Xiaobian from Hu Boyu’s keynote speech at XVC Annual Conference on December 19, 2017:
Everybody is good! Leo and Rickey shared how we at XVC think about “trading platforms” and “social networks.” Let me talk to you about our overall investment logic and approach.
I wrote an article in 2016 called “The VC Way to Trade Stocks.” Today I want to go the other way and talk to you about “doing VC by trading stocks”.
In this article is a chart showing the performance of my personal stock account from the beginning of 2012 through April 15, 2016.
In this picture, the red part is the return, and the blue part is the principal, and you can see that the return in red eventually went up to 4 times the principal, so it went up 5 times.
Why is there a little regret? As you can see, when the return (red line) is almost double the principal (blue line), because the family needs money, I withdraw the principal and keep the proceeds rolling in. Then it withdrew two more times in a row, for a total of three times the principal. As you can imagine, if the principal stays in there, the red line will warp even more, and it should at least double again, so it’s still a big price to pay.
Some of you might wonder how this portfolio is going to perform over the next year and a half. Here’s a picture of what happens next.
I calculated that if it had been left alone, the total would have increased by 10.8 times as of Last Friday (December 15, 2017). But then, the most unfortunate thing happened. A few weeks after April 15, ’16, the account was liquidated for family needs. So everything after the circle in this picture, it doesn’t happen.
The first principle I sum up from this is that “to do a good job in investment, we must have capital”.
We have the opportunity to try our own way to do investment, without leaving the trust and support of investors to us, I would like to say thank you.
We had an internal discussion not to hold an annual meeting this year because we only invested in a few companies and it would be too shabby to hold an annual meeting. However, later I thought that the annual meeting was actually an opportunity for us to communicate and enhance mutual understanding. So two or three weeks ago WE decided to do a quick, unpretentious, no-frit chat in our own conference room on our island.
Today, I want to talk with you about “using the method of frying stocks to do VC”, then I will first say how I fry the stock.
Let’s look at this picture first. This is a company THAT I have held for a long time.
This might look familiar to some of you. In fact, this is Tencent. Since going public in 2004, Tencent’s market cap has increased 590 times to $473 billion, or 63% compound annualized earnings (IRR), before dividends.
My core approach to stock speculation is, in a word, “look for companies like Tencent and hold them intensively for the long term.”
What are the advantages of such a company as Tencent and how do we find it? Let’s discuss it slowly later. Let’s talk about the overall method first. I don’t really spend much time trading stocks. I usually own about four or five stocks at a time, change one or two every year, and don’t really care much about them most of the time.
I think the first way of thinking reflected in this method is “long-term value thinking”.
I think “long-term value thinking” is a structural advantage. Why do you say that?
In the long run, the stock price will reflect the long-term value of the company, but in the short run, the stock market is more like a “voting machine”, stock price changes have nothing to do with the long-term value of the company, mainly reflects the results of buyers and sellers with their capital voting.
Look at Tencent’s stock price graph. It’s a nice exponential function as a whole, but if you break it down into segments, each segment has its ups and downs.
By my calculations, of the 3,353 trading days since Tencent went public, only 1,684, or almost 50%, have gone up. So for each day, it’s up, it’s down, it’s almost random, and if you try to make money trading by predicting each day’s ups and downs, it’s hard to succeed. But if you ignore short-term volatility and hold it for the long term, you can make a lot of money.
We know that Tencent had two Series A investors who invested $1.1 million each, each accounting for 20%. After one year of investment, someone bought them at ten times the price, and they sold them one after another. It was probably their fastest earning project, and probably their most regrettable decision.
It’s simple enough to focus on long-term value, but why is it so hard for most players in the market to avoid the distractions of short-term thinking?
About this point, I actually in “with VC method fry stock” this article did some analysis. Many of you may have seen this article, and we put it in the pamphlet that we handed out to you, so I won’t bore you too much.
Editor: can click “view original text” open “fry stock with VC method”, article core viewpoint is
1) The world has changed, and finding and understanding the next generation of “great” companies requires different skills
2) Human instinct is not good at resisting emotional interference in decision making;
3) Understanding the real world requires “hard thinking,” and the human instinct tends to be “lazy”;
4) Then collective decision-making tends to rely on human instinct, which in turn tends to rely on collective decision-making.
At first, I held almost only Tencent stocks. Later, in order to “spread the risk”, I reduced my holdings of Tencent to buy Tesla, QIWI, Good Future and JD.com. On average, I made 2 to 3 times more money on these stocks. But now, if I only hold Tencent, the return will be much higher than now. So I paid a high price to “spread my risk.”
Look back 10 years from now, investor need not cast what fund actually, want to buy all money Tencent only, hold all the time good. So from another point of view, we have a lot of pressure to fund.
Then again, is there a portfolio that has a better long-term return than Tencent? This one is really hard to find. But I did find one.
The Yale Endowment has published a 20-year IRR for the VC portfolio on their website. I was also taken aback by the 77.4% figure. I talked to the VC guy at Yale. Their core investment method, is to find the world’s top GP, concentrated, long-term investment. Their VC portfolio, there are only 15 core GP’s worldwide.
Why do they do that? Let’s look at two sets of data.
On the left, CambridgeAssociates has tracked the performance of thousands of VC’s over 30 years and found that the overall performance is about the same as the s&p 500, but the top VC’s have significantly outperformed the s&p 500 most of the time.
On the right, Wealthfront looked at 1,000 VCS and found that 2% of them made 95% of their money. So, the top VC’s are very profitable, and the top 2% should be particularly profitable.
So let’s look at a few “super VC” exit data. Sequoia has invested in more than 600 projects in the past 20 years, including 50 ipos. About 20% of them have been acquired, but most of them have not quit. Six percent of Accel’s portfolio companies went public, 32 percent acquired, and 62 percent didn’t exit. Benchmark, another great investment firm, has 10% of its investments in IPOS, 35% in acquisitions, and 55% in exits.
The other one is from Andreesen Horowitz. As you can see from this curve, funds with high returns actually have higher loss rates than funds with average returns.
From these data, we can actually draw several lessons.
The first is to invest in VC funds, do not cast a net, to find the best, focused long-term investment. Our dollar fund is backed by some of the top UNIVERSITY endowments, family offices and parent funds in the US and Europe, many of which are Sequoia, Benchmark, Accel’s largest or longest-running LP. Their investment logic is the same – scour the world for a few good managers and invest intensively and for the long term. Several of them started investing in VCS 40 years ago.
Another conclusion is that for these top VCS, there is also a huge amount of uncertainty in every project. Sequoia sees only 8% of its ipos, and Benchmark sees only 10%.
For the XVC RMB fund, instead of casting a net, we plan to invest in a concentrated group of 10 to 15 companies. If we can do as well as Sequoia and Benchmark, there might be an IPO. But early investment uncertainty is very big, in case there is no IPO? Everybody here, are you scared?
To tell you the truth, out of the fund, I also beat the drum in my heart. I’ve had good luck in the past. I went public with my first company. The valuation of the 10 companies has increased 76 times, with one IPO, one merger and three unicorns at an average valuation of $7 billion. I wrote a blog post, The Unspoken Truth, about my good fortune.
I was worried, too. What if I wasn’t so lucky?
I spent a lot of time thinking about this question: Is there a scientific way to manage “luck”?
I want to share my thoughts with you.
Basically, the success rate of most funds is not more than 30%, even if you do a good survey, seriously invest, or there will be one-third dead, one-third can only return capital. We do industry and company research every day, just to improve the success rate, but you can hardly lead the market by a large margin at this point, because there is too much uncertainty in early investment, products change, industries change, people may change.
But we can pick our battles, and what we can optimize is that when something succeeds it’s a huge success. So choose a field with no ceiling, and look for a company like Tencent with no ceiling.
Why is Tencent a “company with no ceiling”? This is determined by its business nature. It does “communication”, which is the most basic and rigid requirement. Seven or eight billion people use its apps every day to send and receive messages, get information, pass the time and buy goods and services. In such a “virtual world”, it not only acts like a government, making policies and collecting taxes, but also acts like God to change the rules of physics.
Let me give you three more examples of companies THAT I’ve invested in.
The first company, when I found them, they had eight employees, no revenue, no assets, in a really shabby apartment building, and their competitors were adding ten times as many users a day. It’s hard to judge how high the ceiling is, but I found that it was aimed at the “average Joe” and that its core need was “people entertaining each other.” This is a basic, universal need, do this need, as long as it is done, must be a big company. I don’t have their current data, but it is said that 100 million people use its app every day, spend 60 minutes on it per person, and the monthly income is over 1 billion yuan.
The second company is a mobile e-commerce company serving the catering industry. When I found it, it was selling more than 200,000 yuan a month, with only 90 orders a day and losing money on every one. But it’s also an industry with almost no ceilings. Catering is a $3 to $4 trillion industry, still growing at a high rate, almost one-third of the total turnover is procurement. The second year I invested, it did a couple billion in sales, and the third year it did four or five billion. The cash flow was healthy, but it was still very, very far from the ceiling.
The third company deals in used cars. Used cars are also a huge market. 10 million new cars and 40 million used cars are traded each year in the United States. That means the average car in the United States will be transferred about four times in its lifetime. A few years ago, it was the other way around, with new cars trading many times more than used cars, but in the long run it will move closer to the US. The number of cars in Stock in China is still smaller than that in the United States, but the sales volume of new cars has far exceeded that in the United States, so there will be more and more old cars, and then the second-hand market will see explosive growth, and the transaction volume will be trillions, so this is also a company with almost no ceiling.
So what are the companies that we invest in at XVC? Let’s take a look.
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Tutoring. It’s a business with no ceiling. As long as there is a good supply, as long as it can help children gain a competitive advantage, parents are willing to break the bank, no matter how high the price is willing to pay. For example, the listed Good Future and New Oriental have a combined market value of more than 30 billion DOLLARS, but their market share is less than 3%.
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I think the logic of auto parts is very similar to that of second-hand cars, and the market potential is also great. It’s a $100 billion market in the United States, with five $100 billion or $20 billion companies.
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Decoration, building materials, furniture are respectively a trillion – level industry.
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Social, transportation, this is a trillion-dollar industry.
These companies have almost no ceilings. I can’t say all of them will be successful, but any of them will be a huge success.
The second method I’ve come up with to “seize luck” is to choose great founders and ceos.
Why choose good founders? because
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Even if you can’t win a war, that’s zero. A good founder can win a war.
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In times of adversity and despair, a good founder can turn the tide and survive
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When it comes to small achievements, great founders are ambitious, not content with small achievements, and able to constantly push the boundaries and take the company to new heights.
Take Ma Huateng for example. Why is he a good founder?
First, he is a good product manager with good habits of thought. In the early days of QQ, he would take time to chat with his users every day to get an intuitive user experience, which showed that he was a fact-driven person and kept thinking.
Besides, he is an excellent leader. He is not only good at recruiting and accommodating outstanding people like Martin and Zhang Xiaolong, but also good at building a good system and culture, bringing into play the role of internal competition and collaboration, and making the whole organization run efficiently.
Let me give you a couple more examples. These are the three projects that passed me by.
The first one, as you might have guessed, is today’s headlines. When they found out about this project, they were in round B financing. After a round of meeting with VCS, no one voted, and finally Yuri Milner from Russia personally voted. I didn’t understand it at that time, so I didn’t want to spend any time talking with them. I didn’t meet Zhang Yiming for the first time until 2016, when I started a fund and asked him for financing… So I’m not going to say how awesome today’s headlines are.
Second, this is Pinduoduo, when they were melting round A. At that time, I met with huang Zheng, the founder of the company, and did some serious research. Then I turned him down. They’re now rumored to have a $20 billion monthly GMV and a $10 billion valuation.
Third, this is Qudian. I went to Luo Min in rounds A, B and C, but didn’t dare to strike three times. They just went public in the US and made $650 million a quarter before going public.
All three companies, in addition to their good fortune, have a common characteristic: they have an “S-class” founder.
Zhang Yiming is an excellent product manager, see the problem is very essential, can be described as “thinking without frame”. When other news apps called themselves “attitudinal news”, he realized that jokes were not much different from news. They used data to speak for themselves, insisting on “no operation” and using only machines to recommend. While others are still obsessed with user cognition and tonality, he can transcend the theoretical rubbish and go straight to video and news stream advertising. Others emphasized “focus,” and he quietly came up with several new products with tens of millions of daily active users.
Huang zheng is also an excellent product manager. Although Pinduoduo has captured the “dividend of wechat flow”, it has also experienced a major mode transformation, from self-support to platform, from wechat group to its own app, which is a great leap forward. And they’re growing so fast that it’s hard for the back end supply chain to keep up. To support this growth, founders need to be leaders who can lead wars.
Luo Min of Qudian is also the founder who can manage the major transformation and complete the “life after death”. After more than two years of rapid growth of business and team, I was stopped by the supervision. I had to completely abandon the original customers and business, start new business and new crowd from scratch, and achieve a profit of 650 million yuan in a single quarter in one year. Of course, now the regulation and policy, they may have new challenges, but as long as there is a new opportunity, he will seize the probability is very high.
So my conclusion is that when a big opportunity, a big opportunity, arises, only the best founders seize it. That’s the kind of founder you invest in.
The third way I’ve come up with a scientific way to capture “good luck” is to “look for ways to monopolize core scarce resources.”
Let’s take a look at what resources Tencent has monopolized.
Let me ask you a question. How do you feel if you forget to bring your phone to work one day? Must be anxious? I get anxious when I go to the bathroom and forget my phone. You think you’re anxious because you don’t have your phone, but more importantly, you don’t have wechat. Don’t believe it, you take the phone, but unplug wechat, see if anxiety is not anxiety.
Hunter-gatherers “lost touch with the pack” and their chances of survival dropped, so over time our genes learned to use substances like dopamine and endorphins to create a system of rewards and punishments that kept us in touch with the pack. Contact, cool; It’s hard to be disconnected. Social tools like Facebook and wechat have greatly raised the threshold of people’s dependence on staying connected. If you lose it for a little while, you feel bad. It works the same way that drugs make you addicted.
Wechat, using this mechanism, monopolizes the “communication protocol”. Because the people you want to contact will frequently check wechat messages and reply to wechat messages, so you use wechat to send messages to others, the response rate and response time will be better than “laiwang”, “yixin” and short messages. On the other hand, when people send messages to you, they will also use wechat first.
We “didn’t have an appointment”, but we “made an appointment” to use wechat together. Whoever doesn’t abide by the agreement will be punished. That’s a natural monopoly.
Why should we invest in such a company? Why not invest directly in high-growth and high-margin companies?
We invest in early-stage companies, and a high gross margin now does not mean a high future, and a low gross margin now does not mean a low future. What really matters is whether you have long-term pricing power.
Companies that can monopolize core scarce resources have strong pricing power. Because he monopolizes scarce resources in the industry, his supply side, demand side and his customers have no other choice, so I have the pricing power, so I can protect profits and continuously create value.
The second is that such companies can overcome “anti-scale gravity” and make their businesses bigger. If you’ve ever been in a big company, the bigger the company the more expensive it is to manage and the less efficient it is. Tencent is no exception. With each additional level between a junior employee and a company’s owner, the junior becomes less accountable. The strongest sense of responsibility is self-employed. They are extremely diligent and frugal, have low tax burdens, and can acquire customers and deliver products and services in many low-cost ways. These are “anti-scale gravity”, and only companies that monopolize core scarce resources can overcome these “anti-scale gravity” and grow bigger, losing the efficiency and flexibility of smaller companies while still maintaining their competitive edge.
In addition, such a company can decouple from the macro environment. In times of inflation, such companies always raise prices first; In the destocking and deleveraging cycle, such companies take the opportunity to expand market share. So if you invest in a company like this, you basically ignore it.
At this point, we haven’t come up with a definition of core scarce resources.
What are core scarce resources? Some resources are scarce, but not core, and that doesn’t matter. Core scarce resources must be those that have a significant impact on the customer’s purchase decision. For retail, a good location is a core scarce resource. For consumer goods, quality shelves are the core scarce resources.
We have also defined a number of “characteristics” for the areas and directions we are focusing on, and we feel that business models that fit these characteristics tend to monopolize core scarce resources.
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Social networks and trading platforms with network effects and scale advantages
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Applications that generate data and use it to continuously improve the core experience
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The core standard setters of the ecosystem
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Brands with self-enhancing attributes
So that’s investment logic, so let’s talk about execution. The key to execution I have summarized is “concentration, patience, and sincerity”.
Before we talk about our implementation approach, let me talk about the concept of a “decision engine.” We can think of each investment institution as a decision-making engine similar to Alphago: information goes in at one end and decisions go out at the other. Hedge funds are a “decision engine”, VC funds are a “decision engine”.
This “decision engine” has two limitations:
1) A decision engine can only have one algorithm, and the algorithm can not be too complex;
2) There is a limit to the amount of information a decision engine can process.
We must first acknowledge our limitations. As an investment institution, our capabilities are limited. Algorithms can’t be too complicated, and there are conflicts between algorithms, so if we choose one, we have to abandon the others. We are also limited in the amount of information we can acquire and process, and when we study some industries, we have to abandon others.
This is what we call “three thousand weak water, but take a ladle to drink”.
I typically have only four or five companies in my portfolio, and I replace one or two of them every year. So there are many excellent companies that I have never touched, such as Alibaba, Weibo, Qihoo, netease. If the timing is right, these companies can be bought many times over. I did have impulses at certain points, but I held them in.
In retrospect, I held back, usually for one or more of these reasons:
1) Not sure how to monopolize scarce resources
2) I don’t think I know enough about the company and haven’t had time to research it
3) To buy this stock, you have to sell some other stocks, such as Tencent
In fact, we constantly review, ask ourselves, if the early stage of Toutiao, Pinduoduo, qudian again appear in front of us, we will vote.
To be honest, we still don’t have an answer. With our knowledge framework and understanding, we may not be able to determine at an early stage whether they have a chance to monopolize core scarce resources. We will gradually expand our cognitive boundaries, but until then, certain opportunities may just not be for us.
You may want to challenge me: Your cognitive boundaries are limited, but you can solve them by recruiting a team. You see, there are many funds in addition to TMT group, consumer group, and medical group, each of the large groups can also continue to sub-group, what consumer Internet group, enterprise services group, intelligent hardware group, online education group, frontier technology group.
Hiring is a real temptation. We only have four full-time and one part-time investment team including me. Whenever I’m too tired, or I don’t have time to research a case, I wonder if I should hire someone else.
In the end I held back. I have two concerns. One is that if there are too many people, someone will have to manage the information, and it is impossible to ensure that everyone is on the front line, the quality of information will be reduced. The other is that if there are too many people, there will be more communication, and the overall efficiency of information processing will be reduced.
Too many people, the ability to think may decline, will become superficial. I can give you a few examples.
Many people think jd is too “heavy” a business. But it has been cash flow positive since very early on. Not only JD.com but also Wal-mart is a company with negative working capital. This means that the growth of the company’s business not only takes away cash, but contributes to cash flow.
A static view of the unit economy is also a common problem. When Vipshop was listed in 2012, the gross profit of each order could not cover the cost of warehousing and logistics, and the unit economy could not be accounted for, so the whole market was very pessimistic about vipshop. But in practice it has high barriers and pricing power. It turned cash flow positive in its second quarter as a public company, and continued to improve gross margins in subsequent quarters while reducing logistics costs, resulting in profits.
The funniest mistake I’ve seen is when someone simply thinks the “Internet of Things” has network effects. Network effects are defined as “when a new node is added to a network, the experience of each node is improved”. May be some of the Internet of things application network effects, but most of the Internet of things applications, is the terminal added sensor and then use the Internet to collect data, as the “Internet of things” is “net”, but there is no network effect, because you have 1000 nodes and 10000 nodes, experience is the same.
Another reason for not wanting to enlarge the team is that we have a unique understanding of Teamwork.
We believe that “democracy and equality” leads to poor quality investment decisions, and that people in a group discussion environment pretend to know what they don’t know in order to “contribute”. We think of all communication as inefficient communication because language is flawed. We especially find it difficult to discuss problems clearly in groups.
We think, by comparison, that group thinking is the least effective, followed by one person thinking independently, and “a group of people thinking independently” is the most effective.
So we do something unique. Let me give you a couple of examples.
We have a culture of independent observation. We hope that everyone will not be influenced by the opinions of others. If a person always wants to influence others through his opinions, we are discriminated against here. And vice versa. You can have an opinion, but without looking behind it and thinking behind it, your opinion will not be respected. We talk about problems, we ask, “What’s your opinion?” but then we challenge, what’s your observation, what’s your logic.
We do not encourage collective discussion. Our weekly meetings are just for sharing knowledge, and discussion projects are generally held offline. Because we find that discussion in a group often turns into a debate. To argue, you need to take a stand. Once you take a stand, your instinct is to put on a pair of glasses and pick out facts to support your point of view, and eventually you will believe it. Only in offline one-on-one discussions can you really “sit down and figure things out.”
We may have several people working on the project together, but they are all looking at each other separately, without division of labor and cooperation. Do their own customer research, do their own analysis, the final investment memo is also written by each person, the conclusion may not be the same.
The logic of our team building is also different from others.
We don’t pay much attention to background, investment experience and track record. What we value most is a good habit of thinking, whether there is curiosity, whether there is the habit of independent and objective thinking.
Another is to have a passion for entrepreneurship and venture capital. This is to stay true to why we started out.
The third key to implementation that I have concluded is “stay true to why you started.”
Investing early is a hard thing to do, and you need to constantly challenge yourself. It’s hard work, with late nights and business trips. VC needs anti-human thinking, and feedback cycle is very long, it is easy to hesitate. In addition, VC industry toxic, every day to reject others, a long time is easy to forget who they are.
Therefore, it is very important to have a little ideal.
Creating long-term value by engaging and supporting innovation and entrepreneurship is our original mission.
So when we don’t know how to make a decision, we often ask ourselves, does this thing create value, does it have long-term value? If something doesn’t create long-term value, we don’t do it.
Finally, a word for you: Wealth comes from one or two big highs, but happiness comes from many small highs.
The big orgasm raises the threshold of happiness, so I often remind myself that I need to decouple happiness from wealth to maintain happiness in a sustainable way. I’m better at feeling happiness from the process. I found that the happiest time for me was when I had a coffee meeting with the CEO at 10 o ‘clock in the evening, talking about how to fight the war until the coffee shop closed at 2 o ‘clock in the morning. Walk out, see the empty street, the heart is very full.
I feel very fortunate to have the support of all of you and other investors who are not here, to do VC in a different and innovative way, to go to war with some great founders, to create some long-term value.
I think that’s my best luck. Thank you!
Editor: Make a small advertisement. XVC will host two product manager panels in January 2018 to discuss “Product Strategy under Traffic Dividends”. If you are interested in applying, please send an email to [email protected] with the subject line “Apply to attend the product Manager seminar”, briefly introducing your professional background and outstanding contributions.