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?


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.


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)


(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.


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.


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.


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.


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.


Questions 3: When I reflect on where I am here in my 30’s I often think about the multiple tuck-ins you were done with when you were my age, in Pasadena, shouldering your multiple griefs alone.  In contrast to that, could 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)


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.


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.


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.


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)


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)


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)


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)


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.


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.


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.


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)


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.


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)


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.


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.


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.


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.


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.


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.


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.


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.


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.


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.


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.


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.


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)


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).


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.


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.


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.


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.


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.


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.


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.


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 Charlie Munger 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.



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


“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



” 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 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 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


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.”


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,”


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”

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.


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?

Russell Westbrook: The Non-Quantifiable Draft Pick

Whether you’re buying a stock or drafting an NBA player, it pays to avoid standard causes of human misjudgment. (link)

In the case of the 2008 NBA draft, most NBA teams committed a huge error of omission when it came to Russell Westbrook.  He went overlooked and underappreciated by nearly everyone but the Seattle SuperSonics.  There were three key causes of misjudgment associated with this oversight:

  1. An over-reliance on quantifiable data: Most front-offices calculated too much and thought too little. Russell Westbrook was not a very quantifiable player.

“There wasn’t much data to predict his future. Most experts pegged Westbrook as a mid-first round pick.” (link)

“He didn’t start in high school until his junior season and didn’t earn a scholarship to UCLA until after his senior year. He couldn’t dunk until he was 17 and owes his career to a late growth spurt that shot him to 6-foot-3.”

  1. Anchoring & Adjusting: Anchored to their prior assessments, most front-offices weren’t willing to properly update their old assumptions with new information.

“Westbrook’s combine performance, against players who were supposedly better than him, only made the Sonics more curious. ‘He was the best athlete in the gym,’ Weaver said. ‘I was sitting in my seat trying to contain myself.'”

  1. Social Proof: Most professional basketball analysts and front offices did not list Russell Westbrook near the top of their draft lists. Those relying on social proof likely assumed that the crowd’s consensus was rational and accepted it as accurate. Ed Thorp calls this behavior ” the lunacy of lemmings”. (link)

“One day, Weaver went to Presti’s office and declared: ‘I’m looking at everybody, and I don’t understand why this guy is not the best of the group.'”

Investment Lessons:

  1. Standard Causes of Human Misjudgment create great investment opportunities…just so long as you can avoid them yourself and remain objective.  In essence, follow the advice from the poem “If” by Rudyard Kipling;

“If you can keep your head when all about you are losing theirs…” (link)

  1. Not everything can be quantified.  As Charlie Munger says;

“There’s never going to be a formula that will make you rich just by going through some numerical process.  If that were true, every mathematical nerd that gets A’s in algebra would be rich. That’s not the way it works.” (link)

  1. Qualitative Investments can be very lucrative.  Warren Buffett’s best investments have been qualitative in nature;

“Interestingly enough, although I consider myself to be primarily in the quantitative school…the really sensational ideas I have had over the years have been heavily weighted toward the qualitative side where I have had a “high-probability insight”. This is what causes the cash register to really sing.” (link)

The Seattle SuperSonics relied on qualitative factors such as Russell Westbrook’s character, competitive drive, and shear athleticism, to develop a high-probability insight that paid off in spades. (link)

“That was the day Westbrook sold him. Presti and Weaver looked at his story-overcoming the odds to become an indispensable part of a winning team-and saw his relentless competitive streak. ‘We don’t know how good Russell Westbrook will be,’ Presti said, ‘but the person that Russell Westbrook is will allow him to maximize his potential.'”

Fireside Chat with Charlie Munger: Full Transcript

Following the 2017 Daily Journal meeting, Charlie Munger treated everyone who stayed to an informal fireside chat.  For over two hours, he graciously answered any questions.  I transcribed this fireside chat verbatim and as accurately as possible.

The Full Transcript is 15,508 words.  It was transcribed from this fantastic 1 hour and 48 minute recording of the talk.  Below is a sample of this transcript.

For a full copy of the transcript, simply Subscribe via Email to Latticework Investing today.   It’s free to subscribe!  You should receive the full transcript within 24 hours of signing up.  

If you do not receive a copy within 24 hours of subscribing,  please email me directly at

Event Info

Location: 949 E 2nd St, Los Angeles, CA 90012

Event: Informal Fireside Chat following the DJCO Annual Meeting

Date: February 15, 2017

Start of Transcript

(Video 1 of 22 0:27)

Charlie: …Why do you want to strain and (feel like you) have more danger when you’re already filthy rich?  As Warren says, ‘What difference does it make to him if he has an extra zero on his tombstone?’.

Question: For return on invested capital, isn’t that already taking into account leverage?

Charlie: Well of course everybody would rather have billions with a high return on capital.

(Video 2 of 22 0:04)

(Video 3 of 22 0:28)

Question: What’s your reading habits every day?

Charlie: I read 3 or 4 newspapers when I get up in the morning, and I always have two or three books that I’m reading.  I kind of go back and forth between them.  And that’s what I do.  That’s what I’ve done all my life.

Question: What are your four newspapers?

Charlie: Wall Street Journal, New York Times, Financial Times, L.A. Times. (Questioner: No Washington Post?) No, no Washington Post.

(Video 4 of 22 1:14)

Question: (Question Regarding deferred gratification)

Charlie: What about medical school, that’s a lot of work.  You’re not living very high or this or that.  Later you’re a doctor and you have a better life.  That’s deferred gratification.

Question: So Charlie, you’re the chairman of the Good Samaritan Hospital, do you have any recommendations or any suggestions about lowering the prices…

Charlie: Well I took that because basically it was basically a losing hand and I play so many winning hands, so I thought, I should force myself to play a losing hand, and I must say it’s been very difficult.

Question: Do you believe in a single-payer health system?

Charlie: I think a single-payer health system would work a lot better, yes.  I think it will eventually come.  I think the existing system is a ridiculous (inaudible) system.  Ridiculous system.

Question: How should we help our children to avoid envy and jealousy.

Charlie: Well you can’t.

(Video 5 of 22 0:41)

Question: What’s your go to (valuation approach)?

Charlie: We don’t have one way of doing it.  We have certain things we avoid because we don’t think we have the competency to deal with it.  And we have certain things we kind of like because we’re use to them.  And so, we don’t have just one set of rules.  We don’t have any formulas that are exact or anything like that.  And some of the stuff we do, we just know it’s a little better than our alternatives.  We’re doing all kinds of stuff now that we would not have done.  We would have never bought Apple stock in the old days.

(Video 6 of 22 0:51)

Question: (Regarding Todd Combs.  How he got introduced to Charlie and Warren)

Charlie: He seemed like very straight forward.  But you see I get a million letters from people who want to come work for Berkshire.  Or want to come work…I sometimes get a check from somebody who says, “Here’s $50,000, I’ll pay this to work for you.”  I sent the $50,000 back.  I will say that it’s kind of a brash thing to do, and I kind of admire it because it was kind of a smart-ass stunt, and I was something of a smart-ass when I was young myself.  But I’m not looking for another starting helper or something.  I’m playing out the end game.  Anybody who’s playing anything else but an endgame when they’re 93 is crazy.  It’s an endgame.

(Video 7 of 22 2:35)

Question: So you bet against the jockey, not against the horse necessarily?

Charlie: Well, no…McKinsey.  Skilling came out of McKinsey.  There are a lot of manipulative types that (inaudible) McKinsey.

Question: So is it simply an observation of the people more so than the quantitative factors?  You don’t need to look at the balance sheet when you’re looking at the person.

Charlie: Well I can see the chain-letter aspects of the game.  And the huge leverage and the huge…he was just sort of building a chain-letter.  It’s intrinsically sort of a dishonorable thing to do.  Because the nature of the thing you’re…doing something that you can’t continue on its own motion.  You know, making it look like oil.  So it’s intrinsically sort of dishonorable.  So I don’t like chain-letter operators and I don’t like drunks.  I don’t like people who puff and lie and I don’t like people who raise prices on drugs that people have to have by 500% overnight just because it would work.  There’s a lot of flags we’re flying.

Question: Charlie, we’ve seen a lot of folks boycotting retailers because they sell Trump brand merchandise and vice-versa because…

Charlie: I don’t like all that.  Basically, I’m not in favor of young people agitating them and  trying to change the whole world because they think they know so much.  I think young people should learn more and shout less.  So I’m not sympathetic to anybody…young people are out in the streets agitating and I say, ‘to hell with them’.  That’s not my system.  I think if you got Hitler or something you can go out and agitate, but short of that, I think the young people ought to learn more and shout less.  They ought to act more like Chinese.

Question: Did you personally know Richard Feynman and what do you think of him?

Charlie: Yes.  I knew him slightly.  Very slightly.  Well he was a genius.  On the other hand he was a screwball.  He absolutely was nuts about screwing around with a lot of different woman, and going after the wives of his own graduate students (I think).  That’s disgusting.  So he had this blind-spot.  Now in physics, in teaching, he was one of the nobelist people we ever had.  But in his personal life he was a little nuts.

(Video 8 of 22 2:22)

Question: Charlie, I have a question about real estate.  When I look at real estate and stocks, real estate is just easier to evaluate.  You know, comps, cash flow, and replacement cost.  It just seems like an easier game than the equities market.

Charlie: The trouble with real estate is that everybody else understands it.  And the people who you are dealing with and competing with, they’ve specialized in a little twelve blocks or a little industry.  They know more about the industry than you do.  So you’ve got a lot of bull-shitters and liars and brokers.  So it’s not a bit easy.  It’s not a bit easy.  The trouble with it is, if it’s easy…all these people…a whole bunch of ethnics that love real estate…you know Asians, Hasidic Jews, Indians from India, they all love real estate.  They’re smart people.  And they know everybody and they know the tricks.  You don’t even see the good offerings in real estate.  It’s not an easy game to play from a beginner’s point of view.  Real estate.  Whereas with stocks, you’re equal with everybody.  If you’re smart.  In real estate, you don’t even see the opportunities when you’re a young person starting out.  They go to others.  The stock market’s always open.  It’s (like) venture capital.  Sequoia sees the good stuff.  You can open an office, “Joe Schmoe Venture Capitalists: Start-ups come to me!”  You’d starve to death.  You got to figure out what your competitive position is in what you’re choosing.  Real estate has a lot of difficulties.

Those Patels from India that buy all those motels?  They know more about motels than you do.  They live in the g.d. motel.  They pay no income taxes, they don’t pay much in worker’s compensation, and every dime they get, they fix up the thing and buy another motel.  You want to compete with the Patels?  Not I….Not I.

(Video 9 of 22 1:44)

Question: You and Warren throughout your business history were incredible at judging people.  Whether it’s Mrs. B. (Charlie interjects: We were pretty good, yes.)  What was it that you and he looked for.  And what were mistakes that you made that you learned from along the way in judging who would be good business partners to work with.

Charlie: Well, first there’s some very good people in Warren’s family.  One of them I worked under was Fred Buffett.  So we had people we knew well that were really noble people.  So we had basis to compare people against.  And we had basis to compare people in terms of capacity and talent and so forth.  So we had a lot of data in our heads that helped us.  And I think we had some genetic advantages.  Not IQ points, just absolute quirks of nature that made us better.

Question: Like Harry Bottle?  Tell me about Harry Bottle and what you saw in him.

Charlie: Well I worked with him in an electronics business that got into terrible difficulties and he’d help us work out of that business trouble by downsizing.  He knew how to do it.  And Warren had a business that needed downsizing and Warren did not know how to do it.  So I put those two together and of course it worked well. (link)

Question: Charlie, could you talk about the episode at Solomon Brothers and what you really learned about people…

(Video 10 of 22 8:14)

Charlie: What I learned is that all that easy money and easy leverage and so forth in investment banking creates a culture that’s full of envy, jealousy, craziness, over-reaching, over-leveraging.  It’s a very hard business to manage…investment banking.   It was out of control.  The envy was…these people went berserk.  If one jerk got $4 million some year, the other guy was furious that he only got $3 million.  And they just seethed and caused trouble.  It was a very difficult business to manage.  I think a lot of easy money that comes into finance just ruins practically everybody.

Question: Charlie, anything thoughts on Apple Corporation?

End of Sample Transcript

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Wall Street Journal Recap: March 13-19, 2017

My full notes and analysis on the Wall Street Journal from the past week: March 13-19, 2017 (Week 11).  Please Enjoy.

The New Obsession: Corporate Cost Cutting

Wall Street has become obsessed with cost cutting.  And when Wall Street becomes obsessed with a metric of success you can bet that they’ll take it too far.

It seems pretty clear that today’s CEOs are being measured more and more on their ability to cut costs.  Articles about corporate cost cutting appear to dominate the WSJ these days.  Given the focus on cost cutting, it’s not a coincidence that profit margins have soared since the financial crisis.

(Chart Via Goldman Sachs link)

While cost cutting can lead to more efficient operations, excessive emphasis on cost cutting will almost certainly lead to problems.  CEOs will attempt to game the system, and cost cutting is highly gameable.

It’s easy to boost short-term profit margins and cash flow by cutting costs which are necessary, but whose harmful side-effects will not be noticed for years.  For example, a CEO may;

  • Neglect proper maintenance of assets.
  • Reduce R&D and marketing expenses.
  • Cut staff to the point that your service suffers.
  • Acquire assets which you formerly leased and then depreciate them at an exceptionally slow rate.
  • Become excessively short-term oriented and forego long-term investments.

Adding to an unsustainable profit margin trend, a tight labor market likely means that, as the workers gain negotiating power,  current profit margins will decline.

Between unsustainable cost cutting endeavors, and a tightening labor market, corporate profits are likely to decline in the coming years.  This means that the market is actually more expensive than it currently appears.  The S&P 500 is trading at a trailing P/E of 24.52, and an estimated forward P/E of 18.27, while the DJIA trades at 21.01 and 17.72 respectively. (link)  But after factoring in negative headwinds on profit margins, the market is likely trading at a forward “Price/Sustainable Earnings” in excess of 20x.

Here are some of the article which mentioned cost cutting:

  • U.S. Army: Quote on the U.S. army’s decision to cut Burger King abroad: “We went a little too far on some of the luxuries,” (link)
  • Valeant: Ackman then bought a stake in Valeant itself in early 2015, a bet on Mr. Pearson’s ability to buy up companies and squeeze profit out of them. The stock kept rising, boosting his portfolio broadly. (link)
  • Fiat: “Mr. Marchionne has advocated for mergers in the car industry as a way for companies to share their fixed costs. In 2015 he began openly courting General Motors Co., which rebuffed him multiple times.”
  • Hudson’s Bay Co.: “Hudson’s Bay Co., which owns Saks along with Lord & Taylor, has been looking to take over another U.S. rival to gain scale and cut costs.”
  • CSX & Hunter Harrison: ” An executive familiar with his methods calls him a “savant” when it comes to spotting inefficiency.”

Standard Causes of Human Misjudgment: Examples

Charlie Munger likes to say he’s a collector of “inanities” (i.e. Stupidities”).  Here’s a collection of inanities reported by the WSJ.

Consistency and Commitment Bias:

“Mr. Ackman once predicted Valeant would be the next Berkshire Hathaway Inc., saying its shares could hit $330.  The stock closed Monday at $12.11.”

Charlie Munger on this kind of approach:

“When you pound out an idea as a good idea, you’re pounding it in!  So by asking people for their best ideas, they were getting the stuff that people had most pounded in so they’d believe.  So of course it didn’t work.” – Charlie Munger

Pavlovian Association:

Boston & Citco

The people of Boston identify so strongly with a corporate advertisement billboard that they want to preserve it as an official landmark.  Deep down at the heart of it, it’s really crazy.

“For Boston sports fans, the luminescent Citgo sign visible above Fenway Park’s left-field wall is already a hallowed icon.  They are pushing the city to add protection for the 60-foot-by-60-foot sign by making it an official landmark, saying it is an internationally recognized symbol, a target for Red Sox sluggers and an inspiring unofficial milepost for runners chugging to the Boston Marathon finsih line.”

“Boston, the Red Sox, Fenway, the Boston Marathon,” said Nicholas MacDonald, a 34-year-old Massachusetts native and concierge at a local hotel, describing what the sign means to him.

“…the Citgo name- has been dominating the neighborhood’s skyline for more than 50 years.”

“Citgo tried to remove the sign in the early 1980s but changed course amid an outcry from Bostonians.  There was also a failed attempt at the time to turn it into a city landmark.”

Liking Tendency and Shared Identify:

1) Liking Tendency

“Mr. Duarte…was an admirer of the late Spanish dictator Francisco Franco, both for Mr. Franco’s ‘strength and energy’ and because, like himself, Mr. Franco had a high-pitched voice.” (link)

2) Shared Identify

Former L.A. County Sheriff was “found guilty Wednesday of obstructing a federal investigation into violent abuses by his jail guards.”…”The probe uncovered various crimes related to the local jail system including beating inmates.” (link)

General Limitations of the Mind:

When a risk is hard to understand, it will seem less likely to occur.  This is true in investing as it is in medical disclosures.

Stem-Cell Clinic’s Treatments Left Three Patients Blind, Doctors Say: “The patients involved did not understand the risk they were taking by going to this clinic,” (link)

“Many experiments have shown that the harder a risk is to understand, the less it will seem likely to occur.”  (link)

Fast Solutions to Big Problems = Big Money

We pay a big premium for fast solutions to big problems.  This is true for corporations, governments, and consumers.  Here are two examples from this past week:

1) Warren Buffett & AIG

Warren Buffett met with the CEO of AIG earlier this year, and ultimately agreed to a $10 billion insurance contract with AIG.  This insurance deal was largely based on the need for a fast solution to a big problem (i.e. Activist Investors)

“The AIG directors feared disruption if they didn’t quickly address concerns from Mr. Icahn and some directors about the CEO’s ability to complete the turnaround, people familiar with the matter said.”

2) Tesla’s battery solution for Australian government

“Very impressed. Govt is clearly committed to a smart, quick solution,”  – Elon Musk (link)

3) Intel & Qualcomm acquisitions

“Intel Corp. agreed to buy Israeli car-camera pioneer Mobileye NV for $15.3 billion, one of the chip maker’s biggest acquisitions ever and the latest bet on Silicon Valley’s vision of cars as turbocharged computers on wheels.” (link):

” Intel is joining a race to create autonomous vehicles that has accelerated recently as unconventional auto companies have jumped in, sparking bidding wars for companies that specialize in self-driving gear or software.”

“Qualcomm Inc. bought automotive chip supplier NXP Semiconductors NV for $39 billion.”

Investment Lessons: The need for fast solutions to big problems creates fantastic profit opportunities.

1) Look for companies which may help companies, governments, or consumers, address the “big problem + fast solution” market.

2) Be patient and capitalize on forced selling.

Budget Doctors. Just as good as High Spending Doctors? (link)

Fascinating article detailing how doctors who spend less on their clients have the same results as high spending doctors.  Major implication: “The results suggest high-spending doctors could do less without harming patients, the researchers wrote.”

“U.S. Medicare patients whose doctors spent more on tests, scans and consultations were as likely to die within a month of leaving the hospital as patients with more parsimonious physicians, new research shows.”

“Patients of high-spending doctors were also as likely to return to the hospital within a month, according to the results, published by JAMA Internal Medicine.”

Buyout Firm Acquires Own Assets

Private equity firm Novel who is raising funds to buy $800 million of its own assets.  Novel wants to extend its holding period of its assets beyond its lock-up period.  This behavior is a dangerous trend.  Here’s what’s happening:

1) Heeding to Competitive Pressure: “Investindustrial, founded by Italian deal maker Andrea Bonomi, has decided on this course of action as it responds to greater competition for assets from institutions such as sovereign-wealth funds, which don’t have restrictions on how long they can own companies. The competition is pressuring buyout firms to devise new ways to own companies.” (link)

2) Subjecting Themselves to Naive Extrapolation: “Investindustrial’s move to hold on to PortAventura park for longer comes as fierce competition is pushing up prices for companies, meaning it increasingly makes more sense to hold on to assets than to sell.”

I’ve often thought that the historical success of private equity owes much of its success to the use of lock-up periods, and to eliminate them is very dangerous.  That’s because the lock-up periods help prevent two psychological biases which generally destroy investment returns.

First, it prevents buy high and sell low behavior.  Being in a lock-up period, clients must ride the ups and downs with forced equanimity.

Second, lock-up periods prevent ‘naive extrapolation’.  Naive extrapolation happens when investors unrealistically assume that favorable investment results will continue indefinitely.  Lock-up periods help PE firms avoid this problem because they must exit their investment before a certain date.  As a result, private equity groups look forward to favorable market conditions as opportunities to sell, and not as justifications to hold their position even longer.  (i.e. They’re forced to sell their position when it becomes over-priced.  A feat which is easier said than done.)

By eliminating lock-up period as Novel is doing, they are no longer are exploiting naive extrapolation, but instead have become the victims!

Poor Temperament + ‘Risky Assets’ = Trouble

Low interest rate policies by global central banks have pushed many individuals into stocks and other risky assets.  This may prove ruinous for many investors who don’t have the psychological temperament to handle the wide swings in asset prices that occur during a bear market.

Here’s one such example: (link)

“His five children, including current White House counselor and chief strategist Steve Bannon, had often joked growing up that their devout father, a product of the Great Depression, would sooner leave the Catholic Church than sell those shares. The stock symbolized his deep trust in the company and had doubled as life insurance for his children.

“As he toggled between TV stations, financial analysts warned of economic collapse and politicians in Washington seemed to mirror his own confusion. So he did the unthinkable. He sold.”

Marty Bannon, now 95 years old, still regrets the decision and seethes over Washington’s response to the economic crisis”


  • “However, retail sales clocked the slowest increase in 11 years, with a 9.5% rise in the two-month period,”
  • “Car sales surged 10.1% in 2016, as tax cuts for car buyers aimed at stimulating the economy encouraged consumers to move forward their purchases, economists said. The tax cuts have since been partially rolled back: auto sales fell 1% year over year in the first two months of 2017, data showed.  “They’ve overdrawn part of consumers’ purchasing power,”

Market Developments

  • “Investors pulled a net $342.4 billion from U.S.-backed actively managed funds last year, while pouring a record $505.6 billion into U.S. passively managed funds,”
  • “Addiction to painkillers and other opioids such as heroin has caused U.S. overdose deaths to reach all-time highs.”