Value investors have several things in common when it comes to their investment style, but one way in which they differ is their public personas. Some, like Warren Buffett (Trades, Portfolio) and Howard Marks (Trades, Portfolio), frequently give interviews and write memos, and are generally happy to be in the spotlight. Others prefer to keep a much lower profile.
Li Lu is a notable member of this second group. Despite his impressive track record and stellar reputation (he is the only active manager that Charlie Munger (Trades, Portfolio) has given money to manage), he is relatively unknown outside of the investment community.
In 2012, he spoke with students at San Francisco State University. One part of his speech that particularly stood out to me was his discussion of the Russian privatization of state-owned assets in the early 1990s, the exorbitant profits that a small group of individuals was able to reap from it and what value investors can learn from this experience.
Learn from history
Li thinks the best way to train yourself to discover great investment opportunities is by reading history:
“As some of you may know, in the early '90s Russia went through a shock therapy and became a free market almost overnight. In a short period of time, they privatized some of the most prized state assets, including Lukoil (LUKOY, Financial) and Gazprom (RTO:GAZP, Financial)Â [Russian oil and gas giants]. And it was so short that most people didn’t even understand what it was all about.
A lot of the people who worked in those companies, as well as ordinary citizens, were given certificates that could be converted to stock ownership, but most people really didn’t know what they were. So somebody could come along with real cash, which they recognized, and they freely gave them away. So as a result of all this, these assets were trading at extraordinarily low prices.
How low were these prices? Forget about earnings, just consider the assets on the balance sheet. At the time, the five-year average for oil prices was about $20 per barrel and on a per-share basis, they were trading for as low as 1 cent on the dollar, sometimes half a cent on the dollar, so about 10 cents to 20 cents per barrel of crude oil. And that’s not even counting the earnings from the company! It was ridiculous.”
Leaving aside the ethics of fleecing an unsuspecting public - and this undoubtedly was a fleecing, which laid the foundations for the oligarchification of the Russian economy, as well-connected insiders scooped up state enterprises for pennies on the dollar - it represented incredible value. Sure, you had to buy the physical certificates from their holders (there was no stock exchange to speak of at the time), but the basic principles of value investing holds here.
Previously, state-owned assets traded at such extreme discounts to their intrinsic values in 1993 that even when the government defaulted on its debt and devalued its currency by 90%. In 1998, those who had bought certificates five years previously were still up tenfold on their investment. How’s that for a margin of safety?
Conclusion
The point of this story is not to encourage you to to travel to far-flung locations and buy physical stock certificates from unsuspecting locals. Rather, this extreme example illustrates a number of basic truths about value investing - markets can be extremely inefficient, and those who do their homework can profit immensely in these circumstances.
Disclosure: The author owns no stocks mentioned.
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