Core Philosophy: Anchoring to Business Quality, Not Price

 

Core Philosophy: Anchoring to Business Quality, Not Price

The guide's foundation is pure quality-focused, long-term ownership. It echoes the philosophies of Warren Buffett, Charlie Munger, and Philip Fisher (whose quote concludes it). The central message is: your decision to sell should be tied to the underlying business's fundamentals and your personal capital needs, not to stock price movements or market noise.

---

Analysis of "WHEN TO SELL" (The Valid Reasons)

1. WRONG FACTS: This is the "admit your mistake" clause. It requires intellectual honesty. If your initial thesis was flawed (you overestimated management, misunderstood the business model, or missed a weak moat), selling is correct. Pride and ego are the enemies here.

2. CHANGING FACTS: This is crucial for dynamic investing. A business is not a static asset. Deteriorating fundamentals (falling returns on capital, poor acquisitions, ethical lapses in management) invalidate the original reason to hold. This forces continuous monitoring of the business, not the stock quote.

3. NO CASH FOR A BETTER OPPORTUNITY: This is a sophisticated portfolio management concept. It acknowledges opportunity cost. However, it comes with a major caveat: you must be highly confident that the new opportunity is significantly better. Swapping a great business for a marginally cheaper one is often a mistake.

4. NEED CASH: A practical, non-investment reason. It underscores that investing serves life goals. This reason should be planned for (via an emergency fund or staggered liquidity needs) to avoid forced selling at inopportune times.

The common thread: Each valid reason is fundamental or personal, not technical or speculative.

---

Analysis of "DO NOT SELL" (The Behavioral Pitfalls)

This section brilliantly tackles the emotional reflexes that destroy long-term returns.

1. "STOCK IS OVERPRICED":

   • Challenges Market Timing: It rightly questions the investor's ability to define "overpriced" for a compounding machine. A high P/E ratio can persist for years if growth continues.

   • Forward-Looking Perspective: It shifts focus from static multiples to the 10-year potential. This is the heart of value investing—estimating future cash flows.

   • The Compounding Argument: The "quadruple in size" example is powerful. If you expect 15% annualized returns, paying a 50% premium today might still deliver outstanding absolute returns over a decade. The real risk is selling a compounder and missing the entire journey.

2. "OTHER REASONS": These are pure behavioral errors:

   • Anchoring to Purchase Price: Irrelevant to the stock's future. The market doesn't care what you paid.

   • "Surged 50%" / "Paper Profits": Reflects a scarcity mindset, treating profits as something to be "captured" rather as evidence of a working thesis. It confuses volatility with permanent loss.

   • "Sell to Buy Lower": Attempts to time the market, a famously losing game. The risk of the stock continuing upward and never returning to your buy price is high.

---

Commentary & Practical Insights

Strengths:

• Discipline Framework: It provides a clear checklist to curb emotional selling.

• Emphasis on Business Quality: It keeps the investor's eyes on what matters—durable competitive advantages and capable management.

• Long-Term Orientation: It forcefully aligns the investor with the power of compounding.

Challenges & Nuances:

• Execution is Hard: The discipline requires immense patience and the ability to watch portfolios decline 30-40% without panicking, trusting the business quality.

• Valuation Still Matters (Subtly): While arguing against selling for being "overpriced," the philosophy doesn't advocate buying at any price. The "expected returns over 10 years" inherently includes a judgment on current price. A price so high that it guarantees poor returns for a decade is a valid reason not to buy, and arguably to sell if you own it.

• "Almost Never" is Extreme: Philip Fisher's quote is inspirational, but few businesses remain outstanding for 50 years. Industries disrupt, scales diseconomies emerge, and management changes. The "Changing Facts" reason is the necessary counterbalance to "almost never."

• Portfolio Concentration: This approach works best for a concentrated portfolio of high-conviction ideas. It is difficult to follow if you own 50 stocks, as you cannot know each business well enough to judge "changing facts."

Conclusion

This guide is a masterclass in investor psychology and business-focused investing. It's not a trading manual; it's an ownership manual. Its greatest value is inverting the typical investor's mindset: instead of asking "Should I take profits?" it forces the questions "Is the business still great?" and "Do I need the capital for something more pressing?"

For the individual investor, adopting this framework means:

1. Doing deep research before buying (so you have a "fact base" to judge later).

2. Developing the fortitude to ignore short-term price volatility.

3. Having a systematic process to periodically review business fundamentals—not stock charts.

It’s a simple, but not easy, path to long-term wealth creation.

Li Lu's Value Investing Strategies Explained

Based on the lecture transcript, Li Lu presents a disciplined and high-conviction approach to value investing. The core of his strategy is a fundamental mindset shift: viewing stock ownership as buying into a real business, not just trading a piece of paper.

Below is a summary of the main points from his 2006 lecture, followed by a discussion and analysis of his key principles.

📝 Summary of Li Lu's 2006 Lecture at Columbia Business School

The central theme of Li Lu's lecture is the psychology and practice of being a true value investor. He frames this as belonging to a rare "genetically mutated" 5% minority of market participants, defined by a distinct mindset rather than just a strategy

💡 Discussion and Commentary on Key Ideas

Li Lu's framework is more than a checklist; it's a philosophy for navigating financial markets.

• The "Two Markets" Theory: Li Lu posits there are effectively two markets. The first is designed for the 95%—traders and speculators motivated by gambling instincts and short-term price movements. The second is for the 5%—long-term owners who use the first market's emotional volatility to acquire ownership stakes in businesses. This explains why, despite its proven long-term success, value investing remains a minority discipline.

• From Analyst to Owner: His emphasis on "encyclopedic knowledge" and acting as an investigative journalist (as seen in the Timberland case study, where he researched lawsuits and met management) bridges the gap between theory and practice. His checklist ends with the crucial question, "What did I miss?" underscoring a focus on avoiding errors and psychological pitfalls.

• Concentration vs. Diversification: His strategy leans heavily toward the Buffett/Munger school of making large, concentrated bets on high-conviction ideas, as opposed to the Graham/Tweedy Brown approach of holding many statistically cheap stocks. Modern portfolio data shows he practices this: his top five holdings consistently make up over 85-90% of his portfolio.

• Evolution of a Value Investor: The lecture hints at the investor's journey. Beginners might find "cigar-butt" opportunities like Timberland (which rose ~700% in two years). The ultimate goal, however, is to find exceptional "compounder" businesses where the math of high returns on capital creates immense wealth over decades, making selling a tax-inefficient mistake. His early and massive investment in BYD, which grew exponentially for Berkshire Hathaway and his own funds, is a real-world example of this principle in action.

🔍 Connection to Broader Themes & Current Practice

Li Lu's teachings are part of a continuous intellectual tradition and are reflected in his current investment decisions.

• Intellectual Heritage: His philosophy is deeply interwoven with the teachings of Benjamin Graham (Mr. Market, margin of safety) and, more significantly, Charlie Munger (circle of competence, worldly wisdom, mental models). Munger is his direct mentor and partner, and Li Lu credits him for evolving his thinking beyond pure quantitative bargains.

• Modern Application: While the lecture is from 2006, his principles remain consistent. In a 2019 speech, he distilled value investing into four core concepts: stock as ownership, margin of safety, Mr. Market, and circle of competence. He also advises investors to "take the macro as it is" and focus on the micro-analysis of businesses they can understand.

• Portfolio as a Reflection: His current portfolio is a testament to his philosophy. It is hyper-concentrated, with a recent top-five holding percentage of 94.08%. Major holdings include Alphabet (a modern "compounder"), Berkshire Hathaway (alignment with mentors), and Bank of America (a traditional value play), demonstrating application across different business types.

In conclusion, Li Lu's strategies offer a powerful, psychology-centric framework for value investing. Its difficulty lies not in complexity, but in the discipline and temperament required to execute it consistently against the crowd.

Read more:

Li Lu sharing his Value Investing Strategies

https://myinvestingnotes.blogspot.com/2010/06/li-lu-sharing-his-value-investing.html

Donald Yacktman's Investment Strategy. "A low purchase price covers a lot of sins."

 

Donald Yacktman's Investment strategy and methodology. “A low purchase price covers a lot of sins.”

https://myinvestingnotes.blogspot.com/2010/02/investment-strategy-and-methodology-low.html

Executive Summary: Donald Yacktman's Investment Strategy

For the disciplined, long-term investor, Donald Yacktman's approach offers a masterclass in rational, cash-flow-focused value investing. The core takeaway is this: Invest like you're buying a bond with a growing coupon, not trading a stock ticker.

Here’s the actionable framework:

1. The Guiding Principle: The "Forward Rate of Return"
This is the heart of the strategy. When evaluating any stock, calculate its expected annual return as:

Forward Rate of Return = Current Free Cash Flow Yield + Annual Growth in Free Cash Flow + Inflation Adjustment.
For example, if a stock trades at a price that gives an 8% free cash flow yield and you expect 5% growth, your estimated return is ~13%. This metric directly competes with bond yields and other stocks.

2. Market & Macro View: Ignore the Noise, Focus on the Business

• Do Not try to time the market or predict economic cycles. It's a distraction.

• Do assess how a specific business will perform through cycles. Avoid assuming peak earnings or margins will last forever.

3. Cash is a Strategic Outcome, Not a Market Bet
Your cash balance is a natural result of your investment criteria, not a tactical forecast.

• Cash rises when you can't find stocks meeting your minimum required return (e.g., 30% in 2007).

• Cash falls when bargains are abundant (e.g., 0% in late 2008).

• Holding cash is acceptable; forcing investments in an overvalued market is not.

4. The Sell Discipline: It's All About Relative Value
Forget price targets. You sell for only two reasons:

1. The stock's forward rate of return has fallen below your minimum threshold.

2. You find a significantly better opportunity with a higher risk-adjusted return.
   This process naturally trims winners and recycles capital into undervalued assets.

5. The Ultimate Margin of Safety: A Low Purchase Price
Yacktman’s key adage: "A low purchase price covers a lot of sins." Even if your analysis is slightly off, a cheap entry point provides critical protection against permanent capital loss.

Current Application (as of early 2010):
Following this framework, Yacktman finds value in high-quality businesses with predictable cash flows that are temporarily out of favor—like media (News Corp, Viacom) and consumer staples (PepsiCo). The model demands patience and the courage to buy during declines, but it systematically directs capital to its most efficient use.

Investor's Bottom Line: Yacktman’s strategy is a powerful, self-correcting system. It removes emotion and macro speculation, replacing them with a cold, comparative analysis of cash flow returns. For an investor seeking to build wealth over decades, this discipline of buying "dollar bills for 40 cents" and holding until the value proposition erodes is a timeless and effective approach.

This is a solid, time-tested value investing checklist suitable for long-term investors seeking to build wealth steadily while avoiding big mistakes.

 

This chart outlines Terry Smith's investing philosophy, as summarized by Brian Feroldi. Smith is a well-known value-oriented fund manager (Fundsmith), and his principles emphasize quality, patience, and discipline. Below is a breakdown and analysis of each section:

---

1. The Rule of 3

• Buy Good Companies – Focus on quality businesses with durable competitive advantages.

• Don’t Overpay – Even great companies can be bad investments if bought at too high a price.

• Do Nothing – Avoid overtrading; let compounding work over time.

Comment:
This is a distilled version of Warren Buffett’s philosophy: buy wonderful businesses at fair prices and hold them. “Do nothing” is especially important—many investors hurt returns by over-trading.

---

2. Disqualifying Features

• Start by eliminating bad companies rather than searching for good ones.

• Reduces the risk of catastrophic losses.

Comment:
This is a practical risk-management tool. By filtering out companies with poor economics, high debt, or dubious governance first, you save time and avoid “value traps.”

---

3. High Returns on Capital

• ROIC (Return on Invested Capital) is a key metric for quality.

• Formula:

  $$ROIC=\frac{\text{Net Operating Profit After Tax}}{\text{Invested Capital}}$$

Comment:
ROIC measures how efficiently a company uses its capital. Consistently high ROIC often indicates a moat and competent management. Terry Smith heavily emphasizes this in his stock selection.

---

4. Look for High FCF Yields

• Free Cash Flow Yield compares FCF to the company’s market value.

• Formula:

  $$\text{FCF Yield}=\frac{\text{Free Cash Flow}}{\text{Market Value of the Company}}$$

• Compare to “3% over expected inflation” as a hurdle rate.

Comment:
FCF is harder to manipulate than earnings. A high FCF yield can signal undervaluation, but it must be considered alongside business quality—a declining business may have a high but unsustainable yield.

---

5. Create a Watchlist

• Track companies that are good but not cheap enough.

• Use price targets to wait for the right entry point.

Comment:
This encourages patience and preparedness. Many investors miss opportunities because they don’t track companies systematically over time.

---

6. Exploit Advantages of Being an Individual Investor

• Play the long game – no quarterly performance pressure.

• Buy unloved stocks or industries – contrarian opportunities.

• Invest anti-cyclically – go against market sentiment.

Comment:
This section is crucial. Individual investors can be more flexible and patient than institutions. They can exploit market inefficiencies in neglected areas without size constraints.

---

Overall Commentary:

Strengths:

• The framework is simple, disciplined, and focused on quality and value.

• Emphasizes psychological and behavioral edges (patience, contrarianism).

• Uses few but powerful metrics (ROIC, FCF yield).

Potential Limitations:

• Requires deep business analysis and patience—not suitable for short-term traders.

• “Don’t overpay” is subjective; determining intrinsic value is challenging.

• Anti-cyclical investing demands strong conviction and can involve long periods of underperformance.

Verdict:
This is a solid, time-tested value investing checklist suitable for long-term investors seeking to build wealth steadily while avoiding big mistakes. It aligns closely with the philosophies of Buffett, Munger, and other quality-focused investors. The emphasis on eliminating bad ideas and waiting for the right pitch is especially valuable in today’s noisy markets.