Charlie Munger: Full Transcript of Daily Journal Annual Meeting 2019

Last month I had the great pleasure of hearing Charlie Munger speak at the Daily Journal Annual Meeting for the fourth time.  Once again, the wit and wisdom of Charlie Munger was on full display at the deceptively youthful age of 95.

In addition to the transcript provided below, you may also watch the entire meeting on YouTube, or listen to it through my audio recording on SoundCloud.

I would like to thank Mr. Munger for energetically entertaining our questions and graciously sharing his wisdom, insights, and time with all of us.

I hope you all enjoy!

(Note: You will find that I frequently summarized the questions from the audience, but as for anything that Charlie, Gerry, or Peter said, I translated them verbatim and as accurately as possible.)

Start of Transcript

Charlie: Gerry, is there anything else that I’m suppose to do?

Gerry Salzman: That’s it Charlie.

Charlie: It’s very burdensome. (laughter) So many of you have come from such great distances (that) I’m going to speak briefly on a number of topics that may interest you and then I’m going to take questions.

It’s amazing the number of people at the meeting of the little Daily Journal Corporation which after all is a pretty small operation. We’ve got two businesses one a steadily declining legal newspaper which now earns about a million in a year pre-tax and shrinking, and a computer software business where we’re trying to automate courts and justice agencies and various other governmental departments. And that is now bigger by far in terms of prospects and customers and employees and so forth than our shrinking newspaper business. It hardly can be imagined how hard it is to deal with a whole bunch of different courts in different states and their advisers and the RFP process and the bureaucracy. This is a part of the software business that the giants tend to hate. They like a business where you just stamp out an extra copy of something and 98 percent of the revenues go immediately into the till as cash and there’s no extra work. And that is not handling a bunch of justice agencies, attorney generals, state courts, federal courts, and so forth all over the country with different requirements, different consultants, and of course steady and aggressive competition. The nature of our business it’s more like technical consulting than it is just stamping out software. It’s a very high service business. It’s very difficult. The computer science is time consuming and difficult. But just dealing with that much bureaucracy over that many different fields with the political realities…it’s just immensely difficult. So it’s a very slow grinding business and that’s the nature of the game. We have always liked it because a business like this requires a company that’s very rich and very determined and is willing to keep plugging. And of course that’s what the Daily Journal has done.

How are we doing? Well that’s hard to judge, but I would say watching it quite closely that it’s like a pharmaceutical company with seven wonderful drugs in the pipeline. We have a lot in the pipeline that is very very important to us. Australia, Canada, California. We’re talking big big markets.

Our main competitor is Tyler Technologies which is listed on the New York Stock Exchange and of course they’ve been at it a long time and are way bigger, but we are getting some significant volume and we have some very pleased customers. How in the hell does the little Daily Journal Corporation attract the Government of Australia? Australia is a big place. But I’ve gotten to love the Australians and I think it’s going to succeed in Australia, mightily. And so it takes a long time and it’s hard work and it’s also very difficult work. Not everybody can do this. Just the mass of complexity. We would never be where we are if we didn’t have Gerry Salzman to do everything he’s done over the last ten years. Anybody else would have failed at this. Now Gerry is 80 and he and I have one thing in common, we both use canes. When I’m not in a wheelchair I use a cane. So the idea of taking on the whole world when the chairman is 95 and the vice chairman is 89 and the chief executive that does all the work is 80 and uses a cane…It’s a very peculiar place that you people have come a long way to. What the hell are you thinking about? (laughter)

It’s weird and what’s happened of course is that we’re standing a bit for some combination of basic morality and sturdy common sense. And it’s amazing how well Berkshire Hathaway, and the Daily Journal for that matter, have succeeded with nothing more than basic morality and sturdy common sense. But of course when people talk about common sense they mean ‘uncommon sense’. Every time you hear that somebody has a lot of common sense it means he’s got uncommon sense. And it is much harder to have common sense than it is generally thought.

Let me give you an interesting example. The investment world involves an enormous amount of high IQ people trying to be more skillful than normal. You can hardly imagine another activity that gets so much attention. And weird things have happened. Years ago one of our local investment counseling shops, a very big one, they were looking for a way to get an advantage over other investment counseling shops. And they reasoned as follows. We’ve got all these brilliant young people from Wharton and Harvard and so forth and they work so hard trying to understand business and market trends and everything else. And if we just ask each one of our most brilliant men for their single best idea then created a formula with this collection of best ideas, we would outperform averages by a big amount. And that seem plausible to them because they were ill-educated. That’s what happens when you go to Harvard and Wharton. So they tried it out, and of course it failed utterly. So they tried it again and it failed utterly. And they tried it a third time and it also failed. Of course what they were looking for is the equivalent of the alchemists of centuries ago who wanted to turn lead into gold. They thought if you could just buy a lot of led and waive your magic wand over and it turned into gold, that would be a good way to make money. This counseling shop was looking for the equivalent of turning lead into gold and of course it didn’t work. I could’ve told them but they didn’t ask me. Nothing.

The interesting thing about this situation is that this is a very intelligent group of people that’s come from all over the world. You’ve got a lot of bright people from China where people tend to average out a little smarter. And the issue is very simple. It’s a simple question. Why did that plausible idea fail? Just think about it for a minute. You’ve all been to fancy educational institutions. I’ll bet you there’s hardly one in the audience who knows why that thing failed. That’s a pretty ridiculous demonstration I’m making. How could you not know that? It’s one of the main activity of America with an obvious and important failure. Surely we can explain it! You have to have stayed awake in your freshman college courses to answer that question. But if you ask that question at a Department of Finance at a leading place, the professors wouldn’t answer it right. Now I’m going to leave you that question because I want you perplexed. (Laughter) And I will go on to another issue.

But that’s one you should be able to answer. It shows how hard it is to be rational on something very simple. How hard it is…How many kind of crazy ideas people have and don’t work, and you don’t even know why they don’t work even though it’s perfectly obvious if you’ve been properly educated. And by the way my definition of being properly educated is being right when the professor is wrong. Anybody can spit back what the professor tells you. The trick is to know when he’s right and when he’s wrong. That’s the properly educated person. And of course they’re frequently wrong particularly in the soft sciences. In fact if you look at a modern elite institution, it’s fair to say that a lot of the faculty are a little crazy. It’s so left wing now in the humanities and it’s very peculiar. That’s another thing. Why should 90 percent of the college professors in the humanities be very left wing? I leave that question for you too. But it happens.

Another issue of course that’s happened in the world of stock picking, where all this money and effort goes into trying to be rational, is that we’ve had a really horrible thing happen to the investment counseling class. And that is these index funds have come along and they basically beat everybody. And not only that, the amount by which they beat everybody is roughly the amount of cost of running the operation and making the changes in investments. So you have a whole profession that is basically being paid for accomplishing practically nothing. This is very peculiar. This is not the case with bowel surgery or even the criminal defense bar in the law or something. They have a whole profession where the chosen activity they’ve selected they can’t do anything.

Now in the old days the people in the profession always had some of this problem and they rationalized as follows. ‘We are saving our clients from the insurance salesman and the stock broker, the standard stock broker that serves the active trader.’ And they were saving people from the life insurance salesman and the hustling stockbroker who liked active trading. And I suppose in a sense that the investing class is still saving those people from an even worse fate.

But it is very peculiar when a whole profession that works so hard, and is so admirable, and the members of which we are delighted when they marry into our families, and they just can’t do what their profession is really trying to do, which is get better than average results. How is that profession handling this terrible situation, as index investing gets more and more popular and including a lot of fancy places?

Well it’s a very simple answer, they’re handling it with denial. They have a horrible problem they can’t fix, so they just treat it as nonexistent. This is a very stupid way to handle a problem. Now it may be good when you’re thinking about your own death which you can’t fix and it’s just denial all the way to the end. But in all the practical fields of life, this problem thoroughly understood is half solved or better coped with.

So it’s wrong to have all these people in just a state of denial and doing what they always did year after year and hoping that the world would keep paying them for it even though an unmanaged index is virtually certain to do better. It’s a very serious problem. And think of how much New York say needs a flow of money from finance. Think what would happen to Manhattan if there weren’t any fees for investment management or trading spreads and so on. So it’s a weird situation and of course it’s unpleasant. Big investment counseling shops, some of them shrink and some go out of business. And the value investors, of course who many of I know because we came from that tradition, the value investors who were honorable are quitting. Boom. Boom. Boom. And what worked for them for years stopped working and they’re honorable people they just quit. And they’re also rich which makes it easy. But those who aren’t rich have a hell of a problem. And it costs about fifty thousand dollars in the city of Manhattan to send your kid to pre-school. Non-deductible. And that’s just the start of an endless procession of years of vast expanse. So if your game is money management you have a serious problem. I don’t have any solution for this problem. I do think that index investing, if everybody did 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.

Now 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? Why has that happened? And 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 and so on. We never had that dream. We never thought we could get really useful information on all subjects like Jim Cramer pretends to have. (laughter) We always realized that if we worked very hard we can find a few things where we were right. And that a few things were enough. And that that was a reasonable expectation. That is a very different way to approach the process. And if you had asked Warren Buffett the same thing that this investment counseling did, “Give me your best idea this year.”, and you had just followed Warren’s best idea, you would find it worked beautifully. But he wasn’t trying to know the whole…he would give you one or two stocks. He had more limited ambitions.

I had a grandfather who was very useful to me, my mother’s grandfather, and he was a pioneer. He came out to Iowa with no money but youth and health and took it away from the Indians. He fought in the Black Hawk…he was a Captain in the Black Hawk Wars, and he stayed there and he bought cheap land and he was aggressive and intelligent and so forth and eventually he was the richest man in the town and owned the bank, and highly regarded, and a huge family, and a very happy life. He had the attitude…having come out to Iowa when the land was not much more than a dollar an acre, and having stayed there until that black topsoil created a modern rich civilization, and some of the best land in the world…His attitude was that in a favored life like his, when you were located in the right place, you just got a few opportunities if you lived to be about 90. And that the trick in coming out well was seizing a few opportunities that were your fair share that came along when they did. And he told that story over and over again to the grandchildren that hung around him all summer, and my mother who had no interest in money remembered the story and told it to me. But I’m not my mother’s natural imitator and I knew Grandpa Ingham  was right. And so I always knew from…when I was a little boy that the opportunities that were important…that were gonna come to me…were few and the trick was to prepare myself for seizing the few that came. This is not the attitude that they have at a big investment counseling thing. They think if they study a million things they can know a million things. And of course the result is that almost nobody can outperform an index. Whereas I sit here with my Daily Journal stock, my Berkshire Hathaway stock, my holdings in Li Lu’s Asian fund, my Costco stock, and of course I’m outperforming everybody. (laughter) And I’m ninety-five years old. And I practically never have a transaction. And the answer is that I’m right and they’re wrong. And that’s why it’s worked for me and not for them. And now the question is do you want to be more like me or more like them?

The idea of diversification makes sense to a point if you don’t know what you’re doing and you want the standard result and not be embarrassed, why course you can widely diverse. Nobody’s entitled to a lot of money for recognizing that because it’s a truism it’s like knowing that two and two equals four. But the investment professionals think they’re helping you by arranging diversification. An idiot could diversify a portfolio! Or a computer for that matter. But the whole trick of the game is to have a few times when you know that something is better than average and to invest only where you have that extra knowledge. And then if you get just a few opportunities that’s enough. What the hell do you care if you own three securities and J.P. Morgan Chase owns a hundred? What’s wrong with owning a few securities? Warren always says that if you lived in a growing town and you owned stock in three of the best enterprises in the town, isn’t that diversified enough? The answer is of course it is…if they’re all wonderful places. And that Fortune’s formula which got so famous which was a formula to tell people how much to bet on each transaction if you had an edge. And of course the bigger your edge, the more close the transaction was to a certain winner, the more you should bet…And of course there’s mathematics behind it…But of course it’s true. It’s perfectly possible to buy only one thing because the opportunity is so great and it’s such a cinch. There are only two or three. So the whole idea of 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? I find it agony. Who would want to do it? And I don’t see a way…

My father had a client, he was a lawyer in Omaha, he had a client whose husband had a little soap company. The guy died and my father’s sold the soap company. This woman was one of the richest people in town in the middle of the depression, and what she had was a little soap company and the biggest mansion in Omaha’s best neighborhood. When they sold the soap company she had a mansion in the best neighborhood and three hundred thousand dollars. But three hundred thousand dollars in nineteen thirty something was an incredible amount of money. A little hamburger it was a nickel a big hamburger was a dime, and the all you can eat cafe in Omaha would feed you all needed to stay alive for two bits a day. I mean 300,000… Well she didn’t hire an investment counselor, she didn’t do anything, she’s a wonderful old woman. She just took that, she divided it into five chunks, and she bought five stocks. I remember three of them because I probated her estate. One of them was General Electric, one was Dow, one was Dupont, and I forget the other two. Then she never changed those stocks. She never paid any adviser. She never did anything, and she bought some municipal bonds, she never spent her income, and she bought some municipal bonds from time to time with the (inaudible). By the time she died in the 50s she had a million and a half dollars. No cost. No expenses. I said, “How did you decide to do that?” And “Well…” she said, “I thought electricity and chemistry were the coming things.” She just chucked it all in and sat on her ass. I always liked that little old woman. My kind of a girl. But it’s rare!

But if you stop to think about it, think of all the expense and palaver that she didn’t have to listen to and all the trouble she avoided, and zero costs. And of course what people don’t realize, because they’re so mathematically illiterate, is if you make 5 percent and pay 2 of it to your advisors, you’re not losing 40 percent of your future you’re losing 90 percent. Because over a long period of time that little difference causes a 90 percent disadvantage to you. So it’s hugely important for somebody who’s a long term holder not to be paying a big annual toll out of the performance. And of course there are a few big time advisors now who are using indexation very heavily. And of course they’re prospering mightily. And of course every time they get somebody it’s just agony for the rest of the investment counseling business. This is a very serious problem. And I think these people who were used to winning as old-time value investors who are now just quitting the profession. That’s a very understandable thing to do. I regarded it as more noble than staying in…you know…playing along with the denial. It’s an interesting problem.

You can see I’m not trying to make your morning. I’m just trying to describe things the way they are. But this business… Why does Li Lu succeed so mightily? Well partly he’s sort of a Chinese Warren Buffet. That really helps. And partly he’s fishing in China! Not in this over-searched, over-populated, highly competitive American market, and there’s still pockets of ignorance and lassitude in China that gave him so unusual opportunities. The first rule in fishing has always been fish where the fish are. And the second rule of fishing has always been ‘Don’t forget rule number one’. And Li Lu just went where the fishing was good and the rest of us are like cod fishermen who are trying to catch cod where the fish have been fished out. It doesn’t matter how much you work, when there’s that much competition. Every little idea I see in the world some are going after. I sat once on an investment committee at the University of Michigan and in came one of their successful investors located in London. And what had this investor done in London? He decided to invest in sub-Saharan Africa. And the only marginal securities were a few banks that traded in the Pink Sheets, so he would buy very tiny quantities of these banks. And every time some poor person got tired of having their money in the mattress and put it in a bank he did a little better. And of course he made a lot of money. Nobody else was investing in little tiny banks in Africa. But the niche was soon filled. What the hell do you do for an encore after you put your client’s money in a bunch of little tiny banks in sub-Saharan Africa? The niche gets filled quickly. How many wonderful niches are there going to be when some guy in London is buying all these tiny little bank stocks in Africa? It’s hard.

Then if you take the modern world where people are trying to teach you how to come in and trade actively in stocks. Well I regard that as roughly equivalent to trying to induce a bunch of young people to start off on heroin. It is really stupid. And when you’re already rich to make your money by encouraging people to get rich by trading? And then there are people on the TV, another wonderful place, and they say, “I have this book that will teach you how to make 300 percent a year. All you have to do is pay for shipping and I will mail it to you!” (laughter) How likely is it that a person who suddenly found a way to make 300 percent a year would be trying to sell books on the internet to you! (laughter) It’s ridiculous. And yet I’ve described modern commerce. And the people who do this all day think they’re useful citizens. The advertising agents who invent the lingo. In insurance they say, “Well” they say, “the two people who shifted from Geico to the Glotz insurance company save four hundred dollars each.” But what they don’t tell is that there are only two such people in the whole United States and they were both nuts. But they mislead you on purpose. I get tired of it and I don’t think it’s right that we deliberately mislead people as much as we do.

Let me tell you another story that I think is an interesting one about the modern life, but this goes back to a different time. This man has this wonderful horse. And it’s just a marvelous horse. It’s got an easy gait, good looking, and everything. It just works wonderfully. But also occasionally it just gets so he’s dangerous and vicious and causes enormous damage and trouble and breaks arms and legs for his rider and so on. And he goes to vet and says, “What can I do about this horse?” And the vet says, “That’s a very easy problem and I’m glad to help you.” And he says, “What should I do?” And the man says, “The next time your horse is behaving well, sell it.” (laughter) Think about it immoral that is. And haven’t I just described what private equity has to do? (laughter) When private equity has to sell something that’s really troublesome, they hire an investment banker. And what does investment banker do? He makes a projection! I have never seen such expertise in my whole life, as is created in making projections in investment banking. There is no business so lousy that it can’t get a wonderful projection. But is that a great way to make a living to have phony projections and use it to make money out of people you look right into their eyes of? I would say no.

By and large Warren and I, we never tried to make money out…stupidity of our dumb buyers. We tried to make money by buying, and if we were selling horseshit we didn’t want to pretend it was a cure for arthritis. (laughter) And I think it’s better to go through life our way instead of theirs. I think it’s always been this way, I think there’s always been chicanery. Think of the carnivals, the carny operator. Think of how much trickery there is in a carny operation. People just seek out the weaknesses of their fellow man and take advantage. And you have to get wise enough so you avoid them all. And you can’t avoid them if they’re in your family. I have no solution to that one. (laughter) But where you have a fair choice, there are just so many people that should be avoided.

My father had this best friend and client and he also had this other client who is a big blowhard and he was always working for the big blowhard and he wasn’t ever working for his wonderful client whom I admired. And I said, “Why do you do this?” And he said, “Charlie you idiot…” He says, “the big blowhard is an endless source of legal troubles. He’s always in trouble. Overreaching and misbehaving and so forth. Whereas Grant McFadden treats everybody right. The employees, the customers, everything. And if he gets involved with some psychotic he walks over there and makes a graceful exit immediately. A man like that doesn’t need a lawyer.” My father was trying to teach me something and it really worked. I spent my whole life trying to be like Grant McFadden and I want to tell you it works. It really works. Peter Kaufman is always telling me if the crooks only knew how much money you could make by being honest, they’d all behave differently. Warren has a wonderful saying that I like, he says, “You take the high road. It’s never crowded.” And it’s worked.

Take the Daily Journal Corporation. We made quite a few millions of dollars out of the foreclosure boom because we published legal notices and we dominated the publication of foreclosure notices in the worst real estate depression in the history of modern times. And we could have raised our prices at the time and made more tens of millions of dollars. But we didn’t do it. You know what your fellow citizens are losing their damn houses in the worst recession…’Charlie Munger billionaire raises prices’. It would look lousy on the front page of the paper (if people read the story). Should you do it? And the answer is no of course not. Warren always said it’s probably always a mistake to marry for money and it’s really stupid if you’re already rich.

And it’s really stupid when you’re already rich to get a reputation of being a total nogoodnik. Rick Guerin always loved the story about the guy who had been a total miscreant all his life, and (when) he died the minister said, “Now is the time in the funeral ceremony when somebody says something nice about the deceased.” And nobody came forward and nobody came forward and nobody came forward. Finally one guy stood up and he said, “Well” he said, “His brother was worse.” (laughter) Well you can laugh but there are people like that. When Harry Cohn died here the saying was that everybody went to the funeral to make sure he was dead.

So there are a few simple truths that really work. And when it gets to this difficult business the Daily Journal is in, I wouldn’t say it is a real pleasure to be serving these courts and agencies. They need the automation. Other people are trying to take advantage of them in ways that we aren’t. And we’re struggling against the odds (being) a little tiny company. And we’re taking a lot of territory. It’s slow going but the prospects are good. And of course the nice thing about being rich is that it doesn’t matter if it’s a little slow. And how do we get rich? Well we remembered Grandpa Ingham, and when one of the few opportunities came along we reached out and seized it. Think of how your life works?

In my life, to give another example, the Mungers would have twice the assets they now have if I hadn’t made one mistake of omission back in nineteen 70s. And…really stupid. I blew an opportunity that would have doubled my present net worth. That is a normal life. You get one or two. And how things work out…We all know people that are out married, I mean their spouses are so much better. Think of what a good decision that was for them. And what a lucky decision. Way more important than money. A lot of them did it when they were young, they just stumbled into it. Now you don’t have to stumble into it, you can be very careful. A lot of people are wearing signs, “Danger. Danger. Do not touch.” And people just charged right ahead. (laughter) That’s a mistake. Well you can laugh but it’s still a horrible mistake.

It’s been fun for the people on this board to know one another and work on these oddball things and handle life’s vicissitudes. Of course it’s very peculiar that we’re so old. I mean imagine a place where Gary Wilcox is one of the young men. The guy’s wife is still in golf champion. But that’s (not because she’s good when she’s old.) I mean it’s an amazing group. That’s an interesting example too. Imagine me as an old and as impaired as I am and having a pretty good time. How does that happen? Well you…That is another story.

I’ll tell a couple of other stories too because you like stories. Here’s an apocryphal story that is very instructive. A young man comes to visit Mozart. And he says, “Mozart” he says, “I want to write symphonies”. And Mozart says, “How old are you?” The man says, “I’m 23.” And Mozart says, “You’re too young to write symphonies.” And he says, “But Mozart you were writing symphonies when you were 10 years old.” And Mozart says, “Yes but I wasn’t asking other people how to do it.” Now there’s another Mozart story. Here’s the greatest musical talent maybe that ever lived. And what was his life like? Well he was bitterly unhappy and he died young. That’s the life of Mozart. What the hell did Mozart do to screw it up? Well he did two things that are guaranteed to create a lot of misery. He overspent his income scrupulously, that’s number one. That is really stupid. And the other thing was he was full of jealousies and resentments. If you over-spend your income and be full of jealousy and resentments, you’re going to have a lousy unhappy life and die young. All you’ve got to do is learn from Mozart. You can also learn from that young man who was asking Mozart how to write symphonies. The truth of the matter is that not everybody can learn everything. Some people are way they hell better. And of course no matter how hard you try there’s always some guy who achieves more. Some guy or gal. My attitude is ‘so what?’. Does any of us need to be the very top of the whole world? It’s ridiculous.

Another thing that people do that I regard as amazing is they build these enormous mausoleums. I think they figure they want people to walk by that mausoleum and say, “Gosh I wish I were in there!”. (laughter)

Anyway. You can see we’ve have had some fun as we go along and it’s worked so well. But if you actually figure 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 that were meaningful. It’s a game of being there all the time and recognizing the rare opportunity when it comes and recognizing that the normal human allotment is to not have very many. Now it’s a very competent bunch of people who sell securities who act as though they’ve got an endless supply of wonderful opportunities. Well those people are the equivalent of the race track 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 a lot of opportunities you’re not furnishing. And 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. This business 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 invested. And if you live long enough you end up rich. It’s not very complicated.

Now there is a part of life which is, how do you scramble out of your mistakes without them costing too much? And we’ve done some of that too. If you look at Berkshire Hathaway, think of its founding businesses. A doomed department store, doomed New England textile company, and a doomed trading stamp company. Out of that came Berkshire Hathaway. Now we handled those losing hands pretty well when we bought into them very cheaply. But of course the success came from changing our ways and getting into the better businesses. It isn’t that we were so good at doing things that were difficult. We were good at avoid things that were difficult. Finding things that are easy.

By the way, when we bought the Daily Journal that was easy. What we’re doing now in this software business is difficult. But due to the accident of these good associations and the fact that these old colleagues have lived so long, we’re doing pretty well in the new business. It has potential. And it’s fun to do. How many declining newspapers have hundreds of millions of marketable securities lying around and a new business with some promise? We’re like the last of the Mohicans. (laughter)

Well I’ll take some questions now. We need some system of order.

Question 1: In the book outsiders William Thorndike lists eight CEOs that achieved superlative performance to the S&P 500 and their peers, so other than Mr. Buffett and Mr. Murphy, did Berkshire or you invest in the other six companies? And if not, why?

Charlie: Well I can’t answer that question, I don’t know the others six companies. But I would say, generally speaking as things have gotten tougher, we’ve been better at sitting on our asses with what we have than we have in buying new ones. It’s been hard to buy new ones. We haven’t bought a whole company of any size since we bought the truck stop operator. So if you’re having trouble with the present time with anything, join the club.

Question 2: Could you please comment on proposed legislation in Washington to restrict or tax share buybacks.

Charlie: Oh…(laughter)…Well. Rick tells a story about an old Irishman that used to steal from the church and drunk all the time. And when he’s dying the priest asked him to renounce the devil. And he said I can’t do that because in my condition I shouldn’t offend anybody. And I don’t think I should…If you get me started on politicians, I may be impolitic. So let’s go on to another subject.

Question 3: My question is about smaller banks. If you look at banks with assets greater than about a billion dollars in the U.S. and go up and stop at the super regional level, there’s about 250 of those banks. And my question is, is that a hunting ground that you would think, applying the principles of value investing, is likely to yield one or two great businesses?

Charlie: Well thank you for answering that question, the answer is yes.

Question 4: You and Warren have advocated for decades that CEOs should tell shareholders everything they need to know to value a business. From visiting and calling courthouses around the country, I’ve personally seen the success that you’ve had being awarded contracts against larger competitors for JTI. However your opaqueness regarding contracts that have been awarded but not completed leaves a wide range that an estimated value could fall for. So if a shareholder unwilling to cold call 50 courts around the country to find these contracts that haven’t been accepted yet, could you please provide a little bit of detail for us shareholders as far as the willingness for courts to accept these? Have you had any contracts that haven’t been accepted after you put in the work?

Charlie: Well we’ve got contracts or possible contracts at every stage you could imagine. And it’s very complicated and I don’t purport to understand each one because I’ve trusted Gerry and the people who are doing it. But generally speaking I can see that the trend is favorable. But more than that I can only say you would be horrified if you watched it up close how difficult it is. It’s difficult. But in spite of its difficulties we’re doing pretty well. But we haven’t got any magic wand. If you read all the reports…If I read all the reports in great detail and spent all my effort trying to understand it, I wouldn’t understand it very well. So I think your chances are very poor.

Question 5: One of my favorite lines from you is you want to hire the guy with the IQ of 130 that thinks it’s 120 and the guy with an IQ of 150 who thinks it’s 170 will just kill you.

Charlie: You must be thinking about Elon Musk.

Question 5 (continued…): How do you assess someone when making a hiring decision?

Charlie: Of course I want the guy who understands his limitations instead of the guy who doesn’t. On the other hand I’ve learned something terribly important in life. I learned that from Howard Ahmanson. You know what he used to say? “Never underestimate the man who overestimates himself.” These weird guys who overestimate themselves occasionally knock it right out of the park. And that is a very unhappy part of modern life. But I’ve learned to adjust to it. I have no alternative. It happens all the time. But I don’t want my personal life to be a bunch of guys who are living in a state of delusion, who happen occasionally to win big. I want the prudent person.

Question 6: What did you see in Li Lu versus other investors in China? Because in his biography it looks like he’s more of an outsider. And how similar or different is he versus Todd Combs and Ted Weschler? And Is there any reason why you gave that interview last year with Li Lu in China?

Charlie: Well I did it because he asked me and I sometimes do that, I am foolish that way. And I said what I believed when they asked me the questions. The answer is Li Lu is not a normal…He’s the Chinese Warren Buffet. He’s very talented. Of course I’ve enjoyed bagging him, but it’s interesting that way…I’m ninety five years…I’ve given Munger money to some outsider to run once in ninety five years. And it’s Li Lu, and of course he’s hit it out of the park. It’s very remarkable but it’s also pretty picky. And of course once I’ve got Li Lu if I’m comparing to him, who else am I going to pick? And by the way that’s a good way to make decisions and that’s what we do. 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 because there aren’t that many people better than Li Lu. So I just sit. It’s amazing how intelligent it is to spend some time just sitting. A lot of people are way too active.

Question 7: Good morning Mr. Munger. You said in the past that you expect the U.S. to adopt a single payer health care system or Medicare for all the next time that Democrats control all three branches of government…

Charlie: I Do, yes.

Question 7 (continued): What will this mean for health insurers, hospitals, and medical device companies?

Charlie: Well it will be a hell of a mess. It’ll still be a big business but it will be a hell of a mess. The existing system is so over expensive and over complicated and has so much unnecessary cost. So much unnecessary overtreatment of the dying. So much overtreatment of items that would be best left alone. So much unnecessary expense. Yet on the other hand it’s the best system there is in the world in terms of the quality at the top. So it’s a very complicated subject, but it’s a hell of a mess. I find it demoralizing to see in Singapore they spend 20 percent of what we spend in America on medical care and their system is way better. And what they’re doing is just the most elemental common sense. But of course it was created by one Chinese guy who was in control. Of course it’s more intelligent than the outcome of our political process.

That Singapore system was created by Lee Kuan Yew. Of course it works better. But to have it cost 20 percent and work better in an advanced place likes Singapore…So there’s a lot to be demoralized about in terms of the potential of our medical care system. And of course it isn’t that our politicians are good at fixing systems like that. So if you don’t like it now, I confidently predict you won’t like it later either. (laughter)

Question 8: I read a lot of the stoic philosophers last year. Epictetus, Seneca, Marcus Aurelius…

Charlie: Well I can see why you would. There’s a lot to be stoic about. (laughter)

Question 8 (Continued): And as I glean lessons from them there was one name that kept coming to mind, that is Munger, Munger, Munger….

Charlie: Well some people think that Marcus Aurelius is all right. (laughter)

Question 8: Can you talk to me about the influence that the Stoics had on you and some of your favorite advice from them.

Charlie: A lot. A lot have had (a lot of influence) on me, including Epictetus who started as a slave. No I like those old Stoics. And part of the secret of a long life that’s worked as well as mine is not to expect too much of human nature. It’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 than trying to fix the world in a way that ruins yourself and doesn’t fix the world? It’s pretty stupid. I just don’t do it. I have a rule for politicians. It’s a stoic rule…I always reflect that politicians are never so bad, you don’t live to want them back. When I was young, the California legislature was full of small time insurance brokers and lawyers looking for an unfair advantage. They were being entertained by restaurants with prostitutes and bars, by racetracks, and liquor distributors and so on and so on. Fade in fade out. We have a different kind of a legislature now, and I just want all those old crooks and lobbyists and prostitutes back. (laughter) You laugh but you young people, you’re going to live to wish…Nancy Pelosi and Donald Trump we’re immortal. (laughter)

Question 9: Could you share a reading recommendation for us, potentially a new one, that maybe fundamentally change your viewpoint on something?

Charlie: Well there are very few ninety-five year olds that are changing their viewpoint on things. But I do find that there are amusing anecdotes and so forth that I occasionally read and like. But I like the old anecdotes pretty well too. Like that one about the vet and the horse. It’s so obvious though, some of these pithy stories. The storytelling really works to get messages around. One of the interesting things is look at our modern politicians and then think about Abraham Lincoln. (Which) modern politician reminds you of Abraham Lincoln? In either party? Lincoln at one time was hired by some guy whose partner had died, leaving practically no money to a wife and three children. And he owed some money to his surviving partner and the surviving partner came to Lincoln and said, “I want you to collect this money.” And Lincoln said to this guy, he says, “Well” he says, “You look like an enterprising fellow who could get that much money back pretty easily through a little effort. And if you want to ring a little money out of this poor widow and her three children then you’ll have to get a different kind of lawyer.” Does that remind you of any of our modern politicians? That was Abraham Lincoln. What a story. No wonder he’s remembered.

And you know who deserves the credit for Abraham Lincoln and never gets it? It’s his stepmother! Abraham Lincoln was the child of two illiterates. But the step mother, who his father just married in desperation to help raise the children, she took a shine to Lincoln and saw he was bookish and she helped him all the way along. I am going to donate a picture of that stepmother eventually to a particular place because I admire what that stepmother accomplished in life. Imagine being responsible more than any other person for the life of Abraham Lincoln.

Question 10: My question is about the intellectual property because you are a lawyer by training. Given the complicated landscape in this field, is there a better way to share intellectual property across nations, especially in the case of Huawei, is there better legal framework to handle intellectual properties?

Charlie: Well you know, I don’t know that much about the world of intellectual property. I made my way i n insurance, and furniture stores, and little legal newspapers and so on. So other people are good at intellectual property. I’m good at avoiding subjects which I’m not good at. And one of them is intellectual property. I’m not surprised that the Chinese are stealing a little intellectual property. We Americans did it all the time. We stole Dicken’s work. We just reprinted his copyrighted stuff. We stole the technology from the English textile manufacturers. It isn’t as though people haven’t been pretty aggressive about wanting to know other people’s ideas. This is an old problem. I do think that allowing intellectual property to have these profits is desirable. But the exact complexities of how you handle it, I don’t spend much time thinking about.

Question 11: In last year’s Daily Journal meeting, you talked about one of the five aces of a money manager was a long runway.

Charlie: Yes.

Question 11 (continued…): I’m young and have at least hopefully a 40 year runway ahead of me.

Charlie: How are your legs? (laughter).

Question 11 (continued…): I passed my physical with flying colors, so thanks a lot. I’d like to compound my money at the highest rate and then give most of it away at the end. Which money managers would you recommend besides you and Warren?

Charlie: Well I just said I’ve only hired one myself in a lifetime, I don’t think that makes me an expert. Although I must say that one did work out rather well. No I can’t help you. Everybody would like to have some money manager that would make him rich. Of course we all would want that. I would like to be able to turn lead into gold. But it’s hard. It’s very hard. And if you’re finding it difficult that just shows you understand it.

Question 12: Charlie and Peter Kaufman. I don’t have a question, I just want to thank you both for putting together Poor Charlie’s Almanac. It has been an incredibly foundational book in my life and it has really helped inflect my thinking on many different things. So thank you both very much for your work on that.

Charlie: It was really Peter Kaufman’s idea. He did the whole damn thing, and he paid for it himself, being a rich and eccentric man. I just wish there was one change in Peter Kaufman. Peter Kaufman has made me adored in India and China. I wish the hell he could do more for me in Los Angeles. (laughter) The Chinese version of Poor Charlie’s Almanac has been pirated enormously in China. Totally pirated. But the legal sales are three hundred forty thousand or something. Peter has made me very popular in China but he does nothing for me in Los Angeles. (laughter)

Question 13: You’ve paraphrased Ben Graham in saying that good ideas are wonderful but you can suffered terribly if you overdo them.

Charlie: Yes.

Question 13 (continued…): How do you balance that against the risk that you potentially forego an opportunity altogether? Or are late to an opportunity for fear that a good idea has been overdone?

Charlie: The problem that is 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 and start classifying opportunities into one category or the other. You’ve got the problem half solved. You don’t need me. You’ve already figured it out. You’ve got to be aware of both potentialities and the tensions.

Question 14: In your letter on Berkshire’s past and future, you wrote about the principles that have made Berkshire successful over the years. My question is, why is it that Berkshire’s organizational principles as a holding company have not been copied more by others given its incredible success and track record?

Charlie: Well it’s a good question. I think the main reason is that it looks impossible. If you were in Procter and Gamble, with its culture and its bureaucracy, and you sat down to figure out, ‘How can I make Procter and Gamble more like Berkshire Hathaway?’, it wouldn’t go immediately to the ‘too hard pile’. It’s just too hard. There’s too much momentum.

But you raise by your question a very interesting thing that deserves more attention than it gets. One of the reasons that Berkshire has been so successful is there’s practically nobody at headquarters. We have almost no corporate bureaucracy. We have a few internal auditors who go out from there and check this or that. But basically we have no bureaucracy. Having no bureaucracy is a huge advantage if the people who are running are sensible people. Think of how poorly all of us have behaved in big bureaucracy even though we have a lot of talent because we couldn’t change anything.

So bureaucracy has a standard bunch of evils on a standard and bunch of stupid wastes and so forth, and avoiding it is hugely important. Of course there’s a tendency of successful places, particularly successful governments, is to have more and more bureaucracy. Of course it’s terribly counterproductive. And of course the bureaucracy, the individual bureaucrats they’re benefiting from more assistance, more meetings, more this, more that. So what looks like poison to us from the outside, because the decisions are so terrible, looks wonderful for them, it’s opportunity. I’ve just described the great tragedy of modern life. Modern life creates successful bureaucracy and successful bureaucracy breeds failure and stupidity. How can 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 and then place works better? They’re doing the Lord’s work. But you wouldn’t think so if you were working there. But there’s a lot of horror and waste in bureaucracy and its inevitable. It’s as natural as old age and death. With that cheerful thought, we can go on to the next one.

Question 15: I’m researching personality psychology and what makes partnerships successful, such as you and Warren. What are your thoughts on that?

Charlie: Well I’ll tell you what makes a partnership successful. Two talented people working well the together. Of course that works better.

Question 16: In the past you’ve praised the significance of cultures at firms like Glenair, Kiewit, and Costco. What are your views on the culture at Daily Journal and in particular Journal Technologies and similar to your Berkshire 50 year essay, can you share a multi-decade vision for Journal Technologies.

Charlie: Well you got to remember that I was old when Journal Technologies came into being. I guess I had a weak moment when…Guerin talked me into it. And it worked because Gerry took a hold of it and work miracles. So I don’t deserve much credit. It’s Guerin and Salzman who are responsible for Journal Technologies. I just clap. I’m good at clapping.

Question 17: You speak about the importance of fishing in waters with ample fish. If you were starting out today, what sea would you be fishing in, other than China of course.

Charlie: Well other than China, but…if there’s one good place in the world that’s more than my share. There are others I’m sure, but it’s hard for me to believe that any can get better for the Mungers than China. So I can’t help you. I’ve solved my problem. You’ll have to solve yours. By the way, the water’s fine in China. Some very smart people are wading in. And in due course I think more will wade in. The great companies of China are cheaper than the great companies of the United States.

Question 18: I have a question regarding long term investment and compound interest. In the last few years with very low interest rates out there it’s been difficult to find opportunities for having a long term compound interest based strategy. So beyond investing in Berkshire, Value Investing, or index funding, where would you invite us to find opportunities for long term investment where compound interest is really that force?

Charlie: Well, 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. Makes you less crazy. I think that…you know they say that common stocks from the aftermath of the Great Depression, which was the worst in the English speaking world in hundreds of years, to the present time may be an index that’s produced 10 percent. Well that’s pre-inflation. After inflation it may be 7 percent or something. And the difference between 7 and 10 in terms of its consequences are just hugely dramatic over that long period of time. And if that’s 7 in real terms, but achieved starting at a perfect period and through the greatest boom in history, starting now it could well be 3 percent or 2 percent in real terms. It’s not unthinkable you’d have 5 percent returns and 3 percent inflation or some ghastly consequences like that. The ideal way to cope with that is to say, “If that happens, I can have a happy life.” Because why shouldn’t you be happy in spite of the fact that civilization wasn’t quite as easy as it was for my generation. Now beyond that, when it gets more difficult, how should you do it? Well the answer is, because it’s going to be very difficult, you should work at it. And if all that gets you is 6 percent for a lifetime of work instead of 5, you should be cheerful about it. If you want to hit it out of the park easily, you should talk to Jim Cramer. (laughter)

Question 19: Building on the question about the corporate culture at Daily Journal Corporation, could we ask the other board members about the long term succession plan for the board.

Charlie: I don’t think we want to go to another speaker. (laughter)

Question 20: Has the Berkshire Hathaway equity portfolio outperformed the S&P over the last five or ten years? And if it has not, why wouldn’t Berkshire just invest in the S&P for its equity portfolio?

Charlie: I think Warren, who is after all a mere boy of 89, thinks that Berkshire can do a little better than the S&P. From this point. I don’t think many people can, but he may be right about himself and the team he has in place. It won’t be by huge margins, that I confidently predict.

Question 21: How do you think about downside protection and how do you know when to exit an investment?

Charlie: Well you’re not talking to a great ‘exiter’. My Berkshire I bought it in 1966. My Costco I bought… I mean I’ve been a good picker. But other people know more exiting. I’m trying never to have to exit. So you’re talking to the wrong…I think there are working styles of investments that work well with constant exits. It just hasn’t happened been my forte. So 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 that make me a little…In the first place, I’d be less rich not more after taxes. The second place is it’s a much less satisfactory life than rooting for people I like and admire. So I say find Costco’s, not good exits.

Question 22: You mentioned that in an interview with CNBC on May 2018, Berkshire too restrained on buying more Apple stock. Do you still believe so?

Charlie: No I don’t. I don’t think the world would be improved by more comments from me on Apple. You know, I’m a very opinionated man and I know a lot, but I don’t know everything. I like Apple but I don’t have the feeling that I’m the big expert.

Question 23: Last year you said that you wish you had more of Apple stock, but now its price has declined by a lot, so what is your opinion about its moat or the competitive advantage. Why do you think it has declined?

Charlie: Well I don’t know why Apple stock is going up or down. I know enough about it so I admire the place, but I don’t know enough to have any big opinion about why it’s going up and down recently. 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 ‘too hard’ pile. And everyone once in a while an easy decision comes along and I make it. That’s my system. Everything was the ‘too hard’ pile, except for a few easy decisions which I make, promptly.

Question 24: When you’re assessing the quality of a business do you place more emphasis on quantitative metrics such as return on invested capital or qualitative ideas like brand strength or quality of management?

Charlie: Well we pay attention to qualitative metrics and we also pay attention to other factors. Generally we like to pay attention to whatever’s important in the particular situation and that varies from situation to situation. We’re just trying to have that ‘uncommon sense’ I’m talking about. And part of our uncommon sense is just to refer a lot of stuff to the ‘too hard’ pile.

Question 25: The simple life is the obvious right answer, but most of America ends up like Mozart, in debt and overspending. How did you maintain the discipline to live the simple life in the face of all these other temptations?

Charlie: I was born this way. (laughter)

Question 26: I’m an engineer at BYD, and I was interested to hear your perspective on the current state of infrastructure in the U.S. and some areas of growth that you might see in the future for infrastructure.

Charlie: Well I think infrastructure will be a big deal. Practically everybody…in China where BYD is so active, by the way the Daily Journal owns some BYD, but BYD is going to be huge electric vehicles. They are already huge. And they’re going to be much more huge. And then they’re going to be huge in monorails which is also a business whose time has come. And they’re also huge in these lithium batteries, and the lithium batteries are being improved…materially improved. And the place is full of fanatics, and by the way they’re a big supplier to Apple and Huawei. And they’re a very satisfactory supplier to those things. So I am terribly impressed with BYD and its been one of the real pleasures of my life to…Wang Chuanfu is the eighth son of a peasant. An older brother recognizing a genius had been born into the family, he just gave up everything in life to nurture that little brother genius. Now that’s Confucianism. And by the way Confucianism will do a lot better for civilization than the Ford Foundation did. Confucianism with a strong family ethos like that is a really constructive thing. And Confucianism partly created BYD. That older brother of Wang Chuanfu was a hero. And of course what Wang Chuanfu has done is a miracle. And of course that was a venture capital type investment. We bought marketable securities, not Berkshire, but Li Lu did. And it’s been a wonderful investment and it’s been a very admirable company. And I like being part of something that’s inventing better lithium batteries and better monorails and so on and so on. So if you work for BYD, you’re a very fortunate person and you’re gonna have a wonderful life watching and participating. You could hardly have a better employer. At least if you like demanding achievement and 80 hour weeks.

Question 27: You mentioned earlier that when you had an opportunity to raise prices you didn’t want to raise them during the Great Recession because it didn’t seem right for Charlie Munger to be raising prices on people that were losing their houses. So I wanted to thank you for that as well.

Charlie: Nobody else ever has.

Question 27 (continued…): I wanted to ask you about the causes of the Great Recession, specifically the credit ratings agencies, and your twenty four standard causes of human misjudgment. I think they hit them pretty much all. Pavlovian Association, denial,…

Charlie: You’re right about that. The financial behavior in our leading financial institutions was inexcusably awful. When other people were making money in a disreputable stupid fashion, everybody piled in because they didn’t want somebody else to be making money and they’re not participating. The standards in lending, the standards in managing…It was disgusting intellectually, disgusting morally, and of course it caused a whirlwind that could have taken the whole civilization down into a Great Depression. That’s a pretty major sin. And none of those people’s been punished. It’s usual that I agree so thoroughly with Elizabeth Warren, but it was wrong to have that big of a mess and have nobody punished.

Question 27 (continued…): I’ve written a blueprint for a nonprofit credit ratings agency and I’d love to get your feedback.

Charlie: Things that far out I usually leave to other people and not because Berkshire Hathaway owns a big chunk of one of the credit rating agencies. But I can see why the existing situation would draw your concern. But there are some human problems I don’t want to bother with. And you have just produced one. But you’re right it wasn’t perfect.

Question 28: My question relates to the country’s national debt. We’ve just recently passed twenty two trillion dollars and our debt to GDP is above 100 percent now. At a time when our GDP may be near a peak and interest rates may be rising. It seems to me that politicians seem fine running the deficit because there when the crisis comes, and consumers are happy to take a deficit because it’s better to consume now than tomorrow. My question is, do you think that there’s something we can do about this? And if so, what should be done? Or is human psychology such that until the crisis is upon us, it’s hard to imagine anything it’s done?

Charlie: Well that’s a very interesting question. The whole science of economics had no idea 15 years ago that it would be possible to print money on the present scale, and get so awash in internal debt as we have. And certainly in a place like Japan, which is way more extreme, nobody dreamed that was possible. And the people who did dream what was possible…and they were few…they would not have predicted 20 years of stasis in spite of everything the Japanese did which was very extreme.

There’s a lot that’s peculiar in what we’re doing and eventually if you try and solve all your problems by printing money there’ll be some disaster. When it’s coming and how bad it will be, nobody knows. Nobody dreamed 15 years ago we could do as much as we have now with as little bad consequence. Churchill use to say that Clement Attlee had a lot to be modest about. Well that’s the way I feel about the economics profession. They have a lot to be modest about. They thought they knew a lot, but turned out not to be so. There was a Greek philosopher that said, “No man steps in the same river twice.” You know the river is different the second time he comes in and so is the man. And that’s the way with economics. It’s not like physics where the same damn principles are going to apply. You do the same damn thing at a different time and you get a different result. It’s complicated.

And of course you’re raising a very important question. And of course nobody really knows the answer. Who knows how much of this we can get by with. My personal bet is that these democracies will eventually borrow too much and cause some real troubles. I don’t know when.

Question 29: A lot of people ask how you determine what investment or deal to do, and you tell people that you can do this fairly quickly. My question is how do you tell if a money manager or management of a company has the right character or the right integrity? How long does it take you to do that and what are some traits that you look for?

Charlie: Well now that I found Li Lu I don’t look for anybody else. So I’m the wrong person. What are my chances I’m going to get somebody better than Li Lu. So it’s very easy for me. What you need is a Li Lu and I don’t know how to get you one.

Question 30: Last year we saw a record amount of share repurchases, and now we’re hearing rhetoric out of Washington D.C. specifically legislation to curb stock buybacks. What’s your take on stock buybacks and do you think politicians should be telling companies what to do?

Charlie: Well generally speaking I’m restrained in my enthusiasm for politicians telling corporations what they should do. But I will say this. 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 price that it’s frequently a bad idea, they’re doing a lot. Welcome to adult life. This is the way it is. But it’s questionable at the present levels whether a lot of it is smart. Was Eddie Lambert smart to buy back so much Sears Roebuck? No. And there’s a lot of that kind of mistake that’s been made.

Question 31: Similar to your Mozart anecdote, I wanted to ask you, what advice would you have for someone my age looking to live a long successful life like yourself.

Charlie: Well I haven’t had that much success changing any of my children. And I don’t think I can give helpful advice to a perfect stranger. It’s hard to improve the next generation, and the standard result is going to be mediocre. Some people are going to succeed. They’re going to be few. That’s the way human significance is allotted. Human significance will always go to the few. There’s no way of creating enough (few in significance), to meet the demand. 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, they all work.

Question 32: You point out a great deal of human folly, but you don’t seem to be that upset about it. Has that always been the case and is that a correct perception

Charlie: That’s a very correct perception. It’s my system. I’ve copied it from the Jews. I saw it work well from them, and it was my natural inclination anyway. And so, humor is my way of coping.

Question 33: What is your proudest accomplishment in life and why?

Charlie: I don’t have a single accomplishment in life that I’m all that proud of. I set out to try and have more uncommon sense than most. Pretty limited objective. I am pleased I did as well as I did in that game. If I had to do it all over again, I think it’d be a lot harder. I think part of my success was being born in the right place at the right time. So, I’m not particularly proud of success that came from being born in the right place at the right time. I’m pleased but not proud.

Question 34: Mr. Salzman. I have a question for you. Could please comment on how Journal Technologies implements the invariant strategy principles? Things like trust, getting employees to go all in, positive sum, and win/win relationships.

Charlie: Gerry that’s a simple question. How do you solve the problems of God?

Gerry Salzman: First of all you have to deal with each individual because each individual, each employee, each independent contractor that we have to work with, each client is different. And so you have to relate to their specific circumstance. You do not handle it because it’s in a checklist or something.

Question 35: This question is for both of Charlie and Peter. Charlie once said any year that you don’t destroy one of your best loved ideas is probably a wasted year. Have either of you destroyed any of your beloved ideas in 2018? And if so, what are they?

Charlie: Guerin have you destroyed any good ideas 2018?

Rick Guerin: …Probably unbeknownst to me.

Gerry Salzman: We always think into the future, we’re not worried about the past. It’s just that simple. The day ends, we’re on to something different. It’s a different challenge every day. And the good part about my job, it changes every day. So I face something different. I’m more like a newspaper editor. I start with the blank page every day. Well how do I go to the next situation? How do I solve a particular problem? That’s my day. That’s what I do.

Question 36: In October 2008, a month after Lehman filed bankruptcy and in the depths of the abyss, Mr. Buffett famously wrote an editorial saying that he was buying stocks and he was bullish on America. You’re famous for bottom ticking Wells Fargo in March of 2009. What made you decide to buy Wells Fargo in March of 2009 instead of October of 2008?

Charlie: Well I had the money in the later period. And the stock was cheaper. Those are two very important parts of the purchase.

Question 37: I’ve heard that you started some new real estate developments. What are you developing now and what’s going to be the key to its success?

Charlie: No I bought some apartment houses for my grandchildren. It seemed like a good idea at the time. By the way that phrase, ‘It seemed like a good idea at the time.’, came to me from a man I knew many years ago. In five minutes between trains he managed to conceive an illegitimate child by somebody he met in the bar car. And my father was asked by the young man’s father, he had a nice wife and three children, “What the hell were you thinking about?” And you know what the young man said? “It seemed like a good idea at the time.” (laughter)

Question 38: Herb Kelleher passed away recently and I’m hoping that maybe you have some anecdotes about Herb that you would like to share with us?

Charlie: Yeah well. Well he was a very remarkable business man. I never knew him, but he was an original and he created an amazingly sound company while drinking one hell of a lot of whiskey and smoking a hell of a lot of cigarettes. This is not my personal style. To do as well as he did with so much Bourbon and so many cigarettes, it set a new record in human life. So, we should all remember Herb Kelleher. And we should all wish we could have so much strength that we could abuse it so much and still perform. I didn’t get such a hand. I regarded it as a miracle.

Question 39: If you didn’t have access to Li Lu and to the Chinese exchanges through him, like many Americans don’t, would you feel comfortable investing in the American Depository Shares of most Chinese companies that are comprised of a V.I.E. Structure and offer shareholders few rights and minimal protections from the Chinese government?

Charlie: I don’t know much about depository shares. I tend to be suspicious of all investment products created by professionals. I tend to go where nothing is being hawked aggressively or merchandise…sold aggressively. So you’re talking about a world in which I don’t even enter. So I can’t help you. You’re talking about a territory I avoid.

Question 40: The derivative portfolios of major U.S. banks are getting quite large on the balance sheets. S.E.C. reporting doesn’t require much transparency. So do you worry about this kind of stuff in the banks that you own? And do you worry about other banks as well?

Charlie: All intelligent investors worry about banks because banks present temptations to their managers to do dumb things. There’s so many things you can easily do in a bank that looks like a cinch 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.” And he’s right about that. So I would say that if you invest in banks you have to go in at a time when you got a lot going for you. Because there’ll be a fair amount of stupidity that creeps into banking.

Question 41: When you don’t have the luxury of picking your negotiation counter parties, what’s your best recommendation for dealing with somebody who, not only won’t negotiate rationally but will also criticize you for trying to negotiate rationally?

Charlie: You’re talking about a situation I try and solve by avoidance. If I can solve that problem I’d have a line around the block. I mean you wouldn’t be able to squeeze in here. Everybody who has an insoluble problem with a difficult person…Think of what we’d all do to solve that one? I’m afraid I don’t have a solution to that one. Avoidance is my general principle method.

Question 42: I have two questions. Both you and Mr. Buffett worked in Buffett’s grandpa’s grocery store during your teenage years. Do you think that your early working experience helped give you a strong advantage in this investing profession?

Charlie: Absolutely. I was able to learn from my dead great grandfather when I was a little boy. What I learned at a very young age when I was just a kid, I could see some of the adults around me were nuts and yet they were very talented. I could see how much irrationality there was in very talented people.

So I got interested in seeking out the patterns and understanding why it happened and learning tricks to cope and so on. And I did that when I was a little kid. And of course it helped me. Who is not helped by an early start in a promising activity? And what activity could be more promising than in diagnosing stupidity?

Question 43: What level of discount would you be applying to potential investments today?

Charlie: Well generally speaking, I think the professional investors have to accept less than they were used to getting under different conditions. Just as an old man expects less out of his sex life than he had when he was 20.

Question 44: I want to come back to William Thorndike books, and I now have the list of the eight companies. It is General Dynamics, Berkshire Hathaway, The Washington Post, DCI, Capital Cities, Teledyne, General Cinema, and Ralston Purina. I know that Berkshire Hathaway had the long-term investment in the Washington Post and Capital Cities and have been invested in companies of John Malone. But why did Berkshire not have a long-term investment into General Dynamics, Teledyne, General Cinema, or Ralston Purina?

Charlie: Well we did have a huge investment in General Dynamics for a long time and we made an enormous amount of money with it. After the defense business contracted, nobody else was willing to sell anything except for General Dynamics, which kept selling at higher and higher prices. And Warren noticed that. We had a huge position in general dynamics and made a fortune. We always admired the founder of Teledyne who was a genius. Henry Singleton. But we admired him from afar, we never invested. It’s just one of many mistakes of omission.

Question 45: I was happy to see you at this meeting turned 90, now you’re ninety-five…

Charlie: You think you’re happy, think of the way I feel! (laughter)

Question 45 (continued…): Well I hope you live to be 120 and I always thank you for your positive influence on our lives. My question is related to stress and sleep and longevity. In business, there are what I call ‘criminal competitors’. You’re honest and ethical but the competitor across the street is beating you by cheating and running a massive insurance fraud. Business and life can cause a lot of stress, but you’ve always seemed to stay cool. What mental tools do you use to de-focus and keep your equanimity for ninety-five years? How do you detach? And even during the Salomon Brothers scandal were you always able to get eight hours of sleep at night?

Charlie: Well that is not true. As a matter of fact, I had more difficulty sleeping when I was young, but I do have a tip that I’ve learned late in life. I never consciously blanked out my mind when I tried to go to sleep, so I allowed my mind to wrestle through my problems and keep me awake very very late while I lay in bed wrestling with problems. And then if I didn’t sleep well one night I figured, “What the hell I’ll sleep the next night.” But that was pretty stupid. But now I actually deliberately blank out my mind I can go to sleep rather easily and I recommend it to all of you. It really works. I don’t know why the hell I didn’t get to it before 93. (laughter)

Question 47: You gave Robert Cialdini one share of Berkshire for writing influence, and a twenty thousand dollar check to Atul Gawande for writing a New Yorker article on health care. Are there any other writers you gave something to for their writing or ideas?

Charlie: I’ve forgotten, but there aren’t many. Atul Gawande is a very remarkable person and so is Cialdini. So I do that kind of weird stuff occasionally, but I don’t do it all the time. I’m proud of those two by the way.

Question 48: If someone can invent a time machine and you can go back and have dinner with your 41 year old self, what piece of advice would you give your former self?

Charlie: Well I’d avoid that one mistake of omission that cost me half of the net worth I would now have if I’d been smarter. We can all go back and make some decision better. But it’s the nature of thing that you’re going to blow one occasionally. My general idea is there’s no point in fretting too much about what you can’t fix. It’s a big mistake to fill yourself with resentments and hatreds and so on. It’s such a simple idea but so many people ruin their lives unnecessarily. Envy is such a stupid thing to have because you can’t possibly have any fun with that particular sin. Who in the hell ever had any fun in envy? What good could envy possibly do for you? And somebody is always going to be doing better than you are. It’s really stupid. So my system at life is to figure out what’s really stupid and avoid it. It doesn’t make me popular, but it prevents a lot of trouble.

Question 49: Could you comment on why there’s so little health care in the Berkshire portfolio?

Charlie: I think we don’t understand it well enough and we don’t like a lot that we do understand. Those are two pretty good reasons for not investing.

Question 50: Do you have any thoughts on a winner-take-all business model, and have you seen it in the 50’s and 60′?

Charlie: That’s ideal if you can find one in advance and predict it accurately. It’s perfect. Winner take all. It’s obviously perfect. It’s very difficult to do because everyone’s looking for the same thing.

Question 51: I’m at a point in my life where I don’t really know my circle of competence, so I would like to know how you found yours.

Charlie: Well it’s a hugely important thing, knowing the edge. It’s hardly a competence if you don’t know the edge of it. You know, if you have a misapprehension regarding your own competency that means you lack competence, you’re going to make terrible mistakes. I think you’ve got to constantly measure what you achieve against other people of achievement, and you have to keep being determinedly rational, and avoiding a lot of self-delusion. But after a lifetime of observing it, I think the tendency to be pretty rational about one’s own competency is largely genetic. I think people like Warren and I were just born this way. Now it took a lot of education. But I think we were born with the right temperament to do what we did. And I have no way of taking you back and rebirthing you.

Question 52: In spite of being partners for so long, why is Warren so much richer than you?

Charlie: Well. He got an earlier start. He’s probably a little smarter. He works harder. There are not a lot of reasons. Why was Albert Einstein poorer than I was? (laughter)

We are coming to the end of our allotted time. I’ll take one more question and then we’ll quite

Question 53: You’ve been very positive on the investment prospects for China and you’ve said that most of Americans are missing out on China. What do you think we’re missing? And what should we be aware of when we invest in China?

Charlie: Well what you’re missing is that there’s more opportunities there than there is here. And I don’t see how I can guide you any more firmly than that. Are you finding things so easy here you don’t need China?

Well with that we’re through.

Gerry Salzman: Thank you all for attending the Daily Journal shareholder meeting this year. We welcome you all back for next year.

End of Transcript

Thank you for reading. I hope you all thoroughly enjoyed the transcript. If you found any errors, kindly let me know and I will fix them.

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Sincerely,

Richard Lewis, CFA

 

Links to additional Transcripts:

Peter Kaufman on The Multidisciplinary Approach to Thinking: Transcript

2018 Daily Journal Meeting Transcript

2017 Daily Journal Meeting Transcript

2017 Fireside Chat with Charlie Munger

2016 Daily Journal Meeting Transcript

Peter Kaufman on The Multidisciplinary Approach to Thinking: Transcript

Last week I had the great pleasure of attending a talk by Peter Kaufman on the Multidisciplinary Approach to Thinking.  I would like to thank Mr. Kaufman for delivering such an engaging and insightful talk.

Mr. Kaufman does not normally allow his talks to be on the record, but is making a rare exception in this case.  He believes the message within this talk – that it is possible to succeed in business, yet fail in life – is critical for anyone interested in living a full, meaningful life, with minimal regret in later years.  He hopes that “going positive and going first”, “win/win”, and “going far by going together” are ideas that aspiring money managers will take to heart in their own lives.

I transcribed the full event from my audio recording which you may listen to on SoundCloud.  Throughout the transcript you will find;

  1. Time stamps, each linked to its corresponding recording location.
  2. Links to relevant supporting information.

Furthermore, I’d like to thank Spencer Hoff, President of the Cal Poly Pomona Economics Club, who graciously invited the Latticework Investing Community to attend.  I would also like to thank the Cal Poly Pomona Economics Club for hosting such a great event.

Transcript: Peter Kaufman on The Multidisciplinary Approach to Thinking

0:00 Talk Begins

Spencer Hoff: Thank you for coming. Today we’ve got Mr. Peter Kaufman, CEO of Glenair, who wrote this book, Poor Charlie’s Almanack about Charlie Munger. It’s an excellent book, the best book I’ve ever read, by far, in my life. He serves on the board of Daily Journal with Mr. Charlie Munger and he’s going to give us a few words today. So please welcome Mr. Peter Kaufman everybody.

0:26

Peter Kaufman: Thank you. Now I’m happy to talk about a subject. I was asked to talk about the multidisciplinary approach to thinking. So I’ll start out with that. But if you guys get bored or something and say ‘Well I thought we were supposed to have fun listening to this today.’ You can raise your hand and say ‘Could you talk about leadership or team building or business strategy or ethics or something else?’ I gave a talk recently at Google, in fact I’ve given three talks at Google. And the first talk I gave they said ‘What are you going to talk about?’ And I said, ‘Well, what do you want to talk about?’ They said, ‘About whatever you want. What do you usually talk about?’ Well I usually talk about leadership, culture, team building, strategy, ethics. And they said, ‘We don’t want to hear about that team building crap. We get that all the time. We want to hear about self-improvement.’ So I will mix in with our multidisciplinary topic a little bit of self-improvement as well. Is that OK? OK.

So why is it important to be a multidisciplinary thinker? The answer comes from the Austrian philosopher Ludwig Wittgenstein (link 1, 2, 3) who said, ‘To understand is to know what to do.’ Could there be anything that sounds simpler than that? And yet it’s a genius line, to understand is to know what to do. How many mistakes do you make when you understand something? You don’t make any mistakes. Where do mistakes come from? They come from blind spots, a lack of understanding. Why do you need to be multidisciplinary in your thinking? Because as the Japanese proverb says, ‘The frog in the well knows nothing of the mighty ocean.’ You may know everything there is to know about your specialty, your silo, your “well”, but how are you going to make any good decisions in life…the complex systems of life, the dynamic system of life…if all you know is one well?

2:33

So I tried to learn what Munger calls, ‘the big ideas’ from all the different disciplines. Right up front I want to tell you what my trick was, because if you try to do it the way he did it, you don’t have enough time in your life to do it. It’s impossible. Because the fields are too big and the books are too thick. So my trick to learn the big ideas of science, biology, etc., was I found this science magazine called Discover Magazine. Show of hands, anybody here ever heard of Discover magazine? A few people. OK. And I found that this magazine every month had a really good interview with somebody from some aspect of science. Every month. And it was six or seven pages long. It was all in layperson’s terms. The person who was trying to get their ideas across would do so using good stories, clear language, and they would never fail to get all their big ideas into the interview. I mean if you’re given the chance to be interviewed by Discover Magazine and your field is nanoparticles or something, aren’t you going to try your very best to get all the good ideas into the interview with the best stories etc. OK. So I discovered that on the Internet there were 12 years of Discover Magazine articles available in the archives. So I printed out 12 years times 12 months of these interviews. I had 144 of these interviews. And I put them in these big three ring binders. Filled up three big binders. And for the next six months I went to the coffee shop for an hour or two every morning and I read these. And I read them index fund style, which means I read them all. I didn’t pick and choose. This is the universe and I’m going to own the whole universe. I read every single one. Now I will tell you that out of 144 articles, if I’d have been selecting my reading material, I probably would have read about 14 of them. And the other 130? I would never in a million years read six pages on nanoparticles. Guess what I had at the end of six months? I had inside my head every single big idea from every single domain of science and biology. It only took me 6 months. And it wasn’t that hard because it was written in layperson’s terms. And really, what did I really get? Just like an index fund, I captured all the parabolic ideas that no one else has. And why doesn’t anybody else have these ideas? Because who in the world would read an interview on nanoparticles? And yet that’s where I got my best ideas. I would read some arcane subject and, oh my god, I saw, ‘That’s exactly how this works over here in biology.’ or ‘That’s exactly how this works over here in human nature.’ You have to know all these big ideas. Or there is an alternative, find somebody who did what I did and just get all the ideas from them. Now when I was your age and I was in school I thought the asymmetry of it was very unfair because I had to do all the work. So every time I go back and meet with a group of students I change the asymmetry around. I did all the work for you…

6:15

I have (multiple examples) of models that I derived from what I call my ‘three buckets’. Let’s see if I’ve got my three buckets in here. I do. I do have my three buckets. Ok. So this is how I use ideas that no one else in the world uses and yet I can be comfortable that they’re right. A statistician’s best friend is what? A large, relevant sample size. And why? Because a principle derived from a large relevant sample size can’t be wrong can it? The only way it could be wrong is if the sample size is too small or the sample itself is not relevant. So I want to tell you what my three buckets are where I derive my models, my multidisciplinary models. Number one is 13.7 billion years. Is that a large sample? It’s the largest one in the whole universe. There is no larger sample. Because what is it? It’s the inorganic universe. Physics. Geology. Anything that’s not living goes in my bucket number 1. 13.7 billion years.

Bucket number 2 is 3.5 billion years. It’s biology on the planet Earth. Is that a big sample size? Is it relevant? We’re biological creatures. Let me ask you this, inorganic, bucket number one, is it relevant? We live in it. So bucket number one we live in, 13.7 billion years. Bucket number two is what we’re part of, biology. 3.5 billion years. And number three is 20,000 years of recorded human history. That’s the most relevant of all. That’s our story. That’s who we are.

So we’re going to take a couple of examples here of multidisciplinary thinking. We’ll ask this question, is there a simple two word description that accurately describes how everything in the world works? That would be very useful wouldn’t it if you know how everything works in just two words? So we go to bucket number one. How does everything work? We go to Newton’s Third Law of Motion. We’re getting very multidisciplinary here. Does anybody in the room know what Newton’s Third Law of Motion says? (Answer: “For every action there will always be an equal and opposite reaction.”) That’s beautiful. He wins one of my pens here for answering that question correctly. I always give out rewards. It’s like operant conditioning from psychology, right? So there you go.

Yes if I put this bottle of water on this table, Newton’s Third Law of Motion says that if the bottle pushes down on the table with ‘force x’, and it also strangely says that the table pushes back with equal ‘force x’. That’s very strange. But you know how long that’s been true? 13.7 billion years that’s been true. Now what if I push down twice as hard, what does the table do? Well if I push down twenty one and a half times as hard? What does the table do? Twenty one and a half! OK. Now is there a good word, a catchall word to describe what we’re talking about here when this pushes down and this thing pushes back? Yeah, it’s reciprocation isn’t it? But it’s not mere reciprocation. It’s perfectly mirrored reciprocation. The harder I push, the harder it pushes back. Does everybody buy that? That’s bucket number one. That’s how the world works. It’s mirrored reciprocation. Everything in the inorganic universe works that way.

We go to bucket number 2. I’m going to introduce a little humor into this. Even though this is a dog, pretend it’s a cat. OK? This is a cat for the time being. Mark Twain said that a man who picks up a cat by its tail will learn a lesson he can learn in no other way. What is this cat going to try to do? It’s going to do what? (Answer: “Attack you.”) Yeah it’s going to try and scratch me with its sharp claws. And why? It doesn’t find being picked up by its tail very agreeable does it? Now what if I start swinging this cat around by its tail. What does the cat do now? Now it’s trying to scratch my eyes out. It said, ‘You escalated on me pal, I’m going to escalate back on you.’ Does that sound a lot like mirrored reciprocation? But what if instead of doing something disagreeable with this cat we do something very agreeable with this cat? And this cat’s sitting here and we come over and we gently pick it up by its tummy and we put it in the crook of our elbow and we gently stroke it. Does the cat try and scratch us? What does it do? It licks our hands. And as long as I sit here and stroke it, it’s going to continue to try and lick my hand. It wants to show me what? ‘I like this. This is agreeable. You’re a good guy. Keep it up man!’ It is mirrored reciprocation isn’t it? If I act in a disagreeable way to the cat, the cat acts in a disagreeable way back, and mirrored. If I act in an agreeable way, what do you think we’re going to find when we go to bucket number three? It’s exactly the same thing isn’t it? Your entire life. Every interaction you have with another human being is merely mirrored reciprocation. Now you’re going to say to yourself ‘This is too simple. It can’t be this simple.’ It is this simple! It doesn’t mean it’s not sophisticated. This is a very sophisticated model we just derived isn’t it? We did it in a multidisciplinary fashion didn’t we? We looked into the three largest sample sizes that exist, the three most relevant, and they all said exactly the same thing. Do you think we can bank on that? 100 percent we can bank on that.

13:04

So, if you think about things being complex as being sophisticated like most people do, you think the more complex it is, the more sophisticated it is. I want you to remember, as best you can, what I’m about to say. It’s very, very important. Albert Einstein once listed what he said were the five ascending levels of cognitive prowess. Now there’s nobody in this room that doesn’t want to be level number one. Right? That’s why we’re here. You don’t want to be level number five. You want to be level number one. Wait until you hear what these levels are, it’s going to blow your mind. So number 5 he said, at the very bottom, was smart. OK. That’s the lowest level of cognitive prowess is being smart. The next level up, level 4, is intelligent. Level 3, next up, is brilliant. Next level up, level 2 he said is genius. What? What’s higher than genius? He must have that backward. No he doesn’t. Wait until you hear what number one is according to Albert Einstein. We just demonstrated it. Number one is simple. Simple transcends genius.

Why is simple, the right kind of simple, better than genius? Because you can understand it! I bought this book I usually take it when I’m giving a talk like this. It’s the Ethics by Spinoza. Spinoza’s ethics book was written by a true genius. And guess what? You can’t understand anything in it. But can you understand what I walked you through, mirrored reciprocation? OK.

14:59

Now, because this is an economics club, right, everybody here is interested in economics? So let’s give an example of a model derived, multidisciplinary, same way we did before, but is just about as pure an economic model as you can find. So now we’re going to ask the question, what’s the most powerful force that we as human beings, both as individuals and groups, can potentially harness towards achieving our ends in life?

Ok. We go to bucket number one. We ask, what’s the most powerful force in bucket number one? I’m going to quote Albert Einstein again. He said, ‘The most powerful force in the universe is compound interest.’ But that’s not all he said about compound interest. He not only said that it’s the most powerful force in the universe, he said it’s the greatest mathematical discovery of all time. He said it’s the eighth wonder of the world. And he said that those who understand it get paid by it and those who don’t pay for it. He said all these things, Albert Einstein, about compound interest. Now what’s a good working definition of compound interest? I will propose one. You can have your own, but this is mine. I say compound interest is dogged incremental constant progress over a very long time frame. Is that a fair definition? Alright? I think that’s the answer from bucket number 1. The most powerful force that could be potentially harnessed is dogged incremental constant progress over a very long time frame.

We go to bucket number 2. 3.5 billion years of biology. What’s the most powerful force in three and a half billion years of biology? It’s the machine of evolution. How does it work? Dogged incremental constant progress over a long time frame. This is the beauty of deriving things multidisciplinary. You can’t be wrong! You see these things lined up there like three bars on a slot machine. Boy do you hit the jackpot.  

What do you think we’re going to find when we go to bucket number three? 20,000 years of human experience on earth. You want to win a gold medal in the Olympics. You want to learn a musical instrument. You want to learn a foreign language. You want to build Berkshire Hathaway. What’s the formula? Dogged incremental constant progress over a very long time frame. Look how simple this is. This is above genius. It’s absolutely above genius because you can understand it. This isn’t somebody drawing all these formulas and things up here about, you know, how numbers multiply and amplify over time. The problem that human beings have is we don’t like to be constant. Think of each one of those terms. Dogged incremental constant progress over a very long time frame. Nobody wants to be constant. We’re the functional equivalent of Sisyphus pushing his boulder up the mountain. You push it up half way, and you go, ‘Aw, I’ll come back and do this another time.’ It goes back down. ‘I’ve got this great idea, I’m going to really work hard on it.’ You push it up half way and,’ Aw, you know I’ll get back to this next month.’ This is the human condition. In geometric terms this is called variance drain. Whenever you interrupt the constant increase above a certain level of threshold you lose compounding, you’re no longer on the log curve. You fall back onto a linear curve or God forbid a step curve down. You have to be constant. How many people do you know that are constant and what they do? I know a couple. Warren Buffett and Charlie Munger. Everybody wants to be rich like Warren Buffett Charlie Munger. I’m telling you how they got rich. They were constant. They were not intermittent.

19:37

Let me give you an example of why intermittency is perhaps the most important thing in your lives whether you realize it or not. We’ll begin with the example of bringing home a puppy from the pet shop. Brand spanking new puppy from the pet shop. And the kids are so excited, they’re so excited. What’s your goal of bringing home this puppy to your household? I say it’s to have an engaged, contributing, all-in, new member of your household. And night number one, how are we doing? It’s a disaster. This thing’s over in the corner shaking like a leaf. It’s anything but engaged. It’s anything but contributing and it’s anything but all-in. It’s shaking like a leaf. Human beings are really good at solving this problem. We know we need to create a calm, reassuring, secure, and safe environment.

We know that even though this puppy can’t understand what we’re saying, we need to communicate in soothing tones. And we also know that we need to provide food and water for this puppy. But underlying all these things, stitching them all together, we really know we have to be constant don’t we? You can’t not feed the puppy one day or what happens? Well, the puppy freaks out. The puppy becomes a neurotic puppy. It doesn’t know whether it can trust you or not. This trust that this puppy needs to go all-in is dependent upon you being constant in these behaviors. Does everybody accept that? So, if we are constant, usually in about seven days more or less, if we are constant this little puppy will trot over to our side and it will attach itself to us. And for the rest of its life it will be willing to die for us. That puppy just went all-in, didn’t it? Now did it go all-in because it’s our idea that we want an engaged contributing all-in new member of our household? It doesn’t even know what our idea is, does it? Why did it just go all in? It was the puppy’s idea!

21:57

Now let me tie this to your lives. I did this at Google and they really couldn’t figure out what I was doing. And then afterwards they said ‘You know that was really good. Your eight dollar crystal ball that’s really a good trick. So I’ll do my eight dollar crystal ball trick. And I told them…I had rows bigger than this one, full of the smartest people in the world. And I said guess what I’m going to do with my eight dollar crystal ball? I said, I’m going to do a psychic reading of anybody in this room. Anybody. And I said to Google, ‘If you think that I’ve got a stooge in the room where I’ve got this prearranged. I don’t. Go out in the corridor and bring somebody in. I’ll do the psychic reading.’ This eight dollars I spent on Amazon is the best money I ever spent. So I’m going to select you. What’s your name? (Answer: “Emily”) We’re going to take Emily, we’re going to do a psychic reading of Emily right in front of you. You’re not going to believe this. I’m going to nail this. You’re all going ‘This guy’s a nutcase.’ Spencer’s going, ‘Man why did I invite this guy?’ Just be patient Spencer, this is good stuff. I’ll pull it off. So I’m going to tell Emily what she’s been looking for her whole life. Is there anybody here who thinks I can do this? Well wait until you hear my answer and then for the rest of your life you’re all going to go, ‘I know what everybody in the world is looking for.’ Emily, your entire life you’ve been on a quest, an odyssey, a search for that individual that you can 100 percent absolutely and completely trust. But who’s not just trustworthy, but principled, and courageous, and competent, and kind, and loyal, and understanding, and forgiving, and unselfish. I’m right aren’t I? (Answer: “Dead on”) You know what else my eight dollar Crystal Ball tells me? If you ever think you may have encountered this person, you are going to probe and probe and test and test to make sure that they are real, that you’re not being fooled. And the paradox is that it looks like you’re probing for weakness but you’re not. You’re probing for strength. And the worst day of your life is if instead of strength you get back weakness. And now you feel betrayed. You know why? You’ve got to start your search all over again. It’s the worst thing in the whole world isn’t it? Does everybody here agree with me on this? Look how simple this is.

24:53

Here’s your 22 second course in leadership. That’s all it takes. You don’t have to go to business school. You don’t need books. You don’t need guest speakers. All you have to do is take that list that’s in Emily’s head, and every single other person in this room, every single other person in the whole world, has this list in their head – trustworthy, principled, courageous, competent, loyal, kind, understanding, forgiving, unselfish, and in every single one of your interactions with others, be the list!  Remember how that puppy went all in? You do this with the other human beings you encounter in life. They’re all going all-in and not because it’s your idea. Most people spend all day long trying to get other people to like them. They do it wrong. You do this list, you won’t be able to keep the people away. Everybody’s going to want to attach to you. And be willing to do what? Just like them puppy, they’d be willing to die for you. Because you are what they’ve been looking for their whole lives. This is pretty profound isn’t it?

Look at this picture. I love this picture. Does this woman look like she’s having a good time? OK. So I helped teach this high school class in Los Angeles, and the first class of each semester, a brand new group just like you guys, and I make them go through the following exercise. And believe me just like my eight dollar crystal ball, afterwards you’re going to go ‘I’m really glad I heard that. Because now I really understand things at a level I didn’t understand them before.’ And to understand is to what? To know what to do.

This will clear up all your blind spots about yourself and other human beings. I asked the group, show of hands, how many of you think all human beings are alike? Why? (Answer: “We all have the same basic needs. We express them differently. Tremendous diversity in how we go about meeting them, but ultimately we all have the same needs.”) You get two pens! That’s a beautiful answer. So we’re going to identify what those needs are. What’s your name? (Answer: “Craig”) Craig nailed it. Show of hands. How many of you want to be paid attention to? I mean is there really anybody here who doesn’t want to be paid attention to? You’re a different kind of human being if you are. OK. How many of you want to be listened to? How many of you want to be respected? How many of you want meaning satisfaction fulfillment in your life in the sense that you matter? And then I tell the high school kids, number five. I put it number five, even though it’s the most important of the five I put it last, because if I put it first you wouldn’t raise your hands because it’s awkward. They’re just going to think I’m weird. But then they do raise their hand because I soften them up. How many you want to be loved? Everybody’s exactly the same. The only difference is, as Craig said, is the strategy the that they’re employing to try to get to fulfill those needs. OK.

28:30

Now I’m going to tell you the strategy that dogs use. The dog is going to be very unhappy with me for telling you this. I’m ratting them out. So when your dog is in the backyard and he goes to the fence between your house and the next house and he talks to the dog next door, I’m going to tell you what he says, no one has ever divulged this before. You’re the first group to hear this. Your dog says to the dog next door, ‘Can you believe how easy it is to manipulate human beings and get them to do whatever you want them to do for you?’ And the dog next door goes, ‘I know it’s a piece of cake.’ And your dog says ‘Yeah. All you have to do is every single time they come home, you greet them at the door with the biggest unconditional show of attention that they’ve ever gotten in their whole life. And you only have to do it for like 15 seconds and then you can go back to doing whatever you were doing before and completely ignore them for the rest of the evening.’

However, you do have to do this every single time they come home. And what will the person do? They’ll take care of them. They’ll do anything for this dog. OK? Now do you think that this woman feels she’s being paid attention to? And listened to? And respected? Do you think she’s getting meaning, satisfaction, and fulfillment? Do you think she matters to this dog? And do you think she thinks this dog loves her? And what does the dog get in return? Everything.

All you have to do, if you want everything in life from everybody else, is first pay attention, listen to them, show them respect, give them meaning, satisfaction, and fulfillment. Convey to them that they matter to you. And show you love them. But you have to go first. And what are you going to get back. Mirrored reciprocation. Right? See how we tie this all together? The world is so damn simple. It’s not complicated at all! Every single person on this planet is looking for the same thing. Now why is it that we don’t act on these very simple things?

31:08

So I have an example I use with the class, my elevator example. I’m famous for my elevator story. You’re standing in front of an elevator. The doors open. And inside the elevator is one solitary stranger, you’ve never met this person before in your whole life. You walk into the elevator you have three choices for how you’re going to behave as you walk into this elevator. Choice number one you can smile say ‘good morning’. And I say, at least in California, if you do that 98 percent of the time the person will smile say good morning back. You can test it. OK. My guess is you’re going to find that 98 percent of the time that people say ‘good morning’. Choice number two, you can walk in and you can scowl and hiss at this stranger in the elevator. And they have no idea why you’re scowling and hissing at them. And I say 98 percent of the time, they may not hiss back at you, but they will scowl back at you. And option number three. This is where the wisdom comes. You can walk into the elevator and you can do nothing. And what do you get 98 percent of the time if you walk into an elevator and you do nothing from that stranger in the elevator? Nothing. It’s mirrored reciprocation isn’t it? But what did you have to do? You have to go first. And you’re going to get back whatever you put out there.

This is why these bars are full of people at 2:00 a.m. drowning their sorrows. Knocking down these drinks. ‘When’s the world going to give me something man? When am I going to get mine?’ Well what did you ever do? Did you ever get up of the morning and smile at the world? No. You either did nothing or you scowled and hissed at the world. You’re getting back exactly what you would expect to get back if you understood how the world really works. Which is why we study multidisciplinary things right? We can’t be wrong on this can we? It’s all mirrored reciprocation. So what do you want to do? You want to go positive, you want to go first. What’s the obstacle? There’s a big obstacle. This is an economics club. Certainly you have all heard of Daniel Kahneman, Nobel Prize winner in economics. Behavioral economics. And what did he win his Nobel Prize for? For answering the question, why would people not go positive and not go first when there’s a 98 percent chance you’re going to benefit from it, and only a 2 percent chance the person’s going to tell you to ‘screw off’ and you’re going to feel horrible, lose face, and all the rest of that. And that’s real. That’s why we don’t do it. He said there’s huge asymmetry between the standard human desire for gain and the standard human desire to avoid loss. Which one do you think is more powerful? 98 percent versus 2!

34:14

Now I gave this same talk at Fairfax up in Toronto, Prem Watsa’s outfit. It’s the Berkshire Hathaway of Canada. And I said ‘Of all people in the whole world, you guys should not be making this mistake.’ Why? Because you’re in the insurance business. How does insurance work? You’re supposed to spend 2 percent to protect 98 percent, right? Look what you’re doing. You’re spending 98 percent to protect against the 2 percent probability that somebody makes you look foolish. Lou Brock set the Major League record for stolen bases with the St. Louis Cardinals many years ago. And he once said, ‘Show me a man who is afraid of appearing foolish and I’ll show you a man who can be beat every time.’ And if you’re getting beat in life, chances are it’s because you’re afraid of appearing foolish. So what do I do with my life? I risk the two percent. I was so proud the other day, I was reading Bono on Bono. Bono’s the lead singer of U2. He’s the only other person I’ve ever encountered in my entire life, and I asked all my cronies, ‘Has anybody else ever encountered this elevator model before?’ ‘No. No that’s yours Peter.’ And I said, ‘You know how I said 98-2? Guess who’s got the exact same model? Bono! Well he doesn’t have 98-2, he’s got 90-10.’ Those are his numbers 90-10. Can I be wrong on this? That guy is really squared away. I hope some day I’m as squared away as he is. It’s incredible to think, he figured it out. That’s why that guy’s had such a great life. He goes, ‘You know, I know 10 percent of people are going to screw me. That’s OK. If I’m not willing to be vulnerable and expose myself to that 10%, I’m going to miss the other 90%.’ Does that makes sense? Now Charlie Munger one day, you know he turned my whole life upside down. I was over at his house one day and he said, ‘Peter, I’ve been hearing about you going around giving all these talks. You don’t have to go around the country telling people how to make more money.’ I said, ‘Well that’s not what I do Charlie.’ I was very nimble on my feet. I said there’s a catch. I do tell how to make more money but, by the way, if you do these things that get people all-in and whatnot, you’ll make all the money there is to be made. You really will. That’s not why I’m here. I’m here to give you the second half of the message, which is how to be a good person!  What’s your name? (Answer: “Albert”) Albert, How many lifetimes do you have Albert? (Answer: “One”) That’s correct, you get a pen. You see Albert lucked out, he got an easy question. Is your lifetime important to you Albert? (Answer: “One of the most important. Absolutely)

37:15

Now what do we know in economics, it’s an economics model, what do we know we need to use as our decision making prism whenever something is both finite, like one, and important like your life? How do we have to make decisions? You had Mankiw here right? He didn’t talk about opportunity cost? Have you all heard of opportunity cost? It’s the classic illustration of opportunity cost. You have a finite number of something, it’s important. If you’re doing ‘A’ with it, it means what? It means you’re not doing B or C or D or E. What do you have to do? You have to evaluate all the different alternatives and pick the one that’s most optimal. Is that fair? So you’ve got one lifetime. How do you want to spend your one lifetime? Do you want to spend your one lifetime like most people do, fighting with everybody around them? No. I just told you how to avoid that. And in exchange have what? A celebratory life. Instead of an antagonistic fighting life. All you have to do is go positive, go first, be patient enough.  You know we have to be patient for a week with this puppy. Do you know how long it usually takes for a human being to do all the probing and testing that Emily was going to do and to find out that you’re for real? It takes six months. This is why nobody does it. ‘Oh it takes too long.’ Compared to what? Look at the plan B that everybody uses. It’s terrible! It doesn’t work. They spend their whole lives fighting with everybody.

39:01

The three hallmarks of a great investment are superior returns, low risk, and long duration. The whole world concentrates on Category 1. But if you’re a leader of any merit at all, you should be treating these three as what? Co-priorities. How do you get low risk and long duration? Win-Win. This is the biggest blind spot in business. People are actually proud of a win-lose relationship. ‘Yeah we really beat the crap out of our suppliers.’ You know, ‘We’ve got these employees for…you know, we’ve got them on an HB1 visa, they can’t work anywhere else for three years.’ They’re proud of it! Total Win-Lose. You take game theory (link 1, 2) and you insert the word lose in any scenario in game theory and what do you have? A suboptimal outcome. What happens you insert win-win in any game theory scenario, what do you get? Optimal every time. What must you necessarily do if you’re interested in achieving win-win frameworks with your important counterparties in life? You must understand the basic axiom of clinical psychology, which I know because I’m multidisciplinary. I also learned psychology. The basic axiom of clinical psychology reads, ‘If you could see the world the way I see it, you’d understand why I behave the way I do.’ That’s pretty good isn’t it? Now there’s two corollaries to that axiom. And I say if you buy the axiom, which you should, you must buy the two corollaries as well because they’re logical extensions. They’re undeniable. Corollary number one, if that axiom is true and you want to understand the way someone’s behaving, you must see the world as they see it. But corollary number two, if you want to change a human being’s behavior and you accept that axiom, you must necessarily, to get them to change, change how they see the world. Now this sounds impossible. It’s not really that hard. You take a business. Most employees of a business see the world as employees. What if you could get them to see the world instead through the eyes of an owner? Do you think that’s going to change how they behave? It totally changes how they behave. Employees don’t care about waste. Owners do. Employees don’t self-police our place. Owners do.

42:05

This is the secret to leadership. The secret to leadership is to see through the eyes of all six important counterparty groups and make sure that everything you do is structured in such a way to be win-win with them. So here are the six. Your customers, your suppliers, your employees, your owners, your regulators, and the communities you operate in. And if you can truly see through the eyes of all six of these counterparty groups and understand their needs, their aspirations, their insecurities, their time horizons. How many blind spots do you have now? Zero. How many mistakes are you going to make? You’re going to make zero. People don’t think this is possible. It’s really easy. To understand is to know what to do. So I’m going to wrap up here because I’ve only got two minutes. There’s this great African proverb. It’s the definition of win-win. ‘If you want to go quickly go alone, if you want to go far, go together.’ Live your life to go far together. Don’t live it to go quickly alone. Most people grow up wanting to go quickly alone. It doesn’t work. You wind up like Ebenezer Scrooge in A Christmas Carol. You get to the end of your life. Yeah you’re rich, you’re powerful, you’re famous, and you want a do over because you realize at the end of your life, ‘I didn’t live my life right.’ I don’t have what really matters. What really matters is to have people pay attention to you, listen to you, and respect you, show you that you matter, and to love you. And to have it be genuine, not bought. Does that makes sense?

44:00

And I’ll leave you my last bit of wisdom. There’s another proverb, it’s a Turkish Proverb. ‘No road is long with good company.’ The essence of life is to surround yourself, as continuously as you can, with good company. Like I have today. You’re marvelous company. But how did I get that? I had to earn it, didn’t I? I’m not just some guy you picked off the street. I earned the privilege of coming here and the privilege of being with you. It gives me what? It gives me meaning in my life. It makes me feel I matter. To have people listening to me. This is my strategy for getting those five thing. You can develop your own strategy and I hope it involves going positive and going first. Thank you.

End of Transcript

Links to additional Transcripts:

Charlie Munger: Full Transcript of Daily Journal Annual Meeting 2018

Last week I had the great pleasure of hearing Charlie Munger speak at the Daily Journal Annual Meeting for the third time.  For two hours he captivated the audience with an abundance of whit, wisdom, stamina, and kindness.  At 94 years young, Charlie shows no signs of slowing down.

I transcribed the full event from my audio recording which you may listen to on SoundCloud.  Throughout the transcript you will find;

  1. Time stamps, each linked to its corresponding recording location.
  2. Links to relevant supporting information.

I would like to thank Mr. Munger for energetically entertaining our questions and graciously sharing his wisdom, insights, and time with all of us.

I hope you all enjoy!

(Note: You will find that I frequently summarized the questions from the audience, but as for anything that Charlie, Gerry, or Peter said, I translated them verbatim and as accurately as possible.)

2018 Daily Journal Meeting Transcript

0:00 Meeting Begins (Note: Tedious meeting details of the first 4 min. 33 sec. were edited out of the transcript.)

Charlie: We are waiting for some of our directors who are in the restroom. If you have a group of elderly males, they never get together on time. (laughter)  Well I call the meeting to order, I’m Charlie Munger, Chairman, and here’s the rest of the directors… We will now proceed to the formal business of the meeting, and that will be followed by pontification and questions… (laughter)

Ellen Ireland: (Votes for independent accountants)…For the auditors, 1,283,388.  Against, 275.  And Abstaining, 244.

Charlie: That is very interesting.  That is a lot of votes to vote against an auditor.  Some of this stuff is really weird. (laughter)  Maybe they fired somebody who doesn’t like them. (link)

4:33 “Pontification” Begins

Now on to pontification and questions.  I’ll first comment briefly about the general nature of the Daily Journal’s traditional business.  We are surviving but at a very modest profit, and it’s quite interesting what’s going on.  There’s a huge…trove of valuable information burred in the court system that nobody could get out before under the computing power of the procedures of yore.  And of course lawyers want to know what their judge did in all previous cases.  And how many cases the opposing council has won or lost and so forth.  So it’s going to be a big business of delivering more information to people.  But of course there are a horde of people trying to get into that.  Some of them are computer science types and some are just other types.  God knows how it’s going to come out, but we’re doing our part of that struggle.  The chances that we get as dominant a position as we had before when we were the only newspaper that had timely publications and print, all the court opinions of course where lawyers needed to have them is zero.  In other words, our glory days are behind us in this traditional business.  It may well survive creditably, but it’s not going to be a big business.

Most newspapers by the way I think are going to perish.  It’s just a question of when.  I mean they’re all going to die.  You know the New York Times will continue because people will pay $5 for it in an airport.  So there will be a few survivors, but by and large the newspaper business is not doing well.  Berkshire Hathaway owns a lot of them.  And buying them we figured on a certain natural decline rate after which the profits would go to zero. (link)  We underestimated the rate of decline.  It’s going faster than we thought.

On the other side we have this second business in the Daily Journal Company which is this software business.  That of course has taken a lot of treasure and a lot of effort to get started.  But our software business now produces a lot more revenue than our traditional print business, and it’s generally doing quite credibly.  It’s a very competitive business, and it’s difficult.  A lot of people in the software business don’t want to deal with a bunch of government agents.  It’s just too much agony.  They’re use to just printing money automatically…(inaudible)…not being overwhelmed by it, the money rolling in.  And the way we’re making money is slow and hard.  It’s a software business, but it’s a slow hard software business.  We have internal arguments about whether the first real revenue comes four years after the first customer contact or seven.  That’s the kind of business it is, it’s constantly spending money now just to…(inaudible)…returns for a long, long time…before we have a lot of difficult bureaucracies to get through in the mean time.  And the funny thing is, we actually got to kind of like it.  If you do it right, these courts eventually trust us, and district attorney offices, etc. etc.  And it’s a real pleasure just slowly earning the trust of a bunch of customers by doing your job right and scrambling out of your glitches as fast as you can.  I would say that business is doing well.  Jerry would you make a few comments about this new business?

9:00

Gerry Salzman: The new business is slow in coming as Charlie indicated, but (it’s long-term) once you get there.  You have to understand it’ll be quite long because government agencies do not want to spend additional time changing software companies.  It’s very painful.  And one of the problems is always the conversions and the interfaces.  Some of our clients have upwards of 20 different interfaces and an appetite for many more because they recognize that if there’s an interface it probably takes a lot of effort.  And so we have maybe 25 people primarily based in our office in Denver doing nothing but interfaces and conversion.  And implementation of most systems depends on the implementation of the conversions and the interfaces.  That is one of the continuing headaches because most government agencies have old systems and it’s extremely difficult to convert information that went into their system 30 years ago.  That’s one of the problems we face on every single installation.

We have a large number of installations going on.  Most will take upwards of a year, some much longer, depending on the client.  Some clients have very few people that are assigned to work with us on the implementation.  And other clients have upwards of 15 people.  So we find that the 15 people is a great investment from the client’s standpoint because it’s much faster, and they learn how to do it and make changes into the future, and that’s our objective, is to have them be totally familiar with the system, and when their requirements change they are then able to configure it and create documents in a very effective way.  In contrast, historically, the government agencies would ask their IT department to do something, and it would take forever for the IT department to do it.  Now it’s much more efficient and very effective.  And it helps the IT department feel important, and it’s important for us that the IT department feel important because then the IT staff will stick around rather than find greener pastures.  That enables us to get in and out much faster and satisfy the Client.

12:26

Charlie: There are two things that shareholders should know about our software business.  One is that our system is more configurable than that offered by many of our competitors.  That is a hugely good idea on our part.  And the other thing is that we’re slower to recognize revenue when somebody hires us than most of our competitors, and that is also a good thing because if you agree to give somebody selling computer software a lot of pay for developing a system, you can spend a lot of money and get nothing back.  Buyers are very wary.  And we are playing to that by…one of the advantages of being very rich is that we can behave better than other people.  Not only are we very rich, we don’t give a damn about what we report in any given quarter, and that gives us an advantage in saying to these government agencies, “You’re not going to take a big risk with us because you’re not going to pay us until the system is working.”  And I think it’s a very good idea that we’re using conservative accounting and have that attitude towards dealing with our customers.  We want the customers to be right when they trust us.  It’s rather interesting the way it has happened.

I will confess to one thing to this group of shareholders.  I’ve fallen in love with the Justice Agency of South Australia.  We have a contract there, and I think we trust them and they trust us.  And we are going to do a hell of a good job for Australia.  And it gives me an enormous pleasure.  So I’m biased in favor of Australia.  The shareholders will just have live with it.  We may end up with pretty much all of our business in Australia.  If we do, it will because we deserve it.  That’s our system, we try and deserve the business, that’s the way we’re trying to get it. (link)

Well, that’s pretty much…It’s been a long slog to date and there’ll be a long slog ahead.  We’re taking some territory, but it’s not rapid and it it’s never going to be the kind of thing that Google gets into, or Microsoft, where the sky just rains gold.  It’s going to be a long, long slog.  But we have a big pack of money and we have a strong will, and we have a lot of good people working in the system, and I think we’ll end up slogging pretty well.

Now, in addition to our businesses, we have a great bundle of securities.  And I want to try and dispel for the hundredth time, that this is not…we do not have some minor version of Berkshire Hathaway which has a big bundle of securities in its insurance companies, plus a lot of operating business.  We have a big bundle of securities by accident when we made a lot of money out of the foreclosure boom.  And it just happened to come in about the time when the market hit bottom.  And of course we look like a genius now because we put the money into securities because we preferred them to holding cash.  But this is not a Berkshire Hathaway (version), this is a computer software company who has a stable but small print business, and we just have a lot of extra liquidity on hand, which came to us by accident.  But of course when the money came to us by accident, we invested it as shrewdly as we could.  But the chance that we will continually gain at the rate we have in the past 4 or 5 years is zero.  Now having said that, we’re going to report in the next quarter a big increase in net worth because our deferred taxes have gone down thanks to the Trump changes in the tax code.  So we’re going to look like a genius from another accident for one more quarter. (Laughter)

16:55

(Inaudible)…There’s one security in there that is very interesting because BYD has gotten to be a significant position around here.  That with Berkshire Hathaway and the Munger family money that went into it was really a venture capital type play even though it was in the public market.  And BYD has developed into a huge company.  It’s got 250,000 employees more or less. It has a huge electric car business, it has a small gasoline car business, it has a huge battery business, it has a huge new lithium mine coming into production…(Inaudible)…near Tibet, but has a lake full of toxic water that if you drank it, it would kill you.  But it’s perfect for mining lithium.  And it’s a big lake.  One of the biggest in the world.  So we have an interesting venture capital type business, and BYD has gone into a business they were never in before, which is monorails.  And they are selling monorails like you can’t believe.  Boom-diddy, boom-diddy, boom to whole cities in China.  And some even in other countries.  And they’re also selling those big electric buses, etc. etc. and so on.  It’s weird that anybody at Berkshire or in the Munger Family, or the Daily Journal would have anything to do with a little company in China that becomes a big company, but it happened.

And there’s a buried story here that’s wonderful.  The man who founded BYD was like the eighth son of a peasant, and an older brother noticed that he was a genius and then with their Confucian system, the older brother just devoted his life to making sure the genius got educated. (link 1, 2, 3, 4)  And he got to be a PhD engineer, and then he decided to go in to the business of making cell phone batteries, in competition with the Japanese who had all the patents.  And he got $300,000 from the Bank of China, he had a cousin that approved the loan…a very Confucian system.  At any rate, from that tiny start, he created this enormous company.  250,000 employees.  And of course the governments of Shenzhen and this province up in Tibet, love BYD.  It’s not some partially owned joint venture, it’s a Chinese company created by Chinese, it’s high-tech, it does wonderful things.  And it hasn’t disappointed anybody yet, in any significant way.  So it’s heartening for me to watch.  Think of how hard it would be to create a big mono-rail business that suddenly starts to gallop.  Think how few mono-rails there are in the United States.  But of course the Chinese permitting system is totally different from the United States.  If the Chinese want to do something, they just do it.  Of course I love that system.  That’s the Salzman system.  If Gerry wants to do something he just does it.  But there are some varied stories like that, and it’s a pleasure to be affiliated with people who are accomplishing a lot.  And of course it’s good that you have electric buses in place where you can’t breathe the air, which is a lot of places.  And it’s good that we have a new lithium mine up in Tibet, or near Tibet, etc. etc. and so on.  There are some weirdness around here.  I don’t think we were very weird in buying into banks when they were very depressed.

21:00

The Wells Fargo position is interesting, and I know I’ll get questions about that, so I’ll answer them again in advance. (laughter)  Of course Wells Fargo had incentive systems that were too strong in the wrong direction.  And of course they were too slow in reacting properly to bad news when it came.  Practically everybody makes those mistakes. (Note: See Question 16)  I think around here we make fewer than others, but we still make them in the same direction.  I think Wells Fargo will end up better off for having made those mistakes.  Any bank can make a lot of money by making a bunch of gamier loans at higher interest rates or abusing their customers with very aggressive treatments.  And of course banks really shouldn’t do that.  And I think as a result of all the trouble, Wells Fargo’s customers are going to be better off (for) this event, and I think it’s time for the regulators to let up on Wells Fargo.  They’ve learned.  I can’t think of anything else that deserves a lot of comment in our basic businesses.

I’m looking at a bunch of shareholder that really didn’t buy Daily Journal stock because of its prospects.  There’s one exception.  Big exception.  But most of you here for some other reason, you’re groupies. (laughter)  I know a few nerds when I see them, of all ages, and all I can say is, “takes one to know one.” (laughter)  Well I guess that’s enough of the…oh, I might go on.

One of our directors came up with a list of qualities that any investment advisor should have.  And he gave it to a future picker of professional investors, and the picker immediately fire half his picks.  And I thought that was such a peculiar outcome that I’ll let Peter Kaufman share with you his ‘five aces’ system for picking an investment manager.  Peter, go ahead.

23:58

Peter Kaufman: So I came up with this list in giving reference to a very exceptional money manager.  And I not only wanted to give what I thought was the correct reference, I wanted the person that I was giving the reference to, to in turn be able to relate this above to the real shot-caller.  So that a compelling narrative would be transferred from me directly to the ultimate shot-caller.  So I came up with what I call the “five aces”.  The five aces being the highest hand you can have in a wild card poker game.  Ace number one is total integrity.  Ace number two is actual deep deep fluency on whatever it is you say you’re going to do on behalf of the client.  Ace number three is a fee structure that is actually fair in both directions.  Ace number four is an uncrowded investment space.  Ace number five is a long run-way.  Meaning that the manager is reasonable young in age.  I further add that if you ever find a money manager who possesses all five of these characteristics, there are two things you should do.  One, you should put money with them immediately.  And number two, put as much money as you are allowed to put.  Now I know we have money managers in the room, and we have…

Charlie: Do we ever! (laughter)

Peter Kaufman: And we have people who employee money managers who are in the room.  If you employ money managers, this is an excellent formula to evaluate your money managers.

Charlie: Yeah, but it will cost you to fire half those you’ve hired..or you have hired. (laughter)

Peter Kaufman: But perhaps more importantly, if you’re a money manager, this should be your list of five aspirations.  What characteristics should I seek as a money manager to possess?  I should be completely trustworthy.  I should have actual deep fluency in what I claim that I’m going to do.  I should adopt a fee structure that’s generally fair in both directions.  I should seek an uncrowded space because as we all know, in business where there’s mystery, there’s margin.  What kind of margin are you going to have in a crowded space? (Note: See Question 21)  And number 5, many of you in here, you’re very fortunate.  You get to check that box for having a long runway.  Some of the best money managers in history only get four out of these five aces because they don’t qualify for number five.

27:23

Charlie: Those include those who you’re invested with. We do not have a long runway.  That doesn’t mean the company won’t do well, (laughter) but in terms of investment management runway, it’s rather interesting.  Berkshire Hathaway’s peculiar in that its directors are so old and its managers are so old.  The only institution that exceeds Berkshire Hathaway and the Daily Journal in terms of old directors in office is the Mormon Church. (laughter)  The Mormon church is run by a group of people and they have two wonderful qualities.  There’s no paid clergy in the Mormon church.  And the ruling powers in a group of males between about 85 and 100.  And that system is more successful than any other church.  No paid clergy and very old males.  Obviously we are copying that system at Berkshire and the Daily Journal. (laughter)  And we are so much older than the Berkshire directors who are also very old.  Warren says we’re always checking to see how the young fellows are doing at the Daily Journal versus Berkshire.  It is slightly weird.  But the world is…who would have guessed that the church with the best record for keeping people happy and so on and so on…(inaudible)…which is the Mormon church.  Who would have guessed that it had no paid clergy, run only by males who are about 85 and up?  Now that is a very odd result.  I guess I should like odd results, because I’m sure as hell living a life of a lot of odd results.  And I’m very surprised to be here.  Somebody said, an old woman whom I liked, said at her 94th birthday party, “I’m very pleased to be here”, in fact she said, “I’m very pleased to be anywhere.” (laughter)  Well that’s what it is, and it is weird.

I think the incentive structure in investment management is very interesting.  If you look at the people who have a ton of money from the past, like say the Massachusetts Investor Trust (link) or something like that, which pioneered Mutual Fund investing in the early days after Mutual Funds were allowed.  It was certainly a respectable and honorable place.  But once it gets to be $700 billion or whatever it is, and hires a lot of young men and has a big staff and so forth…and young women too…and spreads its investment over 50 securities at least, the chances that it’s going to outperform the S&P average really shrinks to about zero.  And of course they wondered what we’ll keep paying, whatever number of basis points Massachusetts Investor Trust’s management operation charges for the long-term, and they may feel under pressure and that their world is threatened.

Another place that’s threatened.  Suppose you’re charging say 1 and 20, one percent off the top and twenty percent of profits…or even worse, two percent off the top and twenty percent of profits…and you’ve got $30 billion or so under management and an army of young ambitious people, all of whom want to get unreasonably rich very fast.  What are your chances of doing better for your clients?  Well the average entity that charges those fees, the chances the clients will do well is pretty poor.  That’s the reason Warren won that bet against the hedge funds.  Where he bet on the S&P averages and they bet on carefully selected bunch of geniuses charging very high fees.  And of course the high fees will just kill you.  It’s so hard in a competitive world to get big advantages just buying securities, particularly when you’re doing it by the billion, and then you add the burden of very high fees and think that by working hard and reading a lot of sell-side research and so forth, that you’re going to do well.  It’s delusional.  It’s not good to face the world in a delusional way.  And I don’t think, when Berkshire came up, we had an easier world than you people are facing this point forward, and I don’t think you’re going to get the kind of results we got by just doing what we did.  That’s not to say what we did and the attitudes that we had are obsolete or won’t be useful, it’s just that their prospects are worse.  There’s a rule of fishing that’s a very good rule.  The first rule of fishing is “fish where the fish are”, and the second rule of fishing is “don’t forget rule number one.”  And in investing it’s the same thing.  Some places have lots of fish and you don’t have to be that good a fisherman to do pretty well.  Other places are so heavily fished that no matter how good a fisherman you are, you aren’t going to do very well.  And in the world we’re living in now, an awful lot of places are in the second category.  I don’t think that should discourage anyone.  I mean life’s a long game, and there are easy stretches and hard stretches and good opportunities and bad opportunities.  The right way to go at life is to take it as it comes and do the best you can.  And if you live to an old age, you’ll get your share of good opportunities.  It may be two to a lifetime, that may be your full share.  But if you seize one of the two, you’ll be alright.  Well with that pontification done, I’ll take questions.

34:56 Q&A Begins

Question 1: How do you define mid-western values, and how have they influence you?  How much are they embedded into the DNA of Berkshire?

Charlie: Well I think there is some Middle Western values embedded in Berkshire.  I don’t think it would be the same place if it had grown up in the middle of Manhattan island.  There’s just so much buzz and craziness in finance in a place like Manhattan that I think it was actually an advantage for Warren to be brought up in a place out of Omaha. (link 1, 2)  Certainly I have a deep ties of affection and respect for my life in Omaha and my parents and their friends.  And so I like what I think of as Middle Western culture.  And I really don’t like crazy culture.  There’s a lot of it in a lot of places.  So yeah, I…(inaudible)…Mid-Western culture.  I don’t think it’s that bad in the South or the East or the Rocky Mountains, but I have less experience with that culture.  And I go to Montana to fly-fish, and I like Montana when I’m there, but that’s too rugged for me.  I like more intellectualism in the bigger cities.  So Omaha was just right for me.

36:49

Question 2: My question relates to BYD.  Given that you’ve successfully invested in commodities in the past, how do you view investing in things such Cobalt, Lithium, and Helium as technologies of the future?

Charlie: Well I’m hardly an expert in commodity investing, but certainly cobalt is a very interesting metal.  It’s up about 100% from the bottom.  And it could get tighter, but that’s not my game. (link)  I don’t know much about…I haven’t invested in metals in my life much.  I think I bought copper once with a few thousand dollars.  I think that’s my only experience.

37:53

Questions 3: When I reflect on where I am here in my 30’s I often think about the multiple sufferings you went through when you were my age.  I have the image of you walking the streets of Pasadena, shouldering your multiple griefs, alone.  In contrast to that, would you tell us about some of the people and experiences that helped you through that period?  And my friend also has a question…

Question 4: Did you ever have aspirations to be a comedian?  Because your jokes per minute are off the charts. (laughter)

Charlie: Well, I think you understand me best.  I’m really what I call a “gentile Jew”.  You know if you look at the way the world is working and just about 2% of the people provide about 60% of the humor.  And this is weird because this is a group that’s had a lot of trouble.  And so I just like the Jews, I like the humor.  My way of coping.  And by the way, I recommend it to all of you.  There are…I might tell a story about a darling little girl, wispy blonde hair, beautiful curls, charming lisp.  She goes into the pet store, and the pet store owner says, “Oh you little darling blonde haired girl, what can we do for you?”  “Wabbits, I want Wabbits.”  “Oh we’ve got wonderful ‘Wabbits’.  Grey wabbits, white wabbits, brown wabbits.  What kind of wabbits do you want?”  And she said, “I don’t think my lovely big snake is going to give a shit.” (big laughter)  It does help to go through life with a little humor.  One thing that’s nice about the human condition is that people are always doing these utterly ridiculous things.  You don’t lack for new things to crack jokes about. (link)

40:56

Question 5: I have a question about the talk you did about the talk you did back in 1995 at Harvard on “the Standard Causes of Human Misjudgment” (link 1, 2), and I thought you ended it in a very interesting way where you said, “I don’t think it’s good teaching psychology to masses, in fact I think it’s terrible.”  Would you elaborate on that comment?

Charlie: Well it sounds as though I’m somewhat misquoted.  I do think it’s hard to teach the whole reach of psychology the way they do it in academia.  Because the way they do it in academia is they want to do experiments and they want to learn things from the experiments that they can publish.  Therefore the experiments have to be pretty simple, testing one particular triggering factor if they can.  And by doing that over a vast number of triggering factors, they accumulate a big body of experimental events and you can drag some general principles out of it.  The great utility of psychology is when you know those principles as bluntly as you know how to read or something, really fluently.  And you use those principles in synthesis with the rest of knowledge.  The interplay of psychology with the rest of knowledge is a vastly productive area for correct thinking. But the psychology professors can’t do it because they don’t know the rest of knowledge, and there’s no reward in psychology for synthesizing the rest of knowledge with psychology.  The rewards are for doing another experiment and publishing.  And so it’s mis-taught.  It’s a subject that intrinsically works best when you use it in combination with some other discipline.  But academia is not set up for people to get good at using a blend of two disciplines.  So the whole damn system is wrong.  On the other hand it gave great opportunity to me because I always figured when I was young that if my professor didn’t know it, it just didn’t matter I’d figure it out for myself.  I could tell though from the first instance that the big territory was synthesizing psychology with the rest of knowledge.  So I learned psychology so I could do it.  But psychology professors, they just try and learn it the way it’s taught.  There’s no reward if you’re a professor of psychology for synthesizing psychology with the rest of knowledge.  Now you people should follow my example.  Not the example of the psychology professors.  I guarantee you that you won’t make any money doing it their way.  Occasionally you find a group like Thaler’s group, Thaler just won the Nobel prize by the way.  And he’s trying to synthesize the process.  And I say more power to Thaler.  May his tribe increase.  (“Abou Ben Adhem” link 1, 2, 3)  And it’s a good sign that the world has given it to Thaler…the Nobel Prize.  He’s doing exactly what I’m recommending.

45:15

Question 6: Speaking of Munger’s system, if you had to teach the Munger system of mental models to primary children, would you focus on covering all the models or would you focus on teaching them how to figure it out themselves?

Charlie: I’d do both.  Of course if you get the right number of models in your head it helps, and of course you want to get fluency of using the models, there isn’t any real road to getting it done fast.  At least if there is I’ve never found it.  You can keep at it.  But that’s my system.  My whole system in life is keeping at it.  I’m a big admirer of Carlyle’s approach, which was quoted all the time by Sir William Osler, who was one of the most highly regarded physician in the world.  Carlyle says that “The task of man is not to see what lies dimly in the distance, but to do what lies clearly at hand.” (link)  I think that’s right.  I think that most of the time, you should get the work that’s before you done and just let the future fall where it will.

46:33

Question 7: My Question is concerning commercial banks, obviously Berkshire has a very large $60 billion portfolio there, and Daily Journal has a very sizable one.  My question is, as I look at that portfolio, especially the Berkshire portfolio, there are quite a few banks that appear to be at or close to the quality of what’s in that in that portfolio, some of which people like you think highly of.  My question is, I realize they’re pretty fully valued now, maybe 4 to 5 years ago when they weren’t, why aren’t there more of those high quality banks in the Berkshire portfolio?  Is it just the concentration of the portfolio?  Because $60 billion’s a lot.  Or is there some pattern among those banks to make them less attractive to you and Mr. Buffett?

Charlie: Well, banking is a very peculiar business.  The temptations that come to a banking CEO are way…the temptations to do something stupid are way greater in banking than they are in most businesses.  Therefore it’s a dangerous place to invest because there are a lot of way in banking to make the near term future look good by taking risks you really shouldn’t take for the sake of the long-term future.  And so banking is a dangerous place to invest and there are a few exceptions.  And Berkshire has tried to (pick) the exceptions as best it could.  And I haven’t had any more to say on that subject except, I’m sure I’m right.

48:26

Question 8: Your thoughts on the valuation of software companies like Apple, Facebook, Google, Amazon, Alibaba.  Are they over-valued, potentially under-valued, too early to tell?

Charlie: Well my answer is I don’t know. (laughter)  Next question. (laughter)

49:04

Question 9: This question is for Mr. Kauffman.  You mentioned about the “five aces” and aligning the interests with investors with the right fee structure to benefit both.  What have you seen as a good fee structure, both from a start-up fund with say $50 million in assets, and then the larger funds with assets over billion?

Peter Kaufman: I’ll let Charlie answer that because he can describe to you what he thinks is the most fair fee formula that ever existed and that’s the formula in Warren Buffett’s original partnership.

Charlie: Yeah, Buffett copied that from Graham.  And Mohnish Pabrai is probably here…is Mohnish here?  Stand up and wave to them Mohnish.  This man uses the Buffett formula, and always has, he just copied it.  And Mohnish has just completed 10 years…where he was making up for a high water-mark.  So he took nothing off the top at all for 10 years, he sucked his living out of his own capital for ten long years, because that’s what a good money manager should be cheerfully willing to do.  But there aren’t many Mohnish’s.  Everybody else wants to scrape it off the top in gobs.  And it’s a wrong system.  Why shouldn’t a man who has to manage your money whose 40 years of age be already rich?  Why would you want to give your money to somebody who hasn’t accumulated anything by the time he was 40.  If he has some money, why should he on the downside suffer right along with you the investor?  I’m not talking about the employees under the top manager.  But I like the Buffett formula.  Here he is, he’s had these huge successes.  Huge in Buffett’s career.  But who is copying the Buffett formula?  Well we got Mohnish and maybe there are a few others, probably in the room.  But everybody wants to scrape it off the top, because that’s what everybody really needs, is a check every month.  That’s what is comforting to human nature.  And of course half the population, that’s all they have, they’re living pay check to pay check.  The Buffett formula was that he took 25% of the profits over 6% per annum with a high water mark.  So if the investor didn’t get 6%, Buffett would get nothing.  And that’s Mohnish’s system.  And I like that system, but it’s like many things that I like and I think should spread, we get like almost no successes spreading that system.  It’s too hard.  The people who are capable of attracting money on more lenient terms, it just seems too hard.  If it were easier, I think there would be more copying of the Buffett system.  But we still got Mohnish. (laughter)

52:50

Question 10: Why have you chosen to have your friends call you Charlie Munger when you could have instead chosen to go by “Chuck” Munger?

Charlie: The only people who call me “Chuck”, call me blind on the telephone and ask me to invest in oil plays. (laughter)  No I don’t mind being called Charlie.  My Grandfather was Charlie Munger.  When he got appointed as a federal judge he thought it was undignified to be a “Charlie”, so he reversed his initials, then he was T.C. Munger instead of C.T.  But I didn’t follow my grandfather’s practice, I was quite willing to have an undignified name. (laughter)

53:46

Question 11: Two Questions.  Could you give more detail around the Berkshire, J.P. Morgan, Amazon, healthcare partnership and why in the initial press release it said that the model would be spread beyond the employees of the three companies, but then the WSJ reported that the model would only be for the employees of the three companies?  My second question is, can you give your view on ‘what is Li Lu’s talent’?

Charlie: Well those are two unrelated questions but there’s no rule against it.  But three are too much just for the record. (laughter)  On the healthcare system, the existing system runs out of control on the cost side and it causes a lot of behavior which is not only regrettable but it’s evil.  There’s a lot of totally unnecessary crapola that’s crept into the medical system so that people can make more money.  And the costs are just running completely out of control.

And other people have systems that have better statistics that cost maybe a fifth as much, if you talk about Singapore, or half as much if you talk about some liberal European country.  So they’re just concerned about something that’s run out of control because the incentives are wrong and they want to study it and do something…for the three companies.  Of course that’s a very difficult thing to take on.  I don’t know how it will work out.  The man in America that thinks about these subjects in a way that I much admire is Atul Gawande whose a professor of medicine at Harvard.  He’s not only the best writer that I know of in the whole medical profession, he’s also a very honorable and very clear thinking man.  Both his parents were physicians.  This is a man that can check all the boxes.  There’s a lot wrong and these people are looking at it to see if they can do something.  They’re going to find it plenty difficult.

It wouldn’t be hard if you were a benign despot to do something pretty dramatic.  Take macular degeneration of the eye.  Old people who have it, which is a lot, need a shot on a regular (basis).  Well I can give that damn shot.  It’s not that hard to shoot a little gook into an eyeball if you know how to do it.  It draws a lot of pay.  And there are two different substances you use, and one of them costs and fortune and the other costs practically nothing and they both work about equally well.  And of course what’s really being used in a lot of America is the more expensive of the two substances.  There’s a lot wrong with that situation.  It’s just crept in.  A lot of unnecessary costs.  Medicine’s just full of that kind of stuff.

And many a man whose dying is like a carcass in the plains of Africa, in come all the vultures and jackals and hyenas and so on.  A dying old person in many American hospitals looks just like a carcass in Africa.  Where the carnivores come in to feed.  It’s not right to bleed so much money out of our dying people.  And there’s not a hospital in America that doesn’t have people lying in the dialysis ward who have no chance of waking up, who are being dialysized to death.  Easily immoral, stupid conduct.  So the extent that somebody makes some assault on some of these asininities of our present healthcare system, I’m all for it.  On the other hand, I’m glad I’m not doing it because it’s really difficult.  I’m too old for that one.  But I welcome somebody who’s trying to…It’s deeply wrong what’s happening.  It’s deeply wrong.  And some stuff is not getting done that’s very cost effect and a lot of totally unnecessary stuff is being done.  Why shouldn’t we do that?  Well I’m all for somebody trying to figure it out.  But if they asked me to serve on such a panel I’d decline.  It’s really hard going and you’re stepping on a lot of…(inaudible).

The second question was Li Lu.  What was unusual about Li Lu.  Li Lu is one of the most successful investors. (link) Imagine him, he just popped out of somebody’s womb and he just assaulted life the best he could and he ended up pretty good at it.  But he was very good at a lot.  He’s ferociously smart.  It really helps to be intelligent.  He’s very energetic.  That also helps.  And he has a good temperament.  (link)  And he’s very aggressive, and he’s willing to patiently wait and then aggressively pounce. (link)  A very desirable temperament to have.  And if the reverse comes, he takes it well. (link)  Also a good quality to have.  So it’s not very hard to figure out what works.  But there aren’t that many Li Lu’s.  In my life, I’ve given money to one outside manager, and that’s Li Lu.  No others in my whole life.  And I have no feelings that it would be easy to find a second.  It’s not that there aren’t others out there, but they’re hard to find.  It doesn’t help you if a stock is a wonderful thing to buy if you can’t figure it out. (link)

1:00:13

Question 12: My question is really about brands.  In the past, you’ve talked about buying a business with a durable competitive advantage.  You’ve talked at length about great brands with pricing power.  Currently big consumer brands are losing their cache with younger consumers, new emerging brands started online, private label brands like Kirkland Signature are getting better by the day, and in turn big consumer brands are losing sales and pricing power.  In a world where the durable advantage seems to be acquired through scale, like Amazon and Costco, has your view on big consumer brand moats changed?

Charlie: Well the big consumer brands are still very valuable.  But they had an easier time in a former era than they’re going to have in the future era.  So you’re right about that.  And of course Amazon I don’t know that much about except that it’s unbelievably aggressive.  And the man who heads it is ferociously smart.  On the other hand he’s trying to do things that are difficult.  Costco I know a lot about because I’ve been a director for about 20 years and I think Costco will continue to flourish and it’s a damn miracle the way the Kirkland brand keeps getting more and more accepted.  You’re right about that.  So you’re right that it’s going to be harder for the big brands, but they’re still quite valuable.  If you could own say, the Snicker’s Bar trademarks and so forth, it will still be a good asset 60 years from now.  Now it may not be quite as good for the owner as it was in the last 60 years.  But it doesn’t have to be.  But in fact it makes it harder for you investors.  It use to be the groupie could buy Nestle and they’d think, ‘Well, I’ll just sit on…(inaudible)’.  I don’t think it’s quite that simple anymore.  It’s harder.  You’re right.  But you know that.  It was a great question. (laughter)  I just wanted you to breathe it in.  That’s what everybody likes.  You want the answering voice to agree with us.

1:02:37

Question 13: You once said in an interview that you’d prefer that the U.S. would import oil instead of getting it from the ground.  From where I come from, which is the Middle East, Kuwait, oil represents around 85 to 90% of the government’s revenues.  What do you think is the future for oil?

Charlie: Well, I said last year that oil was very interesting in that the great companies like Exxon were producing about a third as much as they use to at the peak, and yet they’re still very prosperous because the price of oil has gone up faster than production has gone down.  But it’s a weird subject, what’s going to happen with oil.  Eventually it’s going to get very hard to have more oil and eventually the price will go very high.  As a chemical feed-stock it’s totally essential, the hydrocarbons.  So it’s never going to go out of vogue, and of course we’re going to need it for energy for a long, long time ahead.  But as an investment I think it’s a difficult subject, and I think you’ll notice that Berkshire in its whole history has had few investments in oil.  Some, but it’s not that many.  The Daily Journal doesn’t have any.  It’s a tough subject and of course as I said here last year, I think the correct policy for the United States would be not to produce our oil so fast.  I think oil is so precious and so desirable over the long pull that I’d be very happy to have more of our oil just stay in the ground and just pay up front to the Arabs to use up theirs.  I think that would be the correct policy for the United States.  Only 99.9% of the rest of the people in world are against me. (laughter)  But why would we want to use up all our oil as fast as we can?  Why would that be smart?  Would we want to use up the topsoil of Iowa as fast as we can?  I don’t think so.  So I think our current policies are totally nutty.  And if you go on, when I was young, there were about 2 billion bushels of corn in the whole production of the country.  There are about 6 times as many bushels of corn (today), and a big chunk of that corn is being turned into motor fuel.  That is an utterly insane policy that happens because of the political power of the farm states in our weird system.  But nothing could be dumber than using of our topsoil to create corn to turn into motor fuel.  It’s really dumb.  Yet it’s there and nobody has any power of changing it.  It’s weird, the whole oil subject is weird.  It’s weird that companies prosper by producing less and less of their main product in physical terms, and it’s weird that a whole nation could do something as dumb as turn a big percentage of the corn crop into motor fuel by edict of the government.  So it’s a weird subject.  But the oil’s totally essential, the hydrocarbons.  Without the hydrocarbons, our great top soil doesn’t work very well.  The miracle grains are miracles if you use a lot of hydrocarbons, plus our good soil.  The miracle grains don’t work very well without the hydrocarbons.  It’s weird.  The current population of the earth is being fed by miracle grains and their miracle is they turn oil into food.  So you raised a weird subject, you must like weird subjects.

1:07:15

Question 14: Some of the greatest advancements to humanity seem to be the result of public-private partnerships.  The railroads, electrification, the technology revolution.  Now all those require some measure of rationality and foresight among politicians and business leaders.  Do you see any opportunities today in terms of the possibility for partnering for infrastructure or basic research or that sort of thing?

Charlie: Well the answer is yes.  I think one of the obvious needs is a really big national grid.  Which takes new government legislation and a lot of other things.  I think it’ll come, we should have it all ready.  It’s the failure of the government that we don’t have a wonderful electric grid.  But it will come and I think Berkshire Hathaway will be a big part of it when it happens.  But it’s easy to over-estimate the potential…why don’t we have a big electric grid that works already?  There are a lot of things that should happen but don’t happen, or happen very slowly.  I don’t think…calling it a public-private partnership sounds wonderful.  Everybody wants what my friend Peter Kaufman calls a “robust narrative”, that’s what people specialize in in America, robust narratives.  Public-private partnerships sounds like a robust narrative.  It sounds to me like a bunch of thieving bankers who get together with a bunch of thieving consultants. (laughter)  But it’s a robust narrative.

1:09:13

Question 15: You once said, when you acquire a company, your time horizon is typically forever, that being said, what did you recognize about General Electric before you got out?

Charlie: Well, we made an investment in General Electric in the middle of a panic because it was a decent buy as a security to be passively held.  It worked out for us fine.  General Electric of course is a very complicated and interesting subject.  It is interesting that a company so well regarded for acumen, education, technology, etc. etc. etc.  Could end up so ill-regarded as a result of a long period of sub-par performance.  People didn’t expect it.  Of course people are saying what caused the failure of performance at General Electric?  My answer would be partly, life is hard and there’s some accident in the world.  That’s part of it.  And part of it I would say that the system at General Electric where you rotate executives through different assignments as though there are so many army officers building up a resume to see if they can be promoted to be generals.  I don’t think that works as well as keeping people in one business for a long time and having them identify with the business the way Berkshire does.  So I would say to some extent, what’s happened in the case that…maybe there should be a little less of this corporate management in the style of the U.S. Army.  And maybe people should do actually a little more of Berkshire style where by and large people spend their whole careers in one business.  (link 1, 2)

1:11:47

Question 16: You served for many decades on a variety of boards, including for-profit sector and also the non-profit sector.  Could you give us any lessons you learned from serving on a board and touch on the criteria you consider for hiring and when necessary removing executives.

Charlie: Well, I don’t think I could do that in one short burst of pomposity.  Each situation is different, but I would say this, that If you asked people with long experience in management what their mistakes were looking backward, the standard response is, somebody who should have been removed wasn’t for way too long.  So I think that general lesson is true practically everywhere.  And in all contexts.  But beyond that, I don’t think I can…it’s too broad a question for me.

1:13:13

Question 17: Are you concerned at all about the rising level of government debt to GDP at the same time that we’re running large deficits late in the economic cycle.

Charlie: Of course I’m concerned about the rising level of government debt.  This is new territory for us, and new territories probably has some danger in it.  On the other hand, it is possible that the world will function more or less pretty well, even with a very different pattern of government behavior than you and I would have considered responsible based on history to date.  Of course if you look at the inflation we got out of the last hundred years when the announced objective of government was to keep prices stable.  Now the announced objective is 2% inflation.  Well what the hell’s going to happen?  Well the answer is, we don’t know.  But isn’t the way to bet that it’s going to be…inflation over the long-term is way higher than 2%?  I think the answer is yes.  But I think that we have learned from what has happened in the past that macro-economics is a very peculiar subject and it doesn’t work like physics. The system is different in one decade, than the system that was present in the last decade.  Different systems have different formulas, but they don’t tell you when systems have changed, and when the formulas have to change. (link 1, 2)

So I don’t expect the world to go totally to hell because…well, look at what happened in Germany after World War I.  They had a hyper-inflation when the currency basically went to zero in value.  They really screwed up big time.  And what happened?…Well what happened was they recovered from it pretty quick.  And they did it by creating a new Reichsmark backed by the mortgages which they put back on the houses and properties of the people who had unfairly gotten rid of their mortgages at no cost.  And that new Reichsmark was working pretty well and Germany had pretty well recovered from that catastrophe and then along came the Great Depression.  And the combination of the Great Depression and the Weimar inflation really brought in Hitler.  Without the Great Depression I don’t think he would have come into power.  What happened…now you’ve got…by the late 30’s, what was the leading economic power in Europe?  It was Germany.  Cause Hitler in his crazy desire for vengeance and so on, bought a lot of munitions and  trained a lot of soldiers and so forth.  And the accidental Keyensianism of Germany under Hitler caused this vast prosperity.  So Germany was the most prosperous place in Europe in 1939.  So all that catastrophe, they recovered from.  So I don’t think you should be too discouraged by the idea that the world might have some convulsions.  Because there’s a way of recovering.  Now I’m not advocating the German system (laughter), but I do think knowing these historical examples creates what I call “mental ploys.” (link)  And you’d think that a country that destroyed (itself) in a silly war, destruction of your own currency, great depression, and by 1939 it’s the most prosperous country in Europe.  It’s encouraging.  I hope you feel better. (laughter)

1:17:24

Question 18: Since the mid-1990’s, the number of DOJ cases filed annually under the Sherman Act has collapsed from 20 to almost zero.  Over the same period, we’ve seen a dramatic increase in the ‘winner-take-all’ effect.  Where market share of the top five companies across almost all industries have surged, not just technology and media.  And the number of publicly traded companies has dropped close to 50%.  So for example, from 8,100 to 4,300.  Why do you think the DOJ has less active in enforcing anti-trust legislation over the past 20+ year and do you think the DOJ is likely to become more active and how do you think that will affect the financial markets?

Charlie: Well I don’t know whether the DOJ is going to become more active or not.  I am not terribly disturbed by the present state of the economy or the present state of concentration of economic power.  Wherever I see companies by and large are having plenty of competition.  And so I’m not…(inaudible)…on the theory that the whole world is wrong as it’s presently constituted.  There are companies now, that people were worried about them being too powerful like Kodak and they’re not even here anymore.  I think we have enough competition by and large.  I do not think the world is going to hell from lack of activity in the Justice Department.

1:19:02

Question 19: How did Ajit Jain build Berkshire reinsurance from scratch?

Charlie: Well it’s very simple.  He worked about 90 hours a week.  He was very smart.  He’s very honorable.  He’s very pleasant to deal with.  And he talked every night to Warren Buffett.  Just find somebody else like that.  But he won’t do as well because the game is harder now than it was then.  And that’s my answer to your question.

1:19:49

Question 20: Question regarding Warren Buffett.  In 2008 he wrote an op-ed article regarding the depths of the bear market, talking about how he (Buffett) had previously put his own money into treasuries, and in my mind he’s normally thought of as a buy and hold investor, but in this case, a lot of his money, almost all of it was in treasuries.  And I wanted you to speak to the value of holding money in a portfolio at the proper time.

Charlie: Well, it’s possible that there could be when a wise investor would be all in treasuries.  That is not an impossible event.  It’s virtually impossible for me.  I can imagine such a world, but I don’t think…I haven’t been in that kind of a world yet.  Generally speaking long-term treasuries are a losing (investment) over the long-pull.  And that’s my view.

1:21:05

Question 21: In 1999, Warren Buffett said that he could return 50% if he ran $1 million.  Give what you said about the investment landscape today being more difficult, what do you think that number would be today?

Charlie: Well I do think that a very smart man who’s patient and aggressive in combination, is willing to work hard, to root around in untraveled places like thinly traded stocks and other odd places.  I do think a person with a lot of shrewdness, working with a small amount of capital, can probably earn high returns on capital even today.  However that is not my personal problem at the moment.  And for me it’s hard.  And for Berkshire it’s hard.  And for the Daily Journal we don’t have any cinch either.  It’s disadvantageous to have securities in a corporate vehicle like the Daily Journal Corporation.  It’s an accident that we have them there.  We have them there because that’s where the money was.  The way it’s worked out, it’s not desirable if you’re a shareholder and you have a layer of corporate taxes between you and your securities that are indirectly owned.  And once you get public securities held in a public corporation taxable under sub-Chapter C of the internal revenue code, all kinds of factors, including income taxes affect your investment decisions.  And it’s much easier to invest in charitable endowment or your personal pension plan.  Generally speaking, I would say, if you’re shrewd enough with small sums of money, I think you can compound pretty well.  The minute you get bigger sums, I think it starts getting difficult.  It’s way more difficult for all you people sitting here than it was for me when I was in your position.  But I’m about to die and you have a lot of years ahead. (laughter)  You would not want to trade your position for mine.

1:23:40

Question 22: What would you advise me as a teacher to help my students become better thinkers and decision makers and also become happy in life?

Charlie: I did not pick that up.  You were trying to help me by hurrying up, that’s not the best system…(laughter)

Well, that’s a wonderful question.  I would say the minute you have the attitude you’ve already expressed, you’re already probably going to win at everything you want to win at.  You just keep trying to live a good life, and a constructive life, and to be rational, and to be honorable, and to meet the reasonable expectations of people who depend on you.  Of course you’re going to get ahead over time.  And of course the best way to teach is by example.  And of course the example works better when you win and if you behave right you’re more likely to win.  So I would say, you’re on the right track already.  All you have to do is keep at it.  With your attitude, you can’t fail.

1:25:32

Question 23: Good morning Mr. Buffett…Mr. Munger.

Charlie: I’m flattered to be called Mr. Buffett. (laughter)

Question 23 Continued: The most recent annual report for Berkshire, as in the past reports, the growth in book value was shown and over the past 52 years it has grown from $19 to $172,000.  Which represents a return of 19% a year.  Is a large part of that outsized percentage attributable to the leverage inherent in the insurance company, such that you can own an investment in the insurance company which returns say 14% and it becomes 20% to book value?

Charlie: 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.  There were years when it was helping.  There were years when Ajit made so much money that it was almost embarrassing.  And then he’d give the money to Warren and Warren would make 20% on the money.  So there were some years when some remarkable synergies between the insurance business and Berkshire Hathaway.  But basically the insurance business is not some cinch easy way to make money.  There’s a lot of danger and trouble in the insurance business and its more and more competitive all the time now as we’re sitting here.  Berkshire succeeded because there were very few big errors…there were like no big errors, really big. (link) And there were a considerable number of successes.  All of which would have been much harder to get under present conditions than they were at the time we got the results.  And there are very few companies that have compounded at 19% per annum for fifty years.  It’s (a weird) in net worth.  That is very peculiar.  I wouldn’t count on that happening again soon.  It certainly won’t happen at the Daily Journal.

1:28:07

Question 24: Question regarding margin trading for Charlie and Rick Gueren.  With the recent decline in the stock market, there were a lot of margin calls to customers.  I know back in your partnership days, there was a big bear market and a lot of big declines in your portfolio.  Would you care to comment on the productivity of margin trading?

Charlie: Well of course it’s dangerous when you have a margin account because the person whose giving you credit can wipe you out at the bottom tick just because he feels nervous.  And therefore of course, people like Berkshire just totally avoid any position where anybody else would start selling our securities because he felt nervous.  And of course there are a lot of people now that are pushing margin trading very, very hard.  And…the minute you got weird new instruments like these VIX contracts that triggered new selling because existing selling happens.  So you get a feedback effect that were a little decline becomes a big one and then a big one becomes and bigger one, and so on.  And it rapidly goes down a lot in a short time.  I’m afraid that under modern conditions the risk of what happened recently with the VIX is just part of the modern conditions.  And of course we’ll always have margin traders who want to push life hard and we’ll always have catastrophes.  Neiderhoffer (link 1, 2) was just wiped out by the VIX, and that’s the second time he’s been wiped out.  And he’s a very talented man.  Neiderhoffer was famous at Harvard.  His name became a verb.  He learned to what was called “to Neiderhoffer the curriculum”.  He was a great card player and a great squash player, and a good national champion, and he was a scholarship student.  He didn’t have much money.  So he had to get very high grades, and he didn’t want to do any work.  So he figured out how to “Neiderhoffer” the curriculum of Harvard.  He signed up for nothing but the toughest graduate courses in economics.  And the economics students in those advanced courses were doing a lot of the scut work for the professors, and so nobody ever gave them anything less than an A.  And for a while Neiderhoffer didn’t even go to class.  They thought they had a new John Maynard Keynes at Harvard.  And he was just signing up for courses where you couldn’t get a low grade.  Interesting story.  Interesting man.  Wiped out a second time.  He’s very brilliant.  He was a very talented man.  Pushing life that hard is a mistake.  It’s maybe a less of a mistake when you’re trying to get out of the mire of mediocrity and get your head a little above the crowd.  But when you’re already rich, it’s insane.  Why would you risk what you have and need in order to get what you don’t have and don’t need?  It really is stupid.

1:31:50

Question 25: Question about the U.S. high-speed rail system.  As you know the high-speed rail act was introduced back in 1965 when Berkshire had their first annual meeting.  What is your thinking, or outlook, or comments about the U.S. high speed rail system.  Including the one that’s being built here in California, as well as the possibility for a national high speed rail system.

Charlie: Well that’s a very interest question.  The high speed rail system which was aggressively create in China is a huge success and very desirable.  So it’s not like it’s intrinsically a dumb idea.  However in the…(inaudible)…we actually have in America, getting a big high speed rail system is really difficult, including having one even in California.  And I’m not at all sure that trying to have a high speed rail system in California was wise all factors considered.  But I’m not sure that it isn’t on the other hand.  Just put me down as skeptical, but not determinedly opposed.  And I know it will cost a fortune, that I’m sure of.  The trouble with it is that it’s competing with something that works pretty well called the airplane.  So, I can’t answer your question except as I have.  I know we need a big grid.  I’m not sure the United States needs a high speed rail system for passengers.  I would say that may have passed us by.

1:34:04

Question 26: Could you comment on whether you ever considered investments in Hershey’s or Tiffany’s over the long term and have offered attractive entry points?

Charlie: Well I’d be delighted to own either Hershey’s or Tiffany’s at the right price, wouldn’t you?  It’s just a question of price.  Of course they’re great companies.  But that’s not enough, you have to have great companies available at a price you’re willing to pay.  Hershey’s is a private company.  Nobody’s offering me Hershey’s.  I can buy the candy, but I can’t buy the company.

1:35:30

Question 27: I’m here with my 92 year old Grandma whose spent the past 50 years investing for our family.  As a college senior with a passion for value investing, it keeps me up at night knowing that I will eventually be entrusted with a portfolio she built for a lifetime.  Based on the successful decisions that you’ve made for your large family here today, what advice do you have in regards to seizing the few opportunities when I will have to act decisively for my family without jeopardizing her life’s work?

Charlie: Well of course I like any 92 year old person. (laughter)  Particularly if it’s a good looking woman whose also rich. (laughter)  And whose descendants admire her.  Instead of being eager to have her gone. (laughter)  I’d say you have a big winner there in your family.  Try to live your life so that you can be a big winner too.

1:36:54

Question 28: It looks like the A.I. will have a much bigger impact on society than the internet revolution, so would you mind maybe sharing some of your thoughts on how artificial intelligence will impact different industries in general and who it will impact the future of the human race?

Charlie: Well, that’s a nice question. (laughter)  The people who studied artificial intelligence don’t really know the answer to that question.  I’m not studying artificial intelligence because I wouldn’t be able to learn much about it.  I can see that artificial intelligence is working in the marketing arrangements of Facebook and Google, so I think it is working in some places very well.  But it’s a very complicated subject.  And what its exact consequences are going to be, I don’t know.  I’ve done so well in life by just using organized common sense, that I never wanted to get into these fields like artificial intelligence.  If you can walk around the shores and pick up boulders of gold, as long as the boulders keep being found and picked up, I don’t want to go to the placer mining sifting vast amounts of data for some little edge.  So you’re just talking to the wrong person.  And I’m not at all sure how great…I don’t think artificial intelligence is at all sure to create an economic revolution.  I’m sure we’ll use more of it, but what are the consequence of using artificial intelligence to become the world’s best (golden boy)?  There may be places where it works, but we’ve thought about it at Geico for years and years and years, but we’re still using the old fashion intelligence.  So I don’t know enough about it to say more than that.

1:39:16

Question 29: Questions about culture.  How can an outsider really know a company’s culture?  And for that matter, how can an insider, at the top of an organization, really be certain about the culture of the company beneath him?  And how would you go about assessing the culture of giants like Wells Fargo or General Electric?  What is it that you look at that helps you understand culture?

Charlie: Well, you understand culture best where it’s really down (low) in a place like Costco.  And there the culture is a vast and constructive force.  Which will probably continue for a very, very long time.  The minute you get into General Electric, partly decentralized, partly not.  Multi-business instead of one business.  It gets very complicated.  What is the culture of General Electric when the businesses can be so radically different?  Maybe headquarters can have a certain kind of culture.  And maybe the culture will be a little wrong.  And maybe it’s wrong to shift people around from business to business as much as they do.  Which I strongly suspect.  I do think…there are very few businesses like Costco that have a very extreme culture where everybody’s bought into.  And where they stay in one basic business all the way.  I love a business like Costco because of the strong culture and how much can be achieved if the culture is right.  But the minute you get into the bigger and more complicated places…I mean you can talk about the culture of General Motors or the culture of AT&T, it’s a very difficult subject.  What big businesses have in common by and large is that they get very bureaucratic.  That’s the one norm in culture is that they get very bureaucratic.  And of course it happens to the government too.  A big governmental body.  And basically I don’t like bureaucracy, it creates a lot of error.  I don’t have a substitute for it.  I don’t have a better way of running the U.S. government than the way they’ve been doing it.  But I basically don’t personally like big bureaucratic cultures and so I don’t think very much about big bureaucratic cultures.  I don’t know how to fix bureaucracy in a big place.  I would regard it as a sentence to hell if they gave me some company with a million employees to change the culture.  I think it’s hard to change the culture in a restaurant.  A place that’s already bureaucratic, how do you make it un-bureaucratic?  It’s a very hard problem.  Berkshire has solved the problem as best it can…of bureaucracy.  You can’t have too much bureaucracy at headquarters if there’s no bodies at headquarters. (laughter)  That’s our system.  I don’t think it arose because we were geniuses or anything.  I think partly it was an accident.  But once we saw what was working, we kept it.  But I don’t have a solution for corporate culture at monstrous places.

1:43:08

Question 30: What’s your current view of climate change today?

Munger: Well, I’m deeply skeptical of the conventional wisdom of the people who call themselves climate scientists.  I strongly suspect that they’re more alarmed than the facts call for.  And that they kind of like the fact that they can prattle about something they find alarming.  I am not nearly as afraid as the typical so called climate scientist is, and I think the difficulties of what they urge as a remedy are under-estimated by these people.  And besides, just because you’re smart enough…suppose you, by knowing a lot of physics and so forth, could actively figure out that climate change was a huge problem, you were right.  That would not automatically mean that you know how to fix it.  Fixing it would be a vast complicated problem involving geo-politics, political science, all kinds of things, that just because you understood the chemistry of climate say, you wouldn’t have any expertise as…So I think there’s a hell of a lot of non-sense being prattled on the climate change things.  But no, there’s no doubt that the CO2 does cause some global warming.  But just because you accept that doesn’t mean that the world is absolutely going to hell in a hand-basket.  Or that the seas are going to rise by 200 feet any time soon and so on.  So I’m deeply skeptical of a lot of these people, and yet I don’t want to be identified with the no-nothings who really are vastly ignorant and wouldn’t even recognize that CO2 does have some influence on temperature.  Now I’ve tried to offend everybody…(laughter)

1:46:02

Question 31: In an age that’s very different than the one you grew up in, if you’re a young guy like me with a lot of runway like Peter talked about, where would you focus your attention?

Munger: Well, I’d approach life a lot like Carlyle.  I would just get up every morning and do the best I could in every way and I’d expect over time to do pretty well.  And it’s not very hard.  I’d try to marry the right person instead of the wrong person.  Everything would be quite (trite).  I would guess that practically everybody your age in this room is going to do pretty well.  You’re not that mad at the world here.  You’re trying to figure out how to cope with it a little better.  You’re going to do alright.  People like that succeed.  But if you all came in here with placards, sure you were right on every subject and wanted to shout back?  You wouldn’t have such a bright future.  Those people are pounding their idiocy in instead of (shutting it out).

1:47:46

Question 32: Which cognitive biases are particularly at scale on a national scale these days?

Charlie: Well its hard, with so many cockroaches in the kitchen it’s hard to identify each…(laughter)  I would say every bias that man is prone to is always working.  That’s the nature of the system.  It’s amazing what people have come to believe.  And it’s amazing how polarized our parties are becoming.  And now you turn on TV, and you can even turn to channel A and you’ve got your kind of idiot, or you click channel B and you got the other fellow’s kind of idiot.  What they have in common is that they’re both idiots.  They’re playing to an audience that is mentally defective. (laughter)  Of course it’s a little disquieting.  I was use to a different world.  I liked Walter Cronkite.  This choose your idiot form of news gathering, I don’t much like.  What do you do?  I flip back and forth between idiot types. I will not stay with just one type of idiot. (laughter)  So that’s my system.  But you’re right.  It’s weird.  Now the world has always had weird idiots.  Hitler was an idiot…a smart idiot, but an idiot.  We’re always going to have crazy people and crazy people who follow crazy people. Part of what I like about that situation is…it gives you more incentive to think correctly yourself.  I find life works best when you are trying to stay rational all the time.  And I must say, these idiots are giving me more incentive.  I don’t want to be like any of them.  Don’t you feel that way when you turn on the TV and here’s one idiot mouthing this way, and the other one mouthing this way, and misrepresenting the facts?  I don’t want to be like either of them!  I don’t know whether we’re going to have more of what’s developed or whether we’re going to go back to something that’s more pleasant.  But it’s kind of interesting to watch, I will say that.

1:51:11

Question 33: What do you think of the critical challenges that business models relying heavily on advertising as a source of revenue in a digital age?

Charlie: Well if I’m following that correctly, you do live in an age where people using computer science to sift out correlations that might be predictive and then to try trading on those algorithms on an instant basis, in and out.  Where large amounts of money have been made, by say, Renaissance Technologies.  And there’s way more of that and its worked for those people.  And I don’t consider it a good development.  I don’t see any big contributions to civilization, having a lot of people using computer algorithms to out-trade each other on a short-term basis.  Some people think it creates more liquidity in the markets and therefore it’s constructive.  But I could just as soon do without it.  I would rather make my money in some other way than short-term trading based off of computer algorithms, but there is more of it, you’re right about that.  And by and large, the one thing they have in common is that they can’t take infinite amounts of money.  You try and file too much money into an algorithm and it’s self-defeating.  And thank God it’s self-defeating.

 1:52:51

Question 34: I was hoping to gain some insight regarding your and Warren’s discussions into airlines.  Whether or not it was a light-bulb that went off in a certain year.  Or whether it morphed over time.  Just trying to get an idea about when you got open minded about maybe investing into airlines and how you changed your mind.

Charlie: Well, we did change our mind.  For a long time, Warren and I (painted over) the railroad because there were too many of them, and it was too competitive, and union rules were too crazy.  They were lousy investments for about 75 years.  And then they finally…the world changed and they double decked all the trains and they got down to four big rail systems in all the United States in terms of freight and all of a sudden we liked railroads.  It took about 75 years.  Warren and I never looked at railroads for about 50 years, and then we bought one. (link)

Now airlines, Warren use to joke about them.  He’d say that the investing class would have done better if the Wright Brothers would never have invented flight.  But given the conditions that were present when the stock was purchased and given the conditions of Berkshire Hathaway where it was drowning in money, we thought it was ok to buy a bunch of airline stocks.  What more can I say?  Certainly it’s ok to change your mind when the facts change.  And to some extent the facts had changed, and to some extent they haven’t.  It is harder to create the little competing airlines than it was.  And the industry has maybe learned something.  I hope it works better, but I don’t think its…I think the chances of us buying airlines and holding them for 100 years is going to work that well.  I think that’s pretty low.

1:55:19

Question 35: Question about DJCO.  The auditor’s report discussed material weakness in segregated duties.  I was curious if that was something you could speak on.  If it’s something you’re fixing.  Or not if not, whether or not it’s rational.

Charlie: Well, all auditors are now paid to find some kind of weakness and then fix it.  So there’s very few companies that don’t have some little material weakness that needs fixing.  I am not that worried about the accounting at the Daily Journal.  Basically it’s more conservative than other people in our industry.  And basically we’re not trying to mislead anybody.  And basically we’ve got a couple hundred million dollars in marketable securities and we’re not mismanaging those, they just sit there.  So I don’t think we have big accounting problems at the Daily Journal.  I think it’s typical of the modern developments in accounting that the accountants have gotten…(inaudible)…and they’ve gotten new responsibilities and they’re amorphous.  Like “weakness”.  Well everybody has weakness, you, me.  And I don’t think there’s some wonderful accounting standard where all the accountants know what’s weak and what isn’t and exactly how much and how dangerous it is.  And so I am not much worried about the accounting at the Daily Journal.  But I think this business of…everybody in America is worried about somebody hacking in and getting a lot of data, and everybody has some weakness, meaning they’re all afraid of, and they’re right to be afraid of it.  You’ve got these amorphous terms.  I’m just doing the best we can, and taking the blows as they come.  Or the benefits too.  But I’m not worried about material weaknesses in accounting.

There was a guy name B.B. Robinson when I came to Los Angeles, and he had gotten out of the pools, the stock pools of the 20’s, as a young man with 10 or so million dollars, which was a lot of money to come out here in the 30’s.  When he got here with all this money, he spent his time drinking heavily and chasing movie starlets.  And in those days the bankers were more pompous and old fashioned.  And one of them called him in and said, ‘Mr. Robinson, I’m terribly worried about your drinking all this whisky and chasing all these movie starlets.  This is not the kind of thing our sound banks likes.’  What B.B. Robinson said to the banker, he said, ‘Listen.  My Municipal Bonds don’t drink.’ (laughter)  That’s basically the answer to the material weakness problem with the Daily Journal.  Our lovely marketable securities aren’t drinking.

1:58:38

Question 36: I believe you said that, If you’re not willing to put the work into investigating specific stock investments, that you should perhaps put your money into a passive index fund.  One of my advisers is very concerned about the move of capital into index funds for three reasons.  First he says, there’s an inadvertent concentration into (few) stocks because similar investments in different indexes.  Second, he thinks long term, the concentration of capital into preferred companies that are in the index fund…that they’re able to raise money easily despite poor performance.  And third, he’s also concerned long-term that the concentration of the management of these index funds into three institutions which is detrimental to the market place.  I’d appreciate your comments.

Charlie: I think that a lot of people who are in the business of selling investment advice, hate the fact that the indexes have been outperforming them.  And of course, they can’t say, “I hate it, because it’s ruining my life.”  But they say, “I hate it because it’s too concentrated.”  Well the index contains 75% of the market capitalization.  It’s hardly so small.  Index investing will work for quite a while when it’s so broad.  I don’t think it’s ruining the world or anything like that.  It is peculiar that we lived a long time without this.  I think it’ll keep running a long time forward, and I think it’ll work pretty well for a long time.  And I suspect most money-managers just hate it.  It’s making their life hard.  But you see I don’t mind if people are having a hard life.

2:01:05

Question 37: History doesn’t repeat itself, but it certainly rhymes.  And we’re seeing this mania in Bitcoin, that is often akin to the Tulip mania, and I’d like to see your views on how you and Warren navigated through these waters in your several decades of investing.  And what it says about the human condition that we tend to keep constantly falling for these things despite what history teaches us otherwise.

Charlie: Well you’re of course right to suspect that I regard the Bitcoin craze as totally asinine.  To create some manufactured currency…A different payment system could happen like WeChat in China.  It’s a better payment system than the one we have in America.  So something like that could happen.  But Bitcoin where they’re creating an alternative to gold…and then make a big speculative vehicle?…I never considered for one second having anything to do with it.  I detested it the moment it was raised, and the more popular it got, the more I hated it.  On the other hand, I expect the world to do insane things from time to time.  Everybody wants easy money.  And of course the people who are peddling things and taking money off the top for promoting the investment, they like it too.  And so these crazies just keep coming and coming and coming.  But who would want their children buying things like Bitcoin?  I just hope to God that doesn’t happen to my family.  It’s just disgusting that people would be taken in by something like this.  It’s crazy.  I’m not saying that some different payment system might not be a good thing like WeChat.  That could come and be constructive.  But Bitcoin is noxious poison.  Partly they love it because the computer science is quite intriguing to people with mathematical brains.  It’s quite a feat what they’ve done as a matter of pure computer science.  But, you know, I’m sure you can get terribly good at torture if you spend a lot of time at it. (laughter)  It’s not a good development.  And the government of China which is stepping on it pretty hard is right and our government’s more lax approach to it is wrong.  The right answer to stuff like that is to step on it hard, and it’s the government’s job.

2:04:30

Question 38: What are the qualities you look for in a life partner?

Charlie: In a life partner?  Well I’ve been quoted on that.  I think what you really need in a life-partner, if you’re constructed the way I am, is somebody with low expectations.

2:05:23

Well I think it’s 12 o’clock and that should probably do for this group.  I know you…I’m use to the groupies, but standing up for two hours?  I wouldn’t stand up for two hours to listen to Isaac Newton if he came back.  (laughter)  So I guess our meeting is adjourned.  I certainly wish you all well, you’re my kind of people.

End of Transcript

Links to additional Transcripts:

P.S. If you found any errors in the transcript please let me know and I will gladly fix them.  Thanks!

Wall Street Recap: September 17-23, 2017

My full notes and analysis from the past week: September 17-23, 2017.  Periodicals covered in this Wall Street Recap include the WSJ, FT, NYT, and LA Times.

Investing in “Hot” Industries

“A lot of the places where the industries are doing a great job for the world, it’s very hard to make money out of it.  Because these wild enthusiasms come into it.  I don’t have a favorite industry.” – Charlie Munger

In the depths of the ocean, the glow from a small lure stands out among the darkness.  Fish from the surrounding waters swim toward the lure, tempted with the promise of a free lunch.  Little do they realize that they are swimming right into the jaws of an angler fish and their impending doom.

Likewise, “Hot” industries have historically acted like an angler fish, attracting investors who unwittingly swim into the jaws of poor investment returns.   Think back to the hot industries in history such as autos, airlines, and dotcoms.  The lure of those industries was typified by two compelling elements;

  1. A story of a world-changing product or service,
  2. Stellar growth wrapped around massive consumer demand.

Even though those industries had favorable long-term tail-winds, industry returns were abysmal and left thousands of bankrupt companies in its wake.  Why?

Two key reasons:

  1. Durable Moats are Illusive: “Hot” industries are defined by growth and rapid change.  This constantly evolving environment makes it incredibly hard to predict winners and losers.  The best product or service today may become obsolete tomorrow.  And a perceived competitive advantage today may vanish overnight.
  2. Wild Enthusiasm Attracts Too Much Capital: Wild enthusiasm attracts massive amounts of capital into hot industries.  This in turn increases competitive pressures and drives down the returns on invested capital.

Examples of “hot” industries from the last century:

Autos: “Autos had an enormous impact on America, but in the opposite direction on investors.”…”of the two thousand companies, as of a few years ago, only three car companies survived. And, at one time or the other, all three were selling for less than book value which is the amount of money that had been put into the companies and left there.” – Warren Buffett (link)

Airlines:  “Here’s a list of 129 airlines that in the past 20 years filed for bankruptcy. Continental was smart enough to make that list twice. As of 1992, in fact–though the picture would have improved since then–the money that had been made since the dawn of aviation by all of this country’s airline companies was zero. Absolutely zero.” – Warren Buffett

Nifty-Fifty Tech Stocks: A study found that the compounded annual return of the Nifty-Fifty portfolio from the peak in 1972 to 1998 was actually quite admirable, 12.5%.  The study also found that the Technology stocks in the Nifty-Fifty were significantly over-valued at the peak, and, as a result, performed poorly over the 26 year period.  On the other hand, predictable and “boring” consumer staples stocks like Gillette, Phillip Morris, and Coca-Cola all performed well, and, in hindsight, were still undervalued at the peak of the investment craze.  (link)

Mental Model: Viscosity

Viscosity: the state of being thick, sticky, and semifluid in consistency, due to internal friction.  Liquids show a reduction in viscosity (stickiness) with increasing temperature. (link)

Hot industries are like a fluid with low viscosity.  They are fluid, in a state of change, and have little resistance to deformation by (industry) stress.  All of which make them hard to predict.

Meanwhile, industries and businesses that are highly viscous are “sticky”.  Their future can be predicted with reasonable confidence.

As a fluid increases in temperature, its viscosity decreases (i.e. becomes less sticky).  Applying that model to investing, as an industry becomes “hot”, it becomes more fluid and less predictable.

This has implications regarding the usefulness of a company’s historical financials.  As an industry’s “temperature” increases (i.e. becomes more fluid and subject to change), a company’s historical figures may no longer be an accurate representation of its future performance.  Using a company’s historical financials in this new environment invites error and potential over-valuation.  (Or under-valuation if the reverse is true; low viscosity moving to high viscosity)

Investment Lessons:

Avoid “Hot” Industries: Subject to intense competition and an ever shifting environment, it is challenging if not impossible to predict winners and losers in a hot industry.

“We make no attempt to pick the few winners that will emerge from an ocean of unproven enterprises.  We’re not smart enough to do that, and we know it.” – Warren Buffett

Invest in Sticky “Predictable” Businesses: Investing in sticky businesses follows Buffett’s prescription of not fooling yourself and not losing money.

“…we try to apply Aesop’s 2,600-year-old equation to opportunities in which we have reasonable confidence as to how many birds are in the bush and when they will emerge.” – Warren Buffett

“Hot” Industries: In the News

Netflix, Tesla, and Blue Apron are the hottest companies in hottest industries.  Each one is contending with wild enthusiasm and a flood of investment capital.  Some of the most recent developments threatening these companies are listed below.

Netflix

Facebook

“Facebook Inc. is loosening its purse strings in its drive to become a major hub for video.  The social-media giant is willing to spend as much as $1 billion to cultivate original shows for its platform,” (link)

“It also signals Facebook’s readiness to spend more than before to become what Chief Executive Mark Zuckerberg calls a ‘video-first’ platform.”

HBO, Amazon, Netflix, Facebook, and Apple are all “banking on video to capture the fleeting attention of users and seize billions of dollars in advertising that is expected to migrate from television to digital video.”

Apple

“Apple Inc. is preparing its own billion-dollar war chest for content.”

Disney

“For Netflix, Disney’s decision to hold on to rights to ‘Star Wars’ and Marvel movies will add to the pressure to create appealing original content of its own to replace some of the high-profile franchise films Netflix will lose starting in 2019.” (link)

“The big problem is not aggregate costs, but costs versus competitors. If your costs are out of line, you’re going to get killed eventually.” – Charlie Munger

Tesla

VW

” VW, the world’s biggest carmaker, says it will build 50 all-electric models by 2025 and electrify 300 models by 2030.”

The speed of the shift is remarkable…The switch is driven by policy: “European regulators were previously content to set environmental standards and let manufacturers decide how to meet them.  Since the emissions cheating scandal, they are quite reasonably inclined to be more prescriptive…This is prompting a rapid change in consumer behavior: few people will risk buying a car that may be of limited use within a decade.”

Mercedes, Smart, BMW

“Daimler boss Dieter Zetsche said the Mercedes owner’s ‘entire portfolio’ will be electrified by 2022.  The Smart brand will become fully electric by 2020, making it the first internal comustion engine marque to make the switch.”

“BMW told reporters at the show: ‘Our top priority now as a company is electric mobility.'”

Nissan-Renault-Mitsubishi alliance

“The chairman and chief executive officer of the Nissan-Renault-Mitsubishi alliance is pushing ambitious targets for the auto makers in an effort to leapfrog Silicon Valley and swipe market share, even as some of his biggest rivals look to scale back.” (link)

He is also planning 12 new electric cars, forays into robotaxi fleets and the debut of a fully autonomous car within six years.”

“With the explosion of technology that is coming, it is going to make it very difficult for smaller players to follow. Mr. Ghosn said.  “You’re going to have a premium for the large car manufacturers because we are the only one who are going to be able to invest in all the fields, all the products, all the markets, all the technology without making any shortcuts or without having any blind spot.”

Blue Apron

Albertsons

“Albertsons Cos. is buying the Plated meal-kit service, the first acquisition of a prepared-meals company by a national grocery chain as supermarkets scramble to keep shoppers coming to their stores.” (link)

Bob Miller, chief executive of Boise, Idaho-based Albertsons, said in an interview Wednesday: “We think there’s an opportunity to grow this thing tremendously,” adding that the supermarket will give Plated a “cost advantage” over other meal-kit companies by the scale of its food purchasing and network of 18 manufacturing plants.

“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money.” – Warren Buffett

Psychology of Human Misjudgment

Confirmation Bias

Anti-Soros conspiracies sweep the globe (link)

“Conspiracy theorists have an explanation for everything.  So the fact that the Financial Times should publish a column defending Mr. Soros will simply be taken as further evidence of his nefarious influence.

Deprival Super-Reaction Syndrome

Along with the migrating steelhead, Oregon river pool holds life lessons (link)

“He recalls watching a man catch a wild steelhead.  The man was furious because by law, he could keep a marked hatchery fish, but had to throw back a wild fish.  He tore the fish’s mouth and bashed it against a rock.”

“‘As a species, we can be unbelievably kind on an individual basis – a person will give you the shirt off their back on the trail.  But start creating vested interests and people can be unbelievably brutal.‘”

Over-Influence by Authority

Shortcomings in Tesla’s self-driving tech cited among factors in fatal crash (link)

“Joshua Brown, a Tesla owner, was killed last year when his car ran into the side of a truck that was turning across the roadway in front of it.”

“He said Brown had put a higher level of trust in the Autopilot system than was intended and that the driverless technology had not been designed to operate on the road where the crash occurred…Brown had his hands on the steering wheel for only 25 seconds during the 37 minutes leading up to the crash.”

Say-Something Syndrome

Instragram video of weapons leads to an arrest (link)

“A Texas gang member suspected of violent robberies, home invasions and murder, was captured by the LAPD after…he posted a video of himself on Instragram displaying a gun collection,”

Forgetting what one is really trying to do

What started out as a plan to reduce the pigeon population in Lisbon, has turned into a mission to provide “dignity and quality of life” to pigeons.

Lisbon Has Too Many Pigeons, So It Built Them a Luxury Resort (link)

“Since the birdhouse opened…its mission has crept beyond mere population control.  Caretakers have equipped the facility, which costs 250 euros per month to maintain, with a pigeon first-aid station, and there’s talk of offering services such as deworming and, paradoxically, a nursery….’Pigeons deserve and need dignity and quality of life,’ she says”

“A majority of life’s errors are caused by forgetting what one is really trying to do.” – Charlie Munger

Simple Psychological Denial

Ex-Pakistan PM’s wife wins Lahore by-election (link)

The Panama Papers “revealed documents detailing (Mr. Sharif’s) offshore accounts, and show his family owned assets he could not account for…This was followed by the supreme court’s ruling that his unexplained wealth made him unfit for office.”

“But many of Mr. Sharif’s supporters believe the guiding power behind the supreme court ruling was the army,”

Tattoos: Lollapalooza Effect

Youths’ tattoos aren’t always cause for alarm, report says (link)

Consistency and Commitment:

“A 2016 Harris Poll found that most adults who have gotten a tattoo-86%-have never regretted doing so,”

“People think if they have committed to it, it has to be good. The minute they’ve picked it themselves it gets an extra validity. After all, they thought it and they acted o­n it.” – Charlie Munger

Liking Tendency

“They’re emulating people who are out there – athletes, musicians, military personnel – people they look up to,”

Incentive-Caused Bias

“People who get inked typically say they feel sexier, rebellious, attractive or strong.”

Social Proof

“As many as 38% of young people 18 to 29 report having a tattoo…’More often’, she says, ‘(tattoos are a) generational act of solidarity.'”

Mental Model: Parkinson’s Law

Parkinson’s Law. Observation that “work expands to fill the time available for its completion,” and that a sufficiently large bureaucracy will generate enough internal work to keep itself ‘busy’ and so justify its continued existence without commensurate output. (link)

Trump champions UN while urging reform (link)

“‘While the United Nations on a regular budget has increased 140 percent, and its staff has more than doubled since 2000, we are not seeing the results in line with this investment,’ said Mr. Trump”

Various Fascinating Excerpts

A test of compassion (link)

“‘For the first time in my life I was really proud of German,’ she says…But the initial enthusiasm soon wore off…(when she) quickly realized what a hard slog it would be to absorb so many immigrants from an entirely different culture.  The trigger was when an elderly Syrian man told her that ‘Hitler was a good man, because he gassed all the Jews.’

Japan Post share sales faces uncertain journey (link)

“Mr. Nagato was hauled before senior figures in the ruling party and told to ‘work for a living, rather than gambling,’.”

Youths’ tattoos aren’t always cause for alarm, report says (link)

“Human resource managers named tattoos as the third physical attribute likely to limit career potential (non-ear piercings and bad breath were the top two).”

Russian-built nuclear plant revives Chernobyl fears in eastern Europe (link)

“All the profits go to Belarus, all the risks are on the Lithuanian side” – Regarding Nuclear power plant being constructed in Belarus, near the Lithuanian boarder.

Waters Rise and Hurricanes Roar, but Florida Keeps on Building (link)

“Florida was built on the seductive delusion that a swamp is a fine place for a paradise.”

“The risks of building here are far better known today.  Yet newcomers still flock in and building still rise, with everyone seemingly content to double down on a dubious hand.”

Wall Street Recap: Part 2

Part 2 of my full notes and analysis from the past two weeks: September 3-16, 2017.  Periodicals covered in this Wall Street Recap include the WSJ, FT, NYT, and LA Times.

The “Burned Cat” Phenomenon

Investors who get burned by an asset bubble often develop a learned apprehension towards that asset class, regardless of its future economics or valuation.  In other words, they go about acting like Mark Twain’s cat who, after sitting on a hot stove lid, never sat on a hot or cold stove lid ever again. (link)

Learned apprehension can lead to depressed asset prices as well as severe under-investment in new supply.

1) Depressed asset prices

Investors may develop an irrational resistance towards an asset which has burned them before.  Making them reluctant to invest, even at very attractive prices.  Example:

Elon Musk

Elon Musk experienced this “Burned Cat” phenomenon while working for a bank early in his career.  He found Brazilian debt trading for 25 cents on the dollar, which was guaranteed by the U.S. Treasury for 50 cents on the dollar.  He presented this investment idea to the Bank’s CEO who promptly rejected it saying, “the bank had been burned on Brazilian and Argentinean debt before and didn’t want to mess with it again.” (link)  Taken aback, Elon tried to explain that you couldn’t lose unless you thought the U.S. Treasury was going to default, making it an effective “no-brainer”.  The CEO still declined.

2) Severe under investment in new supply

During an asset bubble, investors eagerly build out new supply, over-extend themselves, and set the ground for their own demise.  Following the bust, investors may become hesitant to develop new supply, even when favorable economic tailwinds present themselves.  As a result, an industry that was once defined by chronic over-supply, can shift into one defined by chronic under-supply.  Examples:

Ethiopian Famine

This feast or famine industry cycle contributed to Ethiopia’s 1983-1985  famine.  Having been burned by  a bountiful harvest and low prices the year before, “Ethiopian farmers produced less grain and more cash crops or livestock, reducing food production in the following year.” (link)

Ireland Housing

Ireland’s real estate market is experiencing the after-effects of the “Burned Cat” phenomenon.  Leading up to the financial crisis, Ireland produced one of the most severe housing bubbles in the world.  The subsequent bust resulted in years of under-investment in new housing.  The country has since developed a chronic shortage of new homes and property prices are rapidly rising.

As the Financial Times described: (link)

“With Ireland facing a chronic shortage of homes and property prices again rising rapidly,”

“Builders are struggling to meet 10 years of pent-up demand for new homes, while rents are rising and Dublin faces a growing homelessness crisis.”

“Housebuilding, which declined to a trickle after the crash, has stepped up markedly yet acute strains remain.  Although private builders are projected to complete 18,000 homes this year, industry figures estimate 30,000 units will be required for years to come.”

“Figures this week showed annual property inflation on a national basis is advancing at 12.3 per cent.” 

Misjudgment underpinning the Burned Cat Phenomenon:

“Burned Cat” investments are influenced by a lollapalooza of human misjudgment, including:

  1. Extra-Vivid Evidence: Investors who have been burned by an investment won’t soon forget.
  2. Pavlovian Association: Through negative reinforcement, investors learn to reflexively avoid an asset class.
  3. Over-Influence from Authority: News coverage of a “burned cat” investment is likely to be prominent, negative, and pessimistic.
  4. Social Proof: No one else is investing in it, so that reinforces the notion that it’s the right thing to do.
  5. Bias from the non-mathematical nature of the human brain: Investors tend to naively extrapolate past returns which contributes to extreme valuations during bubbles and busts.

Investment Lesson: Actively look for assets that have burned investors.  They may present excellent opportunities due to;

  1. The market’s unwillingness to invest in the asset, even when favorable economics and valuations exist.
  2. Severe under-investment in new supply, which sets the stage for future supply shortages.  (Pay special attention to areas where supply cannot ramp up quickly.)

Standard Causes of Human Misjudgment

Social Proof: Rationalized/Normalized Terrible Behavior

At Home Among the Giants (link)

Wllie McCovey: “I tried working as a bus boy in a whites-only restaurant, but I quit after a week.  All the things that make you cringe was normal talk then.  You took it or you walked away.”

“The five most dangerous words in business are: ‘Everybody else is doing it’.” – Warren Buffett

Social Proof: Fear of Missing out

Leveraged Loans too Popular (link)

 “Some companies that reprice loans have cut debt-to-earnings multiples. But for many, nothing has changed other than the strength of investor demand for debt.

“When demand is strong, any investor that declines the lower yield risks seeing another buyer take their place, and many are battling to keep their money invested.”

Deprival Super-Reaction Syndrome

That Airline Seat You Paid for Isn’t Yours (link)

“Political commentator Ann Coulter…erupted in a Twitter tirade earlier in July after Delta moved her from a preferred aisle seat to a window seat in the same extra-legroom row.”

 “…passengers think they can buy the rights to a specific seat…Airlines say that legally, you don’t.”

Contrast Caused Distortion

Passive Migration: Denver Wins Big as Financial Firms Relocate to Cut Costs (link)

 “If you’re talking to someone who’s been in Denver, they’ll say it’s getting unaffordable, but if you’re coming from San Francisco, the reverse sticker-shock is wonderful,” said Ms. Droller. 

“And while Denver home prices reached a record in June, they are still far below San Francisco.”

Incentive Caused Bias 

Wall Street Needs You to Borrow Against Your Stock (link)

“Morgan Stanley’s finance chief said, ‘that the bank expects more clients to take out loans in the months ahead. ‘That’s been a real key driver of our wealth business.‘”

“The Massachusetts securities watchdog last year accused Morgan Stanley of developing a sales program that encouraged brokers to pitch these loans regardless of whether clients needed them.

“Several Merrill Lynch brokers said they have asked long-standing clients to open a securities-backed line of credit to help them hit bonus hurdles,”

“The guy tells you what is good for him…So you’re getting your advice in this world from your paid advisor with this huge load of ghastly bias.” – Charlie Munger

Lesson: Watch out for rapidly growing products and services on Wall Street.  They likely are associated with massive incentive-caused bias.

Consistency & Commitment Tendency

Wall Street Needs You to Borrow Against Your Stock (link)

Merrill Lynch brokers asked long-standing client to open lines of credit “assuring that clients wouldn’t need to use it or pay any fees for opening it.”

“Brokerage executives have said the longer a client has one of these loans tied to their account, the more likely they are to use it.”

“People think if they have committed to it, it has to be good.” – Charlie Munger

Lesson: Beware of commitments, even seemingly harmless ones.

Lollapalooza Effect: Examples

“I would say the one thing that causes the most trouble is when you combine a bunch of these (causes of misjudgment) together, you get this lollapalooza effect.” – Charlie Munger

LIBOR: Incentive Caused Bias, Pavlovian Association, Social Proof, Envy/Jealousy

The LIBOR was a terribly flawed benchmark.  It was easily to manipulate and bankers were highly rewarded for doing so.  Everyone around them was doing it, and they were all getting rich.  Hence, “studies have estimated that hundreds of trillions of dollars of financial contracts around the world were created based on the benchmark.

Libor: A Eulogy for the World’s Most Important Number (link)

“It turned out that banks were skilled at getting Libor to move in favorable directions.  After all, it was their employees who were guesstimating their borrowing costs, so it was simple enough to skew those figures in helpful directions.”

“But government investigations soon showed not only that manipulation was wide-spread and easy to pull off, but also that government officials and central bankers had known for years about Libor’s vulnerabilities but failed to act.”

“If you carry bushel baskets full of money through the ghetto, and made it easy to steal, that would be a considerable human sin, because you’d be causing a lot of bad behavior, and the bad behavior would spread.” – Charlie Munger

Fire Ants in Japan: Stress-Induced Mental Changes, Social Proof, Extra-Vivid Evidence

The sudden stress from the arrival of fire ants in Japan, along with extra-vivid coverage from the media prompted faster and more extreme reactions.  Furthermore, Social-Proof amplified the power of this reaction.

Evacuate the Sandbox! Japan Is Freaking Out About Fire Ants (link)

“The mild panic here is partly due to sensationalism in the mass media, with some reports falsely depicting fire ants as murderous,” said Mr. Hashimoto.

“Better safe than sorry, said one wrestler.”

“He drew a parallel in Japan’s experience with how U.S. fire ant infestations in the 1950s were caught up in fear about communism.”

“Shares of pesticide makers have surged on the Tokyo Stock Exchange, and one manufacturer started selling ponchos made from industrial-strength material that allegedly protects the wearer from fire ants.”

“He added, ‘It is necessary for everyone in the nation to recognize correctly the characteristics of fire ants and address the matter calmly.'”

“One consequence of this tendency is that extra vivid evidence, being so memorable and thus more available in cognition, should often consciously be underweighed while less vivid evidence should be overweighed.” – Charlie Munger

Wall Street Recap: Part 1

Part 1 of my full notes and analysis from the past two week: September 3-16, 2017.  Periodicals covered in this Wall Street Recap include the WSJ, FT, NYT, and LA Times.

ROE & Customer Ignorance

Ideally a company’s product or service would increase in demand as its customers become less ignorant.  This is not always the case.  Some companies build their businesses upon the ignorance of their customers.  As a result, their moats decrease in direct proportion to the savviness of their customers.

Moats built upon ignorance have become increasingly tenuous as technological developments and market conditions have led to savvier customers.

Ignorance removal may occur with:

  1. Increasing competition.  A more challenging competitive environment increases the pressure for businesses to cut costs, which incentivizes ignorance removal.
  2. Early adapters and social proof. Early adapters who assess the benefits of less known products, may induce others to adapt later on.
  3. Declining search and discovering costs.  Low S&D costs lead to savvier customers.

Examples of Ignorance Removal

Honeywell (Increasing Competition)

China has become an increasingly competitive market for international businesses.  This is due in part to the improved quality of Chinese-made products  in conjunction with savvier customers. (link)

The fact that Honeywell’s struggles in China are related to the “savviness” of its customers and the quality of competing Chinese brands is disconcerting.

Football Helmets (Early Adapters, Social Proof, & Extra-Vivid Evidence)

The first football helmet from Startup firm ‘Vicis’, “tested better for safety than any helmet in NFL history.”  Yet only “about 50 of the league’s 1,700 players-roughly 3%-took the field in week 1 in a Vicis helmet,”

The rest of the league continues wearing helmets that have inferior safety ratings. Riddell and Schutt, who have long outfitted most NFL players, continue to dominate the market.

The resistance to the new helmet comes from:

  1. Consistency and Commitment: “They are loathe to change, because of the familiarity they have with the helmet they have been using all these years,”
  2. Bias from non-mathematical nature of the human brain: “Executives and players say NFL locker rooms are largely populated by men who believe long-term brain damage is something that will happen to someone else and who fear the consequences of any dip in performance due to an equipment switch.”

While the incumbents may benefit from these psychological tendencies in the short-term, it’s a tenuous proposition to suggest that, without sufficient improvements to their helmets, their moats will endure.  Early adapters and social proof will aid continued adoption of safer helmets.  Furthermore, extra-vivid evidence of any injury sustained with a Riddell or Schut helmet could drive wide-spread adaption of safer helmets.

Toys “R” Us (Declining search and discovery costs)

Highly reliant upon ignorant consumers, retailers and consumer brands have crumbled under the pressure of increasingly savvy-shoppers.  Having built their moats upon high search and discovery costs, they’re unable to withstand rapid declines in  consumer ignorance. Toys “R” Us is one such example.

“Industry-wide, toy sales have been strong in recent years, though much of the growth is shifting to online sellers like Amazon.com Inc. and discounters like Wal-Mart Stores Inc.  Amazon’s toy sales were up 24% last year, compared with 5% for the overall market and five years of declines for Toys “R” Us,”

Investment Lesson

Lesson: Beware of moats built on exploitation.  Seek moats built on reciprocity. 

A moat built around consumer ignorance is tenuous in nature.  For a long-term sustainable advantage, search for companies that would benefit from declines in ignorance.  Or as Charlie Munger might say, find companies that deserve to earn sustainable high returns on equity.  Companies who exploit ignorance don’t deserve it.

One of Charlie Munger’s three investment holdings is Costco.  Costco offers best in class service at best in class prices.  Both of which are highly valued by its customers.  Neither of which is easy to duplicate.  Hence, Costco deserves the favorable return it earns.

Checklist Question

Question: Would customers choose this company’s product or service if they were well informed and had access to their competitor’s products/services?

Drive for Efficiency Gains

Companies will accumulate operating inefficiencies as they grow.  When this growth inevitably slows or declines, companies may seek to expand margins by eliminating these inefficiencies.

Cycle: Growth —> Excess & Inefficiency —> Slowdown —> Drive for Efficiency Gains

Such strategies include;

  • Simplify management structure (eliminate bureaucracy),
  • Trim staff and eliminate redundant positions (can include industry consolidation),
  • Simplify product offerings,
  • Focus on core competencies (can include disposing of non-core assets),
  • Become more adaptive to consumer demands and industry trends,
  • Improve capital structure and return more cash to shareholders,
  • Close poorly performing stores.

Examples of Companies Seeking Efficiency Gains following a Slowdown

Lego

Problem: First Sales Decline after 13 years of growth.

“Lego said Tuesday that its revenue for the first half of this year fell 5% from a year earlier to $2.4 billion, its first revenue decline in 13 years.” (link)

“Lego (said) its organization had grown too bureaucratic ‘to support global double-digit growth.’…We have added complexity into the organization which now, in turn, makes it harder for us to grow further,”

Solution: Seek efficiency gains through cutting jobs, reducing layers of management, & speeding up product roll-out.

“We will build a smaller and less complex organization than we have today, which will simplify our business model in order to reach more children.”

“On Tuesday, Lego said it would cut roughly 1,400 jobs, with between 500 to 6000 of these coming from its Billund, Denmark, headquarters alone.”

“It is also working to reduce layers of management and administration to speed product rollout, which Mr. Knudstorp said can involve 20 teams on average before a product is ready for global launch.”

Eli Lilly

Problem: Experiencing Industry-wide Pricing Pressure & Expiring Patents.

“Health insurers and politicians have stepped up pressure on prices…” (link)

“Lilly cited a number of issues that are plaguing many drug makers, including the need to lower costs and raise investment in new drugs ahead of patent expirations that are expected to erode sales of older products.”

Solution: Seek Efficiency Gains through cost cutting and dramatic reduction in the work force.

“That has left companies leaning on cost cuts and efficiency improvements to drive profit growth.  The result is a dramatically shrinking workforce.”

“When the pressure gets heavy, the scrutiny turns to the size of a company’s payroll,”

“Drug companies have cut more than 269,000 U.S. workers since the beginning of 2007,”

Unilever & Nestle

Problem: Experiencing Shifting Consumer Tastes and Declining Sales.

“Amid this shift (in consumer tastes), sales from traditional players have flagged, spurring consolidation, cost cutting and restructuring.” (link)

Solution: Seek efficiency gains through Cost Cutting, Industry Consolidation, Restructuring (simplify product offerings), Boost Dividends, and Make Acquisitions to Accelerate Growth.

“In response (to activist posturing) the two consumer-goods firms (Nestle and Unilever) have focused on cost cutting and promises to boost dividends while going on the hunt for nimbler food and beverage brands with the potential to accelerate growth.”

“Nestlé, Unilever and other big companies in the sector are making (acquisitions) to catch up with fast-changing consumer tastes.”

VW

Problem: Dealing with Major Corporate & Political Scandal, recently became the largest auto company, by volume, in the world.

“VW long pursued the industry’s crown, only to face billions of dollars in penalties related to a U.S. regulatory scandal.  It used software to cheat on diesel-emissions tests, a result of a growth-at-any-cost philosophy that claimed Detroit’s auto giants a decade earlier.” (link)

“We’re a big company and don’t have any interest in getting anymore bloated.” (link)

Solution: Optimize business through Restructuring (selling any business segments no longer considered critical).

“The company is open to talks and a new team is working to sell any businesses no longer considered critical.  These noncore assets account for as much as 20% of the company’s current annual revenue,”

“…in order to see how we can optimize our business,”

Aerosoles

Problem: Expanded store count too fast and with too little consideration for cost.  Struggled with major shifts in the retail sector as well as disruptions in its supply chain.

“In 2012 and 2013, Aerogroup expanded to 125 retail stores, a ‘rapid pace’ that meant the company didn’t always get the best terms on leases, according to court papers.” (link)

“Last year, the company’s supply chain was disrupted when the sole sourcing agent in Asia stopped providing goods.  The interruption cost Aerosoles customers permanently, court papers said.”

Intense industry competition,” & “major shifts in the retail sector.

Solution: File for bankruptcy production, close a majority of company stores, and (presumably) focus efforts on sales through department stores, online retail, and  home-shopping networks.

“Some 74 of Aerogroup International Inc.’s roughly 80 stores are candidates for immediate closure, with proceeds of the liquidation earmarked to help fund a continued sales effort, according to court papers.”

“In addition to its retail operation, the Aerosoles brand is sold at well-known department stores, on home-shopping networks and Amazon.com.”

Changed in a “Big Way”?: Value of U.S. College Degrees

“You have to be thinking all the time to see if something has changed the game in a big way.” – Warren Buffett

For decades properties surrounding U.S. colleges had a can’t miss combination of limited supply and an ever increasing demand for degrees.  On several occasions I’ve been advised by successful real estate investors to buy college properties .  This was sound advice for decades, and may still be, but what if the game has changed in a big way? What if the demand for U.S. college has shifted dramatically lower, and with it, demand for university housing?  Two WSJ articles shed some light on these very real, yet uncommonly held concerns.

1) Americans Losing Faith in College Degrees, Poll Finds (link)

“Four years ago, (Americans without college degrees) used to split almost evenly on the question of whether college was worth the cost.  Now skeptics outnumber believers by a double-digit margin.

“Overall, a slim plurality of Americans, 49%, believes earning a four-year degree will lead to a good job and higher lifetime earnings, compared with 47% who don’t…That two point margin narrowed from 13 points when the same question was asked four years earlier.”

“Meanwhile, student debt has surged to $1.3 trillion, and millions of Americans have fallen behind on student-loan payments.”

2) U.S. Colleges Slip in Global Rankings (link)

“The U.S. continues to lay claim to more elite research universities than any other country in the world, but that dominance is beginning to fray.

“(This) marked the first year that schools outside the U.S. seized the two top positions in the 14-year history of the list.”

“This marked the fifth year of consecutive decline in the overall showing of the U.S.  This ranking listed 62 U.S. schools in the top 200.  In 2014, 77 U.S. universities ranked in the top 200.

“…there are clear warning signs and fairly significant flashing red lights that the U.S. is under threat from increasing competition,…Asia is rising.  It’s worrying time for stagnation for the U.S.”

“In recent years, Chinese universities have worked to internationalize their course offerings and attract more foreign students.  The efforts have paid dividends: in 2016, according to government figures, more than 440,000 foreign students were studying in China, with students mostly hailing from South Korea and the U.S.  That figure marks a 35% increase over 2012.”

“The rise of Chinese universities also comes as the Chinese Communist Party has invested heavily in research universities.”

Investment Implications

The tailwinds that favored college housing for the last 30 years have slowed.  If the demand for U.S. college degrees has indeed shifted downward, I’d expect demand to dry up in traunches, starting with third tier universities and moving on up.  This would imply that real estate around third and second tier universities is more vulnerable to a downward shift in demand, while first tier universities would fair relatively well.

Investment Lessons

Lesson 1: Insist on thinking things through.

It’d be far too easy to blindly follow the advice of a successful investor.  To avoid going terribly astray, insist on thinking things through.  Do not simply take an expert’s word for it.

Lesson 2: Look out for things that have changed in a big way.

In the past, college housing benefited from huge long-term tailwinds.  But as the famous investment clause suggests, past performance does not guarantee future returns.  Do not naively extrapolate past trends into the future.  Rather take time to assess what drivers will harm or benefit an investment moving forward.

Checklist Question

Question: Has anything changed in a big way?

Standard Causes of Human Misjudgment

Disliking Bias

Why China Can’t Stop Hating Japan (link)

“Beijing sanctioned a relentless diet of anti-Japanese propaganda.  A besieged party eager to rally the masses saw no better vehicle than reviving attacks on the ‘historical criminal,’ Japan.  Over time, policy towards Japan has become so sensitive that any Chinese official who advocates reconciliation risks career suicide.”

“If you [say] any nice words about Japan then you will get an angry reaction from students,”

Reciprocation: Role Theory

Why China Can’t Stop Hating Japan (link)

“Leaders in Beijing still use the idea of Japan as China’s enemy to rouse the citizenry.  The Japanese, seeing themselves depicted as China’s foe, have increasingly begun to act like one.”

“Sixth: bias from reciprocation tendency, including the tendency of one in a role to act as other persons expect.” – Charlie Munger

Bitcoin: Reinforcement & Social Proof

1) China Bans Digital Coin Offers as Celebrities Like Paris Hilton Tout Them (link)

“The losses haven’t deterred some (crypto currency) buyers, many of whom have made so much in other deals that they are eager to take more chances.

“In a year, he turned an in heritance of $80,000 into a couple of million dollars.  “It was pure luck, literally,” he said.  Mr. Bardi then put $1 million into Bancor, even as the price was falling”

“While Mr. Bardi said he is mindful of price swings, and isn’t willing to take a chance on another token offering, he said he believes in Bancor’s product and has no plans to sell.  “I’m not really touching it,” he added.”

“Nothing seduces rational thinking and turns a person’s mind in mush like a big pile of money that was easily earned.” – Charlie Munger

2) Bitcoin in sharp drop after Jamie Dimon ‘tulip bulbs’ barb (link)

“(Jamie Dimon’s) comments were dismissed by fintech executives who said Mr. Dimon had criticized bitcoin before but the currency continued to surge.”

“If you think about the doctrines I’ve talked about, namely, one, the power of reinforcement — after all you do something and the market goes up and you get paid and rewarded and applauded and what have you, meaning a lot of reinforcement, if you make a bet on a market and the market goes with you. Also, there’s social proof. I mean the prices on the market are the ultimate form of social proof, reflecting what other people think, and so the combination is very powerful. Why would you expect general market levels to always be totally efficient, say even in 1973-74 at the pit, or in 1972 or whatever it was when the Nifty 50 were in their heyday? If these psychological notions are correct, you would expect some waves of irrationality, which carry general levels, so they’re inconsistent with reason.” – Charlie Munger

Pre-suasion: Fear of Missing Out

Newport Beach precious metal dealer Monex accused of $290-million fraud (link)

A complaint against Monex, a precious metals investment firm, says that the company encouraged its sales force to use this ‘pre-suasion-esque’ sales pitch:

“If gold were to increase in value by $100 per ounce in the next year, and you had a 30% to 40% net gain, you’d feel pretty good, wouldn’t you?”

Uncertainty & Extra-Vivid Evidence

Florida Gas Stations Running Out of Fuel as Irma Threatens State (link)

The unknown path of Irma, along with extra-vivid evidence of its destructive power  induced widespread panic and buying across the entire state of Florida.  There’s an investing lesson in there somewhere.

Because of Irma’s unknown path, panic buying has been widespread in the state, rather than confined to a few counties…’You basically had all 67 counties with a run,'”

“This storm has the potential to devastate our state,” Rick Scott said (link)

Incentive Caused Bias

U.S. Colleges Slip in Global Rankings (link)

“Elizabeth Perry, a professor at Harvard and expert on China, said the Chinese are actively ‘gaming’ the system.  ‘They are hiring an army of postdocs whose responsibility is to produce articles,’ she said.  ‘They are changing the nature of a university from an educational institution to basically a factory that is producing what these rankings reward.‘”

Economic Warfare: Companies in the Crossfire

International disagreements and conflicts result in economic “attacks” much more frequently than they do in military attacks. Be careful that your investment doesn’t end up a casualty of economic warfare.

Examples of Recent Activity

Germany & Turkey: Germany threatens to cut aid to Turkey

“…prompting Berlin to issue a travel advisory for the country and threaten aid cuts.” (link)

“The two countries’ ties started fraying last year, after Germanys parliament adopted a resolution branding the killing of more than a million Armenians by Ottoman Turkey in 1915 and 1916 as genocide, sparking protests in Ankara.”

Saudi Arbia & Qatar:

“Saudi Arabia, the United Arab Emirates, Bahrain and Egypt in June severed diplomatic ties and closed their air routes and land and sea borders with Qatar to protest its alleged support for regional extremist organizations and terrorist groups.” (link)

USA & North Korea:

“A U.S. proposal for new United Nations sanctions would clamp an embargo on its oil and textile trade and slap a full asset freeze and world-wide travel ban on leader Kim Jong Un and key regime members and institutions.” (link)

“We are worried that cutting off oil exports will inflict damage on North Korea’s hospitals and an ordinary people,” Mr. Putin said

(De)Commoditized Flights

The statements below address what’s happening in air travel, but doesn’t address why.

“Passengers get into anything that flies if the ticket is cheap.”

“For a small fare difference, (passengers) still pick less-comfortable airplanes.  Airlines say cost is the No. 1 factor when evaluating new airplanes.” (link)

To draw the inference that customers only care about price would be misleading.  After all, price is the only factor in the purchase decision which customers can easily assess.  Factors such as comfort, amenities, and service are either not easily assessable or completely unknown.  So of course air travel has tended towards commoditization.  After all, why pay 20% more for a flight when I have no idea what I’m getting for the extra money?

Why not give consumers an easy way to objectively assess comfort, amenities, and service and see what happens?  If an American Airlines flight had an 87 rating on comfort, amenities, and service, I’m likely to pay up for that flight over one with a 62 across the board.  Or better yet, attempt to assign some dollar value to them.

Such a system would contribute to the de-commoditization of flights.  But as it stands, these factors are wholly unassessable, and thus, I’ll continue to be over-influenced by price.

You need to have a passionate interest in why things are happening.  That cast of mind, kept over long periods, gradually improves your ability to focus on reality.  If you don’t have the cast of mind, you’re destined for failure even if you have a high I.Q.” – Charlie Munger

Various Fascinating Excerpts

Flood Insurance: Highly Skewed Losses

“(In Florida) Homes and other properties with repetitive flood losses account for just 2% of the roughly 1.5 million properties…But such properties have accounted for about 30% of flood claims paid over the program’s history.” (link)

The Economics of Politics

Here we are in the minority…and we’re dealing from strength because they don’t have the votes…Here the vote is the currency of the realm.  It’s all about having the votes.” – Nancy Pelosi (link)

“They’re the only two people who came to the meeting with a deal to be made.” – President Trump on cutting a deal with Democrats.

Demand Excellence

“‘The lesson’, he said, was that ‘if you don’t demand excellence, you’re not going to get it.'” – Don Ohlmeyer (link)

Censoring Social Media in China

“Last year, officials imposed stricter controls on (social media) apps, forbidding sexual content and original reporting during live-streams.  The government has also shuttered dozens of live-streaming sites and fined some hosts for obscene language.” (link)

“Mr. Li understands the government’s power to break stars, and said he had cleaned up his act to avoid trouble.”

Future of Augmented Reality

“A lot of people underestimate what is happening,..This is one of those things that is going to completely change the game in the next two or three years.  It’s like right before the Big Bang…It is definitely not a novelty,…This fundamental shift will change how we interact with computers, live our lives – and sell furniture.” – Michael Valdsgaard, head of digital transformation at Ikea, an early adopter of ARKit (link)

China credit expansion

“No other economy in history has grown this fast without confronting some kind of a big crisis.” (link)

Hilarious Foot-in-mouth moment

“Martin Schulz, leader of Germany’s Social Democrats, had some strong words for a Hamburg landlord planning a huge rent rise.  It was ‘daylight robbery’, ‘immoral’, the ‘unscrupulous exploitation of poor people’.” (link)

“But there was embarrassment in store for Mr. Schultz.  A presenter revealed that Ms. Braun’s landlord was a construction company owned by Hamburg City Hall – which is Social Democrat-controlled.  All 150 studio guests erupted in laughter.”

Wall Street Journal Recap: April 10-16, 2017

My full notes and analysis on the Wall Street Journal from the past week: April 10-16, 2017 (Week 15).  Please Enjoy.

The Wealth Transfer Mechanism

Companies who buy things they do not need, will soon have to sell things that they do.  Toshiba is learning this lesson the hard way.

“Toshiba is looking to cash out (its prized computer-chip business) assets to stay alive.” (link)

“Last month, nuclear-reactor maker Westinghouse Electric Co., which is majority-owned by Toshiba, filed for bankruptcy in the U.S., and Toshiba said it expected to book a 1 trillion Yen loss…to account for losses at Westinghouse.”

Investment Lesson:

The stock market works like a wealth transfer mechanism which funnels money from the impatient to the patient.

As a patient investor, Warren Buffett has been on the winning side of this equation for his entire career.  He has capitalized on companies selling things they need in order to pay for things they didn’t.  An excellent example includes his purchase of a pipeline from Dynergy in 2002.

In November 2001, Dynergy had bought a pipeline from Enron for $1.5 billion.  But not too long after, its credit ratings collapsed and it desperately needed to lower its debt levels.  So in July 2002, just 8 months later, it sold its pipeline to to Berkshire Hathaway for $928 million.  And there you have the wealth transfer mechanism at work. (link)

Gaming Capitalism: How Communists Exploit Free Markets

I don’t think we’ve come to grips with just how easy it is for a communist government to game a capitalist system.  Let’s take the following quotes for example:

“A recovery in producer prices in China and a broad rally in commodities have helped stoke Chinese stocks in Hong Kong,” (link)

“The economic data is not bad, and commodity prices have increased compared to last year.”

I tend to view this news with great skepticism.  Reason being, there’s just too much incentive for communist governments to manipulate commodity prices through artificial demand.  The positive ripple effect of artificial demand through a free-market system is profound.  Just a little bit can go a long way as I describe below.

  • Commodity Prices: Higher prices for steel and other basic commodities create a sense of price stability and fuels investor confidence.
  • Stock Market: Artificial demand creates artificially high profits. These unsustainable profits are then naively extrapolated and equitized by the stock market, thereby creating a multiplier effect on the value of artificial demand.
    • For example: If artificial government demand creates $100 million in profits for Company XYZ, and the market naively extrapolates these profits out indefinitely, a 10% discount rate will create $1 billion in market value. In essence, a communist government can turn the stock market into a printing press.  As in this example, 1 unit of artificial profits go in, and 10 units of market value comes out.

  • Corporate Debt Market: Stable markets and higher profit margins allow companies to borrow and refinance debt at attractive interest rates.  This is especially important for highly indebted commodities-based companies.  Lower interest rates and fresh capital make companies seem more stable than they are.
  • Banks : Banks receive three major benefits from artificial demand, as they:
    • Remain Solvent: Banks remain solvent as a result of improved financial outlook of debtors.
    • Appear to be better capitalized than they really are: Any equity on the banks’ balance sheets that came from a debt to equity swap suddenly looks more valuable, thereby making the banks seem better capitalized than they really are.
    • Can make more loans on a larger equity base.

An entire eco-system is then built on top of the foundations of artificial demand.  The longer this heavy handed market manipulation persists, the more real investors perceive it to be, and the bigger the bubble becomes.

As Gordon Gekko said, “The illusion has become real, and the more real it becomes, the more desperate they want it.”

Standard Causes of Human Misjudgment

There were many great examples of human misjudgment in last week’s WSJ:

Wells Fargo: (link)

  • Incentive Caused Bias: “At one point, she is described as being ‘scared to death’ of hurting her unit’s sales figures.”
  • Over-Influence by Authority: “The report also highlighted how the bank’s push to boost revenue and profit trickled down to thousands of employees who felt pressured to meet unrealistic sales goals. One Wells Fargo branch manager, for example, had a teenage daughter with 24 accounts, and adult daughter with 18, a husband with 21, a brother with 14 and a father with four.”
  • Liking Bias & Shared Identity: “The board’s effort to understand the scope of the issues were hampered by the ‘insular and defensive’ way in which Ms. Tolstedt ran her division, as well as Mr. Stumpf’s loyalty to her,” Stumpf declined to remove Ms. Tolstedt, calling her, “The best banker in America,”

United Airlines: (link)

  • Deprival Super-reaction Syndrome: “It is unusual, however, for an airlines to remove passengers who have already boarded the plane.”

Commins & Columbus, Indiana: (link)

  • Reciprocity: “Amid halting negotiations back in Columbus for the city to land its first Japanese autoparts maker, one of the Japanese executives had an emergency eye problem. So Cummins Inc., the biggest company in town and the key player in its push for internationalization, lent the Japanese executive use of its corporate jet for a trip to the Mayo Clinic.  The deal was closed shortly thereafter.”

Lotte: (link)

Disliking Bias & Pavlovian Association: “To top it off, Lotte this year became the target of raucous protests by Chinese nationalists, who uploaded videos of themselves ripping up Lotte products in stores…The Chinese protests,…came after the company made a deal that allows the U.S. military to put a missile-defense battery on a Lotte golf course in southern South Korea.”

“Greater than 0%”

The other week an analyst suggested that Apple could acquire Disney if there’s a cash repatriation holiday.  When asked for the probably of such a deal, the analyst responded that it’s “greater than 0%” (link)

“Greater than 0%” means practically nothing.  For example, I’d bet there’s a greater than 0% chance that we’re in the Matrix.  So the chance that we’re living in a vivid computer simulation and that Apple could acquire Disney both have probabilities greater than 0%…

Causes of Thyroid Cancer

It’s been found that higher rates of Thyroid Cancer are caused by:

  • Obesity
  • NOT Smoking Cigarettes
  • Certain fire-retardant chemicals

Mind-blowing article of the week: 5 Things to Know About Crispr (link)

This is a mind-blowing article about genetic modification.  It revolves around Crispr, a bacteria is found in the our immune system’s bacteria and acts like “the Borg” from Star Trek to fend off future diseases.  Scientists want to hack Crispr and use it to cure genetic diseases.  Ultimately, they could use Crispr to hack egg, sperm or embryos to pass on genetic alterations, thereby permanently altering future generations.

I can just imagine a future where genetic modifications replace vaccinations.  It also makes me uncomfortable thinking about the Gattaca-like implications and abuses of such technology.

The Subordinated Investor: Challenges with International Investing

Investing in a foreign country is often akin to investing in non-voting B Shares of common stock or Subordinated Debt.  While such investments will allow you to share in a country’s success, it also means that you may share disproportionately in the country’s woes.

Foreign investors are particularly vulnerable to “economic persecution” during periods of political or economic hardship.  When a country or political party becomes concerned about self-preservation, foreign investors, who are not part of their “shared identity”, become easy targets for their ire.

The following are three examples where foreign investors were treated as a subordinated class.  From them, we can extract some valuable lessons.

Indonesia: Raise taxes on foreign corporations and ultimately force them to sell.

Indonesia has been targeting foreign copper mining corporations with higher taxes and increased pressure to sell their Indonesian assets to domestic investors.

“As part of its push to earn more from the mining sector, Indonesia banned ore exports and placed restrictions on exports of mineral concentrates in 2014 to push companies to invest in domestic smelting.” (link)

“Indonesia has asserted more control over foreign investment with the aim of redistributing economic benefits in a more equitable manner, an effort that began after the fall of dictator Suharto.”

“It said the divestment obligation was meant to “facilitate” mining companies to join with the government and “bring justice” for the people of Indonesia as the “absolute” owners of the country’s resource wealth.”

“Freeport derives roughly one-third of its copper output from Indonesia.”

Reasons for “Economic Persecution”:

  1. Slowing GDP Growth
    • “Southeast Asia’s biggest economy has been undershooting the 7 percent growth target set by Widodo when he took office two years ago, mainly due to low commodity prices and weaker global demand.” (link)
  2. Rising Income Inequality
    • “Inequality in Indonesia is climbing faster than in most of its East Asian neighbors, raising the concerns of many Indonesians,” (link)
    • “The country’s official poverty rate has halved between 1999 and 2012, falling from 24% to 12%.  However, the Gini coefficient, a measure of national consumption inequality, has increased from 0.32 in 1999 to 0.41 in 2012[1].  Hence income distribution has become much more unequal.” (link)

Brazil: Sue the heck out of foreign corporations.

Brazilian prosecutors were surprisingly aggressive towards Chevron after an oil spill in 2011.  They sought $20 billion in damages and filed criminal charges against the executives.  Meanwhile, State owned oil company Petroleo Brasileiro which owned 30% of Chevron’s well, was not sued by the Brazilian government. (link)

“But Brazil remains a politically challenging place to operate, with complex environmental licensing procedures and requirements that a lot of equipment and labor be made and hired locally.”…”Oil companies were rattled in 2011 when a minor oil spill by Chevron prompted Brazilian prosecutors to seek nearly $20 billion in damages and file criminal charges against executives.  The charges were ultimately dropped, and Chevron agreed to pay $42 million to settle the suits in 2013.” (link)

Reasons for “Economic Persecution”:

  1. Politically Expedient: A headline catching $20 billion lawsuit will direct the country’s attention and blame towards Chevron, and away from politicians and regulators.  Furthermore, it may help advance political careers or party agendas.
  2. Socially Acceptable: A foreign company is an easy and socially acceptable target.

Russia: Force foreign investors to sell.

In 2015, Russia passed a law limiting foreign ownership of Russian media companies to 20%.  There was really only one company affected by this law, CTC Media, whose stock price subsequently crashed.  Before the announcement, CTCM had attracted many value investors who were enamored with its strong financials and compelling valuation. (link)

What good is it to own a foreign company if you’re forced to “sell low” every time things get bad in that country?

Reasons for “Economic Persecution”:

  1. Political and Economic Tension: 2014 Russian military intervention in Ukraine, subsequent capital flights, and negative GDP growth due to collapsing oil prices. (link)
  2. The Ruling Political party felt threatened: Foreign ownership in Russian media companies could undermine the ruling political party’s agenda and power, especially during an unstable period.

Tombstones

The financial industry uses “tombstones” to announce particular transactions.  Perhaps we should use tombstones to announce economic mistreatment of foreign investors.  Using the examples above, I imagine they’d look something like this:

Investment Lessons

Be aware that governments can often turn on foreign companies or investors when it suits them.  Before investing in a foreign country, ask yourself:

  1. What percentage of this company’s revenue and profits come from this country?
  2. How critical is this company’s relationship with this country?
  3. Does this company, in any way, undermine the agenda or power of the ruling political party?
    • Political parties may tolerate minor political subversion when things are stable.  But under uncertain political conditions, politicians may act swiftly and harshly against any foreign investors seen as a threat to power.
  4. Is the country’s economy slowing down?
    • A country with high growth will have less animosity towards foreign investors than one with slowing growth.
  5. Is Income Inequality becoming an issue?
    • Increasing income inequality creates a hostile political environment for foreign investors.  They are the easiest and least controversial of targets.
  6. Are there heightened international tensions with this country?
  7. Does this country have a strong history of protecting foreign investors?
    • i.e. Does the ruling political party have the autonomy to quickly and effectively subvert the rights of foreign investors?