Fundamentals of Value Investing:
Develop an understanding of the fundamentals involved in value investing. Have a clear search strategy to identify undervalued opportunities. Aim to be better informed than others in the trade or make more sensible decisions.

Valuation and Industry Understanding:
Develop an approach to valuation that leads to superior outcomes. Have the judgment to process accounting information and understand industry context. Gain a deep understanding of the industry’s economic model to make better valuations.

Collateral Information:
Pay attention to collateral information, such as insider buying or selling. Analyze past mistakes to avoid repeating them. Assess whether the investment aligns with your personal makeup and investment style.

Risk Management:
Develop a systematic approach to managing risk. Learn from successful investors who excel at incorporating these elements into their investment strategies.

Lee Liu’s Success:
Lee Liu, a former student of the business school, has achieved remarkable success in value investing. He initially worked for Julian Robertson’s hedge fund and later started his own fund, outperforming his former employer.

Conclusion:
The speakers in the upcoming sessions have unique attitudes towards risk and varying degrees of optimism. Pay attention to how each speaker integrates these elements into their investment style.

Li Lu’s Background and Introduction:
Li Lu, a former Tiananmen Square protest leader who escaped China, shares his journey into value investing. He credits a lecture by Warren Buffett as his inspiration for pursuing a career in investing.

Defining Characteristics of a Value Investor:
Li Lu engaged with the class, asking about their perspectives on value investing. He emphasized three key attributes of a value investor based on the teachings of Ben Graham:
1. Viewing oneself as an owner of a business, not just a paper shuffler.
2. Demanding a large margin of safety when investing.
3. Understanding that they are different from most market participants.

The Role of the Stock Market for Value Investors:
Li Lu questions why a value investor would want to be in the stock market, given its fractionalized nature and focus on short-term trading.

Percentage of Assets Managed by Value Investors:
Studies suggest that value investors manage less than 5% of all assets, aligning with the concept that value investing is not the dominant approach in the market.

General Outlook on the Stock Market:
The stock market is primarily designed for the majority (95%) of investors who engage in short-term trading and are driven by short-term returns.

Understanding One’s Investment Style:
It is crucial for investors to recognize whether they belong to the 5% of value investors or the 95% majority who focus on short-term trading.

Challenges for Value Investors:
Value investing involves emotional challenges, as it requires investors to resist the temptation of short-term gains and focus on long-term value.

Why the Majority Doesn’t Embrace Value Investing:
Despite the proven success of value investing over the long term, most investors do not adopt this approach due to: Emotional difficulty in resisting short-term gains. Performance measurement based on short-term returns.

The Market’s Focus on Short-Term Trading:
The market rewards short-term trading behavior, attracting assets and capital to that segment.

Performance Discrepancies:
Value investors consistently achieve superior returns over the long term, while the majority of investors’ capital remains in short-term trading strategies.

The Importance of Self-Awareness:
Investors should assess their personality traits and determine if they are suited to be value investors, as it requires a unique mindset and comfort with being in the minority.

Evolutionary Perspective on Value Investing:
Value investors possess a unique genetic predisposition that allows them to be comfortable in the minority and resist herd mentality, which is deeply ingrained in human evolution.

Key Traits of an Independent Investor:
Ability to survive and thrive despite a different gene, likely through a mutation process. Comfort in being very much by oneself, leading to a strong internal conviction. Adopting the attitude of being right, not because others agree, but because of reason and evidence.

The Investor as an Academic Researcher:
Spend most time as an academic researcher, not as a professional investor. Insatiable curiosity and a desire to understand how just about everything works. Knowledge in various fields, including businesses, politics, science, technology, humanity, history, poetry, and literature, influences investment decisions.

Finding Investment Opportunities:
Rare insights from extensive studies can lead to tremendous opportunities. Other investors may miss these opportunities due to psychological limitations, institutional constraints, or other reasons.

Evaluating an Investment Opportunity:
Assess the cheapness of the opportunity. Evaluate the quality of the business. Assess the trustworthiness of the management. Consider the external checks and balances on management. Understand why the opportunity arose.

Final Decision:
Go through a checklist to ensure comfort with the investment. Overcome the last psychological barrier to execute the investment.

Introduction:
Li Lu shares insights into his investment approach through a case study of Timberland, a company he invested in during the late 90s.

Identifying Opportunities:
Li Lu starts by examining the stock price fluctuation of Timberland, noting a significant drop in price. He emphasizes the importance of focusing on valuation before delving deeper into the company’s financials.

Assessing Valuation:
Li Lu analyzes Timberland’s book value, highlighting its tangible liquid assets, working capital, and real estate holdings. He estimates the company’s liquid assets to be around $200 million and its fixed assets to be $100 million, providing a decent downside protection.

Evaluating Earnings and Cash Flows:
Li Lu emphasizes the significance of pre-tax and pre-interest earnings, which provide a better understanding of the business’s profitability. He estimates Timberland’s operating margin to be around 13%, generating roughly $100 million to $110 million in earnings.

Calculating Return on Deployed Capital:
Li Lu estimates Timberland’s deployed capital to be around $200 million, consisting of liquid assets and buildings. He calculates the company’s return on deployed capital to be approximately 50%, indicating a strong business performance.

Understanding the Market Sentiment:
Li Lu investigates the reasons behind the company’s decline, attributing it to the Asian financial crisis, which negatively impacted Timberland’s competitors and retailers.

Conclusion:
Li Lu concludes that Timberland, despite the market conditions, exhibited strong fundamentals and a solid return on deployed capital. He highlights the importance of conducting thorough financial analysis and understanding market dynamics to identify undervalued investment opportunities.

Analyst Report:
No analyst report exists on the company despite having a billion dollars in sales.

Profitability:
The company’s profitability has improved dramatically in recent years.

Financial Market Needs:
The company has a limited need for financial markets as it is profitable and family-owned.

Ownership Structure:
The family owns 40% of the company with 98% voting control, which can deter potential investors.

Investigative Approach:
Li Lu stresses the importance of an investor’s curiosity and investigative mindset, comparable to that of a journalist.

Shareholder Lawsuits:
The company has faced various shareholder lawsuits, indicating potential issues or concerns.

Investigative Research:
A small company with few analysts, shareholder lawsuits, and a dominant owner with limited voting rights may raise red flags for investors. Normal investors may avoid such stocks due to lack of information and perceived risks. The speaker suggests downloading and reading all court documents related to the company to gain insights into the situation.

Personality and Management Assessment:
The speaker emphasizes the importance of understanding the management’s personality and competence. By reading court documents, one can get a sense of the owner’s personality and approach to business. The owner’s decision to stop providing guidance and talking to the street highlights his independence and confidence in the business.

Investigative Approach:
The speaker encourages investors to adopt an investigative journalist mindset when researching small companies. Most business owners have a history that can be audited or researched, providing insights into their character and business practices. Professional managers may not consider such research as part of their business, but it can be valuable for informed investment decisions.

Pre-Investment Research:
Li Lu emphasizes the importance of thorough research before investing. He suggests visiting a company’s community, attending religious services, and meeting with friends, family, and neighbors to gain a deeper understanding of the company’s culture and values.

Family Dynamics:
Li Lu delves into the family dynamics of the company’s founder, who had a son who also pursued a business education. He becomes close friends with the son and gains insights into the family’s integrity and business acumen.

Stock Analysis:
Despite the stock trading at around $30, Li Lu believes that it is undervalued. He calculates that the downside risk is minimal, as the stock is trading at only five times earnings.

Understanding Industry Trends:
Li Lu visits different stores to understand the reasons behind the company’s improved margins. He discovers a fad for Timberland shoes and jeans among inner-city youth, indicating strong demand for the company’s products.

International Business:
Li Lu assesses the company’s international business, which is based in Shenzhen, China. He calculates that the international business contributes less than 10% of the company’s total revenue, minimizing the impact of potential losses.

Earning Growth:
Li Lu highlights the steady growth in earnings, with a 30% annual increase. He emphasizes that the stock’s rise over the next two years was driven by earnings, minimizing risk exposure.

CEO Transition:
The company undergoes a CEO transition, with the new CEO having a different approach to running the business. The new CEO’s articulate communication skills and willingness to meet with analysts lead to increased interest in the company.

Selling Decision:
Li Lu decides to sell his entire stake in the company after observing a significant increase in analyst coverage. He recognizes that this could indicate that the stock’s undervaluation has been discovered by the market, prompting him to exit his position.

Inside Trading and Ethics:
Li Lu emphasizes the ethical implications of having close relations with the subject of a potential investment. He avoids insider trading by refraining from purchases after establishing such a relationship.

The Power of Patience:
Lu highlights the importance of patience in investing. Once a solid investment is made, it’s often best to hold onto it and let the business’s strength drive returns.

Selective Due Diligence:
Lu’s due diligence process is relatively brief, typically taking no more than a couple of weeks. However, when an opportunity arises, he dedicates significant time and effort to fully understand the investment.

Seizing Opportunities:
Lu emphasizes the importance of seizing investment opportunities when they present themselves. These opportunities are rare, and when they arise, investors should be prepared to act quickly and decisively.

Continuous Learning:
Lu’s investment approach involves continuous learning and curiosity about various businesses. This knowledge allows him to quickly recognize and assess investment opportunities when they arise.

Value Line’s Utility:
Lu finds Value Line to be a valuable resource for his investment research. He appreciates the comprehensive data and multi-year historical information it provides.

Understanding Market Cap and Earnings:
Li Lu emphasizes thinking like an owner, focusing on the company’s market cap and earnings rather than per-share numbers. He demonstrates calculating the market cap of a company using the share count and market price, which is approximately $60 million in this example. To assess profitability, he asks for pre-tax earnings, which are estimated to be around $31 million based on historical data.

Analyzing Book Value and Working Capital:
Li Lu stresses the importance of understanding the company’s book value, which represents the net worth of its assets. He calculates the book value by dividing the won-denominated value by 1,000, resulting in approximately $230 million. He also highlights the significance of working capital, which comprises current assets and liabilities.

Determining the Composition of Book Value:
Li Lu emphasizes the need to understand the composition of the book value, distinguishing between fixed assets, working capital, and goodwill. He explains that fixed assets and working capital are essential for operating a business and should be considered when evaluating a company.

Understanding the Company’s Cheapness:
To determine if a company is undervalued, Li Lu suggests examining why it is trading at a low market cap compared to its earnings and book value. He advises further investigation into the company’s financial statements to understand the reasons for its apparent cheapness.

Evaluating Financial Statements:
Li Lu emphasizes the significance of independently assessing financial statements rather than relying on predetermined assumptions.

Asset Composition:
A case study highlights a Korean company with significant undervalued assets. The company’s financial statements revealed that its current assets consisted entirely of cash and liquid securities, totaling $180 million.

Valuing Fixed Income Investments:
The company’s so-called fixed income investments included a 100% ownership stake in a hotel and a 13% stake in a department store, both of which were undervalued.

Identifying Hidden Value:
The department store’s market capitalization was significantly higher than its recorded book value, suggesting a potential value of around $80 million.

Assessing Additional Assets:
The company also held stakes in three cable companies and leased various real estate properties.

Analyzing the Department Store:
The department store functioned more like a shopping mall, with no inventory and revenue generated from a percentage of merchants’ sales.

Valuing the Hotel:
The hotel’s value had remained unchanged over the last decade despite significant real estate appreciation in Korea.

Comprehensive Valuation:
Considering the company’s undervalued assets, its total value was estimated to be approximately $320 million, significantly higher than its initial purchase price of $60 million.

Value Investing Approach:
Li Lu emphasizes the importance of using a rational and careful approach to value investing, considering all factors that can impact a company’s value, including governmental regulations, lawsuit liability, and local market dynamics.

Identifying Undervalued Companies:
Lu highlights the potential for uncovering undervalued companies, citing examples from his own investments, where stocks he purchased at low prices experienced significant gains.

Importance of Research and Due Diligence:
He stresses the need for thorough research and due diligence, including understanding local investor sentiment and market dynamics, to make informed investment decisions.

Personal Investment Experience:
Lu shares his personal experience of making hundreds of thousands of dollars by applying value investing principles, emphasizing that it requires not only listening but also taking action and putting in the necessary effort.

Return on Investment:
Lu encourages students to view the class as an investment, with the potential to recoup the cost of tuition and more by applying the principles learned in the classroom.

Emphasis on Practicality:
He distinguishes the value investing class from others by its focus on practical, actionable advice, rather than theoretical concepts, highlighting the potential for real-world financial gains.

Encouragement to Take Action:
Lu urges students to take advantage of the opportunity to learn from experienced investors and use the knowledge to make profitable investments, emphasizing the potential for substantial returns.

Common Mistakes in Investment Analysis:
Inaccurate and incomplete information gathering is a common pitfall. Confidence in one’s knowledge and predictions is crucial when making investment decisions. One must be able to withstand doubts and criticisms when investing against the crowd.

Sources of Outsized Returns:
Value investors should not expect exceptional returns from most stocks. The highest returns come from a handful of investments with exceptional insights gained over a lifetime of study and curiosity.

Li Lu’s Mistakes:
He acknowledges making mistakes whenever he failed to gather accurate and complete information or lacked genuine insights. One significant mistake was not making certain bets despite recognizing their potential.

The Regret of Missed Opportunities:
Li Lu’s biggest regret was missing out on a company with exceptional insights and undervalued assets. The company’s subsequent growth resulted in missed opportunities for substantial gains. He attributes this mistake to not fully committing to the investment due to conventional market expectations and short-term return pressures.

Key Points:
Risk Management: Li Lu emphasizes the importance of risk management in investing. He believes in investing with a sufficient margin of safety so that the odds are in your favor. Conviction: Lu stresses the need for conviction in one’s investment decisions. He asserts that if you cannot bet on the things you know and have insight into, you will likely not be successful in value investing. Insightful Investing: Lu believes that successful value investing requires deep insights into the businesses you invest in. He studies companies for many years, developing insights that give him conviction to swing with. Lollapalooza Effect: Lu refers to the convergence of various factors at the conscious, subconscious, psychological, political, and other levels as the “Lollapalooza” effect. He believes that this confluence of forces can create huge waves of opportunity for investors. Continuous Learning: Lu emphasizes the importance of continuous learning and curiosity across diverse fields. He believes that learning from various disciplines can provide models and insights that can enhance investment decisions. Investment Frequency: Lu states that the number of companies he invests in each year depends on the availability of opportunities. He does not have a steady pace of investment but rather takes advantage of opportunities as they arise. Early Insights: Lu shares that during his undergraduate and graduate studies, he had only three or four big investment ideas that paid off significantly. He notes that as his investment experience grew, he became progressively better at identifying opportunities.

Key Insights and Opportunities:
Li Lu emphasizes the significance of quickly identifying investment opportunities by recognizing patterns and anomalies. He stresses the importance of continuous learning and development, aiming to learn something new every day. Lu highlights the satisfaction of gaining insights and the disappointment of losing them, viewing the process as a form of mental discipline.

Financial Situation and Book Deal:
Despite writing a book and receiving a small sum for its movie rights, Li Lu’s net worth remained negative due to outstanding borrowings. However, he had cash on hand, which he considered fortunate.

Focus on Searching for Ideas:
Lu categorizes all his activities, such as reading biology, physics, and history, as searching for ideas. When he finds actionable ideas, he pursues them actively; otherwise, he engages in other activities. He dedicates the rest of his time to his family.

Key Points:
Li Lu’s investment approach is influenced by his experience as a business owner and his understanding of human psychology. He believes that value investors should have a long-term horizon, demand a margin of safety, and possess a cautious mindset. Lu emphasizes that value investors are not natural participants in the stock market but must be aware of their unique perspective and position themselves accordingly. Over time, he has evolved his selling philosophy, shifting from an approach of selling when he would not buy at the current price to recognizing that certain businesses may warrant long-term ownership. Lu believes that value investors can find profitable opportunities in the market due to the fundamental flaws of those attracted to trading and the emotions that drive their decision-making.

Making the Most of Investment Opportunities:
Success in the business world is often characterized by an uneven distribution of capital, with leading businesses securing a disproportionate amount. In certain industries, the advantages gained by leaders are particularly pronounced.

Recognizing the Tax Implications of Selling:
Li Lu emphasizes the potential drawbacks of selling a successful investment. Selling may limit the ability to buy back the investment at a favorable price in the future due to tax implications. Significant tax liabilities can accumulate when selling an investment that has appreciated substantially, as the unpaid taxes effectively represent an interest-free loan from the government.

Leveraging the Power of Compounding:
When a business can deploy capital at a high rate of return, the benefits of compounding can be significant. This leverage, effectively an interest-free loan from the government, can create substantial wealth over time. Li Lu suggests that a superb business can achieve a return on deployed capital of 50% to 100%.

The Rarity of Long-Term Projections:
Li Lu acknowledges the difficulty of making accurate long-term projections in investing. He cautions against the practice of investment bankers projecting into infinity, which he considers unreliable and misleading.

Identifying Rare Opportunities:
Li Lu believes that investors with a deep understanding of businesses may encounter a small number of exceptional opportunities over their careers. These opportunities involve a high degree of confidence in projecting the business’s performance over the next 10 to 20 years.

Criteria for Holding onto Investments:
When faced with such an opportunity, Li Lu advocates holding onto the investment rather than selling. The favorable combination of tax efficiency, high returns on deployed capital, and long-term growth potential makes selling inadvisable.

Applying the Principles:
Li Lu acknowledges that not all businesses in his portfolio fit the criteria for such long-term holding. He refrains from discussing specific examples of such investments in the interest of maintaining their privacy.

Buffett’s Value Investing Criteria:
Identify industries with established vendors that continue to grow in strength. Seek companies with addictive products like nicotine, creating a loyal customer base. Look for businesses with products that bring happiness and are affordable. Consider industries with depth of liquidity, such as commodity exchanges or trading agencies. Transportation companies that consistently transport goods can be compelling investments.

Monopoly Business Characteristics:
High switching costs due to the time and effort required to learn complex systems like Bloomberg. Industries where a single player becomes dominant, such as Bloomberg in the financial data industry. Observe industries carefully to identify when a player crosses a threshold and becomes a monopoly. When a monopoly business is publicly traded, recognizing this insight can lead to significant investment opportunities.

Examples of Monopoly Businesses:
Philip Morris (Marlboro) with its addictive nicotine product and strong brand recognition. Coca-Cola, a widely consumed and popular beverage with a global reach. eBay, providing an online marketplace for various goods and services. American Tower, a leading provider of cell phone towers with a dominant market position. Building materials companies with limited competition due to regulations and geographical factors.

Insights on Bloomberg’s Success:
Bloomberg’s user-friendly interface and extensive data offerings have made it a popular choice among financial professionals. High switching costs associated with learning the Bloomberg system contribute to its dominance in the financial data industry. Merrill Lynch’s investment in Bloomberg’s early stages may have provided financial support and credibility.

The Power of Bloomberg’s Software:
Bloomberg’s software is used by 95% of traders, emphasizing its dominance in the industry. It offers a vast range of functions but lacks a manual, intentionally keeping users hooked on specific features.

Bloomberg’s Hooked Customers:
Trader’s reliance on specific functionalities creates a dependence on Bloomberg’s software. The emotional attachment to certain numbers and tailored software reinforces this dependency.

The Cost of Bloomberg’s Software:
Bloomberg’s cost is effectively zero for its users. While they pay a substantial fee, it is seen as an unavoidable expense in the pursuit of potential million-dollar gains.

Bloomberg’s Unfair Advantage:
Bloomberg’s success stems from its understanding of individual user preferences. They charge a significant fee without offering a manual, ensuring their users’ loyalty. This model allows Bloomberg to bully its suppliers due to its leverage and lack of competition.

The Challenge of Competing with Bloomberg:
Bloomberg’s personalized approach to its software creates a high barrier to entry for competitors. The lack of documentation further increases the difficulty for competitors to understand user needs.

Investment Insight:
Opportunities for high returns can arise from recognizing inflection points in a company’s performance, even in publicly traded companies. Pay close attention to the dynamics of each business, as they all have cycles of ups and downs.

Bloomberg’s Premium Pricing:
Bloomberg’s high premium price and the need to sell a large portion of his stake to raise capital create a situation where selling is not always the best option for the founder.

Involvement with Management:
Li Lu’s involvement with the businesses he invests in varies depending on the investment. He actively participates in managing some companies, serving as chairman or board member, especially when he holds a significant stake. In other cases, where access is limited, he still makes an effort to learn as much as possible about the company and its industry.

Relationship with the CEO of Sun:
Through his investment in Timberland, Li Lu formed a close relationship with the CEO, who became one of his investors. He values such relationships and strives to establish friendly connections with business leaders.

Dynamic Nature of Business:
Li Lu emphasizes the ever-changing nature of business environments. The things that lead to successful investments can change over time, so continuous learning and adaptation are essential. Even within the same industry, like Microsoft, the dynamics can change significantly with factors like free software.

Path to Success:
Success in investing involves being prepared, open-minded, and psychologically ready to act when opportunities arise. This combination of preparation and readiness can lead to substantial wealth creation.