Investment Notes #3: Corporate Failure, Li Lu, Charts

As investors, we are always searching for more upside (higher growth, bigger market share, improved margins, increased dividend payouts, etc.)

There are at least two issues with such an approach. Firstly, by focusing solely on the upside, we miss risks associated with a specific investment opportunity. Avoiding risks is more important than chasing upside, definitely in the long term.

Secondly, we become exposed to the survivorship bias.

As the legendary investor Charlie Munger used to say: “Invert. Always Invert.”

In other words, when seeking the best companies to invest in, first consider what makes a company the worst investment. By eliminating all the qualities that lead to corporate failure, you will be left with a more robust framework for finding long-term winners.

I am glad that during my last trip to Omaha in May 2024, I picked up this short and not-so-recent book at Epsley Airport on my way back to London.

The book deals precisely with the topic of corporate failure. It was written by Don Keough, a friend of Warren Buffett, who has had an equally exciting career, having served as the president of Coca-Cola, chairman of Allen & Company and a board member of several leading companies, including Berkshire Hathaway.

Even more exciting is the fact that just like Buffett, Don Keough was born and grew up in Omaha on the same street (Farnam).

Here is what Warren Buffett wrote about Don in the introduction to the book:

The book covers the ten most common reasons that lead to corporate failure. I think it is essential to periodically review them, especially before making a new long-term investment.

— Don Keough

You can read the summary of the Ten Commandments in my latest Book Review.

Li Lu is a remarkable investor. In 1989 (at 23 years old), he was granted asylum in the US. He did not speak English and, with no financial means, had to rely on human rights activists. He learnt about stock investing at Columbia University, where he graduated in 1996.

He used a student loan to invest in stocks and went from a negative net worth to his first capital (over $100k, according to some accounts).

He became friends with Charlie Munger, whom he met in 2003. They have maintained a close relationship since then until Charlie’s death last year. Munger invested $88mn in Li Lu’s fund.

FT had an interesting story on Li Lu’s journey last year.

Unlike some other investors, he has given many talks.

This month, he gave a rare interview to the Chinese media, sharing his thoughts on Charlie Munger, Tesla and BYD, AI and, of course, value investing.

The original transcript is in Chinese, but I have shared an automatically translated version here.

1. Are Mag7 stocks in a Bubble?

If you just focus on the bottom-up fundamentals of the Mag7 stocks, you would not call them a bubble. Few other companies have delivered such consistent double-digit growth, expanded margins, maintained net cash balance sheets and enjoyed high FCF conversion with generous buybacks.

Yet this chart from BofA suggests that they could be the biggest bubble in recent history.