啰嗦版

Long-winded version

> By Duan Yongping · his NetEase blog (nteswjq.blog.163.com, now closed; read from web archives) · 2012-04-06 · [Original link](http://nteswjq.blog.163.com/blog/static/12699812012369951218/) ([archived](https://web.archive.org/web/20120410050304/http://nteswjq.blog.163.com:80/blog/static/12699812012369951218/))

Do the right thing, and do things right!

What is investing?

Long-winded version:

Buying a stock is buying a company, and buying a company is buying its future cash flows. Cash flow here means net cash flow, and future means the company's whole life cycle: not 3 years, and not 5 years.

The discount rate is really relative to the investor's opportunity cost. The lowest opportunity cost is the risk-free rate of return, such as the interest rate on US Treasuries. Some people put the limited capital of their own business into the stock market, which is often actually not worth it, because their own business often earns more than the stock market's average return. Of course, putting in surplus funds is beyond reproach (I hear a certain Chinese internet company bought a lot of Apple stock; that's the beyond-reproach type). But I really do see quite a few companies buying stocks while carrying loans; I don't get it.

Being able to understand a company means being able to understand its future cash flows. (Doing the right thing.)

Future cash flow is only a way of thinking. Whatever you do, don't plug it into a formula, because no one can really pin down the variables in the formula, and all the assumptions may be unreliable.

My personal view: actually the most important, perhaps the only, point that distinguishes whether something is "value investing" is whether the "investor" is buying future cash flows. In fact I do see many people whose reasons for buying a stock often have nothing to do with future cash flows but with other things, such as how the market sees it, such as new issues always making money, such as restructuring stories, such as, heh, all that stuff the analysts on TV talk about every day. Sometimes I watch CNBC with a smile. The hosts often talk with mouths full of jargon, but somehow, after talking for so many years, they don't know what they themselves are saying.

Everything said about investing is really a discussion of how to understand cash flows (how to do things right), such as business model, moat, circle of competence and so on.

The most important thing I learned from Buffett is the business model. Before, although I knew the business model mattered, I often looked at it mixed together with many other important things. Back then Old Buffett specially reminded me that one should look at the business model first, and over these years I've gradually come to feel that that's indeed how it should be.

I think the moat is actually part of the business model; a good business model often has a very wide moat.

A good business model is often the guarantee of good future cash flows.

Knowing how big your circle of competence is is often much more important than how big your circle of competence is!

I think margin of safety should really refer to the circle of competence and not just to price.

Businesses within your own circle of competence are often much easier for you to understand, and what is uncertain for others is often very certain for you. For example, when I invested in NetEase, the reason the market didn't like it was that many people thought the games market wasn't very big. Because I had been in this industry a long time, I was very sure the market was very big (though I didn't know how big; in fact the eventual result was even bigger than I saw).

Don't lightly "expand" your circle of competence. Understanding a business often takes many years. Don't jump lightly into an unfamiliar field or place just because you've seen one or two concepts, or sooner or later you'll fall. For example, some friends jumped into the Indian market, and some into the Japanese market.

I always assume the market is very smart in the vast majority of cases, unless I find the market really is wrong. (This sentence is aimed at "contrarian trading." Contrarian thinking is very important, but contrarian trading and following the crowd are both unwise. The most important thing is the ability to think rationally and independently.)

Many people say future cash flows are hard to understand. Actually I can't understand the future cash flows of the vast majority of companies either. What I don't understand I don't touch. Within a year or two, or perhaps longer, targets always come along. Some companies have very good business models but their share prices are sometimes too expensive, so you can only wait. Luckily it's always been like this over the years: every few years there's a crash, and often good companies come crashing down along with it.

For most people who don't understand business very well, whatever you do, don't think the stock market is a place to make quick money. In the long run, those who lose money in the stock market always outnumber those who make money. People who want to gamble on luck would do better to buy lottery tickets; at least they know their chances of winning are small and won't bet heavily.

Some also say the stock market is a casino. In fact, for people who treat the stock market as a casino, the stock market really is a casino: gamble often and you're sure to lose!

Investing my way, you may miss countless opportunities in a lifetime, but you'll also have little chance of making big mistakes (though you still can't avoid making mistakes).

I often hear people telling stories about how much this or that stock made them, but they just won't tell you their overall results. You know what I mean.

By the way, thanks to Mr. Buffet-Meal [Translator's note: the original says 自助餐先生, "Mr. Buffet-Meal," a jokey nickname for Buffett that plays on "buffet"]. Anyone who finds the bits I write helpful should read more of the old man's own material; everything I can say, he has said many times.

I write whatever comes to mind, mainly so I can remind myself at any time.

Someone asked how to avoid the problem of thinking you understand when you're actually wrong. My personal view: mistakes are unavoidable, but staying within your circle of competence, plus focus and hard work, can greatly reduce the chance of making them.

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