It is 1884 in Atlanta. You are brought, along with twenty others like you, before a rich and eccentric Atlanta citizen named Glotz. Both you and Glotz share two characteristics: first, you routinely use in problem solving the five helpful notions, and, second, you know all the elementary ideas in all the basic college courses, as taught in 1996. However, all discoverers and all examples demonstrating these elementary ideas come from dates transposed back before 1884. Neither you nor Glotz knows anything about anything that has happened after 1884.
Glotz offers to invest $2 million, yet take only half the equity, for a Glotz charitable foundation, in a new corporation organized to go into the non-alcoholic beverage business and remain in that business only, forever. Glotz wants to use a name that has somehow charmed him: Coca-Cola.
The other half of the new corporation’s equity will go to the man who most plausibly demonstrates that his business plan will cause Glotz’s foundation to be worth a trillion dollars 150 years later, in the money of that later time, 2034, despite paying out a large part of its earnings each year as a dividend. This will make the whole new corporation worth $2 trillion, even after paying out many billions of dollars in dividends.
You have fifteen minutes to make your pitch. What do you say to Glotz?
via Tim McAleenan on SeekingAlpha
Warren Buffett’s sidekick at Berkshire Hathaway (BRK.A), Charlie Munger, has been described by Microsoft (MSFT) co-founder Bill Gates as, “The broadest thinker I’ve ever encountered.” Munger’s own personal story is one of triumph over significant adversity—at the age of 31, Munger was divorced, broke, grieving the loss of his nine-year old son, living in a dingy apartment, and driving a cruddy yellow Pontiac that doubled in value if he filled it up with gas. But yet, over the next fifty years of his life, Munger was to remarry (and enjoy a 40+ year marriage), have nine children, and amass a billion dollar fortune. Munger was able to accomplish such extreme success after such profound hardship through relentless discipline, independent thinking, and a long-term mentality. While Warren Buffett, Phil Fisher, David Dodd, and Benjamin Graham are normally the go-to guys for investing wisdom, Charlie Munger offers investors quite a lot to learn from. Here’s a collection of my five favorite quotes from Charlie Munger that I believe can make you a better investor today.
1. “Over the long term, it’s hard for a stock to earn a much better return that the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return – even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you’ll end up with one hell of a result.”
Although Munger said this about a decade ago, this seems to be the perfect justification for Buffett’s recent investment in tech stalwart (IBM). Although IBM has traded in the $70-$120 range for much of the past decade, Buffett didn’t begin purchasing shares until the price was over $150, and most likely, he paid $160-$175 for the bulk of his IBM shares. Getting past Buffett’s previous aversion to tech, it struck many as particularly uncharacteristic of Buffett that he would buy shares of a company that was trading at an all-time high. But I think it’s good to remember that Buffett paid a steep premium when he bought out See’s Candies and GEICO Insurance because he liked the ability of the businesses to generate significant returns on capital that required little reinvestment. Buffett read IBM’s five-year plan that aims to get earnings up from $12 per share to $25 per share within five years, and believed that management has a suitable strategy in place to make that happen. Even if shares are trading at an all-time high, Buffett still believes that great growth lies ahead.
2. “All intelligent investing is value investing – acquiring more than you are paying for. You must value the business in order to value the stock.”
Munger famously looks at a business, examines its earnings power, finds out how many shares of the company exist, and then determines how much each share should be trading for. After bringing up the price of the company, Charlie Munger then compares it to his own analysis, and if the price is noticeably lower than Munger’s calculation, he has the self-confidence to make big bets. If Munger sees that Kraft (KFT) is earning $3.2 billion per year, he will look at the quality of the earnings (What is the competitive advantage? Are these earnings sustainable? Do they require significant reinvestment?), and then determine what he would pay for the entirety of the company. After seeing how many shares outstanding there are, he comes up with his own price before even looking at what Mr. Market happens to offer.
3. “Acquire worldly wisdom and adjust your behavior accordingly. If your new behavior gives you a little temporary unpopularity with your peer group then to hell with them.”
Munger has never been one afraid to go against the crowd and be the object of ridicule when his particular investing strategy is out of favor with his peers. Like Buffett, Munger loaded up on shares of Wells Fargo (WFC) in 1991-1992 for his firm, Wesco, which was widely derided by Barron’s, The Wall Street Journal, and analysts covering both companies. We see the same thing today—while the popular sentiment is against the banking sector, Buffett has been adding billions of dollars to his Wells Fargo holding this year, and he does not care whether or not you approve of it. Once you have your own rationale for doing something and believe in it, stay the course no matter what those around you have to say about it—after all, it’s your money that is on the line.
4. “Experience tends to confirm a long-held notion that being prepared, on a few occasions in a lifetime, to act promptly in scale, in doing some simple and logical thing, will often dramatically improve the financial results of that lifetime. A few major opportunities, clearly recognizable as such, will usually come to one who continuously searches and waits, with a curious mind that loves diagnosis involving multiple variables. And then all that is required is a willingness to bet heavily when the odds are extremely favorable, using resources available as a result of prudence and patience in the past.”
Although Munger personally has over 100 holdings that vary from commercial real estate to publicly traded stocks, he has made several very large bets that have contributed to the financial success over the course of his lifetime. In addition to the stock of Berkshire Hathaway which contributed the lion’s share of Munger’s personal wealth, he has also made a small fortune in the stock of just seven companies—American Express (AXP), Johnson & Johnson (JNJ), Coca-Cola (KO), Kraft (KFT), US Bancorp (USB), Proctor & Gamble (PG), and Wells Fargo (WFC). Munger has gone as far as to say that the first thing every investor should do is buy a couple hundred shares of Coca-Cola as soon as they can to make sure that they have a little bit of insurance to get through life. By keeping a list of high-quality companies and ready cash on hand, you can pounce on significant opportunities when they arise—just two years ago, you could have bought Wells Fargo for $8 per share. If you had ample cash on hand to make an investment then and hold on for fifteen to twenty years, it’s easy to see how this could be the type of investment that makes a career.
5. “The number one idea is to view a stock as an ownership of the business and to judge the staying quality of the business in terms of its competitive advantage. Look for more value in terms of discounted future cash-flow than you are paying for. Move only when you have an advantage.”
Munger has a fanatical focus on the competitive advantages of companies, and it’s easy to see why. Eastman Kodak (EK) was a storied century old firm that took care of shareholders for over ninety years, but the shares have fallen from $48 in 2000-2001 to penny-stock status today. Now, Eastman Kodak’s portfolio is worth little more than its lucrative patent portfolio, and even if you think it’s poised for a comeback, you have to concede that the company is a shell of what it what 15-20 years ago. Munger likes companies like Coca-Cola (KO) and Proctor&Gamble (PG) because he believes they have the strength in the brand names to be successful for decades on end. After all, it’s not likely that a start-up dish soap company will be able to produce a product cheaper than Colgate-Palmolive (CL) because of its vast economies of scale, and most likely, people are going to stick with the brand name they recognize and trust if all else is equal. While we do not know what the future holds, we can use our own common sense to recognize the likelihood for continued success for some businesses, invest heavily in them when the price is right, and diversify to the point that one wipe-out won’t significantly alter your standard of living.
From a 2003 speech to UC-Santa Barbara, Ladies and gentlemen, please join me in welcoming Charles Munger. He will speak to us today on Interdisciplinary Wisdom Involving Economics…
Click to download pdf:
Below is a checklist of investment insight from Charlie Munger, taken from the book “Poor Charlie’s Almanack”.
The book is in the tradition of the ‘Poor Richard’s Almanack’ series published by Benjamin Franklin. In it Charlie dispenses a lifetime of investing wisdom and psychological insight. Charlie graduated from Harvard law, but one key insight he gives is the idea that you should learn the basics of a number of courses (Engineering, Finance, Chemistry, etc.) He describes how to apply these to investing. He seems to especially favor engineering by the way. He’s a seriously deep thinker and great investor.
An Investing Principles Checklist
from Poor Charlie’s Almanack
Risk – All investment evaluations should begin by measuring risk, especially reputational
Incorporate an appropriate margin of safety
Avoid dealing with people of questionable character
Insist upon proper compensation for risk assumed
Always beware of inflation and interest rate exposures
Avoid big mistakes; shun permanent capital loss
Independence – “Only in fairy tales are emperors told they are naked”
Objectivity and rationality require independence of thought
Remember that just because other people agree or disagree with you doesn’t make you right or wrong – the only thing that matters is the correctness of your analysis and judgment
Mimicking the herd invites regression to the mean (merely average performance)
Preparation – “The only way to win is to work, work, work, work, and hope to have a few
Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day
More important than the will to win is the will to prepare
Develop fluency in mental models from the major academic disciplines
If you want to get smart, the question you have to keep asking is “why, why, why?”
Intellectual humility – Acknowledging what you don’t know is the dawning of wisdom
Stay within a well-defined circle of competence
Identify and reconcile disconfirming evidence
Resist the craving for false precision, false certainties, etc.
Above all, never fool yourself, and remember that you are the easiest person to fool
“Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things.”
Analytic rigor – Use of the scientific method and effective checklists minimizes errors and
Determine value apart from price; progress apart from activity; wealth apart from size
It is better to remember the obvious than to grasp the esoteric
Be a business analyst, not a market, macroeconomic, or security analyst
Consider totality of risk and effect; look always at potential second order and higher level impacts
Think forwards and backwards – Invert, always invert
Allocation – Proper allocation of capital is an investor’s number one job
Remember that highest and best use is always measured by the next best use (opportunity cost)
Good ideas are rare – when the odds are greatly in your favor, bet (allocate) heavily
Don’t “fall in love” with an investment – be situation-dependent and opportunity-driven
Patience – Resist the natural human bias to act
“Compound interest is the eighth wonder of the world” (Einstein); never interrupt it unnecessarily
Avoid unnecessary transactional taxes and frictional costs; never take action for its own sake
Be alert for the arrival of luck
Enjoy the process along with the proceeds, because the process is where you live
Decisiveness – When proper circumstances present themselves, act with decisiveness and conviction
Be fearful when others are greedy, and greedy when others are fearful
Opportunity doesn’t come often, so seize it when it comes
Opportunity meeting the prepared mind; that’s the game
Change – Live with change and accept unremovable complexity
Recognize and adapt to the true nature of the world around you; don’t expect it to adapt to you
Continually challenge and willingly amend your “best-loved ideas”
Recognize reality even when you don’t like it – especially when you don’t like it
Focus – Keep things simple and remember what you set out to do
Remember that reputation and integrity are your most valuable assets – and can be lost in a heartbeat
Guard against the effects of hubris (arrogance) and boredom
Don’t overlook the obvious by drowning in minutiae (the small details)
Be careful to exclude unneeded information or slop: “A small leak can sink a great ship”
Face your big troubles; don’t sweep them under the rug
In the end, it comes down to Charlie’s most basic guiding principles, his fundamental philosophy
of life: Preparation. Discipline. Patience. Decisiveness.