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2024.04.03 08:30
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Li Lu: Uncover intrinsic value, understand the essence of the market

Short-term investment performance is often influenced by luck, not your personal abilities

Comprehensive from Qile Club.

Editor's Note: As the chairman of Himalaya Capital Management, Li Lu now manages assets of one to two hundred billion US dollars and is the primary manager of Charlie Munger's family assets.

The market itself is a combination of everyone. If you don't understand what you are doing, the market will definitely knock you down at some point. That's why the stories heard in the market are all about making money, but in the end, everyone actually loses.

What is the essence of investment? How to become an excellent investor?

First, stocks are not just securities that can be bought and sold, they actually represent certificates of ownership in a company, a partial ownership of the company.

This is the first important concept. Investing in stocks is actually investing in a company. As the GDP grows, value is continuously created in a market economy. Therefore, as partial owners, our held value will also increase along with the company's value growth. So, if we invest in the form of shareholders and support this company, we will receive our fair share of benefits as the company's value grows. This path is sustainable. What is the right path, what is the wrong path? The right path is when you get what you deserve, so this kind of investment is a righteous path. However, very few people are willing to understand stocks in this way. (The cornerstone of value investing)

Second, understanding what the market is.

On one hand, stocks represent partial ownership, on the other hand, they are indeed tradable securities that can be bought and sold at any time. There are always people making bids in this market. So how do we understand this phenomenon? From the perspective of a value investor, the market exists to serve you. It provides you with opportunities to purchase ownership and also gives you the opportunity, many years later when you need money, to sell it and turn it into cash. Therefore, the market exists to serve you. The market can never tell you what the true value is. It only tells you what the price is. You cannot treat the market as your teacher. You can only treat it as a tool that you can utilize. This is the second very important concept. However, this concept is exactly the opposite of the understanding of almost 95% of market participants. (Get rid of the toxic belief that the market is the best teacher, it is just a tool for you)

Third, the essence of investment is to predict the future, and the results of predictions cannot be 100% accurate, only ranging from zero to close to one hundred.

Therefore, when making judgments, you must leave a large margin of safety. Because you cannot distinguish, no matter how confident you are, always remember the margin of safety. Your purchase price must be significantly lower than the company's intrinsic value. This concept is the third most important concept in value investing. Because with the first concept, stocks are actually a part of the company, the company itself has value, intrinsic value, and the market exists to serve you, so you can wait to buy when the market price is far below the intrinsic value. When the price far exceeds its value, you can sell. (Assessing intrinsic value requires a deep knowledge base and exploration) As a result, if your predictions about the future are wrong, you won't lose a lot of money; even if your predictions are often correct, such as having an 80% or 90% certainty, because it's impossible to reach 100%, when that 10% or 20% possibility occurs, the outcome is still unfavorable to your intrinsic value. However, if you have enough margin of safety at that time, you won't lose too much. If your prediction is correct, your returns will be much higher than others. Every time you invest, you need to demand a huge margin of safety, which is a skill in investing.

Fourth, Buffett, through his fifty years of practice, has added a concept: focus.

Investors can truly build their circle of competence through long-term and unremitting efforts, gaining a deeper understanding of certain companies and industries than almost everyone else, and making more accurate judgments about the long-term performance of companies in the future than anyone else. In this circle is your unique ability.

The most important concept of the circle of competence is boundaries. Without boundaries, competence is not real. If you have a viewpoint, you must be able to tell me the conditions under which this viewpoint is not valid, then it is a real viewpoint. If you directly tell me that this is a conclusion, then this conclusion must be wrong and cannot withstand scrutiny. Why is the concept of the circle of competence important? It is because of the "market master". What is the purpose of the market's existence? For market participants, the purpose of the market's existence is to discover human weaknesses. What you haven't really understood, what psychological and physiological weaknesses you have, will definitely be exposed in a certain state of the market. Everyone who has rolled in the market must know the meaning of what I am saying. (The significance of thinking hard)

The market itself is a combination of everyone. If you don't understand what you are doing, this market will definitely knock you down at some point. That's why the stories heard in the market are all about making money, but in the end, everyone actually loses. People always hear stories of different newcomers because the old ones no longer exist. The market itself can discover your logic, discover almost all the problems on you, as long as you are not within the circle of competence, as long as your circle of competence has no boundaries, as long as you don't know your boundaries, the market will definitely find you at some point in some form, and you will definitely be badly beaten by it. (Ignoring the cost of silence creates illusions, leading to erroneous judgments)

Only in this sense is investing truly risky. This risk is not the ups and downs of stock prices, but the permanent loss of capital, which is the real risk. Whether this risk exists depends on whether you have this circle of competence. And this circle of competence must be very narrow. You have to define each boundary of it very clearly. Only within this narrow boundary is it possible to build truly accurate predictions for the future through continuous long-term efforts. This is a concept proposed by Buffett himself.

These four aspects together constitute the entire meaning and fundamental concept of value investing. The concept of value investing is not only simple and clear to talk about, but also a broad and right path. The right path is something sustainable What is sustainable? Sustainable things all have one common characteristic, that is, what you get is considered deserved by everyone else, by all others. That's sustainable. If when you disclose your way of making money without reservation, everyone thinks you are a fraud, then this method is definitely not sustainable. If you share your money-making method with everyone bit by bit without holding back, and everyone thinks your method of making money is right, good, and admirable, then it is sustainable. This is called the right path, the correct path.

Why is value investing itself a right path, a correct path?

Because it tells you that investing in stocks is actually investing in ownership of the company. Investing first helps the company's market value get closer to its true intrinsic value, which is beneficial to the company. Not only do you help the company continuously increase its intrinsic value, but also, as the company grows continuously, due to the continuous growth of the company's intrinsic value caused by growth, you get a share of the growth in the company's value.

This is the entire concept of value investing. It sounds very simple and logical. But what is the reality? In the actual investment process, such investors account for a very small proportion in the entire market, very few. Almost all theories related to investment have a lot of followers, but true value investors are few and far between. So the characteristic of investment is that most people don't know what you are doing, and the result of investment becomes a wealth killer. The recent stock market turmoil we just went through is the best example.

But on the path of investment, there is no one, it's deserted. Where have all the people gone? They are bustling on the side roads. Why take the side road? Because the main road is very slow. We also know in life that the success of a company requires many people, a lot of time, relentless effort, and some luck. So this process is a very difficult one. (The right path in the world is full of twists and turns)

Another difficult aspect is that it is very difficult to judge the future. The skill of investment is to predict the future, to truly understand a company, an industry, and to be able to judge what it will be like in 5 or 10 years in the future. There are too many uncertainties, and for the vast majority of industries and companies, it is impossible to predict that far ahead. But is it completely impossible? Not really. After you really work hard, you will find that in some companies, in some industries, you can see very clearly what the worst-case scenario for this company will be in ten years? It could be much better than that. But this requires many years of relentless effort, many years of hard study, to reach such a level. (I think this is the best theoretical basis for left-side trading, of course, I can't see ten years ahead, maybe three years)

When you can make this judgment, you start to build your circle of competence. At the beginning, this circle is definitely very small, and it takes a very long time to build this circle. This is why value investing itself is a long journey, although it will definitely come to an end, most people are unwilling to walk it. It does indeed take a lot of time, even if you spend a lot of time, you still know very little. (It's very difficult and niche, but you have to persevere, and also be humble) You wouldn't go on financial TV and start evaluating all companies, immediately telling others what the stock prices should be like. If you are a true value investor, you would never dare to do that; you wouldn't casually say that 5000 points are too low, the bull market is about to start, and you should buy the dip at least at 4000 points. You can't say these things, you can't make these predictions. Anyone who stretches beyond their own abilities will eventually completely ruin themselves in a certain market environment. The market itself is a mechanism to discover weaknesses in you.

The most fundamental requirement in this industry is to be a person who is complete in knowledge and 100% honest. Never deceive yourself, because you are actually the easiest to deceive, especially in this industry. As long as you sit here, you can tell others lies, and if you tell lies too often, even you will believe them. But such a person can never become an excellent investor and will definitely be completely ruined in a certain market condition.

That's why our industry hardly produces many long-term outstanding investors. Some so-called star investors we talk about today have had a consecutive annual return of 20% for over a decade, but when they closed in the last year, they suddenly dropped by tens of percentage points. When they first started their fund, the fund size was small, but when they lost money, the fund size was already large, and the final loss for investors might be much greater than the money they made for investors. But they made a lot of money themselves. If you calculate from start to finish, they shouldn't have made a penny.

So even though this path may seem like an easy road, in reality, it is very far from success. Many people are scared by this. At the same time, because this market always makes you feel like you can profit in the short term - your short-term assets can indeed have huge changes, so this can give you illusions, imagining that you can make huge profits in the short term.

So you are more inclined to hope to put your time, energy, and intelligence into short-term market predictions. That's why everyone is willing to take shortcuts and not willing to take the long way. In reality, almost all shortcuts have turned into detours. (It is very necessary to establish investment beliefs, which is a lighthouse. You need to reflect and correct specific investment actions regularly.)

So we see that in the long term, at least in the trading records in the United States, almost all kinds of so-called strategies and tactics aimed at short-term trading have almost no long-term successful records. And those truly long-term, excellent investment records, almost everyone is a value investor.

Short-term investment performance is often influenced by the overall market luck, not your personal abilities.

For example, in a very short period, not to mention 1 or 2 years, at any time, one or two weeks, there will always be some stock gods. In the past 8 months in China, I don't know how many stock gods have appeared. Many stock gods eventually jumped off the building. In the short term, there can always be winners and losers, but in the long term, winners are very few. So even if it's 1 year, 2 years, or even 3 years, 5 years, or 5 to 10 years, very good performance often cannot determine how their future performance will be. For example, if someone tells me their performance is very good, saying it's 5 years, 10 years, if I can't see their actual investment results, I still can't judge whether their success is due to luck or ability. This is a core issue in judging value investing, luck or ability In the market, the average cumulative return over 15 years is 14%. At this time, you don't need to be a genius. As long as you are in this market, your performance will be very good. However, there are also times when the return in the market is negative for over a decade. If your return is excellent during this time, it will be different. So, if I can't see the specific investment content, it's generally difficult to judge. But if one of my investment managers can maintain excellent performance for over 15 years, researching on the right path, then they have basically succeeded.

At this point, ability far exceeds luck, and we can basically determine their success. In other words, in this industry, one needs to work hard continuously for a long time to truly succeed, probably over 15 years. This is why even though this road to success will definitely lead to success, there is no traffic congestion at all, and very few people walk on it. However, this is precisely the opportunity for those who want to take the road to success and are willing to take the difficult path. Those who walk down this path, the success they achieve is truly deserved in the eyes of others.

I sincerely hope that everyone can boldly move forward on the right path, because there is no traffic congestion here, and the scenery is particularly good. Don't feel lonely, because this industry is full of all kinds of novelties, challenges, and scenery. I believe that everyone can walk better on this road in the future. Persist and work hard for fifteen years, and you will definitely become an excellent investor!