One of our favorite investors to follow here at The Acquirer’s Multiple is Li Lu, Founder and Chairman of Himalaya Capital. In 2015 Li Lu did a value investing lecture at Peking University titled – The Prospect of Value Investing in China, in which he provided a number of fantastic value investing insights. Here’s an excerpt from that lecture:
On this wide open main path of investing you find very little traffic and wonder where everybody is. You need only look at the ‘heterodox paths’ of shortcuts with traffic backed up for miles. Investors take shortcuts because the right and main path takes too long. In theory, value investing is a sure way to reach your goal successfully, but the biggest problem is it takes too long.
It may be the case that a company has fallen out of favor with Mr. Market and its price is therefore much lower than its intrinsic value when you buy it. Unfortunately, you don’t know when Mr. Market will come to his senses. In addition, the growth of a company depends on the efforts of everyone from top executives to frontline staff, in addition to time, persistence and some luck. It is an arduous process.
The other difficulty lies is in your ability to predict the future, as the ability to invest involves the ability to correctly make such predictions. Understanding a company or an industry means you can’t predict what state the company/industry will be in 5 or 10 years, by no means an easy task. However, before we make an investment decision, we need to know what situation the company will be in. What will happen if there is an economic downturn?
Otherwise, how can we know if the value of the company is higher or lower than the price? We need to have an estimate of the company’s future annual cash flow for the next 10 or 20 years to discount them to today’s value (present value of future cash flow). It is difficult to know what shape your company will be in, even as the founder.
You may say, ‘of course I know,’ and undoubtedly say this to your customers and investors. You may even tell your employees that the company aspires to the Fortune 500. In reality, you probably cannot predict the company’s growth more than 10 years into the future, as few can due to innumerable uncertainties. This does not mean it is a completely lost cause. You can probably predict with high degree of confidence the worst case scenario for selected companies and industries over the next ten years. They may perform better than expected. However, this skill requires relentless effort and studies, along with many years of hard work.
When you are capable of making these judgments, you have begun building your circle of competence, which must be a very tight one at first, but will expand outward as time passes.
This is why value investing is inherently a long haul. While it will definitely take you to your destination, most people are not willing to make the effort. You can spend a lot of time, yet still understand very little.
If you are a true value investor, you won’t go on a TV money show to critique the stock prices of all companies, or tell others what the stock prices should be. You won’t casually state 5000 point is too low, that a bull market is imminent, or that 4000 point is a bottoming out.
You will know that such pronouncements are outside of your circle of competence. No matter how big the circle you draw, those statements won’t fit into it, and those who set the boundaries of the circle beyond their competence are destined to be destroyed by the market at some point or somehow. As I stated previously, the market is a mechanism that discovers your weaknesses. Any fault/defect you have will be magnified infinitely, to the point of complete destruction.
You can find a copy of the entire lecture at the Himalaya Capital website here.
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