Collection: Li Lu - #35 | True Value Investing



[Transcript]

LI LU 00:00

At the heart of it (value investing) is obviously it is this bargain idea that you want to really get what you pay for.


Now, obviously there's what everybody wanted, and if everybody want the same thing, you would have think that all of the professional investors will be value investors. And that's just a further thing from truth.


In fact, value investing as it properly practiced constituted a tiny small minority of all the investment professionals. Majority of people hold a different views. And let me just articulate for them the alternative views about investing;

  • Number one, yes, stock legally represent a fractional claims – a fractional ownership, but is first and foremost, a piece of paper you can trade all the time. And therefore, it follows that successful investing lies in the successful guessing of the stock movement, based on whatever informed theories or practices that you can find.

  • And thirdly that the market is to be respected indeed to be feared, because they really – through the market, you can actually find a value and through the market, you can actually buy and sell.


So this and here you go, a different view that sounds even more persuasive than the first view that I laid out as a value investor. In fact, I would say majority of the people really follow the latter rather than the formal.


So as a young student trying to get into the business which way do you follow?


I would suggest before you do that you want to go to some fundamental studies as sort of result of various different approach and philosophies. And fortunately, there has been numerous studies have done because we kept a pretty good track record over the last 100 years at least.


And all the studies that have given an unmistaken conclusion that the true value investors as it properly practiced have consistently outperformed the market, whereas all – just about all other strategies either match the market or severely underperform the market over a long period of time. Now, you can dispute the result of it, but I think the evidence is a pretty persuasive.


And so the question becomes if that were the case – of course, the study also concluded that the true value investors that is properly practiced, really are tiny small percentage of investing professionals.


And it's also very interesting study, and but they really do conform our day-to-day observation having been in this profession for close to 20 years. So why is the case? Why is the case?


If the empirical studies concluded overwhelmingly that going through value investing is the way to go and the philosophies and the practice are being well articulated for seven decades, and the well practices indeed publicized by tremendous successful examples, such as Mr.Buffett as we just mentioned. Why not more people follow what they do?


What it turn out has a lot to do with human psychology. In value investing, you have to have this frame of mind that if you did your work correctly and the market against you, you should be comfortable standing along.


And this is the concept behind Mr.Market, but that's really very difficult to do, it is a very unnatural thing to do, when the whole market is against you, when everybody else really think you're stupid and neurotic and wrong.


And you now, tend to think everybody else is in Mr.Market's irrational neurotic. That is very very unnatural things to do, it was a borderline of a self delusion. Indeed, that's probably most people's view about you at the time, you look quite ridiculous and very uncomfortable.


In fact, our very evolution requires a certain deal of conformity. Think about over the millenniums – over the millions of the year of evolutionary past, our ancestors are animal predecessors, you know, basically hunting groups. And the one that was a left out and disagree with everybody else in the group, very easily that one is not the one to survive.


So all the genes that have survived in the past are the ones content to extreme degree of conformity. And conformity also works very well as for human society because we are at the end at the heart of social animals. We need that sense of glue of a conformity and the sympathy – compassion to bring the society in peace and live together.


So, you need a certain mutated genes in a sense to be utterly comfortable to stand alone when everybody else disagree with you.


Now that is the reason, at least that's one of the reasons the financial market in itself is not that efficient. Free market ever since it was practiced in modern time about two or three hundred years ago has worked remarkably well, but it was work remarkably well, primarily I think in goods and services; physical goods and definable services.


We have several hundred years of overwhelming evidence to the support that one, every country practice that one all turned out to be extraordinarily prosperous.


Now, we also have several hundred years of history of free market is a practice in the financial market, they're full of disasters, up and down from truth movement, it doesn't really work nearly as well when it comes to financial assets. Why is it?


Well, the financial asset at the core – in essence – is a discounted mechanism to predict the future. It's the discounted estimated cash earnings into the infinity. And of course, we all know A. we cannot predict infinity and B. we can't even predict immediately beyond what we can see, which is usually very short.


And so there's a necessary elements of a speculation and guessing – estimation – into the valuations of financial asset. But that is exaggerated, there is an element in stock market and financial market in general, the element of a gambling. Element of guessing, element of speculation.


And, as we all know in pure casinos and a pure gambling, there is a huge advantage stack against players and really to the benefit of a casino owners who define the rules. This is why gambling is a such a profitable business.


And yet that has never really persuaded the people away from gambling. There is certain element that really fit human nature, they love gamble, even if everybody knows the odds are stacked against them.


That is a never prevented gambling from a very big business, especially when it's allowed ascension by the government, such as a practice in Nevada or Macau or in certain different geography around the world.


And so there is some aspect of that one in the financial market as well. And this is the reason why that it does not work perfectly well as recently illustrated by the 2008-2009 financial crisis, which is only in the stream of a long history of financial crisis.


But it doesn't really mean and we have a better way of dealing with that. So it's just as Churchill said about democracy is perhaps the worst except when compared with all the others.


And so is the market, so is the free market when it comes to financial asset. It doesn't work very well, it certainly doesn't work nearly as well as goods and services, but is still one of the better ways we have come up with in terms of facilitating the flow to financing, which is vital for the – working as a modern economy.


So it doesn't, so it works – So that really give us the challenge as a value investor – true value investor – you just have to really refrain yourself from betting too often. Knowing that the financial market doesn't really work too well, but a lot of the time it worked reasonably well.


And so you want to really wait for the extreme situation before you can really make a bet. So that you have A. enough of a margin of safety and B. that you can actually stand against the whole market when that do happen. That requires an extreme discipline of demanding a large amount of margin of safety.


Virtually, all the successful value investors practitioners really have all that element in common. They do not bet often. And whenever they bet they require a large large amount of margin of safety. So that they will be comfortable in case the market moves against them. And so that they are seizing the opportunities that almost no brainer.


And that really is the most difficult challenges. Most people really has – do not really have the necessary discipline, mental discipline to do that. And so you would say that it in a bull market, everybody practice – everybody at least would have called themselves "value investors," they buy something they think there is a 20% discount to what they think is an intrinsic value.


And when it goes up, they really trumped themselves as a successful, intelligent and value investor, but when the market really against them which is very easy, 20% discount is almost within error, margin of errors in the sense. If the market began to – you would have say that you will be the first one to inspect the market wrong, that's typically the case.


And so when you see a situation like that, that's usually a sign is not true value investing as it properly practiced.


So as a young student and a young analyst or somebody who is interested finance, I want to strongly encourage you the best way to do that is to study the successful practices in real life and examples or history. Study very well all the examples of great value investing decisions.


(Source: https://youtu.be/OkwXPnnbUXE)

 

[YAPSS Takeaway]

  • A true value investor never forget these rules:

  1. Never lose money.

  2. It is better to be roughly right than precisely wrong.

  • Value investing is not for everyone, it is simple but it's not easy and many are doing it wrong. So it's best to learn from real life examples of successful practices like Warren Buffett, Charlie Munger, etc.