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Imagine you are in an investment class at Columbia, New York in 2006. The person in front of the class is not a professional course-selling speaker. This is Li Lu, who went from a student with almost no money to running her own investment fund. He asked a question that sounded very simple. What truly makes someone a value investor?
The [musical] answers in class were also familiar. Think of the stock as a form of ownership in the business. Ah, demand a price with a margin of safety and understand that the market frequently changes sentiment while the company's value doesn't necessarily change in sync with the stock ticker. If you only heard this much, anyone might think I already knew those three things.
I've read Buffett's work. I also know that you shouldn't buy expensively, you shouldn't be afraid of price drops [in music], and you should invest for the long term. So why do the majority of market participants still not act like business owners? This is the [musical] paradox Li Lu wants to explain.
The problem isn't just about being able to memorize a method. The question is whether we can live with that approach, especially when it makes us stand out from the crowd. In the first three episodes of the series, we've walked through Li Lu's life, his [musical] challenging early investment years, and the turning point when Charlie Munger helped him change the way he organized his funds.
This episode will not recount those events. We will delve into the underlying philosophy behind the entire journey: what transforms a stock buyer into a true investor in a business. And by the end of the episode, I want you to answer another question for yourself. When a stock price drops 30%, the first thing you want to know is why the price dropped, or whether the business is doing better or worse?
Well, the answer might say more about how you [in the music] invest than any slogan. To understand Li Lu, we have to go back to a Warren Buffett lecture at Columbia in the early 1990s. At that time, Li Lu had just arrived in the US from China and was worried about tuition fees, debt, and making a living.
He lacked a Wall Street financial background, and his vision of the stock market was quite negative. According to later accounts, what astonished Li Lu about the music wasn't a strange stock price calculation formula. Well, Buffett just presents principles that sound [musically] too commonplace. Buying shares means buying a part of a business.
The future is always uncertain, so there must be a safety margin. And the market is just where people set prices for buying and selling each day; we are not obligated to agree to those prices. But it was that very ordinariness that changed the whole picture. If investing is simply about predicting whether a stock will rise or fall tomorrow, Li Lu has no reason to believe she is better than experienced professionals.
But if investing is about studying a business's operations, is about understanding its assets, customers, products, and people, then he can learn. He can work hard, find things others overlook, and gradually build an advantage in knowledge. That difference is very important. In the short-term price guessing game, you have to be right about how others will react.
In investing in a business, you need to understand how much value your business can create. How much am I paying, and what could possibly lead to my judgment [of the music] being wrong? That doesn't mean value investing is easy. It simply transforms a game that was once heavily reliant on crowd judgment into a work that can be learned, studied, and progressed upon.
There's a lesson here that we often overlook. Successful people don't necessarily possess secret knowledge. Sometimes they start by asking the right questions. Then, persevere and go further than those who only offer superficial answers. Suppose an acquaintance invites you to invest in a small company that owns three food stores .
They don't give you a flashing stock ticker symbol . They provided ledgers, lease agreements, supplier lists , store revenue reports, and cash flow statements. What would you ask? You'll want to know how much money each store actually makes after all its expenses are paid. Is the number of visitors increasing?
Is there a significant amount of damaged inventory? How much will the rent for venues increase? Does the company have too much debt ? So, is the manager honest ? And most importantly, when and how will I recover my investment? No one would seriously invest billions of dong in a business just because someone was willing to buy its shares at a higher price yesterday than the day before.
But when that company goes public, many people replace all those previous questions with a single question: Can the price still go up? Lilu wants us to reverse that habit. A stock doesn't become a completely different asset class just because it has a ticker symbol . It remains the right to receive a share of the economic value that the business creates, after taking into account its obligations to creditors and other stakeholders.
Well, if the business is doing well, the assets belonging to the shareholders have the potential to increase in value. If a business performs poorly, the stock price may still rise for a while, but investors need to ask whether that increase has any support beyond the expectations of the next buyer.
Well, the key point here is changing the unit of observation. investors typically start trading at the price chart and then look for reasons to explain it. The business owner starts with the business and then asks if the proposed market price is attractive . When you understand this [in music], many things become very different.
Short-term rumors are less important than whether profit margins change [to the music] . A quarter of declining profits isn't necessarily a disaster if it's the cost of a long-term, profitable project. Conversely, a quarter of exceptionally high profits is n't necessarily a good thing if that growth comes from selling assets or recognizing an unusual item.
Value investing, therefore, doesn't begin by finding the lowest-performing stock. It begins with learning how to see the true workings of a [business] operation. Now let's put those three food stores up for sale. Every morning someone comes knocking on your door and offers to buy back your stake. That person is very optimistic today.
He wants to buy your shares at a high price. The next day, hearing about the economic downturn, he changed his mind and offered a much lower price. A few days later, in a better mood, he raised the price again. In Benjamin Graham's famous story , that person is referred to as Mr. Market. The cleverness of the Easy Khơ [musical] example lies not in mocking the buyer and seller, but in defining roles.
The market may give you an opportunity to trade every day, but the market doesn't have the power to decide how much your business is worth just by changing the offer [for] the music is worth. Warren Buffett also used this perspective in his 1987 letter to Berkshire shareholders , stating that evaluating an investment requires looking at the company's performance , not just the daily or annual fluctuations in its stock price.
Imagine the stock price of a company you've thoroughly researched drops from 70,000 to 50,000 VND. If all business assumptions remain intact, a lower price could make the investment more attractive. But if a business has just lost a major customer, borrowing costs have skyrocketed, or a flagship project is at risk of failing, the price drop could be signaling a very real shift.
Therefore, independent thinking [in music] doesn't mean you have to buy whatever the market sells, nor does it mean always siding with the minority. Independence means being willing to examine the facts before acting. Sometimes the market overreacts, sometimes the market sees things we haven't seen before.
The market is only useful to those who already know what they are pricing. Otherwise, any lower price could become an excuse to average down the price of , even if the business argument has long been wrong. We've talked a lot about buying below its value, but what is value? It wasn't a number displayed on a digital screen, nor was it a magical result that appeared in Excel.
In essence, the value of a business to its owner depends on the amount of money the business can generate and distribute to the owner in the future after maintaining the necessary assets to continue operating. That future is not [musical] certain, so valuation is a process of making assumptions and testing risks.
Let's take a very simple example. A business with no debt, capable of generating 10 billion VND of active free cash flow annually, and we assume that this figure can be maintained indefinitely without growth. If the rate of return that investors require is 10% per year, the theoretical value in this model would be approximately 100 billion VND.
But what happens if we are too optimistic? The business might have to spend more on repairs, major customers might leave , or profit margins might decrease. If the cash flow remains at only 8 billion per year with a required rate of return of 10%, the value according to the simple model would only be 80 billion.
If the cash flow drops to 6 billion, the corresponding value of the would be 60 billion. So buying a business for 100 billion VND because of its attractive business model is one thing. Buying for 65 billion after checking for potential problems is a different matter. At a price of 65 billion, well, buyers have a buffer compared to the base scenario of 100 billion and the conservative scenario of 80 billion.
However, if the reality is worse, for example, the value is only 60 billion, they could still incur losses. That's why the safety margin doesn't need to insure against all losses. It's how investors acknowledge they can be wrong, then choose a price point where a smaller mistake won't easily destroy their assets.
Yes, Li Lu emphasizes this principle many times, but the lesson is n't the fixed 30 or 40% discount figure. A business with stable cash flow, a strong balance sheet, and a clear competitive advantage is very different from a cyclical business with high debt and rapidly fluctuating profits. The same price reduction does not create the same margin of safety.
Therefore, intrinsic value is always a conditional estimate , and the less understood the business, the greater the uncertainty. And if you can't evaluate a business in the most responsible way , sometimes it's simply a matter of not buying. A fairly common mistake [in music] is equating value investing with buying stocks that have low P/E or P/B ratios.
In reality, two companies with the same P/E ratio of 5 can be completely different. The first business has stable profits , has little debt, and doesn't require much capital to maintain production. The second business has just gone through five years of soaring commodity prices, profits at the peak of the cycle, while needing significant investment to replace equipment and maintain capacity.
If you only look at the profits over one year, both seem very cheap. But the potential for making money over the next 10 years could vary greatly. Let's think of a steel company. When selling prices rise faster than raw material costs, profit margins per ton of steel can expand significantly. The denominator in the P/E formula, which stands for earnings per share, has skyrocketed.
The P/E ratio therefore decreased even though the market price was not low. That's If the cycle reverses and profits return to normal, the P/E ratio calculated on the peak year will no longer accurately reflect the long-term earning power of the business. But the reverse is also important. If a business is bringing a new plant into operation, increasing capacity, decreasing unit costs , and expanding market share, then profits in the next period may be different from the past because the business has changed.
You can't use a rule about cyclical stocks to conclude that all steel companies are expensive just because their P/E ratio is low. The approach that suits Li Lu is to look at the factors that generate cash flow, output, selling price, profit margin , investment capital, debt, and reinvestment capacity.
Only after understanding those factors can we ask whether the market price is attractive enough. That's the reason behind an ideology that can lead to very different investment decisions . Someone bought a multi-asset business that was neglected. Someone bought a great company with the potential to reinvest in for decades.
The common point is that they don't all have a low score. Well, the common point is that the price paid [for the music] is lower than the economic value that the researcher has a basis for seeing. If that perspective makes sense, why does most of the talk in the market still revolve around tomorrow's price , next week's price, and which sectors will surge?
In his 2006 lecture, , Li Lu used the image of a very small minority group that actually acts as business owners . He wanted the students to ask themselves whether their personality could handle going against the crowd. It's not a test to divide the world into 5% intelligent people and the remaining 95% .
Li Lu is talking about the difficulties in terms of [musical] behavior. People like to know what other people are doing . Seeing the stocks we hold stagnate for six months while another group's music is steadily rising, it's easy to feel like we've missed out on something. Seeing an investment plummet, we're easily tempted to act immediately to relieve anxiety, and there's also a very real pressure, action that's easier to measure than the quality of thought.
A person who is constantly buying and selling, monitoring the electronic charts, and commenting on the news seems busy and quick-witted. Someone who spends a whole week reading reports and then decides not to trade anything [in music] seems like they're not working. But investing is n't a profession where you get paid by the number of button presses.
It is rewarded [by music] when capital is invested in opportunities with favorable probabilities and prices, and then real economic value is created [by music]. Therefore, a paradox exists in the market: the more technology makes trading cheaper and faster, the easier it is for investors to turn trading into a habit.
But lower transaction costs don't make the cost of wrong decisions disappear [from music]. In 2000, researchers Brad Barber and Terrance Odean published a famous study on the trading performance of individual investors. They used data from over 66,000 accounts at a US discount brokerage firm between 1991 and 1996.
The results are thought-provoking. The most actively traded group achieved an average annual return of approximately 11.4% [on music] , while the benchmark market index reached 17.9%. The average investor in the sample was approximately 16.4%. The authors view overtrading, coupled with overconfidence, as a significant factor contributing to reduced results.
Please pay attention to how the numbers are read. This is a sample US account during a specific historical period, not a rule that says anyone who trades a lot today will only make 11.4%. It also doesn't prove that holding any stock forever is a good idea. What it shows is that excessive action creates real costs and can make things significantly worse.
This helps us to better understand Li Lu's argument. If an investor is constantly reacting to price, they must win not only against the risks of the business, but also against transaction fees, spreads , taxes, timing errors, and their own psychological biases. Value investors [in music] are trying to pick a different game.
They want to profit primarily from the value the business creates [in the music] and from the difference between the purchase price and that value, rather than from accurately predicting the next reaction of the person on the other side of the transaction. This is not a denial of all active trading strategies .
There are professional investors who truly have an advantage in trading. But for those who lack that advantage, constant activity can easily create a greater sense of control rather than produce better results. Ah, imagine a business expanding its distribution network. Well, in the first year, the cost of building the network reduced profits.
Ah, in the second year, power consumption increased, but the effect was unclear. In the third year, revenue per point of sale began to exceed fixed costs, and cash flow improved significantly. If investors only focus on the most recent quarter's results, the first year can look very bad. But if you understand the cost structure, the rate of expansion, and the profit per store, what might seem like a bad sign could be the stage where the business is building the foundation for the future.
Of course, businesses can also fail. That's why long-term investing is n't about blindly waiting. We need operational indicators to know if [the music] is playing as expected. The point Li Lu wants to emphasize is that market times and business times are often different. The market can react to news in minutes.
Ah, a project that takes 3 years to achieve its design performance. A brand can spend decades [through music] building trust. A cost advantage is built through multiple rounds of investment and learning. If you are unable or unwilling [the music] to follow the economic timeline of the business. Even correctly analyzing a long-term opportunity doesn't guarantee you'll make money.
We discussed capital structure in detail in the previous episode. In this episode, a different, more important question arises. Are you independent enough to evaluate a business based on actual progress, or will your judgment constantly shift according to the mood of the market? There's a principle that's often less appealing than stories of buying stocks and multiplying your investment many times over, but it's incredibly important.
One must know the boundaries of understanding. Li Lu emphasized this point in exchanges after 2006. Imagine you suddenly inherit a component manufacturing company from your uncle. You know nothing about that industry, but from now on, all of the family's main assets depend on it. What will you do? Ah, perhaps you would n't start by asking how much the stock price increased today.
You will go to the factory, meet the manager, check on customers, learn about the product, ask why competitors can't get all the contracts and in what situations the business might lose money . You want to understand the company as a responsible owner. In a 2019 talk at Peking University , uh, Li Lu posed a question he used with his analysts.
If major adverse events occur in the next 10 years , what will the business's economy look like? This question forces researchers to look at the vitality of the company rather than just the extending a nice growth rate on a spreadsheet. The circle of competence doesn't mean investing only in industries you've been familiar with from the start.
It can be expanded through learning, but there must be a distinction [in music] between truly understanding a field and simply reading a positive report and feeling like you understand it. Another very useful way to check is to find someone who understands the business and has a different perspective than yours.
Let's see what they're worried about. If you ca n't accurately express their point through music, it's likely you don't understand it well enough to refute it. Good investors don't need to have an opinion [on music] about every listed company. They need to have a firm opinion on some opportunities within their scope of research, going back to the original .
When we talk about the margin of safety, we usually think of it as the difference between the purchase price and the estimated value. But there is another layer of safety that comes from the quality of the appraiser's understanding. Suppose a company announces a sharp increase in profits, you can take EPS multiplied by a target P/E ratio and conclude the stock is attractive.
But without knowing whether the profit comes from regular operations or extraordinary income , without knowing the working capital requirements and the cost of maintaining the asset, well, the valuation figure only creates the illusion of accuracy. A [musical] spreadsheet might yield reasonable values down to the penny, but the quality of the conclusions still depends on the reliability of the [musical] assumptions.
How long will customers continue to buy the product ? How have input prices fluctuated? Can competitive advantages be replaced by technology ? Does the management team make good use of [musical] capital? Li Lu always encourages people to delve deeper. In his notes on the Columbia lectures, he posed very practical questions.
Is the business cheap? Is it good? Who is running it? And what did I miss [in the music]? The last sentence is especially important. It forces researchers to seek counter-evidence before translating beliefs into a major [musical] status. This is where ability and personality meet. Some people are very good at analysis, but refuses to admit it's wrong.
Some people are extremely patient, but they lack the metrics to know when a business has changed. Both can call themselves value investors, but the results will be very different. Low purchase price is important [for music] . Understanding what you're buying and in what situations you're making a mistake is even more important.
There is a counter-argument we need to confront. If everyone understood the principles of business ownership, margin of safety, and long- term investing, why are there still so many opportunities in the market ? And how do you know if a low price is a real opportunity and not just the market accurately predicting bad things to come?
In 1984, Warren Buffett presented his famous essay on outstanding investors who emerged from the Graham and Dodd school of thought. He wanted to refute the idea that all long-term outstanding [musical] achievements are simply due to random luck. Well, the strength of the argument is that Buffett doesn't just pick a few investors with impressive track records and then tell their stories.
He tried to show that they had a common ideology from the beginning. However, this does not mean we should assume that market prices are always wrong. For much of the time, there are many intelligent people competing [in music] to find and correct pricing biases. Information can spread very quickly.
The market is efficient in many respects, but this is not necessarily true in all circumstances and at all times. Great opportunities often arise when factors such as fear, liquidity needs, business complexity, or investment mission constraints force some people to sell even though they understand the business.
But discovering a salesperson under pressure still wasn't [musical] enough. You need to understand the value of what you're selling and have the resources to keep it. Value investors don't make money because has an anti-market attitude. They make money if their analysis is better than the price being offered and if the true value [of the business] is then created or better perceived by the market .
This point is crucial because sometimes the feeling of belonging to a particular [musical] minority group can become a psychological trap. Proudly going against the crowd is no substitute for reading reports and testing assumptions. Let's return to the original paradox. Many people want superior profits , but superior profits don't come from claiming that you are smarter than others.
It requires the ability to do things that are difficult to repeat. One option is to conduct more in-depth research. That takes time [for music] and is often quite boring. You have to read the notes under the financial report, research the competitors, ask about customers, and check where the money is actually going.
Second, accept disagreement. There are times when you see value that the market hasn't seen yet, but that also means you have to live with the feeling that you might be wrong. Not everyone feels comfortable sitting still in that state of doubt. Third, know how to wait. You can do all the necessary work [on the music] and still not buy it because the price isn't attractive enough.
You can look at a good business for years before a suitable opportunity comes along. Sometimes the most valuable action is inaction. It's about making a decisive [musical] decision when the opportunity arises. Endless patience without the ability to make decisions will not produce [musical] results.
Li Lu has emphasized independence, rationality, immense patience [in music], coupled with the ability to act decisively and a genuine passion for business. These are four qualities that are difficult to learn simply by watching videos summarizing investment quotes. They were formed over the years of reading material, making decisions, learning from mistakes, and refining my own thinking about .
There's a very relatable example in the notes from Li Lu's 2019 lecture at Peking University [of Music]. He observed two gas stations located close together, but one attracted significantly more customers. If you only look at the basic structure and industry, they seem similar. But after observing for a while, he realized the difference lay in the way the service was provided.
A family directly runs the gas station, takes care of customers, and provides small additional services to make customers feel cared for. The other station operates in a conventional way and doesn't provide the same experience. It's worth noting that only by observing the actual operations can you realize an advantage that industry overview reports might overlook.
It's not cutting-edge technology or a patent. That's how people organize their work and do well even the smallest things. Li Lu didn't give an example, but rather a formula that any gas station offering free water will be successful. He used it to remind us that competitive advantage can lie in a very specific mechanism .
To understand a business, you have to go to where the revenue is generated, observe the customers, and find the answer to why one company does better than its competitors. This is also why value investing is more than just reading financial reports. The report shows the results of a period, but the research work must explain the causes of those results and whether those causes can continue to exist.
If we apply these principles to the Vietnamese market, the question isn't which stocks to buy according to Li Lu, but rather what changes we need to make in the research process. Taking the steel industry as an example, instead of starting with how much the stock price has fallen , start with actual capacity, plant utilization rate, selling price, input costs, steel-to-raw material price difference, domestic demand , cash flow, depreciation, and debt.
A report of strong earnings growth is just the beginning. We need to understand whether growth stems from price cycles, new production capacity, or sustainable cost advantages. For power businesses, it's essential to understand power purchase agreements , fuel costs, dispatch levels, plant performance, environmental obligations, and the cash flow that can be distributed after major maintenance.
A company with ample cash reserves is n't necessarily cheap if it requires significant investment to maintain its safe operation . For pharmaceutical companies, the key question is: which products have competitive advantages , and are those profit margins sustainable ? How effectively can the company reinvest its capital, and will the growth come from the brand, the distribution system, or simply a short-term price increase?
The disciplines are very different but follow the same [musical] sequence of thinking. Understand the business first, analyze its value later, and ensure a margin of safety.
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