We Study Billionaires - The Investor’s Podcast Network - TIP636: Billionaire Investing Legend Li Lu w/ Clay Finck

Starting point is 00:00:00 You're listening to TIP. Hey, everybody, welcome to the Investors podcast. I'm your host, Clay Fink, and today I'm going to be sharing what I learned from studying the investment approach of billionaire value investor Lee Liu. Lee Liu is the founder and chairman of Himalaya Capital, which is a multi-billion dollar investment firm that primarily focuses on long-term investment opportunities in Asia and the U.S. Himalaya Capital was started by Leelieu back in 1997, and as of the first, and as of September 2023, it looks like the firm manages around $14 billion in assets.

Starting point is 00:00:36 Lee Liu is well known for being close friends with Charlie Munger in Monash Pabri, and he rarely does public appearances, so during this episode, I'm going to be sharing what I found after scouring through all publicly available resources I could get my hands on. In fact, when Charlie Munger recently passed away, part of his $2.5 billion fortune was invested with Lee Liu, who he referred to as the Chinese Warren Buffett. With that, let's get right to it.

Starting point is 00:01:06 Celebrating 10 years and more than 150 million downloads. You are listening to the Investors Podcast Network. Since 2014, we studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now, for your host, Clay Fink. So I wanted to kick this episode, off and just share what's on Himalaya Capital's website. At the top, they share a quote from

Starting point is 00:01:42 Charlie Munger on the seamless web of deserved trust. I quote, the highest form which civilization can reach is a seamless web of deserved trust. Not much procedure, just totally reliable people correctly trusting one another, end quote. I'm not exactly sure what personally led him to posting this quote specifically, but it reminds me of the early days of Lee Liu, which I'll be getting into a little bit here. So, Li Lu has one of the most interesting backstories of all the investors I've studied on this show. He was born and raised in China, and his parents were sent to labor camps by the government,

Starting point is 00:02:20 so he transitioned through multiple orphanages and caretakers growing up. In fact, when he was 10 years old, he survived a catastrophic earthquake in Tang Shen, which official records show killed 240,000 people, including all the members of of Lee Lou's adoptive family. When he was at university, he participated in protests organized by students, and this eventually led him to being put on the government's list of 21 most wanted student leaders. So Lee Lou played a pivotal role in orchestrating a six-day hunger strike, which provoked a response from the government.

Starting point is 00:02:58 Reportedly, there were one million people together at this protest, and the government had to interfere, and they ended up opening fire on them. Lee Lu was then one of 21 people that they wanted to capture for leading this uprising. He then somehow managed to escape China through these underground channels and make his way to the United States. He was in New York. He had no money, didn't speak English, and he was able to initially get by because of the generosity of human rights groups that admired the stand he had taken while he is in Communist

Starting point is 00:03:29 China. To learn more about his early days, Li Lu actually wrote a book about it. It's called Moving the Mountain My Life in China. There's also an FT magazine article that I'll be sure to get linked in the show notes that dives into this as well. So Lee Liu, in doing all this research on him, he is just really ungodly smart and hardworking. He learned English in one summer before enrolling in Columbia University. He was one of Columbia's first students to ever get three degrees simultaneously.

Starting point is 00:04:02 So not just like three majors, three degrees. So he had an economics degree, an MBA, and a law degree. And he did this while staying in an apartment living room that he shared with eight other people. And he was doing these studying a language that wasn't even his first language. Charlie Munger has previously said that he likes to partner with people who can be dropped off into a completely new country or completely new environment without any resources and still end up making a fortune. And that's exactly what Lee Lou did early on in his life. Apparently, he had done so well in his investing endeavors in college that when he graduated, he had a million dollars. And the way he had this money to invest is that he would get these student loans and he'd pay these loans maybe three, four, five months

Starting point is 00:04:54 later, and he'd use those loans as float that he would invest in the meantime, and he just did so well investing in this manner. Munger had said in the 2017 Daily Journal meaning that, I quote, I've read Barron's for 50 years, and in 50 years, I found one investment opportunity, out of which I made about $80 million for almost no risk. I then took the $80 million, gave it to Lilu, who then turned it into $400 or $500 million. So it's no wonder that Charlie referred to Li Lu as a Chinese Warren Buffett. Lee Lou started Himalaya Capital right out of college, which was practically unheard of at the time to do. And after Munger had met Lelieu, he wanted to hire him at Berkshire, but Munger just knew this was totally against his nature. Lee Loo is like Munger and that he

Starting point is 00:05:40 sort of wants to run the show and have full autonomy over his life. Once Lee Lou started a new fund in 2004, Munger gave him $88 million of his family's money. So on Lelu's website, it's shares what Himalaya Capital does. It says they embrace the value investing principles of Benjamin Graham, Warren Buffett, and Charlie Munger, and aimed to achieve superior returns by being long-term owners of high-quality companies with substantial economic modes, great growth potential, and run by trustworthy people. The website also shared a piece that Lee Lou wrote in Poor Charlie's Almanac, the 2009 edition where he talks about Ted Williams, who was the only baseball player who had a 400 batting average in the last 70 years. His technique to doing so was to

Starting point is 00:06:27 divide the strike zone for hitting into 72 different cells. So each represented the size of a baseball, and Ted Williams would only swing at what he considered to be his best sales, even at the risk of striking out because the worst spots is where the ball ended up going and it would significantly reduce his chances of success. To apply this concept to the stock market, he explained, how all sorts of businesses are out there that we can invest in, but for the most part, you don't have to do a thing or two other than be amused. Once in a while, the quote-unquote fat pitch that is slow, straight, and right in the middle of your sweet spot comes along and then you swing hard at it. He argues that many investors tend to swing too often, and this leads

Starting point is 00:07:12 them to not being able to take full advantage of the best opportunities. When I pull up DataRoma to get a glimpse into Lelieu's portfolio, I see $2 billion in assets under management that's allocated to five companies. And this, of course, excludes his international holdings, but it still gives me a sense of how he invests. He's fairly concentrated and really acts with high conviction. So as of Q1, 2024, he had holdings in Alphabet, Bank of America, Berkshire Hathaway, East West Bank Corp, and Apple. So before I dive into some of the resources I found here, I'll mention that some parts are just summaries of talks he gave and may not necessarily be 100% accurate because these talks weren't recorded or written and people had taken notes on them.

Starting point is 00:07:57 So please take all of this with a grain of salt. There were a couple of quotes that I found from Lee Liu that are very much like what you hear from Charlie Munger. The first is that knowledge compounds almost in the same way that your money compounds. In fact, only when your knowledge compounds at a faster pace, your money is safe. To me, that is a very fascinating journey and a rewarding life. And the second quote here is, you should consider it a moral duty to compound your knowledge and ability. So Li Liu has such an admirable story when it comes to not only compounding money, but

Starting point is 00:08:31 also compounding knowledge. After he escaped from China, he didn't hardly know anyone, he had no money, he was deep in debt, and he just wanted to figure out how to make ends meet in this new life. Then around 1991, he found himself in a lecture that was done by Warren Buffett. And Leloo thought that he might be able to make something of himself in this investment business. Buffett shared the core principles he had learned from Benjamin Graham. Don't think of yourself as a security owner, but a business owner when investing in stocks. Invest only with a huge margin of safety and let Mr. Market be your servant, not your master.

Starting point is 00:09:08 This was two years after Lelu had come to America and all he was thinking about, is how he was going to pay his bills. So after listening to Buffett speak, he believed that value investing required a lot of reading, a lot of mathematics, hard work, and good judgment, all things that he thought he would reasonably be able to do. And the fundamental principles of value investing really appeal to him, by good securities at a bargain price. If you're wrong, you won't lose a lot, but if you're right, you're going to make a lot. Lee Lou saw an opportunity in thinking like a value investor because something like 5% of all investors fell under this camp and were a minority in the market.

Starting point is 00:09:48 Emotionally, it's very difficult to think like a true value investor and achieve superior returns. While most are prone to following the crowd, a true value investor is comfortable sitting all alone and being in the minority of shareholders. You have to adopt the idea that you're right because of your reasoning and evidence, not because other people agree with you. This is a concept that Francois Rochon also mentioned during my interview with him. Li Liu and Francois both considered it sort of a genetic mutation

Starting point is 00:10:18 because most people are hardwired to just stick and follow with the crowd because this is what helped their ancestors survive and pass along their genes. Most people are not genetically capable of straying away from the crowd and thinking differently when the facts suggest they should do so. And it's an interesting thought experiment that if 100% of stock participants were true value investors, then he wouldn't be able to have a functioning market overall. No well-informed investor would want to sell to someone that demands a huge margin of safety. And if everyone invested like Lee Lou invests, hardly anyone would be purchasing IPOs to get

Starting point is 00:10:56 public company's shares traded on the market. For two years, Lee Lou did everything he could learning about Buffett and Monker because he had attended that Buffett lecture. He figured that without any special access to money, connections, or whatever else, he could be quite successful in America doing this thing called value investing. After college, he went to work at an investment bank and used all the money he had saved to invest in the stock market. And he didn't like his job and he was already making more from investing than he was from his job. He quickly realized that he could comfortably make a living as a full-time investor. So he started up his own firm in 19,

Starting point is 00:11:34 1997, partially due to the inspiration of Buff and Munger to run your own company. Leloo was also a big fan of Value Line, which is a publication service that prints out information on all sorts of companies. I think they share an overview of any company above a certain market cap, and Lee Lou would just read the whole thing from beginning to end, and he believed it was the best kind of education because it gave him really an encyclopedic knowledge of companies. The first thing that he liked to check in Value Line was the new low list, stocks that were at 52-week lows or stocks that had the lowest PE or lowest price to book. If you haven't seen his talk at Columbia that's on YouTube from 2006, I would highly recommend

Starting point is 00:12:18 it. In his talk at Columbia in 2006, he used the example of Timberland, a shoe manufacturing company and apparel that I'm going to outline briefly here. He starts with a quick five-second look at the business and sees that it's trading at around book value, consisting mostly of tangible liquid assets, working capital, and $100 million in real estate. It had $200 million in capital deployed, with a $100 million return. The business was trading below what Liliu called clean book value, which is the $100 million figure I mentioned there. Then he asks himself why the business would have become so cheap, and he finds that at the height of the Asian financial crisis, they saw their sales fall off a cliff because anything with exposure to Asia was just a disaster.

Starting point is 00:13:06 He then finds that no other analysts were covering the company. Then he looked at the business's history. It had been growing. It was pretty profitable. It didn't need to tap into the capital markets. It was family owned as a family had control of 40% of the company and had 98% of the voting rights. Upon further research, he finds that there are a bunch of shareholder lawsuits and he thinks that maybe the family is milked. the business's profits for themselves. From there, he downloads every court document lawsuit and reads

Starting point is 00:13:35 every single one of them. He found nothing too concerning in the lawsuits, but he still wasn't sure if the managers were good people that he'd want to be running a business that he owned. So the only way to find out was to turn into an investigative journalist because most business owners leave a trail for you to follow and see how they deal with different situations. Most professional managers wouldn't see this as a part of their job. And that is why by definition, most managers aren't in the 5% that have the capacity to outperform the market. Investing for Lee Lou doesn't mean hopping on his investment platform and making trades or investments. The vast majority of his time is spent researching and having that intense curiosity and learning.

Starting point is 00:14:21 He knows that the more he knows, the better off he is as an investor. And this drive to figure out everything he can about a business isn't just a desire to make money. If he wanted to just make money from it, then he probably wouldn't have gone through all those materials and figured out everything he could about a company. He needed that really deep curiosity to drive that intense research. He'd go on to talk to the people the managers knew and talked to their neighbors to really get a sense of who the managers were. He'd then come to find that they were high-quality people and ethical businessman. After consuming all of the information he possibly could on the business, he decided that the stock was far too low, and his advantage was that he had simply done more work than at least 90% of other

Starting point is 00:15:08 investors. Lee Lou would always tell his analyst that he always needs accurate and complete information. He claims that most people fail on both of these big time. To get there, you have to go the extra mile that others don't. simply aren't willing to go. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future.

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Starting point is 00:19:30 All right. Back to the show. This is so critical because the best value investors most of the time are standing alone relative to everybody else. I'm reminded of William Green's chapter in his book, Richard Weiser Happier, titled The Willingness to Be Lonely. This is the chapter that was focused on Sir John Templeton. So now is the time to buy the Timberland stock that I had mentioned earlier. But how much?

Starting point is 00:19:55 Most investors would take tiny positions, but Lee Liu isn't like most other investors. He takes these big, chunky positions well over 10%, perhaps more than 20%. Lee Lou bet big on Timberland. and two years later, the stock went up by 700% propelled by increasing earnings and an expanded multiple. The stock went from five times earnings to 15 times earnings and was growing at 30% per year. He talked about how he goes to all this tremendous effort to figure out the issues within a business, how much it's really worth, and figure out everything you can about it. And most funds wouldn't do near that work, so they take these small, tiny positions. Lelu isn't going to do all this

Starting point is 00:20:38 work just to take a 1% or 2% position. If you figure out that you have virtually no downside and tremendous upside, then he reasons that you might as well bet big on it. In the notes on his lecture at Columbia in 2010, Bruce Greenwald had stated that Lee Liu managed all of Charlie Munger's money, which of course excluded his shares of Berkshire Hathaway. And Greenwald also claimed that Warren Buffett would prefer that three people manage his money. These three people included Seth Carman, Greg Alexander and Lee Liu. At this lecture at Columbia in 2010, he talked about how when you find those insights along the road of study, you need to have the guts and the courage to back up the truck and ignore the opinions of everyone else. So that gives you a sense of the type of investor

Starting point is 00:21:26 that Lee Lou is. He trained himself to become a learning machine. He devoted himself to seizing the opportunities and seizing it fast before the train left the station. You want to find yourself in a setup where you can know something that most other people don't know. Most people don't take this sort of thorough approach because they view stocks as tickers that can easily be traded and because they can easily be traded, they don't need to be well understood. He's constantly searching for new ideas and knew that the best ideas were rare and could only be gained from continuous learning. He stated that in life, you may only have five to 10 key moments of insight. And those key moments of insight and those big ideas can deliver

Starting point is 00:22:12 10,000 X returns. Buffett said, if you can find 10 good investments over your 40-year career, you're going to be extraordinarily rich. For those that want to learn how to come to these key insights, he tells his insurance to work through a certain exercise. Pick one business and start to truly understand it. Imagine a distant relative passed away and you've found out that you were going to inherit 100% of that business. Once you have that mindset, you can start to understand it inside out. And it doesn't have to be a great business. It could be any business. Understand how it makes money, how it organizes its finances, how the management team makes its decisions, how it compares to the competition, how it adjust to the environment,

Starting point is 00:22:56 how it invests extra cash and how it finances its business. This gives you an idea of how you would do as a 100% owner, which gives you a leg up on the competition who typically view stocks as a ticker that they can trade in and out of freely just because it's easy to do so. But if you inherited 100% of that business, you wouldn't be trading it. You would really seek to understand the inner workings of it, how it works, and how it should be run. If you start with the inner workings, you can eventually determine how much that business is worth. Every long-term investor is going to go through some period where the quoted share price of their holdings gets hammered, March 2020 being the most recent example of this. As business values plummet, investors were put to the test.

Starting point is 00:23:45 And during this period is when the best opportunities arise and your temperament and judgment really come in handy. And the better you understand the businesses and how much they're worth, the better judgment calls you can make during those time periods. The best opportunities require what Charlie Munger calls the Lollapalooza Effect, where a whole bunch of these factors are working together and you have that insight and you're willing to bet big on it. He knew that his deep curiosity would eventually bring him a new great idea and they didn't have to come often for him to make them count. There might be years without opportunities and there might be years with a lot of them and you can't expect them to come at a steady pace.

Starting point is 00:24:25 In year one of his fund, he was in the middle of the eight years. Asian financial crisis, and he bought into excellent Asian companies and oil companies in the U.S. and Canada. He had very few investors. The fund was down 19% on the year, and he had a really tough time bringing in more money. Psychologically, this was a very difficult period for Leloo since he was barely making ends meet, and he was performing every function related to the fund himself, and he fought through that adversity and ended up achieving exceptional returns over the two years that followed. But he still had trouble to attract. new investors. Most investors, especially institutional investors, believed in theories that Lee Lou

Starting point is 00:25:04 deemed to be absurd. Things like the efficient market hypothesis and the idea that risk equals volatility, it was as if most investors spoke a different language than those who followed Buffett and Munger. In the view of Lee Lou, Charlie Munger and Warren Buffett, risk in the stock market was not in the volatility of prices, but whether you will have a permanent loss of capital. Not only is a drop in the stock price, not a risk, but it may present an opportunity. For a few years, Li Lu had made some compromises with his fund and his investors, such as adding to short positions to dry and dampen the volatility of it, and this was successful in dampening the volatility, but it also delivered lower returns, and most importantly, it distracted

Starting point is 00:25:49 him from finding the best opportunities. When Lee Lou met Charlie Munger in 2003, he had shared the issues he had in dealing with with shareholders that really didn't think long-term in the way that Buffett and Munger did. And Munger told him that his problems would continue unless he restructured his fund. And if he did restructure it, then Munger was willing to invest with them. Once he changed the fund structure with Charlie's help, all of the shortcomings of a typical hedge fund just withered away. Investors who agreed to stay and stick around for the long-term signed lock-up agreements

Starting point is 00:26:25 and they also stopped accepting new investors. Now he wasn't bothered with the ups and downs of the market and could now devote all of his time to researching and understanding businesses. From January of 1998, over the 12 years that followed, the compounded annual growth rate of his fund was over 29%, and it increased 20-fold over just a 12-year time frame. The returns were even better starting in late 2004, which I believe is when he launched that second fund.

Starting point is 00:26:55 from Q4-2004 to the end of 2009, that new fund achieved an annualized return of 36% per year. In addition to the key principles originally outlined by Graham, Lee Liu took to heart Charlie Munger's mental model of inversion. Instead of thinking about how he could make money, he first had to figure out how he could possibly lose in any particular investment. This ties indirectly with the margin of safety principle as well. The future is fundamentally unpredictable, and you're always going to be dealt surprises, some positive, and some negative. Lee Liu was quite close to Charlie, and is forward to the Chinese edition of Poor Charlie's Almanac is a really good read and touches on some things about Charlie that I hadn't read before.

Starting point is 00:27:42 So when learning about all these different legendary investors and studying different investments, it's so easy to fall in love with a new investment or a new approach. Lee Liu was once asked how his approach differed from Warren Buffett's, and I really liked the answer he gave that I'm going to read here. So I quote, part of the game of investing is to come into your own. You must find some way that perfectly fits your personality because there is some element of a zero-sum game in investing. If you buy, somebody else has to sell. And when you sell, somebody else has to buy. You can't both be right. You really want to be sure that you are better informed and better reason than the person on the other side of the trade.

Starting point is 00:28:26 It is a competitive game, so you're going to run into a lot of very intelligent, hardworking fellows. The only way to gain an edge is through long and hard work. Do what you love to do, so you just naturally do it and think about it all the time, even if you're just relaxing and even if you're just walking in the park. Over time, you can accumulate a huge advantage if it comes naturally to you like this. The ones who really figure out their own style and stick to it and let their natural temperament take over will have a big advantage. The game of investing is a process of discovering, discovering who you are, what you're interested in, what you're good at, what you love to do, then magnifying that until you gain

Starting point is 00:29:11 a sizable edge over all other people. When do you know you're really better? Charlie Munger always said, I would not feel entitled to a view unless I could successfully argue against the best counterargument of the smartest opponent. He's right about that. Investing is about predicting the future, and the future is inherently unpredictable. Therefore, the only way you can do it better is to assess all the facts and truly know

Starting point is 00:29:37 what you know and know what you don't know. That's your probability edge. Nothing is 100%. but if you always swing when you have an overwhelmingly better edge, then over time you will do very well, end quote. I like how he mentioned here that it's really a discovery process for all of us, discovering who we are, what we're interested in, and what we're good at. Think about the subjects that you naturally gravitate to and enjoy learning about.

Starting point is 00:30:04 Those are some of the most likely areas where you're going to be able to gain an edge. When Lee Liu was asked about his circle of competence, he talked about how he knew China, Asia, and the American markets very well. And he also talked about his development as an investor. When he was first starting out, he wanted to ensure he didn't lose money. So he started to focus on these really cheap securities like the cigar butt types. But over time, he became more and more acquainted with different business models and getting a better understanding of the DNA of businesses, how these businesses progress over time and why some businesses are just so, so strong. And over time, he really fell in love with strong businesses, but never lost his initial taste for really cheap

Starting point is 00:30:47 securities. He had said that, I quote, I've become more attracted to looking for great businesses that are inherently superior, more competitive, easier to predict, and with strong management teams, end quote. Lee Lou definitely puts his money where his mouth is as Alphabet is his largest holding according to his 13F filing, which doesn't include what is in the outside the US, of course, Alphabet is certainly not a crazy cheap company, but more so a high-quality business that he was able to get in at a fair price. As of March 31st, 2024, his fund had over $800 million invested in

Starting point is 00:31:25 Alphabet. It seems that Lee Liu went through a similar transition to Buffett and Munger in that he got probably his best returns out of the cigar butts, but this method of investing really doesn't scale as your capital grows. So if you have $5 billion, these tiny micro or nanocaps really aren't going to move the needle for you anymore. He was asked about shorting stocks, which he said he no longer does and was one of the worst mistakes he's ever made. He mentioned that you could be 100% right about your short, but still bankrupt yourself because you expose yourself to unlimited downside. So he no longer shorts, which I suspect most of our audience doesn't do as well. Lee Lou was once asked about the asset management industry more broadly, and I thought that he had

Starting point is 00:32:11 some interesting insights related to this. The asset management industry is really tricky because it's one of the few industries where you're purchasing a service where you really have a hard time determining the quality of what you're buying, and the quality can vary drastically across different managers. Because of this, Lee Lou believes that all investment professionals should make it their ethical obligation to seek truth and seek wisdom and consciously refrain from allowing where you sit to determine what you think. So what he's getting at here really is incentives. Depending on someone's particular situation, they're going to naturally do what's in their best interest rather than what's in the best interest of their clients. So you really want those

Starting point is 00:32:54 interests to be aligned. For example, many managers who have a two and 20 fee structure have an incentive to grow their asset base, so they may spend more time on growing their fund, marketing their fund, or rather than investing their current assets in the best possible way. He also said that asset managers need to develop a sense of fiduciary duty and treat every single penny that's entrusted with them to be treated as if it were money your parents had worked really hard for and saved with thrift over their lifetime. He stated, quote, when you can treat every penny of your client's money as their life savings of your parents,

Starting point is 00:33:32 you will begin to understand the meaning of fiduciary duty, end quote. He advises only investing with managers who seem to have this trait and learning this trait is very, very difficult, if not impossible, as he believes it's something we're born with. Lee Lou is also a big student of history. He saw that over the long run, stocks were by far the best asset class to invest in over the long run. From 1801 through 2014, stocks return 6.7% per year after inflation, but the return profile from one decade to the next can be quite volatile. You might have one really good decade of 10% plus returns, followed by a decade where the market overall really goes nowhere.

Starting point is 00:34:16 He also found that despite there being a number of different approaches to investing in the stock market, there was only one method that based on data and based on statistics could deliver safe and outstanding returns to clients over a long period of time. This was value investing. Value investing to Lilu means that the investor adheres to four principles, three of which came from Benjamin Graham, and the fourth came from Warren Buffett. The first principle was that stocks represent fractional ownership in a real business. This recognizes that as the value of the company increases over time, then your wealth as a shareholder will also increase with it. He argues that's few people understand stocks in this manner. The second principle is understanding the role of Mr.

Starting point is 00:35:01 Market. The stock market is like an auction to buy or sell fractional ownership of a business. Successful value investors let Mr. Market serve them in acquiring shares when Mr. Market offers a good deal to acquire partial ownership in a company and then sell shares when the same company is fully priced or overpriced by Mr. Market. Mr. Market can never tell you what the true value of a stock is, it can only tell you what the price is. This is a super critical insight. The third principle is buying with the margin of safety. Since investing involves forecasting into the future in making predictions, we can never be 100% certain that our predictions are correct or accurate. This is why successful value investors leave a wide margin for error when making a purchase.

Starting point is 00:35:48 If you buy with a large margin of safety, then your losses when you're wrong will be minimized and your gains when you're right will reward you adequately. And finally, the fourth principle, which comes from Mr. Buffett, is on investing within your circle of competence. With a lot of reading, experience, and effort, investors can build their circle of competence to understand the business and industry better than the vast majority of other investors. Given this level of insight, these investors can make more accurate predictions about what the future will look like for a company. With regards to this, Lee Lou wrote, I quote, the most important idea behind Circle of Competence is knowing the boundaries. No real competence

Starting point is 00:36:31 can be limitless. When you advance an argument, you must be able to tell me which premises will disprove this argument. If you're able to do so, your argument is sound invalid. If you simply state the conclusion without providing the premise, your argument will not stand up to scrutiny, end quote. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up and customers now expect proof of security just to do business. That's why Vantza is a game changer. Vanta automates your compliance process and brings compliance, risk, and customer trust together on one AI powered platform. So whether you're prepping for a SOC 2 or running an enterprise GRC program, Vanta keeps you secure

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Starting point is 00:40:18 circle of competence and don't know what they're doing. This is because the market overall is very smart. And those who get lucky over time will see that luck fade away. He argues that the real risk investing in the market is investing outside of your circle of competence. And I think when you really learn these four concepts, you also understand why value investing can be so difficult. Oftentimes, the market is right in beating down a stock, but value investors are the ones who

Starting point is 00:40:47 are able to find the rare and large mismatch between the price and the value. I think psychologically and emotionally, people have a tough time truly detaching what they believe a business is worth from what the market says a business is worth. Lelu also believes in investing in great businesses and that the return of a value investor will be achieved through the growth of the intrinsic value of that business over. time, plus the potential return you get from the market value approaching the intrinsic value. Li Lu has also talked a good amount about investing in China, which, to my knowledge, is a market he studied and been invested in since the beginning. He's also stated that China could go

Starting point is 00:41:27 through economic troubles similar to that of the Great Depression in 1929 or the Great Financial Crisis in 2008. And I don't think Li Lu is one to make those types of predictions. In an interview with Bruce Greenwald, when he was asked about the current market conditions in 2021, he had stated, I quote, we usually don't study the market too much except when they're at the extremes. Today is one of the more extreme periods and in many ways we are in uncharted territory. The amount of liquidity that has been printed, the level of interest rates in the slow pace of growth, I guess I'll mention here that interest rates in 2021 were quite low and they've risen here in 24. All of these factors are quite remarkable. How do you deal with them? We don't think history

Starting point is 00:42:14 repeats itself because every time is slightly different. Instead of guessing the patterns of history, we focus on selecting companies that can live through thick and thin. Whatever the environment, business will continue and somebody will do well. End quote. In making the case for investing in China, he first outlined how it's well known that in the U.S. stocks over the long run, tend to generate good returns for investors because of the growth in GDP, which leads to growth in corporate profits, in addition to inflation lifting up the value of stocks over time. He looked at data from 1991 to 2014 for both the United States and China, and both stock markets performed very well. U.S. markets performed around 10% per year, depending on which index you look at,

Starting point is 00:43:02 And then the Chinese indexes returned anywhere between 10 and 13%. And again, this is due to GDP growth and then you have inflation as well. With that said, when I look at the Chinese index returns since 2014, the returns relative to the U.S. really are naming close. Since the end of 2014, the S&P 500 has returned to just over 10% annually. And the SCI 300, which is the Chinese index, is essentially flat. and it's also had a lot of volatility along the way. Liliu also points out that China is a highly leveraged economy,

Starting point is 00:43:39 and the Chinese government owns a lion's share of the stocks that are traded in the market. But Liliu does not invest in these indexes. He's investing in individual companies. There are plenty of well-known companies in China that have been just massive winners, just like how you've seen all these massive winners in the U.S. Baidu, for example, had a 48% internal rate of turn over a 10-ish-year period, increasing by 54 times. And Lee Liu is well known for investing in B-Y-D. And based on scouring around online, it looks like he bought it in 2002 before the company

Starting point is 00:44:13 even produced a single car. At the time, the company was a battery manufacturer, and it got into producing electric vehicles in 2008. And starting with little to no experience in the auto business, they went on to create the best-selling single-model vehicle in China, while competing with these joint ventures that were working with the government, and they had way more capital at their disposal relative to B-Y-D. So back in 2002, there was no reporting requirements for Lilu to report Himalay's ownership, stake in B-O-D. But then in 2005, he crossed a threshold where he needed to report his holdings in it, and he purchased a substantial amount of his stake around the fall of 2008 when the share price collapsed during the Great Financial Crisis. And then in 2002, they owned around

Starting point is 00:45:00 55 million shares, which looked to be valued in the ballpark of $1.5 billion. And from the prices, Lili was buying the stock, it just seemed substantial share price appreciation. Berkshire Hathaway also purchased a stake back in 2008. They bought 230 million shares during the Great Financial Crisis, and then they trimmed their investment back in 2022. And Berkshire is up around 25 times on their original investment. And BYD shares are up around 50 times. since Lee Liu's initial investment in 2002, but don't quote me on that because we don't necessarily know the exact price he purchased that back in 2002. Monish had mentioned that Berkshire bought at around eight Hong Kong dollars per share, and now it's around 211 Hong Kong dollars per share

Starting point is 00:45:47 at the time of recording. But many investors are concerned about the different political system that China has. He outlines in a piece titled, The Prospect of Value Investing in China, that he believes that China is in the works of modernization, and it's developing an economy that will continue to grow. He also believes that there's a misunderstanding in the West that China will move away from a free market economy for political or cultural reasons. And he sees a lot of disconnect and dislocations in the Chinese market because a substantial portion of who's investing and who's buying and selling is retail investors. Since I mentioned Monish, Mokosius William Green had asked Monish Papry what he thought Charlie Munger saw in Lee Lou. And Monich talked about how Charlie

Starting point is 00:46:32 believed that as an investor, you had to have someone close to you that you could talk to as an investment peer. So Charlie would have lunch once a month with Lee Lou and Monish Pabri. At one of those lunches, Lee Lou suggested to Monish Pabri that he looked into a company called Amor Pacific as an investment. And this is a company, Monish, he looked at the reports and he saw that every, Everything was written in Korean. So he just passed on the company. And then he just kept an eye on the stock and it just took off like a rocket. It went up something like 80 times according to that podcast, Moni, was on.

Starting point is 00:47:09 I'm connected with someone who works closely with Moni. She's an analyst for him. And he had mentioned to me that Lee Lou really had two big winners over his career. That was B-Y-D and Mao Tai, M-O-U-T-A-I. And this is another one that Modis mentioned in that interview with William. And in talking about China, Li Lu not only comes across as someone who is extremely rational, but he's also fairly optimistic. He discussed with Bruce Greenwald about how when you combined a free market enterprise or a way of organizing economic affairs combined with the invention

Starting point is 00:47:44 of modern science and modern technology, you created this modern economy that he referred to as a paradigm shift because it creates this continued and sustained economic growth ever since the Industrial Revolution. But what you also need is a political environment that can allow that magical economic force to take place. So Li Liu for many years has said that these economic forces will lead to the growth of the Chinese economy, which he's been largely right on. And he sees that continuing over the long run. All right. So that pretty much wraps up what I wanted to cover related to Lee Liu. Since one of Lee Liu's top holdings is Alphabet, I also wanted to touch a little bit on this company, which I'm sure a number of our listeners are also interested in or invested in. I personally

Starting point is 00:48:30 do not own this company. Stig Broderson, my co-host, invited a member of our TIP Mastermind community to do a presentation on this company. So I tuned into that as it was really helpful in getting a better understanding of the company and where it's at today and where it sits with the competitive threats we've seen through AI, chat, GBT and such. Lee Liu added to his alphabet at stake in Q2, 2022 and Q4, 2022 as well. And at that time, shares were trading around $90 to $120 per share. And here in May, 2024, shares trade around $173 per share. And I should also say that just looking at Lelu's portfolio and seeing his position in alphabet, you can quickly tell that, like Buffett, he's had to play a much different game than he did in the earlier days. Gone are the days for Lilu of

Starting point is 00:49:24 sifting through microcaps or finding these cigar butts that nobody's ever heard of. He's now in the big leagues, looking at these much bigger companies, at least in the Himalaya Capital portfolio. In 2023, close to two-thirds of alphabets of revenue came from their search business. And then an increasing part of their revenue is coming from YouTube and their cloud business. And then they also have their other bet segment, which is also fairly minuscule in terms of revenue, but worth mentioning here. When you look at the search business, this is just a massive segment for them, and it's still

Starting point is 00:49:58 growing. And this is primarily driven by an increasing number of search results. And then this leads to an increasing number of ads delivered, which are then monetized by Google based on the number of clicks. So in 2019, the number of paid clicks was 240 billion. And in 2023, the number of paid clicks was 419 billion. So clearly, this is still a growing business, which of course doesn't mean that the growth will continue indefinitely. There's also a little bit of a tailwind with AI and the machine learning, figuring out how to increase the click-through rates on their ads. So the click-through rate in 2019 was 4.8%. And then in 2023, it was 5.9%. So that is also a trend that is working in their favor. And for those of you who might think that Google Search is dead or is dying, I'll just

Starting point is 00:50:51 mention that in 2023, the number of search queries that were run on Google Search was 7.1 trillion, you know, pretty much an incomprehensibly high number. Alphabet's return on invested capital is also really good. In 2019, it was 21%. 2023, it's up to 27%. So a very capital efficient business, at least for the time being. They're very cash generative, so they recently announced a dividend, and over the last three years, they've bought back almost 3% of shares per year, and then they also recently authorized a new share repurchase program of $70 billion. Now, the big question with Alphabet is the risk, and how long Google Search will be able to be the behemoth that it is. There's concerns on whether OpenAI or some other company is going to

Starting point is 00:51:42 disrupt the search business. And I think that it's going to be pretty difficult to get consumers to change their behavior. And I think it also helps that Google is the default option on so many platforms. You know, you look at Safari, for example, on the iPhone. So to some extent, Google's moat lies in having the ability to pay Apple $30 billion to make them the default option. And this is capital that an AI startup simply isn't going to have. Google's AI segment, which, which is referred to as Gemini. This is their segment where they're trying to create their own developments and sort of counter what's happening in the AI space.

Starting point is 00:52:21 So Alphabet is also going through a period where their capital expenditures are increasing at a pretty rapid clip. They're building out data centers and that cap expense is increasing. So it's unclear how well those returns are going to be. That's yet to be seen. AI investments and data centers are proving to be. pretty capital intensive for many of these big tech companies. And as much as we want to think that CAPX is reinvesting for growth, I think a lot of it is simply maintaining their current competitive

Starting point is 00:52:52 position, which seems to be becoming more and more expensive over time. Zuming out and looking at the valuation, you have the search business that's producing 60 to 70 billion dollars in profits. Then you have YouTube and the cloud business, each producing around 10 to 12 billion dollars in profits. The search business is obviously their biggest business and also their slowest growing business. So we can apply a conservative multiple of 20 to this segment. Then if we assume a multiple of 25 to YouTube and the cloud, those businesses are growing a bit faster. This gives alphabet intrinsic value in the ballpark of 1.8 to 1.9 trillion. And at the time we're recording, we're sitting just under 2.2 trillion, which would imply that the

Starting point is 00:53:38 stock is trading just above fair value based on these assumptions. So I personally wouldn't expect outsize returns for investors who purchase around this price, but I also believe that this is just a really high quality business. And the pullback that happened when Chat GPT was released was far overblown. I actually purchased some shares during that drawdown, which I then sold later in 2023 after I found names that I thought offered a much better risk reward over a five or 10 year time frame. I also thought the audience might be interested in my thought process around selling Alphabet. I held it for probably six months or so. Generally, there are three reasons to sell a company.

Starting point is 00:54:19 The first is that the business is no longer a great business, and in my opinion, this definitely isn't the case with Alphabet. The second reason for selling is that a stock becomes extremely overpriced. Again, it's not the case with Alphabet. And the third reason is you find a better opportunity. So if you sell a stock, you better have a good reason for doing so. And when I looked out over a five or 10 year time period, I thought I saw some better opportunities in the market.

Starting point is 00:54:46 For example, let's use one of my holdings, Dino Polska, as an example, because I think it's so simple to understand. Kyle Greve and I covered this on the show in late 2023. So Dino Polska is a grocer in Poland. And without going too much into the company, they have a return on invested capital of 20%, they've reinvest all of their cash flows. So while I believe that Alphabet is going to grow earnings at, say, the low teens over the next five years, say 10 to 14%. I think Dino Polska is going to be able to grow earnings at around 20%, potentially more. And then I was able to sell a great

Starting point is 00:55:25 company in Alphabet for an even better opportunity. And these were both companies that were at similar valuation multiples. So of course, I'm taking on a different risk profile investing in Dino Polska in that it isn't a giant mega cap with unlimited capital, but it also means that there's more potential upside in terms of growth. So there's a little bit of a give and take in each of these companies. As someone who's in the first half of their investing journey, I tend to look for these higher growth opportunities and fall back on the investing principle that stocks over the long run tend to follow the growth in the free cash flow per share. And with Alphabet, just generating so much cash, I think that their level of share buybacks and dividends means that their growth going forward

Starting point is 00:56:13 is going to be somewhat limited relative to some other companies that have a lot more reinvestment opportunities. The ideal situation for me is that a company can reinvest 100% of their earnings back into that compounding machine and then generate that long-term growth, which is why Dino Polska is quite appealing to me. So this is not a buy or sell recommendation for Alphabet or Dino Polska. It's just the way I sort of think about it. Time will tell whether I look smart or like totally silly in buying a company that 99.99% of people have never heard of here in the U.S. at least. And maybe it's the case that my growth assumptions are just simply wrong. Maybe Alphabet has a new leg of growth with the rise of AI and it's going to be Dino Polska that grows at 12%

Starting point is 00:56:59 instead of 20%. Who knows? Investing is really a game of probabilities, and I'm continually working to stack those probabilities in my favor. All right, so that's all I wanted to touch on today. I really hope you enjoyed this episode on Lee Liu. I enjoyed doing all this research on this one. I've been wanting to do this episode for quite some time now, and I'm glad that we are able to put this together.

Starting point is 00:57:21 If you enjoyed this episode, please consider sharing it on your favorite social media platform. You can tag me on Twitter or LinkedIn to let me know your thoughts. Thanks so much for tuning in, and I hope to see you again next week. Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes. To access our show notes, transcripts or courses,

Starting point is 00:57:46 go to theinvestorspodcast.com. This show is for entertainment purposes only, before making any decision consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP636: Billionaire Investing Legend Li Lu w/ Clay Finck

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