Investing (and Life) Lessons from Li Lu
“Intelligent investors are the ones who are always intellectually honest.”
Happy Thursday and welcome to our new subscribers!
Next week, when the latest round of 13F filings reveals exactly what the top super-investors have been up to during the third quarter, I’ll be keeping a special eye out for two in particular: Berkshire Hathaway (of course) and Li Lu’s Himalaya Capital.
Charlie Munger once dubbed Li “the Chinese Warren Buffett” and, for a long time, predicted that the Chinese-American value investor would succeed Buffett as steward of Berkshire’s massive stock portfolio.
Li, instead, chose to stick with Himalaya — the fund he founded after graduating from Columbia University — but remains a favorite of the Berkshire crew.
But the most extraordinary aspect of Li Lu’s life has nothing to do with investing. He was one of the brave student leaders at China’s Tiananmen Square in 1989, protesting against the Chinese Communist Party.
The aftermath of that tragedy spurred Li to move to the United States and placed him on the path towards value investing greatness.
Although Li prefers to keep a relatively low profile, I recently stumbled upon a very informative interview that he gave to Graham & Doddsville, the student newspaper of Columbia Business School, in 2013. In it, he openly discusses his investing philosophy and much more.
It’s certainly worth your time to read the whole thing.
But, if you’re in that TL;DR mood, I’m here to help.
Below are five lessons that I learned from Li’s chat with the CBS students…
Showing up is half the battle
Li Lu’s life took a big turn for the better when he decided to say yes to a friend’s invitation — even though he didn’t really know what he was signing up for.
As a broke college student at Columbia — who also didn’t speak English or know very many people — Li was on the lookout for opportunities to make a little cash and forge a new life for himself in his new home. So a friend asked Li to come with him to an event and hear someone speak who had a well-earned reputation for making money.
“I wasn’t sure what it was all about,” Li said. “I just remember thinking that there was a ‘buffet’ involved. I assumed that it was some kind of talk with a free lunch.”
Not exactly.
“There was no lunch,” Li said. “There was just a guy with the name Buffett.”
Warren Buffett’s speech lit a fire within Li that has never stopped burning. The Berkshire chief has often remarked that value investing either clicks with you — or doesn’t — right away. And, it’s safe to say, it clicked with Li.
“Mr. Buffett really made a lot of sense during that talk,” he said. “It was like a punch in my eyes. It was like I had just woken up and a light had switched on. His honesty came through right out of the gate.”
From that moment on, Li’s path was set. He would pursue a career in finance and emulate the philosophy and style of Buffett.
And it was all because he showed up to what he thought was a buffet.
“I guess it turned out better than a free lunch,” Li laughed.
Intellectual honesty above all else
In George Goodman’s The Money Game, one of the author’s irregular rules is that, if you don’t know who you are, the stock market is a very expensive place to find out.
I think Li Lu would agree.
“The most important thing in our business is intellectual honesty,” he said.
“Intelligent investors are the ones who are always intellectually honest.”
To Li, investing is a game of discovery. Primarily about oneself. Understanding — and accepting — who you are, what you know, what you don’t know, etc. makes all the difference between a successful time in the market and a disastrous one.
Whether it’s correctly identifying your circles of competence or admitting that you don’t have the stomach to weather the occasional downturn (and, thus, should not be in the market at all), honesty is the best policy.
Li explained:
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 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.
Times of crisis, too, will put an investor’s intellectual honesty to the test.
If you know yourself — both strengths and weaknesses — while also defending against the dreaded “unknown unknowns” (or what you don’t know that you don’t know), you’ll come through any crisis in one piece.
Without that intellectual honesty, though, trouble (and losses) await.
Cast a wide net for ideas
Like many investors, Li Lu gets his best investment ideas from a lengthy (and varied) reading list and a network of intelligent friends.
A questioning mind, one willing to explore new areas and humble enough to learn from others, will turn over more stones — and find better investment opportunities — than one that already thinks it knows everything.
I don’t discriminate how [ideas] come, as long as they are good ideas. You can recognize good ideas by reading a great deal and also by studying a lot of companies and constantly learning from intelligent people — hopefully, more intelligent than you are, especially in their field. I try to read as much as I can. I study all of the interesting and great companies, and I talk to a lot of intelligent people. You know what? In some of those readings or conversations, ideas just click. Then you do more research and then you get comfortable or you don’t get comfortable.
But not everyone has a ready-made network of intelligent friends with whom to bounce around ideas.
So what does Li look for?
“I am more interested in talking to people who are actually running businesses and entrepreneurs or CEOs or just good businessmen.”
In other words, learn from the man in the arena.
Know when to walk away
Deciding when to sell — or not sell — a particular stock can be one of the thorniest problems that an investor will face.
It’s one thing to preach a buy-and-hold investing philosophy and quite another to actually carry one out in practice. Even Warren Buffett, who famously espouses a preferred holding period of forever, tinkers with his portfolio each quarter.
Li Lu holds just six American positions in his Himalaya portfolio and makes relatively few changes quarter-to-quarter. In 2022, all he has done is bulk up his stake in Alphabet and sell out of Meta Platforms. That’s it.
(We don’t know much about Himalaya’s international positions — other than BYD — since they don’t show up on each quarter’s 13F. But it stands to reason that Li handles his Asian stocks in the same patient manner as he does his American ones.)
In his conversation with Columbia Business School students, Li revealed the three reasons that cause him to sell a stock:
Number one — if you make a mistake, sell as fast as you can. Even if it’s a correct mistake. What do I mean by a correct mistake? Investing is a probability game. Let’s say you go into a situation with 90% confidence that things will work out one way and a 10% chance they work out another way — and that 10% event happens. You sell it. Then there’s a mistake that your analysis is completely wrong. You thought it was 99% one way, but it was 99% the other way. When you realize that, sell as fast as you can.
The second time you want to sell is when the valuation swings way too much to the other end of the extreme. I don’t sell a security because it’s a little overvalued, but if it is way overboard on the other side into euphoria, then I will sell it.
The third occasion when to sell is when you find something that is better. Essentially, a portfolio is opportunity cost. Your job as a portfolio manager is to constantly improve on your basket. You start with a high bar. You want to increase the bar higher and higher. You do that by constantly improving the opportunity costs. You find something better.
Last summer, Himalaya Capital pared back about 15% of its position in BYD. I’d love to ask Li whether it was reason #2 or #3 that prompted this surprise sale.
Look for “learning machines”
Speaking of BYD, Li Lu sang the praises of the Chinese EV maker in his G&D interview.
[BYD] is a learning machine. Think about it — they really didn’t get into the industry until ten years ago. They didn’t produce their first car until eight years ago.
They also have an engineering culture and a can-do spirit. They consistently demonstrate that they’re able to tackle really complex engineering problems and come up with very practical solutions faster, cheaper, and better than most people. That is an advantage in the manufacturing economy.
No surprise there. It was Li, after all, who first told Charlie Munger and Warren Buffett about the impressive operation that Wang Chuanfu was building in Shenzhen.
And that’s turned out to be a most profitable stock tip for all involved.
Even though Li, Munger, and Buffett have all trimmed their positions in BYD over the last eighteen months, the company remains a “learning machine” that’s striving to improve every day.
Much like Li Lu himself.
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Disclosure: This is not financial advice. I am not a financial advisor. Do your own research before making any investment decisions.
Jeff & Chas
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