Over the past 35 years, since the company’s IPO in April 1991 through July 13, 2026, AutoZone’s common stock has increased 448-fold, which equates to a compounded annual growth rate of 18.9%. Moreover, the company is famous for dramatically shrinking its share count during that time by 89%, from 152.7 million shares at the peak in June 1998 to 16.5 million shares as of May 2026.

Share buybacks are a widely misunderstood corporate action, both by critics and, to a lesser extent, by adherents.

Subscribe now

AutoZone has been the poster-child for share buybacks done well. And the conventional explanation is that these share buybacks were the primary driver that led to great returns. But that conventional explanation is incomplete

Eddie Lampert and AutoZone

What first turned me on to AutoZone was reading, perhaps around the year 2007, about Eddie Lampert, then a superstar investor who had accumulated a large stake in the retailer, had apparently prodded management to begin buying back stock, and had earned stellar returns on his investment.1 I’ve always wondered what Lampert saw in the stock and how and why share buybacks seemed to be very effective in producing returns for the company’s equity investors.

Although AutoZone has produced tremendous returns for shareholders over its entire life as a public company, I’ll limit the analysis here to Lampert’s investment in AutoZone, from 1997 to 2012, so as to definitively restrict us to a single point in time at the start so we can try to see the same potential he saw when he invested.

The first public disclosure of Lampert’s ownership that I could find is a 13D filing from August 1998 for several of Lampert’s investment vehicles that lists a combined ownership of exactly 11 million shares, or 7.2% of the company’s stock.2 According to a BusinessWeek article, Lampert started accumulating AutoZone in 1997, although no specific date is given. The SEC requires investors to file a 13D within five business days of acquiring 5% or more of a company’s stock, so it seems likely that Lampert owned less than 5% of AutoZone’s stock starting sometime in 1997. I’ll assume he started buying in Q2 of 1997 and that he had access to the 1996 annual report and any disclosures prior to March 31, 1997.

AutoZone was an excellent company

AutoZone was and still is in the business of auto parts retailing, and it’s been in business since 1979. Here is a succinct explanation of the company’s business from the 1996 10-K:

The Company began operations in 1979 and at August 31, 1996, operated 1,423 stores in 27 states, principally located in the Sunbelt and Midwest regions of the United States. Each AutoZone store carries an extensive product line, including new and re-manufactured automotive hard parts, such as alternators, starters, water pumps, brake shoes and pads, carburetors, clutches and engines; maintenance items, such as oil, antifreeze, transmission, brake and power steering fluids, engine additives, protectants and waxes; and accessories, such as car stereos and floor mats.

Two things jumped out at me when I opened the 1996 10-K report:

1. how consistent their business was, and

2. how profitable it seemed to be.

In fact, as a loose confirmation of the consistency, AutoZone conveniently laid out 10-year financial histories in its annual reports and 10-K’s; I couldn’t help but feel that management was showing off how consistently the company was growing sales and earning more and more income. Below, I reproduce an abbreviated version of AutoZone’s income statement that appeared in the 10-K.

From the data above, it is not hard to see that AutoZone had been doing very well over the ten years prior to 1997:

• Net sales were growing consistently in the range of 20-25% per year. That suggests the company was continuing to tap into some form of unsatisfied demand.

• Gross margins were high, and they had improved. That suggests that customers were willing to pay up for whatever AutoZone was providing them and/or AutoZone was paying less to obtain salable items.

• Operating and profit margins were good, and they had improved a lot. That suggests the company had been improving the way it was run and/or that its business model was benefitting from scale.

Why was AutoZone able to perform so well? What was the company’s business model?

AutoZone had a simple and compelling business model: It was “professionalizing” the auto parts retailing business, opening larger stores with more selection, in convenient locations, with good prices. From the 1996 10-K:

AutoZone is dedicated to a marketing and merchandising strategy to provide customers with superior service, value and parts selection at conveniently located, well-designed stores. The Company has implemented this strategy primarily with knowledgeable and motivated store personnel trained to emphasize prompt and courteous customer service, through an everyday low price policy and by maintaining an extensive product line with an emphasis on automotive hard parts. AutoZone’s stores are generally situated in high-visibility locations and provide a distinctive merchandise presentation in an attractive store environment.

Management takes the time in its 10-K to expound upon each part of its retail strategy by discussing customer service, product selection, price, and store location and design at length. For those interested in a more in-depth look, I’ve reproduced their strategy and philosophy on each below:

I’m quoting extensively from the 10-K here in order to relay something important about the retail industry: customers do not shop at great retail stores for one reason alone. They need several compelling reasons. I’m reminded of the following quote from Sam Walton’s autobiography, Made in America:3

...the secret to successful retailing is to give your customers what they want. And really, if you think about it from your point of view, as a customer, you want everything: a wide assortment of good quality merchandise; the lowest possible prices; guaranteed satisfaction with what you buy; friendly, knowledgeable service; convenient hours; free parking; a pleasant shopping experience. You love it when you visit a store that somehow exceeds your expectations, and you hate it when the store inconveniences you, or gives you a hard time, or just pretends you’re invisible.

Of course, it would be naive to suggest that AutoZone was another Wal-Mart simply on the basis of quotations from the management team. In fact, a skeptic would argue that “superior service, value and parts selection at conveniently located, well-designed stores” are the kind of thing any retailer would claim.

In order to understand whether or not the stores were truly resonating with customers, I needed some better proof. And I found it in the company’s financials. The table below shows an expanded version of the financials shown earlier.

These financials show a few things over the course of ten years through 1996, which I have highlighted in different colors:

1. Green lines: AutoZone was growing consistently over those ten years, with net sales growth, as evidenced by line 2, in the 20-25% range. A careful reading of the 10-K shows that the company was doing this with a combination of good same-store sales growth, and, more importantly, very strong new store growth (see line 20). In fact, new store growth was accelerating from 1990 to 1996; the company was growing faster.

2. Teal lines: AutoZone’s underlying business was improving too. Lines 5, 8, and 13 highlight the company’s margins. Each had increased over the past several years since 1989. Higher margins indicate that the company was benefiting from scale by getting more favorable purchasing terms from suppliers, benefiting from centralization of certain expenses (like advertising), or simply benefiting from its experience in running a better, more profitable business as time went by.4

3. Blue lines: AutoZone consistently generated a high amount of profit relative to the capital the business employed, as shown in lines 15 and 17, return on average assets and return on average equity capital. This implies that the company was delivering something (or things, plural) to customers that other retailers were not or could not. Otherwise, I would expect the company’s return to be falling as other competitors swooped in and deployed their own capital to challenge AutoZone.

So from the 1996 10-K alone, AutoZone looked like an excellent business, growing, profitable, and earning high returns on its capital. But a great business in a tapped-out market is a different proposition than a great business with room to run. Before Lampert could be confident that what he was seeing would continue, he needed to understand the industry AutoZone was operating in: how large it was, who else competed in it, and how much of it AutoZone had already taken.

Next week, in Part Two, we’ll cover each of those things.

Subscribe now

Subscribe now

The best investing records

Below are some of those examples. For sources, see footnotes1.

• Warren Buffett: From 1957 to 1968, he produced annualized returns of 31.6% for his partnership.

• Charlie Munger: From 1962 to 1975, 19.8% annualized for his partnership.

• Walter Schloss: From 1956 to 1984, for 28 years, 21.3% per year.

• Ted Weschler: From 1989 to 2012, he turned $70,385 into $131 million in his IRA account, equivalent to about 39% per year.

• Joel Greenblatt: From 1985 to 1994, a stunning 50% per year.

• George Soros: From 1969 through 1994, the Quantum Fund produced 35% annualized returns.

• Stan Druckenmiller: Returned 31% per year over 30 years. I believe this record overlaps with Soros’s above.

• Jim Simons: From 1988 to 2018, Renaissance Technologies’ Medallion Fund generated an incredible 66.1% average gross annual return.

• Peter Lynch: From 1977 to 1990, for the Fidelity Magellan Fund, he produced a 28.9% annualized return. The fund grew from $18 million to $14 billion.

• Bill Ruane: From 1970 to 1984, the Sequoia Fund generated 17.2% annualized returns for investors. (Bill also produced 14.7% annualized returns from 1970 to 2015, a 45-year record.)

• Tom Knapp: From 1968 to 1983, for Tweedy, Browne Partners, 20.0% annualized returns.

• Lou Simpson: From 1980 to 2004, 20.3% per year for the GEICO equity portfolio.

• Nick Sleep and Qais Zakaria: From 2001 to 2014, the Nomad Investment Partnership generated 20.8% gross returns for investors.

How much return should we seek?

Warren Buffett has stated that, if he were managing small sums of money, he could produce annualized returns of 50% or more. Buffett’s claim here is so interesting that he has been asked this question many times at Berkshire’s annual meetings, at student talks, and elsewhere.

The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then… I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.
- Warren Buffett, “Homespun Wisdom from the ‘Oracle of Omaha’”, BusinessWeek, July 5, 1999

I think the lack of good, comprehensive studies of stock returns is one reason why this question of Buffett has been so popular and why investors are so mesmerized by return records like the ones listed above. Most people, even after hearing Buffett say it aloud, are quietly incredulous. How could it be possible to return 50% a year?

Many investors know that an index of large-cap stocks, like the S&P 500, has produced something like 8-10% returns over the long-term, and many understand that even modest outperformance of a few percent can lead to huge long-term outperformance, but how many are familiar with incredible return performances?

I think most investors only have a vague sense of what is possible. An enterprising investor should understand what the very best return performances look like to get a sense of how high they should be shooting. When I am considering an investment, and I think it has the potential to return, say, 15% per year, should I pull the trigger or should I continue looking at other investments?

It is important for me as an investor to have an understanding of what level of stock returns has constituted greatness in the past, however defined. That way, when my research suggests that a stock might produce forward returns around some level, I might have a little more confidence around using up one of my twenty punches.2

Bessembinder’s study of great companies

In a prior article, I discussed a research study by Hendrik Bessembinder from 2017 that analyzed wealth-creation among US-listed public companies over the 90-year period from 1926 to 2016. Bessembinder showed how rare it was to find a great company that could produce dramatic outperformance over its life.

In the study, Bessembinder analyzed the dollar-wealth created by companies3, which is useful but somewhat abstract. His study was so popular, and he must have wanted to provide more performance than the dollar-wealth metric, so he published another study in 2024 that measured US companies and stocks by their compounded annualized growth rates. Many investors find it more natural to think in annualized rates, of course. The study is called Which U.S. Stocks Generated the Highest Long-Term Returns?, and it has some very interesting takeaways.

A newer study focused on annual returns

The second study is useful because it can provide a kind of gauge for the enterprising investor, as I described. It shows us how much return the best stocks have produced over various periods of time. It can help provide us with a historical point of view when aiming for returns.

Bessembinder performed his new study using the daily common stock database from the Center for Research in Security Prices (CRSP), just as he did in the 2018 analysis. However, this time he studied the 98-year period from December 31, 1925 to December 31, 2023. He analyzed 27,731 publicly listed companies and their common stocks, and he calculated the annualized returns that the stocks generated over their lifetimes.4

The chart below shows the amount of time that each stock was listed in the CRSP data. The median time for a stock being listed was 6.8 years, suggesting that half of all companies undergo a delisting (due to merger, bankruptcy, or other reasons) in less than that time. Only 10% of companies are in the database for 28 years or longer. Very long-lived companies are rare.

What level of annual returns have stocks produced?

Focusing now on the 27,731 stocks that were listed for more than one year, what can we glean about the annualized returns they produced?

The chart below shows those stocks bucketed by the annualized return that they generated over their listed life. The black line separates stocks that generated a negative return over their lives from those that generated a positive return.

Most companies produced a negative return

One of the most striking observations is that most companies (51.1% of them) generated a negative annualized return (implying, of course, a negative outright or total return) over their lives. The median return for all stocks was -0.8%. In other words, randomly selecting a company’s stock to invest in is likely to produce a majority of outright losers over the respective lives of those companies.

How do we reconcile this with the observation that stock indexes tend to produce significant gains over the long-run? For instance, the S&P 500 produced an annualized return of 10.5% per year over the last 100 years.5

Two reasons. First, the profile shown above has a large positive skew. Even though only a minority of companies (48.9%) produce positive returns over their lives, there are enough of them, and enough that produce high returns, that it drags upward the total returns for the entire group.

Second, the S&P 500 is naturally biased to select longer-lived, stalwart companies, and that bucket is less likely to feature the loser companies. For instance, in the bucket of companies that have lives of 1 to 5 years, 63% generated a negative annualized return, while in the bucket of 20 to 40-year companies, only 30% generated a negative annualized return. (Side note: Yes, there are a lot of long-lived companies that end up with negative returns at the end of the day.)

Extremely-high returns are short-lived and likely not accessible repeatedly

What about that long tail on the right side of the chart? There is only a small minority of firms that produce very high annualized returns over their lives. One thing is clear about those companies: they tend to have short lives. In fact, for the firms that produced annualized returns greater than 53%, none of them had lives over 10 years. Why? The highest-returning companies are bought by other firms and taken private, and, if they are not, their ability to produce very high returns abates with size and age.

The figure below shows the top 20 companies (out of 27,731) by annualized returns in Bessembinder’s study. Not surprisingly, all of these companies were listed for less than three years before they were bought and delisted. Because of their short lifetimes, almost none of these companies are familiar, but some may make good case studies in the future.

So, the first takeaway for an enterprising investor is that extremely high annualized returns are likely to be very short-term, and, because of their nature, may not be possible to capture systematically.

For example, the third company on Figure 5 is Synthorx Inc. Synthorx was a pharmaceutical company founded in 2014 that underwent an IPO in December of 2018 and was acquired by Sanofi in January 2020, in part because of one major drug that Synthorx was developing. Capturing such gains would have been difficult unless I was neck-deep in drug development research and keeping up rigorously on progress at Synthorx.

Ok, then what about company lives that are a bit longer?

Let’s take a more detailed look at Bessembinder’s data. The figure below shows annualized returns versus the lifetime of each company for all 27,731 companies in the study. It becomes easy to see that, the longer a company is around and the larger it gets, the more difficult it becomes to keep producing astounding returns. The second chart below zooms in on the y-axis. On that chart, I’ve also drawn a crude kind of “frontier” for annualized returns generated by firms over their lifetimes. That line can give a sense for what the absolute best historical return levels have been for companies that have lived for various amounts of time.

The best returns across times

Using this data, we can get a feel for the best returns posted by the best companies over longer periods. To do that, we’ll divide the list of companies in the study into various buckets based on the lifetimes of the stocks in the database. The figure below shows the lifetime returns for companies in these buckets.

I’ve broken out companies in the 99th percentile to show the levels of returns that the very best companies have put up over their lives. I also show the median company return for comparison.

There are some astounding numbers in the above figure. Those companies in the top 99th percentile (that is, 1 out of 100) have produced annualized returns anywhere from 18.4% (over very long lives of 40+ years) to 105.5% (over very short lives). One could rightly wonder if the 99th percentile is too high a bar to be targeting, but I think it is a healthy target (1 in 100) to keep in mind for an enterprising investor who is devoting his time to sifting through many ideas in an attempt to find the very best ones. Keeping the 99th percentile returns in mind as a target also reinforces Buffett’s advice of investing with a punch card mentality: when making an investment, imagine that it is one of only 20 investments you will get to make in your life. Set the bar high.

Breaking out the return levels by stock lifetime is useful too. As mentioned before, I might be attracted to that 105.5% level of annualized returns in the 1-5 year bucket, but such stocks often produced those returns over very short lifetimes from events like buyouts that are very difficult to predict.

What about longer time frames?

What about stocks in higher lifetime buckets? There, the longer lifetimes over which great returns were generated might afford me the time to learn about the company, follow its progress, and capture some of those great returns. Indeed, the lists of companies by lifetime seem to bear that out.

The figure below shows the top 20 companies, ranked by annual returns over their lives, for four buckets: those stocks in the database for 5-10 years, 10-20 years, 20-40 years, and those with over 40 years of life.

The trend I mentioned above holds for these company lists as well. Among the shorter lived companies, there seem to be several for which high returns would have been dependent on predicting a high-priced merger, which is difficult to do. In another example, US Robotics Corp is on the 1-5 year list, and it was purchased by 3Com in 1997 amid the dot-com frenzy.

As we go out further in stock lifetime, however, the degree of predictability seems to increase, and annualized returns can still be stellar. Netflix, for example, produced 32.1% annualized returns over its life from May 2002 to the end of the study at December 2023. One could complain that it would have been very difficult to predict how great a business Netflix would become in 2002, so capturing those great returns would have been difficult. However, even if we give ourselves ten years of leeway and restrict ourselves to the period from December 2013 to December 2023, the stock still returned 25.0% per year.

Return targets for the enterprising investor

It is incredibly hard to try to go back in time, and making great investments like that is always more difficult than it seems in retrospect. However, this exercise can show us just how many companies (and how few on a percentage basis) have actually put up great returns and what those levels might be for a great investor who could find them.

The companies listed in Figure 8 bear that out. The figure suggests that investing in the very best companies over the long term could produce returns that are in the rough range of 20% to 50% (judging by the companies in the 10-20, 20-40, and 40+ year lifetime lists). The data serves as a good reminder that great investment returns have been out there in the past and are likely to continue in the future.

There is one issue with the above analysis that might cause the annualized returns to be boosted a bit. The study ends at 2023, which we can think of as being 14 years into a bull market that started in 2009. Several of the top stocks in the study show December 2023 as their last listing period, which means that the returns of those stocks will be benefitting from that bull market. For example, in the bucket of stocks with 20-40 year listed lifetimes, 30% of the top returners (95th percentile) have December 2023 as their endpoint.

On the other hand, there is one critical point that argues for returns that could be even better than shown for the enterprising investor.

The returns listed are extreme buy-and-hold returns. They show the annualized returns that would have been available for an investor who simply bought each company’s stock at the time it was first listed and simply held the stock until delisting (or through December 2023). The analysis makes no accounting for valuation and company fundamentals. While there is something to be said for the simple approach, the enterprising investor should be able to increase their returns through fundamental research and buying stocks in the best companies when their market prices are suffering versus their fundamentals and future returns are likely to be higher than ordinary.

Summary and takeaways

• Hendrik Bessembinder produced a valuable and unique study in 2024 that shows the best annualized lifetime returns from the stocks of publicly listed US companies.

• The very best annualized returns are produced over very short lifetimes, and those may be hard to predict and thus inaccessible to an investor.

• However, there are many great companies that have produced incredible lifetime returns over medium or longer terms, like 10-40 years.

• An investor seeking to put up the best possible performance should be shooting for annualized returns in the range of the very best companies and above. Data from the Bessembinder study suggests that number could be the 20-50% range.

  • To be fair, the data may be biased high because the end of the study coincides with a bull market.

  • On the other hand, the enterprising investor may be able to obtain even higher levels than those cited above by leveraging fundamental research and buying stocks in the best companies when their market prices are depressed.

Subscribe now

In Parts One and Two, we discussed the government plan to privatize Russian businesses using an interesting voucher system after the fall of communism, and we saw just how cheap Russian businesses were at that time. We also discussed a host of risks in investing in the country at that time.

With the value case established and the risks weighed, we can now attempt to put together Li’s actual investment in Lukoil at the time.

Piecing Together Li’s Investment in the Company

At the end of Part Two, we recreated Lukoil’s market cap from three different sources. I’ve reproduced that chart below.

Subscribe now

Now that we have that recreation, can we piece together Li’s investment more specifically? Li speaks briefly and vaguely about the market prices of Lukoil and Gazprom around this time and is not very specific about the exact time when he bought and sold the stock, but he does provide some clues:

Forget about the earnings. Just... the assets on the balance sheet. At the time oil prices [in the world market], I think the four or five year average was around twenty dollars [per barrel], and the [value per barrel of proven oil reserves for Lukoil was] at really low prices... about 10 cents to 20 cents per proven barrel of oil on the balance sheet and that’s not even counting the earnings... This is how low it went. It was ridiculous.

From this quote and others throughout the talk, it seems that Li’s main focus was just how cheap Lukoil was trading relative to how much proven oil reserves were on its balance sheet. He seems to have virtually ignored any loss (or any income) that the company was making at the time, reasoning that such an extreme undervaluation relative to the company’s assets dwarfed the numbers on the income statement.

Let’s take Lukoil’s proven oil reserves of 10.9 billion barrels from its 1996 annual report and translate the above chart, this time showing the market cap of the company per proven barrel of reserves.

Now, we are beginning to see what Li saw around the time of his investment. More from Li’s talk:

For the longest period of time [the market cap of Lukoil or similar firms] was at 20 or 30 cents [per barrel of proven oil reserves], [then] 50 cents, then quickly moved to a dollar and briefly traded to three dollars.

From this quote (and Li’s discussion of the 1992-1994 voucher period in his talk), I am going to surmise that Li made his initial investment in Lukoil somewhere in early 1995 to mid-1996.

More clues:

And then a few years later the Asian Financial Crisis occurred and Russia devalued the currency. All of a sudden that two dollars [per proven barrel of] oil no longer looks very protected because the currency [is] literally at one point... down ninety percent... But if you bought [Lukoil] at ten cents [per proven barrel of reserves]... you still came out all right. In fact, you still probably made 10 times your money.

For example... in Lukoil and Gazprom, I sold it two years after I first bought it... but at the time they [were] still kind of trading probably 80 to 90 percent discount, but i think the 80 to 90 percent discount is warranted somehow. Today [Author’s note: “today” was the year 2012], they are still trading at a huge discount.

When Li talks about the 80 to 90 percent discount for the stock, he seems to be referring to Lukoil’s market cap per proven barrel of oil and gas reserves versus the market price of crude oil. I’ve recreated that in the chart below, effectively showing the price of Lukoil’s stock (its market cap) versus the market price of Lukoil’s “stuff”: all of its proven oil and gas reserves.

When I saw this chart, I thought I might be off a bit, since Li mentions that he sold when Lukoil was trading at a discount of “80 to 90%”, but after extending this chart over an even longer timeframe, the market cap of Lukoil versus the market price of oil does not meaningfully cross 10% (which is a discount of 90%) until the year 2020! However, from the early 1995 to mid-1996 time period, Lukoil does go from trading around a 98% discount to a 91 or 92% discount.

All in all, with the limited information we have, I think the most reasonable conclusion is that Li made his initial investment in Lukoil somewhere in early 1995 to mid-1996 when the stock was trading around $3 billion to $5 billion in market cap and $0.30 to $0.50 per proven barrel of oil and gas reserves, and he sold it somewhere around mid-1997 to mid-1998, in the region of $12 billion to $20 billion of market cap and $1.25 to $2.00 per proven barrel of reserves. (Recall his comments from earlier, that he sold “two years after” he first bought it and that the $2.00 price per proven barrel of oil no longer looked protected.)

With those crude, round numbers, his investment would have made him anywhere from 2.5 to 6.6 times his money in just over two years of time.

Li Lu first got interested in investing after attending a lecture by Warren Buffett, who was invited to the school to speak, in 1993. (It is possible the exact date was October 27.) At the time of his investment in Lukoil, he may still have been a student at Columbia University, from which he graduated in 1996. He worked at the investment bank Donaldson, Lufkin & Jenrette for about one year before founding Himalaya Capital in 1997. It was likely right at the start of his work at Himalaya that he sold his stake in Lukoil (and any other Russian oil and gas companies he may have bought).

I mention this as a brief aside because it may suggest something about Li’s boldness of character. After first learning about investing just two or three years back, he had the temerity to both do the work on a foreign investment in an emerging democracy and to pull the trigger.

How Cheap Is Cheap Enough?

Li talks about the dramatic cheapness of Lukoil and other Russian stocks at the time, and he was right to some extent. But that cheapness had its limits. Below, I show the price of Lukoil’s stock from 1993 to 2021. I also show a variation of the chart with Lukoil’s market cap versus the value of its proven oil reserves (a measure of Lukoil’s “cheapness”).

The charts paint a picture that is difficult to rectify: For virtually the entire period from 1993 to 2021, Lukoil appeared to be cheap, trading at a market cap that almost never valued the entire company greater than 8% of the value of its proven oil and gas in the ground. Exxon (and later Exxon-Mobil), by comparison, averaged a market cap of 34% of the value of its reserves from 1993 to 2021.

So, at all points, an investor might have thought that Lukoil was cheap. And yes, buying the company’s stock in 1995 and holding it for two years, like Li, would have produced a great return. Even holding it for 10 years, from, say, June 1995 to June 2005 would have produced an annualized return (excluding dividends) of 21%, as the stock went from $5.21 to $34.75.

However, the next 10 years, through June 2015, would have only produced an annualized return of only 3%, despite the company appearing cheap in June 2005, when its market value was only 4.7% of the value of its reserves.

As Much As Possible, Seek a Catalyst

What are we to think about this? How are we to know, for future investment opportunities, when apparent cheapness is “real” and when it’s not?

This case study was particularly enjoyable for me because the lessons are so difficult to tease out. Simply buying Lukoil stock at any point in its history because it was cheap relative to other companies around the world would have been a mixed bag. Buying in the 1990’s or early 2000’s would likely have worked out great. Buying in the late 2000’s or the 2010’s would likely have been poor. At all times, Lukoil looked cheap versus Exxon and other western oil companies.

It is very difficult to know how to think about this issue, but one thing to keep in mind is the timing of Li’s investment. In the early to mid 90’s, Russia was emerging from communism and still getting accustomed to the cultural shift toward capitalism and democracy. One could argue that, although corruption was still rampant, the prevailing winds were blowing in the direction of a country getting more used to democracy and slowly reaping the benefits of capitalist markets. These trends could serve as a gradual but important kind of catalyst to close the gap between price and value. In Russia, for example, these changes would slowly lead to more Western investors participating in Russian markets through the 1990s and 2000s.

But it’s important to realize too that the lack of such change (or timing) could make for a difficult investing situation, whereby an investor thinks a stock is cheap by some measure but that situation sticks around for many years.

So one takeaway from Li’s investment is that extreme cheapness is a great thing to hunt for, but seek to have it come along with a changing situation or an outright catalyst.

Summary and Takeaways:

• Li’s investment in Russian oil and gas companies in the 1990’s was a situation where the stocks were obviously cheap relative to the value of their assets and relative to other companies around the world.

• Dramatic changes, like the shift from communism to liberal democracy in Russia, often come with extreme undervaluations.

• It is very difficult and perhaps impossible to know just how much discount the market will demand of a given situation or investment. As much as possible, look for undervaluations that come with a naturally changing situation or an outright catalyst.

Subscribe now

In Part One of our case study of Li Lu’s investment in Russia, we discussed the the fall of communism, the government plan to privatize Russian businesses, and the voucher system that was used to convey interests in those businesses to private citizens.

Now, I would like to focus on one of the two companies mentioned by Li to try to get a more specific sense of what he saw at the time. That company is Lukoil. A good part of this case study will be focused on attempting to recreate basic information from the time, like Lukoil equity pricing and company fundamentals, since it is very difficult to get any good information about Russian stocks from that period.

Subscribe now

The History of Lukoil and Early Information Advantages

Lukoil was formed in 1991 with the merger of three companies, the Langepas Oil Company, Urai, and Kogalym (the “Luk” in Lukoil)1, and in November 1992, Boris Yeltsin officially designated Lukoil one of three integrated holding companies2. In those early days of the company’s formation and Russian market privatization, the trading of stocks was in its infancy and systems were rudimentary:3

The lack of good trading infrastructure is relevant for our case study today. Early trading prices for Lukoil are not available in any records I checked, which may be due to the disorganized nature of trading in those days. The first trading price I was able to find for the stock was January 12, 1996 from Bloomberg.

The same goes for information about company financials or any supplemental information. In fact, it was so difficult to obtain basic information about Russian companies in the early 90’s that it was cited by some investors as a distinct advantage. From David Hoffman’s The Oligarchs:4

The earliest annual report I was able to find for Lukoil was from the year 1996. It is from that report that I obtained the total for the company’s share count and for the company’s proven oil reserves that I will use in the analysis below.

Do The Legwork Others Won’t

The lack of financial and pricing information available raises a critical point about Li’s investment in Lukoil: it shows what it takes to invest well.

In the early and mid 1990’s, Li Lu was a student at Columbia University. If simply finding information about Russian companies was as difficult as it seems, especially for a student in New York like Li, it speaks to the extreme level of dedication and commitment he must have had in pursuing an investment like this.

Some very interesting and compelling investment opportunities come with the need to do “frontier”-type of work. (See also Li’s willingness in his investment in Timberland to travel to the hometown synagogue of the managing family to get to know them.) In the case of Lukoil, Li would have needed to figure out how to simply obtain basic information about the company and also how to execute a purchase of Lukoil’s stock.5

Recreating Lukoil’s Market Price History

Let’s imagine what Li might have seen in those early years of Lukoil’s formation and trading, recreating the company’s market cap and market price from those years, even if we can only do so crudely.

Since the first trading price of the stock I was able to find was January 12, 1996, I will stitch together an effective “Lukoil market price” for the stock prior to that date from a few data sources. It won’t exactly match the pricing traded by Russian stockbrokers from those early years, but it should be close enough for us to see how this investment unfolded.

1. From 1992 to December 1993, I used the pricing for vouchers we saw in Part One of this article. That figure is reproduced below. However, I could find no information about the outcome or pricing of Lukoil’s first privatization auction in April 1994.

   But some sources did report the results of the Gazprom auction as valuing the entire company at $228mn. Gazprom’s auction took place between April 1994 and June 1, 19946. And just a few years later, in 1996, Gazprom was trading at $1.775bn of market cap (versus $3.073bn for Lukoil)7.

   In determining the effective “voucher-price” of Lukoil, I used the assumption that Lukoil’s market cap coming out of auction was equal to the same ratio of 1.73 times that of Gazprom. It is very crude, and it shouldn’t be relied on for anything more than what we are doing here: trying to get a feel for roughly how this investment opportunity progressed in the early 90’s.

2. Credit Suisse created and maintained a valuable index of the Russian stock market called the ROS index, which tracked 30 Russian stocks (one of which was Lukoil). From December 1993 to January 1996, I make the assumption that Lukoil’s stock price tracks the ROS index exactly. This assumption is crude too, but the correlation between the two after 1996 is very high, so, again, this recreation should give a pretty good feel for what Lukoil’s stock price was doing during this period.

3. From January 1996 onward, I use Lukoil’s stock price from Bloomberg.

Finally, I am going to make two more crude assumptions.

1. Lukoil’s oil reserves. In his talk, Li does not discuss the earnings of Lukoil at all. In fact, he only mentions one metric that indicated how severely undervalued Lukoil was at the time: the number of barrels of proven oil reserves on the company’s balance sheet.

   Finding this figure was difficult, but I was able to discover one annual report of the company’s from those early years, the annual report for 1996. In that report, the company lists its total proven oil reserves in Russia as 10.5 billion barrels of oil and 2.150 trillion cubic feet of natural gas8, for a total of 10.9 billion barrels of oil equivalent. While these reserves will change each year as the company taps those reserves and discovers new reserves, we will use it through 1998 as a fixed value in order to recreate the metric Li spoke about. I was able to find annual reports from 1998 onwards, so any reserve figures from those years will be accurate.

2. Lukoil’s share count. In the same vein, I could find no sources that gave specific share counts for Lukoil’s common stock in the early years. So, I use the total from the 1996 annual report (714,563,255 total shares), assume that figure is fixed through 1998, and use it to calculate Lukoil’s market cap from its stock price.9 Again, I was able to find annual reports from 1998 onwards and have used share count figures for those years.

With the details out of the way, here is my recreated chart of Lukoil’s stock price (or its voucher-equivalent) from 1992 to 1999, made from the above data sources.10

The chart above makes the extreme undervaluation of Lukoil plain in absolute terms. To further drive home just how cheap Lukoil was relative to the rest of the world, consider how it stacked up against a major Western peer.

Lukoil versus Exxon

Lukoil was cheap in those days, but how cheap was it? Let’s take a look at the valuation of Lukoil versus that of another leading oil company at the time, Exxon.

While Lukoil’s trading prices implied a market cap of 20 cents to 50 cents per barrel of proven oil and gas reserves around the time of Li’s purchase, Exxon’s valuation implied a market cap around $6 to $8 per barrel. In other words, Lukoil was trading about 5% the value of Exxon on a reserve basis ($0.35 divided by $7). At the time, the price per barrel of crude oil on world markets was around $20.

Seeing the market cap of Lukoil at such a big discount from the market price of oil during that period (and versus other oil and gas companies as well) makes an investment in the company seem like a no-brainer. And according to Li’s comments in his speech, at the time, he regarded it as such.

But it is impossible to go back in time and truly recreate how any of us would have reacted at the time. To further explore that, let’s discuss the arguments against an investment in Lukoil.

Giving Weight to Arguments Against Russian Investments

To avoid looking at the past through rose-colored glasses, let’s explore some of the arguments against Russian stocks at the time.

Argument #1: Russian companies needed too much capital

At the time of Li’s investment, in the early 1990’s, Russia was still recovering from the collapse of communism, and it was widely thought that Russian companies needed a lot of capital to modernize after underinvestment in the years prior.11

Moreover, these concerns seemed to be more than just academic. In fact, Russian oil production was suffering declines in the early 1990’s:12

Argument #2: Rampant inflation

Another argument against any equity investment in Russia was that inflation was rampant in the country at that time. I spoke about this in Part One of this article. Prior to the fall of communism, the prices of many goods and services were set by the state. Starting in 1989 and in a few stages in the years following, Russian leaders slowly freed prices from government control. The effect was a massive inflation that gripped the country in the 1990’s, as shown in the table below.13

For me, this argument is an easier one to rectify than the first. Here, I’m reminded of Mohnish Pabrai’s investment in the Turkish company Reysas in 2019. Reysas owns warehouses in Turkey that are leased to large multi-national corporations.

At the time, Pabrai was concerned about the rampant inflation (both current and future) in Turkey, but rightly reasoned that a company that controls valuable and irreplaceable assets as part of its business should be able to raise prices to keep pace with inflation (or better). He was right, and, for Li’s investment, Lukoil’s proven oil reserves have a similar aspect.

Argument #3: Rampant corruption

This one is easy for a Westerner to understand today, and it is difficult to rectify. At the time, and despite its moving toward more democratic politics, Russia had a reputation for corruption. Perhaps nowhere was this more evident than in the “loans for shares” scandals that pervaded Russia’s privatization charge.14

The loans for shares program was emblematic of how much corruption was at play in Russia at the time, and the scheme helped fuel the subsequent rise of the Russian oligarchs. To give a more concrete feel for some of the undervaluations that resulted from the scheme, 5% of Lukoil was sold in these schemes for $35mn to $45mn, when the value for 5% of the company that was implied from stock market trades was $180mn.

Argument #4: Russia was cheap, and it should have been.

This argument goes along with #3: There is good reason for the cheapness of Russian stocks. Corruption puts the rule of law at risk, particularly property laws around equity ownership. As in the loans for shares deal, there was no guarantee that further portions of Lukoil wouldn’t be sold for large discounts, effectively diluting existing owners and raising their (per barrel) cost of ownership. Moreover, investing as a Westerner in a country that just came out of a Cold War with the US would have raised serious questions about the risk of the Russian government being antagonistic toward Western ownership.

Next week, in Part Three, the final installment of our case study, we’ll see how Li weighed these arguments, what he ultimately decided, and piece together his investment and just how lucrative it was.

References

1. Capitalism Russian-Style by Thane Gustafson (1999)

2. Wheel of Fortune by Thane Gustafson (2012)

3. Kremlin Capitalism by Joseph K. Blasi, Maya Kroumova, and Douglas Kruse (1997).

4. The Oligarchs by David Hoffman (2001).

Subscribe now

He mentions a very interesting investment that he made in the 1990’s in at least two Russian companies, during the time the country was emerging from communist rule and undergoing the privatization of its government-owned assets. Li begins with a summary:

As some of you might know, in the early 90’s, Russia went through shock therapy and went into a free market almost overnight. In a short period of time they privatized some of the most prized state assets, including Lukoil and Gazprom... And it was so short [a period of time] that most people didn’t really understand what it was all about. A lot of the people who worked in the companies and also other citizens were given a certificate that they could convert into stock ownership, but most people really didn’t know what it was, so to anybody who came along and offered them real cash [for the certificates], they would just freely give [the certificates] away. As a result, [the certificates], at one point, were trading at extraordinarily low prices...

The price of oil... was 20 dollars per barrel on the open market, [and Lukoil or similar firms were trading at market caps as low as] about 10 to 20 cents per barrel of proven oil on the balance sheet... It was ridiculous. At that point in time, I thought “now that’s a margin of safety”, even considering the political situation in Russia.

The Fall of Communism and the Plan to Privatize Russia

Li is referring to the period of time after the fall of communism in Eastern Europe, stretching from the revolutions of 1989 and the fall of the Berlin Wall on November 9 of that year, to the formal dissolution of the Soviet Union on December 26, 1991.

The revolutions of 1989 saw the adoption of liberal democratic policies, governments, and economic structures across central and eastern Europe in countries like Poland, East Germany, Bulgaria, Czechoslovakia, and Romania. In the Soviet Union, such principles were also taking hold and ultimately led to dramatic changes in 1991.

The more progressive Boris Yeltsin was elected as the first President of Russia in June of that year, and an unsuccessful coup attempt was launched in August against Mikhail Gorbachev, whose policies of glastnost and perestroika were perceived as too progressive for staunch Soviets. After the failed coup, the pace of reform increased, and the final step in the Soviet Union’s dissolution occurred in December when the Supreme Soviet ratified the Belavezha Accords.

During and following these events, Yeltsin and the new Russian government moved rapidly to establish principles and structures around a new economic model for Russia. Among the most important decisions was what to do with the thousands of Russian businesses that had been nationalized ever since the October Revolution of 1917 long ago.

To solve the problem, the State Committee on the Management of State Property (GKI) was created, and Anatoly Chubais was charged with heading it in October 1991. Chubais championed and shepherded Russian privatization from planning to realization, through a very turbulent time for the Russian economy, and the appeasement of a host of stakeholders who each had their own interests, from the politicians to the managers of the businesses themselves to their employees and to ordinary Russian citizens.

Ultimately, Chubais and his team landed on a system of vouchers for privatizing Russian businesses.

The Voucher System

The voucher system worked as follows.

Starting in October 1992, each Russian citizen would be given a paper voucher that could be used, in government-organized auctions, to purchase a portion of a Russian business. 147 million vouchers would be printed, one for each Russian citizen, and distributed until January 1993 via local branches of the State Savings Bank. To obtain the vouchers, a citizen needed only to pay a nominal fee of 25 rubles (equivalent to 10 cents US).

We’ll discuss exactly how a person could turn their voucher into a share in a Russian business later. But first, let’s consider the broad facts and what that meant about the value of Russian companies.

By January, 144 million of the vouchers had been picked up and were circulating in public.

Importantly, the vouchers were freely tradable, which could help poorer Russian citizens monetize their vouchers if they chose to (and many did), and free tradability helped attract larger pools of capital that were needed in privatizing the economy.

Once Russian citizens had their vouchers, they could either hold them and use them at the auctions or they could trade them immediately for cash, typically on the streets of Russia.1 As soon as the vouchers began trading, it was apparent that they were trading for very low prices.

That statement is a critical point in this case study.

Sometimes, in studying the past, we deceive ourselves by oversimplifying the situation or misreporting or misremembering facts. But in the case of Russian privatization, there are a host of reports, some of which I will discuss, that make it clear just how cheap Russian assets were and how it could have been clear even to people with only modest experience in finance and investing. The situation in Russia at the time was enormously complicated, yes, but, in those early days, the discounted prices of businesses was extreme enough to offset tremendous risks.

Russian Vouchers Were Very Cheap

Just how cheap were Russian businesses and assets at the time?

Consider the following chart from the great book Privatizing Russia by Maxim Boycko, Andrei Schleifer, and Robert Vishny, who report the trading price of vouchers from October 1992 to July 1994.2

As the chart shows, from 1992 to 1994, these vouchers were trading on the streets of Russia for anywhere from 5 to 25 USD each.

With some simple work, we can ascertain what these voucher prices implied for the value of Russian businesses, and it is astounding.

144 million privatization vouchers were distributed to Russian citizens. These vouchers were mandated by the government to be converted into the ownership of 29% of all businesses in the country. (In order to garner support for the privatization program, appease the other stakeholders who had control over Russian businesses, the remaining 71% of ownership was to be distributed to company managers and employees and retained by the Russian government. By June 1994, the vouchers accounted for on average 20% ownership of those companies auctioned, not 29%).3

Using a generous value of $20 per voucher, that implies the entirety of Russian businesses was worth $14.4bn at the time (equal to $20 x 144,000,000 vouchers / 20%). As if such an extreme undervaluation needs a comparison, the market cap of Exxon alone, a single US company, at its stock price low in 1993 was $71.7bn.

For another comparison, the market cap of all publicly listed US companies was $5.2tn in 1993.4 So, the opportunity to own Russian privatization vouchers, which would become an ownership stake in one or many Russian businesses, could have been had, between 1992 and 1994, at prices that valued all Russian businesses at 0.28% of all American businesses.

Why Were The Vouchers So Cheap?

Why were the vouchers trading at such incredibly low values? There were several reasons, and I will highlight three of them.

High Russian Inflation

First, inflation was rampant in Russia at that time. Prior to the fall of communism, the prices of many goods and services were set by the state. Starting in 1989 and in a few stages in the years following, Russian leaders slowly freed prices from government control. The effect was a massive inflation that gripped the country in the 1990’s, as shown in the table below.5

Many Russian citizens chose to sell their vouchers after receiving them, which is perhaps not surprising given the level of inflation. The average citizen may have appreciated having any amount of cash now in the face of prices that might be higher the next day.

Vouchers Were Complex for Ordinary Citizens

Second, and perhaps most obviously, the primary owners of the vouchers were ordinary Russian citizens. Now, the voucher auctions were designed to be as simple as possible, to the point where a citizen did not even need to know anything about a company to participate. (So as not to deter the flow of the article, I describe the mechanics of the Russian privatization program and the auction mechanics only in two footnotes below.67)

However, I suspect it is likely that, even with a simple voucher auction design, many citizens simply did not trouble themselves with trying to understand how to bid in the auction process. Moreover, with the Soviet Union recently dissolved, the average citizens’ opinion of Russian government procedure may have been sour. Many probably assumed the voucher auctions would never come to fruition, prompting many citizens to sell the vouchers for cash instead of holding them.

The Vouchers Had A Face Value of 10,000 Rubles

Finally, and for interesting reasons, the vouchers were given a “face value” of 10,000 rubles (approximately 25 USD as of the end of 1992, albeit highly volatile). Why? Boycko, Shleifer, and Vishny8 describe two reasons:

1. Having a face value printed on the vouchers gave the vouchers the feeling of a monetary gift to the people from the government, and helped create support for the fledgling program.

2. The denomination of the vouchers in a currency was purposely designed by pro-privatization government officials to make the government commit to the program. Had the vouchers been denominated using points, for example, it would have been easier for a future government committee to cancel the privatization program later on. But since the vouchers felt like real money, canceling or rescinding them would be very difficult.

The apparent effect of that 10,000 ruble face value (again, about 25 USD as of late 1992) on the trading price cannot be overstated.

It inadvertently created an anchor around which the vouchers traded. That anchor served to keep voucher prices low for virtually the entire time they were outstanding through June 1994 and created the opportunity that Li was talking about in Lukoil (and virtually every other Russian business at the time).

Cheap Russian Businesses Attracted Western Investors

The extremely low prices for Russian businesses implied by the voucher prices held sway for a few years and, indeed, throughout virtually the entire time the vouchers auctions were taking place. From December 1992 to June 1994, 15,052 Russian businesses were taken private, in whole or in part, almost all of them at prices that were incredibly low compared to their counterparts in other countries.9

Boycko, Shleifer, and Vishny describe two of the bargains:

1. VAZ, the auto maker of the popular Lada cars, came out of its auction with a total market value of $45 million. As a point of comparison, in 1991, Fiat reportedly offered the Russian government $2 billion for the company.

2. Gazprom, the gigantic Russian natural gas monopoly, emerged from its auction with a market value of $228 million. This was roughly 1/1000th the value of put on the company by foreign investment banks, presumably by comparing it to other natural gas companies around the world.

So, in those early years from 1992 to some time in 1994, Russian voucher prices and the market values of companies coming out of auctions and their subsequent traded stock prices were extremely low.

The most active foreign investment bank by far at the time appears to have been Credit Suisse First Boston, in large part through the efforts of its president Hans-Joerg Rudloff, who hired the very active deputy Boris Jordan and his teammate Steven Jennings. The two were exploring privatization opportunities for CSFB in Russia at the time and supporting the Russian government in its efforts. Prior to 1994, foreign interest in Russian privatization and investing was nil:10

Bill Browder was working for Salomon Brothers at the time and suffering from the same disinterest that Jordan at CSFB was:11

This lack of interest was surprising to foreigners on the ground in 1992 and 1993, but it all started to change in the spring of 1994. Around that time, investing in emerging markets was becoming hot. Also, The Economist published an important article in May of that year, entitled Sale of the Century.12 The article highlighted the cheapness I mentioned above:

At the time, the article created a stir, and it caught the attention of foreign investors:13

Russia Was Cheap But It Was Incredibly Volatile

I mention this turning point in 1994 in the attitudes around foreign investment in Russia because it highlights just how difficult it is to recreate the investment as Li saw it at the time. When Li discusses Lukoil and Gazprom, he doesn’t mention exactly when he made his investment. And Russian equity prices were so volatile in the 1990’s that understanding exactly when an investment was made could change the potential return by several multiples.

1994, for example, was an incredibly volatile year. The ROS index of 30 Russian stocks (created by CSFB) surged from 116 at the start of the year to a peak of 1,669 in September of that year. Yes, the index was up 1,338% in nine months. That is not a typo. It later dropped to a low of 443 in April 1995.

The End of The Voucher Period and The Start of Russian Stock Trading

So, 1994 was an important year for Russian privatization as an investment. It marks the end of the “voucher period” when Russian vouchers were trading at absurdly low prices and marks the deeper involvement of foreign investors (and the re-pricing and volatility that came with them). It is the time when the price of Russian businesses went from absurdly low to merely very low.

This is important to understand because it makes recreating Li’s exact investment returns virtually impossible. But we can still ascertain what he generally saw in the investment and learn some lessons about extreme opportunities. For example, Li’s commentary in his speech that Lukoil was trading at “10 cents to 20 cents” per barrel of oil reserves on the balance sheet, is consistent with the market cap of the company implied from voucher prices. We’ll see more of this in the next part.

The first period of Russian privatization, of vouchers and voucher auctions, provided astounding opportunities for (very) enterprising investors to invest in Russian businesses at dramatically low prices.

Next week, in Part Two of this case study, we will explore the mid-1990’s period when Russian stocks began trading, we’ll focus on one company in particular (Lukoil) and recreate its market valuations during that period, and we’ll discuss the real risks in investing in Russia at the time.

References

(1) Privatizing Russia by Maxim Boycko, Andrei Schleifer, and Robert Vishny (1995).

(2) The Oligarchs by David Hoffman (2001).

(3) Kremlin Capitalism by Joseph K. Blasi, Maya Kroumova, and Douglas Kruse (1997).

Subscribe now

I first learned about Duca through the excellent blog A Letter A Day by Kevin Gee. Kevin posted the transcript of an interview that Duca gave in 2023 in which he discusses his investment philosophy. In the interview, he stresses the importance of concentration in producing outsized investment returns and also emphasizes that there are a limited number of truly exceptional companies out there.

In driving home the latter point, Duca mentions a research study by Hendrik Bessembinder from Arizona State University. The study is called Do Stocks Outperform Treasury Bills?, and it was first posted on SSRN in 2017.

Bessembinder studied 25,332 companies over the 90-year period from 1926 to 2016, and he reported the dollar wealth generated by those companies.1 He found a few startling takeaways.

Only 4.3% of stocks produce dramatic outperformance

Most surprising of all, perhaps, is that the vast majority of dollar returns over 90 years was produced by a very small minority of companies. Of the 25,332 companies in the study, only 1,092 of them (4.3%) produced all of the net gains when compared to a competing investment in one-month Treasury bills.2 In other words, we can divide the stocks into three groups:

1. Those that produced dramatic outperformance vs Treasuries (1,092 stocks or 4.3% of stocks),

2. those that produced only modest outperformance (9,579 stocks or 37.8% of stocks), and

3. those that underperformed Treasuries (14,661 stocks or 57.9% of stocks).

Duca’s point in referencing the study is that, if one is going to engage in individual stock investing, he had better do everything he can to be invested in that small minority of companies and stocks that lead to dramatic returns (those in bucket number one). Otherwise, he is at risk of producing only modest outperformance for all the work he will be doing, or worse, selecting stocks in bucket number three.

Most stocks do not even outperform Treasuries in their lives

Bucket number three highlights a second surprising takeaway from the study: the majority of companies did not even outperform Treasuries over their lifetimes. That result flies in the face of one typical understanding of equity returns: that equity investors will outperform Treasuries by virtue of “taking on risk”.

While it is true that a well-diversified equity investor would outperform Treasuries over the 90-year period of the study, Bessembinder shows that an investor who seeks to select single stocks will underperform even Treasuries with the majority of his stock selections. Even worse than that, more than half of the stocks in the study produce lifetime returns that are outright negative.

It is only a minority of companies and stocks that vastly outperform, and one can think of those stocks as being the source of all the outperformance that equities generate over Treasuries. This phenomenon of massive outperformance from a small minority of companies is known as skewness of returns and it is well-known among equity investing researchers.

The purported benefits of diversification

Skewness is often pointed to as a reason for equity investors to be diversified. The logic is as follows. If so many stocks underperform even Treasuries, and so few dramatically outperform, then shouldn’t one ought to select a wide variety of stocks in order to minimize the chances of being in the bad bucket number three and maximize the chances of selecting one of the big winners?

Bessembinder advocates “yes” and highlights this benefit to diversification in his paper by constructing random portfolios consisting of various numbers of stocks (shown below) which turn over their holdings every month. The results show the protection from diversifying to more and more stocks: diversified portfolios are better able to avoid poor results.

The drawbacks of diversification

So why does Duca seem to take the opposite view, stressing the importance of concentration in his interview?

Well, the typical plea to seek diversification is sound advice for index investors who want to achieve market-like returns, but I believe (and so does Duca) that it is unsound for any active stock-picking investor who seeks to dramatically outperform.3

Bessembinder’s mock portfolios are selected randomly and mechanically and do not reveal the biggest danger that diversification introduces: the fact that no portfolio manager can know 25 positions as well as he knows five positions. As a result, when the price of one of those 25 selections begins to fall, he will be more likely to take the opinion of Mr. Market and jettison the position, rather than exploit Mr. Market’s mania and hold on or purchase more.

This is why many great investors stress concentration with only a small amount of diversification. Selecting a small enough number of stocks, like three to five or possible a few more, seems to strike the right balance between protecting oneself against ruin on one side and against not really knowing what you own on the other. As Buffett and Munger were fond of saying, “three wonderful businesses is more than you need in this life to do very well.”

…Within Berkshire, I could pick out three of our businesses. And I would be very happy if they were the only businesses we owned… three wonderful businesses is more than you need in this life to do very well.

I mean, if you look at how the fortunes were built in this country, they weren’t built out of a portfolio of fifty companies. They were built by someone who identified with a wonderful business… there aren’t fifty Coca-Colas [an example of a great business].

- Warren Buffett, Berkshire Hathaway 1996 annual meeting

That is why Duca stresses concentration.

Investment managers are incentivized to diversify

Moreover, the academic logic about the benefits of diversification persists in part because the investment management industry is incentivized to follow it. If an institutional manager is paid a percentage of assets under management, like many are, that payment incentivizes diversification so he or she may decrease the risk of ruin, stay in the game, and earn the fees as long as possible, all at the expense of any significant outperformance for their clients.

So, Bessembinder’s study reveals the first reason that most active portfolio managers underperform their index: most individual stocks underperform too. But it doesn’t say anything about the second reason: if one diversifies too much, one will not know any of his positions very well, and, as a result, he may fall prey to following Mr. Market.4

The chart below is from S&P Global’s SPIVA research and shows the degree of underperformance by US large-cap equity funds after fees. Over the past three years, for example, over 80% of fund managers underperformed their benchmark.

Instead of seeking diversification, and as difficult as it may be, the active stock-picker looking to dramatically outperform would be better served concentrating his effort on turning over as many rocks as he can and acting much more deliberately, only when he finds one of the few, rare, great companies (or opportunities) and investing heavily in it.

The greatest companies

In his report, Bessembinder publishes a list of the top 50 companies that have produced the largest dollar returns over the 90 years of the study through 2016. I show the top ten below. The company at the top of the list, Exxon Mobil, generated $1.0 trillion of wealth, meaning that a hypothetical investment equal to the company’s market cap in 1926 would have generated $1.0 trillion more than the equivalent investment in one-month Treasuries through 2016.

As you can see in the last columns of the table, six of the top ten companies on the list have generated their wealth over the entire 90 year duration of the study. (The remaining four needed less time than that to generate such wealth). Generally speaking, more time in existence means more dollar profits accumulated by the firms.

Before I discuss some of the results shown above, there is an important point to make. Bessembinder’s study is so popular that he has published four subsequent updates to the 2016 data at the ASU website, with the latest version from 2025.

Because of the tremendous run that technology stocks have had over the past nine years (and longer), the table above has changed dramatically. See the 2025 version below.

There are a few points to make here.

1. Staggering value produced

First, the amount of dollar wealth created by the largest firms in just the past nine years alone dwarfs that produced by previous US stalwarts. The wealth figures in Figure 5 are measured in trillions of dollars, while those in Figure 4 are hundreds of billions. Naturally, the past nine years have been fantastic for holders of large tech stocks.

2. Compounded returns

The companies on the 2016 list produced large dollar amounts of wealth, but the level of annualized returns they produced is what I would call very good but not extraordinary. (Microsoft is an exception, with a 25.02% annualized return.) This is especially true for those companies that produced their dollar returns over the full 90-year duration of the study. Simply put, it is very, very hard to maintain extraordinary rates of return for very long times. Take the top company on the list for example, Exxon Mobil. Over the course of 90 years, the company produced just over $1 trillion of wealth and an annualized return of 11.94%. That compares to a return for the S&P 500 of 9.9% per year. The dollar amount of wealth produced by Exxon Mobil is astounding, but the level of annualized returns is not near the astounding levels we typically associate with great investors or great investments.

However, the companies on the 2025 list in Figure 5 produced not just huge dollar amounts of wealth, but also did so while producing extraordinary annualized returns (Exxon Mobil being the exception). This may be a function of the fact that technology stocks have been in an extended golden era, or it may be because the economics of many of these firms are quite different than the businesses in the 2016 list. They are generally less capital-intensive and some of them have near-zero marginal production costs, making them very valuable. Alphabet is a good example of that, and it has produced $3.5 trillion of wealth and a stunning 25.27% annualized return over its 21 years of life through 2025.

3. Return inconsistency

For most of these great companies on either of Bessembinder’s lists, they likely did not produce consistent returns for their entire duration. Exxon Mobil produced 11.94% per year over 90 years, but for the past 20 years, from July 2005 to July 2025, the stock only returned 6.7% per year (compared to 10.5% for the S&P 500). And for the 20 years prior to that, from July 1985 to July 2005, the stock returned 15.2% (compared to 12.3% for the S&P 500).

Even Nvidia, the stock story of the decade, which produced $4.5 trillion of wealth and a mind-boggling 37.08% annualized return over its 26 years through 2025, wallowed in underperformance for much of its life. For the 10 years between December 31, 2001 and the same date in 2011, the stock produced a negative annualized return of -4.83%.

Such inconsistency in outperformance should serve as a caution to investors that “great companies” may not be great investments for the entirety of their lives.

In a coming article, I will dive more into great companies with great investment returns using another Bessembinder study. Instead of focusing on dollar-based returns, we’ll discuss the level of annualized returns that are typical of great investments. The goal will be to develop a sense for what levels of returns might constitute astounding performance and just how difficult that might be to achieve over a certain period of time.

Summary

There are three big takeaways from Bessembinder’s fantastic work.

1. Only a small minority of (great) companies produced all of the net gains versus Treasuries over the long term.

2. The majority of companies did not even outperform Treasuries over their lifetimes.

3. Diversification is critical if you want to realize market returns, but it is deadly if you want to produce massive outperformance.

For any individual investor seeking to produce stunning returns, Bessembinder’s study should serve as a reminder of that it is rare to find great companies and great investments. I must be prepared to search through and study many duds before finding one worthy of the punch card.

In Part One, I laid out the challenges facing Tenneco Automotive in late 2001: a crippling debt load, a recession, and a business that had been turned inside out by five years of spinoffs and business sales. It looked like a company heading toward bankruptcy. So what compelled Charlie Munger to invest?

Was there anything positive about Tenneco’s business?

Given all the challenges I discussed last week, Tenneco’s situation seemed pretty dire to the casual observer in 2001 (and even to many financial analysts). However, beneath all these challenges, there were some positive points about the company, each of which were evident with a careful reading of the company’s annual and quarterly reports.

Subscribe now

Positive point #1: Tenneco had great brands and a broad customer base

Tenneco produced auto products in two business segments: Emission Control and Ride Control. In both of those business segments, it had brand names with an excellent reputation and market share. Their leading position is backed up by disclosures in the 2000 annual report:

Moreover, Tenneco’s list of original equipment manufacturers was large, including just about every major auto maker in the world. And the largest automaker (GM) accounted for only 16.6% of the company’s sales, indicating the sales were nicely diversified.

Munger understood the great reputation of Tenneco’s products, as indicated by his brief comments at the Daily Journal meeting, when he stated:

I kind of knew based on experience how sticky some of that auto secondary market was, and how many old cars needed Monroe shock absorbers.

I think this point is critical to understanding Munger’s willingness to purchase these securities. Since customers loved and needed Tenneco’s products, the company still had fundamental value as an ongoing concern. We will see how pivotal this was in assessing the company’s likelihood to pull out of its debt problem.

Positive Point #2: Tenneco’s business was fundamentally healthy and profitable, apart from its large debt load

As indicated in Figure 4 last week (and as suggested by the company’s brand strength), Tenneco’s business was fundamentally profitable before accounting for the large interest payments on its debt.

Figure 8 below reproduces the abbreviated income statement from last week, this time stopping at EBIT and the EBIT margin. While the EBIT margin was low, especially compared to the company’s prior pre-spinoff years, Tenneco was still profitable before the large interest payments on its debt.

Moreover, even though sales were flagging as a result of the recession, the competitive nature and long lead times in the auto business meant that Tenneco’s management had a good idea about its order book for the coming two to three years, and those numbers revealed that the decline in sales, at least for the OEM segment, seemed to be abating by 2002. From the Q3 2001 10-Q report:

Positive Point #3: Management was pursuing aggressive cost controls post-spinoffs

Importantly, and perhaps underappreciated by the market, Tenneco was still in the midst of a major transition in its business. It had gone through five major spinoffs or sales of business units since 1993, it was facing its first recession since that time, and it was coping with all the debt it was saddled with after those spinoffs.

But digging in a bit to the company’s annual and quarterly reports makes it clear that management was keenly focused on right-sizing company expenses and running a more efficient organization. This is from the 2000 annual report:

So, as of the end of 2000, management expected to generate a total of $92 million of savings by right-sizing its workforce and by adopting more efficient processes and practices.

In fact, it was already becoming evident by Q3 of 2001 that those efforts were working better than expected. Figure 10 below (which is Figure 8 reproduced) shows annualized operating costs (plus DD&A) that were $104mn lower than those for the year 2000. And those lower operating costs boosted EBIT by 32% to $152mn.

Not only was the cost cutting working, it was having a large impact on earnings before interest.

The Pro Forma Tenneco

To drive the last two positive points home, let’s imagine a pro forma income statement that accounts for both these cost cutting measures and the forecasted increase in OEM sales (using management’s OEM forecast for 2004). That pro forma income statement is shown below, next to the Q3 2001 (annualized) figures and the year 2000 figures for comparison.1

As you can see, it seems plausible that Tenneco could once again become a profitable company. Perhaps more importantly, Tenneco seemed poised to almost double its EBIT from $115mn in the year 2000 to a pro forma $214mn.

Big deal. What about all the debt?

Of course, all this says nothing about paying down the extraordinary debt load the company was burdened with. However, I think these positive points are ultimately what caused Munger to believe that the company’s bonds, around a price of 35, and the company’s stock, around a price of $1.55 per share and a market cap of only $59mn, were way too cheap. For reference, the entire enterprise value of the company was $1.1bn, a figure I arrive at by conservatively assuming that the company’s debt is valued at par (apart from the 11 5/8% bonds, which I value at 35 cents).

I think Munger saw a very difficult financial situation for the company, and he probably acknowledged that a further, prolonged downturn in the economy and/or a group of unfriendly bank lenders could have pushed the company into bankruptcy. And in bankruptcy, in the wrong economic environment, it was quite possible that his debt and equity got wiped out.

The fact that Munger did not invest fully in Tenneco’s equity, which was more likely to be wiped out in bankruptcy, and chose to split his investment between bonds and equity, shows that he realized this was a possibility.

But more likely, by his judgment, the company could survive a recessionary environment (perhaps by delaying repayment on its debt through the use of its revolver for awhile and continuing to cut costs if the environment got worse). And yet, the pricing of the equity (at a market cap of $59mn) and the debt (at a price of 35 cents) was awarding almost no probability to a recovery.

Bankruptcy game theory

Now, here is the real kicker.

I think Munger likely reasoned about how a potential bankruptcy might play out, and I think this was the most important point of all, prompting him to make his investment.

If Tenneco was forced into bankruptcy, its lenders would then have to decide on the best course of action that might get them a full recovery on their lending amounts. The total amount of long-term debt outstanding was $989mn plus the $500mn of subordinate bonds which Munger would invest in.

Tenneco’s lenders would rightly ask themselves: How are we best off to recover our $989mn?

1. We could force a liquidation of the business and attempt to be paid in full. That would involve a few years of wind-down work, staggered employee layoffs and plant and equipment sales, along with the severance and interim operating costs that come along with it. Plus, we would also need to engage in a process to sell the valuable Walker and Monroe brands, two of the most valuable assets the company had.

Or...

2. We could effectively realize the value of those brands by recapitalizing the company and operating as usual. One way to do that might be to forgive Tenneco’s debt completely, take an equity stake in the new company without debt, and then sell the equity in the new company to make ourselves whole on the lending amounts.2

Munger may have realized that option number 2 (or some variant of it) looked pretty attractive from the perspective of the bankers, especially compared to the more cumbersome option 1.

Once again, the strength of Tenneco’s brands, as evidenced by the healthy operating profit they generated, may partly be what Munger was communicating when he spoke positively about them: “I... knew based on experience how sticky some of that auto secondary market was“. It may also have been part of the reason that Tenneco’s CFO, Mark McCollum, suggested in another article3 that delaying loan repayments by using capacity on the company’s revolving line of credit might be an appealing course of action to their lender, Chase Bank, for the time being:

Investors are worried whether Chase [Bank] would approve, and how the company will come up the money it needs going forward, said Peters.

McCollum said Chase, whose name is on the revolver, as well as the term loan, would not be opposed to such an “in one pocket, out the other” scenario.

“Are they [Chase] going to be happy? No. But they realize that it’s not a bad answer,” he said. Tenneco has $357 million left on the revolver.

Munger’s investment decision and outcome

In the end, Munger decided that the pricing of Tenneco’s 11 5/8% bonds (at 35) and its stock (around $1.55 and a market cap of $59mn) was accounting for too severe a set of outcomes and not enough for what was likely to happen based on (1) the strength of Tenneco’s brands, (2) management’s right-sizing initiatives, and (3) the likely game theory with Tenneco’s lenders.

We know he purchased the bonds and stock around those levels, and we know, from his comments, that his bonds were called away from him and that he “sold [his] stock at 15”.

The chart below shows that Munger likely held his investment for three years until December 2004. Tenneco’s 11 5/8% bonds were called on December 20, 2004 at a price of 105.81, and its stock on that date closed at $16.44, close to Munger’s report of $15.

How much did Munger invest and make?

We also know that Munger made “$80mn” on the investment. But we don’t know specifically how much he invested in either of the securities. Let’s speculate on that for some fun.

The table below backs into rounded amounts that Munger is likely to have invested in each class of security, assuming:

1. he purchased the securities around the prices listed above,

2. the bonds were called from him at 105.81 in December 2004 and he sold the stock at $15 at that time as well, and

3. he made approximately $80mn on the trade in full, including bond coupon payments.

We don’t know how much he invested in each class, so I show the outcome of the trade if he put 25%, 50%, and 75% of his investable capital in each class. Corporate bond markets are typically much less liquid than equity markets. So, in practice, Munger may have simply had approximately $14mn to invest, bought as many bonds as were available, and then put the rest into Tenneco’s stock.

Assuming Munger invested somewhere between 25% and 75% in Tenneco’s bonds (and stock), he likely made anywhere from 4.5 times to 7.2 times on his investment in three years, from December 2001 to the time the bonds were called in December 2004 (and when he likely sold his stock as well). Those returns imply an annualized return of 65% to 93%.

Summary and takeaways

I think there is one clear takeaway from Munger’s Tenneco investment.

When you encounter a company with a quality, in-demand product and/or a great brand, and that company is suffering, look twice.

Tenneco manufactured a quality and beloved product, but it was being punished by the market because of the 2001 recession and a huge debt load from five past spinoffs and business sales.

But the recession’s impact appeared overblown, and we were able to see this with a detailed reading of the K’s and Q’s. Management was making great progress on a large cost-cutting initiative, and they had a book of orders that implied sales would be rising again.

The bankruptcy issues were scarier, perhaps, and the lesson there even more important. If a company has “hidden” assets, like a beloved product and/or a great brand (and could have a healthy business but for its debt), put yourself in the shoes of the lenders and ask “what is the best move for them?”

Postscript

In Munger’s discussion of the $80 million he made in the Tenneco investment, he also mentions that he “took the $80 million and gave it to Li Lu, who turned it into 4 or 5 hundred million dollars”.

In his foreword to Poor Charlie’s Almanack, from 2010, entitled “My Teacher: Charlie Munger”, Li mentions that Charlie first invested money with him in 2004, which lines up nicely with the timeframes presented above.

In 2004, Mr. Munger became my investment partner and has since become my lifelong mentor and friend — an opportunity I would have never dared to dream about.

2

Obviously, this is not a small matter. And I am dramatically simplifying the thought process here by saying that the lenders could ”forgive all the debt” (including that owned by bondholders). But I’m doing so to illustrate the point. Whether the newly imagined company had no debt or $500mn in debt (or an amount in between), it would be dramatically healthier, with an equity valuation that should reflect that.

That would be a much better path for a bank lender (and for bondholders) than liquidating the company. Ultimately, It’s that economic interest that should bring a bank lender and bondholders to the negotiating table. (And a shrewd investor would understand this and make an investment in anticipation of it being the best outcome.)

To allay a lingering doubt about the risk of a company liquidation, I’ve reproduced Tenneco’s balance sheet from Q3 2001 which shows that the company had $242mn of book value; the point here is that it would not be obvious to a bank lender that a liquidation of the company (after all costs) would provide enough proceeds to fully pay back $968mn of loan debt. That supports the allure of the equity recapitalization idea.

This edition is Part One of Charlie Munger’s investment in Tenneco Automotive. Find Part Two at The Owner’s Memo #8.

The story of Charlie Munger’s investment in Tenneco Automotive is a fascinating one. And as far as I can tell, it’s only been told in a cursory way before now.

Munger made the investment in 2001 and it likely returned to him somewhere between 4 1/2 to 7 times his money and an annualized return over three years of 65% to 93%.

This is the story.

Subscribe now

Casually discussing an $80 million profit

At the 2017 annual meeting of the Daily Journal Corp., Charlie Munger spoke to visitors for almost two hours, answering any of their questions. At one point, he mentioned an investment that made him $80 million in profit.

The exchange between Munger and the off-camera crowd of onlookers is very funny. Munger mentions the $80 million, and you can feel the people around him restraining themselves but wanting to ask him about every detail.

Munger never mentioned the company name, but I’ve come to find out that the company he invested in was Tenneco Automotive Inc. (which we will refer to as Tenneco).

Let’s break down what Munger saw at the time and what we can learn from it.

Below, I have transcribed the relevant part of Munger’s comments:

I read Barron’s for 50 years. In 50 years, I found one investment opportunity in Barron’s out of which I made about $80 million with almost no risk. I took the $80 million and gave it to Li Lu, who turned it into 4 or 5 hundred million dollars. So I have made 4 or 5 hundred million dollars from reading Barron’s for 50 years and following one idea... I didn’t find them that easily but I did pounce on one.

It was a little automotive supply company... It was a cigar butt... It was [the maker of the] Monroe shock absorber... The stock was a dollar and the junk bonds which paid 11 3/8% were [priced at] 35. And when I bought the junk bonds, they paid me the 35% and they went right to 107 and were called. And the stock went from 1 to 40, but of course I sold my stock at 15.

Audience member: How long [did it take] you to make the 15x on the stock?

Maybe a couple years.

Audience member: How long did it take you to make the decision to buy it once you read the article?

Oh, about an hour and a half.

I kind of knew based on experience how sticky some of that auto secondary market was, and how many old cars needed Monroe shock absorbers, and I just knew it was too cheap. I didn’t know it would work for sure but I knew [it was cheap].

When did Munger make his investment?

Determining the identity of the company Munger was talking about was the easiest part of this case study. A quick internet search revealed that Tenneco Inc. is the manufacturer of the Monroe shock absorber today, and the company’s financial filings show that it has been doing that business since acquiring the Monroe Auto Equipment Company in 1977.

Based on Charlie’s comments above, I believe he made his investment in Tenneco late in 2001. How do I know this?

Charlie mentions the stock price being “a dollar” and the bonds with a coupon of 11 3/8% being priced at 35. I created a list of the historical issuance of Tenneco bonds using Bloomberg, and the list did not show any bonds with an 11 3/8% coupon, but it did have one bond with an 11-handle coupon, the 11 5/8% bonds issued in October 1999. Prices for that bond indeed show a sharp decline during 2000 and 2001, bottoming right around 35 in March and October 2001. I think these were the bonds Munger bought, and he simply misremembered the coupon.

Also, while Tenneco’s stock price never actually reached the price of $1, it was trading in late 2001 in a range from as low as $1.35 to around $2 per share.

Based on that pricing, I think this is the period when Munger read the article that he mentioned and made his purchase in Tenneco’s bonds and stock. As I’ll show later, I think he did so in December 2001 specifically.

What was the mystery article that Munger read?

Munger mentions that he read an article in Barron’s about Tenneco, and that’s what made him investigate the opportunity to invest. I was intrigued by the idea of finding the exact article he read, so I made a thorough search of the Barron’s archives from June 2000 through 2002 using the ProQuest research database. However, I could find no articles that substantially discussed the company.1

Perhaps Munger misremembered the publication he was reading that contained the Tenneco article. After all, he was telling this story in 2017, fifteen or sixteen years after it happened.

With that in mind, I conducted a more thorough search of news archives using ProQuest. And I came across an article that seemed to fit the scant details provided by Munger. The article is titled “Tenneco Struggles to Pare Down Debt”, and it appeared in the December 3, 2001 issue of Crain’s Business Chicago. I’ve reproduced the article here.

I believe this is the article that Munger actually read, despite him remembering it as being in Barron’s.

Why do I think so?

First, the article was published around the right time, when the stock and bonds were trading at prices close to those mentioned by Munger. And the article specifically mentions Tenneco’s bonds as suffering, not just the stock price:

Second, the tone of the article is pretty well balanced. It describes the troubles Tenneco was having, but it also quotes the CFO discussing how Tenneco might survive. That may have served to stir Munger’s thoughts about the company getting through the downturn and emerging in good shape.

As far as I can tell, this is the first time anyone has found a candidate for the article Munger may have been talking about.2 The article isn’t critical to understanding the Tenneco investment, but it is useful and intriguing to see the actual material that may have spurred Munger’s thinking.

With that itch scratched, let’s now dig into the research that Munger might have done at the time, what he would have seen in the company’s fundamentals, and what compelled him to think that a purchase of Tenneco’s bonds and stock would be profitable.

Assuming Munger read the Crain’s article in the month of December 2001, he would have had access to the 10Q filing from Q3 of 2001 (filed on November 14, 2001) and the annual report from 2000 (filed on March 30, 2001). Naturally, we will restrict ourselves to financial information from those reports and earlier, nothing later.

The Fundamentals of Tenneco’s Business

It’s always amazing to me how much can be learned from simply reading company reports and disclosures. For Tenneco, there are a few relevant points or challenges that jump out of the 2000 annual report.

Challenge #1: Massive company change

In the years prior to 2000, the company underwent several major spinoff transactions of other businesses, completely changing the company.

In 1993, “Old Tenneco” was a large conglomerate in six businesses: automotive, packaging, farm equipment, shipbuilding, energy, and chemicals. In 1994 and 1995, each of the chemicals and farm equipment businesses had been spun out in IPO’s. In 1996, the company spun off its shipbuilding business and sold its energy business. The automotive and packaging businesses were transferred to the “New Tenneco” company. Then, in a series of three transactions in 1999, New Tenneco spun off its packaging business, first forming and retaining 43% of a joint venture, then selling a part of the business, then ultimately spinning off all of its packaging businesses in a new company called Pactiv Corp.

What remained at the end was Tenneco’s automotive business, which sold emissions products (exhaust systems) and ride control products (like shocks and struts). It was this business, Tenneco Automotive Inc., that Munger was considering in 2001.

To say the above series of transactions dramatically changed the nature of Tenneco’s business is an understatement. The company went from being a large, diversified conglomerate with $13.2 billion in revenue in 1993 to a smaller single-line automotive businesses with just $3.5 billion in revenue in 2000.

The substantial changes to the company may have contributed to the decline in the company’s securities prices at the time Munger was looking at the company. I am reminded of Joel Greenblatt’s book You Can Be A Stock Market Genius, in which he discusses the merits of investing in spinoffs:

In the case of Tenneco, something similar may have been happening to the parent company. There were likely a bunch of shareholders who first owned shares in a diversified conglomerate (as recently as 1998 or 1999) and, by 2001, found themselves owning an undiversified automotive business in an industry suffering from a recession. That could have been a recipe for indiscriminate selling.

Challenge #2: Tenneco’s debt load

Tenneco was saddled with a lot of debt as a result of the spinoff transactions.

After all these spinoff transactions were finished, Tenneco was left with approximately $1.5 billion of long-term debt. After reading the history of Tenneco above, I suspect the automotive business was a victim of circumstance with respect to its debt load, being the last business standing after management spun off or sold five others.

When management spins off or sells a business, the natural inclination is to support that business in order to make the spinoff successful or the business attractive to a buyer. Often, this means allowing the spinoff or sale to leave some of its debt behind at the parent.

This was the case for Tenneco’s automotive business, the last of six businesses remaining.

The prior spinoff and sale transactions, each in small steps, left a little too much debt behind at the parent company in order to ensure their successes. Tenneco’s automotive business, by virtue of being the last business remaining, was the entity that was forced to deal with the excess debt at the end of the day.

Tenneco’s long-term debt profile, per its annual report from the year 2000, is shown below.

Pactiv Corp. was spun out in November 1999, and after that, it was almost immediately clear that $1.5 billion of debt was a dangerously large amount for Tenneco’s remaining automotive business to bear. The table below shows the company’s financials for the years 1997 and 1998 (with both the packaging and automotive businesses) and 1999 and 2000 (with only the automotive business, plus a lot of debt).

Focus for a moment on the company’s Operating Income (EBIT) and Interest Expense. Prior to the spinoff of Pactiv, the company was doing well, earning $633mn in EBIT in 1998 and spending $240mn in interest payments, but after the spinoff, the company was earning only $115mn in EBIT and spending $186mn in interest payments. Clearly, the company had too much debt at too high an interest rate.

Challenge #3: The 2001 recession

Tenneco was burdened with too much debt, and it was obvious from looking at their financial reports.

To add insult to injury, Tenneco’s revenues were also suffering from the 2001 recession.

Tenneco served two broad sets of customers, original equipment manufacturers (auto makers) and the aftermarket (auto repair shops). Both were suffering lower sales. The 10Q report from 2001 Q3:

The recession and auto industry weakness can be seen in this 10Q report, the latest financial report that Munger would have had access to at the time. Sales were down in Q3 2001 by -5.5% year over year.

Finally, let’s also not forget that, if Munger was looking at the company in December 2001, the public and the stock market would still have been reeling and worried about the effects of the September 11th attacks.

Challenge #4: Principal payments were coming due

Not only were the interest payments on Tenneco’s debt too much for the company to handle in the years after completing its spinoff, but, on top of that, principal payments were starting to come due in 2001. The annual report from 2000 lists those upcoming maturities as $54 million, $109 million, and $99 million for 2001, 2002, and 2003, respectively. From the perspective of a casual analyst or observer, it was not clear at all how Tenneco could make those payments or how likely they were to work with their lenders on renegotiating terms.

Tenneco’s situation, viewed from the outside in late 2001, looked pretty grim. A company drowning in debt, revenues shrinking, and principal payments coming due. Was there anything worthwhile that an enterprising investor could see? Next week, in Part Two, we’ll look at what Charlie Munger saw beneath the surface, and how it made him $80 million.

Subscribe now

This real-life cartoon has served as a caricatured reminder to me over the years that saying “I don’t know” is not a sign of weakness, as I’m sure my colleague thought. For great investors, in fact, it is a critical skill to practice.

Subscribe now

In a rare interview for Columbia Business School’s Graham & Dodd newsletter (Spring 2013), Li Lu expressed this sentiment well. The interviewer asks Li about real estate prices in China, which was a hot topic at the time given many new stories about the development (and overdevelopment) of some Chinese cities. Li’s response is refreshing.

G&D: Do you think real estate has gotten a little ahead of itself where there would be a need for a correction, or do you think that demand will just catch up?

LL: I put that in the “too hard” basket. I also put in the basket of “I know I don’t have to know.” It certainly is “I don’t know”, but I also know that I don’t have to know! I don’t want those things to worry me.

Missing the lesson, the interviewer issues a similar follow-up question, and Li responds in the same way:

G&D: How do you view the overall attractiveness of equities today?

LL: I also put that into “too hard” and “I know I don’t have to know.” I only think about it when things go to an extreme. I don’t foresee that as going to the extreme, either way. In that case, I know I don’t have to know.

I also ran across this interview of Mohnish Pabrai in which he expresses the same idea. The interviewer, Stig Brodersen, asks about companies for which legal regulations, which are often nebulous, might be important. Stig explains that he would like to expand his circle of competence to better understand certain regulatory laws, but he finds it difficult. Mohnish responds by talking about humility and discipline:

One has to approach circle of competence with a lot of humility... it may be that that question [about regulations] leads to putting that business in the too hard pile... A lot of humans have difficulty with giving up. They don’t want to give up... And I think Buffett and Munger’s answer would be that 99% of businesses need to go in the too hard pile.

Why is it so important to say “I don’t know”? One reason is that truly great investment opportunities come along somewhat rarely and involve sorting through a ton of mediocre opportunities to find the great no-brainers for which “I don’t know” doesn’t even come into play.

These are investments like Microsoft in 2010 when the P/E was around 8x, which I wrote about last week, or one of my favorite no-brainer investments of all time, buying Apple around 12x in 2013 and 2014, when Carl Icahn went on CNBC to shout it from the rooftop and later wrote a public letter using the term “no-brainer” four times.

But there is a second, more subtle reason why “I don’t know” is important. Failing to practice humility as an investor, failure to say “I don’t know” for most questions you come across, is effectively practicing a bad habit, and every time we practice a bad habit, we weaken ourselves and become more comfortable practicing the bad habit.

The book Lessons for Living by psychiatrist Phil Stutz makes this point several times throughout it.

The impulses for all of our bad habits travel along the same path – a straight shot to immediate gratification through what I call the lower channel... Lower channel functioning is a disaster. When the pleasure is over, we’re left with nothing.

Failing to say “I don’t know” is a warped kind of pleasure seeking: it is our attempt to convince others (and ourselves) that we are competent, that we know more than we do. Failing to say “I don’t know” is failing to conquer our insecurity.

Stutz goes on to say that, on the other hand, every time we practice restraint and discipline over our bad habits, we reward ourselves with a kind of energy.

Every time you restrain your impulses, you close off the lower channel... And in this higher channel, the energy accrues. Every act of restraint puts more in the piggy bank.

The more we practice bad habits, the more we become comfortable with these bad habits and keep our brain stuck in a feedback loop: bad habit - quick, but hollow reward - bad habit.

But the more we resist our bad habits, the stronger our psyche becomes, the more energy and creativity we receive, and the easier it becomes to continue to practice good habits.

With that in mind, it becomes a little clearer why investors who practice discipline in investing are better off: they are reinforcing the discipline to act only when the great, big opportunities come in and to refrain from meaningless, compulsive action otherwise.

This psychology plays out with particular consequences in investing.

Most professional investors do not practice enough restraint. In fact, they are incentivized to do the opposite. The practice of charging a management fee, for example, incentivizes them to raise more money. And in order to raise money, they will be inclined to appear as experts to their clients, whose questions will be myriad and which the professional will feel compelled to have an opinion on.

“What will the effect of a ceasefire (or a prolonged war) in Iran be on your investment in XYZ Corp.?”

“Where are interest rates headed?”

“Isn’t the S&P 500 too richly valued at 28 times earnings?”

“Isn’t software company X going to thrive in the Age of AI because of their particular niche?”

There may be unique times when an investor has a very specific reason to have an opinion on questions like these, but most of the time, his answer should be something like “I don’t know. I’m looking for great investments where things like that won’t have a long-term impact”.

But how many professional investors do you think would have the wherewithal or courage to answer their limited partners in such a way? Instead, a smart-sounding opinion is easier to produce and seems like the safer bet. A confident and direct answer is the surest shot at attracting money from new clients or convincing existing clients to stay put.

But falling into the habit of producing opinions when we shouldn’t hurts us.

Perhaps worst of all, it reinforces to our brains that it is ok, even necessary, to have an opinion on everything, when a good investor should be practicing the exact opposite. When he finds something too hard to understand, he should move on. When he finds something he can grasp, he should restrain his opinion until he has done enough research. His job is to work continuously to find the great investments that do not require an opinion on stuff that’s too hard to understand.

“I have what I call an iron prescription that helps me keep sane when I naturally drift toward preferring one ideology over another. And that is I say ‘I’m not entitled to have an opinion on this subject unless I can state the arguments against my position better than the people do who are supporting it.’ I think only when I reach that stage am I qualified to speak.”

- Charlie Munger, USC Commencement Speech, 2007

In the end, Li held the stock for about two years and made roughly seven times his money.

A little more to learn from Li Lu

After publishing the article, a friend of mine told me how much he enjoyed reading it and that he wanted to know a little more. Eddie runs a successful hedge fund, so he knows a thing or two about what constitutes a great investment. He wanted to see what it was exactly that helped Li Lu earn that 7x return in Timberland.

Breaking down returns with John Bogle

The return on a common stock can be decomposed, after the fact, into three sources:

1. The investor receives dividends along the way.

2. The earnings of the business grow or shrink.

3. The multiple the market is willing to pay for those earnings expands or contracts.

Put the three together and you have the stock’s total return over the time it was held.

That framework is most often associated with John Bogle, the famous investor and founder of Vanguard, who set it out in the Journal of Portfolio Management in 1991 and refined it with Michael Nolan in a 2015 paper titled Occam’s Razor Redux. Although the purpose of the work was forecasting stock market returns, the same logic works perfectly well as a backward-looking attribution. It is the cleanest way to ask whether a given return came from the business or from the mood of the market.

In the case of an individual stock, the earnings-growth piece can be dissected further. Earnings per share are simply revenue per share multiplied by the net margin of the company, so growth in earnings per share comes from (1) selling more stuff, (2) keeping more of each dollar sold, and/or (3) shrinking the share count through buybacks.

That gives us five neat drivers for the price performance of a stock:

1. The dividends received.

2. The earnings per share, broken down into

   1. Revenue per share

   2. Net profit margin, and

   3. Share repurchases.

3. The multiple the market is willing to pay.

Timberland in 1998 makes for an very interesting case of this exercise. In some ways, Timberland was an ideal investment.

Li Lu’s Timberland returns broken down

Although I don’t know the exact prices that Li bought and sold his position for, I can make some rough estimates. In Part Two of the case study, I show the rough times and prices for Li’s purchases and sales based on statements he made in his talk.

For the purposes of this exercise, I’ll assume:

1. Li made all his purchases at the real-time closing price of $29.00 per share on October 14, 1998, and

2. Li sold all his shares at the closing price of $181.00 per share on October 24, 20001.

These prices imply that Li made 6.2 times his money, in line with his stated “6 to 7 times”. It equates to a stunning 147% annualized return over the 2+ years.

With those two dates and prices in mind, let’s break down the above five factors. Like any good case study, it will be important to only use information available at the time of Li’s purchases and sales, so we will use the trailing twelve months of financial data available as of the two dates.

Dividends

First off, Timberland did not pay any dividends over the period of time Li held the stock, so we can dispense with that factor. What about the rest?

Earnings per share

In October of 1998, Li would have had financial information on Timberland from the company’s Q2 1998 10-Q (filed on August 7), and in October of 2000, he would have had the Q2 2000 10-Q (filed on August 11). The table below shows the trailing twelve months of revenue, net income, share count, and net income per share.

Price-to-earnings multiple

Based on the trailing twelve months of financial information Li would have known at the time and the prices he would have seen in the market, he would have been buying Timberland at a P/E ratio of 6.6 and he would have been selling it at 22.3.

The columns above require a moment of explanation.

• The columns labeled “as of October” show each metric either at the time Li made his purchase or for the trailing twelve months, as he would have known them to be2.

• “Growth multiple” shows how much each driver increased as a multiple, which we can think about, in turn, as driving the stock price. For example, revenue rose by 1.18x (an increase of 18%)3.

• “Contribution to return” shows the relative magnitude of each driver of Timberland’s total return4.

Ok, so what?

The results paint an interesting deeper picture for what happened as Li made 6.2x his money on Timberland in just two years.

Entries #2 and #3 in the table above show the big takeaway:

• Two-thirds of Li’s return came from the price-to-earnings multiple on the stock expanding from 6.6 to 22.3.

• One-third of his returns came from improvements in the business leading to higher earnings.

  • Of this 33%, 20 points of it was due to improvements in net margin, that is, Timberland running a better business.

  • 9 points was due to revenue increasing, Timberland selling more merchandise.

  • 4 points was due to the company buying back shares.

This may be surprising at first; Li made most of his money just because the market was willing to pay a higher multiple for the stock! But it makes some sense if you think it through.

Three kinds of good investments: A framework

Bogle and Nolan’s 2015 paper, Occam’s Razor Redux, which talks about return attributions like the one above for the broad equity market, has an interesting chart in it.

The chart shows returns for the S&P 500 broken into “Investment Return” and “Speculative Return”.

1. Investment Return (blue line) is equivalent to what we showed above in entries #1 and #2. It is those returns that an investor can earn by (1) receiving dividends and (2) from earnings at the company going up.

2. Speculative Return (red line), on the other hand, is equivalent to #3: the return that might come from the market paying a higher multiple.

The chart’s message is simple: over very long periods of time, investors cannot count much on earning their returns from expanding multiples. Rather, virtually all the returns earned by equity investors have come from underlying businesses doing better and better.

1) The great business at a great price

Now, Li’s return, as we mentioned, came 2/3 from multiple expansion and 1/3 from earnings increasing. Finding investments like this is very hard, but, when they can be found, they can be incredible. To paraphrase Buffett, those are the pitches I should be waiting to swing at.

By buying a good company at a low valuation, whose earnings Li felt comfortable would continue to improve, he was able to generate 6.2 times his money over only two years, for a stratospheric annualized return of 147%.

Note, too, however, that Li’s investment did not last very long. Often, the companies that can be found at low P/E ratios are not the very best companies that can be owned for 20 years or more. Instead, they are typically either outright bad businesses or merely good businesses being misunderstood. (Timberland, being a good company, albeit in the challenging clothing and fashion industry, was in the latter bucket.)

So, investments like Li’s can be excellent, but once in a blue moon, the market hands you a similar investment opportunity that can be even better: those truly great businesses that are temporarily trading at a low multiple.

Microsoft

The example that jumps to my mind here is Microsoft back around the year 2010. The stock was trading at a P/E multiple of 8.2 (a earnings yield of 12.2%), and revenues and earnings had grown by 57% and 53% respectively over the past five years. Microsoft’s competitive position, with Windows and Office, was still very strong, but investors were tired of the stock underperforming for years after it peaked in the dot-com boom and crash and had yet to eclipse those price levels. At the time, there were also questions about how the company could grow in the future.

Over the subsequent 15 years through 2025, Microsoft’s earnings per share increased from $2.10 to $13.64, and its P/E multiple increased from 8.2 to 36.3.

Running the same return analysis as we did for Timberland shows a very even split for Microsoft’s returns: 56% of the returns were due to earnings per share having risen and 44% due to the P/E multiple having risen. Microsoft is similar to Timberland in that regard, but with one big difference: the quality of Microsoft’s business is and was much better than Timberland’s, as evidenced by its earnings rising for a very long period of time.

Over the course of 15 years, and as a result of both tailwinds, Microsoft returned 25.7% per year and its stock rose by 28.5 times. (Microsoft also paid its shareholders a dividend over that time, which contributed 0.7 percentage points to the 25.7%.)

Investments like this are rare, but when they can be found, they can represent once- (or few-) in-a-lifetime opportunities.

2) The great business at a fair price

What about those investments for which earnings increases alone are the driver? These investments, too, can be very good, albeit not at the stratospheric levels of the investments mentioned above. On the other hand, they can often persist for very long periods.

These investments are the purchases of “great businesses at fair prices” as Buffett likes to say.

AutoZone is one such investment. The auto parts retailer has produced fantastic returns across virtually its entire history as a public company.

For example, from fiscal year-end 1996 to 2025, the company increased earnings per share from $1.11 to $144.87 and its stock increased in price from $27.25 to $4,198, a return of 154 times, or 19.0% per year.

At the start of that run, the P/E multiple for AutoZone was 24.1 and at the end, it was nearly the same, at 28.2.

It’s easy to see that a return analysis for AutoZone shows just about all of the returns on the stock, 97% of them in fact, were due to earnings per share marching up over time (the blue bars in the chart above). The tiny remainder were due to a slightly higher multiple.

There are two things to say about this.

1. First, although investments in this category can be great if the business is great, they do not rise to the highest heights like those rare purchases of great business at great prices, like Microsoft.

2. Second, maybe I’m nitpicking a bit with that statement. An investment in AutoZone over the past 29 years could have made anyone very rich simply by buying it and holding on for the ride. Finding a great business, buying it, and holding on, is a great way for an investor to compound his or her money and sleep well at night, even if the purchase was made at what seems to be a high P/E ratio.

3) The fair business at a great price

This category is the most difficult to navigate. There are occasionally some really great bargains that can be had in companies that are not generally increasing their earnings but which the market has punished to an unfair degree.

Take the company Dillard’s, for example. Dillard’s is an apparel and home furnishing retailer with stores in 30 US states. Texas and Florida are their biggest markets.

In fiscal 2021, Dillard’s sold about $6.6 billion worth of merchandise, an amount lower than the $8.6 billion it had sold way back in the year 2000. To say the company was viewed as stagnating would be an understatement.

As a result, and in part due to large disruptions during the COVID-19 pandemic, the stock was trading at a price of just 253.72 at the end of fiscal 2021 and had earned $41.87 per share for the year, for a P/E ratio of 6.1. That’s an earnings yield of 16.4% for a company that, while it wasn’t growing, was in fact doing steady business.

By the end of fiscal 2025 (January 2026), the stock was trading at a price of $607.56 on earnings for the year of $36.42, an amount less than it made four years ago. The P/E ratio of the stock had risen to 16.7.

During the period, Dillard’s stock price rose by 2.4 times, and it generated a large annualized return of 29.8%5.

The result is great, but the numbers need to be caveated with the following warning: Returns like these come with much more work than buying businesses like AutoZone or Microsoft that are more difficult to disrupt.

It’s not enough to simply buy Dillard’s because the P/E ratio was low. I would need to become as comfortable as possible that Dillard’s position wasn’t getting materially worse. And that’s easier said than done. I’d read everything I could on the company, including not just the company’s financial reports but also industry trade journals, listen to earnings calls, and even visit some stores to get a sense for whether things were changing on the ground.

But assuming I could get comfortable with it, then a low P/E is a good thing, especially when combined with the catalysts of share buybacks and dividend payments, both of which Dillard’s management team was doing. Catalysts, including the return of capital to shareholders, can be very reassuring when a stock is priced as cheaply as Dillard’s was.

Over the four years from January 2022 to January 2026, the Dillard’s management team bought back 24% of their outstanding stock, taking the share count from 20.6 million to 15.7 million, and returned an additional $93 per share to shareholders in the form of dividends.

When capital is flowing back to shareholders in such volume, allowing shareholders to realize their 16.4% earnings yield in the form of cash or a larger ownership position in the company, it’s easier to get comfortable that the price will rise as new shareholder see the attraction and bid up the stock.

One final thing to note about these types of investments (P/E multiple expansion in a stagnant business) is that the investments typically don’t last longer than a few years. Recall the chart I showed at the beginning of the article from Bogle and Nolan: “Speculative returns”, that is, multiple expansions, don’t tend to persist for the long term. Once the multiple rises enough, I need to remember not to fall in love with the business.

Part One of this story was published in The Owner’s Memo #3.

Part Three is available as well in The Owner’s Memo #5.

Yesterday, we discussed how Li Lu first discovered Timberland in the fall of 1998 when it was trading at a P/E ratio of 6.6. Some thorough research revealed that the company had a beloved brand and growing revenues, and yet the stock had fallen -55% in three months.

Why was it so cheap?

Today, we’ll discuss the four concerns that were an overhang for the stock, what Li’s research made of each, and the remarkable scuttlebutt that gave him the conviction to act.

Subscribe now

The concerns about Timberland

Despite the good reputation that Timberland had among its customers, there were a few big issues that seemed to be dragging down the company and its stock in 1998.

A thorough search of company filings and news articles from the 1990’s revealed four major concerns. Understanding whether or not Timberland was a bargain at the time would have hinged on deeply understanding these issues and whether or not they were harbingers of poor performance to come.

Let’s discuss each of them.

Concern #1: The Asian Financial Crisis

In his talk, Li Lu cites one reason for the drop in price, the Asian Financial Crisis, but he also goes on to say how ridiculous such a reason was. Timberland only had 4.3% of its sales from markets outside the US and Europe according to its 1998 second quarter 10-Q, so a weaker Asian consumer would not have a meaningful impact.

Now, a thorough reading of company reports does show more exposure to Asia than simply a low sales number. In the early 90’s, the company began outsourcing its manufacturing to foreign manufacturers. By the end of 1997, Timberland had 37% of product manufacturing in Asia, up from 21% for all international manufacturing in 1993:

The Company also continued to shift production of its footwear products to third party manufacturers... Approximately 27% [and] 10%... of the Company’s 1997 footwear unit volume was produced by [two] independent manufacturers located in China [and] Thailand. Source: Timberland 1997 10-K.

So, the Asian Financial Crisis could have affected the company’s manufacturers, but that reasoning alone doesn’t seem plausible enough to justify such a low valuation. After all, the speed with which the company shifted manufacturing over four years from in-house to third-parties suggests that a similar shift away from certain third-parties, if necessary, could be undertaken again with more ease.

But a more thorough investigation of the market at the time shows that the Asian Financial Crisis was likely not the reason for the stock’s precipitous decline. The bigger reasons appear to have been three other large concerns.

Some of these were discussed by Li and some were not.

Concern #2: A struggling retail shoe industry

Li does not mention in his talk one of the issues that seemed to be depressing shoe company stocks at the time, an industry facing lower-than-expected sales. Indeed, the commentary from the August 21st Value Line sheet says as much:

Timberland shares have fallen by over 25% in price since our May report. We believe that the primary reasons for the decline are that the second-quarter sales increase was lower than expected (though earnings exceeded Wall Street’s estimate), and that shoe companies’ stocks, as a whole, are being pummeled in response to sluggish demand in the industry.

And the following is from a Wall Street Journal article from 1999 describing the sentiment in the 1998 period:

Last year was indeed a struggle for the shoe industry, as the market was flooded with cheap close-outs from the shutdown of Kinney Shoes by Venator Group, the successor to Woolworth that has reorganized its shoe-retailing businesses.

There were several other public stocks at the time that could be classified as “retail shoe” companies, among them Brown Group, Deckers, Foot Locker, Nike, Nine West, Payless, Reebok, RG Barry, Stride Rite, and Wolverine World Wide. I created an equal-weighted index of these stocks using historical prices, and that index would have been down -41.7% from July 17, 1998 to October 14, 1998, in contrast with the S&P 500 which was down -15.3%. Timberland, as I mentioned earlier, was down -55% over that time.

But digging deeper into the concerns at the time shows that much of the anxiety was centered around athletic shoes. Another article from the New York Times highlights the distress among makers in that subsector:

For the quarter ended March 31, Fila’s parent company lost $8.7 million. When Nike posted a $67.7 million loss last month, its first quarterly loss in 13 years, Phil Knight, the company’s chairman, said, ‘’It was not a good year by Nike standards, but then our futures aren’t very good either.’‘ Nike’s Asian business is in turmoil, and it is laying off 1,600 workers. Reebok lost $3.4 million in its first quarter ended March 31. Converse reported that sales of its basketball line tumbled 50 percent in its first quarter, which also ended March 31.

But Timberland, on the other hand, is cited as a bright spot in the struggling shoe industry:

Some companies and analysts say they believe consumers are shifting their tastes to the so-called brown shoes, footwear made by outfits like Doc Martens and Timberland.

In fact, the trends we saw earlier in company revenues reinforce that Timberland was doing relatively well in this period of stress. Timberland’s Q2 1998 revenue was up 9.5% from the year prior, compared to Nike’s which was down -2.8%.

Yet, despite this relative (and outright) strength, Timberland’s stock was down -55% over the period mentioned above, while Nike was down only -22%.

Concerns about a “struggling shoe industry”, in fact, seemed overextended to Timberland, whose fundamentals stood in contrast to other companies that saw revenues and earnings actually falling.

Concern #3: The shareholder lawsuit

In his talk, Li discusses that there were “a whole bunch of lawsuits” against the company that could have caused concern for investors at the time. He also mentions how important it is to do the legwork and “download every single... document from the court cases“ and read them.

A search of legal filings against Timberland from 1992 through 1998 revealed just one major lawsuit against the company (and two minor ones related to a distributor-manufacturer disagreement and the selling of counterfeit Timberland products). That major lawsuit, Schaffer v. Timberland Co., was a consolidation of two separate suits and was not hard to find, as it is mentioned directly in the company’s 1997 annual report:

The Company and two of its officers and directors were named as defendants in two actions filed in the United States District Court for the District of New Hampshire, one filed by Jerrold Schaffer on December 12, 1994 and the other filed by Gershon Kreuser on January 4, 1995. On April 24, 1995, the District Court granted plaintiffs’ motion, assented to by defendants, to consolidate the two actions.

In the lawsuit, two investors in Timberland stock sought to charge the management team with a violation of SEC Rule 10b-5 due to the severe drop in Timberland’s stock price from May 12, 1994 to December 9, 1994, when the stock dropped roughly -36%.

What does this mean? SEC Rule 10b-5 is very brief, and it can be found here. It is a broad rule preventing anyone engaged in securities practices from committing fraud, making untrue material statements, or omitting material facts.

While the lawsuit seems concerning on its face, the 10-K also reveals a simple and critical piece of information: the lawsuit had been settled as of December 1997 / January 1998, ten months before Li was considering an investment. The docket for the case also reinforces that fact.

On December 29, 1997, the District Court entered an order granting final approval of the Stipulation. Under the terms of the Stipulation, the settlement of this litigation was final and effective on January 29, 1998. The settlement of this litigation did not have a material adverse effect on the Company’s financial position, results of operations or cash flows. Source: Timberland 1997 10-K

This is a critical piece of information for an investor in Timberland at the time, and it’s one that Li neglected to mention in his talk. Li would have known in October 1998 that the case would not have significant financial impact on the company.

However, although the case was settled, Li was still concerned about the lawsuit. Specifically, because of the nature of the case, he wanted to be sure that the management team was not a group of corporate fraudsters. We’ll discuss below the novel way in which he tackled that issue, with a personal visit to the management team’s home town.

Concern #4: The earnings decline in 1995 and the charge of incompetent management

During the talk, Professor Bruce Greenwald of Columbia Business School asks Li if he had any concern about “what happened between 1994 and 1996”, apparently referring to the company’s reporting negative income in 1995. Li mentions that the decline was due to poor marketing at the company around waterproofed versus non-waterproofed shoes and a hit to reputation and margins that resulted, but he doesn’t address the concern further.

The company’s disclosures from the period don’t say much about the marketing mishap, except for a brief line in the 1995 10-K about expanding its creative staff to better manage its brand.1 But I discovered that there were more issues in the 1995 period than the waterproofing issue alone.

1995 issue #1: A big restructuring at the company

In the 1995 period and earlier, Timberland suffered from the critique that their net margins were too low for a retailer of high-quality, desirable apparel. From a scathing article in CNN Money in May 1995 titled Will Timberland Grow Up?:

For all the brand’s strength and to-the-moon growth, the company has barely enough profit to fill a mukluk... a net margin of 3.9% - terrific for an A&P, but terrible for a worldwide superbrand. Nike, for instance, nets 8%.

With that concern squarely in mind, CEO Sidney Swartz embarked on a plan to stop manufacturing most of the company’s products and begin the outsourcing of their production in order to save on costs and raise gross margins. During 1995, the company took its biggest step in that direction, shutting down two manufacturing facilities in the US and reducing operations in the Dominican Republic. The actions resulted in a one-time restructuring charge of $16.0mn for 1995. In the 1995 10-K, the company also reported that it expected to realize annual savings of $7mn as a result of the restructuring.

The company reported a -$11.6mn net loss for 1995, so adding back the restructuring charge and adding on the anticipated $7mn of net savings brings the pro forma net income for 1995 to $11.4mn. While it’s true that only represents a 1.7% net margin on $655mn of revenue, it is a much better picture than the headline net income figure suggests.

Perhaps most importantly, the restructuring charge demonstrates that management did not have its head buried in the sand when it comes to making difficult choices to better manage its business and implement good, modern, high-margin business practices. By 1997, the company had outsourced 72% of its footwear products manufacturing, compared to only 21% in 1992.

1995 issue #2: Lower gross margins after product pricing cuts

Starting in 1993 and into early 1994, Timberland lowered prices on some of its boots to help increase volumes and in an attempt to bifurcate or better appeal to its different customers. Those changes helped dramatically drive revenues up 52% from $419mn in 1993 to $638mn in 1994. But in 1995, when revenue only increased 2.7% to $655mn (and footwear volume actually declined by 6.0%), the pricing strategy was criticized.2 From the same CNN Money article:

The inexperienced Jeffrey [Swartz, then COO of Timberland] compounded the problem by lowering prices on some products in an inexplicable effort to bring the premium-priced brand down to a less lofty level. As often happens, the price cuts didn’t spark offsetting higher volume. Result: margin squeeze.

Such a strategic move might have been hard to analyze in 1995, however, any potential questions about the company’s strategy were quickly rectified as revenue growth picked up again in 1996 and 1997 and, most importantly, gross margins were not just exceeding the poor 1995 levels, but were near or above record levels. All of this would have been apparent to Li considering an investment in October 1998.

1995 issue #3: More company debt, more interest expense, and more SG&A than in prior years

Timberland’s 1995 income statement can be broken down to show another concern not mentioned by Li: both SG&A expenses and interest expenses had risen sizably as a percent of revenue. The 1995 income statement is shown below versus the 1993 statement for comparison.

The company’s 1995 10-K does not give much commentary around why this was the case, except to say that increased debt levels are being used to prepare the company for more growth:

Interest expense increased to $22.9 million in 1995 from $15.1 million in 1994 and $6.3 million in 1993. The increases primarily reflect higher debt levels attributable to business growth and to support higher than anticipated inventory levels. The increase in 1994 also reflects higher interest rates.

I think the lack of disclosure here is stark, and lack of disclosure is perhaps the main reason why Timberland’s stock price was down so much in 1998. It is clear from reading Timberland’s company reports that management had no interest in making more disclosures than it absolutely needed to and, as a result, had a reputation among investors and the media as being nebulous at best and incompetent at worst.

The lawsuit mentioned above seems to have been a big part of that. Also, as Li mentions in his talk, and as cited in the company’s 1997 proxy statement, the founding family owned 51% of the company’s stock, and the company tended to generate more cash than it needed to run the business. As a result, it did not have much need for the equity brokerage services of Wall Street (and didn’t need to cooperate with or cater to Wall Street equity analysts either). Without the need for Wall Street, and, worse, having been punished with a lawsuit for stating too much, company management now kept its mouth shut. And if the stock suffered because of it, who cares? The Swartz family owned 51% of the stock and the company generated enough cash flow to sustain itself.

To the owner/managers of Timberland, no one or nothing would bully them, not lawsuit plaintiffs, not media commentators accusing them of incompetence, not equity analysts pining for more information, and not swoons in the stock price.

This was another important understanding that Li gained in his research. The company had its own reasons for ignoring public commentary and ignoring its stock price, all while consistently improving the company’s fundamentals. Timberland’s management followed the Mr. Market parable, and Li would as well.

In addition, it would become further evident how wrong the popular narrative was around management when Li met them himself, as we’ll soon see.

Most importantly, the issues around SG&A and interest expense had abated by the time of the investment in October 1998. By then, the company’s investments in SG&A had become apparent, with revenues increasing and gross margins at or above all-time highs. And the company had used some of its cash to pay down over $100mn of the $225mn in debt it incurred in the 1993-1994 period (and, as a result, its interest expense came down too).

Timberland had a lot going for it

Throughout the talk, Li describes the extensive work he did to assuage himself that concerns around Timberland were not serious. In fact, as mentioned, many of the criticisms of the company were outright resolved by October 1998.

But the lawsuit, in particular, made Li curious. Maybe he missed something, and the suit was indicative of a management team that was irresponsible or even committing fraud. In the most entertaining and engaging part of his discussion, Li describes visiting the community where the Swartz family lived and even going to their synagogue. He got to know their friends and community members. From start to finish, Li reports that his entire investment research took him “a couple of weeks”, so it seems like this boots-on-the-ground scuttlebutt may have taken him only several days in the Boston, Massachusetts area.

During that time, Li discovered not only that the family wasn’t a bunch of crooks, but actually that they were admirable and well-respected. Li would have been 32 years old in October of 1998.

The Chairman and CEO of Timberland for many years was Sidney Swartz, son of the company’s founder, and he would have been about 63 years old at this time. In June of 1998, his son Jeffrey took over as CEO. Jeffrey would have been 38 years old and Li’s contemporary. In a clever and original move, Li realized that Jeffrey was on the board of a company with one of Li’s friends, and Li managed to have himself placed on that board, just to get to know Jeffrey better. Li says that the insights he gained painted a very different picture than the media’s image of Jeffrey as a young and inexperienced CEO:

He took over as CEO and he had entirely different ideas about how to run a company. It was very articulate. He was one of the most articulate [people I] ever met. Still is.

This hands-on visit to Jeffrey’s home town is the most striking and eye-opening part of Li’s talk. It demonstrates the kind of dedication it takes to invest well and also the kind of novel thinking that helps unearth insights that others may not have.

By going the extra mile (literally), Li was able to gain a critical and novel insight about the family that the media and other investors were missing. The family and the company’s young CEO were very competent, in contrast to the prevailing narrative. Also, and importantly, the new CEO was about to change the company’s stance on Wall Street and begin communicating more, increasing the likelihood that investors would begin to see what Li was already seeing. In fact, Li mentions that the company began holding analyst meetings shortly after Jeffrey took over as CEO and Li began investing:

He initiates... analyst meetings and the first meeting... how many people showed up? It was him, me, and another analyst, three people. And the last analyst [meeting I went to some time in the year 2000] the room is just absolutely filled with nearly 50, 60 people. [Half-joking] So, that’s how I know when I have to sell.3

Li’s investment

In the end, Li made an investment in Timberland some time in October of 1998. He cites a price of around $28 per share; such a purchase would have been remarkable timing. Timberland’s shares closed as low as $28.94 on October 15th and only closed below $30 per share for three days around that time.

We don’t know exactly when Li sold his shares, but he describes a stock that subsequently went up seven times. Timberland closed as high as $293.00 per share (unadjusted for stock splits) in January 2001 which would have resulted in a 10.1x return trough to peak in just over two years. (The real-time price peak would have been $73.25 after two 2-for-1 stock splits.)

Summary: A very good company at a very low (and temporary) price

Li Lu’s purchase of Timberland is a particular type of great investment. Timberland was a very good company (though not an all-time great one) that had a lot going for it, like a great product and increasing customer demand. Revenues were consistently increasing, and the company had invested a lot of money in prior years anticipating even more revenue growth. Earnings were increasing along with revenues too. And with that backdrop came a stock that had irrationally been beaten down to a P/E ratio of 6-7x, or an earnings yield around 15%, on industry concerns that felt more like a hiccup for the company.

After unearthing all the potential concerns he could and doing a boatload of research and live scuttlebutt too, he realized that those concerns were not valid enough to hurt the company’s long-term prospects (and, to state it more strongly, they arguably weren’t even meaningful to the company at all).

Timberland wasn’t a once-in-a-lifetime great company or investment that could be owned forever. (It is very difficult for retail clothing manufacturers or fashion companies to rise to that level.) But it was one example of a good investment: a very good company that makes a great, beloved product, whose revenues and earnings have been rising and that is suffering a decline in stock price due to extraneous factors that didn’t threaten the business long-term.

In addition, the study of Timberland also highlights the power of using Value Line as a source for new investment ideas. The manuals are still printed today, and a diligent and tireless review of the tables and companies listed still offers the chance at a great investment opportunity like the one in Timberland.

This is Part One of a three part series on Li Lu’s investment in Timberland. Part Two and Part Three are also available.

In the fall of 1998, Li Lu discovered a great investment opportunity in the well-known boot manufacturer Timberland that would reportedly earn him a 7x return on his money. This is that story.

In 2006, Li gave a well-known talk to Columbia Business School students. The talk is perhaps the best source for learning more about Li’s investment style and some of his early investment ideas.

At one point in the talk, Li discusses his investment from the late 1990’s in Timberland Co., the US manufacturer and retailer of boots, apparel, and other footwear. According to Li, he became aware of the stock in the fall of 1998 when it was battered due to the Asian Financial Crisis and appeared to be cheap. Li describes some of the work he did over the course of just a few weeks, the investment he made, and the result: a stunning 6-7 times return in just two years.

Let’s find out more.

Subscribe now

How Li discovered the opportunity in Timberland

Li first discusses one of the ways he gets ideas: by reading manuals. He mentions Value Line specifically and, later in the talk, manuals from S&P. He tells the class how he loved to read every issue of Value Line front to back, page after page, how it was a great way for him to learn about many different businesses. He also specifically mentions checking the “new low” lists, those stocks with the lowest price-to-earnings and price-to-book ratios.

Every weekly issue of Value Line comes with a “Summary & Index” that lists all the stocks profiled by the publication and a variety of valuation tables, like “Lowest P/E’s” and “Widest Discounts from Book Value”.

I went back and checked all the Value Line issues from the summer of 1998 through the spring of 1999, and here is what I found.

Timberland first appeared on the Lowest P/E list on September 25th, 1998, and it remained on the list until February 5, 1999. It also first appeared on the “Bargain Basement Stocks” list in the October 2nd issue and remained on that list through January 8th, 1999. It may be that Li first discovered the opportunity in Timberland reading either of these lists or one just like them from another issue in the fall of 1998.

Let’s go back to October 1998

A good case study must put the analyst back at the moment in time of the investment, as much as possible, without the benefit of information from after that time. Li recalls that he made the investment in Timberland around $28 per share. According to Value Line, the stock traded as low as $28.1 in October of 1998, so it may be that Li first discovered the stock before that time. He may have seen it in the September 25th issue or an October issue and made his investment in the brief period in late October when the stock was just above $28. We’ll take Li at his word and assume he made his investment some time in October.

Establishing the exact time frame here is important, so that we can understand what company filings and other news articles Li would have had access to.

Li proceeds to discuss with the class his investment in Timberland by using the following page from Value Line from its November 20, 1998 issue. Note, however, that if Li was working in October, he would have only had access to the August 21, 1998 issue. Both are shown below.

Li also would have had access to the company’s annual report for 1997, which was filed on March 26, 1998, and the two most recent 10Q’s: Q1 1998 was filed on May 7th and Q2 1998 on August 7th.

If Li was looking into the stock in October when the stock price was in the low $30’s or $29 per share range, he would have done some quick calculations to assess how cheap or rich the stock was.

First, at a share price of $29, and with 11,470,423 shares outstanding, Timberland would have had a market cap of $333mn. According to the latest 10Q, the stock had a book value of $229mn. On that basis, the company wasn’t screamingly cheap.

However, the income statement (or the information in the Value Line sheet) tells another story. The Value Line sheet from August 21st shows the company made $4.37 per share in earnings over the trailing twelve months, which, at a stock price of $29, equates to a P/E ratio of 6.6, or an earnings yield of 15%.

And a further look at the history of the income statement from the K’s and Q’s available at the time shows that the company was doing very well. It was consistently growing revenues from much lower levels during the 1990’s, and earnings were growing throughout the period as well. (Note that there was one major exception in 1995, which we will discuss).

The Timberland brand

In the 1990’s, just as today, Timberland boots had a great reputation for quality among tradesmen, like construction workers, carpenters, and factory workers. Although well-known and even iconic today, Timberland’s flagship product of a waterproof, leather boot was somewhat unique at the time of its creation in 1973 and was still leading its niche in 1998.

Moreover, through many years of prior trial-and-error in the shoe industry by its founder, Nathan Swartz, and later by his two sons, Sidney and Herman, the company had captured an even rarer niche starting in the 1970’s and 1980’s, that of a high-quality product loved by craftsmen but also sought after by the affluent layperson. A 1982 article in Inc magazine contains some entertaining evidence that Timberland boots were a status symbol even in the 1970’s:

Kravetz [Timberland’s EVP] was hired early in the summer of 1976. By July, he was tramping up and down Fifth Avenue in New York with a green plaid suitcase stuffed with samples. One day he marched into the shoe department at Bergdorf Goodman and found the manager in his office sipping tea. Kravetz sold him eight pairs of women’s boots and, with that sale, he uncorked a gusher. In the next two years, Kravetz and his remodeled sales team signed up 2,000 new accounts, including a crowd of fancy department stores and an assortment of smaller, upscale retailers.

In addition, in the 1990’s, the company was also in the enviable position of seeing their product becoming adopted by even more markets. That period saw the start of a new fashion trend that still continues today. Along with other “outdoor” brands like North Face and Carhartt, hip-hop performers (and their fans) began sporting the company’s boots.

The trend was so prevalent that it even prompted a New York Times article that speculated the company did not realize how popular their boots were becoming.1

And yet, [then-COO Jeffrey Swartz] contended, the urban market constitutes less than 5 percent of the company’s domestic sales... Not so, say some outdoor-wear-for-style devotees, like Julia Chance, the fashion editor for The Source, a national magazine that monthly chronicles hip-hop culture. They say spokesmen for concerns like Carhartt and the C. C. Filson Company are grossly underestimating their sales to young black and Hispanic consumers.

Despite all these positives going for the company, Timberland’s stock was down -55% in just three months, from July 17, 1998 to October 14, 1998. Why the precipitous drop in stock price?

The company had strong revenue growth and good earnings growth over the longer-term and the company’s brand and product continued to be strong. Wasn’t a trailing twelve-month P/E ratio of 6-7 a bit too cheap? Were there any valid reasons for such a dramatic decline?

In Part Two, we’ll conclude the story with the four concerns that were dragging Timberland’s stock down, why Li concluded none of them were fatal, and the unconventional research that gave him the confidence to bet big.

Subscribe now

It reminds me of something I have heard Buffett say many times. There is an interview by Miguel Barbosa of Alice Schroeder, the author of The Snowball, from back in 2010, and it is well worth reading. I’ve included a copy of it below1.

Miguel Barbosa interview of Alice Schroeder

In it, Schroeder was asked about Buffett’s intellect and investment decision making. She said:

Typically, and this is not well understood, his way of thinking is that there are disqualifying features to an investment. So he rifles through and as soon as you hit one of those it’s done. Doesn’t like the CEO, forget it. Too much tail risk, forget it. Low-margin business, forget it. Many people would try to see whether a balance of other factors made up for these things. He doesn’t analyze from A to Z; it’s a time-waster.

Here, we have insight into one of the greatest investors in the world and the message is clear: wait for the perfect pitch. Buffett has said this many times of course, but the quote above really hits home. Being patient doesn’t mean buying just because prices are down five or ten percent. It means objectively assessing what you would like to see in a business and the price you would like to pay for it. Recall also Buffett’s advice to invest like you have a punch card with room for only twenty investments in it for your whole life. Being patient means walking away without regret if your terms aren’t met. There is always another opportunity around the corner.

Charlie Munger said something similar many times. Here is a quote from his great speech, “A Lesson on Elementary Worldly Wisdom As It Relates To Investment Management & Business”:

And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.2

Charlie Munger - A Lesson on Elementary Worldly Wisdom 1995-1998

Many times I’ll find potential investments that are good but not great. The price may feel just a bit too high, the management is not as shareholder-friendly as I would like, or maybe the company trends or industry trends could be a little better.

When I find myself in those spots, I try to remind myself of the sheer amount of opportunity out there. The equity of 60,261 companies is listed on major exchanges throughout the world as of January 2026. And this doesn’t count the amount that trades over-the-counter or opportunities that might arise in the huge fixed income market, comprised of corporate debt, municipals, sovereign debt, and mortgage- and asset-backed securities. There are potential investments in commodities and real estate. There are derivatives off of all of those! And there are private equity, venture capital, and angel investing opportunities that might arise for the enterprising investor. There are esoteric alternative investments. There are also completely new business ideas one could develop on their own, like developing or purchasing and running a small business.

I try to remember that my money doesn’t care how it’s made, and the limits should only be defined by my own circle of competence. My job as an investor is to make the best returns possible. Strictly speaking, that means sorting through all of those tens or hundreds of thousands of investment opportunities in order to find the ones that will deliver superhuman returns. It won’t be possible to look through all of them, of course, but keeping this perspective is a good way to counteract any fear of missing out that might surface.

Good investing is as much about maintaining discipline as it is finding opportunities. Search continuously, but wait for the fat pitch down the middle of the plate.

The Owner’s Memo is a newsletter about investing, written for myself, so I have a place to record my thoughts, make sure they’re good and coherent, and to keep myself working constantly to become a better investor. If others find value in it, all the better. There’s nothing like writing to show me whether or not I understand something. I once had a physics professor who told our class, “If you cannot explain the concepts you learn to your grandmother, then you don’t really know them.” I hope this newsletter strikes that spirit and is a place to explore the craft of investing in a way free of pretension, with a goal of getting better and better, finding the best possible investment ideas out there, and continually learning how to manage myself in the course of buying, selling, and holding investments.

My focus will mainly be equity investing, and I’ll draw heavily on the teachings of Warren Buffett, Charlie Munger, and others. Most of all, I hope the writing and analysis I discuss here is grounded in ideas that make sense to me and you, rather than relying on accepted “wisdom” that doesn’t.

On keeping it simple

I’m fond of the idea, expressed by Buffett and others that often the reason for buying and owning an investment is simple enough to be written on a napkin. Professional investors often create extensive investment presentations that serve a secondary purpose: they seek to assure partners or others that the analyst has done a lot of work. Typically, much of the work is ancillary to the core investment thesis. I’ll seek to deliver analyses that both get to the point and examine risks to a balanced degree.

”If you cannot explain the concepts you learn to your grandmother, then you don’t really know them.”

- my former physics professor

On temperament

Controlling or understanding my emotions is critical for good investing. Buffett often likes to say that, for investing, temperament is more important than IQ. From the 2009 Berkshire Hathaway annual meeting:

The market is there to serve you rather than instruct you and to a great extent, that is not a matter of IQ. If you’re in the investment business and you have a IQ of 150, sell 30 points to somebody else, ’cause you don’t need it. I mean, it. You need to be reasonably intelligent. But you do not need to be a genius.

But you do have to have an emotional stability. You have to have sort of an inner peace about your decisions. Because it is a game where you get subjected to minute-by-minute stimuli, where people are offering opinions all the time. You have to be able to think for yourself.

I agree wholeheartedly with this idea, and I have a lot of experience with the notion myself. It seems to me that IQ and temperament are almost completely unrelated. We need enough smarts to understand financial statements, understand the difference between good analysis and bad, and to be able to pick up on positive and negative qualities of an investment, like how “good” the management team might be, but none of that requires a genius-level IQ.

Instead, I’ve found that the way I respond to market prices bears as much weight as good analysis:

• Can I buy a cheap security without worrying about how much cheaper it was a month ago?

• Can I hold it if the price declines but the prospects still look good?

• Can I hold it for extended periods without being tempted by the latest hot stock?

• Can I sell it when things go poorly without berating myself, when often, failures are only obvious in hindsight?

• Can I sell it, if warranted, without berating myself for missing the top?

I plan to write quite a bit about the psychological aspects of investing, about my own temperament, my quest to know myself, and the neverending battle of forming my own theses and assessing them regularly, taking in outside information while avoiding outside noise.

On the rarity of great investments

Great investments come along very rarely in life. Here is Buffett again in a speech to the Terry College of Business at the University of Georgia from 2001:

You would be better off if, when you got out of school here, you got a punch card with twenty punches on it and every [investment] decision you made, you used up a punch. You’d get very rich because you’d think through very hard each one.

There’s a temptation to dabble, particularly during bull markets… you can’t make any money doing that, but if you had a punch card with only twenty punches, and you weren’t going to get another one in your life, you would think a long time before every investment decision, and you would make good ones, and you’d make big ones, and you probably wouldn’t even use all twenty punches in your lifetime, but you wouldn’t need to.

I think the punch card idea is one investing idea that is impossible to overstate. Both professional and non-professional investors have a natural tendency to be hyperactive and to overinvest. Professionals often overinvest with diversification in mind. Diversification is a path to producing less volatile but more ordinary results, allowing the pro a better chance to accrue assets through the things they can control, marketing and salesmanship. For lay investors, ideas are often surfaced in ways that make them seem like great opportunities, for instance, reading an article about how fast a company is growing or getting a stock tip from a friend. However, the layman doesn’t have the experience to understand what separates good ideas like those that are all around from great investments. These ideas and tips don’t come along every day, but they do occur frequently enough to confuse the individual and severely impair results if the hyperactivity is not contained.

I seek to live the punch card philosophy in my own investing, and I’ll explore it and express it in my writing.

What you’ll find here

In The Owner’s Memo, you’ll find a few kinds of articles:

• Case studies of great investments from the past. Great case studies can be the best way to learn great investing, but it is often difficult to find good ones. Case studies can be hard to reconstitute because past documents or data sources may not be around or may be tough to find. Since they’re often about success stories, sometimes they don’t give enough weight to just how hard it would have been to pull the trigger. But when they are written well, there is nothing like them. In learning about the features of great investments from the past, we can analogize to investments of today and understand what to avoid, the pitfalls or those potential investments that don’t rise to the level of top-notch.

• Reviews of investment research, books, writings, and other discussions. Understanding the wide variety of investment work out there is vital to becoming a great investor. I review research articles and other sources to inform my own investment philosophy, both providing interesting ideas to examine and also bad ideas to avoid.

• Current investment ideas or candidates. I may also write about businesses I find compelling and potential investment ideas, but I don’t plan to do this right away. First, I’ll see how readers respond to some of the above articles. I want to avoid any sense that this newsletter provides a drip feed of regular “hot stock” tips, which would contradict the idea that great investments are rare and that the goal is to own just a few of the very best investments one can find.

• Profiles of great investors. In the same way that case studies can help learn about great investing features and habits, studying great investors can provide almost as much in the way of good lessons. They also have the benefit of providing inspiration. I’ll review what I can glean from the life and work of some of the greats, particularly focusing on how they started out, to gain some insight on what personality traits or behaviors might be important.

• Reviews of other interesting work in adjacent areas. From time to time, I will be writing about topics that might not seem immediately to be relevant to investing. For example, I am likely to write about psychology and advances in artificial intelligence. Both of those can aid dramatically (and may even be necessary) in being the best investor I can be. I’ll always be expanding my circle of competence, too, and this will be a place to share that work. Charlie Munger felt that having a well-rounded intellect and a desire for lifelong learning was essential to being a great investor.

• Current events. I do not intend to write much about current events, unless the events are applicable to becoming a better investor. I’ll seek to create a set of writing that is focused on the long term. I want this to be a place where I can put down my own theses, grow and thrive as an investor, and, hopefully, allow others to do the same in reading my work.