In 2006, Li Lu delivered a speech at Columbia University where he discussed his investment in Korean based Hyundai Department Store. Check out the full lecture here.
He found the idea from the Standard and Poor’s investment manual, which summarises publically traded stocks in one to two pages.
Here is the original page from the manual that Li Lu presented to the class. Note that he bought the stock sometime in 2004 for roughly 1200 Korean Won which equalled $12 at the time.
Below, I outline the two key elements of this investment that Li Lu explained in his lecture.
Hyundai was cheap using common valuation metrics
As we can see below, Hyundai was selling at a market capitalisation of $65m (5.5m shares times $12 per share), whilst earning $27m (5.5m shares times $4.5 per share). This gave it a price-to-earnings multiple of roughly 2x. They also had $240m in book value, giving a price-to-book ratio of only 0.27x.
Hyundai was even cheaper when the assets of the business were analysed
Li Lu discovered the following facts after researching the business deeper:
- The book value was comprised of roughly $180m in fixed assets and $70m in working capital, which are tangible
- $70m of the current assets were in cash or cash-equivalents
- Of the $180m in fixed assets, they own a hotel recorded at $30m (which would’ve actually been worth much more than the historical cost paid)
- They also own 13% of a department store’s stock recorded at $13m. This stock had a market cap of $600m, therefore, the value of this asset was actually $80m
- They also own some cable companies and some real estate
This was Li Lu’s summary of the situation:
Li Lu acknowledged that Korean managers tend to have a less shareholder-oriented mindset than American managers. He explained that he analysed what local investors thought of the company to see if there was a high risk of management treating shareholders poorly, and deemed the risk was low.
In the subsequent years, the stock went to roughly $100 per share, giving Li Lu a spectacular return!
This case study of Li Lu’s investment in Hyundai Department Store provides two main takeaways:
#1: Don’t take valuation metrics at face value. Always analyse further to decide if a stock is cheap or not.
Li Lu didn’t see a P/E of 2 and just invest in the business straight away. He analysed all their assets, considered the stability of the earnings and considered the risks. This applies for compounder style businesses too. Perhaps a business had a huge boost in earnings that is not sustainable and their P/E ratio is 10x. This may seem cheap, but without thorough analysis, an investment like this would likely lead to disappointing results when the business converges to its true earnings potential.
#2: Li Lu was very unexact with his figures. This demonstrates the importance of concentrating on the business fundamentals and not getting lost in inaccurate precision
Li Lu did not use a calculator to calculate the market capitalisation, book value, or P/E ratio precisely. He didn’t care if he was wrong by 10-20% in either direction. He knew the business was selling at a significant discount to intrinsic value and didn’t waste time trying to be too precise. This reminds me of a famous quote from John Maynard Keynes.