Using student loans for investments sounds dangerous, right?
That’s because it really is, but that didn’t stop Li Lu, a Chinese student who fled China to study at Colombia University, from investing his student loan funds.
On the basis of the value investing approach as being taught by Warren Buffet, Li Lu was able to compound his borrowed funds by over 30% year over year, and graduate with enough money to retire. Now days, Li Lu is considered one of the best value investors on the planet, running a hedge fund with $Billions AUM, with a terrific track record.
Okay, enough with the introduction. Want to know Li Lu’s Secret to compound capital?
Li Lu And The Start Of His Investment Career
When Li Lu arrived to the US, he was worried that he wouldn’t be able to make it in the country, which was completely foreign to him.
“When I first came to Columbia University, I was dirt poor. I did not choose to come here – I just ended up here because I had nowhere else to go, having just escaped from China after Tiananmen. I was in a new country where I didn’t understand the language, didn’t know anybody, and didn’t have a penny to my name. So I was desperate and afraid”. – Li Lu
Li Lu’s first introduction to Warren Buffett was at a lecture at Columbia Business School in 1993. His friend invited him to a guest lecture of Warren Buffett, knowing Li Lu was seeking ways to make some money on the side.Li Lu, however, misunderstood what his friend said, thinking there was a free lunch buffet along with an opportunity to learn how to make some money.To his disappointment, there’s was no free lunch, however, this lecture transformed his life.
Being inspired from the talk, Li Lu found the value investing approach appealing and rational, and it fit perfectly with his personality. That was the beginning of his value investing career.
The Strategy That Earned Li Lu Astonishing Returns
Li Lu’s investment philosophy was heavily influenced by how Buffet ran his partnership back in the days. Like Buffet, he adopted the belief that the market is irrational, and he looked for opportunities of mispricing where the upside potential is substantially higher than the downside.
While still in university and with the float of his student loan money, Li Lu used the Cigar Butt approach with a little twist of his own, looking for companies that trade dirt cheaply relatively to net asset value, yet with solid earnings.
That is, unlike Graham and Buffet that bought mediocre deteriorating businesses, at an extremely cheap valuation relatively to liquidation value. In Li Lu’s eyes, this strategy was the safest and wisest to compound his borrowed funds, while minimizing the risk of permanent loss of capital.
Li Lu’s Invests In Timberland And Makes 700% Return In 2 Years
Li Lu’s investment in Timberland demonstrates perfectly an investment opportunity with low risk – high return probability, to be seized when encountered.
Timberland is a shoe manufacturing company. The company’s metrics at the time were:
Market Cap:$319 Million
P/E Ratio:5
Current Assets:$387 Million
Total Liabilities:$203 Million
Real Estate Holdings:$100 Million
Although the company was not a net-net (When a company’s net current assets exceed all liabilities), it was a good business with current assets exceeding the market cap, with virtually very little risk of permanent loss of capital. The stock price of Timberland suffered headwinds in a form of an idle lawsuit, and misinterpretation of news by investors.
Li Lu, who went to visit retail stores that sold Timberland shoes, was amazed by the strong brand of Timberland, as store managers complained that demand was huge and there was never enough stock. Additionally, the company was family-owned, buying back shares at statistically cheap prices and paying down debt.
Considering all of those, Li Lu poured 20% of his funds into Timberland, and after just 2 years the stock went up 700%, propelled by earnings growth of 30% a year.
“Heads, I win. Tails, I don’t lose much”
Investing is risky, especially when one does not know what he is doing. Investing is even more dangerous when doing so with borrowed money. However, one can minimize risk and increase potential returns by following similar principals as those applied by Li Lu:
A final word from Li Lu:
“Investing is about predicting the future, and the future is inherently unpredictable. Therefore, the only way you can do better is to assess all the facts and truly know what you know and know what you don’t know. That’s your probability edge”. – Li Lu
Disclaimer
The analyses and evaluations are opinions only. Anyone who makes use of this information does so at his own discretion and responsibility. The text should not be construed as a recommendation, a substitute for independent judgment or an invitation to make any investments and/or actions. The information presented is for enrichment purposes only and is not a substitute for advice. It is necessary to take into account the risks inherent in investments in securities. We are not responsible for financial losses that may be incurred by a person acting on his own initiative as a result of the content posted here
