BIO: Richard H. Lawrence, Jr., is the Founder and Executive Chairman of Overlook Investments Group, an independent fund management company established in Hong Kong in 1991.
STORY: Richard invested heavily in a successful Korean company that brought him great returns until the founder died. The son took over and brought the stock to its demise.
LEARNING: If it’s not working, get out. Invest in a company with no or minimal debt. Operating return is the purest way to measure profitability.
“I’m a big believer in modest self-financed growth.”
Richard H. Lawrence, Jr., is the Founder and Executive Chairman of Overlook Investments Group, an independent fund management company established in Hong Kong in 1991. Overlook invests US$6 billion in a concentrated portfolio of public equities throughout Asia, excluding Japan.
Richard and his wife, Dee, have founded several non-profit organizations; he’s a philanthropist who is devoted to climate change. He has two grown kids and lives in San Francisco, California.
Worst investment ever
In 1992, Richard discovered that stocks in Korea were incredibly cheap. He owned everything at 2-4x earnings. Richard owned a hair dye company and all kinds of oddball companies. Within that mix, there was one company that stood out. Korea, at the time, had massive debt. But this one company didn’t have any debt, so Richard was immediately attracted to it.
Richard purchased shares in the company initially in 1992. At the time, the company was the largest synthetic fiber producer in South Korea, making spandex. It was a formidable company going from strength to strength. It became among Richard’s most significant holdings, the strongest of this cohort of Korean companies he owned.
The company was founded by one of the greatest titans of the Asian textile industry. The founder was Korean and a larger-than-life figure in a manner unlike any other business leader in Korea in the lead-up to the Asian financial crisis when Korea went burst. He was a nonconformist in a culture that admired conformity. That was one of the reasons his company had no debt. He had the confidence and independence of someone who knew how to run a company for cash flow. Just as he disliked debt, he also disliked paying taxes. He was the most aggressive executive Richard had ever encountered in Asia or anywhere else. In one instance, he built a US$400 million facility, depreciated it over two and a half years, then revalued it and depreciated it a second time. By doing so, the founder minimized reported profits to minimize taxes and used cash savings to avoid debt. Richard liked this business model, so he invested heavily in it.
The company did very well in the start-up years until the founder died. His son took over, but he struggled to fit into his father’s giant shoes. Richard thought he could help him be successful and worked on it from 1997 to 2000 during and after the Asian financial crisis. Richard gave him all the advice he could, but he was ignored. By 2000, with no concrete action taken by management, and no upward movement in the sock, Richard’s patience wore thin. Then the new leader crossed a red line and blatantly undertook an unfair related party transaction that effectively bailed out an insurance company owned by the family with cash from the spandex company.
Richard, at that time, requested a reversal of the acquisition. He asked management to initiate paying cash dividends, execute a series of share splits, establish an IR department, and appoint additional directors that are at least partially independent. The largest internationally managed Korean fund cast the deciding vote against Richard ending the investment in a huge loss.
- Being an activist publicly doesn’t help.
- If it’s not working, get out.
- Invest in a company with no or minimal debt.
- Avoid the stock that’s the hype of the day.
- Operating return is the purest way to measure profitability and should be high. The higher it is, the better it is.
- An activist type of shareholder has its limits.
- There’s value in owning a diversified portfolio of stocks over a long period.
Go for companies with modest growth, don’t look for something off the charts. Build a portfolio of roughly 12 companies that can deliver a good operating return and rebalance it regularly.
Richard recommends reading a lot of investing books. You can start with Buffett’s letters and then go to John Train’s books as you grow your library.
“Beginners in this industry can learn from the tough lessons that we all went through.”
Andrew Stotz 00:01
Hello fellow risk takers and welcome to my worst investment ever stories of loss to keep you winning in our community. We know that to win in investing, you must take risks but to win big, you got to reduce it. Ladies and gentlemen, I'm on a mission to help 1 million people reduce risk in their lives to join me go to my worst investment ever.com and sign up for the free weekly become a better news investor newsletter, where I share how to reduce risk and create grow and protect your wealth. Fellow risk takers this is your worst podcast host Andrew Stotz. And I'm here with featured guests. Richard Lawrence. Richard, are you ready to join the mission?
Richard Lawrence 00:42
Oh, I'm delighted to be here with you, Andrew and delighted to help contribute a little bit to your community.
Andrew Stotz 00:51
I appreciate that. And as you hear I'm on a mission. And that mission is very simple to try to reduce risk in the lives of a million people. And a lot of people scoff at me. And I know I'm far from getting there. But man, I'm, I'm a quarter of the way there having now gotten more than 250,000 downloads. And I just keep pushing in want people to get the message. There's so much we can learn from the stories of others. So that's the key. Let me introduce you to the audience. For those people that don't know, Richard H. Lawrence, Jr. is the Founder and Executive Chairman of overlook Investment Group, an independent fund management company established in Hong Kong in 1991. Overlook invest $6 billion in a concentrated portfolio of public equities throughout Asia, excluding Japan, Richard and his wife D have founded several nonprofit organizations. He's a philanthropist who is devoted to climate change and other fantastic missions. And he has two grown kids and lives in San Francisco, California. Richard, just take a minute and tell us about the unique value that you're bringing to this wonderful world.
Richard Lawrence 02:03
Well, I'm, I'm a fairly modest, humble guy. I always found the investment business to be incredibly humbling. So I don't like to get over my skis. But I think what I've been able to accomplish is to really help simplify investing. I wrote about it in my book called the model. And, and particularly as I get older, the investing world gets easier. So for all those people mired in complexity over how to invest, I think my book might be of some assistance. Beyond that, I'm a very modest guy. And I am committed as I think we all need to be to fighting climate change, which is, I think, the issue of our day.
Andrew Stotz 02:51
And I've got the book right here, the model, I bought it about six months ago and went through it in a pretty short amount of time. I mean, I was really interested, it's not that common that you get books written by investment experts that really go through the details of what you're doing. And I think that was the value that I got, I felt like there was some great nuggets in there. And, you know, one of the things is the concentrated portfolio, as we mentioned earlier, that you're not trying to match the market or do anything like that you're trying to identify a small number of companies that you think have, you know, good opportunities, and I just wanted to highlight a couple of quick things. So for the listeners out there, there's four points to the Overlook investment philosophy, and I'm looking at page 68. On the book, I'll have a link in the show notes. But on page 68, it talks about superior businesses management with integrity. It also talks about number three bargain valuations, and then long term investment horizon. In some ways, this is like the dream for a lot of young people that want to build a future and investing. And one of the questions I had about number three, the bargain valuations, which you go through some of the calculations that you do, and the ways that you look at it. But one question I have for you is how do you? How do you deal with a situation where, let's take TSMC, which you've also done a great case study in the back. And I've used that in my valuation masterclass, to work with my students to help understand this particular company and how you looked at it. But when it comes to TSMC, as an example, there's times that that company could be really expensive. And yet, it takes all the other boxes. And I'm just curious, and you do mention that your formulas are kind of a guide and a framework. How do you deal with that when, you know, obviously, great companies aren't going to come at, you know, a seven times PE I'm just curious about that one aspect before we go into a couple of other things.
Richard Lawrence 04:47
Yeah, I think that this is why I enjoy bear markets that they give us these opportunities to get these things really cheaply. And at other times, I think I have a visceral dislike of big bull markets because They're taking everything away. And as I say, the wrong people are making the money. I think there are a couple of things that are useful. One is rebalancing. I think, you know, when you own a stock for a long period of time, you just feel when it's right up at the top of that cycle. And that's when you peel it back, take it, take some money off the table. And then naturally, when it comes back down, you have that money, and you can put it back in. I think that's one thing that's very useful. The other thing that we found very useful, is looking at the valuation characteristics of our portfolio, and comparing each stock against the dollar weighted averages of our portfolio. And so Andrew, if you come to me and say, I got a stock at 25 times earnings, it's got a 12% return on equity, and it's growing at 12%. Well, I would come back, why would I own that, because my portfolios at 16 times earnings growing at 13%, with a with a 19%, return on equity, so that monitoring what you're buying, or what you're selling compared to your overall portfolio, I've always felt just you can take steps which nudge the portfolio in the right direction.
Andrew Stotz 06:09
That's interesting, because most people would do just the opposite way they compare that stock to the rest of the world and the universe of all the stocks. But you're basically saying I don't care about all the stocks, I've got my what I care about is how does this enhance or add value to this portfolio or not. And so that's a great one. I also noticed that in the book, you mentioned that it was the rebalancing that may have prevented you from selling the TSMC steak or other steaks. And so, you know, on the one hand that rebalancing is kind of a tool that people sometimes think about, but what what you mentioned here, and what you've mentioned in the book is the idea that it may save your butt, just when you're thinking you know, I got to do something big? Well, no, you don't have to do something big. What you need to do is maybe consider rebounding, just tell us about that aspect for just a moment.
Richard Lawrence 06:59
Well, I think selling is much harder than buying, okay, we can all get consensus around, oh, we gotta buy this, right. Selling is much harder, because specifically, you know, the stocks, which you have to sell have done extremely well. And so rebalancing is not selling, there's no emotion to it. It's remarkably, it's a completely non emotional event, you're just taking some money off the table. So that helps. There are other times Andrew, when you get what we call tomorrow's price today, where you pull the trigger and sell the whole thing. Now and and and then there are versions, you know, other ways that we sell securities, probably most commonly when we realize we've made a mistake. Otherwise, when fundamentals of an industry are really changing and a company, which was in a sweet spot, it's not where we are where we go from a deflationary environment to an inflationary environment and things change. But, again, go back the rebalancing is great, because there's no great argument on the investment committee about doing it. We're just we're just pulling it back.
Andrew Stotz 08:05
Yeah, that's, that's, that's great. And that's a great nugget for the people who are managing their own portfolios out there. One of the things you mentioned earlier, we were talking about how market downturns provide opportunities to enter it, you know, a good price is that what investing is about is identifying the right targets through your system and all that having a long enough timeframe that when that you are waiting for the opportunity, and then you strike or is that just a port, a small part of the overall thing.
Richard Lawrence 08:39
I think you can't paralyze yourself and wait for the one in every 10 year bear market to roll into town and where you load up all that cash, it just doesn't work that way. What bear markets can give you though, are opportunities to invest in stocks that are gonna get you better IRR, than if you buy a stock in a normal year, you know, and it doesn't even have to be a greater company than the ones you buy in a normal year. But just because you bought it in a bear market gives you that chance for really big IRR. So you can't miss you know, and the trouble that a lot of people run into is, you know, they take in a lot of money at the top Andrew. And then when the bear market hits a lot of that Hot Cash leaves. The fund manager then has to sell his crown jewels. And so when stocks are down, he doesn't have the capital. And so this comes back to business practices, which we talk a lot about in the book, right. But one of the business practices we follow which has been incredibly valuable, is we've had a legal cap on subscriptions right from day one that's precluded investors from coming in hot money coming in at the top, then we don't have to replace them, you know, and some people will always get caught and they'll have to be replaced but we generally keep a backlog because of the cap. And that allows us in a bear market, you just keep moving forward Word you buy, stocks go down, you buy and stocks go down, you're buying stocks go down, you can't buy at the bottom, and even the first leg up, you don't buy very much, because you're saying, Well, you caught me three times already, I'm not gonna get caught again. So you have to by definition you have to buy early and often in these bear markets, and that's the cific to bear markets. And the rest of the time, you just keep trying to buy the best possible companies you can a year and a half to prove their value. And you either kick them out or you stay with you.
Andrew Stotz 10:32
Yeah, in the book, you talk about you, you kind of stumbled on this. Through your meeting with one of your first investors, I believe his name was Crosby, as I recall. Yeah. Yeah. And, but the idea, so let's just review this, for the listeners who may not understand this, the idea is, is that an individual a particular investment investor, or a family or family office, or whatever, has a limit as to how much that they can put in so that what happens is that they if the market starts really racing up, they're tempted to just dump more cash into it. And this prevents that cash from coming in. And that basically is kind of saying, I'm trying to protect you, number one, from rushing in at the peak, go do that somewhere else. And also, what I'm trying to do is protect the portfolio from not being awash with cash that will then be pulled from us. at some other point, let me ask you in the down cycle, is it just the sentiment that, hey, I've got a limit of how much I can buy? So I'm not going to sell it in the down cycle? Or is there any other guidelines when the market goes down for the client?
Richard Lawrence 11:40
Well, I think for us, we just manage the portfolio, we think about that. Usually, when in big bear markets, there's what we called change of leadership. And we might own a perfectly good stock. But if it's not in that change of leadership category, we will sell it and buy something better. And so we've got to do everything, walk in every day, and just keep moving forward on it. Okay, you know, and then the cap has really helped go back to the cap, the cap has really helped us have really stable clients stable capital, because the worst thing that happens is, you know, you hit the bear market and everybody's running for cover you just, whatever you do, you got to avoid it. And likewise, at the top, over the last five years, we've returned a couple of billion dollars, which is also what you should be doing.
Andrew Stotz 12:38
Yeah, and I think that's the last thing I want to say about the discussion about the book is just a, you know, what you could describe as customer first is kind of what you're thinking, when you talk about time weighted versus cap weighted return and trying to understand how do clients lose, you know, so commonly, by allocating at the wrong time, and by you know, and how do funds have to deal with the inflows and outflows. And so, you know, what I get the impression of is that you're balancing not only your benefits to you guys and your team, and you know, you need to be paid, you need to be compensated, but also balancing that with, how do we bring the most to the customers. So that's part of what I'm getting from what you're putting out in the book. Well,
Richard Lawrence 13:22
when I was young, starting out and really didn't know a whole lot, I just wanted to compete. I money has never been the motivator. I just wanted to compete. And I was competing in a world where I had no natural advantage, which I really liked. And so for me, to cap the size of the fund in the early days, and to keep it kept for long periods of time. That was, it wasn't a big deal. You know, it just allowed me to do what I love to do for 32 years, rather than whatever the average life is of an Asian fund manager, you know, so
Andrew Stotz 14:05
for the listeners out there, I'll have a link in the show notes. You can also go to the model.com. You can also go on Amazon or other places and get it and for me, it was a nostalgia that a bit I first came to Asia when I graduated university at Cal State Long Beach before I went to work at Pepsi in Los Angeles. And it was 1989. I was planning to go to Japan, Thailand and Hong Kong. And because it was May 1989, I think it was so we had the Tiananmen Square protests going on in Hong Kong. So I decided just to I was in Japan, and then I was in Thailand when the protests were going on. So I decided to stay in Thailand for an additional week. And that knocked me out. I ended up falling in love with Thailand and I came to Thailand in 1992. I became an analyst in 93. But when I look at, you know, the stories that you're telling and how China was just you know, people asked me why didn't you go to China? There was just nothing happening there at that At time, so listening to your stories about and for the listeners out there, you know, listen to some of these stories about, you know, seeing a landscape that's basically empty. And then you know, three years later or even a year later you come back and it's, you know, a whole nother place. And so it was definitely nostalgia those days going to Hong Kong, bend to your office. I know James Squire and I really appreciated him. He was one of the first guys that I met in the old days when he was at bearings in 1995. Or so I was there with visiting him as as a bank analyst. And so for me, it was a trip down memory lane. And so I really appreciate that. And I would say to all the the listeners and viewers out there, get it, it is not only one of the seminal books now that I would say about portfolio management and about stock selection, but also a little bit of the history of what the heck's going on from the inside with the management of these companies in China and throughout Asia. So well done.
Richard Lawrence 15:59
Thank you for that. Yep.
Andrew Stotz 16:01
So now it's time to share your worst investment ever. And since no one goes into their worst investment, the year will be. Tell us a bit about the circumstances leading up to it. Then tell us your story, which I think you're going to grace us with some of the story that you've put into the book.
Richard Lawrence 16:16
Well, to set the stage, it was 1992. I was just out of the gate. I had discovered that stocks in Korea were incredibly cheap. I owned everything at 234 times earnings. I owned a hair dye company, I owned all kinds of oddball companies. And within that mix, there was one company that stood out that was really different. Korea at the time, had massive debt. And there was one company that didn't and on so I, I was immediately attracted that company and this is the story of Richard Lawrence's investment and take long industrial company. So we purchased our shares and take one originally in 1992. At the time take one was the largest synthetic fiber producers in South Korea made spandex. It was a formidable company going from strength to strength, it became our largest holding by 93 strongest one of all this cohort of Korean companies that we owned and the second largest holding in our portfolio. It was founded by one of the great titans of the Asian textile industry. Most of these guys came out of Hong Kong and China. Well, Mr. Liam young came out of Korea, he was a larger than life figure in a manner unlike any other business leader in Korea in the lead up into the Asian financial crisis. When Korea went bust. He was a nonconformist and culture that admires conformity. I remember one day and I went down to Olson to look at their massive new petrochemical facility. And during a visit to the office, I noticed there was a Mercedes Benz sitting out front of the entrance. You have to understand that in 1993, or 94, it was practically a crime in Korea at that time not to be up by a Korean vehicle. So it caught my eye. Of course, it was Mr. Lee's car, he would drive any kind of car that that guy wanted to drive. No one had anything on him. That was one of the reasons his company had no debt. He had the confidence and independence of one who knew how to run a company for cash flow, just as he like. He just as Mr. Lee disliked debt. He also disliked paying taxes. And so how did he do this? Well, he was the most aggressive depreciate or of any executive I have ever entered I've ever encountered in Asia or anywhere else. He would build a in one case, he built a $400 million facility. He depreciated over two and a half years, then he revalued it and depreciate it a second time. I mean, what a stud. He and what this did was he minimized reported profits in order to minimize taxes, using the cash savings to avoid the debt. He liked it that way. And I liked it too. I could do my homework, even though the audited financial statements were always only available in Korea, but they were so cookie cutter when I translated one set of Korean accounts, I had them all translated, and conch Hassan, which is the only Korean word I know was depreciation. But I knew he was a very, very sharp and savvy investor and take one was a good company and it did beautifully in the early years. And then, quite sadly, Mr. Lee died and that was a startup problems. Control passed with son kojin Lee upon becoming CEO Hogen suffer From obviously a bad inferiority, we probably already complex, they were good, to be fair to whole journey probably suffered from other things as well with this very domineering father. But he was immediately challenged by 9798. When Korea went bust, the stock got hammered, as did all stocks. And despite that, in overlook, I'm pretty stubborn guy. I thought, well, let's teach this guy. And we thought we could, we could help him be successful. And we worked on it from 97 to 2000. During and after the Asian financial crisis, we repeatedly discussed the things that I think are important, which are corporate governance and Capital Management. With him and his team. We called for greater transparency of financial statements, moderation policies, under moderation of the policies, understating the true earnings. And we asked for the inception of paying dividends. Without the steps we felt as we communicate to the management that the share price was going to continue to go nowhere. And Hojin and is yes, men that's random. What was nodded and they appreciated the advice, Richard, that's very nice. And then they sent me on my way, though, by 2000, you know, now granted, I had just polarized the investment by all my limited partners, I was added a little bit of pressure, you know, we'd gone down something like 65% in the Asian crisis. You know, I wasn't managing a lot of money I had two kids and apartment in Hong Kong, which was expensive, and I needed cake one to perform. So, but by 2000, with no concrete action taken by management, and no upward movement, sadly in the sock, my patients were thin do we sell? Can we force the company to act responsibly and change debt and policies to achieve better share price? Well, then one day take one made the decision for us cogent hair, two heir to his father's company, but not to his ability, nor his strength of character, crossed a red line, and he blatantly undertook an end unfair related party transaction that effectively bailed out an insurance company that was owned by the family with the cash from take one. And so we acted. And here's a little excerpt from my report, you can feel a little sense of desperation in my voice. As I'm trying to justify what I'm doing in these early days of overlook, he says our most recent but most by no means our only action on defending fiduciary interests of the Overlook investors occurred recently when we hired a shareholder rights lawyer in Korea to communicate our views to the directors of take long industrial, a company or take long industrial in a more forceful manner, shall we say? The formal step was triggered by the acquisition of commercial building from a life insurance company owned by the controlling shareholders a flagrant transfer of wealth from take long to offset the family's losses. The acquisition took place, gallingly. No less than two weeks after two members of the senior management team assured my lawyer and me during a meeting that no such transaction would ever take place. So we at that time requested a reverse of the acquisition, we asked them to initiate playing cash dividends, we asked them to execute a short series of shares, let's establish an IR department and appoint additional directors that might actually be at least partially independent. The cash cost to take one for the all this stuff's pretty small. It was really more symbolic, you know. So we proposed a shareholder resolution, and this is where it gets a little technical, but it's kind of cute. In 2001, to elect my lawyer at the time, as a quote, outside auditor. Now this was a special category. But the role of the outside auditor was exactly as an independent director. So it was a beautiful loophole. And the key to the loophole was that under Korean law, the controlling Li family couldn't vote. So it was actually a truly for the first time in my history in Asia. It was truly a vote of minority shareholders. All we needed was 51%. And I was getting my lawyer on the inside. And he had all told me privately that look, if I get on the inside, people are going to jail. You know, it's just that's the way it is a Korea. So literally days before the vote. Take one sensing the shareholder revolt, realize that we might well lose, then through their incompetence. are a coincidence or something else. The largest internationally managed Korea fund cast the deciding vote against us. I found that particularly galling because the Korea Fund had been victimized in Korea more than any other foreign investor on by the corporate governance abuses in Korea. I mean, this was a very undeserved loss at a very tough time in Richard Lawrence's life. And it was unfortunate loss for overlook the limited partners and ultimately all shareholders in Korea. You know, and so a week later, after I lost the vote, I was on the front page of the newspaper as a villain. I was in my office in central Hong Kong and I got a call from the lawyer who informed me that a high ranking official within the government of Korea had called him and evidently the government of Korea was unhappy with my nonconformist advice. And he and the government asked him my lawyer to pass along the message that Mr. Lawrence was no longer welcome to come back to Korea. I then turned to my lawyer to tell that to ask him to call the official back and to tell him that overlook investments had no longer any interest in returning to Korea anyway. And so, the story actually has a bit of a couple of happy endings. About About six years ago, and maybe six years after this had happened. I had a client of mine who was in Korea. And he was on a business trip involved with his animal trap business, which is another subject. He faxed me a newspaper article described how Hojin Lee, the son of the founder had been convicted of defrauding take one and was pleading for leniency, they actually wheeled him into the into the courtroom tied up to an IV machine looking all ragged yet he was all about 47 at the time. But what makes Hojin a specially deserving of our vilification even today was that his scheme to defraud take war, ended up convicting his mother as well. Now, as I write Hogen, Lee is back in jail now he went to jail, got out of jail, he's back in jail a third time. And I was very delighted to send a signed copy of my book, to Hogen through his lawyer to be delivered to him in jail, which was one of my, one of the great pleasures and fulfills Andrew the old saying that revenge is best served slow, or meal best served cold. Anyway, it take long ended up costing me 15% compounded on just a mountain angst. Yeah, and
Andrew Stotz 27:58
I think one of the things that for the listeners out there, you know, you touched on it, but you didn't, you know, elaborate, but it's important to understand what was happening in Asia to everybody's portfolio at that time. So this was like you as you said, you had a backdrop of everything kind of collapsing. I started in the Thai market in 93. And the bottom of the time market was 2003. We went from 1789 to 211. And it took a long time. And it took a lot of suffering over that time. So meanwhile you're sitting on a portfolio that's non performing, it's losing value, and then you got this going on. And you know, you talked about inexpensive flat in Hong Kong, you got the kids and the wife and all that those backdrops are emotional pressures that people don't realize,
Richard Lawrence 28:45
well, what particularly galls me was, hey, Kong had no debt. Korea went bust because everyone, every one of those tables, the top 25 tables, every one of them, except for take one had debt. And air I was getting crucified, you know. So anyway, it's brings back bad very bad memories. Andrew
Andrew Stotz 29:07
was a point where you make how he didn't have debt meant that he also had this huge opportunity when everything was going, you know, south to not have debt in 1998 is, you know, in Asia was just on heard of so how would you summarize for the listeners out there? What are the lessons that you learn?
Richard Lawrence 29:32
Ah, well, well, one thing I definitely learned and we've been very activist throughout our time, and I learned that being activists publicly didn't help me in this case. So I think that all our activism today is all very private and confidential, all direct to the Chairman and CEO. And we're just trying to have open and honest conversations with those people on issues. Corporate Governance and Capital Management. And we do it privately and respectfully. And I think it's better. We tried it in this case, you know, he just refused to engage. And when they refuse to engage, the best exit is, get out of the stock. I guess that's the other lesson I pushed. I tried too hard. And I was this, but you got to understand it had no debt. And it was at two times earnings. If I thought, it's give me four times earnings, I'm gonna be gone.
Andrew Stotz 30:30
And what will be the lesson about the change in management, I remember my, my sister went through a divorce and her lawyer that she had had, he got sick, and he had some big problems going on in his life, she felt kind of sorry for him. So she kept him. And she ended up with an awful settlement. And it made me realize, like, you know, that sometimes when things are going south, you really, really have to bite the bullet and say, I gotta get out of this. What? What would have changed if you came across that situation? Now? How would you handle that differently?
Richard Lawrence 31:09
Well, you know, you gave me a stock at two times earnings, I'm gonna make a bid to try to do something, you know, because not a lot of stuff at two times cash flow. But, you know, in, in, in every case, a lot of overlooks work, is engaging with management, we're asking them questions, we're trying to learn about the business. But we're also probing them on how they are as people. Were probing them on how did they behave in Oh, 708? Or if they around in 9788? How did they get their business funded and off the ground? Have they treated shareholders in the past? How do they talk to me? You know, I walk in I'm a kid from New York, you know, I mean, today, lots of people know lots of people from New York. But when I walked in, in 1992, into Seoul, Korea, there weren't a lot of there weren't a lot of people like me walking around Asia, initially asking tough questions.
Andrew Stotz 32:08
I guess my one takeaway is that activism, as an activist type of shareholder has its limits. And the limit can be if the other side's not receptive of it, you've got to at some point, detect that that you can't change the world, you've given your efforts, your best efforts, and they may not be interested in what you say, oh, for reasons that you may not even really know.
Richard Lawrence 32:32
Well, and that's not our fault. That's his fault, or her fault. You know, I've had meetings, where I asked a Singaporean guy who was very well respected. And I asked him to do some stuff for us, you know, that was right down main street of corporate behavior. And I remember at the elevator, I put my hand out to shake his hand, and I look at what, and I gotta shake my hand rally. And boy, I was out of that stock the next day. Yeah. Yeah. So it's one thing I've always liked about activism is that you do are able really to peel back and see what the executives really think? It's, but it's, it's tough left? It's not for everybody.
Andrew Stotz 33:12
So I'm gonna ask you a question. I mean, like, I teach a lot of young people how to value companies build portfolios, and you know, a lot of foundational stuff, and a lot of them have a dream of doing what you've done. But some of them are just going to build their own portfolios, and manage those over a long period of time, and maybe do a job as an engineer or, you know, something like that. And I wonder if you could, you know, in a, in a nutshell, give a wrap up from everything that you've learned into some kind of core principles. I mean, they're not gonna be able to be activists, they're not full time, you know, analysts analyzing, going visiting companies, they have some limits, but there is some value to owning a diversified portfolio of stocks over a long period of time, what would be one or two pieces of advice that you would give that person who's constructing their own personal portfolio of stocks?
Richard Lawrence 34:03
Well, I think there's three or four right? First was avoid the debt, that's not going to do any good. The second thing, avoid what's really the flavor of the month, when it's on the front page and newspaper all the time, you can't be in that stock, you just you got just got to leave it for someone else. Third, I really spent a lot of time looking at what we call operating return, which is EBIT over the operating net assets of the business. That's the purest way to measure profitability. And that number should be high. The higher it is, the better it is. And then the other one is, I'm a big believer in modest self financed growth. And so we talked about a normalized growth rate. You know, I said at the beginning, it was about 13%. Today. Companies that have high operating returns that grow at 13% make wonderful investments because they throw off cash flow, and they can pay you dividends, you'll get your dividends. You'll Get your roll feel they'll make a few acquisitions and, and there's a big margin of safety in it. And so when you put those two together, you just got to watch out about valuation, you got to be disciplined. And so some of the things we talked about earlier,
Andrew Stotz 35:13
Andrew for that individual that would probably find it difficult to have a portfolio of 20 some stocks, because they're just overloading for them. But it wouldn't be wise for them to own one or two, what do you think would be a reasonable balance? I think
Richard Lawrence 35:28
I think, statistically, the minimum they should own is 12. Okay. And we own 20 to 22. And I just think that makes life more interesting than if it was just 12.
Andrew Stotz 35:41
Okay, fantastic. That, let's just review, First, avoid dead. Number two, avoid the flavor of the month, don't get sucked into, you know, what's on the front page of the newspaper. Look, for companies that had strong operating return, you talked about EBIT, divided by the operating capital of the business. And also you talked about modest growth, don't look for something that's just like, out off the charts, you know, if we can if we can deliver a good operating return with a modest level of growth, and you can build a portfolio of roughly 12 companies have that and, and rebalance maybe over, you know, on a kind of a regular basis, maybe every six months, every 12 months or something like that. It sounds like that is golden advice for a young person that is building a stock portfolio. Anything else you'd add to that?
Richard Lawrence 36:32
No, I think if you do that I agree that rebalancing every six months is absolute must you you effectively take some money off your winners? Give it into your losers? And? And when
Andrew Stotz 36:46
would it make sense for a like this type of person that we're talking about to try to kind of aim for an equal weighting of these 12 stocks? And therefore when it starts to get out of that they start to reduce one and bring another one back up to equal? Or should they be sent on our I'm really convinced in these three in this portfolio. So 40 bizarre,
Richard Lawrence 37:07
I think you can have a distribution where you have conviction, the difficulty for investors is that don't let the conviction equal? Oh, the stock went up a lot last month, you know, it's got to be more grounded. So then, you know, the emotion of the stock business is one of the things that really negatively impacts people.
Andrew Stotz 37:32
So stay cool. What's a resource that you'd recommend? I mean, obviously, the book is, number one, is there any other thing besides the book that would help people to think about picking stocks in the light?
Richard Lawrence 37:45
Well, I think there are a massive number of resources that are out there today that didn't exist, this whole podcast thing, I was just in Florida with Ted sight is a capital allocator, who I know has been a guest on your thing. I think Ted's podcasts are also valuable, maybe not for the small read or retail investor, but they're useful resources where you can kind of pick and choose who you want to listen to. My advice is also books. You know, I'm just, I'm just a avid reader of investment books. And there are a lot of really good ones out there. If you can't find them, you start with with, you know, Buffett's letters, and then you go to John trains, books and, and and you begin to as you read more and more investment books, you're beginning to find your, your cousins, and your cousins will give you the lessons that you need to learn that are most helpful for you.
Andrew Stotz 38:43
Yeah, I mean, just even right there going to buffets, you know, stuff is just a great start. And that could keep you busy for a year or two, just going back to annual reports and the things that he said, have ladies and gentlemen, if you want to hear my interview with Ted Syed, he's that's episode 129. That was back in 2019. But it was a great one. So I think that's there's so many great resources. I know, for me, I think about my book collection. Back in the old days, you know, we didn't have much bookstores in Thailand in 93 when I was trying to figure out how to understand investing. So everywhere I went, I kept brought back books, basically. So I have books on my shelf that I carried from Hong Kong, Singapore, UK and other places. So books are so so valuable. Well, listeners, there you have it another story of laws to keep you winning. Remember, I'm on a mission to help 1 million people reduce risk in their lives. If you've not yet joined that mission, just go to my worst investment ever.com and join my free weekly become a better investor newsletter to reduce risk in your life. As we conclude, Richard, I want to thank you again for joining the mission on behalf of East Arts Academy, I hereby award you alumni status for turning your worst investment ever into your best teaching moment. Do you have any parting words for the audience?
Richard Lawrence 39:58
No, I'm delighted that you do this. I think that the more young people, beginners in this industry can learn, you know, the tough lessons that we all went through. I think it's a great idea for a podcast and I'm delighted to have been on it to been invited and support your honor percent. Well, we appreciate
Andrew Stotz 40:21
that. And I just want to tease out one last thing from this discussion that Richard said, We didn't talk much about it. But he talked about debt. And I think that in this world of over debt and governments and over dead companies in a lot of cases and low interest rates and all that, let's not forget that one of the top risks that management face is debt. And so keep your eye on debt. If you can find a company that has no debt, great, low debt, that's fine, but keep an eye on that one of the number one risks out there and that's a wrap on another great story to help us create, grow and protect our wealth fellow risk takers, let's celebrate that today. We added one more person to our mission, Richard, to help 1 million people reduce risk in their lives. This is your worst podcast host Andrew Stotz saying I'll see you on the upside.
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