A boring era can be a good time, and although there isn't much killing and crusade, there are adventures of their own.
特约作者｜Value Gamer
Editor丨Song Wei
The era of whaling in China's capital market is over, and the future will be a slightly "boring" era of land farming for investors. Adventurers who have become accustomed to whaling in the hustle and bustle of the waves may not immediately get used to the slightly quieter land, but there is often an interesting essence hidden in the boring things.
History of Berkshire Hathaway
The history of Berkshire Hathaway can be traced back to the whaling industry in North America.
In fact, whaling was one of the core industries in the United States in the 19th century and was not gradually replaced by the textile industry until later in the century. New Bedford, where Berkshire Hathaway is headquartered, once sparkled like a diamond in the crown of New England. Once upon a time, the fishing boats that set out from its harbor to hunt sperm whales made it the wealthiest city in North America. By 1854, whaling was generating $12 million in revenue each year, making New Bedford the city with the highest per capita income in the United States before the Civil War. The ancestors of the Stanton family, who later took control of Berkshire Hathaway, were a leader of the whaling industry in New Bedford.
As a commercial industry that only emerged in the 16th century, the whaling industry was invested in a way that was close to the venture capital industry we are familiar with today, and even the way the proceeds were distributed was similar (the carry mechanism in the venture capital industry was derived from the way the whaling ship's crew and sponsors split the money).
However, by the middle of the 19th century, sperm whales were becoming increasingly scarce, and whaling ships had to venture north in search of bowhead whales, eventually reaching the Arctic Ocean. In the fall of 1871, many families in New Bedford did not wait for their sons and husbands. Because it came surprisingly early in the winter of that year. 22 ships got stuck in the ice of the Arctic Ocean and never returned. As a result, New Bedford was never the same as it used to be, and the whaling business that had once been a branch was never revived.
In 1888, local businessmen Horatio Hathaway and Joseph Knowles formed a partnership to pursue what they saw as the next business trend: textiles. They built two textile factories, the Aikashner Manufacturing Company and the Hathaway Manufacturing Company, and later passed the business on to the Stanton family.
This is a reasonable choice, because after the first industrial revolution, the textile industry was an emerging technology of that era, a computer or Internet industry of that era, and you could even say that New Bedford has seized a new outlet.
Throughout the 20th century, Hathaway's factories sprung up to comb, reel, spin, and dye stacks of bales unloaded from ships from the South onto the New Bedford Docks. Industrialized production lines and low costs ensure high ROE, while global trade leads to rapid scale expansion.
More than 60 years later, the textile industry is also entering the Red Sea market. In 1954, Hathaway's textile industry in New England was hit hard by competitors from the American South and Asia (e.g., Japan and Korea), and in 1954 Hathaway merged with another factory, Berkshire Fine Textiles, in an attempt to build a resistance to the wave.
In 1962, Warren Buffett bought Berkshire Hathaway's stock price because it was already grossly undervalued, and later that year he eventually bought the company due to a conflict with the founder's family. But the textile company became a money-burning pit and a nightmare for Warren Buffett in the years that followed. After thoroughly confirming that he could not maintain a competitive position against his competitors in the American South and Asia, Buffett finally closed the factory a few years later (which is an interesting story).
Fortunately, Buffett had time to invest enough cheap companies with the cash flow generated by the textile business in between closing factories, using the value investing strategies he learned from Graham. What happened next is history as we know it: Berkshire Khazah is today an $870 billion multi-industry company and the ultimate global epitome of value investing.
Berkshire Hathaway's relationship with the whaling industry is a metaphor. But it is not a metaphor for the highs and downs of the industry between different eras, but the fact that back-to-basics value investing may often be conceived after the magnificent era of adventure.
The end of the whaling era
Like New Bedford in the mid-19th century, the whaling era of China's capital markets is over.
From the first generation of VC funds led by IDG in the late 1990s, to the establishment of the second batch of VC funds such as Sequoia China and Hillhouse in 2005, to the establishment of third-generation funds such as Source Code and Gao Rong around 2014, to the peak of the bull market in Chinese concept stocks in 2021, China's VC market in the past 15-20 years has been a whaling game of "big water, big fish".
The important (or even the only support) for this whaling game is the magnificent development of China's consumer-level Internet industry over the past 20 years. If we subdivide it a little more, the consumer-level Internet can be divided into two stages: PC Internet and mobile Internet, the PC Internet bonus period is from 1998 to 2012, and the mobile Internet bonus period is from 2012 to 2021.
The distribution of returns on these two wave of dividends is extremely concentrated, and it is a veritable whaling game. The return on capital generated by Tencent + Alibaba + JD.com + Baidu could account for more than 80% of the total return of China's VC market in the Internet era, while the return on capital generated by Byte + Meituan + Pinduoduo + Kuaishou could account for more than 80% of the total return of China's VC market in the mobile Internet market.
You may say that there are many middle-waist Internet and mobile Internet companies that have also generated returns, such as Ctrip and NetEase in the Internet era, Xiaohongshu and SHEIN in the mobile Internet era, but the problem is that there are a large number of negative return companies in the technology industry, which have destroyed a lot of capital, and these capital losses offset the returns generated by the middle-waist companies. In this sense, even the first four companies can generate returns that exceed 100% of the total market returns, both in the age of the Internet and mobile Internet.
Of course, there are (or have) some structural opportunities in consumption, healthcare, and new energy, and even many companies with tens of billions of dollars have emerged, but they are not enough to support a systematic and large-scale VC market.
The "VC" we refer to here includes minority investment funds in the primary market, including seeds, angels, VCs, growth and other stages, but does not include buyout funds. The logic of M&A funds has never been whaling, but buying a stable and boring business at a cheap price, which can even be said to be the opposite of whaling logic. But for a variety of reasons, China's buyout funds have not been the mainstream of primary capital markets over the past 20 years, although this may change later.
Not all countries have a thriving VC market, and not all economically thriving countries necessarily have a thriving VC market.
In fact, VC is not the norm in the capital market because of its low liquidity, long investment cycle, large return variance, and relatively low rate of return compared to its risk-taking, but the crown jewel of the capital market.
The VC market exists and even thrives, with extremely high demands on macro beta and industry beta. On the capital side, because of low liquidity and long investment cycles, LPs are required to have strong long-term confidence in specific countries and specific industries, so they will be willing to deploy capital into such an asset class. On the asset side, only systematic long-term opportunities can give birth to a VC ecosystem with sufficient scale, and therefore a large enough sample size and trial and error volume to emerge the top high-return VCs.
Globally, only China and the U.S. (and half of Europe after 2018) have established VC markets. Japan and South Korea have extremely developed semiconductor and consumer electronics industries, as well as relatively developed Internet industries, but they do not have VC markets comparable to their economies.
Israel has a large-scale VC market that does not match the size of its economy (although the total volume is not comparable to China and the United States), but it is an offshore R&D center for the U.S. technology industry (just like India is an offshore outsourcing development and customer service center for the U.S. technology industry), so its VC market can also be counted as part of the U.S. and European VC ecosystems.
However, China's VC market over the past 20 years has been characterized by its large scale and unusually wide range of industries. Although there are basically only two tracks with systemic opportunities (Internet and mobile Internet), the wealth story of Chenggong Fund and the excess US dollar liquidity for the Chinese market have allowed VCs to raise too much money, so they have entered too many industries that may not have systemic opportunities (and therefore cannot support high-risk investment strategies under VC logic), such as manufacturing, new energy, semiconductors, education, consumption, transportation, finance, Internet finance, culture, corporate services, etc.
It is not that these industries cannot be invested in the primary market. In fact, there are also a large number of successful investment cases and funds in many industries, especially in consumption, healthcare, new energy, semiconductors, etc. However, compared with the Internet and mobile Internet, these industries do not have significant winner-takes-all return characteristics.
Essentially, these industries do not have the advantages of zero marginal cost and network effects that are unique to the Internet industry, and they consume relatively heavy capital, so they are not particularly friendly to VC industries with small investment amounts, high risk and high returns. In other words, investments in these industries are not the right game for VCs.
China's VC market has always been very diverse.
Compared with the VC market in the United States, there are basically only two mainstream VCs in the United States:1. Technology VC; 2. Biomedical VC.
Most of the biomedical VCs have a background in pharmaceutical companies, or even CVCs (corporate VCs) or CVC spin-offs that are pharmaceutical companies themselves, which require a high degree of professionalism and will not be discussed in detail here. And technology VC basically only looks at two directions:1. consumer-grade Internet; 2. Enterprise software (including traditional software and SaaS).
According to Ernst & Young's statistics for 2024Q1, the three mainstream industries in the US VC market are enterprise services, information technology, and healthcare. The proportion of sectors in previous years was broadly similar to that quarter.
Of course, there are some other sub-sectors, such as the "hard technology" (controlled nuclear fusion, rocketry, quantum chips, etc.) industry in the United States, which also has a lot of active transactions, although there are no specialized funds in these fields. Of course, there are some small but beautiful vertical VCs in subdivisions such as consumption, energy, media (and even industry), but these are not the mainstream of the VC market in the United States, and the main direction of mainstream VC (Sequoia, benchmark, a16z, etc.) has been basically around the two fields of consumer Internet and enterprise software.
These two areas have had systemic opportunities over the past 20 years. The consumer-level Internet is a wave of opportunities that have existed for more than 20 years from the Internet era to the mobile Internet era (if it has been close to 30 years since the invention of the browser in 1995), and hundreds of billions or even trillions of dollars led by the Magic 7 have emerged. In the field of enterprise software and enterprise services, a large number of companies with hundreds of billions of dollars have emerged in the wave of software cloudification and database cloudification, and it can even be said that one of the foundations of Microsoft's re-emergence is the enterprise service opportunities brought by software cloudification.
On the other hand, in China, basically all the top and mid-waist VC funds cover multiple industries, from the Internet and TMT to consumption, software, enterprise services, and healthcare, and after 2020, they have migrated to chips, semiconductors, intelligent manufacturing, new materials and other industries. The reason why these VCs can cover so many industries is not because these industries can support high growth and high valuations, as well as overall high returns, but more because the return record of these VCs in the 12-year bull market of Chinese concept stocks before 2021 has allowed them to raise a large number of funds, and the macro beta of China's economy is still there, giving them the confidence to invest their capital in these more traditional industries and hope to catch whales in them.
But after 2021, the feast of Chinese concept stocks is over, and this shows a fact that has long been vaguely recognized by some people: the era of whaling is over.
People tend to look in the rearview mirror after the nature of things has changed. The apex of 2021 is just an elongated epilogue. Although Kuaishou went public in 2021, and although Byte, Xiaohongshu, and SHEIN have not yet been listed, the hunt for the most fertile part of their capital appreciation may have ended a few years ago.
III. A review of the whaling era
In the age of whaling, what investors do is pick the winners, and everything they do is not miss out on the big winners, because you can't afford to miss them when 80% or even 100% of the returns in the entire market come from the most successful 3-5 companies. Therefore, investors do not care about mistakes and failures, and are extremely tolerant of risks, but they must catch the biggest whales.
After the end of the mobile Internet era, there are not so many new winners, and the remaining games are stock games ("boring" games such as homogeneous competition, mergers and acquisitions, business closure, divestiture, etc.), in which there are some undervalued businesses and assets that are not liked but still have a certain value, and it is a new game to explore these opportunities and price them. But it's not a game that Whalers are good at.
Even in the age of whaling, the model of picking winners may not have brought as much of a return as imagined.
The Chinese VC market has seen a large number of successful funds and successful investments over the past 20 years, and their investments have had a profound impact on the country's economy and society, which is highly admirable.
On the other hand, these successful investors and funds may also be the result of survival biase, which is the result of probability and statistical selection of survivors. These top "survivors", the top achievers of the last whaling era, are undoubtedly successful in their own right, and their investment results have had a huge positive impact on the world we live in today, but from the perspective of fund investors and capital allocators, these top cases may not make much sense for the overall returns of the VC industry.
This chart shows the net IRRs of VCs and M&A funds by vintage (i.e., established in each year), and the source is Preqin. It can be seen that globally, except for the VC funds that enjoyed the NASDAQ bubble in the 90s, VC as an asset class has created a lower net return for LPs than buyout funds for a long time. The sharp deterioration in returns on the two vintage VCs in 2020/2021 was driven by the impact of the 2022 interest rate hike on the capital markets (although the magic 7 has hit new highs, the valuations of the waist tail technology companies are still low).
Also from Preqin data, we can see that the standard deviation of the net multiple (i.e., return multiple) of VC funds is higher than that of buyout funds for a long time. Combined with the chart above, VC funds do not bring higher returns to LPs even when they are exposed to higher risk and greater volatility.
In fact, after 2022, the long-term cumulative returns of VC funds have even been surpassed by the S&P, let alone the NASDAQ.
The data in the above three graphs is the data of global VC funds. In 2024, the data of Chinese VC funds may not be better than the global average, but the specific data is only known to LPs themselves.
Regarding the whaling game of the tech industry, which has a huge impact on human life, and the VC industry, here is a recap of Warren Buffett's 1999 speech in Sun Valley, California:
"I think it's instructive to look back at a couple of industries that changed the country earlier in the century: automotive and aviation. Let's start with cars: I have a 70-page list of the car and truck manufacturers that once existed in the United States. Overall, there seems to be at least 2000 automakers in this industry, and it has had an incredible impact on people's lives. If you had foreseen how the industry would have developed early in the development of automobiles, you would have said that this is the path to wealth.
So, what progress did we make in the 1990s? After fierce competition and survival of the fittest, we are left with only 3 American auto companies, and their own return on capital is not a surprise to investors. It's an industry that has had a huge impact on the U.S., and it's also had a huge impact on investors, though not the kind expected.
In addition to automobiles, another truly transformative commercial invention in the first decade of this century was the airplane – another industry with a clear future that would make investors salivate. So, I went back and looked at the aircraft manufacturers and found that between 1919 and 1939, there were about 300 companies, only a few of which are still in operation today. Next up is the case of airline failure. I have a list of 20 airlines that have filed for bankruptcy in the last 129 years. My data is as of 1992, and although things have improved since then, all airlines in the U.S. have made zero money since the birth of the aviation industry. Absolutely zero.
I even like to think that if I had been in Kitty Hawk when Orville Wright took off in 1903, I would have been visionary enough, public spirit—I owe it to the future capitalist—to shoot him down. I mean, neither Karl Marx could have done as much harm to the capitalists as Orville Wright.
I won't dwell on other fascinating industries that have dramatically changed our lives but failed to deliver returns for American investors: airlines, automobile manufacturing, radio and television manufacturing, for example.
But I'm going to take a lesson from these industries: the key to investing is not to assess how much an industry will impact society, or how much it will grow, but to determine the competitive advantage of any one company, and most importantly, the durability of that advantage. Products or services that have a wide, sustainable moat are the ones that bring returns to investors. ”
In the above text, Warren Buffett has clearly and vividly described his views on the winner picking game in the tech industry.
Each generation of technological change has produced winners and mega-riches, as well as great companies and business models, but these whale-like people and companies are in a sense probabilistic and statistically selected survivors, the product of the survivor game. In other words, technological progress and fundamental progress are certain, and there will always be winners in these entrepreneurial games and technical games - some games are zero-sum games, some are incremental games, but there are always winners. But the few winners of these risk games and the investors who often make diversification have nothing to do with their capital, and often do not guarantee a reasonable return on capital.
All the companies, institutions, and individuals that we can directly see about any industry or thing are survivors of probability or strength funnel screening. And a large number of historical participants who have been eliminated, we simply do not see and are not even aware of their existence. So unless you dig into all the historical details and evolutionary logic, you can see the full picture before the real, probabilistic screening.
But if we only take a superficial look at the current situation today, we can only see the survivors after the big waves. And making direct comparisons and even analytic conclusions about the outcomes of survivors in various fields can have dangerous consequences. This is true for technology companies, and it is also true for investment funds.
Fourth, our present, and the longer past
After the end of the whaling era, what era are we living in today?
Before we understand the situation we face today, we need to look a little further. The "whaling era" describes only the characteristics of the VC market after 2005, and the VC market is only one segment of China's economic machine. In the whaling era, VCs can rely on the dividends of the Internet and mobile Internet and the non-synchronization between the trend of Chinese concept stocks and the domestic capital market (see the figure below), thus ignoring the macro trend and structural changes of China's economy to a certain extent. But in this new era, the Internet and Chinese concept stocks as a whole have been pulled back to the ground from the stratosphere by gravity. Now, it is imperative for all of us to understand China's economy, because it is these deeper changes and trends that have led us to where we are today.
The Shanghai Composite Index reached an all-time high in 2007 and has not surpassed it even in the great bull market of 2015, and the bull market of 2020-2021 has only made a small jump in the historical perspective. In 2017, Chinese concept stocks had surpassed the highs before the financial crisis, and in 2021 they hit a record high, but they began to decline sharply in 2021, and the historical cumulative return since 2003 has been close to that of the Shanghai Composite Index.
In 1992, China's economy entered a period of rapid development, but after the completion of the price barrier in the early 1990s, the enterprise reform was not smooth, the inefficiency and high losses of central enterprises and state-owned enterprises have always existed, and there was no reasonable and systematically successful solution, so the end of the 1990s can be said to be the trough of China's economy. China's accession to the WTO in 2001 gave China an important opportunity to allow the southeast coast to develop on a large scale the "big in, big out" export model that it had been running since the 1980s, thus bringing about economic growth, and the new export trade, consumer goods production and economic sectors gave policy space, thus giving the government to persist in promoting the reform of state-owned enterprises, the implementation of shutdown and transfer and large-scale layoffs, and the establishment of four major asset management companies to strip the huge bad debts of the banking industry, thus ushering in a 15-year golden age for China's economy.
The end of the 90s was a trough, with the Asian financial crisis affecting external demand and exports, high bank bad debt ratios, and a continued decline in GDP growth. But China's accession to the WTO in 2001, and its subsequent embrace of the global trading system, put China back on track for growth and ushered in a 15-year golden economic age.
The 2008 global financial crisis interrupted the economic upswing, but it was not a systemic risk for China, so a $4 trillion stimulus could be used to revive the economy. However, by 2015, the growth momentum of the economy itself weakened, and the excess capacity and inventory accumulated in the previous years began to release risks. At the same time, the country also started the supply-side reform in 2016, that is, three removals, one reduction and one supplement: de-capacity, de-inventory, de-leveraging, cost reduction, and making up for shortcomings, trying to solve the problem of excess capacity and investment, and trying to switch the momentum of economic growth from infrastructure and real estate to mid-to-high-end manufacturing.
2018 was another year of smaller but similar logic, with declining equities and housing markets, trade wars and geopolitical risks, and increased export pressures. The state continued to choose to inject liquidity, stabilizing expectations and asset prices, the stock market began to rise in early 2019, and confidence in the household sector did not deteriorate as in 2015, but began to continue to increase leverage, and house prices began to rise again.
The impact of the 2008 financial crisis on the housing market was quickly reversed by the 4 trillion yuan in 2009, and the brief declines in 2012, 2015, and 2018 were quickly pulled back, and in 2021, due to the improvement of economic fundamentals and the strengthening of public confidence, the housing market ushered in the last rise so far, and after that, it is the history we are experiencing.
In fact, throughout the economic or asset price downturns after 2008 (2008, 2012, 2015, 2018), the country's solution has been similar, that is, through fiscal policy + monetary policy to inject a large amount of liquidity, guide the society (including the residential sector, the enterprise sector, and the local government sector) to increase leverage, so that the economy can return to the growth track. Although the implementation path will be different each time, there are three main channels to transmit liquidity:1. Local urban investment has increased leverage to invest in "iron public foundation" infrastructure projects, as well as real estate projects, 2. Real estate enterprises have stepped up their efforts to develop residential, office, commercial, mixed-use and other real estate projects; 3. Residents leverage to buy real estate.
On point 1, the debt distress of some local governments after 2022 has weakened their ability to increase leverage, and the marginal rate of return is already declining due to the saturation of infrastructure in many regions. As for points 2 and 3, after 2022, real estate, which has been set to "live in, not speculate", is unlikely to become a carrier of reverse adjustment during the economic downturn. Since 2022, the market has been expecting the government to introduce another policy similar to "4 trillion" or "shantytown reform" to inject huge amounts of liquidity and growth momentum into the economy, but in fact, the utility of traditional liquidity transmission channels has weakened, so the government has to find another way.
Obviously, the government has chosen to increase leverage this time in the manufacturing sector.
There are many advantages to manufacturing. Compared to bubble-provoking, speculative real estate and infrastructure that is already surplus and lacks self-hematopoietic capacity, manufacturing is a more reliable physical asset with sustainable production capacity and self-hematopoietic capacity. In addition, the U.S. science and technology war has led to a certain domestic substitution of semiconductor-led industries and related local industrial chain opportunities, and the concept of "hard technology" investment came into being. Bank credit resources, listed sector resources, government guidance fund resources, and central state-owned enterprise investment resources are all directed to hard technology and manufacturing.
The usual starting point is that the local government needs GDP, tax revenue, and employment, so it sets up a guidance fund to raise funds through its own funds, financial allocations, loans from large banks, bond issuance, etc., and then invests in GPs or directly to enterprises, usually requiring a return rate of more than 100%, and the return investment is based on fixed asset investment and registered capital of local companies, with the goal of generating a higher GDP than the amount of government contribution.
However, unlike real estate, manufacturing factories and production capacity are not standardized investment asset classes and cannot attract private capital to buy. In other words, productive assets can only be invested by professional investors such as governments, enterprises, and funds, and cannot be invested by individual residents. Therefore, it is difficult for manufacturing assets to form the self-realization effect of price rise (while real estate, as the largest asset class in the whole society, will naturally form the self-realization mechanism and wealth effect of price rise in each cycle).
Therefore, if the investment in the manufacturing industry is to return in the end, unless it is only hoped for follow-up financing and listing exit, it must be required that the formed production capacity itself has economic value, that is, it can generate sustainable income and profits, and this requires the factory's products to have strong enough market competitiveness and profit margins. However, under the current boom of local government GDP and economic indicators, it is possible to form a certain amount of vacant capacity, and although the participating government may have reaped GDP and tax revenue, it is also facing the risk of factory output falling later, while market-oriented capital investors are facing a certain risk of negative returns.
In the process, portfolio companies receive no net cash, but are supported by valuations, factory assets, and production capacity, while the government receives GDP, tax revenues, and jobs. Leaving aside for the moment whether the equity value of the investee company can be realized through a subsequent listing (which is of course critical), the process appears to be of value to all participants in the short to medium term. As a result, this government-at-investment model has gradually become the mainstream of the primary market after 2020.
In this landscape, the VC market (more precisely, the Tier 1 minority investment market) has entered the era of "de-financial returns". Because the macro beta of the capital market is gradually blurred, the value of corporate equity has also been blurred by local governments and state-owned investors, and these institutions pay more attention to non-financial return values such as investment promotion, taxation, GDP, employment (for the government) or strategic value, business value (for corporate investors), and the equity investment relationship is only the carrier of these demands.
But as Coase's theorem suggests, things are bound to evolve in the most efficient direction. For the above mixed behavior of investment + investment, the most efficient and reasonable direction is separation, the demand for investment is solved by investment, and the demand for investment is solved by investment. If local governments want to attract investment, the most direct and clear way is to give capital subsidies, whether it is tax refunds, land gifts, fixed assets, and construction subsidies. And if you make an investment, in the long run, you will definitely return to the essence of investment: investment is to get a return on capital.
While this judgment may hold true in the long term, the hybrid model of investment + investment is likely to remain mainstream in the short to medium term. Everything has inertia, and things related to the public sector, such as policy and government, have even greater inertia. Therefore, the previous generation of VC funds can still continue to obtain returns by cooperating with local governments to return to investment for a long time, but the funds that can really stay on the table in the long term must be funds that return to the essence of equity investment.
What is the essence of equity investment? Whether it's a primary or secondary market, whether it's a minority or a controlling stake, equity investment means being a shareholder in a company (recall Graham's phrase: "To buy a stock is to buy a company."). ”）。 To become a shareholder of a company, there are three demands: to obtain dividends, to sell equity in the future, and to gain control, and there must be one of the three.
If it is for dividends, then the entry cost must be low enough to ensure a dividend yield of more than 5-7% in order to be able to calculate the account; In the context of strict listing policies, the possibility of selling shares directly in the secondary market must be carefully evaluated, so it must be assumed that the future will be traded in the primary market (whether sold to other funds or sold to industrial companies), so the entry cost should be considered more carefully; If the control of the enterprise is obtained, the valuation can be slightly more flexible than that of a minority stake because of the cash flow of the enterprise and the control premium, but considering that the sale can only be sold to an industrial company, and the industrial party (especially a listed company) is sensitive to valuation, the valuation must also be carefully considered. In short, no matter what the future aspirations are, you must enter with a very clear account, and not a high-risk and high-valuation investment based on the optimistic expectation of big opportunities in the future as in the whaling era.
Our future
So, this is the new era that is coming, an era of "boring" land farming. Compared to the starry sea and the exciting "pick winner" of the whaling era, there are not so many giant winners in the era of land farming, nor are there so many amazing stories of getting rich overnight, some are just assets, and different assets will have different returns at different prices, which is the value game. In contrast to the whaling era, investors in the era of land cultivation who are reckless in cost and tolerate failure, just to get into the potential big winners, must carefully calculate the value of each asset, patiently wait for the price to fall significantly below the value, and invest when the confidence is highest.
Clear-eyed people may have seen that this line of thinking is value investing, and it is the oldest version of value investing. Compared to Warren Buffett's advanced version of value investing ("buy a good business at a fair price"), which he summarized in conjunction with Munger's advice, it is more like a Raham's version of conservative value investing ("buy a mediocre business at a low price"). The difference between the former and the latter is that the former allows Warren Buffett to buy shares of extremely high-quality companies such as American Express, Coca-Cola, Gillette, Wells Fargo, and Apple at prices that are not significantly cheaper, while the latter is basically only suitable for buying potentially mediocre businesses at extremely low prices (and of course it may be excellent business, which Graham will not match, but only if the price is low enough).
And the reason for this difference is: compound interest. Warren Buffett believes that the compounding mechanism allows high-quality companies with high ROE to reinvest a large percentage of their annual profits, creating a "return miracle brought by compound interest". In other words, the market is unlimited, and the bottleneck lies in supply, so enterprises can reinvest profits to expand their business scale, thus creating a compound interest miracle. When you don't have that much confidence in the macro, it's natural to have more doubts about the space for the company to continue to expand its business scale. Of course, traditional Graham-style value investing does not say that you can't invest in high-quality companies, and one of the investment strategies he recommends is to "buy unpopular and undervalued large companies", but Graham has higher requirements for a lower price than Warren Buffett.
What's more, Graham-style value investing doesn't require you to have any view on the macro, he doesn't ask you to have confidence or no confidence in the country or industry, and the macro view doesn't matter. Because traditional value investing is only interested in the value and price of the asset itself, value investing has the opportunity to generate returns in any era and at any stage of the cycle. It's just that in the age of whaling, the sound and appeal of value investing is often overshadowed by compelling and exciting adventure games.
What is the essence of value investing? Quite simply, there are basically only three principles: try not to predict the future as much as possible, pursue an asset that lasts as long as possible, and then buy when the asset is significantly undervalued.
1. Try not to predict the future as much as possible
Value investors admit that they can't predict the future, and no one can. Value investors believe that it is very difficult to make predictions about the future, and that most of the "accurate predictions" you can see are the product of probabilistic screening survivorship bias.
Therefore, a valuer like Warren Buffett does not make money by accurately predicting future changes. Instead, they look for everything that is as unchanged as possible, which minimizes the predictive component and risk behind the investment, while looking for assets that are as cheap as possible against the unchanging background. The relative cheapness comes from the irrational nature of human nature and the occasional mass panic selling.
Warren Buffett admits that he can't predict short- and medium-term stock price fluctuations, and can only barely see the direction of long-term changes (such as optimism about the United States), but this will do little to achieve excess capital returns. What really brings Buffett a steady return is a sufficiently low entry cost (plus compound interest). So, to a large extent, Buffett is also making money by using human nature, rather than making accurate predictions about the future. The irony is that people call him "the prophet of Omaha," but he is not a prophet.
No one can predict the future of all businesses for sure. Especially when there is great uncertainty in the business model and competitive landscape, such as high-tech industries, retail industries, and manufacturing industries, future cash flow forecasts can become inaccurate. Therefore, Warren Buffett pursues a high degree of certainty in the company's business, so there needs to be an extremely high "moat". Note that the purpose of the moat is not to allow the company to attack or expand the scale of revenue, but to maintain its current market size, revenue, and profits. Therefore, Buffett needs certainty, not growth. When it comes to significant growth, a greater proportion of a company's valuation comes from discounting future cash flows, resulting in overvaluation. And even a business that is not growing can have a high degree of confidence in future cash flow projections as long as it has a strong enough moat.
This is Warren Buffett's approach to value investing: instead of trying to predict the future in a highly dynamic market competition, on the contrary, he avoids predicting the future, and he tries to see today and tomorrow as far as possible (and today as closely as possible).
2. Pursue assets that last as long as possible
In option pricing, the longer the option is exercised, the higher the value of the option, because the longer the time provides more price volatility and the consequent opportunity to generate profits. A stock is essentially an option, such as a $70 stock, which is approximately equal to $69 in cash plus $1 in an option to buy a stock for $70 ($1 is an illustrative number because, as mentioned above, the specific value of the option is related to the time frame of its exercisability and several other parameters).
Therefore, the value of a stock is also of course related to how long its underlying asset can be sustained. The longer an asset is in operation, the greater the option value of the stock, and vice versa. This point is basically not discussed in the equity valuation of enterprises, because investors, like accountants, basically assume that all companies can operate in perpetuity, but in the real world, not all companies can be assumed to operate in perpetuity, such as many technology or biomedical companies that are still losing money and burning money.
Value investing requires that the business you invest in is in an industry that has its own special attributes: a stable and good business in the long term, possibly for a long period of time, with a deep and wide moat, or at least the company's business model and competitive advantage will not be inherently and permanently affected by some short-term fluctuations (although they affect financial and operational data). Companies in these industries have option value and deserve an in-depth analysis.
Not all businesses meet this criterion, but that doesn't mean they're not good industries, such as computers, semiconductors, internet, AI, which may tend to breed winners (or even super winners) in the long run, but you can never (or hard) predict who the winners will be. Companies in these industries therefore have no option value, and short-term winners may fall quickly, while subsequent winners may have no value at all in the previous stage and cannot be judged.
So what that means is that we need to find industries that have long-term moats. More precisely, there need to be "competitive steady-state elements" in these industries themselves, which can limit competition to a minimum in the long run, so as to ensure the stability of the industry pattern, which is not necessarily beneficial to a certain enterprise, and it is enough to stabilize the competitive landscape, but this is a critical first step.
Then, in industries with long-term moats, we need to look for companies that have the opportunity to scale up over the long term, albeit slowly, or at least maintain their current size and competitive advantage. The future of a company that meets these criteria, whether it's the future of the industry, the future of the competitive landscape, or the future of the company's own financial and operational performance, is largely unchanged, so a value judgment with a higher degree of confidence and less risk of deviation can be made. In an industry that is stable enough, companies that meet these criteria are perfect targets for value investors.
Then, it is necessary to have an in-depth understanding of all the information about these companies: history, financials, business data, management, business situation, downstream feedback, etc. You need to read all the documents about it, talk to almost everyone who is involved with it, and then build a very high-quality knowledge of the asset, so that you can make a very high-confidence value judgment about it.
It doesn't matter how much value it is, and how much growth and return it promises. What matters is confidence, not absolute.
The short- and medium-term financial data is also less important (Goodhardt's law: the observed indicator must be manipulated and thus lose the value of being observed), it is more of a manipulated noise. Real, first-hand, unrefined and adjusted operational data is more important than financial data, because the former is often ahead of the latter, but the ultimate goal is to judge the company's business model and long-term vitality, all operational data and financial data are just maps and books, fundamentals are the thing itself, the narrative of the thing itself is the fastest way for us to understand it, not the only or most important way, the ultimate purpose of all analysis is to judge whether a company can exist healthily for a long time.
3. Look for when the asset is significantly undervalued
There are two reasons for price fluctuations for any asset:1. Most of the time price fluctuations are simply due to people overreacting to certain rumors or group sentiments,2. A few of the time, it's because the fundamentals have really changed a bit. As a value investor, you certainly want the higher the probability of the former to be as high as possible, and the lower the probability of the latter, the better, because instead of affecting the value, the former is an opportunity for you to buy, while the latter will make a real difference in value and force you to review your investment decisions.
If the asset you choose is a highly volatile, highly speculative, and highly growing asset, then there may indeed be a lot of fundamental factors influencing its future, that is, the probability of a second change in the stock price is higher, so you are forced to pay frequent attention to the company's fundamental changes, and always worry about whether the changes in the stock price reflect "insider, semi-inside information" that you don't know.
But if the asset you choose (its industry, its own business model, its market position) has a strong enough "moat" or "competitive stabilizing factor", then you have a higher probability of not having to worry about a change in price, because there is a higher probability of a first change in the share price. Therefore, you don't have to look at the value as often as the price changes, but you can consider using the price changes to analyze the buying timing.
So, why and when will the price fall significantly below its value?
At the most fundamental level, value investing argues that, in general, uninteresting and stable companies (roughly equivalent to stocks with low P/E ratios) are systematically undervalued, both in the primary and secondary markets. Because people hate risk and hate boring, they give discounts. Of course, it is true that stocks with low P/E ratios are certainly worse fundamentally than stocks with high P/E ratios and have poor growth potential, but the question is, are the valuations that the market is giving them reasonable and undervalued?
Contrarian investing believes that people tend to overbuy when they buy and oversell when they sell, which is due to the nature of human nature to go with the flow and conform to the herd. So there is room for a buy the dip strategy. But value investing is different in that value investing believes that stocks with low P/E ratios can deliver alpha returns in value, even in the long run.
The essence is that people are disgusted with mediocre and uninteresting businesses and basically zero growth potential, so they give discounts, which is like giving premiums for obvious growth momentum and the sea of stars. Of course, it's possible for a single undervalued stock to continue to fall or even liquidate, but when you buy a lot of undervalued stocks (and select them), you can potentially get alpha over a large sample.
The essence of this mechanism is similar to that of insurance companies, where the market is risk-averse policyholders and value investors are underwriters who are willing to price risk and receive a probabilistic return.
Because your trading price always comes from Mr. Market, and Mr. Market always makes mistakes, when Mr. Market starts to significantly undervalue an asset, you can use its unreasonable pricing and emotional bias to open a position. The market can go crazy for longer than you think you can or can afford, so leave a margin of safety and only sell when the price is undervalued enough.
Because I admit that I can't predict the future, I need a price that is low enough to allow myself to make room for error in my judgment of value. If you have a margin of safety, you can take yourself out of the quagmire of trying to predict the future and doing deep fundamental analysis.
In other words, Expected Return = Expected Sell Price - Buy Price. The expected selling price is extremely difficult to predict and depends on many predictive factors, of course, fundamental analysis is required, otherwise the complete fundamental analysis process cannot be completed. But if you can get a low enough entry price, you can get twice the result with half the effort, or even effortless. Because analysis requires cognition and certainty, and a low entry price is obviously simpler as long as waiting for the market to make a fool.
6. The current situation of whales
There are comments that China will gradually become a big Japan in some ways in the future, although it will still be different in many ways. It is important to note that the concept of "Japan" here is not absolutely positive or derogatory, but rather an attempt to analyze some subtle similarities (although there are a lot of differences) between an economy that has experienced a similar trend and the current situation in China.
In the capital market, Japan does not have a systematic overseas trading of stocks, even though it is already the world's third-largest economy. In the U.S. stock market, there are no Japanese concept stocks or Korean concept stocks. Even if Samsung or Toyota have strong fundamentals and have ADRs traded in the US, their shares are mostly traded domestically – with the possible exception of Sony, but mainly because of its significant consumer business in the US. As long as a country's growth momentum is not strong enough to be similar to the Chinese economy in 2001-2021 or China's mobile Internet in 2012-2021, it is difficult to attract long-term and sustainable large-scale attention, and thus it will not produce a definition of an asset class. Powerful companies like ASML, TSMC, Toyota, and Sony may get some attention, but there is no whole "x-stock" asset class. As a result, valuations and liquidity of companies other than such giants will decrease.
By analogy, the existence of Chinese concept stocks was largely driven by foreign investment access and VIE structure in the Internet or telecommunications industries, but with the overall growth rate of the mobile Internet industry slowing down, the asset class of "China concept stocks" has lost its beta as a whole, and its future may be that except for 3-5 very large companies to maintain liquidity and attention, other companies will not be able to get reasonable valuation and liquidity. This phenomenon was actually discovered in 2014 and 2015 (so it gave birth to a small wave of privatization of Chinese concept stocks), but then the listing of Alibaba and several waves of bull markets in US stocks and Chinese concept stocks covered up the problem. This problem continued into 2021, and then we saw the situation today: valuations of Chinese concept stocks have returned to a decade ago, and the average price-to-earnings ratio has fallen from a paradise of 40-50 times to a hell of 8-10 times. And a large number of Internet companies have fallen to near net cash, which is extremely undervalued.
Of course, this is not a bad thing in the eyes of value investors, and certain assets that are seriously undervalued for some systemic reasons can be a good opportunity to buy, as long as the investors are confident enough about the value of the asset itself.
When the growth of an asset stalls, it quickly changes from a growth game to a value game. That's the game we're facing today, a game like heaven for value investors. This is a completely different game from whaling games. In a bull market, growth games are mainstream, and players of these games think they can predict the direction of future tides and want to prove a lot of things, although most of them will be punctured in the end, and in the end prove themselves to be largely slaves to stupidity and grandiose narratives. And when growth stalls, the mainstream game of a bear market is the value game, and the original growth game players quickly lose confidence in their predictions, and they go from trying to prove a lot of things to trying to keep themselves from being falsified. Everyone believes more in cash and dividends than in growth. The market has gradually become more and more convinced of what was yesterday and today and at most tomorrow, not in the predictions of the day after tomorrow or the distant future, and in the hope that what is in front of you now will not disappear in the short term.
This kind of excessive cautious conservatism will develop to a blind point under the influence of group behavior, which will lead to the fact that the assets in the downturn period that have just ended the growth cycle will always be overvalued, which is the law of the capital market, and China Internet is currently in this state. Growth has indeed slowed down, that's true, but the cash flow and profits of the business are still there, and the value is still there. Geopolitical risks do exist, and this is a risk for US investors with pricing power, so they are oversold, but it is an opportunity for domestic investors. Buying these assets at low prices, coupled with sufficient diversification, is the equivalent of selling "risk-averse" insurance to institutional investors. This may be a "boring" game for whalers accustomed to rough waves, but one that value investors enjoy.
7. The future and offspring of the whales
In the foreseeable future of the next 5-10 years, China's Internet industry will gradually become a stock game for existing whales, and there will be few new whales, but there will still be many interesting return opportunities for existing whales to fight, integrate and trade-off.
As mentioned above, China's VC industry today is basically a product of the consumer-level Internet wave, with the dividends of the first wave (Internet) fading around 2010, and the second wave (mobile Internet) taking off around 2010. Almost all of today's Internet companies are products of the mobile Internet wave (including BAT, which has survived from the PC era and has received mobile ferry tickets). But the bonus period of this wave of mobility is basically coming to an end. The infrastructure of mobile networks has not changed substantially in recent years (5G does not have much performance improvement compared to 4G), and it is no surprise that the software landscape has stabilized until the hardware has revolutionized.
After the whaling game ended, the VC capital invested in the Internet industry decreased rapidly, and the nutrients available to the calves who were still burning money also decreased, and the newly born whales became scarce. Recall that what is the youngest calf (a successful internet company that was recently founded)? Contrary to conventional wisdom, two of the most notable internet companies that are still in the growth period — Xiaohongshu and Dewu — were founded in 2013 and 2015, respectively, and have a longer history than Douyin (which only went live in late 2016).
China's mobile internet dividend exploded between 2015 and 2019, and gradually slowed down after 2020, and has almost disappeared in 2024.
In the context of the gradual fading of the dividends of the mobile wave, the reasons why China's Internet industry has continued to change in the past 3-5 years are mainly due to two major variables: 1. ByteDance, 2. Pinduoduo.
Douyin is a late player of China's mobile Internet, which was only launched at the end of 2016 and only started to start in 2017/18, and commercialization began to be gradually explored after 2019/20, and it is constantly trying various directions, including live broadcast rewards, medical care, education, real estate, cars, reading, games, local life, e-commerce and other vertical businesses, the business structure has not yet been fully finalized, so Douyin's actions will continue to have a significant impact on other Internet companies, such as when exploring reading, There is obvious pressure on Reading Papers; When exploring the video, there is pressure on station B; When exploring the car business, there is obvious pressure on Autohome; When exploring e-commerce, there is obvious pressure on Alibaba; When it comes to exploring local life, there is obvious pressure on Meituan. Of course, there are also cases of failure, such as medical, education, real estate and other vertical businesses. But in short, Douyin's late rise has caused a delay in suppressing other giants, resulting in continuous changes in China's Internet industry after the overall mobile Internet traffic has entered a bottleneck.
Pinduoduo's rapid growth is the result of the dual effect of excess capacity and demand downgrade in some industries after the epidemic in 2020, which has exerted structural pressure on JD.com and Alibaba, which previously bet on consumption upgrades.
The rise of Douyin and Pinduoduo is not without a ceiling. Although Douyin has stronger recommendation algorithms and advertising monetization capabilities than Tencent, as well as stronger self-operated business capabilities (e-commerce, local life), its suppression of Tencent and Baidu in advertising, as well as the suppression of Ali and Meituan in e-commerce and local life also have their steady-state upper limit.
Pinduoduo is the same, its competition with Ali is essentially homogeneous competition, although Ali's previous bet on consumption upgrades has led to insufficient attention to low-end demand, but Taotian is still a super business that generates 200 billion operating cash flow every year, and still has a dominant influence on the e-commerce industry, so the scale ratio of Pinduoduo and Taotian is likely to stabilize at a certain level, and will not continue to maintain a state of rapid growth.
When the dust settles on the mobile Internet war, and before the next war begins, Internet companies will gradually realize the boundaries of their own capabilities and resources, and give up the bayonets on the direct battlefield, so as to reduce the common cost of involution competition at this stage, which will help improve the overall efficiency and profit pool of China's mobile Internet industry, and form a tacit multi-giant pattern: through collusion to reduce subsidies and customer acquisition costs, use monopoly consumer attention and use scenario share, increase commission rates, Profit rate, and reduce losses by cutting overlapping, benchmarking and defensive businesses, and because of the previous overexpansion, the industry will have a systemic oversupply of human resources, so the company's operating costs will also be reduced. At that time, China's Internet industry as a whole will have higher efficiency, a larger profit pool, stronger cash flow, and possibly a larger scale of dividends and buybacks.
In 2020/21, when China's Internet was at its peak, driven by certain landmark events and the economic situation, the regulators began to take anti-capital disorderly expansion and anti-monopoly actions, but the subsequent macroeconomic trends and the situation of the Internet industry no longer allow such continuous pressure on the Internet industry. In the next long-term moderate economic growth or even normalization, there is a high probability that too drastic policies will not be introduced for the consumer-level Internet industry.
When Internet companies gradually start to pay more dividends and buy backs, valuations will bottom. Until then, even if the company has more cash equivalents or investment assets on its books, the secondary investors committed to de-China will not fully recognize their value, because those assets have nothing to do with secondary investors, secondary investors cannot directly get them, and when the Internet founders gradually enter the state of knowing the destiny of heaven, the cash on the account will highlight its assets and return gains, that is, the attributes of its origin.
Returning to the essence of Internet business: this is an excellent business model with almost zero marginal cost (in the context of the peak penetration rate of Internet users, the customer acquisition cost of the leading company is almost zero), extremely strong network effect (whether it is the multilateral network effect of social platforms or the bilateral network effect of trading platforms), and excellent business model. No matter how the capital market views geopolitical risks or the competition situation within the industry, this has not changed the essential advantages of the Internet industry in terms of business model.
The financial statements we see today are still statements of high profits, strong cash flow, low debt, and light assets, which shows the extremely high-quality business model of the Internet industry (as in the United States and in China, the essential business rules will not change due to the national environment). Even with fewer new entrants, existing players face less competitive threats, so there's more room to perfect their moats and finally start enjoying and monetizing the spoils (profits and cash) they've made over the past decade of fierce competition.
Any company, as long as it is not controlled by pure management, still serves shareholders, but it originally mainly served the founder shareholders, and the founder shareholders often have the urge to burn money and take risks because of their entrepreneurial nature - their empire today is the product of risk-taking, and there must be differences in risk appetite from external shareholders. After the growth space becomes smaller, the conservative speed of the founders will be slower than that of external financial shareholders in most cases, so there is a period of cognitive mismatch, and when the situation (of the growth space slows down) is clear and the founders are fully conservative and rational, the risk appetite and interests of external shareholders will be consistent, and they will also pursue maximizing their own wealth, so they will:1. Pursue stock price stability, 2. Seek your own cash flow. Dividends and buybacks are ways to meet both of these demands. When the interests of the founders' shareholders and external shareholders are aligned, the company becomes a real company and the governance structure is reasonable.
Capital markets hate and shy away from complex structures. In the United States, after the bubble burst in the 60s and 70s, diversification premiums became congelomerate discounts. The post-'80s shareholder activism has also forced companies to focus on their core business and profits, which has led to management avoiding diversification and even M&A focusing on its core business and core strategy.
Chinese internet companies diversified rapidly after 2012 and gradually expanded from the new economy to traditional economic sectors such as retail, entertainment, content, hardware, education, finance, and healthcare, also culminating in a bull market in 2021, and slowing their diversification expansion in 2022 as bear market asset prices fell and their own stock prices collapsed. However, the diversification business structure that still exists has a large negative impact on valuations (because the U.S. stock market is systematically diversified). In a bull market, the market may have a high tolerance for disorderly diversification, but it can become an important concern in a bear market. But this can be reversed, and enterprises can achieve architecture and business simplification by shutting down or divesting edge businesses, which many Internet companies are already doing.
What's next? Internet companies are likely to continue to shrink their fronts and sell non-core assets, but they will not fire sell because of pressure, so there may not be many opportunities to pick up bargains.
The loss-making business will be sold first, but it is unlikely that it will be sold in the short term, because few people (especially outside institutions) think they can turn a profit and revitalize their assets, especially in a macro environment that is in a contraction cycle.
Then there will be a gradual transition to selling the break-even business, but the valuation is not expected to be low, and there will be a desire to sell at a P/E multiple of the ideal E, but it will be difficult for anyone to accept unless there is asset viability or synergies.
After a long time, we will consider selling low-profit non-core business assets, which is not a low-hanging fruit, because the price will certainly not have a deep discount, but there is already the possibility and space for capital operation and business optimization.
But at the same time, there are many small companies that have given up market competition, founders who are no longer interested in the environment or their own business, and retired entrepreneurs of the older generation may instead sell their companies and assets to leading Internet companies (or leading companies in other industries), and assets within the main business scope of large companies will still be concerned and even welcomed.
Reducing homogeneous competition, shrinking fronts, divesting marginal and loss-making businesses, and dividend buybacks will all bring valuations back and prices back to values close to value. These processes, while no longer exciting, promise attractive growth and a sea of stars in the future, return to a more fundamental business nature, and therefore the possibility of a more robust return on capital.
VIII. The newest and oldest land
When the Japanese economist Yukio Noguchi went to the United States in the 1970s, he thought that American cities were in decline when he saw the devastation of the civil rights movement and anti-war demonstrations, especially Detroit, where "the city center was like a ruin, just after the baptism of war," and the decaying infrastructure. But he later discovered that on the outskirts of the city, a new America was growing. In the process, American cities and urban classes were reborn.
This applies to any industry, any company, any country. Never try to understand anything in terms of linear extrapolation, because in the real world, it is an axiom that the extremes of things must be reversed and the mean is reverted. It's rare for something to go to extremes without resistance or rebound. All things and entities find balance throughout their life cycles in struggle, repetition, ascension, descent, adjustment, and struggle.
In fact, the fundamentals of things often have nothing to do with whether or not investors can make money on them. Assets tend to be at their highest when fundamentals are at their peak and are bound to be overvalued, and lowest when fundamentals are weakest and tend to be overvalued. So most of the losses in the capital markets come from buying overvalued assets at high prices, while most of the returns come from buying assets that were overvalued at the trough.
Regarding this, Howard Musk has a saying: "A good return on investment does not come from buying high-quality assets, but from buying assets of any quality at a price below their value." As an investor, this is the surest way to succeed. It's crucial to understand this difference. This sentence describes this with great precision.
The more traditional and uninteresting the industry or asset, the greater the chance of generating excess investment returns (and vice versa, sought-after assets tend to deliver dismal returns), and these assets are systematically undervalued because people ignore and dislike these industries because they are ignored and disgusted by irrational factors. This provides an excellent buying opportunity for value investors.
The "traditional industry" mentioned here is not only the manufacturing industry that people can think of at the first time, in fact, as long as most of the manufacturing industry can have technological elements, it has been given too much meaning and excessive valuation in the state-owned investment campaign in the past two years, and may have been out of the target range of value investment. Many times no one even realizes that the "traditional industry" here is an industry, such as the production of custom uniforms for retail chains, such as the manufacture and sale of combs for gifts, such as the discount marketing of food delivery platforms for restaurants, such as the operation of roadside assistance services, and of course, manufacturing companies whose valuations have not yet been pushed into speculative territory. Most of these industries have been around for a very long time and have maintained a stable pattern. In other words, these are the oldest lands, but precisely because of their antiquity and stability, they are often overlooked in the era of magnificent whaling adventures.
Think of the small companies that Warren Buffett bought (those companies that he basically couldn't buy after he had too much money in the later period): Joyce Candy, a Valentine's Day candy chain that basically only operates in California; For example, Le Cordon Bleu Printing, a company that helps department stores and supermarkets make discount coupons; Even Albecca Larson-Juhl, a company that helps framers make custom picture frames, these are very traditional industries, which can't even be described as "traditional", and can be described as close to "boring".
But "boring" often means "no change", meaning that the industry landscape and players haven't changed for a long time. This is a good sign for value investors. First, because value investors don't want industries that change from time to time, because they admit that they can't predict the direction of the future wave, the more constant industries and companies mean that they can free themselves from futile predictions of future changes. Second, long-term stability in the past means that there must be some kind of "competitive stability factor" in the industry, or a "moat" between companies, and these factors can ensure the continued stability of the future with a high probability (although not certainly), which means that the industry and the company have a long enough life cycle to obtain a high option value for the asset.
As long as the state continues to exist, and as long as the decision-makers still have the determination and means to counter-cyclical adjustment (this is certain), the vast majority of social and economic links will remain functional, there will be transactions and cash flows, and as long as there are transactions and cash flows, there will be assets and their corresponding values, as well as opportunities for excess returns. But finding its value requires in-depth value analysis, not just simple confidence and optimism during a bull market.
It should be noted that while Mr. Market and stock price volatility have been frequently mentioned above, all of the "value investing" mentioned above is not limited to the secondary market. As Warren Buffett said, really good companies, even if the exchange closes, investors will not worry at all, because good assets can always bring returns in the long run. And the "hypothetical exchange closure" also has a fairly precise practical mapping in the real world of capital, namely buyout funds. M&A funds began in the '70s with the efforts of a few Bear Stearns investment bankers, and today the industry has $13 trillion in assets under management worldwide. Their investment method is to buy a controlling stake in the company, basically do not maintain the listing status, do not accept the daily quotation of Mr. Market, operate for 5-7 years, and then sell at the right time. While a significant portion of buyout funds' returns come from leverage (as most of their M&A is leveraged), the main returns still come from the discovery of value and the observation of the relationship between price and value. As mentioned earlier, the risk-to-reward ratio of buyout funds beats VC funds most of the time.
In terms of the requirements for industries, companies and assets, M&A funds are also very similar to value investment: the industry is extremely traditional or even "boring", there is no and is unlikely to change rapidly, there are competitive and stable elements, and enterprises have a solid moat, although there is not necessarily high-speed growth, but there is a strong certainty. It can even be said that the buyout fund is a reflection of Graham's value investment in the primary market, and even Graham and Buffett themselves often buy companies in the primary market, and Graham's acquisition of a controlling stake in GEICO has created returns that even exceed the returns generated by all his other investments, and Buffett has made more acquisitions in the primary market.
As for the systematically important and trendy direction of "going global", it is also worth discussing some separately here. Similar to the slightly more advanced East Asian economies such as Japan and South Korea, an important theme in China's future economy will also be the overseas expansion and international operation of local companies. This is not only related to scientific and technological progress, but also a natural trend of capital allocation. The growth of local demand will peak with the disappearance of the demographic dividend, but the production capacity will continue to grow (especially in the macro context of the growth-driven shift to the manufacturing industry and the investment boom of local governments), so industries and enterprises must go overseas.
After World War II, the early stage of the development of the industrial system of all late-developing economies was the export of light industry toys, shoes and hats, textile products, and later it will inevitably develop into the export of mature industrial products, electronic products, and even content and service industries. In addition to East Asian countries such as Japan and South Korea, the history of European and South American countries is also the same. As long as the maturity of the local market can give birth to modern industrial enterprises of sufficient scale, it is inevitable for them to go overseas, even if there are certain obstacles in the early stage of going to developed countries (because of product and technology disadvantages or geopolitical pressures), there are also developing markets in Asia, Africa, Latin America and Eastern Europe. It is possible for all industries to go overseas, but the overseas expansion of the manufacturing industry is relatively the easiest, because there is a mature international trade and logistics system, which makes the manufacturing industry inherently a global game.
As mentioned before, the overseas expansion of industries and enterprises is essentially a kind of capital allocation behavior, which has basically nothing to do with technological progress, and the ROI of local investment in mature countries is low, and excess capital will pour into developing countries, which have fast growth and high investment ROI. And history has proven time and time again that trends driven by economic and social fundamentals are difficult, though not impossible, to be reversed by political action and the will of politicians. Even if there is a geopolitical conflict, it has not affected the American, Japanese, and European companies to continue to do business with the Soviet Union in the 60s and 80s, not to mention the economic and trade ties between Europe, the United States and China today based on cost and efficiency, so except for some sensitive areas involving technology, military, and ideology, Chinese companies will not face essentially systemic obstacles to going overseas.
The problem, however, is that the winners who go overseas are more likely, though not certainly, existing winners who dominate their home markets, rather than emerging companies. The most successful overseas companies that emerged in Japan and South Korea in the second half of the 20th century were basically the previous domestic winners, such as Toyota, Honda, Sony, Nintendo, Kyocera, Asahi, Suntory, Meiji, and Kikkoman, such as Samsung, LG, and Hyundai in South Korea. Even if you look at China, the companies with the highest overseas revenues are still the winners of domestic competition such as Huawei, ZTE, Sany, XCMG, Zhenhua, Ningde, Chery, Xiaomi, Oppo, vivo, Haier, and Midea. Of course, China has special cases such as Transsion and Anker, but they still cut small pieces in the overall cake of "industry going overseas".
This means that even when analyzing companies in a game such as "Sea of Stars", it is still necessary to base it on the strict criteria of value analysis, because the winner in this game is also likely to be the winner in the traditional game.
9. The newest and oldest game
Investors generally go through 5 stages:
The first stage is the blind man touching the elephant, you just see the exaggerated propaganda and money-making cases, but you don't have a systematic investment idea;
The second stage is to establish certain investment values and cognition, selectively worship investment idols, and think that someone can predict the future;
Stage 3 is idol disillusionment (usually after a cycle) but still having faith in oneself and believing that one has the ability to predict the future or at least generate excess returns;
The fourth stage is to become disillusioned with oneself, accepting that one is most likely a mediocre person, but still trying to find a way to create some value in investing;
The fifth stage is to try to find a definitive way to make money, whether it is industry or investment, on the basis of knowing that there is a high probability that it will not be able to consistently generate excess returns;
Value investors tend to be in stage 5, and most of them have realized that there are no saints or prophets in this world who can predict the long-term, macroscopic future. Predicting the short- and medium-term, micro future has a slightly higher winning rate, but you need to be extremely familiar with the micro of the enterprise and the industry. The essence of investment is to make bets based on one's own judgment of the micro future (and possible meso, macro future) based on the uncertainty that you can accept, the winning rate, and the odds, and expect returns, while value investors just want to obtain higher certainty in a systematic way.
If we look at a wider space, there are essentially only four games about money in this world:1. Arbitrage; 2. Doing business; 3. Investment; 4. Speculation. The four methods are ranked from highest to lowest certainty. And all four games have a long history, and it can be said that there have been their own shadows since the emergence of human civilization.
The fourth type of "speculation" is gambling in nature, such as buying lottery tickets, gambling, and possibly even participating in bubble trading of certain assets, just because they think they can be sold to stupider, crazier people later, and sensible people should not participate in such games at all. I won't go into detail here.
1. Arbitrage
Arbitrage is the most certain way to make money. It can even be said that the definition of arbitrage is "making a profit in a largely risk-free situation", and if making money is already so certain and easy, it is arbitrage. The premise of arbitrage is that the market pricing system is ineffective to some extent, that is, the same asset is priced differently in different scenarios. Investment can be arbitraged, and so can industry. At this point, there is no need to distinguish too clearly the difference between investment and industry, and in the early days of reform and opening up, the reselling of automobiles, home appliances and import approvals, or land indicators, or treasury bills, or original stocks, or wagon indicators, or SBF's reselling of bitcoin between Japan and the United States are all arbitrage.
When looking for arbitrage opportunities, don't pay too much attention to the securities you are trading and where you are trading. It would be best if such opportunities could be found in the open market, as liquidity is abundant, but the open market often means that arbitrage opportunities are minimal, as information and trading are highly public. In this sense, liquidity and openness are the mortal enemies of arbitrage opportunities. The stronger the liquidity and openness, the less unreasonable pricing there is, and the less likely it is to encounter arbitrage opportunities. But that doesn't mean there aren't, because there are a lot of inevitable systemic misconceptions about human nature, no matter what the market.
But arbitrage is relatively unsustainable, because the probability of price distortion and pricing failure is not too high in general, and it is not so easy to find, because if you find it today, you will find it tomorrow.
2. Raw Intention
Slightly less certain is doing business, that is, business. Industry is more certain than pure investment, because when a certain business model and organizational structure (and thus can be called a business) are established, there will be a certain strong or weak moat, whether it is from customer relationships, scale effects or industrial inertia. Therefore, there are many profitable businesses in the world, although there are differences in scale and profit margin, but there are far more funds, institutions, and investors that make money. Even in poor and remote places, there are people who set up stalls to sell goods or open restaurants to make money, and to a certain extent, it can be sustained, which is like simplifying to a person's labor organization, selling their time to make money, this mode of selling personal energy and time, plus a certain organization, can create more or less profits.
Interestingly, most of the people who end up making the most money from the stock market are entrepreneurs, i.e., businessmen. Think about Google, Amazon, Facebook, Tesla, LVMH, Zara, after going public, is the winner who makes the most money from the shares of these companies their founders or secondary market investors? Of course, there are special cases of founders such as Apple, Microsoft, and Nvdia selling prematurely, but it is undeniable that the main beneficiaries of the rise in the market value of the stock market are the founder shareholders who basically do not sell. The reason is also very simple, because these businessmen have the most direct and deep understanding of the operation of the enterprise and the industry structure, so they can avoid selling stocks during the trough panic period and when the price fluctuates. At the same time, because these people control the operation of the enterprise and assets, they directly create value, so they go from the share price appreciation to the largest cake, which is also the most reasonable result.
3. Investment
The term "investment" here can include investments in various strategies in the financial markets for various types of assets (primary and secondary stocks, bonds, commodities, foreign exchange, etc.). Compared to arbitrage and business, investment certainty and sustainability are the worst. Companies that are more than 100 years old are not so difficult to find, whether in the United States, Europe, or Japan, but there are almost only a handful of investment institutions that are more than 100 years old, and the world's first stock exchange has been around for more than 400 years. The only investors who have been able to consistently generate alpha after 50 years are likely to be value investors led by Warren Buffett (quantitative funds are a new species that has emerged in recent decades, but the vast majority of their returns come from some kind of mechanism that borders on arbitrage, and their long-term viability has not been proven).
In fact, it is difficult for most investors not to outperform the index, and the growth of the index does not come from investment, but from the value creation of industrial businesses. Some of the world's largest investment institutions (Blackrock, Vanguard, State Street, etc.) that we see today are basically index or passive funds, and the reason for their existence is not mainly because of superb investment returns, but because they grasp the general trend of the index era, firm passive strategies and low operating costs.
In this sense, these investment institutions are also businesses, and they are engaged in the asset management business of passive investment.
Why is it so difficult for investors to beat businessmen? Because investing is a brutal zero-sum game, it's basically about getting the smartest people to trade on the basis of publicly available information (and some grey insider information) in the most transparent markets and trying to compare returns with each other. At the same time, the underlying asset they trade – the business – continues to create value.
4. Value investing
But among all strategies and types of investment, value investing is an outlier, or in other words, the risk-to-return ratio of value investing is actually between arbitrage and business, not like traditional investment, and the reason is systemic certainty.
Graham says in "The Smart Investor": "The best investment is one like a business, that is, like running a business, with a systematic effort aimed at maximizing the likelihood of a reasonable return and minimizing the likelihood of serious losses." We must invest with the thinking of doing business, so as to be invincible with the greatest probability. In fact, only investments like a business are "investments", otherwise they are speculation. ”
For example, investing in highly-valued stocks just because of optimism and confidence in the future, regardless of the outcome, simply because it has risen high in the past, is speculation. A bet that confirms that the price is already significantly below the value is a smart value investment. As long as it is repeated enough times, there is a high probability that it will pay off.
Graham only does arbitrage and value investing with high certainty. It's business, and business is replicable and sustainable.
According to Graham's record in "The Smart Investor," his Graham Newman Investment Fund, after years of operation and experimentation with multiple investment strategies, systematically makes only four types of investments:1. M&A arbitrage, 2. Convertible Bond Arbitrage, 3. Restructuring Arbitrage, 4. Deep Value Investing. Because Graham believes that only these four investment strategies can bring stable and consistent profits. In addition, Graham has tried less deep value investing (i.e., buying stocks that are cheap but have little margin of safety) and non-correlated long-short (long, short) strategies, all of which have not been able to make money consistently.
The first three arbitrage methods are the scope of professional finance, involving more complex long-short (long, short) operations, which will not be detailed here, but the last one is value investing as we know it today.
In essence, the essence of value investing is also arbitrage, which is the arbitrage of the relationship between price and value. However, traditional arbitrage has a high correlation and short-term certainty in the underlying assets, while value investment has a longer term and requires long-term patience and relatively low certainty, but it is also a kind of arbitrage in nature.
The characteristic of arbitrage is that it does not evaluate asset quality and fundamentals, but only focuses on the relationship and divergence between relevant indicators. In this respect, value investing is different, because value investing has a longer horizon and needs to look at fundamentals, but it needs to look for companies with unchanged fundamentals as much as possible, so that they can be relieved as much as possible from the difficult responsibility of predicting the long-term future, so that they can focus on finding the divergence between value and price.
Naturally, this requires an extremely deep understanding of value, because if you don't know the value (the price is certainly not difficult to know, Mr. Market gives it every day), you can't measure and understand the divergence. Graham's view of value is generally measured in two ways:1. P/E multiples (or, more extremely, dividend yields), a lower P/E ratio (or lower dividend yield) usually means a solid lower limit of value, such as 5-8x P/E ratio, 10-15% dividend yield; 2. Liquid assets - all liabilities, which can be understood as the minimum amount of funds that can be left to shareholders after the bankruptcy liquidation of a company. The former is usually suitable for large long-term operating companies and can be evaluated from a long-term perspective, so the price-earnings ratio or dividend yield is used, while the latter is more suitable for small companies that are about to liquidate, and the future business is no longer important, but the current realizable net assets are important.
Because of the above characteristics, value investment cannot make people feel stimulated, and value investment cannot attract optimists, technology activists, and risk-takers, and only practical and prudent investors and businessmen.
10. The Future
In his memoirs, Noguchi wrote, "Japanese tourists [in the 1970s] couldn't get to the suburbs because they couldn't get to, so they saw the depression in the city center and came to the conclusion that 'America is no longer good.'" They don't know that new developments in the United States are quietly sprouting in the suburbs. ”
Living in crowded and bustling cities, Japanese people may not understand why Americans can sprout a new path of development in the quiet and boring suburbs. Like the whalers who lived in the age of the magnificent whaling, they may not understand why the quiet textile industry can have amazing returns.
But no matter what one thinks, money flows slowly but surely in every transaction, every payment, in this economic machine. And the return on capital that can be obtained from investment, although it is no longer so exciting and even boring, is hidden everywhere in this economic machine, waiting to be found by smart investors.
In the late 19th century, among British politicians, a curse that seemed to come from ancient China began to prevail: "May you live in interesing times." The British saw it as a kind of ironic viciousness, and interesting times meant difficult times.
This sentence is clearly not an ancient Chinese proverb. But interestingly, this sentence seems to whisper that boring times can be good times, and although there are not many killing expeditions, there are also adventures of their own.
所以，这句话应该是一句祝福：“May you live in boring times (愿你生活在无趣的时代)。 ”
If so, then hopefully everyone will be able to find what they want in the next "boring" era.
题图来源：Moby Dick, Warner Bros
Resources:
聪明的投资者 The Intelligent Investor, Benjamin Graham, 1973
巴菲特传 Buffett: the Making of an American Capitalist, Roger Lowenstein, 1995
投资最重要的事 The Most Important Thing Illuminated, Howard Marks, 2013
风险投资：美国史 VC: an American History, Tom Nicholas, 2019
Economic History of Postwar Japan, Yukio Noguchi, 2015