Charlie Munger - Choosing 10 Quotes

Charlie Munger, one of the most iconic figures in investing over the last century, has recently left us at the age of 99. Having spent decades studying the lessons of the world's Investment Masters, Charlie Munger's approach to both investing and life have influenced me more than any investor. I feel fortunate to have attended a few Berkshire Meetings, and had the privilege of being present to experience first hand his profound wisdom.

In light of all the lessons and insights I’ve taken from Charlie, choosing a list of just ten quotes from his extensive reservoir of learnings he so generously shared was not easy. While these quotes barely scratch the surface, they have become deeply embedded in the core of how I think about and conduct my own investment process.

RIP Charlie Munger, a hero of mine.

Reading

“In my whole life, I have known no wise people (over a broad subject matter area) who didn't read all the time — none, zero.”

Incentives

“I think I've been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I've underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther.”

Psychology

“Of all the models that people ought to have in useful form and don't perhaps the most important lie in the area of psychology."

Find ‘Holds’

“I’m no good at exits. I don’t like even looking for exits. I’m looking for holds. Think of the pleasure I’ve got from watching Costco march ahead. Such an utter meritocracy and it does so well, why would I trade that experience for a series of transactions? I’d be less rich not more after taxes. The second place is a much less satisfactory life than rooting for people I like and admire. So I say find Costco’s, not good exits.”

Economics

“God knows where the world is headed. I just think that one way or another, the world muddles through.”

Macro-Economic Forecasts

“A great philosopher said 'A man never steps into the same river twice, the man is different and so is the river when he goes in the second time.' That's the trouble with economics. It's not like physics. The same damn recipe done a different time gets a different result.”

Simple Idea

“Take a simple idea and take it seriously.”

Multi-disciplinary

“It’s kind of fun to sit there and out think people who are way smarter than you are because you’ve trained yourself to be more objective and more multi-disciplinary. Furthermore, there is a lot of money in it, as I can testify from my own personal experience.”

Lollapalooza Effects

“Really big effects, lollapalooza effects, will often come only from large combinations of factors.”

High Quality Businesses

“We’ve really made the money out of high quality businesses. In some cases, we bought the whole business. And in some cases, we just bought a big block of stock. But when you analyze what happened, the big money’s been made in the high quality businesses. And most of the other people who’ve made a lot of money have done so in high quality businesses.”

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Charlie Munger’s ‘Bag of Tricks’

Who hasn’t heard of Charlie Munger? If you work in, or even merely have a passing interest in Investing, you are sure to have come across his name, I’m guessing. The name Munger is seen as synonymous with investment smarts, which is no mean feat in itself. Its not surprising, however; Charlie will clock up his 97th birthday on the 1st day of 2021, which means he’s been doing what he does for a very long time. And doing it well.

The more years I spend learning the investment game and taking in all Charlie has to offer, the more I realise that there isn’t a lot he hasn’t worked out. From a lifetime spent reading and thinking, Charlie has extracted all the really big ideas out of every other discipline and applied those to investing. It’s his bag of tricks so to speak. And while Charlie won’t acknowledge his genius, he says it allowed a non-prodigious man to achieve prodigious results.

“I have benefited over the years from closely studying Mr. Munger's own words and actions. As such, I have come to a deep appreciation for his profound thoughts.” Li Lu

"The truth is there is not that much to say, at least, not much that hasn't been said before. That's the curse of being two thousand years younger that Saint Paul, forty-four years younger than Charlie Munger and twenty-nine years younger than my father." Nick Sleep

I recently enjoyed watching a conversation with Charlie at the University of Redlands from earlier this year. Charlie discussed how and why his philosophical foundation was laid, he touched on his love of reading, Berkshire’s investment philosophy and a plethora of life lessons.

Charlie also revealed how he created near a billion dollars in value for the University of California, Santa Barbara when a friend was struggling to sell her family’s 1,800 acre ocean front ranch. Despite two miles of frontage to the ocean, a perfect climate and great views, draconian planning laws significantly inhibited the use to which the land could be put. Recognising an opportunity to realise value, Charlie donated $70m to the University of California, Santa Barbara to buy the land. Charlie knew the University wasn’t subject to the Santa Barbara zoning laws and could therefore develop needed student accommodation on the site. This outside-the-box thinking effectively created a billion dollars of value for the University and a once unattainable sale price for the friend.

And there’s plenty more lessons. I’ve included some of my favourite Munger-isms from the interview below…

Fun

“Warren and I have fun in business. We like our business, and we like the people we work with.”

Problem Solving

“We like the problem solving. That's a huge advantage in life. If you really love problem solving, that is worth about 20 IQ.”

"I have made my way in life with a pencil and a pen, and a calculating machine, and a compound interest table, and I haven't looked at a calculus question since I was 19 years old. So I'm totally a creature of old fashioned horse sense and a little arithmetic."

Take Care of Customers

“I'm also a total nut on the subject that the best way to get what you want in life is to deserve what you want. Of course, if you apply that to business, that means you really take care of the customers.”

Morality

“My life is organised so that just time after time what works for my pocket book works for every moral teaching that I've been taught.”

“Warren always says, ‘You should always take the high road because it's less crowded.’"

Investment Philosophy

“We have a very peculiar way of looking at things. We want to buy something that's intrinsically a very good business, meaning that an idiot could run it and it would do all right. Then we want that business which an idiot could run successfully to have a wonderful person in it running it. If we have a wonderful business with a wonderful person running it, that really turns us on, and it works very well. Now, we do make exceptions, but not many. It's a pretty simple philosophy. Warren sometimes says you have to choose good person or good business. You know what he says? This is not politically correct. He says good business. I had a friend when I practiced law and he said, ’If it won't stand a little mismanagement, it's not much of a business.’ We like businesses that stand a lot of mismanagement but don't get it. That's our formula. We can't make it work perfectly, but it certainly worked better than most peoples.”

Redlands Forum 2020

Tough Businesses

“As Warren says, ‘When a business with a reputation for being tough, and a manager with an opportunity for being brilliant get together, it's the reputation of the business that remains.’ If they start tough they stay tough. It's really hard to change a whole business, or a person.”

Pretend

“I've known a lot of roguish people that made a fair amount of money. They started giving [away] a little money to show off. And, 20 years later, they're actually real philanthropists. You become what you pretend to be, to some considerable extent. Having observed this so much, I think there's something to be said for hypocrisy, but that's not a common observation, but I've seen it do so much good in life that I don't think it's all bad, the hypocrisy. I always try and pretend to be a little better than I am. Not too much.”

Reading

“It's just God's gift. If you're into self-education, there's nothing like reading. Of course, people who do a lot of it have an enormous advantage.”

“I don't think you can take every bookish little boy and turn him into a billionaire by patting him on the head and saying, ‘Read all you want, Johnny.’ If it were that easy, there'd be more billionaires. It enormously helped me, and I think reading, once you've learned it, reading and arithmetic, you can take in so much, and you can take it in on your own time schedule.”

Language and Maths

“Of course, if you learn your own language, that's a very useful gift. Of course learning the basic math of life is another tremendous gift. And if you're really good at picking up language and doing just basic arithmetic, you can take enormous territory. You don't need much else.”

Learn to Learn

“Something that's more important than what they teach you in college -  learn the method of learning.”

“Now, when I want to know something, I just learn about it. The habit of figuring something out for yourself is an important thing to develop.”

Keep Learning

“We all start out stupid, and we all have a hard time staying sensible. You have to keep working at it. Berkshire would be a wreck today if it were run by the Warren I knew when we started. We kept learning. I don't think we'd have all the billions of stock of Coca-Cola we now have if we hadn't bought See’s. Now, you know how we were smart enough to buy See’s. Barely. The answer is barely.”

Resentment and Hatred

“There are two things I have noticed in a long life, that really do enormous damage to the bearer. One of them is resentment, and the other is hatred. What good is it going to do you to have this vast resentment of the way the world is?”

Own Equities

“I am continuously invested in American equities. But I've had my Berkshire stock decline by 50% three times. It doesn't bother me that much. That's just a natural consequence of an adult life, properly lived. If you have my attitude, it doesn't really matter. I always liked Kipling's expression in that poem called “If”. He said, success and failure, treat those two imposters just the same. Just roll with it.”

Warren and Charlie

“I think Warren and I are very much the way we were born. We were both a bit nerdish, and not huge successes as young boys. But we both had this love of humor, and we both loved understanding how things worked. We both have been lucky enough to attract marvellous associates and partners.”

Bag of Tricks

“I just got a bag of tricks, and I got the right bag of tricks early, and of course it’s been an enormous help to me.”

“I have a good mind, but I'm way short of prodigy. I've had results in life that are prodigious. That came from tricks. I just learned a few basic tricks from people like my grandfather.”

“[Using mental tricks,] it's so habitual with me. I revolve possibilities, and I rag problems hard. If they don't yield, I come back. And so, this is just a bag of tricks. It enables a non-prodigious man to get prodigious results.”

Inverting

“There are all kinds of tricks that I just got into by accident in life. One is, I invert all the time. I was a weather forecaster when I was in the Air Corp. How did I handle my new assignment? Being a weather forecaster in the Air Corp is a lot like being a doctor that reads x-rays. It's a pretty solitary. You're in the hangar in the middle of the night and drawing weather maps and calling pilots, but you're not interfacing with a bunch of your fellow men very much. So I figured out the men that I was actually making weather forecasts for: real pilots. I said, "How can I kill these pilots?" That's not the question that most people would ask, but I wanted to know what the easiest way to kill them would be, so I could avoid it. And so, I thought it through in reverse that way, and I finally figured out. I said, “There are only two ways I'm ever going to kill a pilot." I said, "I'm going to get him into ‘icing’ his plane can't handle, and that will kill him. Or I'm going to get him someplace where he's going to run out of gas before he can land." I just was fanatic about avoiding those two hazards.”

Back to Basics

“If you just have the mental trick of constantly going back to the basics, it's pretty basic insight.”

Destroy Best Loved Ideas

“One of the great tricks in life is to destroy your own best loved ideas. That I worked at. I actually go through my best loved ideas occasionally, see if I can weed one out.”

No Perfection

“You don't need to be perfect, if you're 96% sure that's all you're entitled to in many cases. I see these people doing this due diligence and the weaker they are as thinkers, the more due diligence they do. Of course it's just a way of allaying an inner insecurity. Of course it doesn't work. I don't think people who are that insecure mentally ought to be in positions of decision making power.”

Easy Problems

“My grandfather would say, he basically thought it was sinful to be dumber than you had to be. I share some of that. What you can't remove I think is forgivable, but to have an easily removable ignorance in your own head is really stupid.”

“I seek out easy problems. I've tried hard problems. It makes it a lot more difficult.”

Ask Questions

“One thing I’ve learned is to always inquire. Always ask questions, and look at the vulnerabilities of a situation in order to figure out how to solve it.”

Summary

One of my key take aways, beyond the incredible amount of invaluable lessons he can provide, is that the man is inadvertently humble. And that’s a conscious choice. With his track record, anyone could choose to be arrogant; “I’m obviously one of the greatest investors of all time!” But he doesn’t. He acknowledges the people he has learnt from over his long life, and even goes so far as to reward them. Generously. I like that in the man. And he has so many lessons to teach us. I understand that he won’t be around for ever - none of us will - but I expect his lessons for life and his bag of tricks will be.

Source:
University of Redlands - Redlands Forum: Charlie Munger. January 2000.

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How Buffett Manages Risk

Investing involves risk.

No surprise there and virtually every investor will agree. When there’s the chance of losing your capital, and by that I mean permanent loss of capital, then it’s something to be concerned about. You’re exposing yourself to danger and that in essence is the definition of risk. Interestingly though, whilst we’re all on the same page that investing involves risk, if we asked different investors what they actually think risk is, we’d end up with some different answers.

So what is risk to a long term investor?

OK, if your answer is ‘Share Price Volatility’, then you’re incorrect. Risk in investment parlance is not volatility.

Share prices are naturally irrational; emotional participants, and more frequently today, computer algorithms, can drive share prices to nonsensical levels. Of course there is a degree of risk in this, however that risk can be mitigated by two simple factors - the first of which is having a long-term horizon on your investment portfolio, rather than trying to buy this morning and sell this afternoon; and the second is having a deep understanding of the businesses which you own. Too many investors know little about the businesses they invest in, and therefore live or die based on what the stock price does. If you know the company has intrinsic value, a good runway, deep moat, strong management and a healthy culture for example, then the daily rise and fall of the stock price should not be of concern to you. It is not where risk lies for an investor.

Warren Buffett understands this.

For over 60 years he has navigated market cycles, macro forces, technology changes, sharp salesmen and geopolitical currents, and in the process has left a track record of returns few could match. If you want to understand risk, study Buffett.

Prevention

Buffett’s approach to risk management is simple. It’s also common sense. It’s not some esoteric risk management system built with complex formulas, in fact it’s more prevention than anything else.

“Wisdom is prevention but very few people do much about it.” Charlie Munger

“The biggest thing is to have something in the way you’re programmed so that you don’t ever do anything where you can lose a lot. Our best ideas have not been better than other people’s best ideas, but we’ve never had a lot of things that pulled us way back. So we never went two steps forward and one step back. We probably went two steps forward and a fraction of a step back. Avoiding the catastrophes is a very important thing.” Warren Buffett

Before we delve into Buffett’s risk management toolkit, it’s worth taking a step back to understand how Buffett approaches investing. It’s certainly not conventional. But it’s important to understand so we can put his risk management framework into context.

Ever since Buffett picked up Ben Graham’s book, ‘The Intelligent Investor’, Buffett’s defining principle has been that the shares he owns are simply the fractional ownership of the underlying businesses. If he pays a reasonable price for those fractional pieces, and provided the businesses do well, over the long term, the share prices will also do well.

“You are not buying a stock, you are buying part ownership in a business. You will do well if the business does well, if you didn't pay a totally silly price. That is what it is all about." Warren Buffett

Buffett recognises that in the short term, share prices are often irrational. Given his long term investment horizon he doesn’t concern himself with short term price fluctuations. Buffett has an advantage here, he’s got the luxury of permanent capital, which allows him to take a long term view.

“We do define risk as the possibility of harm or injury. And in that respect we think it’s inextricably wound up in your time horizon for holding an asset. I mean, if your risk is that if you intend to buy XYZ Corporation at 11:30 this morning and sell it out before the close today, in our view that is a very risky transaction. Because we think 50 percent of the time you’re going to suffer some harm or injury. If you have a time horizon on a business, we think the risk of buying something like Coca-Cola at the price we bought it at a few years ago is essentially so close to nil, in terms of our perspective holding period. But if you asked me the risk of buying Coca-Cola this morning and you’re going to sell it tomorrow morning, I say that is a very risky transaction.” Warren Buffett

"We look to business performance, not market performance. If we are correct in expectations regarding the business, the market will eventually follow along."  Warren Buffett

Most people don’t think about risk in this way and it’s certainly not the way it’s taught in most business schools. The typical finance textbook defines risk as ‘share price volatility’. In contrast, Buffett sees heightened volatility as opportunity. He can choose to buy shares at cheaper prices or simply ignore them. Buffett actually rejoices when share prices decline as most of the companies he owns are buying back their own stock, effectively increasing his entitlement to the company’s future earnings without him lifting a finger.

“In business schools, volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEO’s astray." Warren Buffett

Ultimately, Buffett views Risk as that which gets in the way of compounding; the permanent loss of capital. Or more specifically, the permanent loss of purchasing power over the holding period.

"The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period." Warren Buffett

Know What You Own

Buffett doesn’t panic out of stocks he owns if their share prices decline because he understands what he owns, he knows what he’s doing. He doesn’t let share prices tell him whether he’s right or wrong.

"Risk comes from not knowing what you're doing." Warren Buffett

Business Risk

Given Buffett’s objective is to own companies whose earnings will be higher in the future, his primary concern is Business Risk; how will a companies earnings manifest themselves over time?

“Should we conclude that the risk in owning a piece of a company - its stock - is somehow divorced from the long-term risk inherent in its business operations?  We believe [this] conclusion makes [no] sense and that equating beta with investment risk also makes no sense.” Warren Buffett

“When we look at businesses, we try to think of what can go wrong with them. We try to look [for] businesses that are good businesses now, and we think about what can go wrong with them. If we think there’s a lot that can go wrong with them, we just forget it. We are not in the business of assuming a lot of risk in businesses.” Warren Buffett

“We think of business risk in terms of what can happen — say five, 10, 15 years from now — that will destroy, or modify, or reduce the economic strengths that we perceive currently exist in a business.” Warren Buffett

Like all investors, Buffett’s not infallible. And when he has stumbled in the past, it’s usually because he’s mis-assessed the fundamental economic characteristics of the business. Think Dexter Shoes, Blue Stamps, Department Stores and the original Hathaway Textile business.

“What costs us money is when we mis-assess the fundamental economic characteristics of the business.” Warren Buffett

“We’ve made mistakes on judging the future economics of the business[es].” Warren Buffett

Filters, Base Rates and Pattern Recognition

Buffett deploys a concise filtering system when considering investments and he’s collected a huge repertoire of ‘base rates’ he applies to avoid risk. Furthermore Buffett has a well developed pattern recognition system drawing on his accumulated knowledge which he uses to identify potential risks and opportunities.

Filters

One of Buffett’s most powerful risk mitigation and prevention tools are his Filters.

“We do care about being right about the economic characteristics of the business, and that’s one thing we think we’ve got certain filters that tell us in certain cases that we know enough to assess.” Warren Buffett

“We have a bunch of filters we’ve developed in our minds over time. We don’t say they’re perfect filters. We don’t say that those filters don’t occasionally leave things out that should get through. But they’re very efficient.” Warren Buffett

Every investment needs an edge and it’s impossible to have an edge if you don’t understand an investment or other people have a better understanding than you. Buffett’s first filter is understanding what he owns and it relies on a strong appreciation for the boundaries of what he knows and what he doesn’t - his circle of competence.

“Different people understand different businesses. And the important thing is to know which ones you do understand and when you’re operating within what I call your “circle of competence.” Warren Buffett

If a potential investment falls outside of that circle or he won’t be able to get it within that circle it is discarded immediately. Buffett doesn’t venture outside of the circle.

“The first filter we probably put it through is whether we think — and we know instantly — whether it’s a business we’re going to understand, and whether it’s a business that — if it passes through that, it’s whether a company can have a sustainable edge.” Warren Buffett

“We do have filters, and sometimes those filters are very irritating to people who check in with us about businesses, because we really can say in ten seconds or so “no” to 90 percent-plus of all the things that come in, simply because we have these filters. We have some filters in regard to people, too.” Warren Buffett

Buffett doesn’t compromise his filters, they’re black and white. He doesn’t raise his discount rate to overcome his risk concerns, the filters work as a strict go/no-go valve.

“We look at riskiness, essentially, as being sort of a go/no-go valve in terms of looking at the future businesses. In other words, if we think we simply don’t know what’s going to happen in the future, that doesn’t mean it’s necessarily risky, it just means we don’t know. It means it’s risky for us. It might not be risky for someone else who understands the business.” Warren Buffett

"Don't worry about risk the way it is taught at Wharton. Risk is a go/no go signal for us - if it has risk, we just don't go ahead." Warren Buffett

Base rates

Base Rates are one of Buffett’s most useful filters to mitigate risk. An example of a base rate would be the history of successful pharmaceutical drug tests as a percentage of the total population of trials. In this case, it’s a very small number. Needless to say Buffett has weeded out a plethora of investment categories with low base rates such as this.

“People who have information about an individual case rarely feel the need to know the statistics of the class to which the case belongs.” Daniel Kahneman

Examples of common investment categories with ‘base rates’ too low for Buffett include: start-ups, turnarounds, new issues, declining businesses, highly leveraged entities, low ROE businesses, low quality management, unpredictable or quickly changing industries and/or business with headwinds as opposed to tailwinds.

“If it’s got a lousy past but bright future we’ll miss it.” Warren Buffett

"Start ups are not our game." Warren Buffett

“Charlie and I haven’t bought an IPO since 1955.” Warren Buffett

“If you really think a business is declining, most of the time you should avoid it. The real money is going to be made by being in growing businesses, and that’s where the focus should be.” Warren Buffett

“We have to stay away from businesses that have low returns on equity.” Warren Buffett

"We do not wish to join with managers who lack admirable qualities, no matter how attractive the prospects of their business." Warren Buffett

“We favor businesses and industries unlikely to experience major change.” Warren Buffett

"I would say anybody that's investing in something they consider opaque should just walk away" Warren Buffett

“One of the lessons our management has learned - and, unfortunately, sometimes re-learned - is the importance of being in businesses where tailwinds prevail rather than headwinds.” Warren Buffett

"We don’t play big trends. We don’t think about demographic trends or anything of the sort.... Big trends, they just don’t mean that much. There’s too much money to be made from year to year to think about things that take decades to manifest themselves." Warren Buffett 

Pattern recognition

Buffett relies on a vast mental database of information which he employs to identify patterns which help him manage risk.

"Pattern recognition is one of [Buffett’s] primary skills and perhaps his greatest skill. So in terms of data points, unlike many people who learn by seeking information on an as-needed basis, Warren is always looking for fuel for pattern recognition before he needs it." Alice Schroeder

Having studied and been exposed to a vast array of businesses and business problems over decades, Buffett utilises his vast filing cabinet of knowledge to identify potential future business risks.

“There is nothing mystical about an accurate intuition .. it’s pattern recognition. With training or experience, people can encode patterns deep in their memories in vast numbers and intricate detail - such as the estimated fifty thousand to one hundred thousand chess positions that top players have in their repertoire. If something doesn’t fit a pattern, a competent expert senses it immediately.” Philip Tetlock

“Charlie and I have seen, and we’re not remotely perfect at this, but we’ve seen patterns. Pattern recognition gets very important in evaluating humans and businesses. And, the pattern recognition isn’t 100 percent, and none of the patterns exactly repeat themselves, but there’re certain things in business and securities markets that we’ve seen over and over, and that frequently come to a bad end, but frequently look extremely good in the short run.” Warren Buffett [on Valeant blow-up]

“If you focus, you do see repetition of certain business patterns and business behavior. And Wall Street tends to ignore those, incidentally. I mean, Wall Street really doesn’t seem to learn, for very long, business lessons.” Warren Buffett

Margin of Safety

In complex adaptive systems like markets and business environments, the future is inherently uncertain. Not all things will work out as expected. One way Buffett mitigates this uncertainty is by seeking a margin of safety in his investments. This means buying at a discount to a conservatively estimated intrinsic value.

"We insist on a margin of safety in our purchase price.  If we calculate the value of a common stock to be only slightly higher than it's price, we're not interested in buying.  We believe this margin of safety principle, emphasised by Ben Graham, to be the cornerstone of investment success"  Warren Buffett

No Intolerable Outcomes

Buffett always looks down before he looks up. And while an investment may have significant upside, Buffett won’t invest if the consequences of a bad outcome to his entire portfolio are intolerable, no matter how remote those consequences might be. Buffett is happy to compromise upside for the ability to sleep soundly at night.

“If we can’t tolerate a possible consequence, remote though it may be, we steer clear of plantings its seeds.” Warren Buffett

“I put heavy weight on certainty .. if you do that, the whole idea of a risk factor doesn’t make any sense to me. You don’t do it where you take a significant risk.  But it’s not risky to buy securities at a fraction of what they are worth.” Warren Buffett

“I would rather be, you know, a hundred times too cautious than 1 percent too incautious, and that will continue as long as I’m around.” Warren Buffett

“We are perfectly willing to trade away a big payoff for a certain payoff. And that’s the way we’re put together.” Warren Buffett

Think About Worst Case Scenarios

To avoid intolerable outcomes, you need to get a handle on what those may be in the future. Buffett spends his time thinking about what those scenarios may look like. These tend not to be the things that fall out of a spreadsheet model.

“We think in terms of not exposing ourselves to any mistakes that could really hurt our ability to play tomorrow. And so we are always thinking about, you know, worst-case situations … we have to think about whether we’re doing anything really big that could have really terrible consequences.” Warren Buffett

“We don’t have any formula that evaluates risk, but we certainly make our own calculation of risk versus reward in every transaction we do.” Warren Buffett

“The best way to minimize risk is to think” Warren Buffett

Summary

You can see that Buffett doesn’t follow the daily irrationality of share prices. And he certainly doesn’t view what they teach in most business schools as the correct definition of Risk. He has long talked about being a business owner rather than a stock owner, and the underlying principle of this is that he understands the businesses within which he owns stock. If he doesn’t understand them, then he simply doesn’t own them.

“We will never buy anything we don’t think we understand. And our definition of understanding is thinking that we have a reasonable probability of being able to asses where the business will be in 10 years.” Warren Buffett

He further mitigates risk by ensuring he avoids fundamentally risky ventures. He doesn’t go into IPO’s, he’s not interested in turn-around businesses, and you won’t see him going anywhere near companies with dangerously high leverage or low returns on capital.

Ultimately, Buffett is trying to avoid Business Risk. He does use three simple tools to assist him with all of this. Base Rates, Filtering and Pattern Recognition. True, he’s had a lot longer at this than most of the rest of us, however that simple fact alone, probably coupled with his outstanding track record over those same years makes it very hard to refute his beliefs in all of this.

So who are you going to believe?

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Further Reading:
Investment Masters Class Tutorials: Volatility, Risk, Permanent Loss of Capital, VAR

Buffett on Recessions, IPO's, Capitalism & the Media Sector

Knowledge is cumulative.

That’s a known fact. As human beings we accumulate new knowledge every day; from reading and listening, experimenting and exploring and from observing others in what they do. And if you’re interested in learning, then the world has a limitless supply of information ready for you to absorb.

It’s one of the things I’ve always admired about the Investment Masters, and in particular, Warren Buffett. Even at 88, and with more than 70 years of investing experience behind him, you’d think he would have already learnt everything there it to know. But it’s not the case. He still has lessons to give, and I am always on the hunt for any new gems that fall from the fertile tree of his mind.

Warren was recently interviewed by Becky Quick on CNBC. During that interview, he spoke about his thoughts on recessions, investing (or not investing) in IPO’s and about the media landscape. All are topical conversations in the investment world currently and I found his thoughts on each subject compelling.

Here are the highlights from that interview:

Recessions

“[Recessions] are part of a capitalistic system. We will have them and it won’t change anything Berkshire invests in. It may offer us more opportunities in marketable securities or businesses. If we see a good business and everybody in the world is bearish and [thinks the yield curve] inversion is going to 100 basis points, we are going to buy it and buy it enthusiastically.”

Interest Rates and Stock Prices

“The lower interest rates are, basically, the better the option stocks are, because stocks are going to produce whatever they are over the next 20 or 30 or 40 years. But if you buy a 30 year bond, you’re going to get that rate. So when the 30 year is at 2.8-2.9% and the Federal Reserve’s intent is to have 2% a year inflation, and you pay tax on that 2.8-2.9% that you receive, your net is around 2%. Your’e essentially saying ‘I’m willing to go with a profitless investment for 30 years’. I don’t get excited about that. You can buy good businesses that may earn 14-15% on taxable equity and they’ve done it in aggregate for a long, long time. You have to think about these good businesses and how they’ll compound over time. You can start with [stock] yields that are higher than the bonds give you and the odds are that a diversified group [which are effectively] bonds with ascending coupons [will do better]. Because that’s all a stock really is, it’s a bond with a whole bunch of coupons that go out to infinity, you just have to [effectively] print the amount on the coupons yourself [because they are not fixed]. The one thing you know is the numbers on stocks as a whole are going to be way greater than 2.8%. The lower bond yields go, the more attractive stocks are as a long term investment.”

The Auto Industry

“The auto industry is not a static industry and if you keep doing everything the same way you did it in that business, if you aren’t thinking many years ahead, you’re making a very big mistake. Every footprint that an auto company might have had 10 or 30 or 50 years ago is going to be obsolete at some time. And the ones they are putting in now are going to be obsolete. It’s the nature of it.”

Change

“Capitalism is described as creative destruction. Change is part of a capitalist system. If you don’t believe it, you’re going to be doing some very dumb things.”

Free Trade

“I’m 100% for free trade. I think is has benefited this country enormously and will continue to benefit it. But the benefits of free trade are invisible. You don’t think about the fact your shoes or underwear or whatever cost ten percent less. You’re benefiting all the time in ways totally invisible. There’s nothing at Walmart that says you’ve just saved 8% because we bought this somewhere other than an American manufacturer. So you have this huge national benefit, unseen, but you ruin the economic lives of people who are 50 or 55 and are not going to be re-trained or re-located. A rich country can take care of those people if they follow policies that benefit all of us and take care of the relatively few who are dislocated. I think that’s the obligation of a rich country.”

IPO’s and LYFT’s $25b Market Capitalisation

“I certainly wouldn’t buy [the] business for $25b. I always think in terms of buying the whole business. I look at what I’m getting as a part owner of a business and I don’t know why, with all the things you could buy for $25b in this world, that you would pick a business that really has to be earning $2.5-$3b pre-tax in five years [versus losses now] to even be on the same radar screen as things you can buy right now. I’ve never been a big buyer of IPO’s. Charlie and I haven’t bought an IPO since 1955.”

“I don’t think buying new offerings during hot periods in the market is anything the average person should think about at all.”

“[Question from Becky Quick - But IPO’s always could be opportunities, e.g. Google and Amazon?] You can go around making dumb bets and win. It’s not something you want to take as a lifetime policy though. I worry much more about the things I do than I don’t do. I’ve missed all kinds of opportunities in my life. You just want to make sure you’re on the side of the house when you bet, rather than bet against the house.”

Media is Too Tough

“Entertainment is a big game with big players in it and they are playing for keeps. One problem they all have is that everybody has just two eyeballs and they’ve got x hours discretionary time, maybe they have 4 hours a day. Obviously there is disruption going on in delivering various things. People are always going to want to watch sports. They’ll want to watch the Olympics; the question is how much it’s worth. You’ve got some very, very big players who are going to fight for those eyeballs. The eyeballs aren’t going to double. The time isn’t going to double. It’s a relatively fixed market and then you get the size of certain players and disruption from Netflix which no-one predicted ten years ago. We’ll see how it plays out but that’s not an easy game to predict because you have very smart people with lots of resources trying to figure out how to grab another half hour of your time. I would not want to play in that game myself, that’s too tough for me.”

“Ten years from now when we look at entertainment delivery, it will be what people want. It will be in the form they want, it will be whatever the creativity comes up with. It’s going to be a very hotly contested game and the one thing I can guarantee you, is the public will be the winner.”

Companies and Mistakes

“I’d love to see Apple succeed [in media]. That’s a company that can afford a mistake or two. You don’t want to buy stock in a company that has to do everything right. In the mining business, they say any mine being dug should be able to stand a certain amount of bad luck because you get into different things as you get 5,000 feet down. There’s some businesses that are quite predictable. Berkshire’s made lots of mistakes over the years; my mistakes. We started with a textile mill and we had two businesses that failed. You’re gonna make mistakes and you don’t want to make them with too big a portion of your capital and you want to recognise them when you make them. You want to basically hang onto your winners. Apple should do some things that don’t work.”

Addressing Bad Acts

“The only thing I worry about Berkshire Hathaway [is bad acts of one or a few people reflecting on the business]. I don’t worry about our financials or earnings. I recognise we have 390,000 people and somebody’s doing something wrong. Probably fifty or a hundred people are doing something wrong at any given time. The only thing I have to remember is an ounce of prevention isn’t worth a pound of cure; an ounce of prevention is worth a ton of cure. So anytime you have anything unpleasant you’ve got to attack it immediately. It’s so easy just to shove it off or hope somebody down the line solves it. You pay a huge price for that.”

Summary

It’s clear that even after those 70 years, Buffett still thinks in simple terms.

He sees recessions as opportunities, doesn’t invest in hot IPO stocks or businesses he doesn’t understand, but he does want the businesses he invests in to make the odd mistake now and then. That’s how innovation comes about - from stumbling on occasion and learning from the error.

Investing is about connecting the dots. This also is a known fact. But if you want to succeed in investing, its important that you actually have dots to connect. In reality, the dots are information, disparate pieces of knowledge that we accumulate through learning from others, such as Buffett. And I for one am glad that the man still has ‘dots’ that the rest of us can learn from.

Source: ‘Becky Quick interviews Warren Buffett at The Gatehouse” CNBC.

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Daily Journal Meeting Notes 2019

What makes a Master Investor? We have covered many of them over the last couple of years, and you would have to agree that every single Master we have reviewed has their own special qualities. Whether its Buffett, Dalio, Rochon, or Akre, et al; all are impressive in their own right and I have learnt from every single one.

Now whilst I have learnt from them all, one of the questions I have often asked myself is: “Which of them would I like my kids to learn from?” Which of these inspiring investors’ footsteps would I wish my children to follow in? And whilst the answer could be indeed them all, there is one that I have always felt would be able to teach my kids more than any other.

Charlie Munger.

At this year’s Daily Journal AGM, Charlie Munger once again shares his wisdom and some of the secrets to Berkshire’s success with the audience. The man is a veritable master when it comes to understanding both business and investing, and he’s a genius in articulating the psychological aspects that makes an investor successful. He’s also built a framework for living a successful and content life. And its this stuff I want my kids to heed. What he talks about, more than anything, I believe is absolutely fundamental to anyone’s success not only in the investment world, but in life in general.

I’ve included some of my favourite quotes below.

Try to Do Less

“At a place like Berkshire Hathaway, or even the Daily Journal, we’ve done better than average and now there’s a question why has that happened? The answer is pretty simple. We tried to do less. We never had the illusion we could just hire a bunch of bright young people and they would know more than anybody about canned soup and aerospace and utilities and so on and so on. We never thought we could get really useful information on all subjects like Jim Cramer pretends to have. We always realised that if we worked very hard, we could find a few things where we were right and the few things were enough and that that was a reasonable expectation. That is a very different way to approach the process [of mutual funds]. And if you would have asked Warren Buffett the same thing that this investment counselling did, give me your best idea this year. And you just followed Warren’s best idea you would find it worked beautifully. But he wouldn’t try to know a whole heap, he would give you one or two stocks, he had more limited ambitions.”

Traits That Help

“I think personal discipline, personal morality, good colleagues, good ideas - all the simple stuff. I’d say if you want to carry one message from Charlie Munger it’s this: if it’s trite it’s right. All those old virtues work.”

Know Something Better

“The whole trick of the game is to have a few times when you know that something is better than average and invest only where you have that extra knowledge. And then if you get a few opportunities that’s enough. What the hell do you care that you own three securities and J.P. Morgan Chase owns 100. What’s wrong with owning a few securities. Warren always says in a growing town if you owned stock in three of the best enterprises in the town that’s diversified enough. The answer is of course it is.”

Diversification vs. Excellence

“The whole idea of [wide] diversification when you’re looking for excellence is totally ridiculous. It doesn’t work. It gives you an impossible task. What fun is it to do an impossible task over and over again?”

Fees Are a Big Toll

“People don’t realise, because they’re so mathematically illiterate, is that if you make five per cent and pay two of it to your advisers, you’re not losing 40 percent of your future. You’re losing 90 percent because over a long period of time that little difference becomes a 90 percent disadvantage to you. So it’s hugely important for somebody who is a long term holder not to be paying a big annual toll out of performance.”

Get Rich Quick Books

“If you take the modern world where people are trying to teach you how to come in and trade actively and stocks - well I regard that as roughly equivalent to trying to induce young people to start off on heroin. It is really stupid. And when you’re already rich do you make your money by encouraging people to get rich by trading? Then there are people on the TV and they say I have this book that will teach you how to make 300 percent a year and all you have to do is pay for shipping and I will mail it to you. How likely is it a person who suddenly found a way to make 300 percent a year will be trying to sell books on the internet to you? It’s ridiculous.”

You Don’t Need Many Great Decisions

“If you actually figured out how many decisions were made in the history of the Daily Journal Corporation or the history of Berkshire Hathaway it wasn’t very many per year. They were meaningful. It’s a game of being there all the time and recognising the rare opportunity when it comes and recognising that a normal human life does not have very many. Now there is a very confident bunch of people who sell securities who act as though they’ve got an endless supply of wonderful opportunities. Those people are the equivalent of the racetrack tout. They’re not even respectable. It’s not a good way to live your life to pretend to know a lot of stuff you don’t know, and pretend to furnish opportunities you’re not furnishing. My advice to you is avoid those people, but not if you’re running a stock brokerage firm. You need them. But it’s not the right way to make money.”

Find Costco’s, Not Stocks to Sell

“I’m no good at exits. I don’t like even looking for exits. I’m looking for holds. Think of the pleasure I’ve got from watching Costco march ahead. Such an utter meritocracy and it does so well, why would I trade that experience for a series of transactions? I’d be less rich not more after taxes. The second place is a much less satisfactory life than rooting for people I like and admire. So I say find Costco’s, not good exits.”

Under Spend Your Income

“This business is of controlling the costs and living simply. That was the secret. Warren and I had tiny little bits of money. We always underspent our incomes and we invested it. You live long enough, you end up rich; it’s not very complicated.”

Scramble Out of Mistakes & Change Your Ways

“There is a part of life which is, how do you scramble out of your mistakes without them costing too much? We’ve done some of that. If you look at Berkshire Hathaway, think of its founding businesses: a doomed department store, a doomed New England textile company and a doomed trading stamp company. Out of that came Berkshire Hathaway. We handled those losing hands pretty well and we bought into them very cheaply. But of course the success came from changing our ways and getting into better businesses.”

Avoid Difficult Things

“It isn’t that we were so good at doing things that were difficult. We were good at avoiding things that were difficult, and finding things that were easy.”

Only Do Things If They Are Better

“If we’ve got one thing we can do more of, we’re not interested in anything that’s not better than that. That simplifies life a great deal. It’s amazing how intelligent it is to spend some time just sitting. A lot of people are just way to active.”

Don’t Expect too Much from Human Nature

“I like those old Stoics. Part of the secret of a long life that’s worked as well as mine is not to expect too much of human nature. There’s almost bound to be a lot of defects and problems and to have your life full of seething resentments and hatreds; it’s counterproductive. You’re punishing yourself and not fixing the world. Can you think of anything much more stupid?”

Recognise Good Ideas Can be Overdone

“A problem thoroughly understood is half solved the minute you point out there’s a big tension between good ideas yet over done so much they’re dangerous, and good ideas that still have a lot of runway ahead. Once you have that construct in your head start classifying opportunities into one category or the other. You’ve got the problem half solved. You’ve already figured it out. You’ve got to be aware of both potentialities and the tensions.”

Less Bureaucracy is Better

“One of the reasons that Berkshire has been so successful is there is practically nobody at headquarters. We have almost no corporate bureaucracy. Having no bureaucracy is a huge advantage. The people who are running it are sensible people.”

“Bureaucracy and successful bureaucracy breeds failure and stupidity. How could it be otherwise? That’s the big tension of modern life and some of these places that go into a stupid bureaucracy and fire a third of the people in place works better.”

Reduce Your Return Expectations

“My advice for a seeker of compound interest that works ideally is to reduce your expectations, because I think it’s going to be tougher for a while and it helps to have realistic expectations - it makes you less crazy.” 

Opportunities in China

“Some very smart people are wading in [to China] and in due course I think more will wade in. The great companies in China are cheaper than the great companies in the United States.”

Have a Too-Hard Pile

“Part of our secret is that we don’t attempt to know a lot of things. I have a pile on my desk that solves most of my problems - it’s called the ‘too-hard pile’ and I just keep shifting things to the too hard pile. Every once in a while an easy decision comes along and I make it. That’s my system.”

Look at Qualitative Aspects

“We pay attention to the qualitative metrics and we also pay attention to other factors. Generally we like to pay attention to whatever is important in a particular situation and that varies from situation to situation. We’re just trying to have that uncommon sense. And part of our common sense is to refer a lot of the stuff in the too-hard pile.”

Companies Tend To Buy Back Stock at the Wrong Time

“When it was a very good idea for companies to buy back their stock they didn’t do very much. And when the stocks got so high - that is frequently a bad idea they’re doing a lot. Welcome into adult life. This is the way it is. It is questionable at the present levels whether it’s smart.”

The Trouble with Economics

“A great philosopher said: 'A man never steps into the same river twice, the man is different, and so is the river when he goes in the second time.' That's the trouble with economics. It's not like physics. The same damn recipe done a different time gets a different result.”

Humour

“Humour is my way of coping.”

Why Buffett is Richer Than Munger

“He [Warren] got an earlier start. He probably was a little smarter, he worked harder. There are not a lot of reasons. Why was Albert Einstein poorer than I was?”

Investment Products

“I tend to be suspicious of all investment products created by professionals, and I tend to go where nothing is being hawked aggressively or merchandised oppressively or sold aggressively.”

Bank Worry

“All intelligent investors worry about banks because banks present temptations to their managers who do dumb things. There are so many things you can easily do in a bank that looks like a way of reporting more earnings soon where it’s a mistake to do it, long term considerations being properly considered. As Warren puts it, the trouble with banking is there are more banks than there are good bankers.”

How to Sleep Better

“Now I actually deliberately blank out my mind and go to sleep rather easily and I recommend it to all of you. It really works. I don’t know why I didn’t get to it before 93.”

Indexing

“I do think that index investing, if everybody does it, won’t work, but for another considerable period index investing is going to work better than active stock picking where you try and know a lot.”

Summary

Munger is a genius. Even at 95, the man is still so intellectually active and has so much to teach. You can see he’s made his life as simple as possible, which has to be an invaluable lesson to us all. You don’t get to his age without gaining some knowledge along the way, and given his track record of success, I for one, and my kids, too, I hope, will gladly listen to what he’s got to offer.

Follow us on Twitter: @mastersinvest

TERMS OF USE: DISCLAIMER

Further Reading:
2019 Daily Journal Annual Meeting [Video]
2019 Daily Journal Annual Meeting [Full Transcript] - ValueWalk
Poor Charlie’s Almanack - Peter Kaufman
CNBC Becky Quick Munger Interview at Daily Journal Meeting 2019

The Berkshire Archive - Part 2

Once a year, investors from all over the world flock to Omaha, Nebraska, for one primary reason: to learn. And the crowd that gathers ranges from beginners who are just just starting out to many of the Investment Masters themselves.

Prior to this year's meeting I was fortunate to chat to Chuck Akre, a true Investment Master. Chuck told me he'd been attending the meetings for over 30 years.

"The reason I come to Omaha is to learn. Warren and Charlie remind us to keep it simple. It's unusual for a CEO to sit for six hours and answer questions. It's unique; it will never be repeated."  Chuck Akre

The recently published book, 'The Warren Buffett Shareholder - Stories from inside the Berkshire Hathaway Annual Meeting', contains lots of anecdotes from great investors and business people on their annual pilgrimage to Omaha.

"Over the last 20 Annual Meetings, I have learned so much about investing from Buffett and Munger, who are truly gifted teachers, able to make even complex topics understandable. There is no doubt in my mind I wouldn't have achieved anything close to the success I did  had I not attended every Annual Meeting and absorbed their investing lessons." Whitney Tilson

"Going to the 1999 Berkshire meeting has been the best investment of my life... Nothing is more important in our business than going to the Meeting." Francois Rochon, Giverny Capital

"As a Berkshire shareholder since 1982, annual visits to Omaha have assume religious proportions... I have come to learn from Messrs. Buffett and Munger's official remarks as well as from scores of Berkshire's operating company CEO's and other executives." Thomas Russo

"The Meetings remain as valuable as a university education." Daniel Pecaut, Pecaut & Company

"The Berkshire Meeting provides a unique opportunity in corporate America for managers and shareholders to learn from each other." Bruce N Whitman, Chairman & CEO Flight Safety International

"There is nothing like this weekend in the world and I hope it will continue for many years to come." Olza (Tony) Nicely, Chairman & CEO, GEICO

The Annual Meeting is an integral part of Berkshire's culture. While it provides a platform for Warren and Charlie to get across all the information and answer shareholder questions, it also helps them find like minded-investors.

"I really think if we spend six hours here answering your questions about the business and we do a half-way decent job of writing the annual report, we should get across the essential information." Warren Buffett

"We’re not trying to talk to an audience that is trying to get some special insight into what next quarter or next year is going to look like. We’re really looking for owners who join us in what we regard as kind of a lifelong investment." Warren Buffett

"Warren and Charlie understand that companies, over time, largely get the shareholders they deserve, and by communicating as honestly and clearly as they do at the Annual Meeting, they contribute to Berkshire's attracting an extraordinary group of shareholders." Robert E Denham, Partner Munger Tolles & Olson, LLP.

The book is full of anecdotes and quotes that are both enjoyable and enlightening. Its clear to see that many Investment Masters journey to Omaha regularly and have both enjoyed and profited from the learning. And with the recent release of the annual Berkshire meeting videos, a veritable gold mine of investing nuggets, that wisdom is available to all of us.

In my last post I outlined a number of important and enlightening themes that had been conveyed in those videos. As a follow on from Part One I've put together a further collection of themes that I enjoyed, and those of which expanded upon or challenged my own way of thinking.

Teaching Finance

"If I were teaching a course on investments, there would be simply one valuation study after another with the students trying to identify the key variables in that particular business, and evaluating how predictable they were first because that is the first step." Warren Buffett

More Than One Way To Succeed

“I don’t think there’s only one way to succeed in life, and our successors, in due time, may be different in many ways. And they may do better.” Charlie Munger

Source: CNBC Warren Buffett Archive

Understand Human Nature

“The better you understand human nature and are able to distinguish between different types of individuals, the better the investor you are going to be.” Warren Buffett

Make you Own Judgement

“You really shouldn’t ask other people their opinion about stocks. Let’s say I give an opinion on the XYZ company. I could change my opinion a week from now and [you won’t know]. You ought to have your own reasons for buying a stock. If you don’t you're going to get shaken out by some event, the stock market goes down a lot or you read some negative comments. You should make you own judgements in stocks.” Warren Buffett

Use Filters

"We do have filters, and sometimes those filters are very irritating to people who check in with us about businesses, because we really can say in ten seconds or so “no” to 90 percent-plus of all the things that come in, simply because we have these filters. We have some filters in regard to people, too."Warren Buffett

“[Our] filters haven’t changed much over the years.” Warren Buffett

"We have a bunch of filters we’ve developed in our minds over time. We don’t say they’re perfect filters. We don’t say that those filters don’t occasionally leave things out that should get through. But they’re very — they’re efficient." Warren Buffett

Book Value Is Not A Consideration

“We’ve tried to put in the annual report pretty much how we approach securities. And book value is not a consideration — virtually not a consideration at all.” Warren Buffett

High Price To Book May Be Better

"If anything, we are less likely to look at something that sells at a low relationship to book than something that sells at a high relationship to book, because the chances are we’re looking at a poor business in the first case and a good business in the second case.” Warren Buffett

Stay Away From Low Return On Equity

"We like to think when we buy a stock we’re going to own it for a very long time, and therefore we have to stay away from businesses that have low returns on equity." Warren Buffett

"If you have a business that’s earning 5 or 6 percent on equity and you hold it for a long time, you are not going to do well in investing. Even if you buy it cheap to start with." Warren Buffett

Price And Value 

"We don’t pay any attention to beta or any of that sort of thing. It just doesn’t mean anything to us. We’re only interested in price and value. And that’s what we’re focusing on all the time, and any kind of market movements or anything don’t mean anything." Warren Buffett

Think Of Value Not Price

“I think it’s almost impossible if you’re to do well in equities over a period of time if you go to bed every night thinking about the price of them. I mean, Charlie and I, we think about the value of them.”  Warren Buffett

Market Won't Do What You Want

“I’d say it’s in the nature of things that the market is not going to do exactly what you want when you want it.” Charlie Munger

Buffett Dropped Technical Indicators

"We don’t think anything that relates either to volume, price action, relative strength, any of that sort of thing — and bear in mind, when I was in my teens I used to eat that stuff up. I mean, I was making calculations based on it all the time, and kept charts on it, even wrote an article or two on it. But it just — it just has no place in the operation now." Warren Buffett

"The chart of the price action doesn’t mean a thing to us, although it may catch our eye, just in terms of businesses that have done very well over time. But we — price action has nothing to do with any decision we make. Price itself is all-important, but whether a stock has gone up or down, or what the volume is, or any of that sort of thing, that is — as far as we’re concerned, you know, those are chicken tracks, and we pay no attention to them.” Warren Buffett

Look At Risk As A Go/No Go Valve

"We look at riskiness, essentially, as being sort of a go/no-go valve in terms of looking at the future businesses. In other words, if we think we simply don’t know what’s going to happen in the future, that doesn’t mean it’s necessarily risky, it just means we don’t know. It means it’s risky for us. It might not be risky for someone else who understands the business. In that case, we just give up. We don’t try to predict those things." Warren Buffett

Buffett Doesn't Use Discount Rate To Compensate For Risk

"And we don’t say, 'Well, we don’t know what’s going to happen, so therefore we’ll discount it at 9 percent instead of 7 percent,' some number that we don’t even know. That is not our way to approach it. We feel that once it passes a threshold test of being something about which we feel quite certain, that the same discount factor tends to apply to everything. And we try to do only things about which we are quite certain when we buy into the businesses. So we think all the capital asset pricing model-type reasoning with different rates of risk-adjusted return and all that, we tend to think it is — well, we don’t tend to — we think it is nonsense." Warren Buffett

"I don’t think you can stick something — numbers on a highly speculative business, where the whole industry’s going to change in five years, and have it mean anything when you get through. If you say I’m going to stick an extra 6 percent in on the interest rate to allow for the fact — I tend to think that’s kind of nonsense. I mean, it may look mathematical. But it’s mathematical gibberish in my view." Warren Buffett

Earnings Power

"By and large, the depreciation charge is not inappropriate in most companies to use as a proxy for required capital expenditures. Which is why we think that reported earnings plus amortization of intangibles usually gives a pretty good indication of earning power." Warren Buffett

Annual Reports

"I don’t think we’ve ever gotten an idea, you know in 40 years, from a Wall Street report. But we’ve gotten a lot of ideas from annual reports." Warren Buffett

Know Who Is Running The Business

"The main thing that they can’t mandate in annual reports: I really to know as much as I can about the person that’s running it and how they think about the business and what’s really going on in the business." Warren Buffett

You Can Learn A Lot From Annual Reports

"We’ve learned a lot from annual reports. For example, I would say that the Coca-Cola annual report over the last good many years is an enormously informative document. I mean, I can’t think of any way if I’d have a conversation with Roberto Goizueta, or now Doug Ivester, and they were telling me about the business, they would not be telling me more than I get from reading that annual report.

We bought that stock based on an annual report. We did not buy it based on any conversation of any kind with the top management of Coca-Cola before we bought our interest. We simply bought it based on reading the annual report, plus our knowledge of how the business worked." Warren Buffett

Weak Competition

“The secret of life is weak competition, you know." Warren Buffett

“We have found in a long life that one competitor is frequently enough to ruin a business.” Charlie Munger

Never Made A Big Sector Play

“We have never made a big sector play on a country. In fact, we’ve almost never made a big sector play." Warren Buffett

No Asset Allocation Theories

“We don’t have any sector allocation theories whatsoever.” Warren Buffett

Wonderful Companies Can Buyback Stock At High Prices

“When we own stock in a wonderful business, we like the idea of repurchases, even at prices that may give you nose bleeds. It generally turns out to be a pretty good policy.” Warren Buffett

Cash Is Cash

“If we could see the future of every business perfectly, it wouldn’t make any difference whether the money came from running streetcars or from selling software, because all the cash that came out, which is all we’re measuring between now and judgment day, would spend the same to us.” Warren Buffett

What Investing Is

"You may have an insight into very few businesses. I mean, if we left here and walked by a McDonald’s stand, you know, and you decided, would you pay a million dollars for that McDonald’s stand, or a million-three, or 900,000, you’d think about how likely it was there would be more competition, whether McDonald’s could change the franchise arrangement on you, whether people are going to keep eating hamburgers, you know, all kinds of things. And you actually would say to yourself this McDonald’s stand will make X — X plus 5 percent — maybe in a couple years because over time prices will increase a little. And that’s all investing is. But you have to know when you know what you’re doing, and you have to know when you’re getting outside of what I call your circle of competency, you don’t have the faintest idea.” Warren Buffett

Good Businesses Invest Now For The Future

"I think almost all good businesses have occasions where they’re making today look a little worse than today would otherwise be, to help tomorrow." Charlie Munger

Call It Value Or Growth

"[Berkshires] trying to put out capital now to get more capital — or money — we’re trying to put out cash now to get more cash back later on. And if you do that, the business grows, obviously. And you can call that value or you can call it growth. But they’re not two different categories." Warren Buffett

Ask For Past Projections

“I was recently involved in a situation where projections were a part of the presentation. And I asked that the record of the people who made the projections, their past projections also be presented at the same time. It was a very rude act.”  Warren Buffett

The Future P/E Is What Counts

"It isn’t a multiple of today’s earnings that is the primary determinate of things. We bought our Coca-Cola, for example, in 1988 and ’89, on this stock, at a price of $11 a share. Which — as low as 9, as high as 13, but it averaged about $11. And it’ll earn, we’ll say, most estimates are between 230 and 240 this year. So, that’s under five times this year’s earnings, but it was a pretty good size multiple back when we bought it." Warren Buffett

Businesses Losing money

“It would not bother us in the least to buy into a business that currently was losing money for some reason that we understood, and where we thought that the future was going to be significantly different. Similarly, if a business is making some money — there’s no P/E ratio that we have in mind as being a cutoff point at all. There are businesses — I mean, you could have some business making a sliver of money on which you would pay a very, very high P/E ratio.” Warren Buffett

Don't Care About Who is Buying or Selling

"We care how much Coca-Cola has sold five years from now, and what percentage of the world market they have, and what they’re charging for it, and how many shares are outstanding, and that sort of thing. But we just — we don’t care who’s buying or selling it in the least, except we like it when the company’s buying it. The same way with Gillette. We care about whether people are trading up in the shaving experience. So capital flows and all of those macro factors that people like to write about a lot just have nothing to do with what we do. We’re buying businesses." Warren Buffett

Listen to Your Customer

“One of our directors said very simply, ‘We should make a list of everything that irritates the customer, and then we should eliminate those defects one by one.’ That is the way to compete in a service business.” Charlie Munger

“I don’t worry about the dumbest competitor in a business that’s service. The customer will figure that out over time.” Warren Buffett

“There’re these fads in management — I mean, obviously, listening to your customer and things like that, I mean, that is — nothing makes more sense. But it’s hard to write a 300-page book that just says, “Listen to your customer.” Warren Buffett

Indexing

"The very nature of index funds is that you are saying, I think America’s business is going to do well over a — reasonably well — over a long period of time, but I don’t know enough to pick the winners and I don’t know enough to pick the winning times." Warren Buffett

“Really  the idea of buying an index fund over time is not to buy stocks at the right time or the right stocks. It’s to avoid buying them at the wrong time, the wrong stocks.” Warren Buffett

Summary

The true value in these meetings, and in all the learning you can take from them, is that if you go just once, don't expect to learn everything there is to know. Many of the Investment Masters that I have met and that I read about in the book above, have continued to attend even though they are incredibly successful in the investment field by their own right. And why is that? Because they have continued to learn every single time they went.

The Berkshire videos that have been released go back to 1994; that's over twenty years of history that allows all of us who haven't been privileged enough to attend to learn as if we were there. And that's gold to me.

So if you've been thinking about attending the Berkshire Meeting, I've got one suggestion .. 'Just Do It'. 

Follow us on Twitter: @mastersinvest

TERMS OF USE: DISCLAIMER

Sources:
Warren Buffett Archive, CNBC
The Warren Buffett Shareholder -  Lawrence Cunningham & Stephanie Cuba
 

Further Suggested Reading:

Investment Masters Class - The Berkshire Archive - Part 1
Investment Masters Class - The Buffett Series
Investment Masters Class - Evolution of a Value Manager

The Berkshire Archive - Part I

What would you pay for the opportunity to spend a few hours with the world's two most successful investors?

And when I say the world's two most successful investors, I'm talking about two guys with a combined 140 years of investment success. They've operated businesses, they've invested across industries and asset classes. They've navigated every political, economic and investment cycle you can fathom and they've been pitched every idea under the sun. They'll cover off on almost any topic you can think of and there really is very little they haven't had to consider over the years. Basically, they'll be willing to share all their investment secrets with you.

Does three or four million dollars sound reasonable?

That's the order of magnitude needed to win Buffett's annual charity lunch where you and seven friends can dine with Warren Buffett at New York’s Smith & Wollensky steakhouse. But you only get Buffett. If you want his partner too, Charlie Munger, you're best bet is taking the 'value' option. It will cost you a plane ride to Omaha, Nebraska for the annual Berkshire Hathaway meeting. Attendance is complementary if you own Berkshire shares. Here Buffett and Munger sit on stage while addressing unscripted questions from the audience for five or six hours.

2018 Power Lunch Auction Source: EBAY

For many decades, the only way to see and hear them was to be in the room itself. Until live streaming began in 2016, those attending, including journalists, were not allowed to make or release any video or audio recordings. For the first time, earlier this year, Buffett shared the entire series of videos, going back to 1994, that Berkshire had taped for their own internal records. These videos and the accompanying transcripts have been compiled by CNBC into one of the Greatest Investment Treasures of this century.  "It blew my mind when I saw it," Buffett said.

This year, I finally took the time out to see my two favourite investors and mentors in Omaha. While standing in line at 4.30am I met two businessmen who'd traveled from New York to attend. These two friends had been coming for the last five years. When I inquired where their interest lied they said  "This is the best 6 hour MBA you will get anywhere. Period." I agree.  

Source: CNBC Buffett Archive

Over 40,000 people flock to Omaha each year to hear Warren and Charlie answer impromptu audience questions covering a broad swathe of topics. Sitting in the stands, you quickly realise these attendees love Buffett. And I can tell you, the locals do, too. Whether it was the Uber drivers, the staff at Gorat's Steakhouse [A highly recommended trip back in time], or Nebraska Furniture Mart's Ronnie Blumkin, [whom I had the pleasure of meeting], the feedback was consistent: Buffett's just your regular, friendly, great guy!

It's lucky for us that one of Buffett's strengths is his ability to change his mind. And thank goodness he does. At the 1995 Berkshire meeting an audience member asked Mr Buffett, "Could you consider availing a videotape of this meeting to us, the shareholders?" Buffett, in his iconic humorous way responded..

WARREN BUFFETT: "Yeah, we’ve had that suggested a number of times. It’s a good suggestion, and we’ve considered it. The thing we’re worried about, in connection with that, is discouraging attendance. I mean, it — (laughter) — we’d hate to have two people here asking questions and then send it out to tens of thousands. So — (laughter) — in the end —

CHARLIE MUNGER: Particularly if it might make sales go down at the jewelry store.

WARREN BUFFETT: Yeah. (Laughter and applause). Since we were just attacking hypocrisy in American business, Charlie felt like he should add that to my comments. (Laughter) But we — it’s a close call on that because we would like everybody — Of course, we try to cover a great many subjects in the annual report. But we like the idea of the meeting — answering a lot of shareholders questions. We don’t want to discourage attendance. And it’s fun to have everybody come in and ask questions. And the chances are, if we had far fewer people, we would have, you know, far more — far fewer — good questions. So that the quality of the meeting is enhanced, I think, by having a lot of people come. But you’ve come a long way, so I can understand why you might be interested in a transcript. (Laughs) I appreciate that. Thank you.

AUDIENCE MEMBER: — or no. Is that a yes or a no?

WARREN BUFFETT: It’s — (Laughter)

CHARLIE MUNGER: It was a no.

WARREN BUFFETT: It’s a no.

AUDIENCE MEMBER: OK. (Applause)

WARREN BUFFETT: Most everything we say is a no. But we have various ways of getting there. (Laughter)

I suppose with 40,000 plus attendees Buffett weighed the odds of releasing the videos against the chances of poor attendence and questions, and found in favour. These transcripts are an unfettered gold mine of investing nuggets. And while I've read every one of Buffett's annual letters from both Berkshire Hathaway and the Buffett Partnership, trawling through the transcripts opened my eyes to so many new concepts and insights I hadn't considered. Not just on investing but on life as well. I hope you'll enjoy them and learn from them as much as I have. 

In Part One of this series I've included some of my favorite insights .. hopefully some of these will be new to you...

How to Behave

“We work all the time at trying to behave with other people as if our positions were reversed. That’s what Charlie’s always advised in all our activities, and we’ve tried to follow it. And we’re certainly far from perfect at it, but if you keep working at it, it does get results.” Warren Buffett

A Good Family Helps

“We owe a considerable amount, both of us, to the families we were raised in. I think the family standards helped us to identify the good people more easily than we would have if we’d had a more disadvantaged background.” Charlie Munger

There is More than Managing Money

“If you’re good at just investing your own money, I hope you’ll morph into doing something more.” Charlie Munger

“If all you succeed in doing in your life is to get early rich from passive holding of little bits of paper, and you get better and better at only that for all your life, it’s a failed life. Life is more than being shrewd at passive wealth accumulation." Charlie Munger

Culture is Important

"Everything we do we hope is consistent with what most people would call a “culture” at Berkshire." Warren Buffett

"I think Berkshire’s culture runs as deep as any large company could be in the world." Warren Buffett

Trust is Most Important

"Trustworthiness is more important than the brains. It’s not that they don’t have the brains, but we wouldn’t hire anybody, no matter how able, if we didn’t trust them." Charlie Munger

Look For a Successful Framework

"Look for the successful framework that’s been successful for people, and there’s nothing like Graham’s, in my view, and you’ll have a lot of fun and you’ll probably make a lot of money." Warren Buffett

Investment Principles Haven't Changed for 40 Years

"I know more about businesses than I knew 20 years ago, or 40 years ago. I haven’t really changed the principles. The last change — the basic principles are still Ben Graham. They were affected in a significant way by Charlie and Phil Fisher, in terms of looking at the better businesses. But they — but I didn’t leave any of — I didn’t leave Graham behind on that. And I really haven’t learned any new fundamental principles. But I may have learned a little bit more about how business operates over time." Warren Buffett

Analysing Stock Prices hasn't Changed in 50 Years

"There’s nothing different, in my view, about analyzing securities now than there was 50 years ago." Warren Buffett

Start Investing

"I think you have to jump in the water, because investing on paper and investing with real money, you know, is like the difference between reading a romance novel and doing something else." Warren Buffett

The Stock Market Offers Better Prices Than Private Market

"The stock market will offer you opportunities for profit, percentage-wise, that you’ll never see, in terms of negotiated purchase of business.  In negotiated purchase of a business, you’re almost always dealing with someone that has the option of either selling or not selling, and can sort of pick the time when they decide to sell, and all of that sort of thing. In stock markets, it’s an auction market. Crazy things can happen." Warren Buffett

Wonderful is More Important than Price

"Generally speaking, I think if you’re sure enough about a business being wonderful, it’s more important to be certain about the business being a wonderful business than it is to be certain that the price is not 10% too high or 5% too high or something of the sort." Warren Buffett

Wonderful Businesses Are Worth More Than Most People Think

"I would say that if it’s a really wonderful business, we probably come up with higher intrinsic values than most people do." Warren Buffett

Could Pay Significantly More for Wonderful Businesses

"Looking back, when we’ve bought wonderful businesses that turned out to continue to be wonderful, we could’ve paid significantly more money, and they still would have been great business decisions. But you never know 100 percent for sure." Warren Buffett

Avoid Declining Businesses

“If you really think a business is declining, most of the time you should avoid it. The real money is going to be made by being in growing businesses, and that’s where the focus should be.” Warren Buffett

Successful Investors Sell Stocks that go up

"I would worry, frankly, if I sold a bunch of things right at the top [of the market], because that would indicate that, in effect, I was practicing the bigger fool-type approach to investing, and I don’t think that can be practiced successfully over time. I think the most successful investors, if they sell at all, will be selling things that end up going a lot higher, because it means that they’ve been buying into good businesses as they’ve gone along." Warren Buffett

Three Week Delay Would be Okay

“I think you could be in someplace where the mails were delayed three weeks, and the quotations were delayed three weeks, and I think you could do just fine in investing.” Warren Buffett

Psychological Edge

"Humans will continue to make the same mistakes that they have made in the past. I mean, they get fearful when other people are fearful... when people get scared, you know, it’s very, very pervasive.. It’s just the way the humans are constructed. That’s where Charlie and I have an edge. We don’t have an edge, particularly, in many other ways." Warren Buffett

Risk Relates to Time Horizon

"If you have a time horizon on a business, we think the risk of buying something like Coca-Cola at the price we bought it at a few years ago is essentially, is so close to nil, in terms of our perspective holding period. But if you asked me the risk of buying Coca-Cola this morning and you’re going to sell it tomorrow morning, I say that is a very risky transaction." Warren Buffett

The Thing to Do

"The thing to do is just find a good business at an attractive price and buy it." Warren Buffett

Get Back more than you Put in

“I just cringe when I hear people talk about, “Now it’s time to move from growth stocks to value stocks,” or something like that, because it just doesn’t make any sense.” Warren Buffett

"Anybody that tells you, “You ought to have your money in growth stocks or value stocks,” really does not understand investing." Warren Buffett

Phil Fisher's Lesson on Compounding Machines

"Phil Fisher was just telling me the same thing that Charlie was telling me, which was that it’s very important to get into a business with fundamentally good economics, and one that you could ride with for decades, rather than one where you had to go from flower to flower every day." Warren Buffett

What to Study

"We think you should study things like Mrs. B out at the Nebraska Furniture Mart, who takes $500 and turns it, you know, over time, into the largest home furnishing store in the world. There has to be some lessons in things like that. What gives you that kind of a result and that kind of competitive advantage over time?" Warren Buffett

Follow the Competition

"If we own stock in a company and in an industry, and there are eight other companies that are in the same industry, I want to own or be on the mailing list for the reports for the other eight, because I can’t understand how my company is doing unless I understand what the other eight are doing.

I want to have the perspective of, in terms of market share, what’s going on in the business or their margins or the trend of margins, all kinds of things that I can’t get unless I know —

I can’t be an intelligent owner of a business unless I know what all the other businesses in that industry are doing. And so, I try to get that information out of a report." Warren Buffett

Never Mind the Macro

"Charlie and I, to my knowledge, or my memory, I can’t recall ever us making an acquisition or turning down one based on macro factors that — you know, and we talk about deals when they come along, but whether it was See’s Candy, or whatever it might have been, the Burlington Northern we bought at a terrible time, in general economic conditions." Warren Buffett

Business Adversity

“One of the things we look for in businesses, is how — you know, if you see a business take a lot of adversity and still do well, that tells you something about the underlying strength of the business.” Warren Buffett

You Need To See A CEO's Track Record

"It is far easier to tell the great baseball batters after you’ve seen a couple seasons of their batting than it is to go to a college — in college baseball teams or high school baseball teams — and pick out the superstars." Warren Buffett

Don't Try and Change Management

“I would say that we’ve found it almost useless in 60 years of investing to give advice to anybody in business.” Warren Buffett

“I would say that the history that Charlie and I have had of persuading decent, intelligent people, who we thought were doing unintelligent things, to change their course of action has been poor.” Warren Buffett

No Single Metric

"I don’t think price-earnings ratios, you know, determine things. I don’t think price-book, price-sales ratio; there’s no single metric I can give you, or anybody else can give you, that will tell you this is a great time to buy stocks or not to buy stocks." Warren Buffett

Forget Concepts & Country Allocations

"When we hear somebody talking concepts, of any sort, including country-by-country concepts or whatever it might be, we tend to think that they’re probably going to do better at selling than at investing." Warren Buffett

Businesses Don't Always Meet Expectations

"Businesses do not meet expectations quarter after quarter and year after year. It just isn’t in the nature of running businesses. And, in our view, people that predict precisely what the future will be are either kidding investors, or they’re kidding themselves, or they’re kidding both." Warren Buffett

Stock Prices in the Lobby is a Tell

"We’ve been suspicious of companies, for example, that place a whole lot of emphasis on the price of their stock. I mean, when we see the price of a stock posted in the lobby of the headquarters or something, you know, things like that make us nervous." Warren Buffett

Avoid Start-Ups

"I've never swung at a ball while it's still in the pitcher's glove." Warren Buffett

Wonderful Businesses beat Cigar Butts

"Those sub-working capital stocks are just almost impossible to find now. And if you got into a market where a lot of them existed, you’d probably find wonderful businesses selling a lot cheaper, too. And our inclination would be to go with a cheap, wonderful business." Warren Buffett

Don't Be 1% Incautious

“I would rather be, you know, a hundred times too cautious than 1 percent too incautious, and that will continue as long as I’m around.” Warren Buffett

Buffett and Munger have spent their whole lives, over a century in time, thinking about not only investment but also leading a fulfilling life. Their track record is unprecedented. Their communicative style can be best described as simple, genius in fact. If you really want to understand investing, I can't recommend highly enough studying the lessons of these Investment Masters. When asked what he would like to be remembered for in the future, or his legacy, Buffett replied "If you really ask me, I’d probably like 'teacher'. I enjoy teaching a lot." To this day, most Finance and Investment Courses don't take up Buffett on his wish. For those that do, let's hope the status quo remains; there will be more opportunities to leverage his wisdom.

I hope to see you in Omaha next year! Maybe we can grab a steak at Gorat's together...

Follow us on Twitter: @mastersinvest

TERMS OF USE: DISCLAIMER

Further Suggested Reading:
Investment Masters Class - The Buffett Series
Investment Masters Class - Evolution of a Value Manager

Buffett's Filing Cabinet

Having thoroughly enjoyed my time in Omaha a few weeks back, I found a recent illuminating post by John Huber of Saber Capital Management discussing his own key takeaways from this year's Berkshire meeting. Huber referenced an observation made in a speech on Buffett by Alice Schroeder, who wrote Buffett's authorised biography, 'The Snowball.' One of the most interesting points raised by Schroeder was how Buffett didn't use a computer to store information, he kept it all in his head.

“He’s created this immense, vertical filing cabinet in his brain of layers and layers and layers of files with information that he can draw back on from more than 70 years of data. He’s like a human computer. He’s wonderful at math. He can recall phone numbers from his childhood, and populations of cities from his childhood. He can do square roots in his head. He does present values and compound interest in his head… The biggest thing he’s done is to learn and create this cumulative base of knowledge in his head. So one reason he doesn’t use a computer is because, in a sense, he is one.”

It's well recognised that Buffett is a lifelong learner, or as Charlie puts it, 'a learning machine'. And Buffett started early. In that same speech, Schroeder explains... 

"Starting at the age of no later than six, he's read everything that he could find about business; the subject that interests him. He's read newspapers, biographies, trade press. He went over to his grandfather's who was a grocer and read the Progressive Grocer magazine and he read articles on how to stock a meat department. He's gone to visit every company that he could find that was even slightly interesting to him. He went down to visit a barrel maker and spent hours talking about how to make barrels. He went to American Express and he spent hours talking about that business. He went to Geico and talked about the insurance business. He has stacks of reports on his desk from the companies he owns - stalls, jewellery, boat winches - everything you can imagine. He reads hundreds of annual reports every year from companies that he doesn't own yet because he just wants to understand their business and when the opportunity arises then he's ready and he can make a decision."

It's likely that Alice Schroeder knows Buffett as well as anyone. After meeting Buffett as an insurance analyst on Wall Street, he encouraged her to write the book about himself that he would never write. Schroeder was given almost unlimited access to Buffett, his friends and colleagues, in the process spending around 2,000 hours with him.

Here are some great insights on Buffett from a 2010 interview with Schroeder.. 

"His knowledge of business history, politics, and macroeconomics is both encyclopedic and detailed, which informs everything he does. If candy sales are up in a particular zip code in California, he knows what it means because he knows the demographics of that zip code and what’s going on in the California economy. When cotton prices fluctuate, he knows how that affects all sorts of businesses. And so on."

"You’re sitting there talking about something like: “Isn’t it amazing that after Jack Welch left GE, the company started having all these problems because of buried accounting issues?” and he will say, “Yes, that’s like …” and pull a company from 30 years prior and start spouting numbers.  Then he will pick another more recent company, and another."

"He has accumulated a filing cabinet of knowledge about companies, and it's very big."

"Through this vast network of connections that he's built, he's created a sort of database of information about business and the economy that's probably irreplaceable."

"[He is] able to pull elaborate modules out of his memory bank. He has thought about so many things over the years that there are polished nuggets prepared to respond to almost any question."

"If there is new information the old version gets overwritten. It’s gone. He remembers stories and certain facts, and the rest is discarded as if for efficiency or comfort."

"His way of articulating ideas is very original. He is a great synthesizer and especially strong at pattern recognition."

"Pattern recognition is one of his primary skills and perhaps his greatest skill. So in terms of data points, unlike many people who learn by seeking information on an as-needed basis, Warren is always looking for fuel for pattern recognition before he needs it."

"If you look at the dotcom stocks, the meta-message of that era was world-changing innovation. He went back and looked for more patterns of history when there was a similar meta-message, great bursts of technological innovation in canals, airplanes, steamboats, automobiles, television, and radio. Then he looked for sub-patterns and asked what the outcome was in terms of financial results.

With the dotcoms, people were looking to see what was different and unique about them. Warren is always thinking what’s the same between this specific situation and every other situation.

That is the nature of pattern recognition, asking: “What can I infer about this situation based on similarities to what I already know and trust that I understand?” Pattern recognition is his default way of thinking. It creates an impulse always to connect new knowledge to old and to primarily be interested in new knowledge that genuinely builds on the old…"

"I don’t want to dispel any notion of his intuition. But he has internalized so much information over the years and uses so many mental models (to quote a Mungerism) that they have coalesced into an almost visceral reaction to an investing situation. And this is what you strive for. It’s not mystical, even if you can’t verbalize your analysis. Much of his decision-making has sunk to almost the unconscious realm, it is so refined."

"Well, I think there are things you can do to improve recall. But there is something to be said about being born with a prodigious memory. It seems to me that there are 3 qualities of great investors that are rarely discussed:

1. They have a strong memory;

2. They are extremely numerate;

3. They have what Warren calls a “money mind;” an instinctive commercial sense.

Warren is all of these."

John Huber noted as much on his trip to Omaha:"Last week I was in Omaha for the Berkshire annual meeting, and while I sat there in the CenturyLink arena, I was thinking about Schroeder’s description while listening to Buffett rattle off trade deficit data from 1970 off the top of his head in response to a question. His mind is an incredible machine, and it appears to be working as well as ever."

Buffett draws on his extensive experience in both investing and managing businesses to help formulate his investment decisions. In an interview with Buffett post the Berkshire meeting, CNBC's Becky Quick made the point that the combination of Warren and Charlie have 181 years of experience! And in investing, all experience is cumulative - provided you learn from the experiences.

Becky Quick noted how easy Buffett and Charlie made it look up on stage and wondered how much longer they could do it. Buffett responded..

"It is easy, actually, at this point. At some point it won't be. But, no, I would say it's as easy now as ever. I mean, you didn't see me enter the [Berkshire fun run] race that took place or anything of the sort. This job doesn't really require hand-eye coordination or stamina or anything. You know, you just sit at a desk and you apply things that you learned 60 or 70 years ago and they come in a little different form now, maybe-- this way or that way. But-- it's the perfect job for somebody that wants to be working at 80 or 90."

We know that Buffett spends his days learning - reading, observing, and thinking. He talks to businesspeople and he collects facts; the resource from which he draws investment wisdom. It's the same approach adopted by Charles Darwin and Leonardi Da Vinci which we learnt about in recent posts.

"Look, my job is essentially just corralling more and more and more facts and information, and occasionally seeing whether that leads to some action." Warren Buffett

"One of the beauties of the business that Charlie and I are in, is that everything is cumulative. The stuff I learned when I was 20 is useful today. Not in necessarily the same way and not necessarily every day. But it’s useful. So you’re building a database in your mind that is going to pay off over time." Warren Buffett

"The beauty of — to some extent — of evaluating businesses — large businesses — is that it is all cumulative. If you started doing it 40 or so years ago, you really have got a working knowledge of an awful lot of businesses. But there aren’t that many, to start with, that you can get a fix. You know, how many — what are there? Seventy-five, maybe, or so important industries. And you’ll get to understand how they operate. And you don’t have to start over again every day. And you don’t have to consult a computer for it or anything like that, it. So it has the advantage of accumulation of useful information over time. And, you know, you just add the incremental bit at some point. You know, why did we decide to buy Coca-Cola in 1988? Well, it may have been, you know, just a couple small incremental bits of information. But that came into a mass that had been accumulated over decades." Warren Buffett

“Things we learned 40 years ago, though, will help [us] recognize the next big idea.” Warren Buffett

And Buffett remembers. The more he learns and the more he reads, the better he gets.

"Investing is kind of a game of connecting the dots. The nice thing about it is the longer you are in the business, as long as you are intellectually curious, your collection of data points of dots gets bigger and bigger. That is where someone like Warren is just incredible. He has had a passion for investing for well over 70 years. He started by the age of 10 or 12. He keeps building that library of data, the ability to recognize patterns in data." Ted Weschler

Coincidentally, I took up the twenty hours travel time getting to Omaha this year re-reading an old favourite book of mine; 'Moonwalking with Einstein - the Art and Science of Remembering Everything,' by Josh Foerr.  I was prompted to re-read it by a recent short post by Chris Pavese of Broyhill Capital on the book highlighting the link between memory, information and creativity.

The book tells the true story of how a rookie journalist's coverage of the US memory competition one year spurred his fascination with memory that led to a journey which culminated in entering and winning the US Memory competition the following year. It's an illuminating story showcasing how an average person can empower the mind to do extraordinary things.

Bill Gates described the book as absolutely phenomenal, and noted "Part of the beauty of this book is that it makes clear how memory and understanding are not two different things. Building up the ability to reason and the ability to retain information go hand in hand."

In the book, Foerr takes the opportunity to delve into the history of memory and the relationship between memory, learning and creativity.  It's uncanny, the commonalities with Buffett's skillsets. Take note of some extracts from the book below ...

"The brain is a muscle .. memory training is a form of mental workout. Over time, like any form of exercise, it's make the brain fitter, quicker, and more nimble. Roman orators argued that the art of memory - the proper retention and ordering of knowledge - was a vital instrument for the invention of new ideas."

"The nonlinear associative nature of our brains makes it impossible for us to consciously search our memories in an orderly way. A memory only pops directly into consciousness if it is cued by some other thought or perception - some other node in the nearly limitless interconnected web."

"What makes the brain such an incredible tool is not just the sheer volume of information it contains, but the ease and efficiency with which it can find that information. It uses the greatest random-access indexing system ever invented - one that computer scientists haven't come even close to replicating." 

"Experts see the world differently. They notice things that non-experts don't see. They home in on information that matters most, and have an almost automatic sense of what to do with it. And most important, experts process the enormous amounts of information flowing through their senses in more sophisticated ways."

"What we call expertise is really just 'vast amounts of knowledge, pattern based retrieval, and planning mechanisms acquired over many years of experience in the associated domain.' In other words, a great memory isn't just a by-product of expertise; it is the essence of expertise."

"Memory is primarily an imaginative process. In fact, learning, memory, and creativity are the same fundamental process directed with a different focus. The art and science of memory is about developing the capacity to quickly create images that link disparate ideas. Creativity is the ability to form similar connections between disparate images and to create something new and hurl it into the future so it becomes a poem, or a building, or a dance, or a novel. Creativity is, in a sense, future memory.

"If the essence of creativity is linking disparate facts and ideas, then the more facility you have making associations, and the more facts and ideas you have at your disposal, the better you'll be at coming up with new ideas."

"The notion that memory and creativity are two sides of the same coin sounds counter-intuitive. Remembering and creativity seem like opposite, not complimentary processes. But the idea that they are one and the same is actually quite old, and was once even taken for granted. The Latin root 'inventio' is the basis of two words in our modern English vocabulary: inventory and invention. Where do new ideas come from if not some alchemical blending of old ideas? In order to invent, one first needed a proper inventory, a bank of existing ideas to draw on. Not just an inventory, but an indexed inventory. One needed a way of finding just the right piece of information at just the right moment. This is what the art of memory was ultimately most useful for. It was not merely a tool for recording but also a tool of invention and composition.

"You can't have understanding without facts. And crucially, the more you know, the easier it is to know more. Memory is like a spiderweb that catches new information. The more it catches, the bigger it grows. And the bigger it grows, the more it catches."

"People who have more associations to hang their memories on are more likely to remember new things, which in turn means they will know more, and be able to learn more."

You can see how Buffett has, over the years, accumulated vast sums of information that, because he is always learning and reading and absorbing new data, he can recall fairly easily when he most needs. It's an incredible skill and one that is invariably available to us all. As I understand it, we tend to remember the things that most interest us, and if investing and business are high on that list, our ability to store and then recall relevant information should be relatively easy. Buffett succeeds because he relies on his physical memory rather than an artificial one stored in a computer. We too can utilise our natural gift of memory, but it will only work if information is stored in our own vertical filing cabinet in the first place. So we need to learn. Every day. And we do that by listening, and reading and talking and only then we will have something worth remembering.

Further Reading:
Investment Masters Class Post - 'Connecting the Dots'
Interview with Alice Schroeder [Microsoft Research]
Interview with Alice Schroeder 2010 [SimoleonSense]
Josh Foerr, 'Moonwalking with Einstein: The Art and Science of Remembering Everything'

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Buffett's Edge

“Defining what your game is, where you are going to have an edge is enormously important.” Warren Buffett

Every successful investor has an edge. And when I say 'edge', I'm referring to the difference we have that gives us an advantage in a situation. In investing, this could be a structural edge such as access to better information or low-cost permanent capital, or it may be an intellectual edge derived from creativity or lateral thinking or a psychological edge like emotional rigor or temperament. It could also mean having a longer time horizon than other investors, or even a better reputation. Outperformance as we know it is usually derived from a combination of more than one edge. 

"First answer the question, 'What's your edge?" Seth Klarman

"You have to figure out where you have an edge." Charlie Munger

I've long thought about the edges Warren Buffett has. These are his differences that he has utilized to allow him to deliver returns far in excess of the market indices; you don't compound capital at nearly 20%pa for over 50 years without some sort of serious edge. 

I've outlined the multitude of Buffett's edges below. There are probably others however these tend to define the key differences for me...

Reads & Thinks

“I insist on a lot of time being spent, almost every day, to just sit and think. That is very uncommon in American business. I read and think. So I do more reading and thinking, and make less impulse decisions than most people in business." Warren Buffett

Discipline

"An investor cannot obtain superior profits from stocks by simply committing to a specific investment category or style. He can earn them only by carefully evaluating facts and continuously exercising discipline." Warren Buffett

Unemotional

“If you’re emotional about investment you’re not going to do well.” Warren Buffett

“I can’t recall any time in the history of Berkshire that we made an emotional decision.” Warren Buffett

Loves Investing

“I get to do what I love to do every day.” Warren Buffett

No Distractions

"The best CEO's love operating their companies and don't prefer going to Business Round Table meetings or playing golf at Augusta National." Warren Buffett

"The wooden shutters on the [office] windows are always closed. You get no sense that a world exists outside, which is what he wants, no distractions. As far as I can tell, he doesn’t need sunlight." Alice Schroeder

No Ulterior Motives

“There’s nothing material I want very much.” Warren Buffett

Humility

“You gotta hit a few in the woods.” Warren Buffett

"You have to put mistakes behind you and not look back. Tomorrow is another day. Just go on to the next thing and strive to do your best." Warren Buffett

Optimism

“I was born in 1930 in my lifetime the real GDP per capita in the United States has increased six for one one person's lifetime. Nothing like it's ever happened and it isn't because we're smarter and it isn't because we work harder - it's because we have a system that unleashed human potential. It's a wonderful wonderful system and it and it's still working and it will keep working.” Warren Buffett

Learns from Mistakes

“One of the reason Warren’s so successful is that he is brutal in appraising his own past. He wants to identify mis-thinkings and avoid them in the future.” Charlie Munger

"It's good to learn from your mistakes. It's better to learn from other people's mistakes." Warren Buffett

A Learning Machine

“If you take Berkshire Hathaway, which is one of the best regarded corporations in the world and it may have the best long term investment record in the entire history of civilisation. The skill that got Berkshire through one decade, would not have sufficed to get it through the next decade with the achievements made. Without Warren Buffett being a continuous learning machine, the record would have been absolutely impossible.” Charlie Munger

Independent Thinker

“You will not be right simply because a large number of people momentarily agree with you. You will not be right simply because important people agree with you. You will be right over the course of many transactions, if your hypothesis are correct, your facts are correct, and your reasoning is correct.” Warren Buffett

Contrarian in Nature

“We have usually made our best purchases when apprehension about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.” Warren Buffett

"Berkshire buys when the lemmings are heading the other way." Warren Buffett

Age

"It's hard to believe that he's getting better with each passing year. It won't go on forever, but Warren is actually improving. It's remarkable: Most seventy-two-year-old men are not improving, but Warren is." Charlie Munger

Communication Skills

"We also believe candor benefits us as managers: The CEO who misleads others in public may eventually mislead himself in private." Warren Buffett

"By our policies and communications, we can encourage informed, rational behavior by owners that, in turn, will tend to produce a stock price that is also rational. Our it's-as-bad-to-be- overvalued-as-to-be-undervalued approach may disappoint some shareholders. We believe, however, that it affords Berkshire the best prospect of attracting long-term investors who seek to profit from the progress of the company rather than from the investment mistakes of their partners." Warren Buffett

[Buffett's skill in writing has helped him develop a rapport with Berkshire's shareholders. He's under no pressure to buy or sell assets or keep up with an index. He doesn't have to worry investors will pull their money. Unlike most managers, it has allowed him to maintain a long term focus].

Away from Wall Street

“If I was on Wall Street I’d probably be a lot poorer. You get overstimulated on Wall Street. You hear lots of things. You may shorten your focus and a short focus is not conducive to long profits. Here I can just focus on what businesses are worth. I don’t need to be in Washington to figure out what the Washington Post is worth, or be in New York to figure out what some other company is worth. Here I can just focus on what businesses are worth.” Warren Buffett

Value Approach

"As far as I can observe and speak to with statistics, there has only been one style which has reliably and safely brought investors exceptional long term returns: value investing. Today, Buffett has a 57-year track record." Li Lu

Generalist / Opportunistic

“Our rule is pure opportunism. If there is a masterplan somewhere in Berkshire, they’re hiding it from me. Not only do we not have a master plan, we don’t have a master planner.” Charlie Munger

"We do have a few advantages, perhaps the greatest being that we don't have a strategic plan. Thus we feel no need to proceed in an ordained direction (a course leading almost invariably to silly purchase prices) but can instead simply decide what makes sense for our owners." Warren Buffett

[Buffett doesn't have constraints such as benchmarks, indexes, asset types, time horizon, etc. There is no pressure to keep up with an index. As a private business owner, Buffett doesn't have to invest in any business if the return profile is unattractive. Furthermore, with a fortress balance sheet, Buffett is often sought out for transactions at times when others are constrained.]

Long Term Focus

"One factor that has caused some reluctance on my part to write semi-annual letters is the fear that partners may begin to think in terms of short-term performance which can be most misleading. My own thinking is much more geared to five year performance, preferably with tests of relative results in both strong and weak markets.” Warren Buffett

“I could do certain things to jiggle up the price of Berkshire - in the short run, that would not be good for the company over five or ten years. [I] could spin off one of our divisions, it might be a pretty big, hot division, but if it's a really good business, I just as soon a keep it for Berkshire. I am running the company for people who want to stick around, not for the ones who are leaving.” Warren Buffett

[Having a long term focus allows Buffett to allocate capital to businesses which may depress short term earnings at the expense of long term gains. When investing, he can focus on what a business will be earning and likely worth many years into the future without the pressure of short term performance.]

Sticks with What he Knows / Defined Filters

“I don’t need to make money in every game. I don’t know what coca beans are going to do. There are all kinds of things I don’t know about. That maybe too bad but why should I know all about them, I haven’t worked that hard on them.” Warren Buffett

"We do have filters. And sometimes those filters are very irritating to people who check in with us about businesses - because we really can say "no" in 10 seconds or so to 90%+ of all of the things that come along simply because we have these filters." Warren Buffett

"Typically, and this is not well understood, his [Buffett's] way of thinking is that there are disqualifying features to an investment. So he rifles through and as soon as you hit one of those it’s done. Doesn’t like the CEO, forget it. Too much tail risk, forget it. Low-margin business, forget it. Many people would try to see whether a balance of other factors made up for these things. He doesn’t analyze from A to Z; it’s a time-waster." Alice Schroeder

Thinks as a Businessman

“When we buy a stock, we always think in terms of buying the whole enterprise because it enables us to think as businessmen rather than stock speculators.” Warren Buffett

“I did a lot of work in the earlier years just getting familiar with businesses and the way I would do that is use what Phil Fisher would call, the ―Scuttlebutt Approach - I would go out and talk to customers, suppliers, and maybe ex-employees in some cases. Everybody." Warren Buffett

“Warren Buffett can always put himself in the shoes of the management team and analyze the situation from management teams point of view instead of his own point of view. I think it is not easy to always try to understand what others think because we are so used to only look at the world from our own perspectives.” Lei Zhang

Buys Simple Businesses He Understands

“We try to stick to businesses we believe we understand. That means they must be relatively simple and stable in character.” Warren Buffett

Insists on Good Management

"In making both control purchases and stock purchases, we try to buy not only good businesses, but ones run by high-grade, talented and likable managers." Warren Buffett

Picking People

"Buffett has a near 100% track record in picking managers which tells me it must be possible to pick good managers. We tend to overestimate our ability to forecast financials and underestimate the role of people and our ability to spot them.” Robert Vinall

“[Buffett’s] trick of management is to find obsessed perfectionists like himself who worked incessantly, then ignore them except for a ‘Carnegizing’- attention, admiration, and Dale Carnegie’s other techniques - every now and then.” Alice Schroeder

Conservative assumptions

“.. take all of the variables and calculate ‘em reasonably conservatively .. don’t focus too much on extreme conservatism on each variable in terms of the discount rate and the growth rate and so on; but try to be as realistic as you can on these numbers, with any errors being on the conservative side. And then when you get all through, you apply the margin of safety.” Warren Buffett

Access to Information

"We have dozens and dozens and dozens of businesses. I've always said I'm a better investor because I've had experience in business and better businessman because I've had experience in investments. Berkshire is about as good a place as you can find to really understand competitive dynamics and all that." Warren Buffett

"There is almost no industry Berkshire doesn't touch in one form or another. I can't count the number of times when I'm looking at something and pick up the phone and talk to [one of our CEOs] and if it's in any one of their adjacent industries, they know more about it in 15 minutes than an investor can learn in a lifetime." Todd Combs

Looks at Price Last

“I always like to look at investments without knowing the price – because if you see the price, it automatically has some influence on you.” Warren Buffett

Doesn't Disclose Positions

“We cannot talk about our current investment operations. Such an “open mouth” policy could never improve our results and in some situations could seriously hurt us. For this reason, should anyone, including partners, ask us whether we are interested in any security, we must plead the “5th Amendment.” Warren Buffett

Buys Established, Predictable, Quality Businesses

"Experience indicates that the best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago." Warren Buffett

“At Berkshire we will stick with businesses whose profit picture for decades to come seems reasonably predictable.” Warren Buffett

"It must be noted that your Chairman, always a quick study, required only 20 years to recognize how important it was to buy good businesses. In the interim, I searched for "bargains" - and had the misfortune to find some. My punishment was an education in the economics of short-line farm implement manufacturers, third-place department stores, and New England textile manufacturers." Warren Buffett

Controls Capital Allocation

Buffett gets to decide where and when the companies he controls direct their capital. Businesses with solid re-investment opportunities receive capital, while other businesses, while they maybe highly profitable don’t have those allocation opportunities.

“When we control a company we get to allocate capital, whereas we are likely to have little or nothing to say about this process with marketable holdings.” Warren Buffett

“Buffett solves the reinvestment conundrum unlike almost any other business we know of. Sure, Buffett can allow CEOs to reinvest in carpets or bricks – but only if the CEO can convince Buffett that these reinvestment opportunities are superior to Buffett’s exceptionally wide canvas of reinvestment opportunities.” David Rolfe

No Committees / Groupthink

"As your company gets larger and larger and you have larger groups making decisions, the decisions get more homogenised. I don't think you will ever get brilliant investment decisions out of a large committee." Warren Buffett

"We try very hard, Charlie and I, not to get eager to do a deal [ie acquisition]. We’re just eager to do a deal that makes sense. And that would be a lot harder if we had directors, strategy departments, whatever it might be, all pushing us toward, you know. So the setting in which you operate really can be very important." Warren Buffett

Aligned Shareholders

“Boredom is a problem with most professional money managers. If they sit out an inning or two, not only do they get somewhat antsy, but their clients start yelling ‘swing you bum’ from the stands.” Warren Buffett

"We do not view Berkshire shareholders as faceless members of an ever-shifting crowd, but rather as co-venturers who have entrusted their funds to us for what may well turn out to be the remainder of their lives." Warren Buffett

"We have an ownership structure that is probably more stable than any company our size, or anywhere near our size, in the country. And that’s attractive to people." Warren Buffett

Avoids Leverage

"Borrowed money has no place in the investor’s tool kit: Anything can happen anytime in markets." Warren Buffett

Maintains Significant Cash

"There will be some incident, it could be tomorrow. At that time, you need cash. Cash at that time is like oxygen. When you don't need it, you don't notice it. When you do need it, it's the only thing you need. We operate from a level of liquidity that no one else does." Warren Buffett

"The ability to say 'yes' very quickly [in turbulent times] with very large sums sets you apart from virtually anybody in the investing universe." Warren Buffett

No Guidance to Hit / Analysts to Please

"We do not follow the usual practice of giving earnings 'guidance.'" Warren Buffett

"We’ve not had to bow to any of the urgings of Wall Street or, you know, whatever may be the fad of the day." Warren Buffett

Zero Cost Permanent Capital

"Berkshire has access to two low-cost, non-perilous sources of leverage that allow us to safely own far more assets than our equity capital alone would permit: deferred taxes and "float," the funds of others that our insurance business holds because it receives premiums before needing to pay out losses." Warren Buffett

"Well obviously there was a little leverage buried in the Berkshire numbers. Obviously the insurance business provided some of that. It’s not over-whelming in its consequences." Charlie Munger

Better yet, this funding to date has been cost-free. Deferred tax liabilities bear no interest. And as long as we can break even in our insurance underwriting - which we have done, on the average, during our 32 years in the business - the cost of the float developed from that operation is zero. Neither item, of course, is equity; these are real liabilities. But they are liabilities without covenants or due dates attached to them. In effect, they give us the benefit of debt - an ability to have more assets working for us - but saddle us with none of its drawbacks." Warren Buffett

"[If your float costs you zero it's like] free money, it’s worth a lot of money. And that growth [in float] has not, probably, generally, been appreciated fully in connection with Berkshire nor has the interplay of how having zero-cost money, in terms of affecting our gain in value over time. People have looked at — always looked at our asset side, but they haven’t paid as much attention to the liability side." Warren Buffett

Berkshire's insurance operations have their own significant edges versus competitors, including the absence of pressure to grow premiums if/when pricing is unattractive, the ability to write premiums no other insurer has the balance sheet to write [a size advantage], speed of response time, lack of bureaucracy, lowest costs (Geico), ability to accept fluctuating earnings etc ....

"I would say that the main difference between our practice and that of most other people is that we are deliberately seeking a method of operation which will give us occasional big losses in a single year, big overall losses. And everybody else is trying to avoid that. And we just want to be rich enough so a big loss in a single year is a blip. And that’s a competitive advantage, that willingness to endure fluctuating annual results." Charlie Munger

“The reaction of other people when premiums are wrong is to take more risk. And our reaction when premiums are wrong is just to go play golf or something and tell somebody to call us when premiums get right again.” Warren Buffett

"We have promised people, at all of our insurance operations, that we will never have layoffs because of a drop in volume. We do not want the people who run our insurance business to feel they have to write X dollars in order to keep everybody there." Warren Buffett

No Mark to Market on Wholly Owned Businesses

"Our equity holdings have fallen considerably as a percentage of our net worth, from an average of 114% in the 1980's, for example, to less than 50% in recent years. Therefore, yearly movements in the stock market now affect a much smaller percentage of our net worth than was once the case, a fact that will normally cause us to underperform in years when stocks rise substantially and over perform in years when they fall." Warren Buffett 2004

[While Berkshire owns marketable securities that fluctuate with markets, wholly owned subsidiaries are not marked to market. On a short term basis this limits exposure to large stock market declines. Over the long term, it's the business performance that drives returns. Buffett focuses on the earnings of the businesses he owns not the share prices]

Avoids Potential Blow-Ups / Focuses on Downside

“If we can’t tolerate a possible consequence, remote though it may be, we steer clear of plantings its seeds.” Warren Buffett

Avoids Turnarounds, Start-Ups and IPO's

"Start-ups are not our game." Warren Buffett

"I've never swung at a ball while it's still in the pitcher's glove." Warren Buffett

“After 25 years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them.” Warren Buffett

“It’s almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors).” Warren Buffett

Ethical

“Both of us [Warren] know that we’ve done better by having ethics.” Charlie Munger

Seeks Win-Win Outcomes

“He [Buffett] wanted win/win results everywhere - in gaining loyalty by giving it, for instance." Charlie Munger

Good Home for Businesses

"We have some significant advantages in buying businesses over time. We would be the preferred purchaser, I think, for a reasonable number of private companies and public companies as well." Warren Buffett

"I won’t close down businesses of sub-normal profitability merely to add a fraction of a point to our corporate rate of return. However, I also feel it inappropriate for even an exceptionally profitable company to fund an operation once it appears to have unending losses in prospect. Adam Smith would disagree with my first proposition, and Karl Marx would disagree with my second; the middle ground is the only position that leaves me comfortable." Warren Buffett

"We are also very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations. We hope not to repeat the capital-allocation mistakes that led us into such sub- par businesses." Warren Buffett

“You can sell it to Berkshire, and we’ll put it in the Metropolitan Museum; it’ll have a wing all by itself; it’ll be there forever. Or you can sell it to some porn shop operator, and he’ll take the painting and he’ll make the boobs a little bigger and he’ll stick it up in the window, and some other guy will come along in a raincoat, and he’ll buy it.” Warren Buffett

"Big private acquisitions are going to come to Berkshire because they want to come to Berkshire. And that’s a significant competitive edge, and I don’t see how anybody really challenges us on that." Warren Buffett

"We can promise that we won’t sell their business, for example, if it turns out to be disappointing, as long as it doesn’t run into the prospect of continuing losses or having significant labor problems. But we keep — we are keeping — certain businesses that you would not get a passing grade at business school on if you wrote down our reasons for keeping them. We promise the managers, you know, that they are going to continue to run their businesses. And believe me, if we didn’t do it, the word would get around on that very quickly. But we’ve been doing it now for 49 years. And we’ve put ourselves in a class that is hard for other people to compete with, if that’s important to the seller of a business." Warren Buffett

"Financial profit was not the key to ISCAR's sale. We wanted to ensure that ISCAR could continue to grow, and we saw Warren Buffett as the person who would help achieve that.. In truth, the money - $4b for 80% of ISCAR - was not the most important consideration for us in this deal .. I liked the fact that Buffett does not operate in the stock market as a speculator but as an investor. He does not look for a rapid profit but instead for stability and growth potential in the companies he acquires. He has said that he buys businesses, not stocks, they are businesses he wants to own forever. For us, the deal was more than a tribute to the unique value of the company I had founded fifty-four years earlier with an old lathe in our two-room apartment in Nahariya." Stef Werthheimer

"There seem to be enough people that have built businesses lovingly over 50 or 100 years, and their parents before them and grandparents, that really do care about the eventual disposition of them in some way beyond getting the last dollar that day, that we have a supply from time to time of those businesses. And I think we’ll continue to see them." Warren Buffett

“For somebody that’s built up their company over 20 or 30 or 40 years — and maybe their father or grandfather built it up even before that — some of those people care about where their businesses go. They’re very rich, they’ve accomplished all kinds of things in life. And they don’t want to build up something which somebody else tears apart very quickly believe they handing it over to a few MBAs who want to show their stuff. So, we do have a unique — close to a unique — asset at Berkshire. And as long as we behave properly, we will maintain that asset. And really, no one else will have much luck in competing with us.” Warren Buffett

[Over time Buffett has attracted more and more quality businesses to join Berkshire. Business founders often prioritize legacy, staff morale, business continuity and management independence above financial gain. Buffett has developed an enviable track record and a reputation as an ethical, discreet, and timely buyer who will maintain a business for the long term. A seller won't be at risk from funding conditions or onerous due diligence requirements or conditions.

"We have a significant advantage, and it gets bigger as we get bigger, because, in terms of big deals, people rely more and more often on process [ie due diligence requirements] in that when people want to get a deal done, they want to know it’s going to be done, they will come to us." Warren Buffett

"We’re so peculiar that there actually are a good number of businesses in America where they prefer selling to us than to other people. That’s very helpful." Charlie Munger

Buffett doesn't participate in auctions (another edge!) and is often the only party to be offered the businesses he buys. The counter to this is that negotiated private asset sales are rarely done at knock-down prices as they occasionally are in the stock market .. Buffett notes .. "You will never make the kind of buy in a negotiated purchase that you can in a bad market— that you can make via stocks in a stock — in a weak stock market. It just isn’t going to happen." ]

Disadvantages

While the list of Buffett's edges is long and I'm sure you can think of others, he does have some headwinds. While size can be an advantage in terms of writing insurance deals no-one else can or seeing business opportunities …

“The one thing about Berkshire is that we do get some opportunities that other people don’t get. If you’re 3G and want a partner for you’re next deal, who in the hell are you going to come to? We know, they know we’re a good partner, so we see stuff other people don’t see. That helps” Charlie Munger

It is also a major disadvantage … 

"The biggest disadvantage we have is size." Warren Buffett

Another is the fact he doesn't close under-performing businesses - that's the likely cost of seeing more private opportunities. He's also conservative. Carrying more debt would have generated even more returns, but it could also have led to the permanent loss of capital. And that would have broken Buffett's first rule: Don't lose money.

Summary

Many of Buffett's edges are available to all investors. He certainly doesn't hide them; he's been writing about them for the last 50 years. But there's one other edge I haven't mentioned, and it could be the most important of all - Charlie Munger. And what an edge that is. Buffet has given us much in the way of learning over those 50 years, and Charlie has as much and more to teach. And if you're looking for more, you could certainly start with him. 

Further Reading: Charlie Munger 50th Anniversary Letter

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Buffett's Annual Letter - 2017

Warren Buffett's annual Berkshire Hathaway letter was released after the market closed on Friday. Like a lot of things Buffett, this is unconventional. Buffett wants to ensure analysts and his investors, or 'partners' as he considers them, have ample time to study the letter before trading re-commences Monday. 

Buffett's genius is not only his stock picking ability, business acumen and all-round investing prowess, but his communication skills. In his annual letters, Buffett talks to the average layperson, often conveying complex issues with both clarity and humour.

"Do not try to impress by big words. Impress by the clarity of your ideas." Lee Kuan Yew

"The definition of genius is taking the complex and making it simple." Albert Einstein

A year or so ago I took the time to read all of the Berkshire Letters, beginning to end. I found so many nuggets of wisdom - which formed part of a series of posts I wrote titled 'The Buffett Series' . 

It continues to amaze me that so few business schools spend the time to study the lessons of arguably the world's greatest investor. These lessons are a gift to investors.

"I think almost anybody can draw [on the] lessons from Warren’s achievement at Berkshire. The interesting thing is you could go to the top business schools and none are studying and teaching what Warren has done." Charlie Munger

"The fact that everyone who cares about business and finance can benefit from his wisdom - just by reading his annual letters - is pretty amazing" Bill Gates

Once again Buffett this year lays out in simple terms how Berkshire performed over the past year, provides some insights into the environment, and enlightens us with some investment guidance.

So let's take a quick look at this year's letter ....

Buffett's 2017 Gain in Book Value was 23%, Berkshire Market Value gain 21.9%, S&P500 21.8%.

"Berkshire’s gain in net worth during 2017 was $65.3 billion, which increased the per-share book value of both our Class A and Class B stock by 23%. Over the last 53 years (that is, since present management took over), per share book value has grown from $19 to $211,750, a rate of 19.1% compounded annually"

Buffett notes prices of Stand-Alone Business are at an all-time high ....

"In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price. 

That last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers."

"The ample availability of extraordinarily cheap debt in 2017 further fuelled purchase activity [by competitors]. After all, even a high-priced deal will usually boost per-share earnings if it is debt-financed."

"If the historical performance of the target falls short of validating its acquisition, large “synergies” will be forecast. Spreadsheets never disappoint."

"We also never factor in, nor do we often find, synergies." 

On Insurance Float ..

"Unlike bank deposits or life insurance policies containing surrender options, p/c float can’t be withdrawn. This means that p/c companies can’t experience massive “runs” in times of widespread financial stress, a characteristic of prime importance to Berkshire that we factor into our investment decisions."

"The downside of float is that it comes with risk, sometimes oceans of risk. What looks predictable in insurance can be anything but. Take the famous Lloyds insurance market, which produced decent results for three centuries. In the 1980’s, though, huge latent problems from a few long-tail lines of insurance surfaced at Lloyds and, for a time, threatened to destroy its storied operation. (It has, I should add, fully recovered.)"

Thoughts on Hurricane Losses ..

"My guess at this time is that the insured losses arising from the hurricanes are $100 billion or so. That figure, however, could be far off the mark. The pattern with most mega-catastrophes has been that initial loss estimates ran low. As well-known analyst V.J. Dowling has pointed out, the loss reserves of an insurer are similar to a self-graded exam. Ignorance, wishful thinking or, occasionally, downright fraud can deliver inaccurate figures about an insurer’s financial condition for a very long time."

Buffett is holding a lot of Cash ... 

"At year end Berkshire held $116.0 billion in cash and U.S. Treasury Bills (whose average maturity was 88 days), up from $86.4 billion at yearend 2016. This extraordinary liquidity earns only a pittance and is far beyond the level Charlie and I wish Berkshire to have. Our smiles will broaden when we have redeployed Berkshire’s excess funds into more productive assets."

Buffett sees stocks as interests in businesses... 

"Charlie and I view the marketable common stocks that Berkshire owns as interests in businesses, not as ticker symbols to be bought or sold based on their “chart” patterns, the “target” prices of analysts or the opinions of media pundits. Instead, we simply believe that if the businesses of the investees are successful (as we believe most will be) our investments will be successful as well. Sometimes the payoffs to us will be modest; occasionally the cash register will ring loudly. And sometimes I will make expensive mistakes. Overall – and over time – we should get decent results. In America, equity investors have the wind at their back."

Eventually Valuation Matters ... 

"Stocks surge and swoon, seemingly untethered to any year-to-year buildup in their underlying value. Over time, however, Ben Graham’s oft-quoted maxim proves true: “In the short run, the market is a voting machine; in the long run, however, it becomes a weighing machine.”

Stocks can be Volatile, so avoid Debt ...

"Berkshire, itself, provides some vivid examples of how price randomness in the short term can obscure long- term growth in value. For the last 53 years, the company has built value by reinvesting its earnings and letting compound interest work its magic. Year by year, we have moved forward. Yet Berkshire shares have suffered four truly major dips. Here are the gory details:

This table offers the strongest argument I can muster against ever using borrowed money to own stocks. There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions."

In the next 53 years our shares (and others) will experience declines resembling those in the table. No one can tell you when these will happen. The light can at any time go from green to red without pausing at yellow.

When major declines occur, however, they offer extraordinary opportunities to those who are not handicapped by debt. That’s the time to heed these lines from Kipling’s If:

“If you can keep your head when all about you are losing theirs . . . If you can wait and not be tired by waiting . . .
If you can think – and not make thoughts your aim . . .
If you can trust yourself when all men doubt you . . .
Yours is the Earth and everything that’s in it.”

Buffett tallies his bet against Hedge Funds versus the S&P500 with Protégé Partners..

"Performance comes, performance goes. Fees never falter."

"The bet illuminated another important investment lesson: Though markets are generally rational, they occasionally do crazy things. Seizing the opportunities then offered does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors then need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period – or even to look foolish – is also essential."

Buffett and the counter-party to his bet, Protege, funded their portion of the prize by purchasing zero-coupon bonds.. 

"Protégé and I originally intended to do no more than tally the annual returns and distribute $1 million to the winning charity when the bonds matured late in 2017.

After our purchase, however, some very strange things took place in the bond market. By November 2012, our bonds – now with about five years to go before they matured – were selling for 95.7% of their face value. At that price, their annual yield to maturity was less than 1%. Or, to be precise, .88%.

Given that pathetic return, our bonds had become a dumb – a really dumb – investment compared to American equities. Over time, the S&P 500 – which mirrors a huge cross-section of American business, appropriately weighted by market value – has earned far more than 10% annually on shareholders’ equity (net worth)."

Buffett sold the zero's in 2012 and put the money into Berkshire .. he also won the bet ... 

"The result: Girls Inc. of Omaha found itself receiving $2,222,279 last month rather than the $1 million it had originally hoped for."

Buffett expands on Bonds as an investment .. 

"I want to quickly acknowledge that in any upcoming day, week or even year, stocks will be riskier – far riskier – than short-term U.S. bonds. As an investor’s investment horizon lengthens, however, a diversified portfolio of U.S. equities becomes progressively less risky than bonds, assuming that the stocks are purchased at a sensible multiple of earnings relative to then-prevailing interest rates.

It is a terrible mistake for investors with long-term horizons – among them, pension funds, college endowments and savings-minded individuals – to measure their investment “risk” by their portfolio’s ratio of bonds to stocks. Often, high-grade bonds in an investment portfolio increase its risk."

And finally keep it simple ... 

"A final lesson from our bet: Stick with big, “easy” decisions and eschew activity. During the ten-year bet, the 200-plus hedge-fund managers that were involved almost certainly made tens of thousands of buy and sell decisions. Most of those managers undoubtedly thought hard about their decisions, each of which they believed would prove advantageous. In the process of investing, they studied 10-Ks, interviewed managements, read trade journals and conferred with Wall Street analysts."

Buffett concludes ... "Come to Omaha – the cradle of capitalism – on May 5th and meet the Berkshire Bunch. All of us look forward to your visit."..  I also hope to see you there!

Source: Berkshire Hathaway 2017 - Warren Buffett Letter

Buffett on Insurance

What's the one commodity that we all want to have, but desperately hope we never have to use? That one product that provides a sense of reassurance and peace of mind, yet in many instances remains untouched by us for its life? That one safety net that we are happy to continue to pay large for, yet rarely implement?

Insurance.

On a Saturday in January, 1951, a young Warren Buffett caught the train from New York to Washington DC and headed to the Government Employees' Insurance Company's [GEICO] downtown headquarters. He had learnt that his hero from Columbia University, Ben Graham, was the Chairman. I'll let Buffett finish the story .... 

"To my dismay, the building was closed, but I pounded on the door until a custodian appeared. I asked this puzzled fellow if there was anyone in the office I could talk to, and he said he'd seen one man working on the sixth floor.

And thus I met Lorimer Davidson, Assistant to the President, who was later to become CEO. Though my only credentials were that I was a student of Graham's, "Davy" graciously spent four hours or so showering me with both kindness and instruction. No one has ever received a better half-day course in how the insurance industry functions nor in the factors that enable one company to excel over others. As Davy made clear, GEICO's method of selling - direct marketing - gave it an enormous cost advantage over competitors that sold through agents, a form of distribution so ingrained in the business of these insurers that it was impossible for them to give it up. After my session with Davy, I was more excited about GEICO than I have ever been about a stock."

It was a fortuitous meeting ... Buffett tells the Berkshire shareholders .. "Berkshire would not be where it is today if Davy had not been so generous with his time on a cold Saturday in 1951."

Like any type of investing, investing in insurance companies requires a solid understanding of the intricacies of the industry. Given it's specialised nature, it generally sits outside most investors circle of competence.  

An insurance company differs from your typical manufacturer or service corporation. The positive differentiating characteristics were well encapsulated by John Rothchild, in the book 'The Davis Dynasty', which chronicles another of the last centuries' great insurance investors - Shelby Davis. 

"Insurance companies enjoyed some terrific advantages, as compared to manufacturers. Insurers offered a product that never went out of style. They profited from investing their customers' money. They didn't require expensive factories or research labs. They didn't pollute. They were recession-resistant. During hard times, consumers delayed expensive purchases (houses, cars, appliances, and so on), but they couldn't afford to let their home, auto, and life insurance policies lapse. When a sour economy forced them to economize, people drove fewer miles, caused fewer accidents, and filed fewer claims-a boom to auto insurers. Because interest rates tend to fall in hard times, insurance companies' bond portfolios become more valuable. These factors liberated insurers' earnings from the normal business cycle, and made them generally recession-proof."

That's not to say it's all positive; there are plenty of pitfalls to be aware of. Over the last half century Warren Buffett has himself generously shared his wisdom on the insurance industry in the annual Berkshire letters and meetings. While far from all encompassing, this post draws on those letters to highlight some of the nuances and the positive and negative aspects of the insurance industry.

What is Insurance?

"Simply put, insurance is the sale of promises. The “customer” pays money now; the insurer promises to pay money in the future if certain events occur. Sometimes, the promise will not be tested for decades (Think of life insurance bought by those in their 20s.)" 

Limited Obsolescence

"Insurance will always be essential for both businesses and individuals.”

Low Historic Correlation

"[Our insurance groups produces earnings] that are not correlated to those of the general economy [delivering] outstanding results in 2008 and have excellent prospects.”

Float

"Float arises because premiums are received before losses are paid, an interval that sometimes extends over many years. During that time, the insurer invests the money."

"There is very little “Berkshire-quality” float existing in the insurance world." 

Combined Ratio

"The combined ratio represents total insurance costs (losses incurred plus expenses) compared to revenue from premiums: A ratio below 100 indicates an underwriting profit, and one above 100 indicates a loss."

Cost of Float

"Our cost of float is determined by our underwriting loss or profit. In those years when we have had an underwriting profit, our cost of float has been negative. In effect, we have been paid for holding money."

"Because loss costs must be estimated, insurers have enormous latitude in figuring their underwriting results, and that makes it very difficult for investors to calculate a company's true cost of float. Errors of estimation, usually innocent but sometimes not, can be huge. The consequences of these miscalculations flow directly into earnings."

"Since our float has cost us virtually nothing over the years, it has in effect served as equity."  

Capped Insurance

"There’s a couple things you can’t cap in insurance. You can’t cap workers’ compensation losses. I mean, they —you can as a reinsurer, but I mean, the primary insurer can’t do that. I believe in auto, for example, in the U.K., that it’s uncapped. And I think that nobody thought that was very serious until they had a recent accident that caused — I think it involved a car doing something that — an auto doing something to a train that was unbelievable. So there are a few areas where insurance is written on an uncapped basis. And in our case, we write some auto insurance in the U.K. and we write some workers’ compensation, primarily in California. But generally, in the reinsurance business, you are capping the liabilities you take on."

What Gives an Insurance Business Value?

"An insurance business has value if its cost of float over time is less than the cost the company would otherwise incur to obtain funds. But the business is a lemon if its cost of float is higher than market rates for money."

How to Evaluate an Insurance Company

"How to evaluate an insurance company - The key determinants are: (1) the amount of float that the business generates; (2) its cost; and (3) most important of all, the long-term outlook for both of these factors."

"Only by making an analysis that incorporates both underwriting results and the current risk-free earnings obtainable from float can one evaluate the true economics of the business that a property-casualty insurer writes."

Four Disciplines to a Sound Insurance Operation

"At bottom, a sound insurance operation needs to adhere to four disciplines. It must (1) understand all exposures that might cause a policy to incur losses; (2) conservatively assess the likelihood of any exposure actually causing a loss and the probable cost if it does; (3) set a premium that, on average, will deliver a profit after both prospective loss costs and operating expenses are covered; and (4) be willing to walk away if the appropriate premium can’t be obtained."

Where Most Insurers Go Wrong

"Many insurers pass the first three tests [above] and flunk the fourth. They simply can’t turn their back on business that is being eagerly written by their competitors. That old line, “The other guy is doing it, so we must as well,” spells trouble in any business, but in none more so than insurance."

Good Underwriting

"A good underwriter needs an independent mindset akin to that of the senior citizen who received a call from his wife while driving home. “Albert, be careful,” she warned, “I just heard on the radio that there’s a car going the wrong way down the Interstate.” “Mabel, they don’t know the half of it,” replied Albert, “It’s not just one car, there are hundreds of them.”

Growth

"Any insurer can grow rapidly if it gets careless about underwriting."

'We shrank - and we will do so again from time to time in the future. Our large swings in volume do not mean that we come and go from the insurance marketplace. Indeed, we are its most steadfast participant, always standing ready, at prices we believe adequate, to write a wide variety of high-limit coverages."

“Anybody can generate float. I mean, if we gave our managers a goal of generating 5 billion of float next year, they could do it in a minute, you know, and we would be paying the price for decades to come. You can write dumb insurance policies, you know. There’s an unlimited market for dumb insurance policies. And they’re very pleasant, because the first day the premium comes in and that’s the last time you see any new money. From then on, it’s all going out. And that’s not our aim in life.”

Losses

"There are a lot of ways to lose money in insurance, and the industry is resourceful in creating new ones."

Pricing

"No matter what others may do, we will not knowingly write business at inadequate rates."

"Appropriate prices don’t guarantee profits in any given year, but inappropriate prices most certainly guarantee eventual losses. 

“The reaction of other people when premiums are wrong is to take more risk. And our reaction when premiums are wrong is just to go play golf or something and tell somebody to call us when premiums get right again.”

“You can do enormous damage in the insurance business with a pen.”

Interest Rates

"As interest rates have fallen, however, the value of float has substantially declined."

Surprises

"Virtually all surprises in insurance are unpleasant ones."

"Surprises in insurance are far from symmetrical. You are lucky if you get one that is pleasant for every ten that go the other way."

Unlimited Policies

"We write huge limits. We’re the biggest — you know, if somebody wants to write a huge limit, or an unusual limit, they should call us. Because there’s no one else in the world that will act as big or as promptly as we will. But we don’t write things that are unlimited.

Now, the interesting thing is that the biggest exposures, in our view, are the people that write a lot of primary business and don’t have the catastrophe cover they need. I mean, if you write 10 percent of all the business in homeowners on — or 15 percent — on Long Island or in Florida, I mean, you are writing a catastrophe cover that would blow your mind.

If you’re Freddie Mac or Fannie Mae and you’re guaranteeing mortgages, you know, for millions of people in areas like that, and they don’t have insurance — earthquake in California or property insurance in Florida — they’d be less likely to have earthquakes someplace — you are taking on enormous risks.

I mean, huge risks, far beyond what we would ever take on. They just — but you don’t get paid for them, unfortunately... So, there are all kinds of risks that can aggregate in huge ways that companies are not thinking about at all. In insurance, the unthinkable always happens.”

P&C Businesses

"One reason we were attracted to the P/C business was its financial characteristics: P/C insurers receive premiums upfront and pay claims later. In extreme cases, such as those arising from certain workers’ compensation accidents, payments can stretch over many decades. This collect-now, pay-later model leaves P/C companies holding large sums – money we call “float” – that will eventually go to others. Meanwhile, insurers get to invest this float for their own benefit. Though individual policies and claims come and go, the amount of float an insurer holds usually remains fairly stable in relation to premium volume. Consequently, as our business grows, so does our float."

"Unfortunately, the financial statements of a property/casualty insurer provide, at best, only a first rough draft of earnings and financial condition."

"The determination of costs is the main problem. Most of an insurer’s costs result from losses on claims, and many of the losses that should be charged against the current year’s revenue are exceptionally difficult to estimate. Sometimes the extent of these losses, or even their existence, is not known for decades."

“Surprises in the P/C business – which can occur decades after six-month or one-year policies have expired – are almost always negative. The industry’s accounting is designed to recognize this reality, but estimation mistakes can be huge. And when charlatans are involved, detection is often both slow and costly. Berkshire will always attempt to be accurate in its estimates of future loss payments but inflation – both monetary and the “legal” variety – is a wild card.”

Casualty vs Property Lines of Insurance

"Because our business is weighted toward casualty and reinsurance lines, we have more problems in estimating loss costs than companies that specialize in property insurance (When a building that you have insured burns down, you get a much faster fix on your costs.)”

Long vs Short Tail

"The industry calls malpractice and certain other kinds of liability insurance "long- tail" business, in recognition of the extended period during which insurers get to hold large sums that in the end will go to claimants and their lawyers.”

"In long-tail situations a [higher] combined ratio can prove profitable, since earnings produced by the float will exceed the [amount] by which claims and expenses overrun premiums. The catch, though, is that "long-tail" means exactly that: Liability business written in a given year and presumed at first to have produced a [acceptable] combined ratio may eventually smack the insurer with 200, 300 or worse when the years have rolled by and all claims have finally been settled."

"We write lots of "long-tail" business - that is, policies generating claims that often take many years to resolve. Examples would be product liability, or directors and officers liability coverages. With a business mix like this, one year of reserve development tells you very little."

"The unpredictability of our legal system makes it impossible for even the most conscientious insurer to come close to judging the eventual cost of long-tail claims."

"In a given year, it is possible for an insurer to show almost any profit number it wishes, particularly if it (1) writes “long-tail” business (coverage where current costs can be only estimated, because claim payments are long delayed), (2) has been adequately reserved in the past, or (3) is growing very rapidly. 

"Where "earnings" can be created by the stroke of a pen, the dishonest will gather. For them, long-tail insurance is heaven."

No Optimists

“We have learned – too often, painfully – a good deal about what types of insurance business and what sort of people to avoid. The most important lesson is that our underwriters can be thin, fat, male, female, young, old, foreign or domestic. But they can’t be optimists at the office, however desirable that quality may generally be in life.”

Proper Reserves

"When insurance executives belatedly establish proper reserves, they often speak of "reserve strengthening," a term that has a rather noble ring to it. They almost make it sound as if they are adding extra layers of strength to an already-solid balance sheet. That’s not the case: instead the term is a euphemism for what should more properly be called "correction of previous untruths" (albeit non-intentional ones)."

Investment Assets

“It’s always struck me as terribly illogical, the way property-casualty insurance companies are run, because they’ve been dominated by the underwriting side of the business. And here they have this important investment side, but it’s always been — virtually every company’s been subservient to the underwriting.”

Commodity Product

“The ordinary insurance company is not a good business.”

"The insurance industry is cursed with a set of dismal economic characteristics that make for a poor long-term outlook: hundreds of competitors, ease of entry, and a product that cannot be differentiated in any meaningful way. In such a commodity-like business, only a very low-cost operator or someone operating in a protected, and usually small, niche can sustain high profitability levels.”

"Many insureds, including the managers of large businesses, do not even know the names of their insurers.) Insurance, therefore, would seem to be a textbook case of an industry usually faced with the deadly combination of excess capacity and a “commodity” product."

"Most insureds don’t care from whom they buy. Customers by the millions say “I need some Gillette blades” or “I’ll have a Coke” but we wait in vain for “I’d like a National Indemnity policy, please.”

"Insurers have generally earned poor returns for a simple reason: They sell a commodity-like product." 

"Insurance companies offer standardized policies which can be copied by anyone. Their only products are promises. It is not difficult to be licensed, and rates are an open book. There are no important advantages from trademarks, patents, location, corporate longevity, raw material sources, etc., and very little consumer differentiation to produce insulation from competition."

Industry Economics

"Market share is not an important determinant of profitability: In this business, in
contrast to the newspaper or grocery businesses, the economic rule is not survival of the fattest. Second, in many sectors of insurance, including most of those in which we operate, distribution channels are not proprietary and can be easily entered: Small volume this year does not preclude huge volume next year. Third, idle capacity - which in this industry largely means people - does not result in intolerable costs. In a way that industries such as printing or steel cannot, we can operate at quarter-speed much of the time and still enjoy long-term prosperity."

Industry Pricing

"Pricing behaviour in the insurance industry continues to be exactly what can be expected in a commodity-type business. Only under shortage conditions are high profits achieved, and such conditions don’t last long. When the profit sun begins to shine, long-established insurers shower investors with new shares in order to build capital. In addition, newly-formed insurers rush to sell shares at the advantageous prices available in the new-issue market (prices advantageous, that is, to the insiders promoting the company but rarely to the new shareholders). These moves guarantee future trouble: capacity soars, competitive
juices flow, and prices fade.”

Demand & Supply

"Unfortunately, there can be no surge in demand for insurance policies comparable to one that might produce a market tightness in copper or aluminium. Rather, the supply of available insurance coverage must be curtailed. “Supply”, in this context, is mental rather than physical: plants or companies need not be shut; only the willingness of underwriters to sign their names need be curtailed.”

"The amount of industry capacity at any particular moment primarily depends on the mental state of insurance managers.”

"Major capacity withdrawals require a shock factor such as a natural or financial ‘mega-disaster.’”

Risk of Courts Orders on Casualty Insurance

"We have far underestimated the mushrooming tendency of juries and courts to make the “deep pocket” pay, regardless of the factual situation and the past precedents for establishment of liability. We also have underestimated the contagious effect that publicity regarding giant awards has on juries.”

Insolvent Competitors Can stay in Business

"In most businesses, of course, insolvent companies run out of cash. Insurance is different: you can be broke but flush. Since cash comes in at the inception of an insurance policy and losses are paid much later, insolvent insurers don’t run out of cash until long after they have run out of net worth. In fact, these “walking dead” often redouble their efforts to write business, accepting almost any price or risk, simply to keep the cash flowing in."

Low Costs

"The most important ingredient in GEICO’s success is rock-bottom operating costs, which set the company apart from literally hundreds of competitors that offer auto insurance. The difference between GEICO’s costs and those of its competitors is a kind of moat that protects a valuable and much-sought-after business castle."

Driverless Cars

"At some point in the future – though not, in my view, for a long time – GEICO’s premium volume may shrink because of driverless cars – but even the most casual follower of business news has long been aware of them. None of these problems, however, is crucial to Berkshire’s long-term well-being.”

Super-Cat [Catastrophe] Business

"In this operation, we sell policies that insurance and reinsurance companies purchase in order to limit their losses when mega-catastrophes strike."

"Since truly major catastrophes are rare occurrences, our super-cat business can be expected to show large profits in most years - and to record a huge loss occasionally."

"Berkshire is sought out for many kinds of insurance, both super-cat and large single-risk, because: (1) our financial strength is unmatched, and insureds know we can and will pay our losses under the most adverse of circumstances; (2) we can supply a quote faster than anyone in the business; and (3) we will issue policies with limits larger than anyone else is prepared to write. Most of our competitors have extensive reinsurance treaties and lay off much of their business."

Climate Change

"We do know that it would be a huge mistake to bet that evolving atmospheric changes are benign in their implications for insurers."

Re-Insurance

"The saying, "a fool and his money are soon invited everywhere," applies in spades in
reinsurance, and we actually reject more than 98% of the business we are offered."

"A bad reinsurance contract is like hell: easy to enter and impossible to exit."

"Choosing the wrong reinsurer, however – one that down the road proved to be financially strapped or a bad actor – would put the original insurer in danger of getting the liabilities right back in its lap."

Alignment

"[It is] vital that the interests of the people who write insurance business be aligned - on the downside as well as the upside - with those of the people putting up the capital. When that kind of symmetry is missing, insurers almost invariably run into trouble, though its existence may remain hidden for some time."

Importance of Management

"There is no question that the nature of the insurance business magnifies the effect which individual managers have on company performance."

"[The Insurance business] tends to magnify, to an unusual degree, human managerial talent - or the lack of it.”

Insurance Cycle

"Commentators frequently discuss the "underwriting cycle" and speculate about its next turn. If that term is used to connote rhythmic qualities, it is in our view a misnomer that leads to faulty thinking about the industry's fundamental economics."

Summary

It's evident that while insurance companies have attractive characteristics, there are plenty of risks for the inexperienced. Berkshire's competitive advantages include culture, very low cost, a fortress balance sheet and the willingness to walk away from mis-priced business. It's the latter point where most insurers go wrong.  

The right management is absolutely critical to success in this industry. The skillset of a good underwriter parallels many of the skills of a the successful investor. Both must think long term, be conservative, be open-minded and creative in considering potential risks. Alignment of interests, is also essential. 

"[Given the time lag between revenues and costs and the risk of under reserving] management quality becomes critical - perhaps more so than other industries. Marathon looks for a long history of stable returns, conservative reserving and the ability to resist growing premiums when profitable opportunities are scarce. Indeed rapid growth of premiums at any time is a red flag, as it is often a precursor to reserving problems. Inorganic growth should also be viewed with caution given the asymmetry of information between the buyer and seller over reserving risk.

.. The way management incentives are structured can be an important way to avoiding these pitfalls - a focus on return on equity over earnings growth is preferable, with return targets ideally set over time period longer than a year

It is important to tread with caution, as the time lag between revenue and costs means it is all the more important to invest alongside those rare management teams who can put long-term value creation above more short-term concerns.” Marathon Asset Management

I'll leave the closing remarks to Charlie Munger, who sums it all up so well ... 

“I’m glad we have insurance, though it’s not a no-brainer, I’m warning you. We have to be smart to make this work.” Charlie Munger

"Berkshire’s marvellous outcome in insurance was not a natural result. Ordinarily, a casualty insurance business is a producer of mediocre results, even when very well managed. And such results are of little use. Berkshire’s better outcome was so astoundingly large that I believe that Buffett would now fail to recreate it if he returned to a small base while retaining his smarts and regaining his youth." Charlie Munger 2014 , Golden Anniversary Letter

Further Recommended Reading:
Berkshire Hathaway Letters
'The Davis Dynasty' by John Rothchild
'General Insurance Fundamentals' IAG
 

Some insights from Ted Weschler and Todd Combs

Ted Weschler and Todd Combs have been anointed to manage Berkshire's equity portfolio when Warren hands over the reigns.  Warren's decision to hire Todd and Ted was based on what they'd done, how they had done it and their character. Both now manage c$10b each of Berkshire capital.  

In a recent rare interview with Yahoo News, Warren, Ted and Todd talk about how they spend their days and how they think about investing.  

I've outlined below my key takeaways from the interview.. 

Reading:  Buffett spends most his day reading. So to does Ted Weschler and Todd Combs. In fact Warren said in the interview "These are the only two guys we could find that read as much as we did". So what do they read? 

Ted Weschler spends half the day reading random things like newspapers and trade periodicals. In a 2016 interview Ted pointed out "Being a successful investor you need to be hungry, intellectually curious, interested, read all the time. Read a lot of newspapers. You need a certain level of randomness in order to connect things that might give you an insight into where a business is going in five years that somebody else might not see." 

Todd Combs reads about 12 hours a day - newspapers, quarterly reports, SEC filings, transcripts and trade magazines. 

Like Buffett, they're hoping to find or confirm an edge - a thought, an idea, insight or trend that's not being recognized by the market. 

Hard Work: Ted and Todd spend most of their day reading.  Successful investing is hard work.  As Peter Lynch noted "The person that turns over the most rocks wins the game. And that's always been my philosophy."

Learning: It's important to be a life long learner. Ted Weschler notes the last 5 years have been the steepest learning curve of his life. Which is a pretty powerful statement at 50 years old. In a large part he believes this is due to the data set from the businesses he's been exposed to at Berkshire [and no doubt learning from Buffett].

Speaking to Corporates: Buffett believes he is a better investor because he has experience in business and a better businessman because he has had experience in investments. Buffett notes that Berkshire is about as good a place as you can find to really understand competitive dynamics. Both Ted and Todd have Berkshire businesses that report into them. As Berkshire owns dozens and dozens of businesses and touches almost every type of industry in one form or another it gives the portfolio managers the opportunity to speak to operating managers who know more about their businesses than an investor can learn in a lifetime. 

Generalists:  There are no rules of any kind on diversification or industries in which Todd and Ted can invest in.

Click here for link to the Yahoo News Interview. 

Click on the yellow links above to link to the Investment Masters Class Tutorials.

Daily Journal Meeting 2017

This Year's Daily Journal meeting contained lots of wit and wisdom from Charlie Munger, Warren Buffett's partner. He's got a cracking sense of humour at 93 years young.  

Some of the more interesting comments Mr Munger made where around the evolution of Warren Buffett as an investor. Buffett has recently purchased positions in airlines and Apple, two things he would never have done in the past given his dislike of the airline industry and his lack of understanding of tech.

Mr Munger also detailed the need for multi-disciplinary thinking, his thoughts on diversification and the need to rely on quality people.

Here are the key points from the meeting ..

On Picking Managers ..

“We are doing something that’s quite difficult. We are judging people because we don’t understand what the people do. And that’s what Andrew Carnegie did. He didn’t know anything about making steel, but he knew a lot about judging whether the people he was trusting making steel were any good at it. And of course that’s what Berkshire’s done, if you stop to think about it. We have a lot of businesses in Berkshire that neither Warren or I could tell you much about, but we’ve been pretty good at judging which people are capable of running those businesses.” 

On Capex …

“If it makes sense over the long term we just don’t give a damn what it looks like over the short term.”

On Wells Fargo ..

“They made a business judgement that was wrong. They got so caught up in cross-selling and so forth, they got incentive systems so aggressive that some people reacted badly and did things they shouldn’t. And then they used some misjudgement in reacting to the trouble they got in. I don’t think there is anything fundamentally wrong for the long haul with Wells Fargo. They made a mistake and it was an easy mistake to make”

“I don’t regard getting the incentives a little aggressive at Wells Fargo as the mistake , I think the mistake was when the bad news came they didn’t recognise it.” 

“I don’t think it impairs the future of Wells Fargo, in fact I think they’ll be better for it. One nice thing about doing something dumb is you probably won’t do it again.”

On choosing what to do in life ..

“In terms of picking what to do .. In my whole I life I’ve never succeeded much in what I wasn’t interested in. So I don’t think your going to succeed if what you’re doing all day doesn’t interest you. You’ve got to find something your interested in because it’s to much to expect from human nature that your going to be good as something you deeply dislike doing. That’s one big issue. And of course you have to play in a game where you’ve got some unusual talents. If your 5 foot one you do not want to play basket ball against a guy that’s 8 foot 3.”

About Amex/Payments Systems…

“If you think you understand exactly what’s going to happen to payments systems ten years out, your probably under some state of delusion. It’s very hard to know. They are doing the best they can, they have some huge advantages. It’s a reasonable bet, but nobody knows...  I don’t think those things are knowable, think about how fast they change.”

On multi-disciplinary learning…

“You have to know the big ideas in all the disciplines to be safe if you have a life lived outside a cave.”

“Frequently the problem in front of you is solvable if you reach outside the discipline. The idea is just over the fence. But if you’re trained to stay within the fence you won’t find it. I’ve done that so much of my life, it’s almost embarrassing. It makes me seem arrogant because I will frequently reach into the other guys discipline and come up with an idea he misses.. I do not observe professional boundaries”

 On Buffett changing..

“If you’re in a game and your passionate about learning more all the time and getting better and honing your skills etc, of course you get better over time and some people are better at that than others. It’s amazing what Warren has done. Berkshire would be a very modest company now if Warren never learned anything... But what really happened was we went out into fields like buying whole businesses and bought into things like Iscar that Warren never would have bought. 

Ben Graham would never had bought Iscar. We paid 5X book for Iscar and it wasn’t in the Graham play. And Warren learned under Graham, he just learned better over time. And I’ve learned better. The nice thing about the game is you can keep learning. And were still doing that.

Imagine, we’re in the press now for all of sudden buying airline stocks. What had we said about the airline business. We thought it was a joke it was such a terrible business. Now if you put all those stocks together we own one minor airline. We did the same thing in railroads, we said railroads were no damn good. Too many of them and truck competition, and we were right for about 80 years. Finally they get down to four main railroads and it was a better business. And something similar is happening in the airline business.”

On Investing now and the need for change …

“It’s got harder and harder, now we get little edges when before we had golden cinches. We don’t make the same returns we made when we could pick this low hanging fruit.”

“Warren bought Exxon as a cash substitute. He would never have done that in the old days.  We have a lot of cash and we thought it was better than cash over the short term. That’s a different kind of thinking from the way Warren came up. He’s changed. He’s changed when he buys airlines and Apple. Think of the hooey we’ve done over the years over high tech as outside our competency and the worst business in the world is airlines. And we now appear in the press with Apple and a bunch of airlines. I don’t think we’ve gone crazy, I think we’re adapting reasonably to a business that has got a lot more difficult. I don’t think we have a cinch due to those positions, I think we have the odds a little bit in our favour. And if that’s the best advantage we can get we’ll have to live with it.”

On Indexing with a small index …

“When you have a small index and it gets popular it’s a self defeating situation. When the nifty fifty were all the rage, JP Morgan talked everybody into buying these 50 stocks. They didn’t care what price the stocks were they just bought those 50 stocks. In time they forced up the stocks to 60X where upon it broke down and everything went down by 2/3rds quite fast. If you get too much faddishness in one sector or one narrow index of course you can get catastrophic changes like they had with the nifty fifty era.”

On funds management and big decisions ..

“The prices for managing really big sums of money are going down down down - 20 basis points and so on. The people who rose in investment management didn’t do it getting paid 20 basis points. I would hate to manage a trillion dollars in big stocks and try and beat the indexes, I don’t think I could do it. In fact if you look at Berkshire and take out 100 decisions, which is two a year, the success of Berkshire came from two decisions a year for fifty years. We may have beaten the indexes but we didn’t do it by having big portfolios of securities and having subdivisions managing the drugs etc.”

On Books ..

“I just read this new book by Thorp, the guy who beat the dealer in Las Vegas.. then he did computer algorithmic trading.  I really liked the book, I recommend Thorp’s new book.”

Destroying old ideas …

"I’m very busy destroying bad ideas. I actually like it when I destroy a bad idea. I know so many people whose main problem in life is that old ideas displace the entry of new ideas that are better. That is the absolute standard outcome in life. There is an old German folksaying ‘we’re too soon old and too late smart.’ That’s everybody’s problem”

“It’s a very important habit getting rid of the dumb ideas. Everytime I get rid of a much beloved idea I pat myself on the back. The price we pay for being able to accept a new idea is awesomely large.”

Ideas …

“A few good ideas is all you need. And when you find the few of course you have to act aggressively. That’s the Munger system. You’re not going to find a million good ideas.”

On Valeant..

“Interesting thing is how many high grade people it took in. It was too good to be true. There was a lot wrong with Valeant. It was so aggressive and it was drugs people needed…  I don’t think capitalism requires you to make all the money you can.  I think there times when you should be satisfied with less. Valeant looked at it like a game of chess, they didn’t think of any human consequences. They just stepped way over the line and in the end of course they were cheating.”

On diversification..

“Am I comfortable with a non-diversified portfolio. I care about the Mungers. The Munger’s have three stocks. We have a block of Berkshire, a block of Costco, a block of LiLu’s fund and the rest is dribs and drabs… Am I comfortable? Am I securely rich? Your damn right I am… Is three stocks enough? What is the chances that CostCo is going to fail?, Berkshire is going to fail? What are the chances LiLu’s portfolio in China’s going to fail. Chances of any one is almost zero.”

“I’ve never for one moment believed this boulder-dash they teach about wide diversification. If you are a no-nothing investor of course you should own the average. If your capable of figuring out something that will work better you’re just hurting yourself looking for 50, when three will suffice, one will suffice if you do it right. Once cinch, what else do you need in life.. To think we are teaching these professors to teach this crap to our young.  People are getting paid for teaching boulder-dash.”

On Banks and the investment in Irish bank investment in 2008..

“That was a mistake we shouldn’t have made. Both Warren and I know you can’t really trust any of the numbers put out by the banking industry. People who run banks are subject to enormous temptations. It’s easy to make a bank report more earnings. Even if you are really good at something, you can drift into a dumb mistake.”

On India..

“India is grossly defective because they have taken the worst elements of our culture. They forged their own chains and put them on themselves. I do not like the prospects of India compared to the prospects of China.”

 On market declines..

“I regard it as a part of manhood. If you’re going to be in this game for the long haul which is the way to do it. You better be able to handle a 50% decline without fussing too much. Conduct your life so you can handle a 50% decline with aplomb and grace. Don’t try to avoid it. It will come. And if it doesn’t come I’d say your not being aggressive enough”. 

On China..

“What I like about China is they have some companies that are very strong and still selling at low prices. The Chinese are formidable workers and they make wonderful employees and there is a lot of strength in that system. The Chinese government helps its businesses, it does not behave like the government of India which doesn’t help its businesses at all. That’s what I like about China. I have to admire taking up a billion and a half people in poverty that fast,  that was never done in the history of the world. What they have done is just an incredible achievement. They have taken a poor nation and saved half their income when they are poor.  It was unbelievably admirable and effective.”

“Chinese people only have one problem, they believe in luck. That is stupid. Your want to believe in odds. Some reason in the culture too many people believe in luck and gamble. That’s a national defect”

On adversity..

“The idea that life is a series of adversities and each one is an opportunity to behave well instead of badly is a very very good idea.”

On Manager fees..

“If your advising other people you oughta be pretty rich pretty soon. Why would I take a lot of advice from somebody who couldn’t himself get pretty rich pretty soon. And if you’re pretty rich why shouldn’t you put your money alongside your investors and go up and down with them. And if it’s a bad stretch why should you scrape money of the top when they are going down a notch. I like the Buffett system.”

On being rational ..

“Rationality is a moral duty. If your capable of being reasonable it’s a moral failure to be unreasonable when you have the capacity to be reasonable”

 On Complex systems..

“If your dealing with a complex system, the rules of thumb that worked in the complex system in year one may not work in year 40.  The laws of physics you can count on, but the rules of thumb in a complex civilisation changes. Who would want to live in a state of sameness, you may as well be dead.”

The Evolution of a Value Investor

Over the years reading plenty of books on investing and studying many of the world's greatest investors I've come to recognise how truly insightful the combination of Warren Buffett and Charlie Munger really are.  

While Warren Buffett cites the book ‘The Intelligent Investor’ as "by far the best book on investing ever written" his style evolved over the years, in a large part influenced by Charlie Munger.  

"Charlie shoved me in the direction of not just buying bargains, as Ben Graham had taught me. This was the real impact Charlie had on me. It took a powerful force to move me on from Graham's limiting views. It was the power of Charlie's mind. He expanded my horizons" Warren Buffett

I think a lot of value investors evolve in a similar fashion. They start out on the hunt for cheap stocks and gradually they move towards the great businesses, the ‘compounding machines’, that can generate attractive returns over long periods of time. They transition from the search for low multiples for what are often poor businesses, to seeking truly great businesses at fair prices.

Here's a look at the evolution of Warren Buffett, as I see it.

The Buffett Partnership Years..

Warren ran the Buffett Partnership prior to undertaking his investment activities in Berkshire Hathaway where he employed a combination of value, event and activist investing styles. The portfolio was constructed to outperform in down markets and perform well [but likely under-perform] in very strong markets.  

Warren sought protection from weak markets by investing in uncorrelated strategies and focusing on bargain purchases. While the portfolio was unconventional when compared to the investment funds of then and now, Warren deemed it more conservative given its ability to protect capital in weak markets.

Many of the events Warren invested in are typical of the hedge fund strategies of today. These were split into three broad categories and their respective weighting were determined based on each categories level of attractiveness. Buffett named them the 'Generals', the 'Work-Outs', and the 'Controls'.

The 'Generals' consisted of generally undervalued securities where there was nothing to say about corporate policies and no timetable as to when the undervaluation would correct itself. They were bought primarily on quantitative factors [but with considerable attention to qualitative factors] with a margin of safety, a diversity of holdings and a 'bargain price' substantially below what careful analysis indicated value to a private owner to be. These securities would be sold at some level between what they were purchased at and what was regarded as fair value to a private owner. Warren sought good management, a decent industry and 'ferment' in a previously dormant management or stockholder group. While being most correlated with the stock market this portion of the portfolio was expected to achieve a satisfactory margin over the Dow over the years. Warren expected this category to be the star performer in a strongly advancing market.

The second category consisted of 'Work-Outs'. These strategies are typical of 'event' hedge funds today and include spin-offs, mergers, liquidations, sell-outs and re-organisation trades. These securities were purchased after company announcements. As the share prices depended on corporate action the timing of the return could be predicted. The attraction of this category was downside protection [most of the time] from falling markets, a big edge. The category was expected to be a drag on performance during bull markets. Despite the gross profits in each 'work-out' being quite small, the predictability coupled with a short holding period, produced quite decent annual rates of return with more steady absolute profits from year to year than the 'Generals'. Like modern hedge funds Warren used borrowed money to offset a portion of the 'work-out' portfolio. On a long term basis, Warren expected the 'work-outs' to achieve the same sort of margin over the Dow as attained by the 'generals'.  

The final category were 'Control' situations where Warren either controlled the company or took a very large position and attempted to influence policies of the company. This is akin to today's activist/private equity investors. Positions tended to develop from the 'generals' purchases unless a sizeable block of stock was purchased. Warren preferred to be passive unless an active role was considered necessary to optimise the employment of capital. This may have involved strengthening management, re-directing the utilisation of capital or effecting a sale or merger. When building stakes in 'control' situations the prices tended to be correlated with the stock market but once a position was built they tended to act more like the 'work-out' portfolio. Once control was achieved the value of the investment was determined by the value of the enterprise, not the market. The asset value was far less volatile than the stock market which provided downside protection in weak markets.  

In the early days, Warren remained focused on avoiding the permanent loss of capital and sticking with businesses he knew that could be bought at a significant discount to what a private owner may pay for the whole business. The 'Control' situations and 'Work-outs' provided the means to insulate the portfolio against market sell-offs. 

In 1969 Buffett announced his retirement from the partnership and returned funds and proportional interests in Berkshire Hathaway to the investment partners. The partnership had delivered an astonishing annual compounded return of 31.6%pa between 1957 and 1968 versus +9.1%pa for the Dow.

onto Berkshire Hathaway...

Berkshire Hathaway then became Warren's investment vehicle. Buffett met Munger in 1959 and they swapped investment ideas before Munger officially joined Berkshire as Chairman in 1968. While Buffett still engaged in activities such as merger arbitrage at Berkshire there was an increasing focus on 'Controls' and in particular, quality companies.

It was the acquisition of See's Candy that enlightened Munger and Buffett to realise they had under-estimated the value of quality.

“If we’d stayed with the classic Graham, the way Ben Graham did it, we would never have had the record we have,” Munger said. “And that’s because Graham wasn’t trying to do what we did.”

"See’s Candy did teach us both a wonderful lesson. And it’ll teach you a lesson if I tell you the full story. If See’s Candy had asked $100,000 more, Warren and I would’ve walked. That’s how dumb we were at that time. And one of the reasons we didn’t walk is while we were making this wonderful decision we weren’t going to pay a dime more, Ira Marshall said to us, “You guys are crazy. There are some things you should pay up for,” quality of business — quality, and so forth. “You’re underestimating quality.” Well, Warren and I instead of behaving the way they do in a lot of places, we listened to the criticism. We changed our mind." Charlie Munger

At See's Candy, Munger and Buffett recognised the enormous value of pricing power. Munger convinced Buffett it was better to pay a higher price for a great business than a cheap price for an average or poor business. Buffett expanded on his evolution at the 2003 Berkshire meeting:

"There was not a strong, bright red line of demarcation where we went from cigar butts to wonderful companies. But we moved in that direction, occasionally moved back, because there is money made in cigar butts. But overall, we’ve kept moving in the direction of better and better companies, and now we’ve got a collection of wonderful companies." Warren Buffett

At Berkshire, Munger and Buffett honed their investment skills. Peter Kaufman, in his excellent book 'Poor Charlie's Almanac' notes ‘Charlie's approach to investing is quite different from the more rudimentary systems used by most investors. Instead of making a superficial stand alone assessment of a company's financial information, Charlie conducts a comprehensive analysis of both the internal workings of the investment candidate as well as the larger, integrated "ecosystem" in which it operates. He calls the tools he uses to conduct this review 'Multiple Mental Models'. They borrow from and neatly stitch together the analytical tools, methods, and formulas from such traditional disciplines as history, psychology, physiology, mathematics, engineering, biology, physics, chemistry, statistics, economics and so on’.

Munger and Buffett sought businesses where a combination of factors could lead to extraordinary results, or as Munger called them, ‘Lollapalooza Effects’.  

The investment in Coke is a great example. Buffett paid a c25X price-earnings multiple for the last piece of Coke he bought. But Buffett and Munger recognised the enormous potential in the business. They started to focus more on a company's moat to protect the businesses economics, a company's ability to raises prices without hurting sales, the ability to re-invest incremental capital at very high rates of return, the huge operating leverage in the business, the large runway for global sales, the economies of scale from a massive distribution business and customer footprint [ie advertising] and the psychological factors that influence a company's customers decision to purchase and how these can be strengthened and reinforced. They also focused on the skill of management in deploying capital. This was the ultimate type of business.  

As Berkshire grew, it's range of investment opportunities like Coke became more limited. At Berkshire’s AGM in 2016 Munger noted they had to revert to Plan B.

More recently Berkshire has acquired far more capital intensive business like the railway business, Burlington Northern Santa Fe. While still a monopoly type of asset, the asset is far more capital intensive than a typical Buffett investment. Buffett has also invested in more mature businesses like Heinz with Brazilian investor 3G who has a reputation for streamlining businesses and getting them re-focused on growth.

It's no doubt Munger and Buffett would love to be able to outlay large licks of capital in attractive businesses like Coke was at the time of acquisition. Given their distaste for technology they have avoided the likes of Google, Ebay and Facebook. Outside of the technology angle these latter businesses would have ticked off a lot of the mental models that Munger loves .. winner-takes-all, first-mover-advantage, network effects, strong and growing moats, high return on incremental capital and economies of scale.

The greatest investing duo of the last century have evolved through the decades. They still focus on value yet their analysis of that value has evolved and improved. They have profressed their skills to better capture the power of compounding. And they are still evolving.

For further reading I highly recommend reading Buffett's Partnership letters, The Berkshire Hathaway annual letters and Poor Charlie's Almanac.  The recent lecture at UCA by Mohnish Pabrai on Berkshire's See's Candy/Coke investment is also excellent.