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2024.04.02 08:20
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Qiu Guolu: There are only a few tricks to successful investment

Choosing the right industry is half the battle; picking the right stocks is fundamental; reading research reports well is twice the result with half the effort; leaving enough safety margin; the greatest enemy is human nature

The Monopoly of the Slums (Written in 2020).

The information in the world is developing explosively, which is not an exaggeration at all. Many people have developed anxiety because of this, always afraid of being left behind by the times, constantly running, trying to conquer the market. Not only is it easy to go in the wrong direction, but "leading the trend" also cannot bring higher investment returns.

If entrepreneurship requires keen market sense, then investment is just the opposite. Investment is about finding the constant amidst the myriad changes. In this regard, the investor Qiu Guolu is obviously an expert.

I. The Correct Concept is the Cornerstone of Success

  1. A-shares can also be used for value investment; Many people say that it is difficult to do value investment in A-shares, with concept stocks everywhere, good companies being unwanted, and stocks that are bought cheap often becoming even cheaper. Looking at it from a different perspective, the undervaluation of good company stocks should be a blessing for value investors. What A-shares lack is not value, nor the eyes to discover value, but the perseverance to stick to value. In fact, everyone knows which stocks are undervalued, but no one buys them, all waiting to invest on the right side.

  2. Policies are not the "king's way"; Many people like to speculate on regional or industry policies, but the excess returns of related sectors are not sustainable. Look at the stocks that have increased more than tenfold in the past 5 years, not to mention Chinese internet companies listed in Hong Kong and the US, but also the Tenbaggers from leading companies in industries such as engineering machinery, white goods, real estate, and food and beverage. It is clear that good companies emerge from competition in the market, not from government subsidies.

  3. Buying growth stocks "doesn't have to be early"; In the stages of "high, small, new", with fierce competition and chaos among the heroes, there is no need to rush to place bets. It might be better to wait until the "Seven Warring States" emerge and then choose the winners, and buy the strongest vassals, because it is always the Qin State, not the Han State, that eventually unifies the world. Buying the leading companies after the industry landscape becomes clear often provides a better risk-return ratio. Tencent and Baidu were not small or new oligarchs a few years ago, but their stock prices multiplied several times later.

  4. The growth potential of small stocks is not necessarily higher than that of large stocks; For many industries, the increase in industry concentration is an irreversible trend, and the increase in industry concentration means an increase in market share of industry leaders. In other words, the growth rate of the industry leaders and the second in the industry is faster than that of smaller companies ranked lower in the industry. In these industries, the investment value of undervalued, high-growth industry leaders is much higher than that of small stocks within the industry.

  5. Buying jade is better than gambling on stones; People who buy dark horse stocks are a bit like gambling on stones: buying an inconspicuous stone, hoping to find a good jade inside. Last year, too many people rushed to gamble on stones, with no one buying jade, resulting in the price of stones being driven close to the price of jade: the market value of some black horse stocks that are not very profitable has reached two to three hundred billion, while the market value of the white horse stocks of industry leaders is only five to six hundred billion. At this point, I would rather buy jade.

  6. Riding a white horse is better than riding a black horse; Last year, white horse stocks were cold-shouldered, while black horse stocks were sought after, with the valuation difference between the two reaching a ten-year high. In fact, the competitiveness of white horse stocks in terms of brand, channels, costs, and management is far superior to black horse stocks. Not buying low-priced white horse stocks and instead buying high-priced black horse stocks, dreaming that the black horse will grow into the next white horse, isn't this like riding a donkey to find a donkey, and riding a horse to find a horse? As a certain brokerage strategy analyst said well: why climb a tree to pick grapes when you can pick apples on the ground

2. Choosing the Right Industry is Half the Battle Won

Benjamin Graham emphasized on undervaluation when investing, some criticized it as picking up cigarette butts. However, considering the Great Depression era he was in, this choice is understandable. When most people couldn't afford bread, concepts like brand, growth, and pricing power were just empty words. At that time, the market value of many stocks was lower than their liquid assets minus liabilities, so emphasizing buying extremely cheap stocks was justified. The investment philosophy of each successful individual often carries the imprint of the times.

As an investment manager, to beat the market and outperform peers, one must possess three elements: independence, foresight, and a big picture view.

Over the past decade, I have followed these principles in value investing, preferring contrarian thinking. Many times, my ideas and investment strategies may differ from others—going with the flow may not underperform the market or peers, but it won't achieve excess returns.

Industry allocation is the key to investment success or failure. "Based on past experience, the performance of leading and lagging industry sectors is vastly different. We have conducted attribution analysis on the long-term performance of many funds, and the conclusion is also: the most important determinant of investment performance differences lies in industry allocation.

For different industries, whether to be overweight, neutral, or underweight should depend on in-depth research and one's grasp of the industry. "Only when you are very confident, clearly bullish or bearish, can you significantly overweight or underweight, while when you have no opinion, you may adopt a follow-up strategy and maintain a neutral position."

Industry allocation is so important, but how do you judge the investment value of different industries?

One must consider both the industry's own factors and the level of valuation—good industries cannot be good investment targets if they are overvalued; not-so-good industries, if undervalued, may become good investment targets.

"It's like having a Mercedes and a Xiali. If the originally 1 million yuan Mercedes is priced at 2 million yuan, and the originally 40,000 yuan Xiali can be bought for 20,000 yuan, would you buy the Mercedes or the Xiali? I think buying the Xiali at half price would be a good investment, while buying the Mercedes at double the price would not be a good investment. Choosing to invest in a particular industry or stock is the same—whether it's a good or bad investment, it's relative to the valuation of the investment target."

Historical facts have proven that there are no absolutely good or bad industries, as long as there are unexpected factors, investments can achieve excess returns.

"We have analyzed data from the past decade, summarized which industries performed the best in which time periods, and clarified the characteristics of each industry in this way. Finally, we determine whether to adopt a long-term holding strategy or a swing trading strategy for different industries. At the same time, we have established a systematic industry valuation comparison system, buying when the industry is severely undervalued, and selling when the industry is severely overvalued, in order to achieve excess returns." How to judge and verify overvaluation? It can be done through reverse indicators. During brokerage strategy meetings, there are often sub-venues for different industries. The number of attendees in each sub-venue can sometimes be an inverse indicator of investment value. At a certain brokerage strategy meeting, the neighboring sub-venue was packed to the brim, while in the construction machinery sub-venue, there were fewer audience members in the audience than there were listed company secretaries on stage. When everyone is crowding in the trees to pick grapes, it may be time to pick apples on the ground.

At the peak of the Internet bubble, General Electric in the United States claimed to be an Internet company (reason being they had the world's largest B2B platform). A few months ago, a well-respected leading investment company also told me that they belonged to the concept of consumer goods (reason being they supply half of the raw materials for a certain consumer goods industry). When leading companies from other industries want to "migrate" to a certain industry, the stock price of that industry is often near its peak.

Some investors like to juxtapose investment and consumption, as if promoting consumption must suppress investment. The past 20 years have been about promoting exports through investment, while the next 20 years will be about promoting consumption through investment, with affordable housing, urbanization, and industrial transfer being manifestations of investment serving consumption. Especially in the central and western regions, without increasing investment and improving the per capita capital stock and employment opportunities in these regions, there is no basis for increasing consumption in the central and western regions.

Looking at the recent annual performance reports, the performance of undervalued blue-chip stocks such as construction machinery, home appliances, and banks mostly exceeded expectations, while the performance of some overvalued small and medium-cap stocks fell below expectations. Those bearish should be cautious of the possibility of a Davis double kill (both profit forecast and valuation multiple lowered) when the performance of overvalued stocks falls below expectations; those bullish can focus on the possibility of a Davis double rise when the performance of undervalued blue-chip stocks exceeds expectations.

History has shown that the excess returns of undervalued value stocks relative to overvalued growth stocks often occur before and after quarterly reports, as the market's expectations for the performance of overvalued growth stocks are often too high, making it easy to disappoint during quarterly reports; conversely, the market's expectations for the performance of undervalued value stocks are often too low, making it easy to exceed expectations during quarterly reports. The recent performance reports have also highlighted this expectation gap, directly driving the market style to shift to a low-valuation blue-chip trend.

Finally, there are 6 criteria for a good industry.

1. Reasonable valuation;

2. Profit growth exceeding expectations;

3. Must have core competitiveness and high barriers to entry;

4. Sunrise industry;

5. High industry concentration;

6. Must have short-term catalysts.

III. Choosing the right stocks is the basic skill of investors

Regarding stock selection, Qiu Guolu believes there are three elements:

Valuation, a good company is not a good stock if it is expensive; Quality, the fundamental deterioration of a cheap company is a value trap, one must analyze brand, channels, costs, team, mechanisms, industry competition landscape, growth prospects, etc.; Timing, even a cheap good company won't rise without catalysts. Among the three, the first is the simplest and can be self-taught, the second is more professional and it's best to have someone teach you, the third relies on insight, anyone can learn it, but no one can teach it.

Regarding catalysts, Qiu Guolu believes in the following:

  1. Profits greatly exceed expectations;
  2. Executives or major shareholders increase holdings;
  3. When the stock price doesn't fall even when bad news comes out, or even rises;
  4. Turning point in fundamentals;
  5. New orders, breakthroughs in new technologies, new products, new management;
  6. In-depth reports by brokerage analysts or rating upgrades;
  7. Financing needs (private placements, H-share offerings);
  8. Equity incentives;
  9. Policy announcements;
  10. High dividend payouts;
  11. Competitors exit due to unexpected events;
  12. Overseas companies in the same sector soar;
  13. Institutional investors and major shareholders among public shareholders finally exit;
  14. Projects reach production capacity;
  15. Opening up new markets;
  16. Listed companies in which the company holds shares;
  17. Hidden gems rise steadily with increasing volume. Obviously, in the view of "Qiu Guolu", investors need to consider not only the fundamentals but also the impact of market and technical indicators when it comes to catalysts.

Among the three key elements of stock selection, timing is the most difficult to grasp. Fund managers, as professionals, may feel the pressure to time the market for short-term rankings, which is understandable. For most people, perhaps timing is not necessary. Find undervalued high-quality companies, hold onto them, endure, as long as you don't fall into a value trap, making money is just a matter of time. This may be a foolish method, but as the "Soldier's Creed" says, if a foolish method is effective, then it is not foolish.

Regarding the "Soldier's Creed," Qiu Guolu believes that there are five more points that can greatly benefit investors:

  1. You are not Superman - that's okay, no one is; if a foolish method is effective, then it is not foolish - value investing;
  2. Don't be too conspicuous, you will be a target; don't hide in the same foxhole with comrades braver than you - be cautious of sell-side analysts' recommendations;
  3. Important things are always simple - don't lose money first; all 5-second fuses will burn out within 3 seconds - pay attention to safety margins;
  4. The easy road is always littered with landmines - contrarian investing; a tracer round can help you find the enemy but can also help the enemy find you;
  5. When the defense is so tight that the enemy can't break through, you may not be able to break out either...

IV. Leave Sufficient Margin of Safety in Investments

There is a joke that making tofu is the safest: if it's hard, it's dried tofu; if it's watery, it's tofu pudding; if it's thin, it's tofu skin; if it's gone, it's soy milk; if it's gone bad, it's stinky tofu.

In the future, in countless scenarios, as long as one is realized, money will be made. When the East is not bright, the West is bright, this is the margin of safety. Stocks that demand too much from the future lack a margin of safety, just as the "Soldier's Creed" says, weapons that must be used in combination generally do not arrive together.

When buying construction machinery last year, I thought: machinery replacing manual labor, affordable housing, urbanization, industrial upgrading, industrial transfer, capacity expansion, development in the central and western regions, import substitution, internationalization, going global strategy - any one of these being realized is a huge positive for construction machinery, this is the margin of safety where the West is bright when the East is not.

Low valuation is an important source of margin of safety. The future is always uncertain, the higher the hope, the more disappointment. Low valuation itself reflects low expectations for the future. As long as the valuation is low enough to reflect most possible bad scenarios, the likelihood of the future falling below expectations is reduced Many people say that high risk brings high returns, while low risk brings low returns. In fact, the safety margin brought by undervaluation is the best way to achieve low risk and high returns. For a company worth $1, buying it for 50 cents, even if later it is found that there is a 30% deviation in subjective valuation of the company, or objectively the company suffers a 30% loss in value due to unexpected events, the company is still worth 70 cents, and investors do not lose money. This is the safety margin brought by undervaluation.

The safety margin is like redundant design in engineering construction. It may seem redundant on normal days, but it is indispensable in times of disaster. For example, having only a backup power generation system in a nuclear power plant is not enough; it is best to have a backup for the backup. Catastrophes that occur once every hundred years in real life may happen once every ten years, and the stock market is no different. While taking risks may increase returns in many cases, one day you will find that "what goes around, comes around".

Zero multiplied by any number is still zero, so one must be particularly vigilant about RuinRisk. If a junk stock does not have a bigger fool to pass it on to, the stock price has no "backup system" support. As the game of fools continues, with more and more scammers, there will not be enough fools to go around. It is better to seek safety margins in undervaluation and fundamental analysis for double protection.

George Soros mentioned reflexivity: a decline in stock price itself has a negative impact on the company's fundamentals, easily forming a self-reinforcing vicious cycle. Companies with safety margins usually have simple business operations, easy-to-value assets, and do not exhibit reflexivity. For example, a plunge in Bear Stearns' stock price would lead to a "run on the bank" by trading partners, showing reflexivity, so one should not buy more as it falls; whereas a drop in Coca-Cola's stock price does not affect its beverage sales at all, showing no reflexivity, so one can buy more as it falls.

In summary, companies with safety margins have the following characteristics:

  1. Shine in the East and the West, shining with a little sunlight, making money in various scenarios by focusing on one aspect;
  2. Valued low enough to reflect most possible bad scenarios;
  3. Have "redundant design", with fundamental support acting as a "backup system" to limit downside risk;
  4. Have simple business operations, easy-to-value assets, do not exhibit reflexivity as mentioned by Soros, and can be bought more as they fall.

Most failures stem from one's own eagerness for victory. Therefore, Sun Tzu said, "The skillful fighter puts himself into a position which makes defeat impossible, and does not miss the moment for defeating the enemy." Avoid showing weaknesses yourself, and wait for the enemy to reveal theirs. Applied to the market, it means not acting impulsively and waiting for the market to present you with opportunities.

V. Beware of Traps in Investing

First, identify the value trap.

The most important thing in investing is perseverance, and the most feared thing is persevering in something that should not be persevered in. During the financial crisis, Citigroup plummeted from $55 to $1, trapping numerous blindly persevering pseudo-value investors.

Assuming we use P to represent price, V to represent value, n to represent the future, and 0 to represent the present, for value investing, growth investing hopes that Vn is much greater than V0, but this requires predicting the future, which is difficult. Value investing hopes that P0 is much lower than V0, which only requires analyzing the present, making it less difficult with a high safety margin. A value trap refers to stocks that should not be bought no matter how cheap they are, because their continuously deteriorating fundamentals will make the stock more expensive as it falls, rather than cheaper So Vn is much smaller than V0, the longer investors hold, the more losses they will incur.

The first type is those eliminated by technological progress. Stocks in this category are likely to see declining profits year by year or even disappear in the future, so investors should be cautious even if the PE ratio is low. For example, after the invention of digital cameras, Kodak, whose main business was film, saw its stock price drop from 90 yuan 14 years ago to just over 3 yuan now, which is a classic value trap. Therefore, value investors generally approach industries with rapid technological changes with extra caution.

The second type is small companies in industries where the winners take all. In the era of globalization and the Internet, the concentration of many industries is increasing, with industry leaders having more obvious advantages in terms of brand, channels, customer loyalty, and costs. At this time, small stocks in the industry, no matter how cheap they are, may still be a value trap.

The third type is diversified, asset-heavy sunset industries. Sunset industries mean that industry demand is not growing; asset-heavy means that if capacity cannot be withdrawn when demand does not grow (if withdrawn, the invested assets will become obsolete); diversified means that in times of oversupply, the industry may face disorderly competition or even price wars. Therefore, the cheapness of these stocks is illusory because their profits may deteriorate.

The fourth type is cyclical stocks at the peak of the economic cycle. In the late stage of economic expansion, low PE cyclical stocks are often value traps because the peak profits at this time are unsustainable. Therefore, cyclical stocks can sometimes be bought at high PE (bottom profit) and sold at low PE (peak profit). In addition, trading cyclical stocks must be combined with top-down macro analysis, not just bottom-up stock selection.

Six, the biggest enemy of investment is human nature

Studying the history of stock markets in various countries, almost every country (including A-shares) has shown that the long-term investment return of undervalued value stocks is significantly better than that of overvalued growth stocks.

The reason is simple: investors often have unrealistically high expectations for future growth, while turning a blind eye to existing value. It is a universal human nature to not cherish what one already has and hold overly idealistic imaginations about what is yet to come.

Weakness 1: Overconfidence; In 1999, during a behavioral finance short training course at Harvard, the professor asked through an anonymous survey: 1. How much money do you think you will have when you retire? 2. On average, how much money do you think people in this room will have when they retire? The average answer to the first question was $30 million (most were American fund managers), while the average answer to the second question was $3 million. In other words, on average, everyone believed they were 10 times better than the average.

Weakness 2: Positioning mindset; Once heavily invested in a stock, one tends to fully embrace positive news and ignore negative news, a psychological phenomenon known as Confirmation Bias or colloquially as "letting your butt decide your brain." The correct decision-making process is to have evidence first, then draw conclusions; but most people draw conclusions first, then look for evidence, which leads them to ignore opposing evidence. Once a position is established, the mindset becomes subjective, hence the term positioning mindset Weakness Three: Anchoring Bias; Some people often say, "This stock has risen so much, why not sell?" or "It has already dropped by half, why not buy?" This is the manifestation of Anchoring Bias, where the subconscious takes the original stock price as a rational and reference anchor. In fact, whether a stock is cheap or not is more reliable to look at valuation rather than recent price movements: when the fundamentals greatly exceed expectations, it can become cheaper as it rises, and vice versa.

Weakness Four: Short-term trends becoming long-term; If a company's profit was 60 cents last year and 70 cents this year, intentionally reported as 50 cents last year and 80 cents this year, showing a 60% growth, then the P/E ratio surges. This is utilizing the tendency in human nature to extrapolate short-term trends into the long term, known as Over-extrapolation in behavioral finance. Extrapolating past growth into the future excessively, treating unsustainable as sustainable, is a common trap for growth and cyclical stocks.

Weakness Five: Loss Aversion; Aversion to losses is common among people. In A-shares, selling stocks at a loss is called "Stop Loss" by foreigners, while we call it "cutting meat and breaking bones" - the aversion is evident. Many people sell when a stock returns to their cost basis, but hold onto it when it's at a loss, deceiving themselves by saying it's not a real loss if they don't sell. In fact, the investment value of a stock has nothing to do with the purchase cost; whether to sell or not is also unrelated to whether you are at a loss.

Weakness Six: Sensationalism; Investors often tend to overreact to news headlines. For example, some stocks recently surged because they could provide a small amount of disaster relief supplies to Japan; similar cases occurred during the SARS period; last year, newspapers were full of discussions about consumption, but research in the central and western regions found that construction sites were bustling with activity, and construction machinery was in high demand. Headlines mostly focus on "man bites dog" events, while research can reveal the "dog bites man" events that don't make the news.

Weakness Seven: Hammer Syndrome; In the US, there are many consumer stocks, suitable for value investing; in Canada, there are many resource stocks, suitable for trend investing. Internet winners dominate, so buy the leaders; in the leisure clothing sector, there is a variety of choices, so buy growth. For differentiated products, buy brands; for homogeneous products, buy the low-cost ones. Different countries and industries require different approaches, but people often rigidly apply the same model. To a hammer, everything in the world looks like a nail.

Seven, Be prepared for the future, but don't rely too much on predictions

The Bond King Bill Gross once said, to predict the future, there is no better teacher than history; a history book that costs 30 yuan contains wisdom worth tens of billions.

After luckily getting several predictions right among the top ten predictions last year, many people ask me how many I can get right this year. My answer is, passing grade for 3, excellent for 5. The questioners often seem a bit disappointed. In fact, each prediction contains several specific forecasts, and each forecast must be mostly correct to count as one prediction. Therefore, I often recall Galbraith's words with caution: the only function of economic forecasts is to make astrology respectable - the final prediction is just the conclusion after analyzing the forecasts, which contain more specific predictions, dynamically tracking these predictions Economic forecasts only need to be as accurate as possible, while stock market forecasts need to be as accurate as possible in predicting human behavior.

Sometimes, the difficulty lies not in predicting the future fundamentals, but in predicting how investors will react. At the beginning of last year, I often said, "I'm not worried about a double dip, but I'm worried that others will worry about a double dip." This year's version is, "I'm not worried about runaway inflation, but I'm worried that others will worry about runaway inflation." This requires some knowledge of behavioral finance.

Predicting the future is a very laborious task. Many people are unwilling to make forward-looking judgments and hold a kind of agnosticism about the future. But I have always believed that as a professional investor, if you don't make a judgment about the future, how can you beat the market and outperform your peers?

Eight, Reading Research Reports Well, Reaping Twice the Benefits

  1. Reading research reports well, a good research report should clarify three points: valuation, why the stock is cheap (valuation level compared to peers, historical comparison; market value size compared to future growth space); quality, why the company is good (pricing power, growth potential, barriers to entry, industry competitive landscape, etc.); timing, why buy now (profit exceeding expectations, insider buying, price stabilization, turning point in fundamentals, new orders as catalysts).

  2. Reviewing old reports; I like to read reports from one or two years ago. Since I already know the industry changes, company developments, and stock price trends 1-2 years after the report was published, I can retrospectively examine the analysts' stock recommendation logic (quality, valuation, timing) to see where they were right, where they were wrong, and what lessons can be learned. 99% of reports have no reading value after one year, but the remaining 1% accurately summarize industry trends and company essence, which is my weekend intellectual nourishment. Regarding Mr. Qiu Guolu's aphorisms on investment, they have been widely circulated online in various versions with mixed logic. I have organized the information I found in the order of a retail investor's cognitive sequence and shared it with everyone