I have always wanted to look deeper into Charlie Munger and Li Lu’s investments since they are both wise and act in a manner worthy of being respected.
I especially like his
quote on his great grandfather, “I am trying to emulate my great grandfather.
When he died they said about him, ‘nobody envied the success so fairly won and
wisely used.’”
Charlie’s holdings/ net worth today comprises approximately
a small part in Costco’s, three quarters Berkshire, and a quarter in Li Lu’s
fund, Himalaya Capital. Himalaya is international, but focuses mainly on China,
and some in Korea/South East Asia.
Certain parts from The Tao
of Charlie Munger by David Clark
Charlie was born in 1924, after
the war, Charlie, despite not having an undergraduate degree, applied to
Harvard Law School, his father’s alma mater. He was rejected. After a phone
call from Harvard Law’s retired dean, who was a Nebraskan and family friend, he
was admitted. Charlie excelled in his law studies and graduated magna cum laude
in 1948. He has never forgotten the importance of having friends in high
places.
After law school Charlie
moved back to Los Angeles, where he joined a prestigious corporate law firm. He
learned a lot about business from handling the affairs of Twentieth Century
Fox, a mining operation in the Mojave Desert, and many real estate deals.
During that time he was
also the director of an International Harvester dealership, where he first
learned how hard it is to fix a struggling business. The dealership was a
volume business that required a lot of capital to pay for its costly inventory,
most of it financed with a bank loan. A couple of bad seasons, and the carrying
costs on the inventory started to destroy the business. But if the company cut
its inventory to lower the carrying costs, it wouldn’t have had anything to
sell, which meant that customers would seek out a competing dealership that did
have inventory. It was tough business with lots of problems and no easy
solutions.
At 30 years old in 1954, Charlie
practically lost all of his money due to his first son Teddy’s death from
Leukemia and his divorce with his first wife. Through resolve and
determination, Charlie made his first million while practicing law and working
on his client’s real estate deals.
Charlie thought a lot about
business during that time. He made a habit of asking people what was the best
business they knew of. He longed to join the rich elite clientele his
silk-stocking law firm served. He decided each day he would devote one hour of
his time at the office to work on his own real estate projects, and by doing so
he completed five. Charlie got into real estate because he didn’t like the way
his client from his law firm managed a certain project— “This is how I would do
it”, Charlie would say, and his partner gave him a significant amount of shares
and said, “Show me.” He has said that the first million dollars he put together
was the hardest money he ever earned. It was also during that period he
realized he would never become really rich practicing law; he’d have to find
something else.
In the summer of 1959,
while in Omaha to settle his father’s estate, he met two old friends for lunch
at the Omaha Club, a wooden-paneled, private downtown club where businessmen
lunched in the afternoon and drank and smoked cigars in the evening. The two
men had decided to bring along a friend of theirs who was running a partnership
they invested in and whom they though Charlie would enjoy meeting, a young man
by the name of Warren Buffett.
By all accounts it was a
case of instant mutual attraction. Warren started by launching into his
standard diatribe about the investment genius of Benjamin Graham. Charlie knew
about Graham, and immediately the two began to talk about business and stocks.
The conversation became so intense that Charlie and Warren barely noticed when
their two friends got up to leave. That was the beginning of a long and
profitable partnership. One night over dinner Charlie asked if Warren thought
it would be possible for Charlie to open an investment partnership like
Warren’s in California. Warren said he couldn’t see any reason why not.
After Charlie returned to
California, he and Warren talked several times a week on the phone over the
next couple of years. And in 1962 Charlie finally started an investment partnership
with an old poker buddy who was also a trader on the Pacific Coast Stock
Exchange. He also stared a new law firm, Munger, Tolles, Hills, and Woods (now
Munger, Tolles, Olson). Within three years he stopped practicing law to focus
on investing full time.
British Columbia Power
Borrowing money for the New America Fund
(some excerpts from Damn
Right and yahoo finance)
Charlie’s investment
partnership early on was different from Warren’s, in that we was willing to
take on a lot of debt to do some of his trades. He was particularly fond of
stock arbitrage.
According to Alice
Schroeder's "The Snowball: Warren Buffett and the Business of Life,"
on one occasion, when Munger saw an attractive opportunity with British
Columbia Power, he invested 100% of his liquid net wealth and borrowed and an
additional significant sum to take advantage of the opportunity. As the book
described:
One arbitrage deal involved British Columbia Power, company that was being taken over by the Canadian Government. The take-over price was $22 a share, and it was selling at around $19.Munger put not just his whole partnership, but all the money he had, and all that he could borrow into an arbitrage on this single stock--but only because there was almost no chance that this deal would fall apart. The trade worked out and BCP was taken over.
During the 1960’s Warren
and Charlie took over Blue Chip stamps in which they used the float to purchase
100% of See’s Candy, and 80% of Wesco financial. During this time, Warren had
made the mistake of buying Berkshire Hathaway, and was consolidating National
Indemnity, a thriving insurance business, into a failing textile business.
One of the investment
decisions that Charlie’s partnership made in 1972 was to team up with the
investor Rick Guerin and take a controlling interest in a closed-end investment
fund called Fund of Letters, which they quickly renamed the New America Fund. The
“New America fund” was extremely concentrated and Charlie used leverage. Despite
Warren’s warning against leverage, Charlie was willing to borrow a significant
amount of money to take advantage of attractive opportunities whenever they presented
themselves.
Unfortunately, Munger's
style ended up causing him significant stress. His strategy of going all-in on
just a few bets and using borrowed money to juice returns meant that in the
market crash of 1973 to 1974, his partners suffered significantly.
Although Munger believed
in the long-term outlook of the companies he owned, predominantly Blue Chip
Stamps and the New America Fund at this stage, he could not rest easy with the
losses his partners were taking.
During this time Buffett
un-winded Buffett Partnerships by liquidating all his holdings, before a huge
bust, but Munger didn’t. Munger had to suffer agony and humiliation for a few
years, but things finally rebounded.
As Jane Lowe's book,
"Damn Right!: Behind the Scenes with Berkshire Hathaway Billionaire
Charlie Munger," described:
"Charlie realized
that some partners would suffer hard-to-bear distress. After all, an investment
of $1,000 on January 1, 1973, would have shrunk to $467 by January 1, 1975, if
the partner had never taken any money out during the period. In contrast, a
similar $1,000 investment that performed in line with the Dow Jones Industrial
Average over the same period would have shrunk much less, leaving $688.
Moreover, following precedents in the Graham and Buffett partnership, all
Wheeler, Munger partners drew cash from their partnership accounts at one half
a percent per month on start-of-the-year value. Therefore, after regular
monthly distributions were deducted, limited partners' accounts in 1973 to 1974
went down in value even more than 53%."
Munger had to suffer
humiliation for a few years before he swore off using leverage after losing a
few clients. The fund eventually rebounded, but this was painful for Munger.
In 1977, New America
bought the Daily Journal Corporation for $2.5million and Charlie became its
chairman. When Guerin and Charlie dissolved the New America Fund, its
shareholders received shares in the Daily Journal Corporation and the company
became a publically traded over the counter stock. Many of today’s Daily
Journal shareholders have literally been with Charlie since the days of his
original partnership, more than forty years ago.
The Daily Journal
Corporation is a California publishing company that publishes newspapers and
magazines, including the Los Angeles Daily Journal and the San Francisco Daily
Journal.
Today, they have
transitioned towards software.
According to Wikipedia: The
Daily Journal acquired New Dawn Technologies, Inc. in 2012; and ISD
Technologies, Inc., in 2013. The Daily Journal now makes software for trial and
appellate courts and agencies related to court systems, including prosecutorial
agencies, public defenders, probation departments and pretrial offices,
throughout the United States, Canada and Australia. The Daily Journal has
distinguished itself in the market with a browser-based case management system
that is a highly configurable business processing engine that is the
centerpiece for document management and e-filing.
The strategy employed
during this period is very similar to the one he uses today: waiting patiently
for high-quality, undervalued businesses and then acting with conviction to
take advantage of the opportunity presented by the market.
Belridge Oil
In the late 1970’s Charlie
stumbled upon the Belridge Oil incident/deal. Belridge was undervalued and
eventually bought up by Shell. In 1977, Charlie only bought 300 shares at $115
and was offered another 1500 shares but was hesitant since the owner was an
alcoholic. Munger described it as one of the most undervalued stock in the
world, with his calculation of intrinsic value finding that the stock was worth
somewhere in the thousands of dollars.
In 1979, the Belridge CEO
put the company on the auction for a bidding war between Shell, Texaco, and
Mobil Corporation. Ultimately, Shell was the high bidder at a price of $3,665
in cash. Munger nearly turned a $34,500 investment into $1,099,500. This
allowed Munger to become a substantial Berkshire Hathaway shareholder.
This was one of his
biggest regrets and omission which Charlie would always complain about it in
speeches. Charlie recalls, those extra 1500 shares would have turned 172,500
into 5,497,500. If Munger had purchased those Belridge shares and then put it
into Berkshire, which was trading at $260 per share— 21,114 Berkshire Hathaway
Class A shares that currently trade in the 300,000 range. This omission cost 5
billion to the Munger family. Since this was early on in his life, and since
the return was significant— it could have greatly boosted his net worth today.
While Munger did purchase 300 shares of the thinly traded stock of Belridge Oil
for $115 in the late 1970s, he was offered 1500 more shares at this price but
chose to pass it up.
Despite recognizing that
the stock was "ridiculously underpriced", he couldn't bring himself
to sell any of his other holdings, even though he could have easily afforded
to. Belridge Oil was selling for a market cap of about $110 million and a book
value of $177 million when Munger declined to add to his holdings. The real
value in this company lay in its proven oil reserves. Underneath land it owned
in California, it had assets of 380 million barrels of oil. That means the
market was valuing each barrel of oil at 29 cents per barrel, while the going
rate was $5-6 per barrel! That decision ended up costing him over $5 million,
as Belridge Oil sold for $3700 per share just two years later! The value was
realized two years later when Shell purchased the company for a price representing
about $8/barrel.
Monroe Springs/Tenneco
(some sections were from BrokenLeg Investing’s blog)
In 2017’s Daily Journal,
Charlie revealed that in 2001, Monroe Springs (now Tenneco) was in a distressed
situation with a lot of debt and nearly facing bankruptcy. Tenneco is a major
supplier of aftermarket auto parts. Its well-known brands include Monroe shock
absorbers, Walker mufflers, and DynoMax exhaust products.
Knowing how sticky shock
absorbers and mufflers were in the secondary market, Charlie saw Tenneco as a
turnaround situation and bought a majority junk bonds and a small chunk of
equity. The debt was trading at a sharp discount to par value. He bought the
stock (which was trading at $1.50-$2/share), as well as the bonds (11.375%
notes yielding 35% to maturity).
Within a few years, the
stock went up to $15, at which he sold. The bonds went back up to par value and
were called in by the company coupled with refinancing.
The 11.38% notes maturing
in 2009 were yielding 35% to maturity, implying he bought the bonds for around
40 cents on the dollar. This situation such as Tenneco in 2001, shows that Charlie
considers both the upside and downside of all his investments. Tenneco was
barely able to meet ends regarding its debt. If bankruptcy occurred and there was a Chapter
11 filing, the value of the equity would be wiped out.
The junk bonds were a good
way to take advantage of Tenneco's disaster. Buying a smaller part in equity
shows you that Munger carefully considered the downside. If Tenneco went
bankrupt, the bonds would most likely be redistributed to shareholders as
equity. Munger was paying less than par value for the bonds, a conversion of
the debt to equity at even half of par value would be a premium to his basis
cost. This is the “margin of safety” in Charlie’s investment.
While generating consistent
profits in the late 1990s, by the new millennium, Tenneco faced significant
headwinds.
Image 1: Tenneco chart 2000-2002. Poor operating performance pushed the stock down more than 80% from highs set in early 2000 (Source: CapitalIQ)
Shares had fallen from
prior highs of over $10 share to just under $2/share.
Image 2: Tenneco Income Statements 1997-2001. While revenues remained largely flat, increased operating expenses reduced operating income from $395m to just $92m (Source: Tenneco 2001 10-K filing)
Operating income had
fallen from $395m in 1997 to just $92m in 2001. EBITDA halved from $505m to
$245m.
Image 3: Tenneco Balance Sheet and EBITDA Data. At the time of Charlie’s investment, Tenneco’s shareholder’s equity had fallen precipitously due to operating losses. EBITDA had fallen significantly from the $300-$400m level seen in the late 1990s (Source: Tenneco 2002 10-K)
At the time of Charlie
Munger’s “cigar butt” investment, Tenneco — which had 40 million shares outstanding
— had a market cap of $80 million and enterprise value of $1.6 billion, as well
as a total debt load of $1.52b.
At first glance, Tenneco
was not an obvious deep value play:
-
Its tangible book was negative
-
EV/EBITDA ratio (6.5) was close to the historical valuation
of auto parts makers (7.5x EBITDA)
On the other hand, thanks
to the high leverage, if things worked out there was a tremendous upside for
the value of the equity. If Tenneco succeeded in restructuring operations and
operating profits improved, the company’s share price could soar multifold. An
environment slightly more favorable to Tenneco’s business would bring EBITDA
back to the $300m-$400m level seen in the late 1990s.
In the $300-$400m range,
even if the company maintained the same EBITDA multiple (6.5x), the enterprise
value would be between $1.95 billion and $2.6 billion. Subtracting the $1.52billion
in debt, this would value the equity somewhere between $430 million and $1.08
billion, or $10.75-$27/share.
Tenneco had set itself up to be Charlie Munger’s cigar butt, providing one last puff that could prove to be a multi-bagger.
After reading Barron’s
piece, Munger’s due diligence on the stock lasted less than two hours. He had
some background knowledge of the auto parts space and believed the brand equity
Tenneco had through its portfolio of well-known brands provided a margin of
safety in a cyclical, commodified industry.
Munger saw the company as
a cigar butt, with a few puffs left of value. But with a high amount of debt on
Tenneco’s balance sheet, the situation had more risks than your typical
investment.
The
strongest opportunities are typically extremely undervalued companies with
relatively clean balance sheets. Tenneco’s valuation was fairly accurate given
its recent performance in 2001-2002. The market had discounted substantial
bankruptcy risk into the price of both Tenneco’s stock and its publicly traded
debt.
Munger bought both the equity and bonds of Tenneco. The
debt was trading at a sharp discount to par value. The 11.375% notes (maturing
in 2009) were yielding 35% to maturity, implying he bought the bonds for around
40 cents on the dollar.
In a situation such as Tenneco in the early 2000s, this
was a smart play. With the company barely able to service its debt, the odds
favored a Chapter 11 filing, wiping out the value of the equity.
Taking a position in the
debt was a conservative but aggressive way to take advantage of Tenneco's low
valuation. Buying a piece of the equity was essentially “schmuck insurance” —
an option that allowed Munger to avoid regrets down the road if the stock
became a multi-bagger.
Buying the bonds gave
Munger’s position some optionality. If Tenneco went bankrupt, his bonds would
likely convert into equity. Even if bondholders took a haircut (were paid at a
discount to the original value of the debt), with Munger paying less than par
value for the bonds, a conversion of the debt to equity at even half of par
value would be a premium to his basis cost.
A Chapter 11 filing would
give the company greater freedom to eliminate obligations and restructure,
allowing the company to return to profitability and valuation levels seen in
prior years.
In a situation where
Tenneco avoided default, investors would regain confidence in both the equity
and debt issued by the company. The bonds would likely return to par value, and
shares would rise on diminished bankruptcy risk.
Investor Carl Icahn made a
similar play in the auto parts industry at this time. He bought a majority of
Federal-Mogul’s distressed debt, which allowed him to gain control in
bankruptcy court. By restructuring the company and taking advantage of
increased demand for aftermarket parts, Federal-Mogul produced fantastic
returns over a long holding period. Ironically, Tenneco was the company that
gave Icahn his exit, acquiring Federal-Mogul earlier in 2018.
The Fruits of One Great
Idea: Plenty of Puffs Were Left in Tenneco
Charlie Munger’s cigar
butt proved to have many puffs remaining in the years following his investment.
Tenneco was able to
restructure its operations, improving the company’s operating performance. With
the risk of default mitigated, Wall Street regained confidence in the
floundering auto parts maker.
Image 4: Tenneco income statements 2000-2004. In the years following Munger’s investment, operating income nearly doubled as the company successfully restructured operations (Source: Tenneco 2004 10-K)
With bankruptcy out of the
picture, the bonds lost their heavy discount, not only returning to par value
but trading at a slight premium. Tenneco called in the bonds, replacing the
debt with proceeds from a refinancing at lower rates.
Image 5: Tenneco balance sheet and EBITDA data, 2000-2004. The successful restructuring of Tenneco resulted in EBITDA margins returning the levels seen before Charlie Munger’s cigar but investment. (Source: Tenneco 2004 10-K;)
Tenneco’s valuation
situation played out exactly as we saw in our back-of-the-envelope analysis.
With EBITDA returning to the $300m-$400m level seen in the late 1990s,
Tenneco’s stock soared well above Munger’s buy price of $1.50-$2.00, soaring to
$15/share in mid-to-late 2004.
Image 6: Tenneco chart 2002-2004. Tenneco’s share price rose in tandem with the new valuation resulting from the company’s EBITDA returning to the $300-$400m level. (Source: CapitalIQ)
With the market rewarding
Tenneco’s turnaround, it was time for Charlie Munger’s cigar butt to be put
into the ashtray. While he missed out on even more appreciation in the years to
follow, it is a whole lot easier to “take the money and run” as opposed to
calling tops and bottoms.
Charlie Munger’s cigar
butt produced close to $80 million in profits from both the equity and debt
investments. Munger invested these proceeds with fund manager Li Lu, who
eventually parlayed the windfall into $400 million.
Tenneco was left for dead
by Wall Street. The investing community believed that the company’s high
leverage and weakened demand for auto parts would drive it into Chapter 11, the
same fate as its rival Federal-Mogul. The stock had cratered to below $2/share.
The bonds fell into vulture investor (distressed debt) territory. According to
Forbes, Munger’s net worth is $1.7 billion, meaning that a quarter of Munger’s
fortune derives from this one idea.
Munger took a look at the
financials and decided in less than two hours that Tenneco presented an
asymmetrical wager. While there was a chance that negative cash flow and high
debt levels would bankrupt the company, if the company stayed afloat, it would
return back to intrinsic value, turning the stock into a multi-bagger once the
company turned itself around.
It is important to note
that not all bleak investing situations have a happy ending. I’m sure you are
well aware of the investing world’s graveyard of stocks that bit the dust.
It is easy for both novice
and experienced investors alike to overthink their way out of a profitable
investing idea. As Charlie quipped during the DJCO meeting, it took him about
two hours of research after reading the Barron’s piece to pull the trigger and
buy Tenneco. He didn’t spend months touring Tenneco’s facilities. He didn’t
call up auto parts stores inquiring about their future demand for Tenneco
products. And he certainly didn’t use geospatial imaging to see how many
pallets of Monroe shock absorbers were coming out of the factory.
Tenneco was cheap but
distressed, with the street overselling the stock on expectations of
bankruptcy. If the fears came to fruition, the stock would go to zero, and the
bonds would likely face a haircut (payout below par value), not being paid off
until years of Chapter 11 proceedings.
If Tenneco rode out the
recession and returned to even a modicum of profitability, the stock would skyrocket,
returning to its intrinsic value range.
Investors oversold on the
bankruptcy risk, and that low valuation presented itself as an asymmetric
wager.
Charlie found this deal in
Barron’s magazine, which he had been reading for 50 years and only acted on a
few times. This proves the point to only load up on sure things and great
investments. Sit on your ass most of the time.
Through this deal, Charlie
made 80million dollars in 2004 through this investment.
Himalaya Capital (Li Lu)
With the 80 million
dollars, he gave it to Li Lu in 2004 or 2003 and invested in his fund Himalaya
capital, which grew to 500 million. Charlie met Li Lu at a Thanksgiving dinner.
Li Lu seized on this opportunity by initially knowing one of the law partners
at Munger, Olson, Tolles. It is incredible for him not to know a word of
English and to graduate Columbia University with 3 degrees, one of them being
in law. Charlie agreed to train Li Lu and was willing to invest in him, on the
condition that he model incentive fee and philosophy of investing under
Berkshire. This would be a fair structure, concentrated investing, no shorting,
etc. etc.
Li Lu is successful
because he is a master at utilizing his time well and knowing which connections
are important to form. He knows how to focus and what activities and people to
avoid. In business, certain deals and certain information are asymmetrical, and
without certain connections, some insights or contracts are not obtainable.
This is not a blog on
politics, so I will only touch upon this briefly. Li Lu influenced Buffett on
BYD and was able to return to China without being banned. Why? How was he
accepted back into China? It was through a letter from George Bush. This proves
my point on connections.
How did Charlie Munger get into Harvard Law
School despite not having an undergraduate degree? He knew a dean. He graduated
top 5 in his class, but without these connections, he would not have been able
to attend.
It proves a Chinese
saying, “è˜äººæ¯”è˜å—更好”, meaning it is better to know someone and have
connections than to know words. I agree with this only to a certain extent. I
think it is important to be financially literate and read a lot to get a clear
view of reality and couple this with great connections. You need both to be
successful and it is obvious Li Lu has this in spades.
Another thing I want to touch upon is how
Himalaya is structured by comparing it to Baupost, Seth Klarman’s fund, and
Arlington Value Capital, Alan Mecham’s fund. I am in no way criticizing Baupost
or Himalaya, or Arlington. I am just comparing how things are structured.
Baupost has a small management fee which
they take from AUM (assets under management). This allows them to have a team
of over 200 people in Boston. Yet Himalaya’s staff is slightly larger than a
dozen people with no management fee (they follow the 6 % hurdle and 25%
incentive fee which Munger recommends). There is no right or wrong. With 200
people, you can scale different activities and open multiple funds like Oaktree.
With less than 20 people, you have to pick your opportunities well.
When I met with Allan Mecham’s employee
through a value investing group, he mentioned that colleagues are free to
pursue their own investment topics, even though some are proposed by Alan. In
contrast, Li Lu picks all, if not most of the companies to look at, and assigns
3-5 companies for each of his colleagues to do in depth research. And when I
mean in depth, I mean really in depth. After they finish a field trip and go
back to Seattle (originally Pasadena, they must have moved due to tax reasons);
they are required to write in Chinese an essay of 1,000,000 words. Why is this
exercise good? When you come back from a trip, it is still fresh in your head.
When you write things out, you need to be logical and articulate your thoughts
to others in a clear manner. It forces your thinking to be straight.
Again, there is not “right” or “wrong” in
both Li Lu and Allan’s methods. It just shows you different ways funds are
structured and how they get the most from their staff.
Also, I want to give a shout out to
Himalaya’s employees. There are really discrete. I got a chance to know one
employee and became good friends. Since I am not an investor in Himalaya, he
has never told me Li Lu’s holdings and he has never told me about his
interaction with Li Lu or Charlie. This shows that Li Lu’s employees are first
class in that they protect the basic interests of the fund. When you hire
someone, you want to hire someone with integrity and character. It is obvious
all of his employees are loyal and capable.
Most of Li Lu’s investments which I know
of, are either publically announced, such as the greater than 5% interest in CRRC
through the stock exchange of Hong Kong or by originally attending the AGM.
These are listed below.
Korean Companies
Amore Pacific – A diversified skin care
company. They have many skin care brands in Asia, particularly China under one
holding company.
Ottogi— A sauce and noodles low cost
producer. Competitor to Nongshin
Chinese Companies
CRRC— A State Owned Enterprise- probably a
place for Li Lu to park his cash
Fuyao— An automobile glass company with
factories in China, Germany, Russia, and USA. Featured in the Netflix
documentary “American factory”
Shanghai Pudong International Airport—HongQiao
Airport, the other airport in Shanghai has zoning restrictions due to noise
level. There won’t be any new airports in Shanghai and the near future
MaoTai—A popular liquior which took
advantage of being the number one brand after competitor WuLiangYe had a slip
up in pricing and brand image
BYD—The electric car company which
specialized in battery production and was an OEM for Samsung and other big
companies. Berkshire also has an investment in BYD.
Some holdings are just my guess though his
publically listed letters on his site. It is obvious that Li Lu does a lot of
due diligence himself and through his team, and knows every nuance of the
business, such as the competitive advantages, risks, etc.-- as if he were the
owner himself. He then looks for an inflection point— an event that results in
which a significant change in the progress of a company and can be considered a
turning point after which the company accrues significant competitive advantage
to consider it safe long term investment.
If you think about it, it is quite simple.
You can always have your cigar butts and special situations when your fund is
small, but long term, you want a long runway with compounders. And by
definition, a great company is a company you can hold on to for more than a
decade. So this means that pharmaceuticals with its unpredictable clinical
trials, silicon chip fabrication and certain technologies which are impossible
to predict with so much change and where the winner is not preordained--- these
companies are all out of the question. It has to be simple, predictable, and in
an industry or business with good prospects.
Then you have to remember that you are a
minority owner participating in a company passively. Who are the owners? Do
they have the same incentives as minority shareholders? Will they liquidate my
shares or screw me over? Warren always says in a card game, if you don’t know
who the patsy/idiot getting fooled is, it is most likely yourself. How can I
get conned through bad accounting or management? Remember, to unethical and
selfish owners, the game is not to benefit shareholders or to create
shareholder value through buybacks. The game is to raise money through cheap
cost of capital by making the company look better than it really is. With a
higher multiple, it is easier to acquire companies and raise capital. Bad
owners never worry about issuing too many shares and diluting their company
through stock options. They never think about funding projects through cash and
debt, they issue shares without an afterthought.
Auditors always list their rating and
opinion in 4 categories. “Unqualified” is unequivocally passing with flying
colors, but you still have to investigate yourself as an investor. Then comes
“qualified”, “disclaimer”, and finally “adverse”. I would suggest to only look
at “unqualified” annual reports. It is a pity that CapitalIQ doesn’t show this,
but Bloomberg does. Also, by the way, CapitalIQ, which was sold to S&P was
actually one of Li Lu’s early venture capital investments.
I will continue this topic in possible a
few other posts. I want to analyze some of Li Lu’s investments. After all,
Charlie calls him the “Warren Buffett of China”.
Citations:
https://moiglobal.com/why-berkshires-approach-is-so-hard-201903/
Daily Journal 2017 AGM
http://www.barelkarsan.com/2009/06/charlie-munger-and-belridge-oil.html
https://www.brokenleginvesting.com/charlie-munger-cigar-butt/
Alice Schroeder "The
Snowball: Warren Buffett and the Business of Life"
David Clark “The Tao of
Charlie Munger”
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