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Rupert Hargreaves
Rupert Hargreaves
Articles (742)  | Author's Website |

Li Lu: How to Be a Value Investor

A lecture from great investor Li Lu on how to be a value investor

February 14, 2018

Li Lu is one of the world's most under-appreciated value investors in my view. While most investors are aware of Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio), both of whom Li Lu learned from, Li Lu is less well-known even though he moves in the same circles.

According to various sources, Li Lu's firm, Himalaya Capital Investors L.P., has produced an annual return for investors of more than 20% since its founding in 1998, this puts the value investor in the same league as Buffett and Munger in terms of returns.

For this article, I'm going to cover a lecture Li Lu gave in 2010 at the Business School of Columbia University to Bruce Greenwald’s value investing class. Considering the volatility, the market has experienced recently; I think the content of this lecture is highly relevant today.

Li Lu: How To Be A Value Investor

To start, Li Lu discusses the importance of assessing risk before anything else when considering an investment. Figure out why most people struggle with investing and then avoid these issues:

“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.”

Then the discussion moves on the importance of using a margin of safety to minimize the risk that you might be wrong in your calculations:

“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 — you will not pull triggers like Wall St. traders. If you are truly intellectually honest, you would not do anything.”

Then Li Lu moves on to discuss how the average investor should go about finding their edge, which is essential to know if you are to be successful over the long-term:

“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.”

And here’s a task Li Lu asks his interns to do to ensure that they understand the businesses they’re looking at. It all comes down to research, research and more research:

“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."

And finally, a warning. If you don’t have the temperament for investing, it’s best to avoid the business altogether:

“So for those of you that have curiosity and the temperament, this game couldn’t be better. Capitalism rewards people who are talented at capital allocator. So if you have the aptitude and temperament, it is the great game. If you don’t have that then I urge you not to go and become a nuisance. That is really what Wall Street did, they don’t really create anything they just move money around. Letting the financial industry get too big is bad for the economy, it is just as bad as getting addicted to casinos, drugs, and alcohol. None of them are really useful, they just transfer wealth. That is what I think happened on Wall Street over the last several decades. So avoid being harmful.”

Disclosure: The author owns no stock mentioned.

About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website

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