Source: Qilehui
Author: Value_at_risk
1. Core Investment Framework: Good Business, Good Company, Good Price
Across the entire investment community, those great investors, whether they practice value investing, growth investing, or trend investing, have all succeeded in similar ways. Without exception, these luminaries possess the following abilities: macro-industry analysis (good business), micro-enterprise analysis (good company), self-discipline, market sentiment comprehension, and capital preference analysis (good price). Therefore, in my view, successful investing is not complicated; it boils down to three words: good business, good company, good price. Among these, the good price represents the biggest distinction between ordinary investors and exceptional ones (i.e., the ability to analyze human nature, markets, and capital).
The essence of investing lies in seeking out good businesses, good companies, and good prices. Thus, to execute a successful investment, adherence to the 'three-good' principle is indispensable. As long as the 'three-good' criteria are met, it does not matter whether a company is listed, which market or sector it belongs to, or when the investment occurs. Investors must avoid prejudice and focus on the essence of investing instead of getting lost in the market. They should understand that while the pendulum of the market constantly swings, such fluctuations do not affect truly 'three-good' companies. For skilled investors, there are only distinctions between macro-industries being favorable or unfavorable, micro-companies being strong or weak, and valuations being high or low. Many people lack a proper investment framework and fail to grasp the essence of investing yet endlessly debate which is better—blue chips or growth stocks. Ultimately, a good investment transcends any specific school of thought.
In China’s market, adhering to the 'three-good' investment framework requires even stronger resolve because most prevailing opinions today suggest that regardless of the method used, making money equates to correctness. This is a typical profit-centric and performance-driven mindset. With such values, it is unsurprising that the market has become so frenzied, with most retail investors engaging in pseudo-investing, while funds obsess over net asset values. Consequently,抱团投资 (herd investing), chasing highs, and gambling behaviors emerge. However, this is clearly a grave misconception. In the long run, markets inevitably revert to fundamentals. Earning profits through incorrect methods is worse than incurring losses through sound practices. Investing is never a short sprint on flat terrain but rather a marathon of vertical rock climbing. A surge in small-cap stocks does not imply rationality, just as a plunge in blue-chip stocks does not signify worthlessness. Although markets are often inefficient in the short term, we must not let this sway our core values.
The market is saturated with too many pseudo-investors whose analyses remain superficial. They often favor companies based on certain themes or concepts without conducting thorough research, sometimes not even knowing what the company's core business is. However, after years of indoctrination by China’s irrational market (where small-cap stocks have maintained excessively high valuations despite continued increases, while blue chips remained undervalued yet continued to decline), value investing has been stigmatized in the eyes of those who “earned money from market trends” as synonymous with losses.
Nevertheless, during the past few years, truly outstanding investors have continued to generate returns even under challenging conditions. For instance, during the liquidity crunch in June 2013 when the main index fell below 1850 points, although some undervalued quality stocks were severely battered, this also presented the best opportunity, echoing the saying: the worst times are often the best opportunities. While the entire market chased hot sectors, some overlooked stocks with promising prospects and low valuations, along with high-quality but undervalued blue chips, received substantial discounts due to a lack of attention. Understanding that investing means 'earning from companies' is crucial.
2. Assessing Good Businesses, Identifying Good Companies, Discovering Good Prices
The criteria for evaluating a good business involve answering two key questions:
1. What are the current barriers in the industry (moat)?;
2. What are the prospects of the industry (growth potential).
Understanding these two issues may not be as difficult as it seems; the key lies in comprehensively analyzing the value and growth of an industry. For instance, the pharmaceuticals industry is a typical example of a good business because outstanding pharmaceutical companies can continuously develop new drugs and apply for patents, which constitutes their competitive moat, while the vast market represents future growth potential.
Future promising businesses will mainly remain concentrated in three major industries: pharmaceuticals, consumer stocks, and TMT. Why? Whether you are rich or poor, in an economic crisis or during wartime, humans will inevitably experience birth, aging, sickness, and death, and require basic necessities like food and drink. Therefore, only pharmaceuticals and consumer goods can become century-old enterprises and long-term bullish stocks. Pharmaceuticals and consumer products ensure human survival, while technology improves quality of life. However, unlike the investment philosophy for pharmaceuticals and consumer goods, the tech industry follows the principle of 'innovate or perish.' Tech giants from 20 years ago have gone bankrupt today, and companies like Google, Apple, and Tencent will also be eliminated if they fail to innovate and progress. Thus, the core element of investing in tech stocks is to seize the trends of the times and live in the present.
After identifying the broader industry, further segmentation is necessary. The pharmaceuticals, consumer goods, and TMT industries can be broken down into sub-sectors such as dentistry, ophthalmology, in-vitro diagnostics (with China’s enormous market), fast-moving consumer goods with unique attributes, and more specialized segments within TMT. Of course, good businesses are not limited to pharmaceuticals, consumer goods, and TMT. Regardless of the specific sub-sector, as long as a company possesses its own competitive moat and promising growth prospects, it can be defined as a good business.
In general, a good business hinges on the ability to predict changes in macro-industries (including shifts in macroeconomic policies). If one can foresee inevitable outcomes following industry changes, there is no need to worry about the twists and turns of the development process or any short-term fluctuations.
The key points for identifying a good company are as follows:
1. Non-quantitative indicators: management team, corporate culture, goodwill;
2. Quantitative indicators: financial statements;
3. Core indicators focus on assessing a company's ability to create value: ROIC and ROE.
Evaluating non-quantitative indicators requires long-term tracking of a company to draw conclusions. Frequent field research helps understand the corporate culture, familiarize oneself with the management team, and assess managerial capabilities through extended observation of the company’s operations.
2. The evaluation of quantifiable financial indicators requires a solid foundation in finance. Reading financial statements is not merely about examining revenue and profit; more importantly, it involves understanding deeper aspects. Through the analysis of financial data, one must assess the quality of a company's operations, identify potential fraud traps, and evaluate its growth potential.
3. The core of evaluating a good company lies in assessing its ability to create value, with key metrics being ROE (Return on Equity) and ROIC (Return on Invested Capital).Return on Investment）。
Why are ROE and ROIC the chosen metrics? This is because simple valuation methods such as EPS or PEG may well be misleading. For example, Company A earned 10,000 last year and 100,000 this year—a tenfold increase—while Company B earned 100 million last year and 200 million this year—a twofold increase. Which is better? In real life, everyone knows that Company B is preferable. However, in the capital markets, this is not always the case, as investors tend to be short-sighted, focusing solely on growth rates (especially in the Chinese market). ROIC and ROE directly reflect a company’s input-output efficiency, indicating whether a company is creating or destroying value, whether it has a competitive advantage, whether its performance is fleeting, and the overall quality of its growth.
From the perspective of ROIC, most stocks in the Chinese stock market are currently engaged in value destruction. Many companies have long maintained ROIC levels below 6%, meaning their profitability cannot even outpace basic interest rates, let alone inflation. Such companies typically operate from a low base of profits, rendering sudden increases in earnings multiples meaningless. Some companies do not generate real profits at all but instead rely on paper gains, continuous fundraising, or significant use of financial leverage, where seemingly high returns correspond to substantial operational risks.
If a company continues to destroy value in future operations, then no matter how cheap its stock price may be, it does not constitute a rationale for purchase. Hence, when identifying a good company—whether it is a growth stock or a value stock—the best companies consistently demonstrate low-input, high-output characteristics, possess excellent management teams (to avoid situations where high ROIC coexists with low ROE), and aim for perpetual operation as their ultimate goal.
The method for discovering an attractive price hinges on a deep understanding and analytical capability regarding human behavior, market dynamics, and capital flows.
For ordinary investors, there is often a misconception: after identifying a good company, they will determine the purchase price using valuation models, which is a grave error. Valuation models serve to establish long-term safety margins (some investors rely on technical charts and indicators, which is even more misguided since any indicator is merely a historical summary and projection). In contrast, the judgment of whether a current buying or selling price is favorable should be based on an analysis of human psychology and market conditions.
This is easy to understand because markets are efficient in the long term, making valuation models necessary for estimating long-term safety margins. However, trades occur in the present, and in the short term, markets are frequently inefficient. Short-term price movements are not driven by fundamentals but rather by shifts in human sentiment and capital preferences. Due to this inefficiency, even if you calculate a “safety margin” precisely through various valuation models, it may still be rendered worthless by the market (although extreme scenarios can cause any valuation system to collapse, this does not negate their importance). Furthermore, metrics like ROE and ROIC primarily assess the quality of a company rather than the level of its price. Thus, experts repeatedly remind us: investing is an art, not a rigorous science—better to have approximate correctness than precise error.
This also explains why even diligent learning and experience accumulation can only make an average investor good, but becoming a great investor remains nearly impossible for most. Great investors are exceedingly rare because their ability to discern value and price is not something that can be acquired through learning or experience. The ability to discover attractive prices is almost innate, and profound insights into human nature and markets are irreplicable.
The assessment of “attractive price” represents the greatest distinction between ordinary investors and great investors under the “three goods” investment principle.
To summarize, there are two key points for great investors to find a "good price":
① Assess market sentiment, meaning the changes in human behavior: it refers to contrarian investing (going against human nature), as Buffett said—be greedy when others are fearful. In many cases, there is no change in a company’s fundamentals; what changes is merely market sentiment. After identifying opportunities such as bear markets, black swan events, or inflection points in performance, one must withstand market panic and seize the opportunity through contrarian investment. If you cannot control your emotions, you will be influenced by them. Greed and fear are the main reasons for our failures, always wanting to buy at even lower prices and sell at higher ones. The imbalance of mindset is the biggest reason why even experts in fundamentals fail in stock trading. What ultimately destroys you is your inner demon. The hardest part of investing is not understanding a company’s fundamentals but understanding market psychology and overcoming oneself.
How can this contrarian investing be quantified? Unfortunately, it cannot be quantified or even learned. As Mark Sellers mentioned in his speech at Harvard about why we cannot become the next Buffett, he believed that the decisive factors for a successful investor are neither high IQ nor the amount of experience gained in past or future professional endeavors. Knowledge can be learned, but human nature cannot be replicated. Successful investors have an innate ability to judge human nature and control their own emotions, whereas the vast majority of ordinary people, no matter how hard they try, will never reach the level of masters like Buffett. Almost no one can achieve a 25% compound annual return over an entire career.
Genius is predetermined from birth. Only a very small number of people will achieve great success. This is true not only in the stock market but also in any industry (almost every industry follows the rule of 70% losses, 20% breakeven, and 10% gains). In the short term, ordinary people might outperform the average, but in the long run, reversion to the mean is inevitable. Countless facts have shown me that great scientists, successful entrepreneurs, artistic geniuses, and investment masters—all these extraordinary individuals almost invariably possess personalities distinct from those of ordinary people: extremely self-confident, arrogant, completely indifferent to others' opinions, isolated, ruthless, and viewing problems from angles different from most people.
Even if we cannot become great investors, as competent investors, we still need to learn to control our emotions. We should not focus too much on price while neglecting value. A decline in stock price does not necessarily mean poor company performance, just as an increase in stock price does not necessarily reflect strong performance. The fact is, if you truly view stocks as businesses, your emotions will not fluctuate with the rise or fall of stock prices. Therefore, always remember value, value, and once again, value—not just price. Only by having a strong sense of value in mind can one resist fear. Human nature has remained unchanged for thousands of years and will remain so in the future (unless we all become robots).
② Assess the preferences of capital, meaning the direction of market fund flows: this can be learned and quantified. It is specifically reflected in trends and changes in volume and price.
Stock price fluctuations result from changes in market funds. Trend formation occurs when market participants develop a consensus expectation, exhibiting uniform directionality—whether upward or downward in the short or long term. The core idea to capture a “good price” at this moment is to assess the consensus expectations of market funds and seize the instant when capital shifts direction. Specifically, this can be done by observing changes in volume and price because inflows or outflows of funds leave traces. Long-term fund behavior forms long-term trends, while short-term fund behavior creates short-term trends.
Assessing short-term market fund preferences allows us to better identify good prices. This point is crucial and should not be overlooked by investors of any style, especially those who claim that value investing doesn’t require attention to price.Technical AnalysisDo not rashly buy just because a company appears undervalued, as Mr. Market can still drive you to bankruptcy! Why apply a discount when calculating the margin of safety? Applying a discount accounts for Mr. Market’s temperament, but how large should the discount be? Value investing theory won’t tell you; only information from the trading chart will. Developing a sense of the market and understanding fund flows require years of experience. Cultivating this intuition is not something that happens overnight.
In summary, the "three-good" concept of good business, good company, and good price can be simply summarized as analyzing macro industries, micro enterprises, and market and human behavior. For me, the direction of macroeconomic operations and stock market trends are not important, and predictions are meaningless. What matters are the development prospects of niche industries, the growth potential of micro-enterprises, and a good entry point.
Therefore, when looking for high-quality companies, one should always ask themselves 10 questions:
1. What is the positioning of the company's products, and what does the future development of the industry look like?
2. Does the company have a competitive edge in its niche market, and where is its moat?
3. Is the company’s profit model sustainable (has it found the right business model)?
4. Are the historical financial statements healthy, while making efforts to rule out any possibility of fraud or embellishment?
5. How is the corporate governance structured; does it involve defrauding minority shareholders or neglecting their interests?
6. Through horizontal and vertical comparisons, determine the company’s ceiling.
7. Is the current price within a safe margin (calculated using valuation models)?
8. What is the sentiment of the overall market, and what are the short-term capital preferences?
9. Have assets been allocated reasonably (using a dynamic balancing strategy to reduce investment risks)?
10. Enhance the cultivation of inner self-discipline, achieving a state of emotional detachment from external gains and personal setbacks.
Lastly, it is worth emphasizing that pursuing the 'three-good' company should not be approached dogmatically. While striving for companies with 'good business, good management, and good price' is ideal, in many cases, fulfilling all three criteria simultaneously is difficult. As a compromise, sometimes a less-than-ideal business can still be attractive if priced low enough, or a less appealing valuation may be justified by the company’s long-term positive outlook. Mr. Buffett has also highlighted that purchasing an outstanding company at a fair price is far better than buying a mediocre company at an undervalued price.
3. Searching for the breeding ground of 'three-good' companies
From the preceding discussion, it is clear that 'good business, good company, and good price' are essential metrics for successful investors seeking high-performing stocks. But in which fields can one find a large number of companies meeting these 'three-good' conditions?
For most people, when thinking of high-performing stocks, they instinctively look to popular industries and well-known enterprises. However, across the entire capital market, while widely recognized blue-chip stocks meet the criteria of good business and good company, they often fail to satisfy the condition of a good price. A careful examination of the history of global star stocks reveals that the highest frequency of such stocks tends to emerge from obscure, overlooked stocks, which are often hidden champions or turnaround companies. The logic is simple: these high-quality yet obscure niche industry stocks have sufficiently low prices, significant room for growth, and solid fundamentals. Therefore, I believe the breeding ground for 'three-good' companies lies in quality obscure stocks, primarily turnaround companies and hidden champions (the essence of Peter Lynch's investment philosophy).
Below is a summary of the characteristics of turnaround companies and hidden champions:
① Main characteristics of turnaround companies (reversal from adversity):
1. On the surface, there appears to be a host of problems and shortcomings, but there is also one key advantage: resource endowment;
2. Financial indicators show a high gross profit margin but relatively low net profit;
3. Valuation based on PE ratio tends to be relatively expensive.
4. Changes in the management;
5. The company is repurchasing or increasing its stock holdings.
The steps to identify a turning-point company are as follows:
1. Assess whether the company possesses resource endowments;
2. Determine whether the company has been unable to fully leverage its resource endowments for some reason;
3. Check if the market has priced the company at a very low valuation;
4. Evaluate whether there may be a potential turning point in the future (Turning-point companies must be analyzed dialectically—cheap stock prices often stem from perceived flaws, so the key is assessing whether these flaws are fatal and whether they can be improved).
First, how to assess resource endowments: For instance, we often hear that a listed company owns a piece of land, and if sold, the cash proceeds would far exceed the company’s market value. However, this does not qualify as a resource endowment. Investing in such companies often turns out to be a trap rather than an opportunity. A true resource endowment must consistently generate cash flow and profitability for the company; only then does it hold significance. Resource endowments fall into two categories: 1. Intangible resources, including goodwill (brands) and distribution channels; 2. Tangible resource endowments, such as properties owned by department stores that continuously produce cash flow and profits, or resource-based assets held by resource companies.
Next, evaluate why the resource endowment has not been utilized. 1. The biggest factor preventing the utilization of resource endowments is corporate governance. For example, many resource-endowed companies, due to historical reasons, are under state-owned enterprises, where systemic constraints have prevented their full potential from being realized. 2. Black swan events, such as melamine scandals; 3. Policy changes; 4. Factors related to shifts in market demand, such as cyclical distressed companies.
Finally, look for catalysts that could signal a turning point.
First, corporate system reform (such as equity incentives, MBOs, employee stock ownership, and the introduction of strategic investments), for example, state-owned enterprise reforms involving MBOs, equity incentives, or introducing private enterprises as strategic investors (e.g., Pien Tze Huang, where state-owned enterprises' sales were largely ineffective, leading to the introduction of China Resources Group as a strategic investor; another example is Shanghai Jahwa, which underwent brand revitalization after bringing in strategic investors).
Second, changes in management leadership result in shifts in business strategy. Specific changes include: divestiture of non-performing assets (reducing diversification), expanding into new markets through diversification, or spinning off high-quality assets for separate listings. For instance, Hengshun Vinegar Industry saw its group chairman replaced in June 2012 (note that this was not the chairman of the listed company), prompting an immediate positive market reaction due to expectations that peripheral non-performing assets would be stripped. Another case is Luzhou Laojiao, whose stock price and performance soared under Xie Ming's leadership. Similarly, Gujing Gong became a ten-bagger stock after Chairman Cao Jie took office, underscoring the need to closely monitor leadership changes.
Third, black swan events can cause significant market sentiment shifts, often resulting in companies being undervalued due to short-term public opinion. However, the situation is rarely as dire as anticipated, and products essential to daily life tend to recover from such setbacks, with black swan events sometimes presenting optimal buying opportunities. For instance, the notorious melamine scandal in 2008 led to Yili Group successfully turning around its fortunes and becoming a ten-bagger stock. Other examples include nuclear power plant leakage incidents.
Fourth, policy changes, with typical examples including nuclear power stocks, hydropower, and natural gas utilities.
Fifth, the reversal of difficulties faced by cyclical companies, which depends entirely on market and economic fluctuations.
Hidden champions refer to companies with relatively low public recognition, producing goods that are either unnoticed or invisible, existing only within the manufacturing process of final consumer products, or serving as components or raw materials for certain consumer goods. Hermann Simon, known as the father of the 'hidden champion' concept, is a renowned German management guru born in Germany who earned his Ph.D. from the University of Bonn in 1976. He authored the book Hidden Champions and pioneered the concept of 'hidden champions.'
In 1986, Hermann Simon, then president of the European Marketing Academy, met Harvard Business School professor Theodore Levitt in Düsseldorf. The latter asked him, 'Have you ever considered why West Germany’s economy, though only one-quarter the size of the U.S. economy, boasts the world’s largest export volume? Which companies contribute most significantly to this achievement?' Simon began seriously considering this question. He quickly ruled out giants like Siemens and Daimler-Benz, as they did not demonstrate unique advantages compared to their international competitors. Thus, he concluded that the answer must lie among Germany’s small- and medium-sized enterprises (SMEs).
Starting from that year, Simon conducted research on over 400 outstanding SMEs in Germany and creatively introduced the concept of 'hidden champions.' Through extensive data and facts, he demonstrated that the true backbone of the German economy and international trade lies not in well-known large corporations but in these SMEs that quietly dominate their respective niche markets and become global industry leaders. Their positions in niche markets (niche) are unshakable, with some even controlling up to 95% of the global market share (e.g., Hauni, a German cigarette machinery manufacturer). Their technological innovations far outpace competitors, with patents per capita exceeding even those of Fortune Global 500 companies like Siemens. However, due to operating in relatively obscure industries and adopting focused strategies with low-profile approaches, they remain largely unknown to the general public.
In earlier studies, Simon believed the phenomenon of 'hidden champions' was limited to Germany, rooted in the long-standing handicraft traditions and pride in craftsmanship of the German people. Further research revealed, however, that hidden champion enterprises are widespread globally, including in the United States, South Africa, New Zealand, and Asia. These companies play vital roles in their respective economies and share remarkably similar success principles with German hidden champions. Simon found that some Chinese companies have become hidden champions in their industries, referred to as market leaders. For instance, a company in Shanghai specializing in port cranes is globally recognized as the best in its field. In Chongqing, a container manufacturer has captured 17% of the global market. A few years ago, a manufacturer of mobile phone microphones in Shangqiu also rose to the top of its industry. An Economist magazine statistic caught Simon's interest: 68% of China’s exports come from small companies employing fewer than 2,000 people, indicating that China’s industrial structure closely resembles Germany’s.
Characteristics of hidden champion companies: In the book Hidden Champions, Hermann Simon summarized their success factors as burning ambition, obsessive focus, close customer relationships, proximity to excellent clients, 'non-technical' innovation, neighboring the strongest competitors, and hands-on management. Hidden champions abound in many inconspicuous niche industries. These sectors typically have low entry barriers, but the key factor remains consistent: focus. Regardless of whether the enterprises initially operated in fields others disdained, could not enter, or had yet to conceive, they remained steadfast, persevered to the end, never gave up easily, and ultimately achieved an unshakable market position.
Some specific characteristics of hidden champions (based on Peter Lynch's criteria):
1. The company’s name sounds dull or even laughable (companies with very unusual names are often undervalued because the public lacks sufficient awareness, and the name does not reveal its industry. This is especially true in China, where the market is dominated by retail investors).
2. The company operates in a dull or even repulsive business.
3. The company was spun off from its parent company (many of them have excellent balance sheets).
4. Institutions hold almost no shares, and analysts do not track the company.
5. The company is surrounded by rumors (black swan events).
6. The company may operate in an industry with almost no growth (facing less competition).
7. The company has a niche.
8. People need to continuously purchase the company’s products.
9. The company is increasing its holdings or buying back its stock.
Specifically for A-shares, many stocks also meet the standards of 'hidden industry champions.' However, these relatively unknown enterprises have a high probability of becoming leaders in niche industries and great companies in the future.
4. Outlook on life, values, worldview
Finally, I would like to share my personal journey and investment insights over the past few years.
When I first entered the stock market, I yearned for a dramatic life. At that time, I admired figures like Jesse Livermore, hoping to build a fortune from nothing to hundreds of millions, even if it might eventually lead to bankruptcy and losing everything. But I still considered it worthwhile, as I would have at least experienced brilliance. Back then, I knew nothing about value investing; I only followed trend trading. I hardly touched technical analysis but instead focused on studying how market manipulators operated, how to follow their moves, and how to go with the flow. This mindset is probably similar to that of some other beginners in the stock market.
After enduring the tests of the market and refining my own mentality, I finally realized that in order to prevent the path of truth from becoming overcrowded, fate always causes most people to lose their way. In fact, investing and living by principles are the same: one’s investment philosophy reflects their values, worldview, and outlook on life. For those who pursue dreams, the most important thing is to remain true to oneself. What others think or do has nothing to do with us. As long as we adhere to our own principles, we will find our own path, pursue our ideals, and incidentally make money (earning while standing firm), which is the most important aspect. Similarly, regardless of how the market changes, sticking to finding quality companies is the key—do not let anything distract you.
I deeply understand that no matter the industry, success never comes easily, and successful individuals are always in the minority. This is especially true in the investment world. Independent thinking and staying away from the crowd inevitably invite various criticisms and even insults. Very few can persevere. Setting aside natural talent, apart from hard work and persistence, there is no second path to success. I have never sought approval from everyone, or even from the majority. Investing is inherently a lonely endeavor. As Zhang Xiaoxian once said: Loneliness is not innate; it begins the moment you truly fall in love with someone.
In my view, loneliness is not innate; it starts the moment you truly understand investing. I would rather be seen as a fool by the masses, steadfastly adhering to my investment philosophy (quality companies). I would rather be a stubborn individual walking alone, for perhaps only the obsessed can succeed. Success is 99% hard work and 1% talent. Although that 1% of talent may determine whether you become a great investor, even without it, we can at least strive to be excellent investors through effort, rather than idly tapping on keyboards, watching movies, and playing games.
Looking to pick stocks or analyze them? Want to know the opportunities and risks in your portfolio? For all investment-related questions,just ask Futubull AI!
Editor/KOKO