before becoming an investor you need to look at how you can fail at this game. There are all sorts of ways you can fail. You need to examine who you are and see if you could be good at it. If you could ever find something you can do well that you really like – that will be your best investment. You will do better than competitors. If you can do it with intrinsic passion, that really over time will add enormous value to you.
Back to the game of investing. This concept of margin of safety is an essential concept to be a good investor. The future is unpredictable; you will always be dealt surprises, some positive most negative. You need to build in a level of safety so that whatever happens, you will not get crushed. If you can really successfully know what you are getting into, you can pretty much navigate. Most people are troubled by what they don’t know. The world is divided by those who know and those who don’t know. If you really know –Â you will not pull triggers like Wall Street traders. If you are truly intellectually honest, you would not do anything.
This class teaches you to know what you are getting into, especially accepting what things you don’t know. The game of investment is really continuous learning. Everything affects an investment; it constantly changes. You are not investing in the past but the accumulative cash flow of the future. You have to want to find a certain setup where you can know something that most people don’t know. There are plenty of things I don’t know, but they don’t factor into the purchase because I am using a huge margin of safety. Buying a dollar at 50 cents. So if things turn against you, you will be okay. That is not easy. This business is brutally competitive. It is so impossible to know everything and know exactly what is going to happen to a business from now 'til the end that you really have to accept that what you don’t know.
Finding an edge really only comes from a right frame of mind and years of continuous study. But when you find those insights along the road of study, you need to have the guts and courage to back up the truck and ignore the opinions of everyone else. To be a better investor, you have to stand on your own. You just can’t copy other people’s insights. Sooner or later, the position turns against you. If you don’t have any insights into the business, when it goes from $100 to $50 you aren’t going to know if it will back to $100 or $200.
So this is really difficult, but on the other hand, the rewards are huge. Warren says that if you only come up with 10 good investments in your 40 year career, you will be extraordinarily rich. That’s really what it is. This shows how different value investing is than any other subject.
So how do you really understand and gain that great insight? Pick one business. Any business. And truly understand it. I tell my interns to work through this exercise – imagine a distant relative passes away and you find out that you have inherited 100% of a business they owned. What are you going to do about it? That is the mentality to take when looking at any business. I strongly encourage you to start and understand 1 business, inside out. That is better than any training possible. It does not have to be a great business; it could be any business. You need to be able to get a feel for how you would do as a 100% owner. If you can do that, you will have a tremendous leg up against the competition. Most people don’t take that first concept correctly, and it is quite sad. People view it as a piece of paper and just trade because it is easy to trade. But if it was a business you inherited, you would not be trading. You would really seek out knowledge on how it should be run, how it works. If you start with that, you will eventually know how much that business is worth.
When I started in the business in 1997, it was in the middle of the Asian Financial Crisis. A few years later there was the Internet bubble. A couple years ago was the Great Crash of 2007-2008. They are billed as once-in-a-century disasters but happen every few years. Every time it goes against you, your net worth or value of your investments might go down 50%. This is really where that insight and temperament comes in. In a sense, you have to have a certain confidence in your own judgment and not be swayed by other people’s views. It is not easy. But that is life. It is just a given. It happens to everyone. Berkshire had at least three times when the stock went down 50%. It happened to Carnegie, too. It happened to Rockefeller. It happens to everyone. If you really made a mistake, it would not stop at 50% but go to 0.
This happens to even mighty companies. Look at the top 50 companies in America every 10 years. By the time 20-40 years go by, two-thirds of them will be gone. By the time it goes to 100 years, there might be only a couple left. It’s just the way it is. Look at what happened to the once-mighty General Motors. So that's why I’m saying investing is a continuous learning process because your investments are constantly changing
Continue reading: http://streetcapitalist.com/2010/06/24/li-lus-2010-lecture-at-columbia/
