A Few Lessons from Li Lu

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Nov 06, 2014
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Li Lu is undoubtedly one of the most under-appreciated investors. According to 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. Next is Greg Alexander of the Sequoia Fund. Third is Li Lu, who manages Charlie Munger (Trades, Portfolio)’s family money.

Li Lu doesn’t appear in public very often, but when he does, he sounds a lot like

Charlie Munger (Trades, Portfolio). In this rare lecture at Columbia, which you can find here, he talked about his investment journey and philosophy. Below are my highlights.

"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.

"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 set up 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 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 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 one 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.

"A certain industry might have characteristics that make it different than others. In certain industries you might have better prospects than others. Find the best of the players in the industry and the worst players. And see how they perform over time. And if the worst players perform reasonably well relative to the great players — that tells you something about the characteristics about the industry. That is not always the case but it is often the case. Certain industries are better than others.

"So if you can understand a business inside out you can then eventually extend that to understanding an industry. If you can get that insight, it is enormously beneficial. If you can then concentrate that on a business with superior economics in an industry with superior economics with good management and you get them at the right price — the chances are that you can stay for a very long time."

All of the above are great insights from Li Lu, and I certainly have nothing to add. One of the concepts that I find fascinating is – pick a business and understand it from the "inside out." A lot of times we have the illusion that we understand the business when in reality we don’t. If you don’t think this is the case, ask yourself do you really understand IBM (

IBM, Financial) and Procter & Gamble (PG, Financial). Why would Warren Buffett (Trades, Portfolio) choose Coca-Cola (KO, Financial) over Procter & Gamble? You may realize that you may not understand the business as well as you thought you do. This is truly a powerful idea. In my next article, I plan to elaborate on this idea with a concrete example.

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