Li Lu: The Prospects for Value Investing in China October ... · charged borders on the outrageous....

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LiLu:TheProspectsforValueInvestinginChina

October28th,2015

Originalsource:http://36kr.com/p/5040874.html

First,thankyoutotheGuanghuaSchoolofManagementandthankyoutoProfessorJiang

Guohuaforestablishingacourselikethistofocusontheprinciplesofvalueinvesting.

Launchingavalueinvestingclassatthistime,inmyopinion,isofgreatsignificance.AsI

understand,thisisthefirstandonlyclassofitskindinChina.Therearen’tmanysimilar

classesaroundtheworldeither.AsfarasIknow,theclassatColumbiaUniversitymaybe

theonlyother–thatis,theclassfirstofferedsome80or90yearsagobyBuffett’steacher,

BenjaminGraham.HimalayaCapitalisproudtosupportthisclass.

Iwouldliketodiscussfourtopicswithyoutoday:

First,sincemanyofthestudentsenrolledinthisclassarelikelytojointhefinancialservices

orassetmanagementindustries,Iwouldliketobeginbytouchingontheuniquefeaturesof

theseindustries,andthemoralbottomlinerequiredofpractitioners.

Second,asassetmanagementprofessionals,wemustknow,fromalong-termperspective,

whichfinancialassetscangrowinasustainable,effective,safeanddependablemanner?

Third,arethereanyeffectivemeansbywhichthroughhardworkyoucanbecomean

outstandinginvestorcapableofprovidingyourclientswithanhonestanddependable

servicetoprotectandgrowtheirwealth?Whatisthe‘truepath’intheworldofinvesting?

Fourth,aretheinvestmenttechniquesproveninmature,developedcountriessuitedto

China?OrisChinaanexception?CanvalueinvestingbepracticedinChina?

Ihaveconsideredthesequestionsforseveraldecadesnowandwilldiscussthemwithyou

today.

1. Uniqueaspectsoftheassetmanagementindustryandthemoralbottomline

requiredofpractitioners

Assetmanagementisaserviceindustry.Comparedwithotherserviceindustries,whatare

itsdistinguishingfeatures?Inwhichaspectsdoesitdiffer?Ibelievetherearetwo

differences.

Thefirstisthatintheoverwhelmingmajorityofcases,theconsumersofthisindustryhave

nomeansorideaofhowtojudgeitsproducts.Thisisdifferentfromalmosteveryother

industry.Forexample,someonecaneasilytellyouifacarisgoodornot;oriftheyouteat

out,theycantellyouimmediatelywhatthefoodwaslikeandiftheservicewasgood.Ifyou

stayinahotelorbuysomeclothes…inalmosteverycase,youcanevaluateaproductjust

byusingit.However,consumersofassetmanagementproductsinmostinstanceshaveno

wayofknowingifaproductisgoodorbad,oriftheservicetheyarereceivingispooror

outstanding.

Notonlyconsumersandinvestorsbutevenpractitioners–includingsomeoftheindustry’s

topstarswhohavejoinedustoday–willhaveahardtimeevaluatinganinvestmentproduct

orservice.Thisisthekeydifferencebetweenfinance–andespeciallyassetmanagement–

andpracticallyeveryotherindustry.Ifyougivemeayearortwoofresults,Iwillhave

absolutelynowayofevaluatingwhethertheyareoutstanding.Itwouldbesimilareven

withfiveortenyearsofresults.Youmustlookatwhatinvestmentsweremade,andstill

youcanprobablyonlymakeausefuljudgementafteranequallylongperiodoftimehas

passed.Preciselybecausethereisnowaytoproperlyevaluateproductsandservices,the

overwhelmingmajorityoftheoriesgetthingsass-backwards.

Anotherkeydifferenceisthatoverallcompensationinthisindustryishigherthanothers,

andoftendetachedfromresults.Infact,theactualserviceprovidedtoclientsinmostcases

isverylimited,andmanyproductsoftendeliverthebestreturntopractitioners.The

industry’spricingstructurefundamentallyreflectsthebenefitsofpractitioners,notclients.

Inmostindustries,onehopestoliftone’sstandardsinawaythatisobvioustoclientsand

whichwillallowforsomekindofpremiumpricing.Butinassetmanagement,irrespectiveof

goodorbadperformance,everyoneusesamethodofcalculatingfeesbasedona

percentageofnetassets.Soregardlessofwhetheronemakesmoneyforone’sclientsor

not,onewillstillgetpaid.Theworstisprivateequitywherethepercentageofnetassets

chargedbordersontheoutrageous.Ifyourclientmakesmoney,yougetpaid;ifyourclient

losesmoney,youstillgetpaid.Eventhoughclientscanbuypassiveindexproducts,asa

fundmanager,youcanstillearnalotofmoneyevenifyouunderperformyourindexbya

widemargin.Thisisveryunreasonable.

Ithinkeveryonethinksaboutjoiningthisindustryisinpartfortheintellectualchallengeand

inpartforthecompensation.Whilethecompensationisundoubtedlyveryhigh,it’svery

hardtodeterminewhethermostmanagersareworthit.

Takentogether,thesetwouniquecharacteristicscreatesomeobviousdrawbacks.For

example,abilitiesaremixed,badproductsarepassedoffasgoodones,andmanymanagers

seemtobetherejusttomakeupthenumbers.Standardsintheindustryareconfusing.

Thereisafloodofspeciousstatementsandfallacieswhichconfuseconsumers.Evensome

managerscannotseethingsclearly.

Thesecharacteristicsposetwofundamentalmoralrequirementsonallmembersofthe

industry.

Iwouldliketodiscussthisissuefirsttodaybecausemanyofthestudentssittingheretoday

willbecomepractitionersinthefuture.Moreover,sinceoneoftheultimategoalsofthis

classistotrainthefutureleadersofChina’sassetmanagementindustry,Iwouldlikebefore

youentertheindustrytokeepinmindtwounbreakable,bottomlinemoralrequirements:

First,makethepursuitofknowledgeandwisdomyourmoralresponsibility.Youmust

consciouslyrejectanyass-backwardstheories.Onceyouentertheprofession,youwill

quicklyrealisethatalmostalltheoriesareofthiskind.Ifyoudon’tthinkaboutthisclosely,

youwillsoonconfuseyourinterestswiththeclient’s.Thisisjusthumannature;noonecan

avoidit.Becausethisprofessioniscomplicated,itisfullofspeciouspointsofview.Even

thoughtherearemanyjudgements,itisnotanexactscience.SoIreallyhopethatany

youngpeoplewhoarewholeheartedlytryingtoentertheprofessioncanletthiskindof

moralbottomlinetakeroot;youmustmakethecontinuouspursuitofknowledge,truthand

wisdomyourmoralresponsibility.Asaninformedpractitioner,don’tknowinglytrotout

thosetheorieswhicharegoodforyoubutnotyourclient.Don’tletyourselfbeconfusedby

specioustheories.Thisisvery,veryimportant.

Thesecondistofirmlyestablishanawarenessoffiduciaryduty.Whatarefiduciaryduties?

Youmusttreateverydollarofclientmoneyasthoughitwerethefruitofyourownparents’

labour,saveduppiecebypieceoveralifetimeofdiligenceandthrift.Evenifit’snotmuch,

ittookyearsofstruggleandsacrificetoaccumulate.Ifyoucanunderstandthe

responsibilitythisentails,thenyoucanstarttounderstandthemeaningoffiduciaryduty.

Ithinktheconceptoffiduciarydutyisinnate:peopleeitherhaveitortheydon’t.Everyone

sittingheretoday,whetheryouentertheindustryinthefutureorentrustyourmoneyto

someoneintheindustry,youmustseeifyouhavethistraitorelsefindsomeonewhodoes.

Thosewithoutcannotbetaughtitbyanymeans.Anditreallywillbetragicifyougiveyour

moneytosomeonelikethat.Soifyouwanttoentertheindustry,youmustaskyourselfif

youhavethissenseofresponsibility.Ifyoudon’t,Iurgeyounottobecauseyouwillmost

certainlybecomethewreckerofcountlessfamilies.Thefinancialcrisisof2008-09wasin

largeparttheresultoftheso-called‘success’ofpeoplewhodidnotunderstandtheir

fiduciaryduty.Thiskindof‘success’isextremelyharmfultoallofsociety.

ThesearethetwomoralbottomlinesIwantedtosharetodaywitheveryonethinkingof

enteringtheassetmanagementindustry.

2.Astheassetmanagementindustry,wemustknow,fromalong-termperspective,

whichfinancialassetscangrowinasustainable,effective,safeanddependablemanner?

Inwhatfollows,wewillanswerthesecondquestion:fromalongtermperspective,which

financialassetscanreallydeliverforclientsandinvestorsadependablereturn?We’vejust

experiencedastockmarketcrashandmanypeoplefeelthatcashorevengoldarethemost

dependableassets.Dowehavethemeanstoassessthepastperformanceoftheseassets?

Andhowlongis‘longterm’?Ithinkthelongerthebetter.Andthebeststatisticswillbethe

oldest,mostcontinuousstatistics.Becauseonlywiththiskindofdatawillwehaveany

persuasiveness.Inmodernsociety,thedevelopedwesterncountriesarethebirthplaceof

themoderneconomyandsawtheearliestdevelopmentofmodernmarkets.Becausethey

havethelargestvolumeofmarketdata,andthelargesteconomies,theycanshedthemost

lightonthisquestion.Andforthisreason,wewillfocusonAmericabecauseithasgood

datawhichgoesbackforalmosttwohundredyears.Soinwhatfollows,wewilllookat

America’sperformance.

ProfessorJeremySiegeloftheWhartonSchoolattheUniversityofPennsylvaniahasworked

hardoverthepastdecadetocompileasetofreliablestatisticsshowingtheperformanceof

variousfinancialassetsinAmericagoingallthewaybackto1802.Todaywewilllooktosee

whichfinancialassetperformedbestoverthistime.

Figure1:PerformanceofFinancialAssetsinAmericafrom1801totoday

Thefirstmajorcategoryofassetiscash.Recentvolatilityinthestockmarkethasincreased

manyChinesepeople’sawarenessoftheimportanceofcash.Perhapsmanypeoplenow

thinkthatcashcanbestpreserveitsvalue.Solet’slookatcash’slongtermperformance.If

youhadadollarin1802,howmuchwoulditbeworthtoday?Whatcoulditbuy?Asyou

canseefromFigure1,theanswerisfivecents.Overtwohundredyears,cashhaslost95%

ofitsvalue,ofitspurchasingpower!Weshouldallbeabletoguessthereasonwhy:

inflation.Nowlet’slookattheotherassetclasses.

FormanytraditionalChinesepeople,gold,silverandheavymetalsareanexcellentmeansof

preservingwealth.Westerncountriesheldtothegoldstandardformanyyearsduring

whichtimegolddidholditsvalue.However,the20thcenturysawacontinuousdeclineinits

value.Usinggoldasthebestrepresentativeofpreciousmetals,howmuchwouldadollarof

goldtwohundredyearsagobeworthtoday?Whatwoulditspurchasingpowerbe?Wecan

againseefromFigure1thatitwouldbeworth3.12dollarstoday.Sogoldhaskeptitsvalue

andevenappreciated3-4timesovertwohundredyears,beatingexpectationsalthoughnot

reallyappreciatingthatmuch.

Let’slookattheperformanceofshort-termgovernmentbillsandlong-termbonds.The

yieldonshort-termgovernmentbillsisagoodproxyfortherisk-freerate,nevertoohigh

andjustabovetherateofinflation.Overthelasttwohundredyears,billshaveappreciated

by275timesandbondsby1600times,alittlebitmore.

Andontoequities,anotherofthemajorassetclasses.Manypeopleperhapsthinkthat

stocksaddriskandcannotholdtheirvalue,especiallyaftertheupsanddownsseeninthe

stockmarketoverthelastthreemonths.Havinggonethroughbothabullandbearcyclein

thelasteightmonths,manypeoplewillnowbemuchmoreawareoftheriskofequities.So

howhaveequitiesperformedoverthelasttwohundredyears?Ifwehadinvestedadollar

intheAmericanstockmarketin1802,howmuchwoulditbeworthtoday?

Theresultisthatadollarinvestedinthestockmarket,evenafterallowingforinflation,

wouldhaveappreciatedamilliontimestobeworth1.03milliondollarstoday.Eventhat

remainderisworthmorethanwhatotherassetclasseshavereturned.Andwhyhave

equitiesbeenabletoproducethisperhapssurprisingresult?Theansweristhatevenafter

theeffectsofinflation,equitieshavereturnedacompoundaveragerateof6.7%.Thisisthe

powerofcompoundinterestandthereasonwhyEinsteincouldcallittheeighthWonderof

theWorld.

Theseresultsraiseanimportantquestion:whydoeseveryonethinkthatcash,anasset

whichovertwohundredyearshaslost95%ofitsvalue,issaferthanequities,anasset

whichhasappreciatedamilliontimesovertwohundredyears?Andthatmilliontimesis

evenafterallowingforinflation.Whyhavetheperformanceofcashandequitiesdiverged

tothisdegreeovertwohundredyears?Thisisaquestionallofusprofessionalinvestors

mustconsider.

Therearetwocausesofthisphenomenon.

Thefirstisinflation.AnnualinflationinAmericaoverthelasttwohundredyearshas

averagedaround1.4%.Thisisequivalenttosayingthatyourpurchasingpowerhasdeclined

byaround1.4%everyyear.Overtwohundredyears,this1.4%hasmadeadollarworthjust

fivecents,eroding95%ofitsvalue.Wecanunderstandthisveryeasilyfromapurely

statisticalpointofview.

Anotherreasonisgrowthintheeconomy,measuredbygrowthinGDP.America’sGDPhas

increasedbyabout33,000timesoverthelasttwohundredyears,equivalenttoanannual

growthrateofabitmorethan3%.Ifwecanunderstandeconomicgrowth,wecan

understandotherphenomena.Stocksareaproxyforlargecompaniesandtheirsales

growthisinturnafunctionofGDPgrowth.Allcompaniesincurexpenses,someofwhich

arefixedandbearnorelationtosalesvolumes.Inthisway,profitscangrowatafasterrate

thansales.Ifacompanycangrowsalesby3-4%,itsprofitsshouldincreasebyabout6-7%;

andsothevalueofthecashthecompanygeneratesshouldalsoincreaseatthesamerate.

Actualresultsseemtoconfirmthis.Thecorevalueofastockisthevaluetodayoffuture

profitgrowth.Overthelasttwohundredyears,stockshavebeenpricedatanaverageof

15xpricetoearnings,theinverseofwhichisabout6.7%,reflectingthegrowthrateofthe

market’searnings.Inthisway,equitypriceshavealsogrownat6-7%fortwohundredyears,

resultinginanappreciationofamilliontimes.Sostatistically,wecanunderstandhow

equitiesinaggregatewillgrowatthisrate.

Thisistheinitialconclusionthen:inflationandGDPgrowthcanexplainthedifferencein

performancebetweencashandequities.

AnotherimportantquestionishowwastheAmericaneconomyabletoproducetwo

hundredyearsoflongterm,continuouscompoundgrowth?Allwhiletherehasbeena

persistentinflation?Howdidtheeconomygrowalmosteveryyear?Ofcourse,therewere

contractionsinsomeyears,andinotheryears,growthwasstronger.Butoverall,the

directionoftheeconomyoverthelasttwohundredyearshasbeenupwards.Ifwetakethe

yearastheunitofmeasure,thenGDPincreasedalmosteveryyearinawaythatwas

cumulativeandcompounding.Howshouldweexplainthisphenomenon?Werethe

conditionsuniquetoAmerica?Havetheyexistedthroughouthistory?Obviously,inChina’s

threeorfivethousandyearsofrecordedhistory,theyhaveneverappearedbefore.They

areindeedamodernphenomenonwithoutprecedentinChinauntilaboutthirtyyearsago.

SodowehaveawaytoestimatethepatternofGDPgrowththroughouthumanhistory?Is

thereaphenomenonofcontinuouseconomicgrowth?

WeneedtorefertoanotherFiguretoanswerthisquestion.Wemustmakeclearwhatkind

ofchangesoccurredinmankind’shistoryafterthedawnofcivilisationtooverallGDP,

overallconsumptionandthelevelofproduction.Ifweweretoincreasethetimespanofour

study,togobacktothedaysofthehuntergatherers,earlyfarmingandearlyagriculture,

howmuchwouldwefindmankind’sGDPgrowthtobe?Thisisaveryinterestingquestion.

Fortunately,Ihappentohavejustsuchafigure.ItwasproducedbyateamatStanford

UniversityledbyProfessorIanMorrisandusesmodernscientificmethodstoestimatethe

progressofmankindoverthelasttenthousandyears.Thisonlybecamepossiblethanksto

advancesmadeoverthelasttwentyorthirtyyears.Forthevastmajorityofmankind’s

history,economicactivityconsistedoffindingenergyandusingenergy.Correlation

betweenthisandtheGDPgrowthwearediscussingisextremelyhigh.Sointhelastsixteen

thousandyears,howhavetheconditionsbeenformankind’seconomicgrowth?

Figure2:Theeconomicprogressofhumancivilisationoverthelasttenthousandyears

Source:IanMorris,SocialDevelopment,2010

Thefigureabove(Figure2)showstheresultsoftheStanfordteam’swork.Themost

importantcomparisonisbetweenEasternandWesterncivilisation.

FromFigure2,wecanseecivilisedsociety’seconomicperformanceforthelastten

thousandplusyears.ThebluelinerepresentsWesterncivilisation,fromtheearliesttimesin

theFertileCrescenttoancientGreeceandancientRome,andfinallytoWesternEuropeand

America.TheredlinerepresentsEasterncivilisation,fromitsearliesttimesintheIndo-

GangeticplainandChina’sYellowRiverbasin,laterenteringtheYangtzeRiverbasin,and

finallyemerginginKoreaandJapan.Thelefthandsideisfromsixteenthousandyearsago;

therighthandsideisfromtoday.Withoutusinganyspecialknowledgeofstatistics,youcan

saythatthesetwocivilisationshavebeenquiteequaloverhistory.Therehavebeenminute

differencesovertimeandyouwouldbeabletoseeevenmoreminutedifferencesifyou

reallydivedintothestatistics.Butoverall,growthhasbeenverysimilarthroughouthistory.

Yetoverasmuchassixteenthousandyearsofhistory,youwouldn’tsaytherewasno

economicprogressbutyouwouldhavetosayitwasminimal.Therehavebeenupsand

downs,butoverallithasbeenasthoughwewereunabletobreakthroughaglassceiling.

Wecameclosethreeorfourtimesbutalwaysrevertedtofluctuatinginanarrowrange.

However,oncewearriveinthemodernera,wecanseethatinthelastthreehundredyears,

radicallydifferentconditionsemergedandhumanprogressshotup.Youcanseethislooks

almostlikea‘hockeystick’;itlookslikeonedollarbecomingamillion.

IfweenlargeFigure2andzoominonthesetwoorthreehundredyears,youcanseethat

thissegmentisverysimilartoFigure1.Theperformanceofequitiesoverthelasttwo

hundredyearsstronglyresemblesGDPgrowthoverthesameperiod.Andifyouzoomin

again,youcanseethatthelineisalmostvertical.Mathematicallyspeaking,thisisthe

powerofcompounding.Buttheconditionsallowingforcompoundgrowthhavenever

beforeexistedinhumanhistory;theyareapurelymodernphenomenon.

Figure3:Theeconomicprogressofhumancivilisationoverthelastfivehundredyears

Source:IanMorris,SocialDevelopment,2010

Inthelonghistoryoftheworld,GDPhasbasicallybeenflat.ThisisespeciallysoinChina.

Takingtheexampleofthelastfivehundredyears,wecanseethesuddenascendanceofthe

WestandthattheEasttrailedbyaboutonehundredyears.TheriseoftheEastone

hundredyearsagoislargelythecontributionofJapan.

AnyonewhowantstounderstandtheperformanceofEquitiesoverthelasttwohundred

yearsandtheirperformanceoverthenexttwohundredyearsneedstounderstandthisline

–thecourseofhumancivilisation.Ifyoudon’tunderstandthis,itwillbeveryhardtostay

rationalduringastockmarketcrash.Eachtimewegetintoasituationlike2008or2009,it

willfeelliketheendoftheworld.Themostimportantthingininvestingispredictingthe

futurebutasthesayinggoes,“forecastingishard,especiallywhenit’saboutthefuture”.

Whyhasmankind’seconomicprogressbeenlikethisoverthelasttwohundredyears?It’s

veryhardtomakeanykindofforecastwithoutunderstandingthisquestion.Ihavethought

aboutthisquestionforalmostthirtyyearsandputmythoughtsintoamonographtitled

“SixteenLecturesonModernisation”.Anyoneinterestediswelcometohavealook.It’s

availableonthewebandProfessorJianghasalsobroughtalongafewcopiestoday.You

canfinditonmyblog,GoogleorBaidubysearchingfor“SixteenLectureson

Modernisation”.

I’vedividedhumancivilisationintothreestages.Thefirststageistheearliesteraofhunter

gatherers.IcallthisCivilisation1.0anditbeganabout150thousandyearsafterthe

appearanceofmankind.Foraverylongtime,humancivilisationwasnotmuchdifferent

fromotheranimals.Thebiggestchangesemergedinthe9thmillenniumBCwhen

agricultureandanimalhusbandryappearedintheFertileCrescent.Similarchanges

appearedinChina’sYellowRiverregionaroundthe5thor6thmillenniumBC,bringingabout

thesecondleapinhumancivilisation.Oureconomicstrengthatthattimewasalreadyquite

strongcomparedtothehuntergathererera.IcallthisCivilisation2.0anditwasbasedon

agricultureandanimalhusbandry.Thiscarriedonrelativelyconsistentlyforseveral

millenniauntilabout1750AD.SuddenlyfromhereGDPbeganincreasingeveryyearata

constantrate,tothepointwhereweconsideritamajoreventwhenGDPdoesnotgrow.It

isevenconsideredamajoreventwhenChina’sGDPgrowthslowsfrom10%peryearto7%.

Thisisaverymodernphenomenonwhichhasalreadybecomeingrainedinourhearts.Its

causeismodernisation.ItentativelycallitCivilisation3.0.

ThiskindofdemarcationcanhelpusunderstandmoreclearlytheessenceofCivilisation3.0:

theentireeconomyexhibitscontinuous,cumulativeandcompoundinggrowthand

development.Youcanonlydiscusscapitalallocation,stocksandcashwheninvestable

financialassetsappear.Thiskindofdiscussionhasnomeaningpriortothatpoint.Inthis

way,ifyouwanttounderstandinvestingandgrowingwealth,youmustunderstandthe

sourceofwealthcreation.Theprinciplesourceisthathumancivilisationhasenjoyedover

thelasttwohundredyearscontinuous,accumulativeandcompoundingGDPgrowth.So

whatistheessenceofCivilisation3.0?Inthistime,foravarietyofreasons,modernscience

andfreemarketsappearedandtheircombinationshapedwhatweseeofCivilisation3.0.

Inthe“SixteenLecturesonModernisation”,Iexplainindetailtheprocessofmankind’s

evolutionoverthelasttenthousandplusyears.Ialsousetwoformulastounderstandthe

freemarketeconomy:‘1+1>2’and‘1+1>4’.Themostfundamentalevolutioninthe

moderneraisfreeexchange.IntheanalysisofAdamSmithandDavidRicardo,free

exchangeishowweachieve‘1+1>2’.Whensocietyadoptsthedivisionoflabourand

allowsfreeexchange,theeconomicvaluecreatedbytwopeopleortwoeconomicsystems

canbegreaterthanthevalueofwhatcouldbeproducedinisolation.Andthemorepeople

participate,thegreatertheadditionalvaluecreated.Thiskindofexchangedidexistinthe

agriculturalerabuttheappearanceofmodernscienceintensifiedthebenefitswhicharose.

Thereasonwasthatexchangemovedbeyondproducts,commoditiesandservicestothe

exchangeofknowledge.Thevaluecreatedbytheexchangeofknowledgeismuchgreater.

Accordingtomylectures,thisis‘1+1>4’.Whentwopeopleexchangeknowledge,they

learnmorethanjustwhattheotheristhinking;theirmeetingwillalsocreatethesparksof

newideas.Thesharingofknowledgerequiresnoexchangeliketradingcornformilk.But

whenyoucombineknowledgeyoubegintoseegrowthhappeninlargeincrementsthanks

tothebenefitsofcompounding.Onlywheneachexchangecanproducesuchlarge

incrementalbenefitswillsocietybeabletospeedilycreatewealth.

Thiskindofcontinuousinter-personalexchangemultipliedbillionsoftimescreatedthe

modernfreemarketeconomy.AndthisisCivilisation3.0.Continuous,sustainable

economicgrowthisonlypossiblewiththiskindofexchange.Thiskindofeconomicsystem

istheonlywaytofullyreleasemankind’senergyandtruemotivations.Thissystemis

probablythegreatestinnovationinthehistoryofmankind.Itwasonlyafterthe

appearanceofthissystemthatwesawtheotherphenomenawehavediscussed,specifically,

thecontinuousgrowthoftheeconomy.Thosestudentswhowishtolearnmorecanread

mymonograph;Iwon’tsayanythingmoreaboutthistoday.

(Clarification:continuousGDPgrowthisthemeanstomeasurecontinuouseconomic

growth)

Inflationisamonetaryphenomenon.Inflationwilloccurwhenthesupplyofmoneyinthe

economyoutstripsthesupplyofgoodsandservices.Whydoesthesupplyofmoney

increase?Thecontinuousexpansionoftheeconomyrequirescontinuousinvestment.Ina

moderneconomy,thisinvestmentmustgothroughthebanks.Banksmustpayinterestto

attractsociety’sidlecapital.Sincethisinterestratemustbepositive,banksmustalso

chargeapositivelendingrate.Andsoifyouwanttogrowthecapitalinthesystem,you

mustincreaseitsquantity.Andifyouwanttoachievegrowthintherealeconomy,there

mustbeinvestment.Thetimingdifferencebetweenthesetwoactionscreatesinflation

almostasanassociatedphenomenonofeconomicgrowth.Ifyouwanttoinvest,this

investmentwillfirstbecomeadeposit,thensemi-finishedgoodsandfinallythefinished

goodsthemselves.Andonceyoudepositthatinvestment,thesupplyofmoneywill

automaticallyexceedthesupplyofgoodsandservicesintheeconomy.It’sthistiming

differencethatcreatesinflation.Thesetwophenomena–continuouseconomicgrowthand

inflation–explainthelargedifferenceinperformancebetweenCashandEquities.

3. Whatisthe‘truepath’ofinvesting?Howdoyoubecomeanexceptionalinvestor?

Foranindividualinvestor,arelativelygoodmethodistoinvestinequitiesandstrenuously

avoidcash.Butequitymarketsarevolatileandalwaysfluctuateupanddown.Andinthe

shorttermwhenweneedcapital,thosefluctuationscanbeverysizeable.Let’slookatthis

tablebelow:

Figure4: USEquityreturnsbyperiodfrom1802to2012

FromFigure4wecanseethattheaveragelongtermreturnfromAmericanequitieshas

been6.6%.Moreover,theaveragereturneverysixdecadesorsohasbeenroughlyequalto

thisnumberandfairlyconstant.Butwhenwelookcloseratshorterperiodsoftime,wesee

thatperformanceisverydifferent.Forexample,theaveragereturninthepost-warperiod

from1946to1965wasabout10%,alothigherthanthelong-termaverage.Butinthe

followingfifteenyearsfrom1966to1981,notonlywastherenoincrease;valuesfell

continuously.Theninthenextsixteenyearsfrom1982to1999,equitiesreturnedan

averageof13.6%ayear,anotherhighrate.Buttheninthefollowingthirteenyears,

equitiesenteredanotherperiodofcontinuousdeclines.Throughoutthistime,valueswere

falling.ThisiswhyKeynesfamouslysaidthat“inthelongrun,wearealldead.”Eachoneof

ushasafiniteinvestmenthorizon.Mostinvestorswithapublicrecordhaveonlytenor

twentyyearsofresults.Butifyoumissed1981andstartedin2001or2002instead,your

tenyearsofincomemightallbenegative.Soasinvestors,ifwelookatequitiesthisway,

thenanindexmightbeOK.Butanindividual’sreturnscanbespecifictoaspecifictime

period.Youmighthavetenyearsofcontinuousnegativereturns.Butinanotherperiod,

youmightfeellikeaRockstarandearn14%annualreturnswithoutliftingafinger.Ifyou

don’tknowhowthisreturnwasobtained,youwillhavenowaytodetermineifitwas

throughluckorskill.

Ifweassumeaten-yearinvestmentperiod,youwouldfindithardtoguaranteea

considerablereturn.Thisisaproblem.Atthesametime,thestockmarket’svolatilityat

differenttimescanbeverystrong.Sothequestionwemustaddressis:isthereareliable

waytoinvestacrossdifferentperiodsoftimewhichcanproduceasuperiorreturntothe

indexwhilestillprotectingclientassets?Whichcanallowclientstoachievealongterm,

reliableandexceptionalreturnbyparticipatinginthatprocessofeconomiccompounding?

Isthereawaytoinvest–nothingheterodox–whichcanberepeatedandstudied,and

whichcanbringusthiskindofresultoverthelongterm?Thisisthequestionwewillseek

toaddress.

Inthelastfewdecades,asfarasIknow,therehasbeeneverykindofinvestmentstyle.And

asfarasIcanobserveandspeaktowithstatistics,therehasonlybeenonestylewhichhas

reliablyandsafelybroughtinvestorsexceptionallongtermreturns:valueinvesting.I

realisedthattherearescantfewlongtermtrackrecordstousetoillustratethis,andthatof

thoseIcouldfind,practicallyallwerevalueinvestors.

Thebiggesthedgefundsinthemarkettodayprimarilyinvestinbondsandhaveproduced

goodresultsovertenyearsormore.Butoverthattime,thereturnonrisk-free,long-term

bondshasgonefrom6-8%topracticallyzero.Ifyouhadusedtwotothreetimesleverage,

youwouldhaveearned10%.Ifyouhadusedfivetosixtimesleverage,youwouldhave

earnedabout13%.It’sveryhardthentotellifthesefunds’resultsareduetoluckorskill,

evenwithmorethanaten-yeartrackrecord.Everyerahasvalueinvestorswhocan

producegood,long-termresults.Today,Buffetthasa57-yeartrackrecord.Othershave

twentyorthirtyyearrecords.Withoutexception,thesepeopleareallvalueinvestors.

IfIwasintheaudiencetoday,Iwouldwanttofigureoutwhatisvalueinvestingand

understandhowtheseinvestorsobtainedtheirresults.WhenIfirstheardaboutvalue

investing,itwasBuffett’sfirsteverlectureatColumbiaUniversityandIhadcome

completelybyaccident.Theaudiencewasassmallasthisonetoday.Iwantedtofigureout

whatvalueinvestingwasandhowthesepeoplecouldcontinuouslyproducesuchgood

resultsinsuchachallengingenvironment.

Sowhatisvalueinvesting?ValueinvestingisasystemdevisedbyBenjaminGrahamwhich

firstbegantotakeshapeeightyorninetyyearsago.It’sleadingfiguretodayisnoneother

thanWarrenBuffett.Butwhatdoesitmean?Actually,it’sverysimple.Thereareonlyfour

principlesofvalueinvesting:threefromGrahamandonefromBuffett,hisunique

contribution.

First,stocksaren’tjustlittlepiecesofpaperthatyoubuyandsell.Eachoneisinfacta

certificatebestowingfractionalownershipofacompany.Thisisthefirstimportantconcept.

Whyisitimportant?Investinginstocksisactuallyinvestinginacompany.Andasthat

companygrowsalongwiththeeconomy,whenthemarketeconomycontinuestogrow,

valueitselfwillbecontinuouslycreated.Asfractionalownersofthatcompany,thevalueof

ourfractionwillgrowalongwiththevalueofthewholecompany.Soifweinvestasowners

ofabusiness,wewillbenefitasaproductofthegrowthinthevalueofthatbusiness.Thisis

sustainable.Whatistherightwaytoinvestandwhatisthewrongway?Therightwayisto

earnwhatyoudeserve.Sothiswayofinvestingistherightway.Veryfewpeopleare

willingtolookatstocksthisway.

Second,understandtheroleofthemarket.Stocksrepresentthefractionalownershipofa

businessbutontheotherhand,theyarealsotradeablesecuritieswhichcanbeboughtand

soldatanytime.Andinthismarket,thereisalwayssomeonequotingaprice.Howshould

weunderstandthisphenomenon?Valueinvestorsbelievethemarketisonlytheretoserve

you.Itcangiveyouthechancetobuyasmallpieceofabusiness.Andmanyyearslater

whenyouneedmoney,itcangiveyouawaytosellandturnthatsmallpiecebackintocash.

Thismarketcannevertellyouwhatthetruevalueofsomethingis.Itcanonlytellyouwhat

thepriceofsomethingis.Youmustneverletthemarketbecomeyourmaster.Youcan

onlyletitbeatooltoserveyou.Thisisthesecondveryimportantprinciple.Butpractically

95%ofmarketparticipantsunderstandtheopposite.

Third,investingisinherentlyaboutpredictingthefuture.Butpredictionscanneverreach

100%accuracy;theycanonlyfallbetweenzeroandsomethingapproaching100%.Sowhen

wemakeajudgement,weneedtoleavealargebuffer.Thisiscalledthemarginofsafety.

Becausethereisnowaytoeverbesure,youmustalwaysrememberthemarginofsafetyno

matterhowmanyotherthingsyougrasp.Thepriceatwhichyoubuyshouldalwaysbefar,

farbelowthecompany’sintrinsicvalue.Thisisthethirdimportantprincipleofvalue

investing.Becausewehavethefirstprinciple,weknowthatourstockisafractionalinterest

inacompany,andthatcompanyitselfhasanintrinsicvalue.Andbecausewealsoknow

thatthemarketistheretoserveus,wecanwaittobuyuntilthepriceisfar,farbelowthe

company’sintrinsicvalue.Andwhenthepricefar,farexceedsthecompany’sintrinsicvalue,

youcansell.Thiswayyouwon’tlosetoomuchmoneyifyourpredictionofthefutureis

wrong.Evenifyourpredictionproves80%or90%correct,youwillstillneverbe100%

correct.Andwhenthatremaining10%or20%probabilitymaterialisesandhasanadverse

impactontheintrinsicvalueofyourinvestment,youwon’tlosetoomuch.Andifyoudo

turnouttoberight,yourreturnwillbemuchhigherthanothers.Demandingahugemargin

ofsafetyeachtimeyouinvestisoneoftheskillsofinvesting.

Fourth,inhisfiftyyearsofpractice,Buffetthasaddedonemoreprinciple:through

unremittinghardworkoveralongperiod,investorscanbuilduptheirowncircleof

competence.Thiscangivethemadeeperunderstandingthanothersofacompanyoran

industry,andallowthemtomakebetterjudgementsoffutureperformance.Yourunique

strengthlieswithinthiscircle.

Themostimportantpartofthecircleofcompetenceistheboundary.Anabilitywithouta

boundaryisnotanability.Ifyouhaveapointofview,youmustbeabletotellmethe

[unsatisfiedconditions]forittobearealpointofview.Ifyoujustgivemeaconclusion,it

willalmostcertainlybewrongandunabletowithstandscrutiny.Whyisthecircleof

competencesoimportant?Becauseof‘Mr.Market’.Whatisthepointofthemarket?As

farasmarketparticipantsareconcerned,itistodiscovertheweaknessofhumannature.If

therearethingsthatyoudon’tunderstand,orifyouhaveanykindofpsychologicalor

physiologicalweakness,therewillbeasituationinthemarketwhichexposesyou.Anyone

who’sbeeninthemarketbeforewillunderstandexactlywhatI’mtalkingabout.The

marketisanaggregateofusall.Ifyoudon’tknowwhatyou’redoingthere,therewillbea

momentwhenthemarketknocksyoudown.Thisiswhyyouonlyeverhearstoriesabout

peoplemakingmoneyinthemarket.Butintheend,everyonelosesitall.Youonlyhear

storiesaboutnewpeoplemakingmoneybecausetheoldoneshavealldisappeared.The

marketcanseethroughyourlogicandallyourproblems.Ifyoustrayoutsideofyourcircle

ofcompetence,orifyourcirclehasnoboundaries,orifyoudon’tknowyourboundaries–

therewillbesomemomentwhenthemarkettakesyoutothecleaners.

Onlyinthissensedoesinvestingcarryrisk.It’snotthepriceofastockbouncingupand

down;it’stheriskofapermanentlossofcapital.Whetherthisriskexistsornotdependson

whetheryouhaveacircleofcompetence.Andthiscirclemustbeverysmallandverywell

defined.Onlywithinthistinycircleofcompetencewillyoubeablethroughhardworkto

makegoodpredictionsaboutthefuture.ThisisBuffett’sconcept.

ProfessorGraham’sinvestmentstylefoundcompanieswithnolong-termvalueorgrowth.

AndtheconceptofthecircleofcompetencearosefromBuffett’sownexperience.Ifyou

canreallyacceptthesefourbasicconcepts,thenyoucanbuildlong-termholdingsatlow

pricesincompanieswithinyourcircleofcompetence,andthroughthegrowthinthe

company’sownintrinsicvalueandthereturnofpricetovalue,youcanobtainlong-term,

goodandreliablereturns.

Togetherthesefourbasicconceptscomprisetheentiretyofvalueinvesting.Valueinvesting

isn’tjustsomethingthat’seasyandcleartospeakabout;it’salsotherightroadtofollow.

Therightroadisonethatissustainable.Whatissustainable?Sustainablethingsallhave

onethingincommon:fromtheperspectiveofothers,whatyoureceivehasallbeenfairly

earned.Ifyourmethodsofmakingmoneywerecompletelyrevealedtothepublicandthey

thoughtyouwereacheat,thenthosemethodswouldnotbesustainable.Ifontheother

handtheythinkyourmethodsaretrue,goodandadmirable,thenthosemethodsare

sustainable.Thisiswhat’scalledthe‘truepath’.

Whyisvalueinvestingtherightpathtofollow?Becauseittellsyouthatwhenyou’rebuying

shares,you’rebuyingpartofacompany.Investinghelpsthemarketvalueofthatcompany

comeclosertoitsintrinsicvalue.Youaren’tjusthelpingthecompanytocontinuouslygrow

itsintrinsicvalue;asthecompanygrowsandcreatesvaluewithinCivilisation3.0,itsintrinsic

valuewillgrow.Andthevalueofyourfractionalownershipofthatcompanywillgrow.And

atthesametime,youwillbegivingyourclientssomethingoflong-termbenefit:a

sustainable,reliableandsafereturn.Finally,theresultisyouwillhelptheeconomy,the

company,individualsandyourself.Earningreturnsthiswaywillmakeothersfeellikeyou’ve

deservedthem.Sothisistherightpath.Youwon'tbethrownoffcoursebytheupsand

downsofthemarket.Youwillbeabletoclearlyassessacompany’sintrinsicvalue.Youwill

haveadeeprespectforthefutureandknowtheuncertaintyinherentinprediction.

Therefore,youwilluseanappropriatemarginofsafetytomanagerisk.Thisway,youwill

notlosetoomuchwhenyouarewrong,andyouwillmakemuchmorewhenyouareright.

Thiswayyoucanletyourportfoliogeneratehigherthanmarketreturnswithlessrisk,ina

sustainableandstableway.

Ifyoustartwithnothing,takea2%commissionandthen20%ofprofits;andifyoulose,you

justcloseonecompanyandstartanotherthenextyear–whatwilleveryonethinkwhen

youtellthem?Willtheythinkthatwhatyoureceivediswhatyoudeserve?Orwillthey

thinkthatyoudeservetobeputinjail?ButifyoufollowBuffett’smethodofleavingabig

marginofsafetyandappropriatelymanagingrisk,everyonecanbeawinner.Andwhen

everyonewinsandyoucollectasmallfee,everyonewillfeelthatyouhavereceivedwhat

youdeserve.Thisistherightpathtofollowininvesting.

Thisisthesumofvalueinvesting.Itsoundseasyandlogical.Butwhataboutinpractice?

Thiskindofinvestorisfewandfarbetween.Everyinvestmenttheoryhasitsfollowersbut

therearevery,veryfewtruevalueinvestors.Consequently,oneofthecharacteristicsof

investmentisthatmostpeoplewillhavenoideawhatyouaredoing.Theresultcould

becomeharmfultoyourwealth.Thestockmarketcrashwejustwentthroughisagreat

illustration.

Sotherightpathininvestingisclearandfreefromanytraffic.Whereiseveryonegoing?

Thewrongway!Theyaretakingthewrongpath.Why?Becausetherightpathtravelsslow.

Itmaysoundlikeyoucanstrolltotheendbutthejourneyisinfactveryslow.Intheory,

valueinvestingappearslikesomethingwhichcanleadtosuccess.Butthejourneyisalong

one.Perhapswhenyoubuythemarketreallydoesn’tunderstandacompany’sintrinsic

valueandthepriceisfarbelowwhatitshouldbe.Butyouhavenoideawhenthemarket

willbecomemorereasonable.Andmuchdependsonthecompany’smanagementworking

hardtobuildthecompany’sworth.Weallknowthatacompany’ssuccessdependsonalot

ofpeople,alotoftime,alotofhardworkandalittlelucktoo.Sothisisaverydifficult

process.

Makingpredictionsaboutthefutureisalsoverydifficult.Investingistheabilitytopredict

thefuture.Youreallyneedtounderstandacompanyanditsindustryandassesstheir

outlookforthenextfiveortenyears.Cananyoneheretellmeaboutacompanywhose

futuretheycanpredictforthenextfiveyears?Itisn’teasy.Beforeinvesting,weneedto

knowataminimumwhatacompanywilllooklikeintenyearsandhowitwillbehaveina

downturn.Otherwise,howcanyoujudgethatthevalueofthiscompanywon’tdecline?To

knowwhatacompany’sfuturecashflowsareworthtoday,wemustknowapproximately

whatthosecashflowswillbeintenortwentyyears.Asthefounderofacompany,howdo

youknowaboutnextyear?Yousayyouknowtoclientsandinvestors.Sometimesyoueven

saythistoyouremployees,thingslikeyourcompanywilljointheFortune500.Butthereis

nowayyoucanreallypredicthowyourcompanywilldevelopoverthenexttenyearsor

more.Thosewhocandosoarevery,veryfew.Therearetoomanyuncertaintiesformost

companiesandindustriestomakepredictionsthatfarout.Doesthatmeantherearenone

atall?Ofcoursenot.Afteralotofhardwork,youwillseewhichcompaniesandindustries

haveaclearpictureofwhattheycouldbecomeintheworstcase.Theywillprobablyendup

muchbetterthanthis.Butitwilltakeyearsofhardworkandstudytoreachthelevelwhere

youcandothis.

Andwhenyoucanmakethiskindofjudgement,youwillstarttobuildyourcircleof

competence.Atthestart,itwillbeverynarrow.Anditwilltakealongtimetoevenget

there.Thisiswhyvalueinvestingissuchalongandslowprocess.Althoughyouwillget

thereintheend,mostpeopleareunwillingtomakethejourney.Ittakesalotoftimeand

yetevenafteralotoftime,youmaystillnotknowverymuch.

Youwon’tgoonfinancialtelevisiontovalueallcompanies,immediatelytellothersthatthis

company’ssharepriceshouldbethat.Ifyouareatruevalueinvestor,youwouldnever

darespeakthisway.Youalsowouldn’tdaretosaythat5,000pointsistoolow,thatthe

greatbullmarketisjustabouttostartorthatyouwon’tstartbargainhuntinguntil4,000

points.Youcan’tsaythesethingsandwon’tdaretomakesuchpredictions.Ifyouareareal

investor,thesethingswillobviouslybeoutsideyourcircleofcompetence.Thosewhodraw

theircirclebeyondtheirabilitywillcompletelydestroythemselvesintheend.Themarketis

amechanismfordiscoveringyourweakness.Ifthereisanareayoudon’tcompletely

understand,youwillbefoundoutandyouwillcompletelydestroyyourself.

Themostfundamentalrequirementofthisprofessioniscompleteandutterintellectual

honesty.Youshouldneverfoolyourselfbecauseyouarethemosteasilyfooled,especially

inthisprofession.Youcantalkbullshittootherpeopleandeventuallyendupbelievingit

yourself.Butthiskindofpersoncanneverbecomeanexceptionalinvestor.Theywill

withoutadoubtcomeundoneinacertainkindofmarket.That’swhyourprofession

basicallycannotproducemanyexceptionallongterminvestors.We’vetalkedtodayabout

manyso-calledstarinvestorswith20%CAGRsearnedovertenormoreyears.Butinthe

finalyeartheycloseshopafterlosingtensofpercentagepoints.Whentheystartout,their

assetsaresmall.Butwhentheylose,theirassetsarelarge.Andsowhattheyloseisfar

morethanwhattheyevermade.Yettheymakealotofmoneyforthemselves.Ifwe

countedfrombeginningtoend,theyreallyshouldn’thavemadeadollar.Thisistheunique

partoftheindustrythatwetalkedaboutearlier.

Soeventhoughthisistherightroadtofollow,successisstillalongwayoff.Manypeople

areputoffbythis.Inaddition,themarketwillalwaystemptyouwithshorttermprofits.

Yourcanhavebigchangesinyourassetsoverashortperiod,givingyoutheillusionthatyou

canearnalotofmoneyinashortperiodoftime.Soyouwillbecomeinclinedtospendyour

timeandenergymakingshorttermmarketforecasts.Thisiswhyeveryonewillinglystarts

takingshortcuts,andisn’twillingtofollowtherightpath.Andalmostalltheseshortcuts

turnouttobedeadends.Becausealmostallinvestmentstyleswhichfocusonshortterm

tradinglosemoneyoveralongenoughtime.Notonlywillyouloseyourclients’money,you

willloseyourown.Therefore,atleastinAmerica,weseeveryfewsuccessfullongterm

trackrecordsfrominvestorsofallstripeswhofocusonshorttermtrading.Andofthose

withreal,exceptionallongtermtrackrecords,virtuallyallarevalueinvestors.

Shorttermresultsoftenbenefitfromluckandhavenoconnectionwithskill.Forexample,

takeashortperiod,notevenoneortwoyearslong.Atanytime,evenoneortwoweeks,

therewillalwaysbesomerockstars.Idon’tevenknowhowmanyrockstarsemergedin

Chinaoverthelasteightmonths.Manycametoaverybadend.Intheshortterm,there

willalwaysbewinnersandlosers.Butinthelongterm,thereareveryfewwinners.One-,

two-orthree-yeartrackrecords–eventhreetofiveyear,orevenfivetotenyeartrack

records–areseldomanyuseforpredictingfutureresults.Ifsomeonetellsmethey’vehad

goodresults,sayoverfiveortenyears,ifIcan’tseetheiractualinvestmentresults,Istill

won’tbeabletojudgeifit’sdowntoluckorskill.Thisisoneofthecoreproblemsjudging

valueinvesting:isitluckorisitskill.

Themarketcandeliver14%CAGRsoverconsecutiveperiodsoffifteenyears.Inthosetimes

youdon’thavetobeagenius;it’senoughjusttobethere.Butthereareothertimeswhen

returnsarenegative.Havingagoodtrackrecordinthoseyearsisnotthesame.Soit’svery

hardtojudgeperformancewithoutseeingthecontext.Butifsomeonecanproduce

outstandingreturnsoverfifteenyearsormore,thenwecanprobablysaythey’resomething

exceptional.It’ssafetosaythere’smoreskillthanluckoverthattime.Butthisalsomeans

thatinthisprofession,ittakesyearsofhardworkbeforeyoucanpossiblyidentifytalent–

anditcanbeupwardsoffifteenyears.That’swhyalthoughthisroadleadstosuccess,there

aresofewpeoplewhofollowit.Butthisisexactlytheopportunityforthosewillingtoface

hardworkandalongjourney.Astheyprogress,thesuccessthattheyearnisseenby

everyoneaswelldeserved.Thisistheonlykindofsuccesswhichissustainable.Your

successwillbearesultofwhatyouputinandeveryonewillbeabletoseethisobjectively.

Ihopeallthestudentsheretodaycanresolvetofollowthispathandearntheirsuccessin

thisway.Youwillalsofeelcomfortablethisway.Youwon’trelyonshorttermgamesto

turnyourclients’moneyintoyourmoney.Ifyouenterthisindustrybutdon’tpossessthe

moralbottomlineItalkedaboutearlier,intheprocessofbecomingsuccessful,youwill

definitelygivethepublicopportunitiestodestroytheirwealth.Itwillbeacrime.Iremind

everyone,especiallythosestillstudyingandthinkingofjoiningtheindustry,toaskyourself

honestlyifyoucanbeagoodfiduciary.Ifnot,Iurgeyounottojointheindustry.Itwillbe

harmfultosociety.Ofcourse,youmaygetrichalongtheway.Idon’tthinkIcouldsleep

wellifitwasmebutofcourse,lotsofotherpeoplecan.Ihopethatyouaren’tthatkindof

personandthatifyoujointheindustry,youwillnotdothesekindsofthings.

Ifyouareoneofthosepeoplewithoutthefiduciarygeneandyoustilldoentertheindustry,

youwillultimatelyfinishinadeadend.Alltheshortcutswillendinabadwayandyouwill

takeyourclients’moneywithyou.Ifyouarenottoosmart,theonlyresultwillbethatyou

willloseallyourmoney.Ifyoudonottreatthepursuitofknowledgeasamoral

requirement;ifyoucannotcultivatethefiduciarygene;ifyoucannottreateverybitofclient

moneyasthoughitwasmoneythatyourparentshadscrimpedandsavedtheirwholelives

toearn;Iurgeyounottojointhisindustry.

SoIhopethateveryoneenteringthisprofessionletstheseprinciplestakeroot,andfollows

therightpath.

4. IsValueInvestingpracticableinChina?

Inwhatfollows,Iwilltalkaboutthefinalquestion:sinceValueInvestingisa‘truepath’,can

itbepracticedinChina?

Overthelastfewhundredyears,equityinvestinghasindeedgiveninvestorsgreatbenefits

overthelongterm.We’veexplainedwhy,whytheseconditionshaven’tbeenpresent

throughouthumanhistoryandhowtheyonlymaterialisedinthelastthreehundredyears.

Mankindenteredanewera,whichwecallmodernityandwhichIcallCivilisation3.0.

Modernscienceandtechnologyhavecombinedwithafreemarket.SoisChinaaspecial

case?IsitonlyAmericaandtheEuropeancountrieswhichcanproducetheseconditions?

ManypeoplehaveconcludedthatChinaisanexception,withmuchthatisdifferentfrom

America.Butforthepurposesofourdiscussiononinvestment,isChinareallyaspecialcase?

Ifmostpeoplearespeculating,priceswillatmanytimesdivergefromintrinsicvalue.So

howcanyoudetermineifChinawilloverthenextfewdecadesfollowthepathofthe

Americaneconomyandstockmarket?Ifbadmoneychasesoutthegoodmoney,pricescan

indeedgoagainstfundamentalvalueforalongtime.Howlongissufficientfor‘longterm’?

Howcanweguaranteeourfinancialassets?AndwhatifChinadoesnotimplementa

marketeconomy?Answeringthesequestionswillbecritical.Theytouchonourforecasts

forthenextseveraldecades:whatwillChinabelike?

Ihavepersonallyspentmanyyearspuzzlingoverwhethervalueinvestingcansucceedin

China.InvestinginaChinesecompanymeansinvestinginChinaitself,andthiscountry

couldwellseeayearlike1929or2008.Infact,manypeoplebelievethatthisyearwehave

alreadyencounteredsimilartimes,andthatoverthenextfewmonthswemayseemore.If

youinvest,youwillalwaysfacesuchquestionsinthemarket.Beforeyoudoanything,you

mustcarefullythinkovereveryproblem.Thisquestionisunavoidableandmustbe

addressed.

Wewillfirstusestatisticsagain.IhavecollectedwhatdataIcantocomparethe

performanceoftheChinesestockmarketagainstotherassetclasses.Figure5showsthe

performanceofAmericanassetsfromtheendof1991untiltheendoflastyear.Wecansee

thattheirperformanceisalmostthesameasoverthelasttwohundredyears.Stockshave

continuouslygainedvaluewhilecashhascontinuouslylostvalue.Thisisbecauseofthe

continuousgrowthinGDP,thesameasithasbeenoverthelasttwohundredyears.

Figure5:PerformanceofmajorAmericanassetclassesfrom1991-2014

NextwewilllookatthestatisticsforChina.The“Original8”onlylaunchedinChinain1990

andthefirstrealindexin1991.I’dliketoinviteeveryonetoguesswhatChinawaslikein

thosedays?WeknowthattheChinesestockmarkethasbeenonarollercoasteroverthe

lastthreemonths.Didstocksbehavethesamewayinthepast?Let’slookatFigure6.

Figure6:PerformanceofmajorChineseassetclassesfrom1991-2014

WhatweseeisthattheresultsinChinahavebeensimilartoAmerica’soverthelasttwo

hundredyears.From1991untiltoday,onedollarofcashhasbecome47.3cents,thesame

asinAmerica.Goldhasbeenthesame,ofcourse.TheShanghaiandShenzhenindiceshave

appreciatedsteadily.Fixedincomehasalsoappreciated.ButthedifferenceisthatChina’s

GDPhaschangedmaterially.Asaresult,thechangeinstockpricesandindicesismorein

linewiththeperformanceofGDP.Inotherwords,higherthanAmerica’s.Thisisaspecial

patternweseeinthisemergingmarket.Whatwehaveseenisthatoverthelastfew

decades,thebasicresulthasbeenthesameasAmerica’sandthatGDPgrowthhasbeenthe

samedrivingforce.Asadirectresultofhighinflation,cashhasdepreciatedandstockshave

appreciatedatahigherrate.Otherwise,thebasicresultisthesame.Thisisveryinteresting.

Figure7:ComparisonofAmericanandChinesestockindicesfrom1992tothepresent

Figure8:GDPgrowthinChina,AmericaandHongKongfrom1991-2014

WecanseethatoverthelasttwodecadesChinahasstartedthepathtowardsCivilisation

3.0andthatitsperformancehasbeenlikeAmerica’s.Yetwhilethetrendissimilar,the

speedhasbeenfaster.However,whiletheShanghaiandShenzhenindiceshaverisen15

times–anannualisedgainof12%–Idonotthinkthatanyonehasindividuallyenjoyedthe

sameresult,includingthoseinvestorssittingheretoday.Yetthereissomeonewhohas

earnedthisreturnfromthedaythestockmarketwasestablished:theChinesegovernment.

EveryoneworriesaboutthehighdebtlevelinChinabuttheyoftenforgetthattheChinese

governmentisthemajorshareholderinjustabouteverycompany.Noneofthestock

marketpuntershaveachievedthesameresult.NooneknewattheoutsetthatChinawould

enjoyalmostthesameperformanceasAmericabecausetheroadwetravelledwasnotthe

same.ButtheresultsarethesamewhenyouadoptmodernityandCivilisation3.0.

Haveindividualcompaniesalsobeenlikethis?I’vechosenseveralfamiliarcompaniesto

illustrate:ChinaVanke,GreeElectricAppliancesofZhuhai,FuyaoGlassIndustryGroup,

StatePowerandKweichowMaotai.Theyhaveallgrownfromhumbleoriginstotheir

currentsize,appreciatingbetween300and1,000times.

Figure9:PerformanceofselectedA-sharecompaniesfrom1991topresent

Hasanyonemademorethanathousandtimesonaninvestmentinthelasttwentyyears?

YouwouldhaveifyouhadinvestedinChinaVanke.Ofcourse,onlythepre-IPOstate

shareholderwasabletobecausethecompanypoppedtentimesonitsfirstdayoftrading.

Soit’sworthdenotingthispre-IPOphenomenon.Afterthefirstday,everyonecaninvest;if

youhadboughtthen,youstillcouldhaveearnedjustabout100timesforVankeand110

timesforInnerMongoliaYiliIndustrialGroup.Thisisn’tabstract;thesecompaniesareall

real.Theyallgrewfromverysmallcompaniesintoverylargecompanies.

ItwasthesameinHongKong.IfyouhadinvestedinTencentHoldings,youcouldhave

earned186times.Andthatcompanyonlylistedtenyearsago,in2004,whichisnotsolong

ago.ThesecompaniesalldoalotbusinessinChina(refertoFigure10).AnhuiConch,China

EverbrightInternational,HongKongExchangesandClearing,Li&Fungetc.It’snotonly

thesecompanies;thesearejustoneswithwhichmostofyouareprobablyfamiliar.Ijust

usetheseasexamplestoshowyouthatit’snotanabstractidea.

Figure10:PerformanceofselectedH-sharecompaniesfrom1991topresent

AtthesametimeorearlierinAmerica,thereareafewcompaniesthathaveachieved

similarreturnswithwhicheveryoneshouldbefamiliar.BerkshireHathawayhasreturned

26,000timesfrom1958untiltoday.ManyofthebestperformingcompaniesinAmerica

havealmostbeenChinesecompanieslikeBaiduandCtrip(refertoFigure11).

Figure10:PerformanceofselectedUS-listedcompaniesfrom1991topresent

I’mnottryingtohighlightanyspecificcompany.Ijustwishtoprovethatgoodreturnslike

theseexist.Stockindicesaren’tabstractthings;theyareconstitutedofindividual

companieslikethese.We’vegonedownmanyroadsoverthelasttwohundredyearsbut

oncewechosetoheadtowardsCivilisation3.0,theresultshavebeenalmostthesameas

othercountries.

Howdoyouexplainthisphenomenon?Howshouldweunderstandtheperformanceofthe

lastfewdecades?Mostimportantly,willtheChinesestockmarketproducesimilarresults

overthenextfewdecades?Whetherit’sthesamecompanyornot,willitgiveyouanother

100to1,000timesreturn?Doesthispossibilityexist?Thisisthefinalquestionwewill

answertoday.

WemustdeterminewhetherChinaisuniquebyexaminingthewholeprocessofits

modernisation.China’smodernisationbeganin1840whenitwasmadetomodernise;this

wasn’tapro-activedecision.Chinaneverwouldhavetakenthisfirststepifithadbeenleft

toitsowndevices.TheprimaryreasonisthattheChinesestatewastoostrongandnever

gavespacetoallowamarketeconomytodevelop.TherewereseveraltimesinChinese

historywhenamarketeconomyalmostblossomedbutitcouldneverreallytakeroot.From

theHanDynastyonwards,theChinesestatehasbeentheworld’smoststable,mostbig,

mostpowerfulandmostprofound.ThisisrelatedtoourgeographybutIwon’tgointothat

today.Themostimportantthingisthatbecausethiscountryhasbeenexceptionallystrong

andstableoverthelasttwothousandyears,itcouldnevergivebirthtoCivilisation3.0.But

thatdoesn’tmeanCivilisation3.0couldn’tbeforceduponit.

Themodernisationweseetodaywasn’tasimplemodernisationofoursystemasthe

changessince1840areoftenunderstood.Itwasn’taculturalchangeorachangeinthe

economicsystem.Itwasachangeincivilisation.

Thischangeincivilisationisakintotheagriculturalrevolutionseen9,000yearsBC.That

revolutioncameaboutthroughaccidentalfactors.Afterthelasticeageendedinthe

MiddleEast,agriculturebecamepossible.IntheFertileCrescent,therewerewildplants

whichcouldbefarmedandwildanimalswhichcouldbedomesticated.Andonce

agriculturehadtakenrootthere,itquicklyspreadtoeverycorneroftheworld.Today’s

Civilisation3.0isanovelcombinationofamarketeconomywithmodernscienceand

technology.AsCivilisation3.0haspropagatedoverthelasttwohundredyears,wecansee

manysimilaritieswiththepropagationofCivilisation2.0.

TheriseofCivilisation3.0resemblesthatofCivilisation2.0:almosteverythingboilsdownto

asetoffortuitousincidentscreatedbygeography.Nothingwasinevitable.Becauseofits

location,WesternEuropewasthefirsttodiscovertheAmericas.TheAmericasareonly

3,000milesfromWesternEuropebutmorethan6,000milesacrossthePacificfromChina

andpracticallyspeaking,closerto9,000milesduetooceancurrents.Chinawasalsonot

motivatedtogototheAmericas.Followingthisdiscovery,atrans-Atlanticeconomy

emerged.Themostspecialpartofthiseconomywasthatthegovernmentwasnotinvolved.

Itwasonlyundertheseconditionsthataneweconomicmodelcouldemergebasedonthe

absenceofgovernment,freeenterpriseandtheprimacyoftheindividual.Thiseconomic

modelchallengedmankind’sworldviewandinresponseprovokedmodernscience.Modern

scienceinturnbroughtitsownrevolution,re-examiningancientknowledgeandsparking

theEnlightenment.Itwasonlywiththisbackgroundandundertheseconditionsthat

Civilisation3.0couldbeformed.

TheseconditionscouldneverhavematerialisedinChinesesociety.Butaswesawwith

Civilisation2.0,onceanewmodelappears,itwillrapidlyspreadaroundtheworldto

supplanttheoldmodel.Thishastodowithhumannature.Perourunderstandingof

ancestralbiology,mansharesacommonnature,ancestorsfromacommonlocationand

fromacommonspecies.ManbeganhisexodusfromAfrica50or60thousandyearsago

andtookabout35thousandyearstospreadaroundtheworld.Hislinefollowedmany

differentpaths,onebranchofwhichbecameEurope,anotherChinaandfinallyonce

coveringtheAmericancontinent.Asaresult,humannatureisevenlydistributed,whether

itisintelligence,enterpriseorcompassion.[Asaspecies,mankindseeksanequalityof

outcomesandacceptsanequalityofopportunities.]Seekinganequalityofoutcomesspurs

moreadvancedmodelsofcivilisationtorapidlypropagatearoundtheworld.[The

mechanismforacceptinganequalityofopportunitiesspurseachsocietytohaveitsown

cultureandcreateitsownsystems,andtoletthempenetrateintoeventhemostbackward

ofplaces.]Butthisprocessfrominequalitytoequalityisaverypainfulone.

Sothepropagationofcivilisationwillhappensoonerorlater.Placeswitharelatively

advancedcivilisationandculturewillassimilatequicker.Thosewithoutahistoryof

colonisationwillalsobefaster.ThisiswhyJapanwasthefirstcountryinAsiatomodernise.

ChinahasfollowedbutIndiahasbeenslowerbecauseitwasfullycolonised.

Wewon’tgointothosedetailsnowbutsufficeittosaythatChinahasbeenundergoingthe

processofmodernisationsinceabout1840–buthasneverfullyunderstoodthenatureof

modernity.Since1840,wehavetriedjustabouteverymethodthereis.Theearliestwas

theSelf-StrengtheningMovementwhichbelievedthatitwouldbeenoughtolearnWestern

scienceandtechnology,andtoleaveeverythingelseasitwas.Itdidn’tworkandwesaw

theTaipingRebellionandtheJapaneseOccupation.ChinanevertriedtoemulateJapan’s

pathtomodernity,largelybecausewebelievedthatwemustdothecontrarytowhatever

roadtheyfollowed.Inthefirstthirtyyearsafter1949,wefollowedyetanotherpath,the

collectiveeconomy,awhollyplannedeconomicsystem.Wehavemoreorlesstried

everythingonce.Thenfromtheendofthe1970s,wefinallytriedsomethingwhichwould

bringustoCivilisation3.0:afreemarketcombinedwithmodernscienceandtechnology.

Wehadtriedeverythingelseoverahundredandfiftyyearsupuntilthatpointwithout

success.Thepoliticalsystemhasnotseengreatchangeandnorhasourculture.Butinthe

last35years,China’sentireeconomicsystemhassuddenlybecomeamazinglyconsistent

withthatofCivilisation3.0.

Inotherwords,ChinatrulyenteredCivilisation3.0inthelast35years.Priortothis,our

pathtomodernityovertheprevious150yearswastortuous.Therearemanyreasonswhy

butweneverwereheadingintherightdirection.

Itwasonly35yearsagothatwe[returnedto]theessenceofCivilisation3.0,thefreemarket

economyandmodernscienceandtechnology.Butassoonaswestarteddownthispath,

theperformanceoftheChineseeconomyhasshownastrikingsimilaritytootherCivilisation

3.0economies.Aswe’vejustseeninthetableabove,overthelast20and30years,the

performanceofstocksandcompanieshasbeentrulyamazing.WhenChinabeganto

resembleCivilisation3.0,thewayitmanifesteditselfwasvirtuallythesameasother

Civilisation3.0countries.Sointhisrespect,Chinaisnotunique.WhereChinaisuniqueis

thatitscultureandpoliticalsystemaredifferent.Butaswe’veseen,thesearenotthe

essentialelementsofCivilisation3.0.

CanChinadeviatefromthispath?BecauseChina’spoliticalsystemisdifferent,many

foreignanddomesticinvestorshavedeepsuspicions.Afterall,Chinahashadthisformof

politicalsystemforalmosttwohundredyearsandhastestedmanydifferentdirections

towardsmodernity.Couldweheadinreverse?

Weknowthatinthefirstthirtyyearsafter1949,Chinaconfiscatedprivatepropertyand

pursuedcollectivisation.Itcoulddosobecauseofourpoliticalsystem.Couldwedoan

aboutfacenowandabandonthemarketeconomy?Thisisaquestionthatinvestorsmust

considercarefully,otherwiseitisextremelydifficulttopredicttheprospectsofCivilisation

3.0inChinaandthepotentialsuccessofvalueinvestingtherein.Ifyoucan’tanswer,or

thinkaboutitclearly,orareunsureinyourheart,themarketwillexposeyou.Onlyifyou

aren’tclearwillyoumakeamistakeandbeshakenout.

Thereisnouniformanswertothesequestions,andtheyhavebeenporedoverby

generationaftergenerationofintellectualsoverthelasttwohundredyears.Thequestions

I’vesharedtodayaremyown,andaresomethingI’vepuzzledoverfordecades.

Mythoughtsareasfollows.WemuststudytheironlawsofCivilisation3.0.We’vealready

madeasuperficialstudyofhowCivilisation3.0candeliversustainable,longtermand

continuouscompoundeconomicgrowththroughfreeexchangeproducingaddedvalue.

Scienceandtechnologyservetoacceleratethisprocess.Asmorepeopleandmore

countriespartakeinthiskindofexchange,thevalueaddedtheycreatebecomesgreater

andgreater.ThiswasAdamSmith’sinsightanditwasextendedbyRicardotoincorporate

tradebetweencountriesandeconomicsystems,therebylayingthefoundationforfree

trade.Anaturalfollow-onconclusionfromthesetheoriesisthatscaleadvantageswill

emergeinlargermarkets.Andthankstothesescaleadvantages,largermarketswill

graduallycompeteawaysmallermarkets.Thatistosay,eventually,thelargestmarketwill

becometheonlymarket.

ThiswouldhavebeenunimaginableunderCivilisation2.0.Freetradewasaresultofthese

insightsandwithouttheseinsights,therewouldcertainlynothavebeenanyfreetrade–not

tomentiontheglobalisationwhichfollowed.Thefinalproofofthisprocesswhichbegan

withtheBritishinthe18thand19thcenturiesonlycameatthestartofthe1990swiththe

firstemergenceofglobalisation.Lookingbackfromtodaytotheemergenceofglobalisation,

wecanderiveanewinference:whentwodifferentsystemscompete,andoneisadding

valueatarateof‘1+1>2’whiletheotherisaddingvalueattherateof‘1+1>4’,thepace

ofaccumulationinthelatterwilleventuallybesogreatthatitbecomestheonlymarket.

Thishadneveroccurredthroughouthistoryuntiltheearlytomid-1990s,andwillnever

happenagain.Ricardobelievedthatwhentwopartiesengagedintrade,bothwouldbe

betteroff.Thiswasthecaseforfreetrade.Butheneverexpectedthattheprocesswould

resultinallmarketsultimatelybecomingasingleglobalmarket–thelargestmarketbecame

theonlymarket.Thisiswhatultimatelytranspiredinthemid-1990s.

Thishasbeenpreciselythetrendofhistoryoverthelastfewdecades.Inthebeginning,

therewasthetrans-AtlantictradebetweenBritainandAmerica.Theytookthisconceptof

tradeandpusheditontotheircolonies.Theyfoughtthetwoworldwars.Andafterthe

secondworldwar,twodistinctbutclosedeconomicblocstookshape,onecentredaround

theUS,WesternEuropeandJapan;theotheraroundtheSovietUnionandChina.The

formerwasobviouslylargerandbecameevermoreefficientbecauseitsubscribedtothe

principlesofthemarketeconomy.Thetwoblocswerewellmatchedtobeginwithbutafter

severaldecades,youcouldseeagapbetweenAmericaandtheSovietUnion;agapbetween

WestandEastGermany;agapbetweenmainlandChinaandHongKongandTaiwanetc.It’s

thesamekindofgapthatweseetodaybetweenSouthandNorthKorea.Theresultwas

thatintheearly1990safterthecollapseoftheBerlinWallandChina’sembraceofamarket

economy,wesawforthefirsttimeinhumanhistorytheemergenceofanewphenomenon

calledglobalisation.ThisiswhenthenatureofCivilisation3.0becametrulyevident.Icall

thisanIronLawofCivilisation3.0:aglobal,unifiedandcommoneconomicsystemwithfree

trade,freeexchangeandfreemarketsatitsheart.

Marketsenjoyeconomiesofscale:asthenumberofparticipantsandexchangesincrease,

themoreincrementalvaluewillbecreated.Themoreefficienttheallocationofresources,

themoreproductive,wealthyandsuccessfultheeconomywillbecome,andthemoreableit

willbetoproduceandsupporthigh-endtechnology.Betweentwocompetingmarkets,the

largermarketwilleventuallybecometheonlymarket.Andanyperson,industryorcountry

whichleavesthelargestmarketwillregressandultimatelybeforcedtore-join.Thebest

wayforacountrytoincreaseitsstrengthistolowertariffsandjointheglobaleconomy.

Thebestwayforacountrytofallbehindistoshutitselfoff.Throughthemarket

mechanism,modernscienceandtechnologywillcontinuetoadvance,andcostswill

continuetodecline.Combinedwithmankind’sinsatiabledemand,theeconomywill

continueitscumulativegrowth.Thisistheessenceofmodernity.Afterthisphenomenon

emerged,wecouldunderstandthegapbetweenEastandWestGermany;betweenNorth

andSouthKorea;andbetweenpre-reformChinaandHongKongandTaiwan.WhydidIran

giveupitsnuclearweaponsprogramme?Tore-jointheglobaleconomy,theonlyeconomy.

AcountryassmallasIrancouldnotsustainadvancedtechnologieswhilesealedofffromthe

world.AndifyouthinkIranisn’tagoodexample,howaboutChina?OrifnotChina,then

howabouttheSovietUnion?

Thespeedofnewinformationisnowsuchthatweaccumulateinjustafewyearsthesum

totalofeverythingthatcamebefore.Inthelastdecade,thispacehadusdoublingevery

eightyears.Inthenextdecade,Ithinkitwillacceleratefurther.TheIronLawof‘1+1>4’

willcontinuouslyrepeatandataneverfasterspeed.Smallmarketswillfallbehind.China

hasalreadybeenamemberoftheWorldTradeOrganisationfor15years,andbeforethis

hadalreadyhadamarketeconomyfor20-30years.Inthisenvironment,anyeconomic

systemwhichchoosestostandalonewillinshortorderbecomearelativelysmallmarket,

andwillinevitablyfallfurtherandfurtherbehind.IfChinachangestherulesofitsmarketor

leavesthecommonmarket,itwill,inarelativelyshorttime,rapidlyfallbehind.Iam

confidentthatinacountryasmature,historicallysuccessfulandculturallyadvancedas

China,thiswouldnotbeacceptabletomostpeople.It’snotthatthereisnochancethat

Chinawon’tleavethisbigmarketforbriefmoments;it’sjustthatChinaisunlikelytobea

loserforever.Chinesepeoplewillnotwillinglyloseafterexperiencingseveralmillenniaof

success.SoiftherearebriefmomentswhentheydeviatefromthepathofCivilisation3.0,

theywillquicklymakeamendsandcomeback.

However,whilethesedeviationsmightlooksmallinthelongcourseofhistory,theymight

berelativelylonginthecourseofourownlives.Butinthisstretch,therecanstillbefree

marketsandwecanstillfindasufficientmarginofsafety.Wecanenduretheseperiods.

[Theseperiodsarenomorescarythanthecontinuousmarketlowswehaveseenoverthe

lastdecade].Whenyouholdthistobetrue,yourunderstandingoftheIronLawof

Civilisation3.0willstillallowtoinvestwithasufficientmarginofsafety.

Withthesereasonsinmind,let’scomebacktotheprospectsforvalueinvestinginChina.

IthinkthatChinaistodaysomewhereinbetweenCivilisation2.0and3.0;let’scallit

Civilisation2.5.We’vealreadycomealongwaybutthereisstillalongwaytogo.Ibelieve

thatthereisahighprobabilitythatChinawillcontinuealongthiscoursebecausethecostof

notdoingsoisveryhigh.IfyoureallyunderstandthehistoryoftheChinesecultureandthe

Chineserace,especiallysincetheyhavecometounderstandthenatureofmodernity,then

youwouldappreciatetheprobabilityofthemreversingcourseisverylow.Theprobability

ofChinaleavingtheglobalcommonmarketispracticallyzero.TheprobabilityofChina

movingawayfromamarketeconomyisalsoverylow.Therefore,theprobabilityofChina

remainingintheglobaleconomyandcontinuingtoimplementafreemarketeconomyand

moderntechnologyisveryhigh.Andwe’veseenthattherelationshipbetweenCivilisation

3.0andpoliticsorcultureisnotverystrong,whiletherelationshipbetweenCivilisation3.0

andfreemarketsandmoderntechnologyisverystrong.Thisisthebiggest

misunderstandingmostinvestorshaveofChina,especiallyWesterninvestors.

Chinawillonlybeabletodeliverreturnsinitsmajorassetclassessimilartothehistoric

returnsseenindevelopedmarketsoverthelast300yearsifitcontinuesdownthepathto

Civilisation3.0andpersistswithfreemarketsandmodernscienceandtechnology.Ifitdoes,

theeconomywillcontinueitscumulativegrowth,creatingtheinflationwhichwillsee

equitiesoutperformotherassetclasses.Andvalueinvestingwillofferthesamepromiseas

inAmericatodeliverclientssustainable,stable,safeandreliableinvestmentreturns.Thisis

theprimaryreasonwhyIbelievevalueinvestingcanbepracticedinChina.

Ibelievethatvalueinvestingisn’tlimitedtoChina,eventhoughinitspresentimmature

stageChinadoesoffervalueinvestorsmanyadvantages.AcrossChina’scapitalmarkets,70%

ofinvestorsarestillretailinvestorswhofocusonshorttermtrading.Eveninstitutional

investorsstillfocusonshorttermtrading.Priceswilloftendeviatewidelyfromintrinsic

valueasaresult,creatinguniqueinvestmentopportunities.Ifyoucanavoidbeingconfused

bytheseshorttermtradesandreallypersistwithlongtermvalueinvesting,youwillhave

fewcompetitorsandyourchancesofsuccesswillbemuchhigher.

Chinaiscarryingoutatransformationofitseconomytoallowfinancialmarketstoplaya

greaterroleinfinancing.Indirectbankfinancingwillnolongerbetheprimarysourceof

capital.Instead,theequityandfixedincomemarketswillbecometheprimarysourceof

capitalandthemaintoolsforcapitalallocation.Thescale,institutionalisationandmaturity

ofthecapitalmarketswillallbelifted.Ofcourse,ifyoulimityourselftowhat’sinfrontof

youreyes,youmightcomplainaboutthegovernment’sexcessiveinterventioninthemarket

anditsinjustice.However,Ibelievethatifyoulookfurtherout,China’seconomyisstill

headinginadirectionthatwillseetheroleofthemarketincrease,withmoreinstitutional

investingandagreatermaturity.Thesewillallplayanimportantroleinthenextstageof

development.Truevalueinvestorswillserveanevergreaterpurpose.

Soseeinghowyoungeveryonehereistoday,Ifeelalittleenvyinmyheart.Ibelievethatin

yourtime,asvalueinvestors,youwillcomeacrossmoreopportunitiesthanIhaveleft.I

feelveryluckythatinthelasttwentyyearsIcouldstudyvalueinvestingunderthetutelage

ofthegreatmasters,andtolearnandpracticeundertheirwatch.Youwillbeevenluckier.

ButIstillhopethateveryonecanalwaysholdontothefeelingyouhavenow,andalways

rememberthetwomoralbottomlines.First,alwaysunderstandyourfiduciaryduty.Treat

clients’moneyasyourown.Treatitasthenesteggthatyourparentssweatedandslaved

theirwholelivestoearn.Onlythenwillyoubeabletomanageitwell.Second,youmust

makethepursuitofwisdomandknowledgeyourmoralresponsibility.Youmustconsciously

distinguishbetweentherealandfalsetheoriesinthemarkettopursuetrueinsight.And

onlythroughhardworkoveralongperiodoftimewillyoubeabletosucceedandearnthe

returnswhichyourclientsdeservetoearn.Andinthisyouwillbeabletomakeyour

contributiontothedevelopmentofChina’seconomyduringthistransformativeperiod–a

win-win-winforthecountry,yourfamilyandyourself.

Isincerelyhopethateveryoneherecanboldlygoforwarddowntherightpath!Theroadis

clearandthesceneryisespeciallynice.Don’tbelonelybecausethisprofessionisfullof

everykindofcuriosity,challengeandlandscape.Ihaveconfidencethateveryoneherewill

haveagoodfuture.Ifyoupersistforfifteenyears,youwilldefinitelybecomeoutstanding

investors!Thankyou!

Li Lu: The Prospects for Value Investing in China October ... · charged borders on the outrageous....

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