Interview with Deep-Value Superinvestor

Henry Lu, AKA Blast Invest, is a pure Grahamian value investor, one of few who remain as strict as Graham.

He has been investing for four years, and emerged as a guru on MITBBS the biggest Chinese forum in the US. He used CANSLIM, momentum trading, TA and other short-term stock movement strategies.

When his returns took a turn for the worse in 1999 he re-evaluated his strategy and he “… started to recognize the biggest problem of short-term oriented speculative methods: the risk control.”

He then looked for a solution to this and eventually found ‘the truth’: Graham investing.

He has been perfecting his value strategy for six years and now runs Blast Invest, an investing newsletter with 200 subscribers, which follows a focused portfolio consisting of stocks he has picked through Graham’s methods. The model portfolio has returned 44% CAGR since inception in 2003.

Right Price Investing: Do you have a ‘5-minute test’ or something you use to filter out stocks as you find them?

Henry Lu: Yes we do. Our method is more toward pure Graham style rather than Buffett style. We also mainly look for high earnings yield stocks.We would discard the stock pick immediately if the price to book ratio is higher than 1.2.

We would also get rid of a stock pick immediately if its earnings yield is not higher than 10%. This is normalized earnings, or sometimes normalized free cash flow. Typically I can guess normalized earnings from its financial statements immediately.

A lot of investors look for high return on equity; we are different. We would prefer a 20% earning yield stock with poor return on equity to a 10% earning yield stock with high return on equity. In other words, we prefer deep value to growth.

RPI: Most Value Investors won’t touch a company unless it has a ROC (return on capital) above 15%, they say this is a measure of business quality, do you have other ways of gauging business quality?

HL: From my own stock market experiences, I have found that it is very difficult to assess the quality of a business. Therefore, we have de-emphasized the business quality issue.

If two companies had the same earnings yield, I would prefer the stock with higher ROC. ROC is a favorite metric of Warren Buffett and Joel Greenblatt. It makes sense because high ROC is source of internal growth for growthstocks.

Unfortunately, most businesses are cyclical. In the past, many extremely profitable companies with high ROC turned into money losers within a couple of years.

Currently, we do not want to pay higher price for high quality business. We do not have billions of dollars to manage, so we can stick with pure Graham style value stocks easily.

RPI: You mentioned in an article on your site that in the past that the Blast Invest Model Portfolio owned two different “growth stocks”; if the opportunity comes will you buy growth stocks in the future? How do you define growth stocks?

HL: Our investment record on growth stocks over the last 6 years was not very satisfactory.

Sure, when growth stocks drops into value stock range, we would consider them. But again, 10% earning yield rule applies to growth stocks as well. We want to be conservative.

When we project growth stock normalized earnings over next several years, we usually hesitate to assign valuation higher than PE of 10 on them regardless how high quality its business appears to be.

RPI: In your Year-end Review you said investing in energy stocks boosted your returns in 2005 and you expect it to help again in 2006, how do you answer analysts who say energy stocks are falsely undervalued now because they are at the top of their cycle so earnings artificially high?

HL: We believe the energy peak of cycle is decades ahead, about 10 to 15 years from here.

Historical business cycle in energy sector has been 15 to 20 years. We do not believe this time is that different. It is very dangerous to assume, "this time energy business cycle is different".

Two Deep Value Blast Invest Style Stocks

Whiting Petroleum (NYSE:WLL)-

We have invested into this stock since it was $23 a share. WLL is still misunderstood oilstock by Wall Street analysts. This stock is dirt cheap and it is trading at 50% discount to its fair value.

USG Corp (USG) -

We have invested into this stock since it was $18 a share. It is still cheapand it settled its asbestos liability recently. USG will emerge from bankruptcy in summer of this year. We believe it can trade close to $140 a share later this year.

Other articles from Blast Invest:

How to Make Big Money Safely in the Stock Market

My Top 5 Pick Sources For 2005

Shorting Strategy and Value Investing