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. It was transcribed from this fantastic 1 hour and 48 minute recording of the talk.  Below is the transcript in its entirety.

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, any thoughts on App

Question: Charlie, any thoughts on Apple Corporation?

Charlie: Well it’s a very odd thing for us to do.  Obviously we’ve got no special insights as to how sticky Apple’s business is.  Apple’s whole supply chain is like one man with two million employees.  That’s very peculiar.  And the man is not perfect.  On the other hand, Apple has a very sticky bunch of customers.  Will they be able to keep that going?  And if so, how long?  I don’t know but I think the chances are pretty good that it’s going to be quite sticky.  And that’s why we bought it.  But as I said, we have a slight edge in our favor there.  But it’s not a big edge.  We’re doing that because we don’t find the stuff we use to find where we knew we couldn’t lose.  Apple we’ve got what we think is a little edge.  We don’t have a big insight into “can’t fail”.  But if you can’t find…if you’ve got the money and you have to put it somewhere and you can’t find what you use to like, you have to put it with what’s best available.  It’s a nice problem to have, to have so much money.  We shouldn’t really be complaining about that it got harder.  The reason it got harder was we have so much money.  When we bought that Coca-Cola, it was a million shares.  It took us 8 months to buy a million shares of Coke.  We were buying like half of all trading every day.  It’s hard to get in and out of these big blocks.

Question: Are you good friends with John Bogle?  (link)

Charlie: No, I just…maybe I met him once or something.  I mean…basically I think he’s right about his basic approach.  That other people are not going to match the averages and he is.  And his idea has succeeded, and he’s succeeded, and he was right.  On the other hand, he’s kind of a one trick pony.  I don’t think he has another…he had one good idea in his lifetime and he rode it very hard.  That’s all you need.  He’s an interesting example.  He had one good idea, he pushed it hard, and it worked.  You don’t need a lot of good ideas, but you do need one.

Question: Can you talk a bit about BYD?

Charlie: That again is something that we would have never done in the early days.  When I got into that Li Lu.  BYD had been pounded down so hard, it was a Graham type stock.  It wasn’t a start-up, but a small-type company.  

Question: Would you see BYD doing infrastructure here in the U.S.?

Charlie: No.  BYD’S now going into monorails.  They’ll do monorails in China.

Question: They wouldn’t do that here in the U.S. though?

Charlie: Oh they would, but it would be pretty dumb.  Monorails in the U.S. have been a peanut business forever.  In China they can get permits.  China…they just go do it.  

Question: How about energy storage?  Do you see that happening here in the U.S.?

Charlie: Of course.  Everybody’s going to do energy storage.  You’ve got to time-shift the power if it comes from either the sun or the wind.  Of course there’s going to be a lot of storage.

Question: This might sound like Max Plank chauffeur kind of knowledge (link), but when it comes to find the sell-out price, the intrinsic value of the company when you want to compare that to the market cap (Charlie interjects: “of what?), just BYD let’s say.

Charlie: Oh that’s hard.  And again we’ve learned things there.  When we bought in, we could see that a venture capitalist would have paid three times as much for that kind of a deal.  So it was cheap as a venture capital…and we could see it was a good venture capital thing because the guy had worked minor miracles already.  So that was a cheap stock, but it was one that took some special insight.  And I wouldn’t have had it without Li Lu who found that.  And once we were in it, I got to know Wang Chuanfu even though he can’t speak a word of English.  And Wang Chuanfu’s a genius. (link)  And he’s shrewd.  And he’s honest and he’s fanatic and he loves his company and so on and so on and so on.  And what he can do is just incredible.  He learns whole new technologies.

Question: So it’s mostly qualitative?

Charlie: It’s partly what they have, and partly I’m betting on the horseman there.  And he’s got a bunch of Chinese.  Young Chinese.  You can’t believe what those employees do.  He’s got 230,000 Chinese working for him.  Berkshire only has 460,000 employees.  That’s a lot of employees.  And they can do things you can’t believe.

Question: Would you buy the whole company if they’d allow that?

Charlie: I don’t think so because one of the reasons that he succeeds is that the Chinese are proud of an 8th son of a peasant that creates a little company all by himself and is doing so far.  And a lot of the other stuff they’re doing, joint ventures in automobiles, they’re joint ventures with the west whose already ahead, so in a sense they love and are proud of their own man the son of a peasant that did it all himself and it’s still Chinese.  So I wouldn’t want to destroy that Chinese image by buying BYD.  It works better the way it’s going.  But you’re right, I’m betting to some extent on the person.  I was in their battery separator plant.  There are about five companies on earth that know how to make battery separators.  That goo comes by and hangs together laterally through its own chemical something, cohesion…it’s the most complicated damn process that you ever saw.  It’s very hard to do.  If you don’t do it exactly right, the battery fails.  He just learned that, boom, what he needs to know he just figures out…there aren’t many people who can do that.

Note: Buffett said, “BYD was Charlie’s idea,…When he encounters genius and sees it operating in a practical way, he gets blown away.”  Berkshire bought a 10% stake for $232 million in 2008. (link) As of April 2017,  that stake is worth $1.84 billion. (link)

 

Question: Do you see similar qualities in Elon Musk or somebody of that sort?

Charlie: No I think that Wang Chuanfu knows what he can do and what would be really difficult. Elon Musk thinks he can do anything.  I’d rather bet on the man who has some limit to his self-appraisal.  

Question: Do you think Mr. Bezos knows the limits of his skills?

Charlie: Way better than you think.  Bezos is utterly brilliant and utterly remorselessly ambitious.  I would never bet against Jeff Bezos.

(Video 11 of 22 7:31)

Question: You mentioned earlier about Coca-Cola becoming a little bit less efficient than it used to be?

Charlie: No.  For the first hundred years, all that caffeinated carbonated sugar water with the same flavor, just swept the earth.  And every year more money came in.  They were drowning in money.  For the better part of a hundred years.  Of course it was interesting.  But of course that kind of spoils you.  Now the basic stuff is going the other way.

Question: Do you think Coca-Cola and Pepsi still win the sparkling water battle?

Charlie: I don’t know.  I think they’re both very strong companies.  And I think they both have a lot of momentum in place.  

Question: Do you think if they were run by 3G they would do better or worse?

Charlie: Well I guarantee they’d do a lot better the second year. (laughter)

Question: If Glotz came to you and asked you to make a new company today, (Charlie: Who?) Glotz.  There’s an article, “Turning two million into two Trillion.”, it’s about creating a company that would be worth two trillion…(Charlie: Yeah, I know.  I gave the talk. (Big Laughter))  If he came to you today and wanted to do another company, what would you tell him? (link)

Charlie: Well I wouldn’t do that because I did that only retrospectively.  In other words, I knew the outcome when I created the story.  Of course that’s a lot easier than starting now and projecting the future.  So I can explain the past a lot better than I can predict the future.  Surprise, surprise.

And by the way, that talk, it was a total failure when I gave it.  It’s been a total failure ever since. Now I think it’s absolute right in that there’s a lot that can be learned in it.  And a few nuts like you make get something out of it.  But in terms of the greater world, I bored the people.  Some of them fell asleep.  It was the most failed talk I ever gave.  And so I published it when they did Poor Charlie’s Almanac because I still think the basic lessons are right.  It’s just it’s hard to understand.  Most people don’t understand basic psychology very well. (link)

Question: Charlie, it looks like you hit a homerun with the physics institute in Santa Barbara. (Charlie: Well all I did is create a building, they already had the institute.)  But it looks fantastic, the whole idea and everything.

Charlie: It’s wonderful.  It’s amazing what you can do if you have a lot of intelligent and unlimited money. (laughter)

Question: How about a Munger Library somewhere?

Charlie: No, I’m working on another student building in UCSB.

Question: Hey Charlie, what scientific innovation is going on right now that you’re really excited about?  And what’s one thing that you’re really scared about?

Charlie: I really am deeply aware of this agricultural revolution.  And everyone just takes it for granted.  It wasn’t…you know, it isn’t like agriculture had productivity had ever increased by 300% in a few decades.  I mean it was just amazing what happened.  And of course the world needed it terribly.  And so I’m quite impressed.  And more of that’s coming.  So all this stuff about gene splicing to make plants grow better and gene splicing to make domestic animals produce better. All that’s coming, some’s starting to work already.   And they’ll push this cross-breeding of seeds…it’s a hugely important thing that’s happening.   And the world needs it terribly.  And it changed the whole world for everybody.  We couldn’t have this civilization without the food.  And there isn’t that much arable land.  We have to get more product out of our existing land.  And our existing land, the way were farming it intensively, is degrading.  And the reason we produce all this stuff is that we pour chemicals and so forth into the land.  Fungicides, herbicides…insecticides too.  But it’s just amazing what’s happened.  We’ve created the miracle of rice, the miracle of grain.  So I’m quite impressed by the fact that they keep doing that stuff.  And to have one percent of the people produce all the food for America on their farms?  When we use to have 80% of the people.  It’s just a huge, huge change in the human condition.  And we’d all be doing stoop labor instead of running around in airplanes to hear people talk.  If it weren’t for all these revolutions that our predecessors created for us.  So I just find that quite interesting.  And we need it.  Costco buys a lot of produce now from vegetables grown in hot-houses.  And by in large those are Chinese.  In a six-acre hot house, they really know where every damn blade is growing.  It’s not that different from rice growing, they’re just very good at it.  That has a lot of potential that is coming.  So I like the agricultural stuff.  Most people just ignore it.  We take it for granted.  But I’m quite impressed by it.  

Question: Is America proving to be a ham-sandwich enterprise in the last few months?

Charlie: Well I think there’s a lot of good left in the American economy and the American people.  Partly because we’re taking in so many talented people from these other nations.  Think what we’ve taken in from China, India, even Japan.  It’s a lot of human talent.  And in the old days we got the poor people.  And you know that was harder because…and now the Chinese that come here, they’re not the poor Chinese. They’re the well-to-do Chinese.  And the children of successful Chinese families that get high grades and so forth.  And the same from India.  Every once in awhile I meet an untouchable who’s just gone up through the main technical institute of India and succeeded.  But most of the Indians I meet are all from the upper-castes of India.  We’re sucking the brains out of India.  And of course that’s good for us.  Same with China.  

Question: Is that a tragedy for China and India though?

Charlie: Well they’ve got a lot of people. (big laughter) They’ve got a lot of brains left. People shortage is not…When you can sift a population that big, you’ll get some smart people.  

(Video 12 of 22 6:56)

Question: You talk about committing when your opportunities come up.  Do you have any mental checklists that help you stick with that or help you prepare before you get to your opportunity?

Charlie: Well if you haven’t prepared, you won’t have the courage to seize it.  When I bought all that stock that the Daily Journal has in like one day, you know I knew something about the Bank of America.  I’ve lived in the culture.  I’ve known the Bank of America bankers.  I know a lot about what’s right with it and what’s wrong with it.  So I knew a lot.  I knew a lot about Wells Fargo.  I knew a lot about U.S. Bank.

Question: Did you pay cash or did you have to leverage up that day?

Charlie: No, I had cash.

Question: Do you have any thoughts on Chipotle and the food safety issues there?

Charlie: Well I do know this.  If you run a business where people have to trust your food, you just can’t afford to have a scandal in the food quality.  Costco just sweats blood to avoid.  Now every once in awhile we get a few cases of some fairly minor thing.  You know some fairly minor thing.  Nobody gets away from it.  Be we are just fanatic about preventing it and stepping on it hard when it happens and so forth.  And they got careless at that and, you know the Fried Chicken company in China, Yum Brand.  And of course it hurt them terribly.  You can’t afford to have a scandal if you’re selling food.  And when people adulterated the baby formula in China.  China killed the people that did that.  They’re dead.  And they didn’t take a long time doing it.  No…a lot of appeals or anything.  Kill our babies to make a little more money?  You never will be missed.  I have a little list.  Off they went to the great beyond.  

Question: Charlie, what about TransDyne?

Charlie: I don’t know TransDyne.  What is TransDyne?

Question: They’re a supplier of aircraft parts to Boeing and to Airbus and to aerospace and defense companies.  And there have been comparisons recently to TransDyne and Valiant.  And was curious if you have any thoughts on the comparisons.

Charlie: Well I don’t know anything about TransDyne.  But of course it’s generally a little easier to cheat the government than to cheat anybody else.  And so a lot of people try and cheat the government defense contracts.  And of course their suppliers, also of the…whole culture has some cheating.  And so I regard it as a little bit dangerous territory.  But I know nothing about TransDyne.

Question: Did Valiant clean itself out?  Or is it still a sewer.

Charlie: Well I’m sure it’s way better.  You’d stop stealing if they already cut off your left hand.  You wouldn’t want to lose the other.

Question: Charlie, did you know Sumner Redstone in law school, and how do you think he could have handled his succession plans different for his businesses.

Charlie: Well, I never knew Sumner Redstone but I followed him because he was a little ahead of me in Law School.  But Sumner Redstone was a very peculiar man.  Almost nobody has ever liked him.  He’s a very hard driven tough tomato.  And basically almost nobody’s ever liked him including his wives and his children.  And he’s just gone through life…there’s an old saying, screw them all except six and save those all for pallbearers.  That is the way Sumner Redstone went through life.  And I think he was into the pallbearers because he lived so long, so…One thing I’ve used Sumner Redstone for all my life is an example of what not to do.  He started with some money and he was very shrewd and hard-driven.  You know he saved his life by hanging while fire was on his hands.  He’s a very determined, high-IQ maniac.  But nobody likes him, and nobody ever did.  And the woman he paid for sex in his old age cheated him.  You know he’s had one disappointment after another.  It’s not a life you want to admire.  I’ve used Sumner Redstone all my life as an example of what I don’t want to be.  But for sure talent drive and shrewdness, you would hardly find anybody stronger than Sumner.  And he didn’t care if people liked him.  I don’t care if 95% of the people don’t like me, but I really need the other 5. (laughter)

Question: Any thoughts on the smaller networks with quality content like Viacom for example, with strong brands.  Any thoughts on their future?

Charlie: I have the general impression based on 60 years of experience in the neighborhood.  That the movie business is a tough business. Not a lot of people have done well at it.  But I don’t know how to create a Star Wars.  I don’t know how to sell it for a price like that.  I’m going to let somebody else make money in those difficult ways.  I regard the movie business as a tough business.  Now if it’s your only way up and you’re good at it, why of course you have to do it.  But I don’t even think about those things I’m not good at.  Take Netflix.  Who did House of Cards?  The guy who gave them the money?  Reed Hastings.  Netflix did it, but HBO turned them down.  That was really stupid.  It had worked in England, it couldn’t fail.  But I am just not attracted.  I don’t want to try and be Reed Hastings.

Question: Charlie do you know Sol Price, the founder of Price Club?  (Charlie: Very well.)  Is he a good guy?

Charlie: Very good guy.  Cranky, but a very very good human being.  Honorable.  Very Honorable.  What he liked about Costco…he thought it was such an honorable way to make money.  Try and make the stuff you’re selling very good and very cheap for the people that bought it.  And he’s right, it was honorable, and he did it very well.  So I liked Sol Price a lot.

(Video 13 of 22 6:45)

Question: Do you think Wal-Mart could turn into Sears?

Charlie: Well not for a long time.  

Question: Charlie, do you think business moats are becoming more fragile with technology and transparency?

Charlie: Well our ancestors were pretty good at creating fragile moats too.  I think it’s natural (with what’s up in one era).  Think of what I’ve lived through in terms of people…DuPont looked impregnable.  General Motors was the strongest corporation in the world.  Kodak was one of the…boom, boom, boom, they’re gone.  Xerox.  I mean, it is hard to keep winning.  And the world keeps changing. (link)  Look, the Daily Journal is hard.  Imagine going into computer programming and dealing with a lot of agencies all over the world including South Australia.  A little company like this.  It’s not a bit easy.  And if we hadn’t done it, we’d just be one more dying newspaper.  

Question: Could you talk more about the airlines and what’s changed from a couple of decades ago til’ now?

Charlie: Well I don’t know that much about it, but I do know that it’s more concentrated now and there’s no real substitute for it.  It isn’t like we have a substitute for air travel.  And it’s down to a relatively few players.  In the old days they could always start a new airline.  They had nothing but young people, they pay the pilots less, they don’t have a union.  They could just start hitting the prices.  They just kept ruining the business over and over again.  And even now South West is just starting to go to Hawaii.  So the vicious competition is continuing including people for doing it…governments own these airlines and do it to show off how strong they are.  So I don’t regard it as a perfect model and I don’t think it’s the greatest idea we’ve ever had.  It’s just something, considering how pounded they were and how the world has changed a little, we thought…as I say, we have a little advantage by that particular gamble.  But it is not that we…it is not a synch.

Question: Is there an outlook on oil prices? (as it pertains to the airlines)

Charlie: I don’t think oil prices will make that much difference over the long-term to the airlines.  It’s not that…if the kerosene (link) doubles in price I don’t think, over time, I don’t think it matters that much to the airlines.  It’s still…you put a hundred people in an airliner and fly somewhere, it’s pretty efficient.  And you can do a lot of flights per day.  It’s worth a lot of money to people who take the trip.  And, there’s not going to be a new airport in Shanghai you know.  A lot of the airports are fixed.  And a lot of them are out of capacity.  It is obviously better than it was in the past.  Whether it’s good enough so that it will do well I don’t know.  Also, if it starts working, you get paid in advance for the tickets.  So there’s no credit.  A lot of people lease the airliners.  So if you make money, you can pile up pretty rapidly in cash.

Question: Is there a reason JetBlue wasn’t in there?

Charlie: I don’t know anything about individual airlines.  Neither does Warren.  We bought a bunch.  It was a sector bet, it was not a bet on individual airlines.  

Question: When industries like airlines and railroads rationalize and turnaround, how do you and Warren know?  

Charlie: We don’t know.  It was easy…in the railroads, we waited until it was all over when we went in.  In the airlines it’s not over.  But it’s a little bit the same story.  Years of consolidation and bankruptcies.  Three, Four, Five, Six big bankruptcies already in the airlines.  

Question: So for 50 years you continually read about these industries even though you have disdain for them?

Charlie: Yes, I talked about patience.  I read Barron’s for 50 years.  In 50 years I found one investment opportunity in Barron’s.  Out of which I made about $80 million dollars with almost no risk.  I took the $80 million and gave it to Li Lu who turned it into 4 or 5 hundred million dollars.  So I have made 4 or 5 hundred million dollars out of reading Barron’s for 50 years and following one idea.  Now that doesn’t help you very much does it?  I’m sorry but that’s the way it really happened.  If you can’t do it, I didn’t have a lot of ideas.  I didn’t find them that easily, but I didn’t pounce on one.

Question: Which idea was that?

Charlie: It was a little automotive supply company.  It was a cigar butt.

Question: Was that K&W?

Charlie: No.  No, no.  This was…I’ve forgotten the name of it.  But it was a little.  It was a little…it was the Monroe shock absorber and all that stuff.  The stock was a dollar and the junk bonds which paid 11 3/8 percent were 35.  You know, when I bought the junk bonds, they paid me the 35% and the went right to 107 and then they called.  You know, it was…and then the stock went from $1 to $40, but of course I sold my stock at $15.  But…

Question: What did the article in Barron’s say?

Charlie: It said it was a cheap stock. (laughter)  But that’s a very funny way to be, to watch for 50 years and act once.

Question: How long did it take to make that 15 bagger on that stock?

Charlie: Maybe a couple of years.

Question: How long did it take you to make the decision to buy it?

Charlie: Oh, about an hour and a half.  

Question: What was it about that company, an auto-supply company?

Charlie: Well, I kind of knew from experience how sticky that auto secondary market was and how old cars needed Monroe shock absorbers and I just knew it was too cheap.  I didn’t know it would work for sure, but knew that…As I say…people were afraid it was going to go broke obviously if their bonds were selling at 35.

Question: Charlie, how do you define your edge of circle of competency?

(Video 14 of 22 9:21)

Charlie: Well each person’s is his own.  But it really helps to know what you can do and what you can’t.  I don’t like to gamble against odds.  I have not lost a thousand dollars in my life betting against race tracks, casinos.  The odds are against me, I just don’t play. (link)  I don’t even want to amuse myself playing against the odds.  Now I have occasionally played bridge against better players where I’m really playing for the instruction which I can afford.  But that’s because I like the learning.  But I won’t even do very much even of that.  I do not like playing against the odds.

Question: Can you maybe say one name that you invested in when you ran your investment partnership that performed beautifully for you and explain, as a case study, what it was about that company that attracted you?  Because there’s not much about the Munger limited partnership.

Charlie: Well I did all kinds of things in those days.  In the first place, in those days, we had what were called “Jewish Treasury Bills”. (link) And that was event arbitrage.  If a company sells out $100 per share, and the stock’s selling at $95.  For 60 years, people who just went in and bought the stock at $95 and made the 20% per annum with a little leverage…for 60 years, Graham, Newman, Warren, I, and Goldman Sachs made 20% per year on anything we did in event arbitrage.  What happened was, when the stock brokers were all on commission, the deal’s announced, every stock broker would call his client and say, “Oh your stock is way up, maybe you should sell that.”  You know, they’re getting commission. So you had dumb selling.  And so of course we did well.   Nowadays people do not do all that well with event arbitrage.  It’s too tough, the deals are…it’s just too crowded. (link) But it just worked fine for all those years.  We had all kinds of things in those days that we can’t do anymore.

Question: I was speaking with Rick Geuren and he was saying that if he was to start a fund today, he wouldn’t do it.  And he says he doesn’t think it’s hard because the size of a fund like Berkshire limits you to large companies.  He just doesn’t think that there’s the same opportunities anywhere.

Charlie: There aren’t.  That’s why people come to this meeting.

Question: Speaking of opportunities Charlie, could you talk a little bit about  your thoughts on John Malone as an operator and what you think about the cable industry’s moat going forward.

Charlie: I do not…I’ve always been troubled by the cable industry.  For one thing it was thinly disguised bribery when they got the franchises.  And I don’t like to even think about all the scummy places that are getting their franchises by bribery.  So I just sort of ignored it.  I didn’t want to think about it.

Malone is obviously something of a genius and he’s a fanatic and doesn’t like to pay taxes and he’s been very successful.  And I’ve just ignored it.  I just don’t want to think about it, so I haven’t.  I can afford the luxury, and I don’t have to think about everything.  But the starting bribery that got the franchises…I just didn’t like it.  And so I just haven’t thought about it and I’m still not thinking about it.  And the movie business I don’t like either because it’s been a bad business.  Crooked labor unions, crazy agents, crazy screaming lawyers, idiosyncratic stars taking cocaine.  It’s just not my field.  And I just don’t want to be in it.  And these other stuff, I find enough of the other stuff that I like.  

We’ve got so many so many places in Berkshire that just do their work pretty well.  I like that.  You’d be amazed.  The See’s Candy, they make the good candy, they work on it.  We’ve got lots of places like that.  Our utility business.  We probably have the best run utilities in the United States.  We care more about satisfying the regulators, we care more about safety records, we care more about everything we should care about.  When we bought Northern Natural Gas which Enron owned.  Of course to show more earnings and more cash they just had done no maintenance.  The g.d. pipeline can blow up and kill people!  The minute the ink dried on that, everybody took six months off and we sent all these pigs through the…pig is a special name for…we went through the pipelines…we just  caught up on all the deferred maintenance.  We were not interested in killing people.  That’s the right way to behave.  Enron is the wrong way to behave.  Imagine deferring maintenance on a pipeline so you can show more cash.  It’s disgusting.  It’s like killing people on purpose so that you can make more money.  It’s deeply immoral.  But they fix it fast.  Of course I’m glad to be associated with the people who behave like that.  Greg Abel is a terrific operator and a terrific guy. (link) Iowa and Nebraska are side-by-side…now Nebraska has public power.  So they borrow tax exempt, build a new plants with General Electric, they’re paying 3% on the debt or something.  And an idiot could run a big public power agency.  Our Iowa utility that Greg Abel runs right across the river, his rates are miles below Nebraska Public Power, entirely financed with…you know.  And the other utility in Iowa, our rates are half theirs. Well of course I like being associated with a company that can the deliver the power (quite reliably).  And more than 50% of all the power in Iowa comes from the wind.  And the farmers are glad to have a few wind machines out among the corn.  So we’ve just quietly created a revolution there.  The regulators, the customers, everybody likes us.  Of course I like people who do that and Berkshire’s full of that stuff.

Question: Do you think that cheaper solar over time as it continues to get cheaper and cheaper, does that pose any potential threat to the utility business as people kind of take (a hold) of their own generation?  Is there a potential for a death spiral there?

Charlie: Well Berkshire has something like $8 billion worth of solar.  Almost all of it in California.  We (get) take-or-pay contracts from the two big utilities.  And the way we leveraged it is like…we’ll probably get 15 or 18 percent, or some ridiculous return on our equity.  Just sitting on our ass while these little mirrors sit out there in the field.  Now we have to polish them every once in awhile.  They’ll get better, but they won’t get 50%…there’s a limit to how much better they can get.  The first one we had they tracked not at all they just laid there.  The second one they tracked east to west  but not from the celestial stuff that goes on with the changing the seasons.  The next ones will be pointed right at the sun through every kind of…But there’s a limit to how efficient that stuff can get.  On the other hand, since it’s free and coming in from the sun, and doesn’t pollute, and there’s a lot of worthless desert in the United States.  It’s a pretty sensible way to get power eventually.  So of course there’s going to be more and more of it.  

Question: But you don’t think that the ability to generate electricity at home or on a business’s own property, is that going to be some sort of threat at some point to the revenue model for all the…

Charlie: Well people try to make money out of the crap.  But I am very skeptical about all this home stuff.  That works if the utility will pay twice what the power is worth.  Then you can reduce the electricity bill.  Well why should the utility pay for twice what the power is worth?  And so we think it’s much more efficient to have some big place like us create the solar and just sell it to the utility.  

Question: Do you talk to Ted and Todd, the new investment guys at Berkshire much?  

Charlie: Not much, but I talk to them some.  And they’re different.  It’s not like they’re clones.  But they’re both good in their own way.  And they both love Berkshire.  And they both make contributions.  

Question: Did you think of the incentive, where each one gets 20% of their compensation from the other one’s performance, who thought of that incentive?  I think that’s brilliant.

Charlie: I did.  It’s brilliant, but I don’t think it’s changed things at all.  It’s my own idea.  And it looks good to you people and it looks good to me when I did it.  I don’t think it’s changed any behavior at all.  

Question: Charlie, how do you feel about auto dealerships with their service component and their low capital requirements?

(Video 15 of 22 5:44)

Charlie: Well that is very interesting.  I don’t want to be in the bottom 80% of the auto dealerships.  I think these people are well up in the top 20.  And so if we’ve got 80 dealerships making $3 million a year after taxes, that’s $240 million.  You have all of these dealer protection laws,  it’s entrenched, we take this real estate which tends to be very good and stick it in our insurance companies where it’s a decent insurance asset.  It’s what I call “ok.”  

Question: So that’s “great” then.

Charlie: No it’s not “great”.  It’s “ok”.  

Question: If it’s “ok” to you, it must be pretty great.

Charlie: No. No it isn’t. It’s not pretty good to me.  It’s “ok”.  I would prefer doing it to not doing it.  There’s nothing exciting to buying a bunch of auto dealerships.  But if you got $90 billion of float, you know, the idea of buying a bunch of auto dealerships that dominates…it’s ok.

Question: Also, do you know Norbert Lew of Punchcard Capital and do you have any thoughts on him…(Charlie: I don’t know…why should I know him?)

Question: Charlie going off of the auto question, what do you think of the advent of self-driving cars?  How’s that going to affect the ecosystem on insurance, scrap value, resale value, supply chains?

Charlie: Well you could change things so much that Geico would be a bad business.  Everything can change.  That’s the nature of the game it’s that your great businesses are being eroded by something at all times.  I think it’s a long time in the future.  I think it’s a very complicated subject.  After all, if you’re in a self-driving car, it works better if all the things are being self-driven by the same people.  We have that already.  The monorails don’t have operators.  Nobody’s driving the monorail.  But one guy owns the whole thing including the roadway.  The minute you’re sharing the roadway with a lot of other people…If I’m driving down the road and some guy goes up and stands there with a machine gun?  I will turn around.  I’ll do something.  The g.d. computer won’t!   He’s not programmed to care about machine guns!

Question: Charlie, what do you make of the legacy that you and Warren have left?  Do you have any idea of the sort of impact you have had worldwide?  On investing, on just basically thinking.  Not just investing.

Charlie: Well I think we’ve had some effect.  But they’re still teaching the efficient market theory.  The old ideas die hard. (link) And by the way it’s roughly right.  It’s just the very hard form which everybody believed.  They believed it was impossible.  They didn’t think it was rare.  They thought efficiency was absolutely inevitable. (link 1,2)  It was like physics.  I call it ‘physics envy’.  That’s what they had in the finance field.  They wanted to make their subject like physics.  Now what kind of a nut would want to make the stock market like physics?  It ain’t like physics.  It’s more like a mob at a football game.

Question: Charlie, would you like to know why I think you should know who Norbert Lew is?  (Charlie: Yeah)  Because he follows the Munger system.  His hedge fund is called Punchcard Capital based out on the philosophy of punchcard investing.  Since ‘08 he’s killed the markets and he’s done well for his investors by being invested in just three stocks.  Wells Fargo, Berkshire Hathaway, and Baidu.  I just thought you’d be interested.  

Charlie: Well I am interested and I’m not surprised.  And I’m not surprised that it’s worked.  It’s just what I recommended.  And he’s picked some of the same stocks.  Well think of what a simple way that was to get rich.

Question: Charlie, were you surprised on election day?

Charlie: Of course.  Of course I was surprised on election day.   

Question: Did you lose sleep for a few days?

Charlie: Well no because I expect to be disappointed with politics.  

Question: Charlie, you were able to change Warren from Ben Graham to high quality companies.  Was there any change that he brought to any of your systems?

Charlie: Well I didn’t change him that much.  You know Warren would have gotten there anyway.  You know maybe I accelerated it six months.  But Warren would have figured out that what he was doing wouldn’t scale.  

Question: Hey Charlie, I hear you talk about your grand-dad, but I hardly hear you talk about your Dad Alfred Munger.  I was wonder if you had any thoughts on the lessons that he taught you?

Charlie: Well, I was very fond of my Dad.

(Video 16 of 22 9:06)

My Grandfather Munger was more disciplined that my Father.  My Father made a good income as a lawyer.  Which he carefully spent, except for his life insurance and his house and so on.  My grandfather always saved his money.  And when the Great Depression came he could save the whole rest of the family.  And so that’s why I remember him more when I talk with investors.

Question: In the Alfred Munger foundation, what does that do?  That foundation.

Charlie: That was named after my father, not my grandfather.  I’m going to give away all that money before I’m dead if I last a little longer.  It’s not that much money.

Question: What do you want to give it to?

Charlie: Whatever appeals to me at the time.  I don’t ask anybody.

Question: How do you think about creating impact through your philanthropy?

Charlie: I do it myself, (I give anything out if) I damn please.  I regard it as a tax-exempts, bunch of Munger money.  I got no staff, I just do it.

Question: Do you have any criteria that you follow?  Or what kind of change were you trying to create?

Charlie: I do it when I want to do it, and I give it when I want to give it.

Question: What is your hope for your grandchildren?

Charlie: Well naturally we hope the grandchildren do well.  And any grandchild…I’ve got one whose running a little tiny partnership.  But my grandchildren are all doing different things.  I’ve got one at Google whose a computer software engineer.

Question: Are there any other periodicals besides Barron’s that you’ve read for 50 years?  And do you have any other inspiring anecdotes out of Forbes, Fortune, Wall Street Journal?

Charlie: I’ve never bought…I’ve read Fortune for 60 years, and I’ve never bought a stock.  And I was not kidding about that deferred gratification.

Question: Isn’t it true that you got a new car when you were in your 50’s or 60’s?  That was the first new car.

Charlie: I’ve bought them for my wives.  But I always bought a Cadillac that had about 3,000 miles on it, way cheaper.  Flew around in coach airplanes.  I use to go to Berkshire Hathaway meetings in coach and the Berkshire shareholders would say that they were all in coach too.  And they’d stand up and clap.

Question: Hey Charlie, I wanted to read you a quote and get your opinion on it.  “My religion consists of a humble admiration of the illimitable superior spirit who reveals himself in the slight details we are able to perceive with our frail and feeble mind.”

Charlie: It sounds that’s some scientist.  (Questioner: It’s Einstein)  Yeah well, that’s the way he felt.  (Questioner: What’s your opinion on that?) Well, I don’t have his idea that, he was good at puzzles.  Physics was a big puzzle to him.  So he naturally loved that great puzzle maker in the sky, that made it difficult but you could figure it out.  I’m different from Einstein.  Of course I couldn’t figure out the puzzles the way he did.

Question: Could you rephrase that, I didn’t understand the answer.

Charlie: Well, Einstein has his own slant on religion.  Certainly no conventional theology in Einstein.  (He didn’t talk about) being nice to other people or anything like that.  He just thought there must be some God out there that created these wonderful puzzles for me to solve.  That’s a peculiar kind of religion.  But that was Einstein.

Question: Charlie, you mentioned that one of your greatest achievements was family.  Could you tell us things you’d do differently with a family, or things you did well with a family, in terms of investing into the family?

Charlie: Well I had a lot of children.  Educated them all.  And I take the results as they fall.  What else can you do with a family?  And I have a lot of very admirable children.  Some of whom are out there today.  And that’s a huge blessing.  One of the things I like about them is that they’re decent, generous people.  One of my daughters who was there, she had a friend who was married to a total jerk, straightened circumstances, bitter divorce.  My daughter just bought her a house.  I think she owns the house but this other family lives in it.  That’s a nice generous thing to do if you’re rich.  I’m glad my children are like that and not Sumner Redstone.

Question: What’s your opinion of the Giving Pledge?

Charlie: Well, I told Gates that I wouldn’t do it.  Because I have already flouted it.  When Nancy died, community property stayed.  She left it up to me to decide where it went.  Well I knew she would want it to go to the children.  Every wife is always afraid that the old man will have his money taken away by some nurse or something (during his dotage).  I knew Nancy would want it to go right to the children.  So I shunted more than half the Munger fortune, quite a bit more than half, to the children.  So I’ve already totally violated the spirit of Gate’s Pledge.  I said, “Bill, I’m not going to publicly be a spokesman for something I’ve already totally flouted.”  And I flouted it because I knew my wife who had helped me all these years would have wanted it that way.  I’m not a good example for his pledge.  So I won’t do it.  I won’t pretend to be doing something I really didn’t do.

Question: Charlie it may be a little bit too personal, but is there anything you’d like to share about your wife Mrs. Munger?

Charlie: A long life has many disappointments and agonies.  I watched a sister die a horrible death from Parkinson’s Disease, dying young, 64.  I lost my first son to Leukemia.  Miserable slow death.  And in the end he kind of knew it was coming, and I’d been lying to him all along.  It was just so awkward.  And it was just pure agony.  And you have some of those agonies that are going to happen.  There’s not so much agony when somebody really old dies.  You know they deteriorate so much that you almost don’t miss them…which I’m doing a good job of.  I think you take the hardships as they come, you take the blessings as they come.  You have fun out of figuring out the puzzles as best you can.  It’s really, we’re very blessed to have…I’m mean we’re in the United States, we’re not in India, we’re not under some crazy dictator like Russia.  We don’t live where everybody’s got to bribe…India.  We’ve got a lot to be thankful for here.  And we’ve got a lot of options, we can change jobs, we can move around, we can do this or that.  We get a huge admixture here with all the cultures of the world without having to travel.  So we’re not restricted to one narrow little group of Bulgarian farmers making olive oil or something.  We’ve got this great mixture of people who are quite interesting and quite different, and they’re all cross-marrying.  Which makes it even more interesting.  And it’s amazing to me, there was a lot of added Jewish prejudice when I was young.  And now every family I know, they’re all cross-married.  I don’t have a friend hardly with a big family that doesn’t have a big Jewish in-law.  The old ideas have sort of died.

Question: How’d you meet your wife and how’d she’d accept you?

(Video 17 of 22 7:09)

Charlie: Well with my wife of 52 years, who died 7 years ago.  That was mutual friends who had introduced us.  We were both divorced, both the same age, both had two children.  All I can say is that I owe a debt of gratitude to the people that introduced us.

Question: Charlie, I’ve heard you and Mohnish talk a lot about the power of cloning great ideas, and I was wondering what you think about the floors or limitations or dangers of cloning.  For example, when you’re not true to yourself.  When does one get in trouble with cloning?  When it doesn’t work?

Charlie: Well cloning is of course…it’s not an ambiguous world, where you use it biologically.  But when you take it into some other field, cloning is a very interesting idea.  You do remove ideas from one place and bring them to another.  And if that’s cloning, I do it all the time.  I like cloning.

Question: Charlie, can you take us back when you bought the Buffalo News Paper, and just the stress that you had to go through because it looked like it was going to go under at one point for a while.

Charlie: We were never the weakest in the town.  So we were betting that we’d be the survivor. (link)  And we were.  So it was unpleasant because we showed no return for a long time.  But when the other guy finally turned up his toes, we suddenly started making a lot of money.  So it was just delayed gratification.  7 years of like no profits.  And he disappears and the sky rains gold.  Earnings went from nothing to $70 million pre-tax.  Boom, boom.

Question: On the topic of cloning, do you really believe as Mohnish has said that if investors look at 13F’s of super-investors that they can really beat the market by picking their spots?…and we’ll add spinoffs.

Charlie: It’s a very plausible idea, and I’ve encouraged one young man to look at it.  So I can hardly say that it has no merit.  Of course it’s useful if I were you people to look at other people you regard as great investors are doing for ideas.  The trouble with it is that if you pick people as late in the game as Berkshire Hathaway, you’re buying our limitations cost by size.  You really need to do it from some guy that’s operating in some smaller and finding prices with more advantage.  And of course it’s hard to identify the people in the small game.  But it’s not an idea that won’t work.  If I were you people of course I would do that.  I would want to know exactly what the shrewd people were doing and I would look at every one of them.  Of course.  That would be a no brainer for me.

Question: What do you mean you encouraged one young man to pursue it?

Charlie: Well the young man is my grandson who has a fair amount of money, fascinated by securities.  So I advised him, why don’t you start there.  So it’s Mohnish’s idea.

Question: Do you think the equity positions within Berkshire going forward?  Or the wholly owned business?

Charlie: Well I think the wholly owned businesses will, because we won’t pay any taxes on selling them.  And I think they will continue to grow, and I think they’ll do better.  I think the wholly owned businesses of Berkshire, are the 80% owned or what have you, are on average better than the S&P.  So I think we’ll do better in that part than the S&P.  And I don’t think our stocks located in a corporation subject to taxation will do enough better than the (APD to) pay the taxes.  But if we’re buying the stocks with the float in some insurance company, then of course the world changes.  But no I would that say of course…If you buy Berkshire, you should not be buying it on the strength of its little portfolio.  Look, we got $8 billion in the biggest market cap in the country.  It took a considerable period to get $8 billion dollars in.  It’s not that big of a deal with a $400 billion market cap.  It was easier to get into it than other things.  No, I…people who buy Berkshire, when you  bought Berkshire back 30 or 40 years ago, you were getting a bunch of marketable securities at a discount and all the business were free.  And of course those people made a lot of money.  We outperformed the market by miles in those days and the businesses did well.  And now we got businesses that are averaging out doing well.  And our marketable securities are a small percentage of our cash…there were years when we had more marketable securities per share than our book value per share.  Now it’s quite different.  And of course the market at its present multiples is a different world.

The one thing about Berkshire that’s interesting is that we do get some opportunities other people don’t get.  If you’re 3G and want a partner for your next deal, who the hell are they going to come to?  They know we’re a good partner.  So we stuff other people don’t see.  That helps.

Question: Charlie, moving on to one of the smaller positions in Berkshire’s portfolio, there was a recent position made in Sirius XM.  Could you talk at all about radio assets and your outlook assets?

Charlie: I don’t know anything about radio assets except that it’s a very mature market.  And the g.d. radio’s basically an auto market.  And it’s totally concentrated.  I never think about it.

Question: How much of your success can be attributed to Occam’s Razor and Kelly’s Formula?  

Charlie: Well Occam’s Razor is of course a good idea.  It’s a basic idea.  Occam’s Razor is like telling a fisherman to fish where the fish are.  Of course you’ll do better.  Fishing where the fish are.

(Video 18 of 22 6:31)

Question: In those businesses that are not wholly owned, but maybe 85% owned, the 15% ownership, when there’s massive investment within that business, how does that effect the ownership of the 15%?

Charlie: Take Nebraska Furniture Mart, owned by parts of the Blumkin, and (we didn’t want a sellout).  They loved the business, they’re very rich, they have an enormous portfolio of marketable securities that came out of money left within their 20%, because there was a lot of surplus money that they’ve accumulated that’s outside of the furniture business.  And it’s very interesting.  Warren says those people, who he treats kind of like sons…they live in the same community, and he lets them control the dividend policy of the company.  It doesn’t make much difference to us, the dividends are mostly tax free.  And he says, “Whatever dividend policy you…”  We owned 80% of it!  So he says to the minority owners, “Just choose the dividend policy for the whole company.  Whatever you want is fine with me.”  Warren’s always doing things like that with the right people. (link)

So is Li Lu.  I’ll tell you a story about Li Lu that you will like.  General Electric was always famous for always negotiating down to the wire.  And just before they close they get one final twist.  And of course it always worked, the other guy was all invested.  And so everybody feels robbed and cheated and mad.  But they get their way, that last final twist.  So Li Lu made a couple venture capital investment and he made this one with this guy.  And the guy made us a lot of money in a previous deal and we’re now going in with him again on another.  Very high-grade guy and smart and so forth.  Now we come to the General Electric moment.  Li Lu says, “I have to make one change in this investment.”  Sounds just like General Electric?  Just about to close.  I didn’t tell Li Lu, he did it himself.  He said, “You know, this is a small amount of money to us, and you got your whole net-worth in it.  I cannot sign this thing if you won’t let me put in clause saying, ‘if it all goes to hell we’ll give you your money back.'”  That was the change he wanted.  Now you can imagine how likely we were to see the next venture capital investment.  Nobody has to tell Li Lu to do that stuff.  Some of these people it’s in the ‘gene-power’.  It’s just such a smart thing to do.  It looks generous, and it is generous.  But there’s also huge self-interest in it.  It’s the right way to behave anyway and secondly it helps you.   And Berkshire’s helped by its past behavior to see things that other people don’t see.  But how many people…would Sumner Redstone have done that?  Would General Electric have ever done that with the whole culture behaving otherwise?

Question: Ben Franklin talked about Morality being the best policy.  But then you see the Sumner Redstones and Ichans and the Trumps doing very well by acting kind of the opposite of Li Lu.  How do you reconcile that and still come out with what is no doubt the correct answer that it’s wiser to be moral?

Charlie: Well of course Sumner Redstone and I graduated from Harvard Law School about a year or so apart.  And he ended up with more money than I did.  So you could say he’s the success.  But that’s not the way I look at it.  And so I don’t think it’s just a financial game.  I think it’s better to do it the other way.  And sometimes when you think you’re getting by with this…but General Electric has a letter that they file out when they take somebody over.  And the letter says, “Dear Joe Schmo”, the major supplier to the business they just bought, “We’re going to accomplish wonderful things together,…(and so on)… but we have to harmonize the systems of General Electric with,…(and so on)…and you’re going to be paid in 90 days instead of 30 days.”  Which is just a horrible imposition on the supplier.  But they got a whole department that’s just organized to brutalize the suppliers and furnishing all the money.  

They did that with one supplier that I know, and of course the sales manager said, “We’re going to tell em’ to go fuck themselves.”  And the guy says, “No don’t do that, just bring me all the stuff where General Electric is my customer where they got no alternative.”  And he just raised the prices by about four times.  I think it’s a mistake to be quite that brutal.  They compete in GE based on who can get the suppliers to furnish more and more of the capital. They’re very tough.  Now it’s a great company with great products and they’ve got some very good people.  I think Jeff Immelt is a good guy, but I would be very uncomfortable doing that.  My theory of life is win/win.  I want suppliers that trust me and I trust them.  And I don’t want to screw the suppliers as hard as I can.

Question: How’d you feel when Berkshire put money into GE during the crisis?

Charlie: Well it was fine.  It was sure to work.  With a high coupon.  And it did work.  When we buy something like that, we’re not making a big moral judgment about the company.  I don’t think GE’s that immoral.  Averaged out, GE’s one of our better companies.  In terms of fanaticism about defect absence, and they’re very good on that stuff.  But I want to get ahead, and you final twist on every deal, just before the closing.  And brutalizing all my suppliers for the last nickel (that I paid them).  That’s not my system.

(Video 19 of 22 8:43)  

Question: Charlie you said in your Almanac, that one of the best deals you’ve ever encountered was one with a snuff manufacturer.  Could you go a little bit more into detail into that?

Charlie: That was Conwood.  It’s an addictive product.  People are totally hooked.  They’re the number two person in the market.  They all believed in their product.  Every damn one of them chewed tobacco.  And the figures were just unbelievable.  There was virtually no (financial issue), nothing but money.  And the cancers caused by that mouth tobacco is maybe 5% of the cancer you get from cigarettes.  But it’s not zil.  You definitely are going to kill people with that product who have no reason to die.  Warren and I just…it was the best deal we ever saw, we couldn’t lose money doing it, and we passed.  Fade in fade out.  Jay Pritzker who was then head of the trustees or something at the University of Chicago Medical School.  Pritskers are big in Chicago.  He just snapped it up so fast.  The Pritskers made two or three billion dollars on it. (Pritsker Acquisition in 1985; $400 million: link)  (Pritsker Sale in 2006; $3.5 billion: link)  But do we miss the two or three billion we easily would have had?  Not an iota.  Have we had a moment’s regret?  Not an iota.  We were way better off not making a killing out of a product we knew going in was a killing product.  Why should we do that?  On the other hand if it’s just a marketable security, we wouldn’t feel that the morality of it was ours.  But it was going to be our subsidiary.  We’re going to be paying the people that advertising on Tobacco?  That’s just too much for us.  We’re not going to do it.

Question: Charlie, is there any one question you’ve anticipated being asked in your whole life that you have not been asked yet?

Charlie: Some people ask me, “what question should I ask you that will help me?”  Anyway.

Question: Do you have a favorite Mrs. B. story that you could share with us?

Charlie: Well she was very preemptory and bossy.  She was illiterate in English although she was fluent in Yiddish.  And she could make arithmetic computations in her head that you can’t make.  I mean she knew exactly how many yards there were in 26 1/2 by 104 1/4 in her head.  And she was there.  But she was a very bossy and domineering hardworking woman.  She worked herself a hundred hours a week.  And she had sons in law who were the nicest people, they worked maybe fifty hours a week after they were filthy rich.  She called them “those bums”.  We know a lot of characters.

The other one is, we bought a business from…it was half owned by a daughter of Moses Annenberg.  She was a very rich woman, and she owned half this business which was her husband’s business.  And she was driving a Cadillac.  Her husband died but she had a company car, and she wanted the Cadillac to go with her (inaudible).  And so she told her lawyer to ask Mr. Buffett if he’ll give me the Cadillac.  And she told the lawyer what to say.  “Tell Warren” she said, “That a lot of people give money to poor people, but that’s easy, they get their reward and fulfillment for helping the poor, observing the tenets of religion.”  She said, “The real charity that’s unusual is giving money to the rich!” (big laughter)  And so she made that pitch to Warren, the lawyer was very embarrassed to do it.   Warren said, “Tell her I’ll sell it to her at a full-sale Blue Book.”  Which she finally did.  But she first made the pitch that we should give her the car because it was so much more generous to give to the rich.  It was so more unusual.  That woman had an adopted child who was a generous.  So she would rent Carnegie Hall and let the child conduct an orchestra.  The rich can get quite eccentric.

Question: Charlie can you go back the Nixon years when you bought the Washington Post and how that whole situation panned out?

Charlie: The market cap of the Washington Post was $75 million when we bought in.  You could have sold it in an afternoon, every single asset, for 4 or 5 hundred million.  So it was a good business, not just a Graham stock, but it was also a Graham stock because it was so cheap.  And they also had a business that was likely to destroy its competitor making it a monopoly.  Now it was only a tiny amount of money that can go in.  That’s what makes it hard for you people.  It’s a great investment, but maybe it’ll absurd 4 or 5 million dollars.  Which we did by the way.  We got $10 million into it.  At the top it was $1 billion.  But we only did that once.  So it’s a great story, but…Now that helped us way back then to have that extra billion on our balance sheet.  But that wasn’t an opportunity that would take billions of dollars.  That’s why what happens in the past at Berkshire can’t happen again.  That little opportunity for a 10 million dollar investment was wonderful.  But we don’t have a lot…If you look at Berkshire, you’d think we’d have 10 investments that are (each of them), say 10 times.  We put in a billion and now it’s 10 billion.  Then we have $100 billion in 10 companies.  Well we don’t.  We have three or something.  And it’s not that damned easy to find these damn things that you can identify.  It’s not that damned easy.

Question: Thank you again Charlie for all of your continuous sharing.  Really appreciate it.

Charlie: I’m glad you guys are still having fun doing it, and I’m glad you aren’t discouraged.  You shouldn’t be.  But you know everybody who did the value investing in my generation and plugged away at it…you didn’t have to be that smart even.  They all did well.  And yours is going to be more difficult.  But you know you want something to do anyway.  That’s kind of interesting to do.  So the fact that it’s difficult shouldn’t discourage you that much.

Question: Is there a good systematic approach to learning from one’s mistakes so you don’t repeat them.  Is there something that’s worked from you in terms of post-mortems?

Charlie: We were active enough so that we had some mistakes to remember.  It’s hard to learn…we learned a lot vicariously.  Cause it’s so much cheaper.  But we also learned a lot from unpleasant experience.  So just doing it, you’ll automatically get those mistakes.  Nobody can avoid them.  And of course you’ll learn from everyone.  Mohnish is good at post-morteming his mistakes.

Question: What did you say when Dexter Shoes came up?  Were you for it or against it at the time?

(Video 20 of 22 7:39)

Charlie: Well I didn’t look at it very hard, but I didn’t mind it. The company, it was loved by all the retailers, it was the number one supplier to JCPenney, it surpassed everything, it was a solid earner, dominated Maine, they were nice people…and of course the Chinese hadn’t come up by that time.  They just came up so fast.  And they just took no prisoners in the shoe business.  And they weren’t just cheaper by a little, they were half-priced.  And the shoe-business is not that easy a business and of course people bought the half priced shoes.  And the business just went to hell very fast.  But that business, because it created such a huge lesson, and it looks awful in terms of what the Berkshire stock is worth.  I mean we’re the main charity in Maine if you call us.  But at the time, it was 2% of one year’s performance.  That’s what we lost by having it go to zero.  So our return from one year went down by 2 percentage points.  Now to be sure if we bought our own stock instead of this thing…you know, or not given away our stock, it’s a huge error.  But we learned from it.  I just think if you just keep going you’ll make some mistakes and of course you’ll learn from it.  How could you not learn from that one?  We’ve learned how awful it is to have somebody who is really way lower priced come in hard and how no amount of managerial skill could protect us. (link) Now we have other shoe businesses in little niches that make $20 million a year or something after taxes.  Maybe a little bit of that is leftover Dempster even.  But we made do…But don’t you all have mistakes that are painful?  And haven’t you learned from them?  And isn’t that good?  But I don’t know what I would do now if I were…I live surrounded by Capital Guardian people.  They have over a trillion dollars.  And they hire all these guys who get A’s in business school and they treat them well, (and on and on).  And they divide them up and they get expertise in various places…it doesn’t work to beat the indexes.  I knew that company when it was smaller, you know 5 or 6 hundred million.  They beat the index by a point a year.  Which was fine because they were drawing the fees off the top and the clients…now they’ve lagged by a point a year or whatever in the hell it is.  And they handle that by denial.  They just don’t face it.  I was there the other day and this very nice portfolio manager whose very smart, polished, generous, nice man.  His assistant, a very nice, intelligent, polished woman.  And he said, “Well you know, we’ve outperformed in my fund which has a hundred million dollars by two percentage points a year.”  I raised my eyebrow.  I just look at him for a while.  He says, “Well I mean we outperform our competitors by two percentage points a year.”  And I said, “Yes, and in that over-performance a lot of it was a long time ago and you had way less money.  And there was another horrified pause and finally the woman says, “He’s on to us!”  And we went on to discuss something else.

At any rate, it is awkward.  You know you want to keep getting paid, you like your line of work, you’re flying around interviewing management and so forth.  And when all said and done…and they did it for a long time before.  It just got harder.  And then I see people leave.  They say, “I can’t manage $30 billion, I’ll manage $3 billion, and now I’ll outperform.”  And they’ve had that happen two or three times, and the new guys don’t outperform either.  Cause the new client still wants 10 stocks or something.

Oh and there was another experiment they’ve done about five…no not five times, three times at Capital Guardian.  Follow what the great investors are doing, that’s one way.  They said, “We’ll get the best idea from our best people and we’ll make a portfolio just of our best ideas from our best people.”  Nothing could be more plausible.  They’ve done it three times and it’s failed every time.  Now how would you predict that?  Well I can predict it because I know psychology.  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.  And they stopped doing it because it didn’t work.  They didn’t know why it didn’t work because they haven’t read the psychology books.  But they knew it didn’t work so they stopped.  And it’s so plausible.  Now I don’t think that’s true at Berkshire.  I think at Berkshire if you asked me or Warren for our best ideas that would have worked.  But it didn’t work in a place like that, of a more conventional manager.  By the way I don’t think it would work that perfectly at Berkshire, I think it would work better than it did at Capital Guardian.  But isn’t that interesting that that would not work.

Question: Is it still true that you talk to Warren once a week now?

Charlie: No, no.  It would be like talking to yourself.  We don’t have any new ideas.  87 and 93.  I mean, what the hell.  Anyway, but the young men make some contribution.  They caused us to think about things that we wouldn’t have thought about before.  We would not have bought the airlines or the Apple if the young man hadn’t come up with the idea.  But once they did, Warren ran with it.  And Warren’s pretty great.  It was hard to buy that much airline stock.  Doesn’t sound like much airline stock, you know by Berkshire standards, but we had to be a hell of a percentage of the market for a pretty long time.  It’s very hard to manage a lot of money.

Question: It must be an awkward conversation with Bill Gates after he bought the Apple stock.

Charlie: Bill Gates does not have any illusions on that subject.  Bill Gates bought that $150 million worth of Apple, I think they sold it.  (Audience: Yeah that was a good buy)  But it was not a good sale. (laughter)

(Video 21 of 22 4:36)

Oh I’ve got another story for you that you’ll really like.  Al Gore has come into you fella’s business.  Al Gore is in your (space, you know this) and he has made 3 or 4 hundred million dollars in your business.  And he’s not very smart, he drank a lot, smoked a lot of pot, coasted through Harvard with a ‘gentleman’s C’.  But he had one obsessive idea that global warming was a terrible thing and (he’d protect the world from it).  So his idea when he went into investment counseling was that he was not going to put any CO2 in the air.  So he found some partner to go into investment counseling with and he said, ‘we’re not going to have any CO2’.  But his partner’s a value investor, and a good one.  So what they did is, Gore hired a staff to find people who didn’t put CO2 in the air.  And of course that put him into services.  Microsoft and all these service companies were just ideally located.  And this value investor picked the best service companies.  So all of a sudden the clients are making hundreds of millions of dollars and they’re paying part of it to Al Gore.  And now Al Gore has hundreds of millions of dollars in your profession, and he’s an idiot.  And it’s an interesting story.  And a true one.  So if you were idiots about global warming and the Vice President would push your theory…

By the way, that’s not the only one.  There’s a leverage buyout operator in Los Angeles that I know casually.  He’s made 35% per annum for 35 years.  All he buys is service companies.  Instead of buying 100% and letting the management have 10,  he always strives to buy 60% and let the old manager who created the company own the other 40.  And he buys nothing but service companies and he knows a lot about it.  And with that formula…you know, inventories, receivables, there’s all kinds of horrible things in business that if you just buy service companies you can avoid.  And it’s amazing how well its worked for…it worked for this guy who did LBOs just the way it worked for Al Gore.  35% per annum.  And he’s smart because he’s causing people to have more skin in the game, they know more about it, they’re more like partners, the new manager’s not an employee.  If some other guy was 40 and you owned 60, that’s a different relationship.  He’s the founder.  But what a clever way to do it.  And it worked better.  And of course he knows more about it when he does nothing but service companies.

I know another guy who does nothing but mail-order and internet companies.  Also an LBO operator.  He’s made 20-something percent per-annum for a long-long time.  But he knows more about getting customers and ‘this ratio’…he knows more about these damn mail order internet companies…he really knows a lot.  So two specialists, each one of them in a different specialty.  Both working.  Interesting.  And that’s why I made all the talk about specialization frequently works.  I’ve had more fun to go out and do everything, but these specialists do better averaged out.  They know a lot.

Question: So how is our little mail-order business Oriental Trading Company doing?

Charlie: That’s one of these guys, this guy sold it.  Not to us, but to one previous to us. Well it’s a very humdrum damn business.  But it’s right there in Omaha.  It’s a non-event.  It may be better than something else we put insurance float into, but it’s going nowhere.  But, you know if your float costs you nothing, and you suddenly make 10-12% on it, it’s a beguiling.   We got $90 billion floating around.  

(Video 22 of 22 9:01)

Speaking of that, Ajit.  There have only been two transactions like that in the history of the world, $10 billion each.  Ajit does both of them.  If you want him to do a port…(Questioner interjects: The reinsurance with AIG?)  Yeah, that’s the second one.  But where else is AIG going to go?  Who else are you going to trust to pay off all that stuff 30 years from now except Berkshire?  Nobody.  It’s nice to be in that position.  And we get along with them.

Question: Charlie, do you still do a lot of work with Ron Burkle?

Charlie: I have not seen Ron Burkle in 35 years.  He always tells people what a great friend he is of mine.  I like Ron Burkle’s father who was our last customer for trading stamps.  I like Ron whose eager, but Ron, when he’s made a lot of money, is a bit insufferable.  I mean…he’s my good friend if you listen to him.

Question: When you look at what’s made you and Warren have relatively happy lives, is there some aspect of that that’s imitable for the rest of us?

Charlie: Well it’s all imitable.  If your marriage reasonably works, and if your family life reasonably works, and that doesn’t mean perfectly because nobody’s family life works perfectly.  Particularly with the children.  And if your partnerships work well.  We have had marvelous partners.  Warren’s been a marvelous partner for me, I’ve been a good partner for him.  All of our other subsidiary partnerships, which don’t overlap totally, have been a bit marvelous.  I do not have a big failed partnership of any kind.  But that’s because I am a good partner.  And Warren is a good partner.  And so it’s like, if you want a good spouse, deserve one.  If you want to have a good partner, be a good partner.  It’s a very simple system.  And of course it wouldn’t work without it.  And also get rid of the bureaucracy.  If you deal with good people you trust…expense, trouble, lawyers, checking.  We’re always closing something with no audit.  We basically are very old fashioned.  We bought the Northern National Pipelines (link) …they needed money Monday and it was like Saturday, and it was lots of money.  We came up with it…the lawyers were having a fit.  We just gave them the money and took the pipeline.  Worked out the details later.  Other people can’t do that.  Our whole culture is…there are all kinds of bureaucrats that want something to do.  They can’t make an exception.

Question: Going back to Enron, do you have any insight into whether Kinder Morgan would be a successor or rejecter of Enron culture?

Charlie: Well I don’t think Kinder Morgan is anything like Enron.  Enron was total fraud and bullshit and craziness and manipulation.  They went berserk.  And Kinder Morgan may puff a little and pretend that cash flow is really cash and there isn’t really an obligation to replace a depreciating asset.  But it’s not Enron.  Enron was just pure disgusting, awful.  And I think most of those limited partnerships have a slight touch of the old mining companies on the San Francisco exchange. (link) And they all paid monthly dividends as they dug into the ore.  And of course once they’ve done that, they had two divisions.  They had a shuck the suckers divisions on the mining exchange in San Francisco.  And a bunch of miners that mine the mine.  It was like a two handle pump.  They’d flood the mine, the stock would go down, they’d buy it.  They’d pump the water out of the mine, pay a big monthly dividend, up.  Blump, blump, blump, blump (Charlie simulating a two handle pump)  Shucking suckers over here by kind of fraudulent illegal…by modern standards…it was disgusting.  But to some extent, the master limited partnerships pretend that the cash is really free, when a lot of it really isn’t.  They’re taking out money the business is really going to need to replace what it’s doing.  In that sense, it’s sort of a mildly immoral way of doing things.  And they’re doing it because they can get by with it.  Do you have a different view about the Master Limited Partnership?

Attendee: No, it’s crazy how they raise so much equity.  Or they were.  Like they issued equity like crazy.

Charlie: Well it’s kind of dishonorable.  Like the old conglomerate business where they issued the stock and then the stock sells at 30 times earnings and they keep buying a bunch of ordinary business.  That was like a chain letter game.  It was dishonorable.  There’s a lot that goes on in finance that’s dishonorable.

Question: So what do you think about the last couple of books that have been written about you?  And if there was an author here, what would you tell him?

Charlie: I haven’t read…what books are you talking about? (Questioner: Like the Tao of Charlie Munger?)  I never finished it.  (Questioner: Well any of the books that have been written about you?)  Well the answer is I don’t finish them. (sigh) Of course people are going to tend to look at stuff that’s been written about them.  But when they just copy old quotes and so forth, why should I read it?

Question: Hi Charlie, I believe you’ve said that if you could have lunch with anybody it would be Benjamin Franklin, and if you did, what would you ask him or what would you talk about?

Charlie: Benjamin Franklin has already taught me what I want to know because he left such a record and his biographers have been so good and he was so famous in his own lifetime, and for so long.  So I already have had my conversations with Benjamin Franklin.  He actually gave us the Autobiography.  And in the various biographies I’ve read, I can piece in the rest of the story.  It was interesting that in the end he failed in his relationship with his only surviving son who was loyal to the crown.  And that rupture never healed.  It was just too much.  Ben thought his son had a duty not to publicly have a big fight with his father who had raised him and gotten his fancy position with the crown for him and everything else.  And the son felt that he had to protect the position he had.  You could understand why they’d feel that way.  Most people wouldn’t do that.  They would reconcile somehow.  Or pretend to reconcile.  But that really ruptured…he didn’t even talk to that son at the end.  It’s interesting.  Franklin was capable of having more resentment than I had.  I have conquered resentment better than Franklin did.  I’m not that mad about the people I disapprove of.  That’s why I kissed off that Trump stuff by making him a compliment today.  I don’t want to…I don’t think much of Trump as you can imagine.  Imagine me voting for Hillary Clinton.  It was very hard to push the pen.  But I did.

End of Transcript

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Charlie Munger: Full Transcript of Daily Journal Annual Meeting 2017

This week I had the great pleasure of hearing Charlie Munger speak at the Daily Journal Annual Meeting for the second time.  For two hours Charlie  captivated the audience with an abundance of whit, wisdom, and stamina.  It was a fantastic performance.  He truly is 93 years young.

I transcribed the full event from my audio recording which you may find below.  At each question throughout the transcript, I provided a clickable link to the precise spot where the question begins in an excellent video recording of the event posted on YouTube.  If you’d like an audio recording of the event I recommend my recording on SoundCloud.  Furthermore, Charlie provided a handout to the attendees.  I scanned them into a PDF document which you can access here.

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 to Charlie, but as for Charlie’s and Gerry’s answers to the questions, I translated them verbatim and as accurately as possible.)

Charlie Discussing the Daily Journal Corporation:

Charlie: I usually talk a little bit before we take the questions.  And the essence of what’s going on here of course is that we have a corporation that was in a branch of the newspaper business.  And our branch of the newspaper business like most newspaper businesses has gone to hell compared to what it was in its peak years, and almost every other newspaper business is going to hell with no pardon, they’re just disappearing.  What we have is this computer software business where we’re serving the same customers to some extent except now they’re all over the country, even some of them outside the country, with this…we were selling software to all these courts and public agencies whereas before we were giving information to lawyers and other people, and publishing public notices and our software business is of a type where it’s a long tough slog.  But we’re slogging very well and we really love the people who are doing it for us, we’ve got a lot of wonderful people in our software business; the implementers, and the computer programmers, and people who deal with the public agencies, and the ethos of the place is very admirable.  Everybody is trying to get ahead here by doing the work right and serving the customers right, and having a lot of financial wherewithal where money is never a problem, and doing what we’re suppose to do.  It’s a pleasure to, people like Rick Guerin and myself, to watch all these young people doing this and of course we were very glad to be able to do it when we should be dead. (laughter)

A lot of you people came into this because Berkshire was successful and Guerin was successful and for various odd reasons of history, and most of you are accidentally in the software business, and I am too because Guerin did it when I wasn’t paying much attention.  I don’t do this kind of venture capital stuff.  And he doesn’t either, but he did it here.  So if there’s anything wrong with what happens in our software business, you’re looking at a man who caused it all over here. (laughter)  I’ll take credit for any successes.  But if there’s failure you’re looking at the man here who got us into this.

It is amazing to me, some of the things that are happening in our software business.  We just are getting a contract from South Australia.  Now if anybody told me when I was young, that the Daily Journal Company would be automating the courts of South Australia, I mean, I hardly know where it is.  Anyway, it’s amazing what’s happening and it’s a fair amount of fun to watch.  Probably because we’re doing more winning than losing.  I’ve never been able to enjoy losses the way some people do.  I would much rather win.  And I really like to work with good people instead of the opposite.  And we’ve got a lot of good employees in our software business.  We’ve got a bunch of implementer in Utah who are really good at it and we really trust.  And who our customers like, and we’ve got all these computer programmers and so forth around here, and a game of service like that when it’s complicated, what you have to do is minimize your glitches and (crawl out of them very rapidly in a way that your customers trust you.)  Our people were good at that and they get better and they’re trying to get ahead by being good at the service, not by hiring some politician as a consultant.  Some of our competitors do that kind of stuff.  But we’re trying to slog our way out by doing the work right.

When I was a lawyer, there was a saying that I’ve always used, “The best business-getter any lawyer ever has is the work that’s already on his desk.”  And that’s the basic ethos of our software business.  If we just keep doing it right, I don’t think we have to worry about the future.  Not that we won’t have down drafts and our failures, but we are actually grinding ahead slowly in that software business.  And it’s very interesting because Guerin and I know practically nothing about it.  And Gerry didn’t come up as a software engineer, so we’re basically doing something that’s quite difficult, we’re judging people because we don’t understand what the people do.  That’s what Andrew Carnegie did.  He didn’t know anything about making steel.  But he knew a lot about judging whether the people he was trusting were good at making steel.  And of course that’s what Berkshire’s done if you stop and think about it.  We have a lot of businesses at Berkshire that neither Warren our I could contribute much to, but we’ve been pretty good at judging which people are capable of running those businesses.

But this is pretty extreme here.  The little Daily Journal building going into the computer software business.  It’s a long slow kind of business.  RFPs.  The first time we contact a customer until we start making money may be 5 years.  So it’s like deciding to start prospecting for oil in Borneo or something.  And they just keep doing that over and over again, and the money goes out and the effort goes out, and it starts coming in five years from now.  I love that kind of stuff, not when I think we’re taking territory, it doesn’t look good when we write it off and we don’t report wonderful numbers or anything.  But if it makes sense in the long-term, we just don’t give a damn what it looks like over the short term.  And we know we’ve collected a bunch of shareholders that share our ideas.  After all we’re running a cult not a normal company.  And I think most of you feel that you’re willing to wait.

I lived all my life with people who were into deferred gratification.  In fact most of them will never have any fun.  They just defer gratification all the way to end, that’s what we do.  And it does cause you to get rich.  So we’re going to have a lot of rich dead people. (laughter)  We can excite a lot of envy.  A lot of you when the people walk by your grave and there will be this nice grave with this nice monument and they’ll say, “God what a great grave, I wish I were under.”  But at any rate, deferred gratification really does work if what you’re doing is growing a business that gets better and better and getting yourself so that your grave can look nice to outsiders.  Guerin and I have never taken any money out of this company in all these years.  We don’t take salaries, we don’t take directors fees.  We’re a peculiar example.  I wish our example spread more, because I think if you’re wealthy and own a big share of a company, and you get to decide what it does and whether it liquidates or whether it keeps going, that’s a nice position to be in, and maybe you shouldn’t try and grab all the money in addition.  That’s my theory of executive compensation.  And some of the old-fashioned guys like Carnegie never took any salary to speak of.  Cornelius Vanderbilt didn’t take any, of course he owned the whole place, practically, and he would have considered it beneath him, he lived on the dividends like the shareholders did.  So there’s a lot of that old fashioned ideas here in the Daily Journal Company.

Charlie Begins Q&A:

Charlie: I’ll first take a bunch of questions about the Daily Journal, and after that we’ll take question on anything you want to talk about.

Question 1: At last year’s meeting you talked about the milestone of getting the L.A. court system here at Journal Technologies and I was wondering, in the last year, as it has gone by, what good milestones have happened and what bad things have happened.

Charlie: Gerry you take that one.  I’ll answer it (shortly), it’s going fine.

Gerry: We have three case types for Los Angeles.  One case type went live last April, another case type will go live this coming July, and the third case type about 10 to 12 months later after that.  We have to work with the Los Angeles schedule, after all they have a lot of people to train.  And that becomes and very important factor.  Training is critical because if the end users aren’t trained properly, virtually everything falls apart.  And so that’s the schedule.  We discussed it this morning.  We meet with the court about 3 miles from here virtually every day.  We have a good team from the court and I think they’re very excited about what they’re doing, and that’s critical to us that the court feels good about the system.

Charlie: One good thing about what we’re doing is it’s slow and it’s agony in the delays between the first customer contact and finally getting into a decent revenue stream.  But once you succeed, it’s very sticky business.  Very sticky business.  And the fact that it’s difficult to do means it’s difficult for people to change much.  So if you go slog through all this tough territory where it’s (slogging through), there’s a reward out there somewhere, and we’re not in a small business.  It has way more potential than the original print business we had giving information about the (cases).  It’s a big market.  And the people have no option but to charge ahead.  These courts and district attorneys, public defenders, all these people were serving…they’re over-whelmed with options…better systems and more software.  So it’s a huge market.  And the fact that it’s so often to grind through.  It means that the people who want easy gratification don’t come in.  If it seems slow and painful to you, we kind of like it that way.

Questions 2: Your thoughts on Tyler Technologies.  How do you think your competitive position versus Tyler is doing.

Charlie: Well Tyler is an extremely aggressive company.  They were bigger faster and so on.  I like our ethos of operation better than I like theirs.  If I were buying software, I’d rather buy ours than theirs.  Our system is to keep fighting the game.  I wish all the customers I had in life were like Tyler.

Question 3: The rate of revenue growth is going down a little bit, while expenses are going up.  Any major milestones in the next 3 to 5 years that you think you’d like to get that you think would really help things along.

Charlie: I’ll take your first question.  It looks like we’re proceeding slowly, but we bought a bunch of contracts, in effect, for money, and we knew they were going to end, so we’re amortizing the cost of those contracts.  But really it was an anticipated decline that we got big revenues up front for taking.  So we’re getting ahead, there’s a little blip in the figures.

(Response to second question) Every contract that’s significant is a major jump.  The business is so big they’re whole states.  I mean this is a huge business and everybody is just scrambling at the first parts of something that’s going to grow bigger and bigger and last and last.  As long as we’re doing the work right, why it’s likely to work out right.

Question 4: Can you comment on Wells Fargo?

Charlie: Well of course Wells Fargo had a glitch.  The truth of the matter is that they made a business judgment that was wrong.  They got so caught up in cross-selling and so forth and having tough incentive systems that they got the incentive systems so aggressive that some people reacted badly and did things they shouldn’t.  And then they used some misjudgment in reacting to the trouble they got in.  I don’t think anything’s fundamentally wrong for the long-pull.  Wells Fargo, they made a mistake.  It was an easy mistake to make.

The smartest man I ever knew made a similar mistake.  Henry Singleton, who was the smartest single human being I knew in my whole life.  And Henry Singleton of Teledyne also had very aggressive incentive systems, like Wells Fargo.  And his customer in many of his subsidiaries was the government.  And of course it’s not that hard to cheat the government.  But his very aggressive incentive systems, 2 or 3 out of 20 subsidiaries cheated the government.  So all of a sudden he’s got three scandals at once.  It wasn’t that Henry was trying to cheat the government.  He just got a little aggressive in applying the incentives and he got blindsided.

That can happen to anybody.  I don’t regard getting the incentives a little aggressive at Wells Fargo as a mistake.  I think the mistake there was, when the bad news came, they didn’t recognize it rightly.  They made a mistake.  But what happens in a tough system like capital, you make a mistake like that and pretty soon you’re gone.

Question 5: For Gerry or Charlie.  Congratulations for inverting and not doing things wrong in regards to Daily Journal.  What’s your insight into the Alemeda court system and the problems that Tyler’s having over them.

Charlie: No, but I’m not dissatisfied with it.  I don’t think I want to criticize Tyler any more than I have.  One of our customers, you’ll be sad to know is having some problems with pleasing a customer…You can see the salt tears running down my cheeks. (laughter)

Question 6: Question on software fees in terms of your revenue lines.  What portion of that business is recurring?

Charlie: That is so complicated that I’m not even going to try to answer it.  I’m just going to answer it in substance.  There’s a lot that’s reoccurring if we stay in there.

You can’t look at our financial statements and make very good judgments about what’s going to happen.  It’s the nature of our game that’s confusing.  It confuses us a little bit.  So we’re not holding back on purpose, it’s a very complex, confusing, system.  You’ve got all these RFPs.  It’s very complicated.

Question 7: You purchased the building in Logan, which I believe is used exclusively in Journal Technologies, but in accounting, it’s under the traditional business, I’m wondering why?

Charlie: Gerry I give you that one.  He says, why is Logan, somehow in the traditional business?  It shouldn’t be.

Gerry: The Daily Journal purchased the building and they own the building.  And Journal Technologies pays rent to the parent company for that and the amount of rent is not, what we would consider, material from that perspective.  And because it’s owned by the Daily Journal that’s how we originally classify it.  No real significant reasons.  All the expenses on the Journal Technologies books.

Charlie: That’s some quirk of accounting.  It doesn’t really matter.

Question 8: Follow up on the question of incentives.  You were explaining at Wells Fargo you don’t have a problem with aggressive incentives.  Can you expand on that a little more?

Charlie: Well how do you know they’re aggressive until you try?  They didn’t react enough to the bad news fast enough.  And of course that a very dangerous thing to do.  I don’t think it impairs the future of Wells Fargo.  As a matter of fact, they’ll be better for it.  The one nice thing about doing something dumb is that you probably won’t do it again.

Question 9: Question in regards to someone early in their career trying to figure out which of several paths to pursue.  Two thoughts that seem helpful for this purpose are 1) figuring out which work you have the possibility to become the best at and 2) ascertaining which line of work would most help society.  Do you think these ideas are the right ones to focus on, and if so, how would you go about answering them.

Charlie: Well, in terms of picking what to do, I want to report to all of you, that in my whole life I’ve never succeeded much in something that I wasn’t interested in.  So I don’t think you’re going to succeed if what you’re doing all day doesn’t interest you.  You’ve got to find something you’re interested in because it’s just too much to expect of human nature that you’re going to be good at something that you really dislike doing.  And so that’s one big issue.  And of course you have to play in a game where you’ve got some unusual talents.  If you’re 5 foot 1, you don’t want to play basketball against some guy whose 8 feet 3.  It’s just too hard.  So you gotta’ figure out a game where you have an advantage and it has to be something that you’re deeply interested in.  Now you get into the ethical side of life, well of course you want to be ethical.  On the other hand, you can’t be just dreaming how you think the world should be run and that it’s too dirty for you to get near it.  You can get so consumed by some ideological notion particularly in a left-wing university.  It’s like you think you’re handling ethics and what you’re doing is not working.  And maybe smoking a little pot to boot.  This is not the Munger system.

My hero is Maimonides.  And all that philosophy and all that writing, he did after working 10 or 12 hours a day as a practicing physician all his life.  He believed in the engaged life.  And so I recommend the engaged life.  You spend all your life thinking about some politician who wants it this way or that way you’re sure you know what’s right, you’re on the wrong track.  You want to do something every day where you’re coping with the reality.  You want to be more like Maimonides and less like Bernie Sanders.

Question 10: Is American Express value proposition more in terms of payment or service and rewards?

Charlie: Well I’m going to give you an answer that will be very helpful to you because you’re somewhat confused about what the exact future of American Express will be…and I want to tell you, I’m confused too.  I think that if you understand exactly what’s going to happen to payment systems ten years out, you’re probably under some state of delusion, it’s very hard to know.  So if you’re confused, all I can say is “welcome to the club”.  They’re doing the best they can, they’ve got some huge advantages that they’re…it’s a reasonable bet.  But nobody knows.  I don’t know if IBM is going to sell that much of Watson.  I always say I’m agnostic on the subject.  You’re talking about payment system 10 years out, I’m agnostic on that too.  I think if you keep trying to do the right thing and you play the game hard, your chances are better.  But I don’t think those thing are knowable.  Think about how fast they changed.

Question 11: Do you think that domestic natural gas, exploration and production, is a good business despite the capital intensity?

Charlie: Well that’s a different subject, I have a different feeling about the energy business than practically anyone else in America.  I wish we weren’t producing all this naturally gas.  I would be delighted to have the condensate that’s coming out of our shale deposits just lie there untapped for decades in the future and pay a bunch of Arabs to use up their oil.  But nobody else in America seems to feel my way.  But I’m into deferred gratification.  Oil and gas is not going away and I think it’s just as important as the top soil in Iowa.  If any of you said, “oh goodie, I found a way to make money, we’ll ship all our top soil from Iowa to Greenland!”  I wouldn’t think that was a very good idea.  And so I don’t think that hastening to use up all of our oil and gas is a good idea.  But I’m practically the only one in the country that feels that way.  There’s not enough deferred gratification in it to please me.  But I don’t see any advantage…I regard our oil and gas reserves just as chemical feed stocks that are essential in civilization. (Leave aside) their energy content.  I’d be delighted to use them up more slowly.  By the way, I’m sure I’m right and the other 99% of the people are wrong.

But no, I don’t know…The oil and gas business is very peculiar.  The people who success in most other businesses are doing way more physical volume than they did in the past.  But a place like Exxon, the physical volume goes down by two thirds, it’s just that the price of oil goes up faster than the physical volume goes down.  That is a very peculiar way to make money.  And it may well continue, but it’s confusing, we’re not use to it.

Question 12: As an 18 year old interested in many disciplines, I was wondering how you can thrive as a polymath in a world that celebrates specialization.

Charlie: Well that’s a good question.  I don’t think operating over many disciplines as I do is a good idea for most people.  I think it’s fun, that’s why I’ve done it.  I’m better at it than most people would be.  And I don’t think I’m good at being the very best for handling differential equations.  So it’s in a wonderful path for me, but I think the correct path for everybody else is to specialize and get very good at something that society rewards and get very efficient at doing it.  But even if you do that, I think you should spend 10 or 20% of your time into trying to know all the big ideas in all the other disciplines.   Otherwise…I use the same phrase over and over again…otherwise you’re like a one legged man in an ass-kicking contest.  It’s just not going to work very well.  You have to know the big ideas in all the disciplines to be safe if you have a life lived outside a cave.

But no, I think you don’t want to neglect your business as a dentist to think great thoughts about Proust.

Question 13: Question about Lollapalooza effects.  What current event is causing you concern and how can you use that inter-disciplinary approach to spot them?

Charlie: Well, I coined that term the “Lollapalooza effect” because when I realized I didn’t know any psychology and that was a mistake on my part, I bought the three main text books for introductory psychology and I read through them.  And of course being Charlie Munger, I decided that the psychologists were doing it all wrong and I could do it better.  And one of the ideas that I came up with which wasn’t in any of the books was that the Lollapalooza effects came when 3 or 4 of the tendencies were operating at once in the same situation.  I could see that it wasn’t linear, you’ve got Lollapalooza effects.  But the psychology people couldn’t do experiments that were 4 or 5 things happening at once because it got too complicated for them and they couldn’t publish.  So they were ignoring the most important thing in their own profession.  And of course the other thing that was important was to synthesize psychology with all else.   And the trouble with the psychology profession is that they don’t know anything about ‘all else’.  And you can’t synthesize one thing you know with something you don’t if you don’t know the other thing.  So that’s why I came up with that Lollapalooza stuff.  And by the way, I’ve been lonely ever since. (laughter)  I’m not making any ground there.  And by the way, I’m totally right.

Question 14: My question relates to a comment you made some years ago about Warren Buffett.  I think you said that he has become a significantly better investor since he turned 65, which I found a remarkable comment.  I was wondering if you could share information about that, that maybe we haven’t heard before.  I know you’ve commented he’s a learning machine and we all know the aversion to retail that came out of the Diversified episode, and so on.  I’d just be interested if there’s something that’s changed about his risk assessment or his horizons or any color there would be fantastic to hear.  Thank you.

Charlie: Well, if you’re in a game and you’re passionate about learning more all the time and getting better and honing your own skills all the time, etc. etc.  Of course you do better over time.  And some people are better at that than others.  It’s amazing what Warren has done.  Berkshire would be a very modest company now if Warren never learned anything.  He never wouldn’t have never given anything back. I mean any territory he took he was going to hold it.  But what really happened was, we went out into the new fields of buying whole businesses and we bought into things like Iscar that Warren never would have bought when he was younger. Ben Graham would have never bought Iscar.  He paid 5 times book or something for Iscar.  It wasn’t in the Graham play.  And Warren who learned under Graham, just, he learned better over time.  And I’ve learned better.  The nice thing about the game we’re in, is that you can keep learning.  And we’re still doing it.  Imagine we’re in the press…for all of a sudden (buying) airline stocks?  What have we said about the airline business?  We thought it was a joke it was such a terrible business.  And now if you put all of those stocks together we own one minor airline.  We did the same thing in railroads, we said “railroads are no damn good, you know there’s too many of them, truck competition…”  And we were right it was a terrible business for about 80 years.  But finally they got down to four big railroads and it was a better business.  And something similar is happening in the airline business.

On the other hand, this very morning I sat down in my library with my daughter-in-law and she booked a round trip ticket to Europe including taxes, it was like 4 or 5 hundred dollars.  I was like, “we’re buying into the airline business?” (laughter)  It may work out to be a good idea for the same reason that our railroad business turned out to be a good idea, but there’s some chances it might not.  In the old days, I frequently talked to Warren about the old days, and for years and years and years, what we did was shoot fish in a barrel.  But it was so easy that we didn’t want to shoot at the fish while they were moving.  So we waited until they slowed down and then we shot at them with shotgun.  It was just that easy.  And it has gotten harder and harder and harder.  And now we get little edges…before, we had totally cinches.  It isn’t any less interesting.  We do not make the same returns we made when we could run around and pick this low hanging fruit off trees that offered a lot of it.

So now we go into things…We bought the Exxon position…You know why Warren bought Exxon?  As a cash substitute!  You would never have done that in the old days.  We had a lot of cash and we thought Exxon was better than cash over the short term.  That’s a different kind of thinking from the way Warren came up.  He’s changed.  And I think he’s changed when he buys airlines.  And he’s changed when he buys Apple.  Think of the hooting we’ve done over the years about high tech, ‘we just don’t understand it’, ‘it’s not in our central competency’, ‘the worst business in the world is airlines’.  And what do we appear in the press with?  Apple and a bunch of airlines.  I don’t think we’ve went crazy.  I think the answer is, we’re adapting reasonably to a business that’s gotten very much more difficult.  And I don’t think we have a cinch in either of those positions.  I think we have the odds a little bit in our favor.  And if that’s the best advantage we can get, we’ll just have to live on the advantage we can get.  I use to say you have marry the best person that will have you, and I’m afraid that’s a  rule of life.  You have to get by in life with the best advantage you can get.  And things have gotten so difficult in the investment world that we have to be satisfied with the type of advantage that we didn’t use to get.  On the other hand the thing that caused it to be so enormously difficult was when we got so enormously rich.  And that’s not a bad trade off.

Question 15: At last year’s meeting you said Donald Trump was not morally qualified to be President, and now that he is President, do you still agree with that, do you think he’s qualified in any capacity?

Charlie: Well I’ve gotten more mellow. (laughter)  I always try and think about the good as along with what’s not good.  And I think some of this stuff where they’re re-examining options about the whole tax system of the country, I think that’s a very constructive thing.  When Donald Trump says he wouldn’t touch Social Security when a lot of highfalutin Republicans have all kinds of schemes for (rising) Social Security, I’m with Donald Trump.  If I were running the world I would have his exact attitude about Social Security.  I wouldn’t touch it.  So he’s not wrong on everything and just because he isn’t like us…roll with it.  Accept a little danger.  What the hell, you’re not going to live forever at any how.

Question 16: What was the most meaningful thing you did with your life?

Charlie: Well, I think the family and children is the most meaningful thing most people do with their life.  And I’ve been reasonably fortunate…I don’t think I’ve been a perfect husband. I’m lucky to have had as much felicity as I got.  And I always needed a certain amount of toleration from the fair sex.  I started wrong and I never completely fixed myself.  I can tell this group…you come here as a cult to talk to a cult-leader?  I want to take you back in history, you’ll see what an inferior person you’re now trusting.

When I was a freshman in Omaha Central High, there was a friend of the family, a girl my age.  She had gone off to summer camp the year before and she met a blonde goddess.  A voluptuous 13 year old.  And I was a skinny under-developed whatever and so forth. ‘You gotta take my blonde goddess to this dance’.  And so I wanted to impress this ‘blonde goddess’ and so I pretended to smoke which I didn’t.  And she was wearing a net dress and I set her on fire!  (big laughter) But I was quick whittled and I through Coca-Cola all over her and in due time the fire was out.  And that’s the last I saw of the blonde goddess.

And then I said, ‘well I’ve gotta make more time with the girls’.  And I wanted to get a letter at Omaha Central High.  Of course I was no good at any sport.  So I went down to the rifle range and learned they gave letters in rifle shooting.  And I was so skinny that I could shoot a 100 in the sitting position by sitting cross-legged and putting one elbow on each foot.  Try it, you’ll break your neck.  But I could shoot a hundred every time.  So I was a good rifle shooter and they gave me a letter.  But I was so skinny and short and underdeveloped that it went from one arm pit to the other.  And I walked down the hallway trying to impress the girls and they wouldn’t turn their head.  What they said was, ‘how did a skinny little unattractive runt like that get a letter?’

And then I had another experience.  There was a girl I still remember, Zibby Bruington.  She was a senior and a very popular senior.  And I was a nerd sophomore.  And somehow she agreed with me to go to a party in one of the out-buildings at the Omaha Country Club.  Perhaps because she liked one of my friends who was a big strapping fellow.  So I took Zibby to this party in my 1934 Ford, and it sleeted and got rainy, and so forth.  And I managed to stick the Ford in the mud and I couldn’t get out of it.  And Zibby and I had to walk for several miles through sleet.  That was the last I ever saw of Zibby Bruington.  And then my car stayed in the mud and I neglected to put in anti-freeze and the temperature went way down suddenly and the block broke!  Because it was too expensive to fix.  I lost my car and my father wouldn’t by a new one because my father said, ‘why should I buy a new car for someone whose dumb enough not to put anti-freeze in it?’  This is the person you’re coming all this way to see!

My life is just one long litany of mistakes and failure.  And it went on and on and on.  And politics!  I ran to be the president of the DSIC in grade school, The Dundee School Improvement Association.  I had the most popular boy in school as my campaign manager.  I came in second by miles.  I was a total failure in politics.  There’s hardly anything I succeeded at.  Now, I tell you all this because I know a nerd when I see one.  And there are a lot of nerds here who can tell stories like mine. (big laughter)  And I want to feel it’s not hopeless.  Just keep trying.

Oh yeah, Guerin wants me to repeat the story of Max Plank.  According to the story, Max Plank when he won the Nobel Prize was invited to run around Germany giving lectures.  And a chauffeur drove him.  And after giving the lecture about 20 times, the chauffeur memorized it.  And he said, ‘you know Mr. Plank, it’s so boring, why don’t you sit in the audience and I the chauffeur will give your talk.’  And so the chauffeur got up and gave Max Plank’s talk on physics and some professor got up and asked some terrible question.  And the chauffeur said, ‘Well I’m surprised that in an advanced city like Munich, people are asking me elementary questions like that.  I’m going to ask my chauffeur to answer that!’ (laughter)

While I’m telling jokes I might tell one of my favorite stories about the plane that’s flying over the Mediterranean.  The pilots voice comes on and says, ‘A terrible thing just happened.  We’re losing both engines, we’re going to have to land in the Mediterranean.’  And he says, ‘The plane with stay afloat for a very short time, and we’ll be able to open the door just long enough so that everybody can get out.  We have to do this in an orderly fashion.  Everybody who can swim go to the right wing and stand there.  And everybody who can’t swim go to the left wing and just stand there.  Those of you on the right wing, you’ll find a little island in the direction of the sun.  It’s two miles off.  And as the plane goes under, just swim over to the island, you’ll be fine.  For those of you on the left wing, thank you for flying Air Italia.” (big laughter)

Question 17: With regard to the proliferation of index funds, do you think there will be an issue with liquidity any time we go through another large crisis?  Do you think that will create large discrepancies between the price of the index fund and the value of the securities underneath?

Charlie: Well, the index funds of the S&P is like 75% of the market.  So I don’t think the exact problem you’re talking about is going to be a big problem because you’re talking about the S&P index.  But.  Is there a point where index funds theoretically can’t work a course?  If everybody bought nothing but index funds, the whole world wouldn’t work as people expect.  There’s also the problem…one of the reasons you buy a big index like the S&P.  Is because if you buy a small index, and it gets popular, you have a self-defeating situation.  When the nifty-fifty were the rage, JP Morgan talked everybody into buying just 50 stocks.  And they didn’t care what the price was, they just bought those 50 stocks.  Of course in due time, their own buying forced those 50 stocks up to 60 times earnings.  Where upon it broke and everything went down by about two-thirds quite fast.  In other words, if you get too much faddishness in one sector or one narrow index, of course you can get catastrophic changes like they had with the nifty-fifty in that former era.  I don’t see that happening when the index is three-quarters of the whole market.

The problem is that the whole thing can’t work perfectly forever.  But it will work for a long time.  The indexes have caused just absolute agony among the intelligent investment professionals.  Because basically 95% of the people have almost no chance of beating it over time.  And yet all the people expect if they have some money, they can hire somebody who will let them beat the indexes.  And of course the honest sensible people know they’re selling something they can’t quite deliver.  And that has to be agony.  Most people handle that with denial.  They think if we’re better next year…they just don’t want to think about that.  I understand that, I mean I don’t want to think of my own death either.  But it’s a terrible problem beating those indexes.  And it’s a problem that investment professional get didn’t have in the past.  What’s happening of course is the prices for managing really big sums of money are going down, down, down, 20 basis points and so on.  The people who rose in investment management didn’t do it by getting paid 20 basis points.  But that’s where we’re going I think in terms of people who manage big portfolios of the American Equities in the equivalent of the S&P.  It’s a huge, huge, problem.  It makes your generation of money managers to have way more difficulties and causes a lot of worry and fretfulness.  And I think the people who are worried and fretful are absolutely right.

I would hate to manage a trillion dollars in the big stocks and try and beat the indexes.  I don’t think I could do it.  In fact if you look at Berkshire, take out a hundred decisions, which is like two a year.  The success of Berkshire came from two decisions a year over 50 years.  We may have beaten the indexes, but we didn’t do it by having big portfolios of securities and having subdivisions managing the drugs, and subdivisions…and so, the indexes are a hell of a problem for you people.  But you know, why shouldn’t life be hard?  It’s what had to happen, what’s happened now.  If you take these people doing some of those early trading by computer algorithms that worked.  Then somebody else would come in and do the same thing with the same algorithm and play the same game.  And of course the returns went down.  Well that’s what’s happening in the whole field.  The returns you’re going to get are being pushed down by the progress of the sons.

Question 18: First question: What books or experiences were most formative to you in your early career? Second question: Where and how do you tell your most ambitious grandchildren to look for business opportunities.

Charlie: Well I don’t spend any time telling my grandchildren what business opportunities to look for.  I don’t have that much hope. (laughter)  I’m going to have trouble getting my grandchildren to work at all!  Anyway, I don’t think there’s an easy way to handle a problem of doing better and better with finances.  Obviously if you’re glued together and honorable and get up every morning and keep learning every day and you’re willing to go in for a lot of deferred gratification all your life, you’re going to succeed.  It may not be as much as you want.  But you’re going to success.  And so the main thing is to just keep in there, and be glued together, and get rid of your stupidities as fast as you can.  And avoid the bad people as much as you can.  And you’ll do reasonably well.  But try teaching that to your grandchildren.  I think the only way you’ve got a chance is sort of by example.  If you want to improve your grandchildren the best way is to fix yourself.

Oh books.  You cultist send me so many books that I can scarcely walk into my own library.  So I’m reading so many now because I never throw one away, I at least scan it.

I’ve just read this new book by Thorp, the guy who beat the dealer in Las Vegas.  And then he did computer algorithm trading.  And I really liked the book.    For one thing, the guy had a really good marriage and he seemed grateful for it.  And it was touching.  For another he was a very smart man.  He was a mathematician using a high IQ, to A) beat the dealer in Las Vegas and so forth and the B) use these computer algorithms to do this massive trading.  I found it very interest and since some of you people are nerds, and maybe you might like a love story.  I recommend Thorp’s new book.

It’s an interesting thing to do to beat the dealer in Las Vegas…wearing disguises and so on.  And Peter Kaufman told me a story about somebody he knows that did the same thing as Thorp did, but he did it more extreme.  He wore disguises and so forth.  He won four million dollars I think, in the casinos.  And that was hard to do because casinos don’t like playing against people who might win.  And then he went into the stock market where he made four billion dollars!  Again, clever algorithms.  You know, these people are mathematically gifted.  It’s still going on.  And I don’t think many of you are going to do it.  There can’t be many people who are mathematically gifted enough, manipulate statistics and everything else so well that they find little algorithms that will make them four billion dollars.

But there are a few.  And so some of them started just like Thorp.  And so Thorp’s book is interesting.  So I recommend it for you.

Question 19: Question on Filial piety.  In this generation, how can we fulfill our filial duties?

Charlie: I like filial piety.  They worship old men.  Rich old men.  That is my kind of a system. (laughter) But I think the idea of caring about your ancestors and caring about your traditions, I think all that stuff is a big part of what’s desirable.  I really admire the Confucians for that notion that it’s not a game that’s played just in one life.  It’s a game where you’re handing the baton off and you’re accepting the baton from your predecessor.   So if filial piety is your game, why I think it’s a very good thing.  Think about how rootless we’d be if we had no families at all, no predecessors, no decedents, it would be a very different life.  Think what we owe to people who figure out things in the past that make our civilization work.  So I’m all for filial piety and its close cousins.

Question 20: You’ve said, “any year in which you don’t destroy one of your best loved ideas is a wasted year.” It’s well known that you helped coached Warren towards quality which was a difficult transition for him.  I was wondering if you could speak to the hardest idea that you’ve ever destroyed.

Charlie: Well I’ve done so many dumb things.  That I’m very busy destroying bad ideas because I keep having them.  So it’s hard for me to just single out from such a multitude.  But I actually like it when I destroy a bad idea because I think I’m on the…I think it’s my duty to destroy old ideas.  I know so many people whose main problem of life, is that the old ideas displace the entry of new ideas that are better.  That is the absolute standard outcome in life.  There’s an old German folk saying, “We’re too soon old and too late smart.”  That’s everybody’s problem.  And the reason we’re too late smart is that the stupid ideas we already have, we can’t get rid of!  Now it’s a good thing that we have that problem, in marriage that may be good for the stability of marriage that we stick with our old ideas.  But in most fields you want to get rid of your old ideas.  It’s a good habit and it gives you a big advantage in the competitive game of life…other people are so very bad at it.  What happens is, as you spout ideas out, what you’re doing is you’re pounding them in.  So you get these ideas and then you start agitating them and saying them and so forth.  And of course, the person you’re really convincing is you who already had the ideas.  You’re just pounding them in harder and harder.  One of the reasons I don’t spend much time telling the world what I think about how the federal reserve system should behave and so forth.  Because I know that I’m just pounding the ideas into my own head when I think I’m telling the other people how to run things.  So I think you have to have mental habits…I don’t like it when young people get violently convinced on every damn cause or something.  They think they know everything.  Some 17 year old who wants to tell the whole world what ought to be done about abortion or foreign policy in the middle east or something.  All he’s doing when he or she spouts about what he deeply believes is pounding the ideas he already has in, which is a very dumb idea when you’re just starting and have a lot to learn.

So it’s very important that habit of getting rid of the dumb ideas.  One of things I do is pat myself on the back every time I get rid of the dumb idea.  You could say, ‘could you really reinforce your own good behavior?’  Yeah, you can.  When other people won’t praise you, you can praise yourself.  I have a big system of patting myself on the back.  Every time I get rid of a much beloved idea I pat myself on the back.  Sometime several times.  And I recommend the same mental habit to all of you.  The price we pay for being able to accept a new idea is just awesomely large.  Indeed a lot of people die because they can’t get new ideas through their head.

Question 21A: My perception is that the (oil and gas) industry itself has continuously gotten more complex and technical, and as the economy expands and you have more division of labor and specialization, it seems to me that it can be very hard for investors unless there’s more specialization.  (Charlie interjects)

Charlie: Of course.

Question 21B: Do you think that capital allocators are going to need to become more specialized going forward?

Charlie: Well you petroleum people of course have to get more specialized because the oil is harder to get and you have to learn new tricks to get it.  And so you’re totally right.  Generally, specialization is just the way to go for those people.  It’s just I have an example of something different.  It’s awkward for me because…but I don’t want to encourage people to do it the way I did because I don’t think it will work for most people.  I think the basic ideas of being rational and disciplined and deferring gratification, those will work.  But if you want to get rich the way I did, by learning a little bit about a hell of a lot, I don’t recommend it to others.

Now I’ve get a story there that I tell.  A young man comes to see Mozart, and says, “I want to compose symphonies.”  And Mozart says, “You’re too young to compose symphonies.”  He’s 20 years old and the man says, “But you were composing symphonies when you were 10 years old.”  And Mozart says, “Yeah but I wasn’t running around asking other people how to do it.”

I don’t think I’m a good example to the young.  I don’t want to encourage people to follow my particular path. I like all the general precepts, but I would not…if you’re a proctologist, I do not want a proctologist who knows Schopenhauer, or astrophysics.  I want a man whose specialized.  That’s the way the market is.  And you should never forget that.  On the other hand, I don’t think you’d have much of a life if all you did was proctology. (laughter)

Question 22: Warren and you are known for saying that if you worked with a small sum of capital, $10 million, Warren publicly said that he could guarantee that he could compound that at 50%  a year.  So my question is, can you provide some examples?  And I would kindly ask that you provide as many examples as possible, and be specific as possible.

Charlie: Well, the minute I hear somebody that really wants to get rich, at a rapid rate, with specifics.  That is not what we try and do here.  We want to leave some mystery so that you yourself can amuse yourself finding your own way.  You know the good ideas that I’ve had in my life are quite few.  But the lesson I can give you is a few is all you need and don’t be disappointed.  When you find the few of course, you’ve got to act aggressively.  That’s the Munger system.  And I learned that indirectly from a man I never met.  Which was my Mother’s maternal grandfather.  He was a pioneer when he came out to Iowa and fought in the Blackhawk Wars and so on.  And eventually after enormous hardship, well he was the richest man in town and he owned the bank and so on.  As he sat there in his old age, my mother knew him because she’d go to Algona, Iowa where he lived and had the big house in the middle of town.  Iron fence, capacious lawns, big barns.  What Grandpa Ingham use to tell her is, ‘there’s just a few opportunities you get in a whole life’.  This guy took over Iowa when the black topsoil in Iowa was cheap.  But he didn’t get that many opportunities.  It was just a few that enabled him to become prosperous.  He bought a few farms every time there was a panic you know.  And leased them to thrifty Germans, you couldn’t lose money with leasing a farm to a German in Iowa.  But he only did a few things.  And I’m afraid that’s the case…you’re not going to find a million wonderful ideas.  These people with the computer algorithms do it, but they have a computer sifting the who world.  It’s like placer mining.  And of course every niche they’re in, if somebody else comes in, the niche starts leaching away.  And I don’t think it’s that honorable to make a living that way.  I’d rather make my money in some other way than outsmarting the trading system so I have a little computer algorithm that just leaches a little out of everybody’s trade.  I always say that those people have all the social utility of a bunch of rats in a granary.  It’s not that great a way to make money.  I would say if you make your money that way that you should be very charitable with it because you’ve got a lot to atone for. (laughter) I don’t think it’s an ambition we should encourage.

The rest of us who aren’t just leaching a little off the top because we’re great at computer science, and that’s what this room is full of.  And if you’re not finding it harder now, you don’t understand it.  That’s my lesson.

Question 23: What’s your favorite industry and why is it your favorite?

Charlie: Well, my favorite industry is taking care of my own affairs. (laughter) And it’s fun it’s creative, it’s the job that life has given me, and I think that you should do the job well that life gives you.  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.

Question 24: Is there any current monkey-business in corporate America that worries you?

Charlie: Well the answer is yes, but not as extreme as Valeant.  That was really something.  That was really something.  I probably should have done that. (laughter)  But you people come so far, and since you’re cult members you like being here.  And I feel an obligation to tell you something sort of interesting and I just went straight into Valeant that year.  It was really pretty disgusting.  What’s interesting is how many high-grade people that took in.  It was too good to be true.  There was a lot wrong with Valeant.  It was so aggressive.  It was drugs people needed.  It was just…take the difference between Valeant and the Daily Journal Company.  When the foreclosure boom came, we had 80% of the foreclosure business in our area.  It’s a big area, Southern California and Northern California too.  It would have been very easy for us to raise the prices and make, I don’t know, $50 million more or something like that, when all these people are losing their houses.  A lot of them are very decent people.  It didn’t ever…the idea that just right in the middle of that we’d make all the money we could?  Which some of our competitors did by the way.  We just didn’t do it.  I don’t think capitalism requires that you make all the money that you can.  I think there are times when you should be satisfied based on...just ideas of decency And at Valeant they just look at it like a game like chess.  They didn’t think about any human consequences, they didn’t think about anything but getting what they wanted which was money and glory.  And they just stepped way over the line.  And of course in the end they were cheating.

But I don’t have a new one.  I got a lot of publicity over that Valeant thing.  I’m not looking for…I don’t want this room to have twice as many people next year.  And I don’t want me not to be here either. (laughter)

Question 25: My question relates to a talk you gave to the foundation of financial officers in 1998 here in California.  And in that talk, you were critical of the complexity and the expense of many foundation portfolios and you said specifically, “An institution with almost all wealth invested long-term in just three fine domestic corporations, is securely rich.”  And you gave as your example the Wicker Foundation and Coca-Cola.  So if you had a foundation today with let’s say a billion dollars, would you be comfortable with it being invested in just three stocks?

Charlie: Well, let’s take the foundation…I’ll change your question around (in the way that I want to answer it). (laughter)  Am I comfortable with a non-diversified portfolio?  Of course…if you take the Munger’s, I care about the Munger’s.  The Munger’s have three stocks.  We have a block of Berkshire, we have a block of Costco, we have a block of Li Lu’s fund, and the rest is dribs and drabs.  So am I comfortable?  Am I securely rich?  You’re damn right I am.  Could other people be just as comfortable as I who didn’t have a vast portfolio with a lot of names in it?  Many of whom neither they or their advisors understand? Of course they’d be better off if they did what I did.  And is three stocks enough?  What are the chances that Costco’s going to fail?  What are the chances that Berkshire Hathaway’s going to fail?  What are the chances that Li Lu’s portfolio in China’s going to fail?  The chances that any one of those things happening is almost zero.  And the chances that all three of them are going to fail?

That’s one of the good ideas I had when I was young.  When I started investing my little piddly savings as a lawyer,  I tried to figure out how much diversification I would need if I had a 10% advantage every year over stocks generally.  I just worked it out.  I didn’t have any formula, I just worked it out with my high school algebra.  And I realized that if I was going to be there for thirty or forty years, I’d be about 99% sure to do just fine if I never owned more than three stocks and my average holding period is 3 or 4 years.  Once I’d done that with my little pencil, I just…I never for a moment believed this balderdash they keep…why diversification…diversification is a rule for those who don’t know anything.  Warren calls them ‘know-nothing investors’.  If you’re a ‘know-nothing investor’ of course you’re going to own the average.  But if you’re not a know-nothing investor, if you’re actually capable of figuring out something that will work better, you’re just hurting yourselves looking for fifty when three will suffice.  Hell one will suffice if you do it right.  One.  If you have one cinch, what else do you need in life.

And so the whole idea that the ‘know-something’ investor needs a lot of diversification.  To think that we’re paying these investors to teach this crap to our young.  And people think they should be paid for telling us to diversify.  Where it’s right, it’s an idiot decision.  And where it’s wrong, you shouldn’t be teaching what’s wrong.  What’s gone on in corporate finance teaching is that people are getting paid for dispensing balderdash.  And since I never believed that it was a great help to me, it helps if you’re out in the market and the other people are believing balderdash and you know what the hell’s going on.  It’s a big help.  So of course you don’t want a lot…if you’re Uncle Horace who has no children has an immense business which is immensely secured and powerful.  And he’s going to leave it all to you if you come to work in the business.  You don’t need any diversification.  You don’t need any corporate finance professors, you should go to work for Uncle Horace.  It’s a cinch.  You only need one cinch!  And sometimes the market gives you the equivalent of an Uncle Horace.  And when it does, step up to the pie-cart with a big pan.  Pie carts like that don’t come very often.  When they do you have to have the gumption and the determination to seize the opportunity shrewdly.  I was lucky.  Imagine learning that from your dead great-grandfather, at a very young age.  But you know I spent my whole life with dead people.  They’re so much better than many of the people I’m with here on earth.  All the dead people in the world, you can learn a lot from them.  And they’re very convenient to reach.  You reach out and grab a book.  None of those problems with transportation. So I really recommend making friends among the immanent dead.  Which of course I did very early.  And it’s been enormously helpful.  Some of you wouldn’t have helped me.  But Adam Smith really did.

Question 26: Question on Irish economy and Irish banking.  Berkshire Hathaway was a shareholder in Irish banks pre-2008.  Could you comment on how the Irish economy and Irish banking system proceeds with the U.K. not being part of the European Union going forward.

Charlie: Well, that of course was a mistake, and it was a mistake we shouldn’t have made because both Warren and I know that you can’t really trust the figures put out by the banking industry.  And the people who run banks are subject to enormous temptations that lead them astray because it’s easy to make a bank report more earnings.  By a thing that any idiot could do which is make it a little more gamey.  And of course that’s dangerous.  And the temptation are very great.  So we shouldn’t have made that mistake, but we did.  And that’s a good lesson too, that even if you’re really good at something you will occasionally drift into a dumb mistake.  And now that’s the question about the bank.  They went crazy in Ireland…the bankers.  And we went crazy when we trusted the damn statements.  And it was a mistake.

Now what Ireland has done was very smart…in reducing all of these taxes.  Now they have English speaking people with practically no taxes.  And there’s a fair amount of charm and so forth in Ireland.  It’s not like it’s a terrible place to be.  They just sucked in half the world into Ireland where they got these…Gates went there very early with Microsoft, and so on.  And they took a place that was really a backward place that had a sort of internal civil war for 60 or 70 years, and bad opportunities, and they really brought in a lot of prosperity.  And they did that by this competitive lowering of taxes and so on.  So it worked for Ireland.  I think Ireland deserves a lot of credit for the way they advanced their country.  And of course they were going to have a thing where all the countries keep trying to reduce their taxes to suck in the foreign…but it won’t work for everybody.  But it did work for Ireland.  I think Ireland deserves a lot of credit, and of course they recovered very well from a very major collapse.  Irish are like the Scottish.   I always think that those Gallic’s are pretty unusual people.  And I’m very glad that I had a Scottish-Irish great-grandmother.

Question 27: My question is in regards to Lee Kuan Yew.  You’ve on several occasions spoken about the economic miracle that is Singapore and how it’s been transferred on by Deng Xiaoping to China.  What are your thoughts about India that’s going through a similar change with the prime minister who also idolizes his people and wants to create a similar sort of situation.  I’d like you’re thoughts on that.  Thank you.

Charlie: Well that’s a very intelligent question, and I’m not saying all the other questions weren’t. (laughter)  I regard Lee Kuan Yew…may have been the best nation builder that ever lived.  He took over a malarial swamp with no assets.  No natural resources.  Surrounded by a bunch of Muslims who hated him.  In fact he was spat out by a Muslims country.  They didn’t want a bunch of damn Chinese in their country.  That’s how Singapore was formed as a country, the Muslims spat it out.  And so hay, here he is, no assets, no money, no nothing.  People were dying of malaria.  Lots of corruption.  And he creates in a very short time, by historical standards, modern Singapore.  It was a huge, huge, huge success.  It’s such a success that there’s no other precedent in the history of the world that is any stronger.  Now China’s more important because there are more Chinese, but you can give Lee Kuan Yew a lot of the credit for creating modern China.  Because a lot of those pragmatic communist leaders, they saw a bunch of Chinese that were rich when they were poor, and they said, ‘to hell with this!’  Remember the old communist said, ‘I don’t care whether the cat is black or white, I care whether he catches mice.’  And he wanted some of the success that Singapore got and he copied the playbook.  So I think the communist leadership that copied Lee Kuan Yew was right, I think Lee Kuan Yew was right.  And of course I have two busts of somebody else in my house.  One is Benjamin Franklin, and the other is Lee Kuan Yew.  So, that’s what I think of him.

Now you turn to India.  And I would say, I’d rather work with a bunch of Chinese than I would the Indian civilization mired down, case system, over-population, assimilated the worst stupidities of the democratic system, which by the way Lee Kuan Yew avoided, it’s hard to get anything done in India.  And the bribes are just awful.  So all I can say is, it’s not going to be easy for India to follow the example of Lee Kuan Yew.  I think that India will move ahead.  But it is so defective as a get-ahead…the Indians I know are fabulous people.  They’re just as talented as the Chinese, I’m speaking about the Indian populace.  But the system and the poverty and the corruption and the crazy democratic thing where you let anybody who screams stop all progress?  It mires India with problems that Lee Kuan Yew didn’t have.  And I don’t think those Indian problems are always easy to fix. Let me give you an example. The Korean steel company, POSCO, invented a new way of creating steel out of lousy iron ore and lousy coal.  And there’s some province in India that has lots of lousy iron ore and lot of lousy coal.  Which is there’s not much use for.  And this one process would take their lousy iron ore and the coal and make a lot of steel.  And they got a lot of cheap labor.  So POSCO and India were made for each other.  And they made a deal with the province to get together and use the POSCO know how and the India lousy iron ore and lousy coal.  And 8 or 9 or 10 years later with everybody screaming and objecting and farmers lying down in the road, or whatever’s going on, they canceled the whole thing.  In China they would have just done it.  Lee Kuan Yew would have done it in (Singapore).  India is grossly defective because they’ve taken the worst aspects of our culture, allowing a whole bunch of idiots to scream and stop everything. And they copied it!  And so they have taken the worst aspects of democracy and they forged their own chains and put them on themselves.  And so no I do not like the prospects of India compared to the prospects of…and I don’t think India’s going to do as well as Lee Kuan Yew.

Question 28: What happened 1973 and 1974 when your investment firm lost over half?

Charlie: Oh, that’s very simple.  That’s very easy.  That’s a good lesson.  That’s a good question.  What happened is the value of my partnership where I was running, went down by 50% in one year.  Now the market went down by 40% or something.  It was a once in 30 year recession.  I mean monopoly newspapers are selling at 3 or 4 times earnings.  At the bottom tick, I was down from the peak, 50%.  You’re right about that.  That has happened to me 3 times in my Berkshire stock.  so I regard it as part of manhood.  If you’re going to be in this game for the long pull, which is the way to do it, you better be able to handle a 50% decline without fussing too much about it.  And so my lesson to all of you is conduct your life so that you can handle the 50% decline with aplomb and grace.  Don’t try to avoid it. (applause)  It will come.  In fact I would say if it doesn’t come, you’re not being aggressive enough.

Question 29: Regarding biases of human misjudgment.  How do you evaluate, handle, and manage people, knowing they might exhibit and suffer from biases that you are not?  And how have you and Mr. Buffett become such good judges of character and not just skills and abilities?

Charlie: Well I think partly we look smart because we pick such wonderful people to be our partners and our associates, even our employees.  And that’s going on right here.  Gerry Salzman is not normal.  He looks normal, but he’s a damn freak.  Gerry does things across 2 or 3 disciplines that are almost beyond human.  And he’s always been that way.  By the way he’s just another mid-westerner.  He’s come out of the soil back there.  So we’ve been very lucky to have his wonderful people.  I wish…I’m not quite sure…I think one thing we’ve done that’s helped us to get wonderful people, I always say the best way to get a good spouse is to deserve one.  And the best way to get a good partner is to be a good partner yourself.  And I think Warren and I have both done good with that.  But whatever the reason we’ve had these marvelous partners, and they make us look a lot better than we are.  You wouldn’t even be here if Gerry Salzman weren’t here.  We did not have a number two choice to run the Daily Journal.  And by the way that happens to me all the time.  We have an executive search or something.  The difference between the number one and number two is like going off a cliff.   And we really…we need one, but there aren’t three good ones to pick, where they’re all good and one’s a little better.  Every executive search I’ve have, it seems there’s one guy whose fine and everybody else is a pigmy.  I think good people are hard to find.  And people like Warren and I have had wonderful people who we’ve worked with all our lives time after time.  That’s one of the reasons Warren says he tap dances to work…you’d tap-dance too if you interfaced with people Warren interfaced with all day.  They’re wonderful people and they win all the time instead of losing.  Who doesn’t like winning in good company?  If you can duplicate that, why you’ve got a great future.  I think we were a little lucky.  And I can’t give you any luck.

Question 30: We have a Chinese platform that focuses content on people trying to invest capital outside of China.  They haven’t been able to invest (outside China) because of capital controls.  But that day will come.  Since they’re at least a half-century behind in terms of investing.  What would be the first thing that you would tell the Chinese person who wants to invest in the U.S.?  What should they do with their money when they’re making their initial investment outside.

Charlie: Well, you’ve made an assumption I don’t follow.  If I were a Chinese person of vast intellect, talent,  discipline, all the good qualities…I would invest in China, not the United States.  I think the fruit is hanging lower there.  And some of the companies are more entrenched.  So I don’t agree with your proposition.  I think they have a tendency to think, ‘we were backwards therefore when we get rich, we should go over and invest in America.’  I think it’s always a mistake to look for a pie in the sky when you’ve got a big piece of pie right in your lap.  And so if I were…at current prices, I think an intelligent person would do better investing in China.

Question 31: You’ve said, everyone should spend 10-20% on some big ideas.  What are one or two big ideas that you are talking about. Meaning, specialize, but spend time working on some big ideas.

Charlie: Well the big ideas, I think you should be intelligent in improving yourself.  You’re way better to take on a really big important idea that comes up all the time than some little tiny idea that you might not face.  I always tried to grab the really big ideas in every discipline.  Because, why piddle around with the little ones and ignore the big ones.  Just all the big ideas in every discipline are just very, very, very useful.  Frequently, the problem in front of you is solvable if you reach outside the discipline you’re in and the idea is just over the fence.  But if you’re trained to stay within the fence you just won’t find it.  I’ve done that so much in my life it’s almost embarrassing.  And it makes me seem arrogant because I will frequently reach into the other fellows discipline and come up with an idea he misses.  And when I was young it caused me terrible problems.  People hated me.  And I probably shouldn’t have been as brash as I was.  And I probably wouldn’t be as brash as I am now.  I haven’t completed my self-improvement process.  But, it’s so much fun to get the right idea a little outside your own profession.  So if you’re capable of doing it, by all means learn to do it.  Even if you just want to learn it defensively.  I do not observe professional boundaries.  My doctor constantly writes, PSA test, prostate specific antigen, and I just cross it out. And he says, ‘What the hell are you doing?  Why are you doing this?’  And I say, ‘Well I don’t want to give you an opportunity to do something dumb.  If I’ve got an unfixable cancer that’s growing fast in my prostate I’d like to find out 3 months in the future, not right now.  And if I got one that’s growing slowly, I don’t want to encourage a doctor to do something dumb and intervene with it.  So I just cross it out.’  Most people are not crossing out their doctor’s prescriptions, but I think I know better. I don’t know better about the complex treatments and so forth.  But I know it’s unwise for me to have a PSA test.  So I just cross it out.  I’m always doing that kind of thing.  And I recommend it to you when you get my age.  Just go cross out that PSA test.  Now the women I can’t help.

Question 32A: How would you invest in a money manager you like?  Through a limited partnership, that would flow through the taxes, and the other way is through a corporation that would pay taxes on the gains and the dividends.  So basically, the corporation would serve no other function though than paying taxes.  So I think you’d be crazy to say that those two ways are equally desirable. (Charlie interjects)

Charlie: You’re certainly right about that.  It’s plumb crazy, and it’s exactly the way people who buy Berkshire are investing.  It’s plumb crazy to have a big common stock portfolio in a corporation and pay taxes compared to a partnership that doesn’t.  And that’s just the way the Berkshire shareholders have invested and they have made, whatever it is, 25% a years since we were there.  But you’re right, it’s not the logical way to do it.

Question 32B: So my question is, if you have to decide, to invest in pool A or pool B, how would you decide on what method you would use to figure out what discount would make you indifferent to whether you would invest in the corporate tax-paying structure when it flows to the… (Charlie interjects)

Charlie: I think it is totally asinine to invest in a portfolio of common stocks through a corporate taxed under the internal revenue code under sub chapter c or something.  It’s totally asinine.  At Berkshire, the public securities keep going down and down as a percentage of the total value, so it doesn’t matter, we’re getting to be sort of a normal corporation.  But I don’t think anybody’s right mind should invest through a corporation in a puddle of securities.  In fact the disadvantage is so horrible.  And so, I wouldn’t even consider it.  In other words…and I regard it as a minor miracle that we were able to get where we did.  So of course you’d invest in a partnership.

Question 33C: So when anyone who invests in Berkshire has to decide the discount to put on a pool of securities that has a future tax lien on the gains…do you have any mental model for…

Charlie: Yeah, my model is to avoid it.  We don’t want to invest in a portfolio of securities in somebody else’s corporation.  You’re totally right.  Which you already knew by the way.

Question 34: What’s your new findings of China?  Also, what’s your take on Ray Dalio’s statement that the U.S. election could unleash a new animal spirit which could lead to a better U.S. economy?  Do you buy this theory?

Charlie: Well, I’m not sure I understood that completely, but I’ll do my best.  What I like about China is that they have some companies that are very strong and still selling at low prices.  And the Chinese are formidable workers and they make wonderful employees.  There’s a lot of strength in that system.  And the Chinese government really tries to help its businesses, it is not behave like the government of India which I don’t think runs it’s country right at all.  And so, that’s what I like about China.  Or course I have to admire taking a billion and half people in a state of poverty up that fast.  That was never done in the history of the world.  And I admire the…you go to China and all the bullet trains go right to the heart of the city…what they’ve done is just an incredible achievement.  And they’ve done it not by borrowing money from Europe the way we did when we came up.  They have taken a poor nation with a lot of poverty and what they did is save half their income when they were poor and drive their nation way up with a lot of deferred gratification.  So it was unbelievably admirable and unbelievably effective.  So I admire that part of the Chinese picture.  China has one problem.  The problem with the Chinese people is they like to gamble and they actually believe in luck.  Now that is stupid.  What you don’t want to believe in is luck, you want to believe in odds.  And China there’s some reason in the culture, too many people believe in luck and gamble.  And that’s a national defect.

Question 35: If the world changes a lot in my lifetime, by the time I’m closer to your age, what do you think will not change about what makes a good successful business?

Charlie: What will not change is that it won’t be that damned easy.  There will be lots of…people will die that you love.  You’ll have close breaks where it goes against you.  There’s a lot of trouble that’s sure to come.  And at the end you’ll know that it’s all over, and that’s the game.  It’s a very funny game when you know when you start you have to lose.  See a dog doesn’t have to do that.  We know from the start we can’t win.  (Somebody) said the law of thermodynamics ought to be restated.  You can’t win, you must lose and you can’t get out of the game.  So we all face this ultimate difficultly. But once you’ve accepted the limitations, you’ve got the problem, how to get through your allot and expand reasonably well.  And I don’t think that’s that hard to figure out.  Because if you do pretty well, considering what you started with an so forth.  And you stand at the end and you’ve done credibly, you’ve helped other people who needed help because you had the capacity and intelligence to do it, and so on, and so on.  Set a reasonable example.  It’s a pretty good thing to do and it’s quite interesting.  And the difficulties make it interesting.

And something else happens that is really weird.  We were talking about, in our director’s meeting that proceeded this meeting, you always get glitches in something as complicated as a new software program going into a big new area.  And you suddenly have reverses and troubles and you’re scrambling.  And what I said is, that I’ve noticed in a long lifetime that the people who really love you, are the people where you scramble together with difficulty and you’ve jointly gotten through.  And in the end, those people will love you more than somebody whose just shared in an even prosperity through the whole thing.  So this adversity that seems so awful when you’re scrambling through, actually is the sinew of your success, your affection, every other damn thing.  And if you didn’t have the adversity you wouldn’t have the bonds which are so useful in life that are going to come from handling adversity well.  The idea that life is a series of adversities and each one is an opportunity to behave well instead of badly is a very, very, good idea.  And I certainly recommend it to everybody in the room.  And it works so well in old age because you get so many adversities you can’t fix.  So you better have some technique for welcoming those adversities.

Question 36: Do you believe that the 0,6, 25 high watermark fees structure that the Buffett Partnership popularized is the fairest structure for both limited partners and the manager themselves?  And what fee structure did you employ during your partnership.

Charlie: Well, I did copy the Buffett formula more or less, and I do think it’s fair and I think it’s still fair.  And I’m looking at Mohnish who still uses it.  I think it is fair and I wish it was more common.  I basically don’t like it where they’re just scraping it off the top.  If you’re advising other people, you ought to be pretty rich pretty soon.  Why would I take a lot of advice from somebody who couldn’t himself get pretty rich pretty soon?  And if you’re pretty rich why shouldn’t you put your money alongside your investors?  And go up and down with them.  And if there’s a bad stretch, why should you scrape money off the top when they’re going down enough?  So I like the Buffett system.  But it’s like so many things I like, it’s not spreading very much.  My net influence in the world, even Warren’s, has been pretty small.  Imagine how much copying we have in our executive compensation methods.  It’s about three examples.  Yes, I think it’s a fine system.

Question 37A: You spoke earlier about natural gas and the shipping of natural gas, and that activity…  (Charlie interjects)

Charlie: If I were running the world as a benign despot, I wouldn’t be shipping any natural gas outside of the United States.

Question 37B: So to tap into that view, you’ve been active in two states big in agriculture, Nebraska and California produce.  What are your thoughts on the agriculture industry and subsidies?

Charlie: Well the interesting thing about agriculture is what’s happened in my lifetime.  Which is the productivity of land has gone up about 300%.  And if it weren’t for that there would be a lot of starvation on earth.  The ag. system is one of the most interesting things that has happened in the last 60 or 70 years.  And we literally tripled the (productivity) of the land.  And we did it all over the world.  And there was just a few people who did it, the Rockefellers, Borlaug, and so forth.  It was one of the most remarkable things in the whole history of the earth and we need another doubling, and we’re probably going to get it.  And it’s absolutely incredible how well we’ve done.  And it’s amazing how efficient our farmers are.  We don’t have much socialization in farming.  We’ve got a bunch of people who own the farms and manage them themselves.  There’s not much waste and stupidity in farming.  Now people complain that we’re using up the top-soil, which I think we are, and I think that’s more of a mistake.  I would fix that if I were a benign despot.  Leaving aside using up the topsoil too fast, I think farming is one of the glories of civilization.  So I think it’s been wonderful what’s happened in farming.

Now in terms of subsidies.  It matters to the farmers where they get their subsidies.  And there’s no question about the fact that we’ve protected our farmers with subsidies and the farmers we’re protecting are getting richer and richer because the farms are owned by fewer and fewer people.  Own more and more acres per person.  So it’s very peculiar that we’re subsidizing people who are already filthy rich, to use up our topsoil a little faster.  And create stuff which we turn into ethanol.  Which is one of the stupidest ideas the world ever…you know I’m a specialist in stupid ideas (links: 1,2), but I would say turning corn into gasoline is about stupid an idea.  I would almost rather jump out of a 20 story building and think I could fly than turn corn into motor fuel.  It’s really stupid.  And yet that’s what our politics does.  I’ve got no cure for the stupidity of politics.  If I (did) the world it would be quite different.  I think that’s pretty minor whether we have subsidies or not.  The main thing that’s happening that has enabled the present population of the world to stay alive is this agricultural revolution and this very good managing of our farmlands.  And the improving agricultural standards in the rest of the world.  It’s gone on quietly that we’ve hardly noticed it.  How many of you are just deeply aware of the fact that grain per acre has gone up by 3 or 4 hundred percent.  That’s a huge stunt.  And by the way, if you take those miracle seeds and don’t use hydrocarbons, the yields are lousy.  We’re feeding ourselves because we know how to turn oil into food.  That’s one of the reasons I want to hold onto the oil.  Something that can be turned into food is quite basic.  And so I don’t mind conserving the oil instead of producing every last drop as fast as one can.  It’s odd that my idea hasn’t spread to more of people.  I may have three or four other people who agree with me in this room.  But you’re a bunch of admirers, and in the rest of the world, I’m all alone. (laughter)

Question 38: You’ve talked on emotions, discipline, and facing adversity.  Can you flesh out more about the spiritual side of this.  How you deal with the struggles and life.

Charlie: Well, just because you don’t have a specific theology, and I don’t…you know when I was a little kid and my grandfather sent me to Bible school and they told me there was a talking snake in the Garden of Eden?  I was very young but I didn’t believe them.  And I haven’t changed.  It doesn’t mean I am not spiritual, it’s just, I don’t need a talking snake to make me behave well.  And I would say that the idea that came down to me, partly through my family, was that rationality is a moral duty.  If you’re capable of being reasonable, it’s a moral failure to be unreasonable when you have the capacity to be reasonable.  I think that’s a hair-shirt that we should all take on, even if we’re pretty stupid.  Because it’s good to be less stupid.  So I think rationality is a moral duty.  And we all have a duty to get better.  And of course we also have to adjust to the other people who are going through our journey with.  I think it would be crazy not to have a social safety net when you’re as rich and successful as we are.  Now I don’t think it has to be as dumb as the one we have, but of course we need a solid social safety-net.  And it’s a moral idea.  So I’m all for morality…without the talking snakes.

Question 39: What are your thoughts on the MLP structure?  And do you have any preliminary thoughts on the border adjustment tax?

Charlie: Let me take the last question first.  We do not know what the boarder adjustment tax is.  I don’t think the people proposing it know what it is.  And I don’t think Trump and the Republicans in Congress have agreed on anything.  So I think we’re just talking about…But do I think some deep revision of the tax system might be a really good idea?  The answer is ‘yes’.  Do I think we should rely on consumption tax more?  The answer is ‘yes’.  Do I really care if somebody piles up a lot of money and leaves it to some foundation.  That’s not my idea of a big evil.  If they do want to live high on their private airplanes and their three hundred dollar dinner checks, I’m all for taxing the people who are living high.  So I like the idea of bigger consumption taxes.  And I think there’s a lot to be said for a different kind of a tax structure.

Question 40: You highlighted this idea of ‘deferred gratification’ a lot today.  In what areas of life is it most valuable?  And where should you enjoy things now vs. grind away and invest in the future?

Charlie: Well, I don’t think you should use up your body by being stupid in handling it.  And I don’t think you should be stupid in handling your money either.  And I think there are a lot of things where the only way to win is to work a long time towards a goal that doesn’t come easily.  Imagine becoming a doctor.  That is a long grind.  All those night shifts in the hospital and so and so on.  It’s deferred gratification.  But it’s a very honorable activity being a doctor.  By and large our doctors are very nice people and they’ve been through a lot.  I tend to admire the life of a doctor more than I admire the life of a derivatives trader.  And I hope all of you do.  And I think deferred gratification in the way our doctors behave is a very good thing for all the rest of us.

Question 41: Question about the circle of competence.  How do you know its limits.  And does it get redrawn from time to time.  Does it always expand, or does it contract?

Charlie: Well of course you know some things that aren’t so, and of course if you’re dealing with a complex system, the rules of thumb that worked in the complex system in year 1 may not work in year 40.  So in both cases it’s hard.  The laws of physics you can count on, but the rules of thumb in a complex civilization changes as the civilization changes.  And so you have to live with both kinds of uncertainty and you have to work longer.  It’s not a bad thing.  It’s interesting.  We’re all the same here…who would want to live in a state of sameness, you might as well be dead.

End of Transcript

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

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Sincerely,

Richard Lewis, CFA
White Stork Asset Management LLC
Partner, Investments

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Wall Street Journal Recap: January 23-29, 2017

My full notes and analysis on the Wall Street Journal from the past week: January 23-29, 2017 (Week 4).  Please Enjoy.

Ruthless pricing formula in Pharma:

When general economic principles are applied to Pharma, the outcome looks ruthless in nature.  For example:

According to this quote, drug pricing has nothing to do with cost of development, or the amount of supply, but rather the demand generated due to the effectiveness of saving lives.

“Mr. McMahon said the price was justified by the improved average survival benefit the drug provides for patients with certain cancers.” (link)

Furthermore, drugs for rare diseases have the best pricing power.

“If you have blockbuster drugs in a rare disease area that’s shown to be more immune to pricing pressure, that is a very valuable asset to have,” said Jefferies analyst Peter Welford. (link)

The Rise of the “New and Now” Consumer

A trend is emerging in retail.  Customers want it “new” and they want it “now”. Whether you’re in consumer goods, video games, or luxury goods, consumers are becoming increasingly impatient and bored.

Here are how some companies are adapting:

Unilever:

“Unilever hopes the move will make it more nimble in responding to local tastes or trends.” (link)

Supercell (Clash of Clans):

“Five months later, Mr. Paananen says Supercell has fixed problems, paying more attention to customer complaints and refreshing its handful of games more often.” (link)

“He said the episode underscores how competition has risen in the sector, increasing pressure on developers to produce ever more attractive games.”

“All the companies, including Supercell, have to find new ways to get new users,” Mr. Hiltunen said.

“When players return to their games, there should be something new,” he said.

PepsiCo:

“The clear plastic bottles will feature textured labels by emerging artists, including the street artist known as Momo, with new designs introduced every few months.”…”PepsiCo hopes the revolving designs will prompt young people to share images of the bottles on social media.” (link)

Fashion (Burberry):

“Luxury consumers, including in China, are increasingly choosing innovation over tradition.  Burberry reported last week that “fashion,” or newly designed items, outperformed sales of core products like its famous trench coats in the Christmas quarter.”  (link)

“This trend is a challenge for companies used to selling products on the basis of timeless appeal.”

Drivers of Luxury Good sales: Peace and Corruption

There are two fascinating insights from this article on luxury brands. (link)

1) Peace is good for business.  Terrorism is not.  High profile terrorist attacks reduce international travel.  When people travel they spend more on luxury goods.  “Chinese and U.S. tourists who don’t travel abroad are less likely to splurge,”

Terrorism = Less International Travel = Less Luxury Brand Sales

2) Corruption is good for business.  A Crackdown on corruption reduces luxury goods sales.  China instituted a stiff crackdown on corruption which led to less luxury brand sales.

Lower Corruption = Less Luxury Brand Sales

Are luxury brands over-extending themselves?

More and more brand names seem to be expanding the price range of their product offerings.  This strategy of offering products at lower and lower price points can increase sales in the short-term, but it can also contribute to brand dilution in the long-term.  The Range Rover Evoque & Mercedes CLA are two possible examples.

This strategy is very similar to retailers like Michael Kors and Coach who embraced the outlet store model.  It helped revenue growth (and stock price) in the short term, but the growth was an illusion and it severely damaged each of their brands.  Their outlet strategies proved to be nothing more than a complete exploitation and degradation of years of goodwill.

Ferris Bueller’s ‘Oh Yeah’ Song Seeded Investing Fortune

Got to like the Buffett-like logic of these investments. (link)

1) BVZ Holding AG:

“Mr. Meier’s banker father offered advice.  A growing middle class in Asia, he said, meant more Asian tourists would be coming to see the Matterhorn in southern Switzerland.  So Mr. Meier bought a large stake in a railway company, BVZ Holding AG, that now takes them there.”

2) Orell Fussli Holding AG:

“Another piece of fatherly advice: ‘As long as Switzerland exists, we will always print our own money.’  So Mr. Meier obtained a stake, which FactSet now values at about $37 million, in Orell Fussli Holding AG, the company that prints Swiss Francs.  He is the firm’s second-largest shareholder, behind the Swiss National Bank.”

Pricing Power:

Warren Buffett says:

“The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business.”

Strong Pricing Power

Merck (link): “Last year, Merck raised list prices by an average of 9.6%, with an average net price increase of 5.5%.”

Weak Pricing Power

Nestle(link): “But Nestle and its rivals have struggled to boost volumes and lift prices amid consumers’ push for healthier fare and super-competitive markets.”

Declining Sales: Strategies

Here are five strategies being used to fight/cope with declining sales.

1) Cut costs

Caution: Cost cutting might lead to under-investment and result in (1) a further slowdown in long-term sales and (2) a need for large capital outlays in the future.

Unilever PLC (link): Reported slower sales growth last year, spooking investors…Last year, Unilever started its own cost-cutting campaign, including so-called “zero-base budgeting-a management practice based on justifying all costs from scratch each year.”

P&G (link): Years of cost-cutting only recently started to bear fruit.

Kimberly-Clark (link): Recently completed a cost-cutting plan aimed at saving $140 million annually.  But it said earlier this week it still forecasts tepid sales growth for 2017.

Norfolk Southern (link): Norfolk Southern posted a decline in revenue but notched higher profit in its fourth quarter as it cut costs, an effort it said it would continue as rival railway operators are pushed to take similar belt-tightening measures.”… “Norfolk Southern cut $250 million in annual costs in 2016 and plans to cut $100 million more this year.”

“Coal has been weighing on the railroad sector’s results”

2) Acquire high growth businesses

Caution: Often times this means over-paying.

Verizon(link): “Verizon needs to do a big deal to boost growth…The telecom giant is exploring a merger with Charter,”  “Charter’s wired broadband service passes 49 million homes and is growing even as the pay-TV market is shrinking.”

AT&T (link): AT&T’s deal to buy Time Warner is a tie-up that would transform the phone company into a media giant, helping it potentially find new areas of growth as its core wireless business has become saturated and its share of the mobile market leaves little room for acquisitions.”

Cisco (link): “Cisco is buying software company AppDynamics Inc. for $3.7 billion…at a big premium to bolster its software offerings to large enterprise customers.”

“Cisco has placed increasing importance on software.  The company has long held a dominant share of sales of the routing and switching equipment used to funnel data over the internet and between computers in data centers.  As competitors enter the market with less expensive options, Cisco has focused on other business lines such as security, collaboration and the “Internet of Things.”

3) Acquire a company to smooth revenue and profits

Caution: Impatience (time) based acquisitions are often expensive.

J&J (link): “J&J has said it has several new drugs in development that could offset any revenue loss from this rivalry, but the Actelion acquisition would more quickly help plug that hole.”

4) Spin off underperforming divisions

Caution: Beware of selling too the division too low.

Intel (link): “It also agreed to sell 51% of its underperforming security division to private-equity firm TPG for $4.2 billion.  Intel expects the two moves to create $1 billion in savings in the coming year.”

Novartis: “Novartis AG is considering spinning off its ailing eye-care business Alcon, one year into a slower-than-expected turn-around for that business.”…”The potential spinoff comes seven years after Novartis gained full ownership of Alcon (for $51.6 billion), a move that it had hoped would allow it to capitalize on the fast-growing eye-care market.”…”The decision comes as the company struggles to revive growth at Alcon.”

5) Adapt to shifting consumer demands and develop a new advertising strategy

Nestle (link): “Nestle SA is betting reduced sugar and a new advertising strategy will boost sales amid a growing consumer backlash against sweet drinks.”

Return Expectations

“With dividend yields about 2.5% for the Dow and 2% for the S&P, not far from historic lows, and stocks trading at almost 29 times inflation-adjusted multiyear profits, or well above their long-term average of about 16, it seems prudent to expect tepid-maybe even putrid-returns for years to come.” (link)

Corruption at Wells Fargo

The corruption at Wells Fargo can be boiled down to:

Past success + high draconian expectations + a lapse in oversight = Ripe environment for corrupt practices.

P.S. Why does this formula remind me of China?  Past success, draconian growth demands, large lapses in oversight…

The Wells Fargo story is pretty wild, here are some of the best quotes(link):

“Managers and employees at the bank’s roughly 6,000 branches across the U.S. typically had at least 24 hours’ warning about annual reviews conducted by risk employees,”…”That gave many employees time to cover up improper practices, such as opening accounts or signing customers up for products without their knowledge.”

“You became numb to it,…it became pretty normal.”

“Growing the business was primary: The more successful you were, the higher the goals were.  So you had to keep up.”

Investment lesson:

Pay close attention to internal corporate performance goals & oversight.  Are the demands too unrealistic and draconian?  Are there lapses in oversight?

Government Debt & Growth Assumptions: A Disaster

Thomas Jefferson said, “To preserve our independence, we must not let our rulers load us with perpetual debt.”

When governments are allowed to borrow based on assumptions of growth, they inevitably set us up for disaster.  Why?  Because they use “naive extrapolation” in their assumptions.  Naive extrapolation assumes that growth will persist, nearly indefinitely.  But the fact of the matter is that growth will eventually slow.  Economies or companies that aren’t prepared for this eventually are devastated.

This undesirable fate has now befallen the U.S. Virgin Islands.  Just check out a few of their problems:

Between 2007 to 2013, tourism feel 19%, a drop of $280 million. During that period the territory’s population shrank by almost 9%.

“With less revenue, the territory has relied increasingly on bond proceeds to pay operating costs while contributing less to pension plans. That borrowing has increased its debt to a level similar to that of Puerto Rico, on a per capita basis.”

“That pension plan has only 27% of what it needs to pay future benefits, according to 2015 financial statements; a 2015 analysis by Segal Consulting predicted the fund would run out of money by 2024.”

What might they have to do to get out of their financial predicament?

1) Sell off key assets.

2) Raise taxes.

3) Cut funding to pension plans, schools, etc.

Investing Lessons:

(1) Beware of naive extrapolation of past growth rates.

(2) Use a margin of safety

(3) Warren Buffett said, “If you buy things you do not need, soon you will have to sell things you need.”

i.e. If you’re looking for investment bargains, look at distressed countries and companies who will be forced to sell things that they need to pay for the things they didn’t.

(4) Remember what happens when you assume things?

 

Wall Street Journal Recap: January 17-22, 2017

My full notes and analysis on the Wall Street Journal from the past week: January 17-22, 2017 (Week 3).  Please Enjoy.

Buffett & AIG

AIG paid Berkshire Hathaway $10 billion to bring “stability to their balance sheet” and gives them “greater certainty”.  (link)

Meanwhile, Warren Buffett has said, “We pay a high price for certainty.”  Howard Marks added to this comment, “People who want to buy bargains should prefer uncertainty.”

Translation: AIG paid a high price and Buffett got a bargain.

China & Autocatalytic Reactions

China’s economy achieved yet another year of “stable” GDP growth, but their growth comes at the expense of increasing disorder everywhere else in their economy.  This type of behavior is known as an “autocatalytic reaction.”, which is a mental model that I now use to think about China’s economy.

Autocatalytic Reaction: “Order can be created in a system by an even greater decrease in order of the systems surroundings…The order of the Earth’s atmosphere increases, but at the expense of the order of the sun. The sun is becoming more disorderly as it ages and throws off light and material to the rest of the universe.” (wikipedia)

China creates GDP Stability at the expense of Economic Chaos everywhere else.  Below are examples of China’s autocatalytic economy in action.

“GDP Stability”

  1. IMF Raises Growth Forecast for U.S. Economy (link)

“(China) is laboring to keep growth chugging along…the government used its long-worn playbook of state policies to stimulate growth.”

  1. China Hits Growth Goal On Big Does of Stimulus (link)

“Beijing is expected to double down on old growth drivers this year – including fiscal spending and the property market- to keep the economy stable in an important year of leadership change.”

“Beijing posted the lowest annual growth in a quarter-century, and economists say it only got there by relying heavily on short-term measures that are likely to delay much-needed reforms to bloated state-owned companies and the country’s inefficient financial system.”

“Economic Chaos”

  1. A Risky Twist on Repo Trade in China (link)

These “dai chi” agreements are outrageous…Used to temporarily move funds around in order to skirt government audits, as well as take on more risk.  Doesn’t this sound familiar to AIG and credit default swaps?

“A little-regulated practice that companies have used to borrow hundreds of billions of dollars and move risky assets temporarily off their book.”

“The risk is that dai chi agreements tend to be informal and often don’t leave a paper trail.”

“These transactions, by one estimate, may easily top $1 Trillion in value.  The practice is just one of the many unexpected risks that have sprouted up in China’s long credit boom.”

China’s credit boom has “helped send Chinese bond prices to a 14 year high in mid-August and pumped up markets for everything from iron ore to garlic.”

“Traders say the deals are so opaque that even estimates are hard to make.”

Banks sometimes use the dai chi agreements to move risky assets temporarily off their books during earnings periods or audits, the people said.  Brokers like Sealand typically use them to borrow quickly and flexibly-leveraging their investments many times over,”

  1. Copper Tethered to Dollars’ Moves (link)

Chinese investors are grasping for any investments to get their money out of China or the Yuan.  As a result, they are creating volatile and unusual behavior in Copper prices, among other asset classes.

“Metals and other commodities that are priced in dollars tend to fall when the dollar appreciates…But copper and the dollar have been moving nearly in lockstep recently, a phenomenon that many analysts attribute to rising appetite for copper among Chinese investors seeking to protect their wealth against the risk of a sharp Yuan depreciation against other global currencies, primarily the dollar.”

“In November, the correlation between copper and the WSJ Dollar Index reached its highest level since 2007.”

“In five hours on one day, we say (copper) prices trade in a range that would normally take a year” to play out.

  1. Bitcoin Trading Faces Greater Scrutiny in China (link)

China is trying to limit the ability of Chinese individuals and companies to move their wealth abroad, a trend that contributes to a depreciating Chinese yuan and risks destabilizing the broader financial system.”

Trump & China

If Trump stops China from dumping highly subsided products into our markets (link), I think he’ll unintentionally destroy the lynch-pin holding together China’s economy…highly subsidized factories.

To give more detail to this picture, this is what I imagine much of China’s economy looks like:

  1. China’s local governments fund themselves by land sales and real estate development. But the land is only valuable if there are people and jobs.
  2. The easiest way to create jobs is to subsidize industries which can generate LOTS of jobs, like steel production. Steel production creates jobs in mining, transportation, energy, engineering, and of course factory workers.
  3. With lots of people working, or soon to be working, demand for real estate skyrockets. This in turn creates more jobs because workers are needed to build all this new real estate.
  4. It might be ok if only a few cities in China used this model, but I believe this to be pervasive. As a result, China is creating WAY too much steel and other products.  With an oversupply of subsidized goods, they must dump them into U.S., and global markets for whatever prices they can get.

If the Trump administration stops China from dumping its highly subsidized products into the U.S., subsidized factories all over China will quickly implode and take entire cities with it.  Being so highly leveraged, China is not in a position to handle the impact of such an event.

This of course is just my hypothesis, and I welcome any disconfirming evidence.

“Retail Meritocracy” & Deteriorating Moats

It feels like we’ve entered a new area that I’d like to call “retail meritocracy”.  Brand names use to serve an important role in signaling both value and quality to consumers.  But with easy access to internet reviews and scores, brand name goodwill seems to be rapidly deteriorating for many companies.

Luxottica appears to be a good example.  Luxottica has a dominant position in the old world distribution and marketing platform of sunglasses and eyewear.  In this old model, floor space and brand names served as a solid barrier to entry.  But there’s been a trend towards commoditization of sunglasses and eyewear as consumers become more comfortable with buying off-brand names like Warby Parker.  Online reviews, ratings, etc. have weakened Luxottica’s competitive moat.

  1. Merger to Create Eyewear Giant (link)

“The merger joins two companies that previously risked stepping on each other’s toes as Luxottica expanded into lens manufacturing and Essilor moved into frames…both companies could shrink because of a harsher price competition for frames and lenses.”

  1. Why Golfers Covet the Costco Ball (link)

In another example of “retail meritocracy”, Kirkland brand golf balls became a hot selling items when it was discovered that they perform nearly as good as Titleist Pro VI golf balls.  “This is just a perception killer,”  The Kirkland golf balls retailed for $1.25/ball, while Pro VI’s retailed for ~$4/ball.

We  have entered a time of retail meritocracy where many brand-name-moats are being eroded more quickly than anticipated.

Know what’s being measured

It’s important to know what’s being measured.  Sometimes we forget.  Here are some examples:

  1. Private Prison Industry Gets Boost From Election (link)

A likely example of lying with statistics.

The DOJ found that private prisons were more dangerous than government-run facilities.

“Contractors criticized the report, saying it compared private and government-run prisons even thought they house different types of criminals.”

“The private facilities are dominated by lower-security, illegal immigrants who have committed crimes, a demographic in which gangs are prevalent.”

  1. Rocky Route for Rail Line (link)

“If you cut 30 minutes off, I’d be for it,”

Note: Nowhere in his comment does this frequent Amtrak traveler consider the $120 billion cost.

  1. Fed Officials Shift focus on Growth (link)

When the Fed and U.S. Government talk about the success of their economic programs they largely speak of 1) an increase in overall demand and 2) a reduction in unemployment.  When they say the economy is “healed”, they are likely measuring it by overall demand and unemployment numbers.

Global Growth Fuels Netflix Surge (link)

“The streaming video giant has prioritized growth over profit as it pursues its international rollout”

Success is being measured by user growth…which is the same metric used by Netflix’s competitors.  All of its competitors are foregoing profits for revenues

Oops! When Little Errors = Big Mistakes.

Two examples of little mistakes that lead to big errors.

  1. Student-Debt Picture Darkens (link)

The U.S. government WAY underestimated how many students have “defaulted on or failed to pay back their college loans.”

Previous numbers “overstated repayment rates for 99.8% of all colleges and trade schools in the country.”

“The new analysis shows that at more than 1,000 colleges and trade schools, or about a quarter of the total, at least half the students had defaulted or failed to pay down at least $1 on their debt within seven years.”

In 2015, the reported number was 347 colleges.  Today it stands at 1,029.

  1. Afghan Payroll Cut in Corruption Fight (link)

The U.S. military was paying 30,000 Afghan soldiers that didn’t exist!  That came out to $13 million per month.  Now, the U.S. military will only pay Afghan soldiers who were biometrically enrolled in the nation’s army.

The Growth Promise

Why does it seem that troubled companies always insist upon expanding into growth markets?  Why are they so eager to grow a business model with fundamental problems?  Examples include:

  1. Pearson Drops as Future Darkens (link)

“Pearson said its revenue fell 30% in the fourth quarter making for a full-year decline of 18% that it called unprecedented.”

“…which has put pressure on Pearson’s business even as it seeks new sources of growth in emerging economies such as Brazil and China.”

  1. Can Revlon Regain Some of Its Lost Luster? (link)

“One way Mr. Garcia intends to lessen Revlon’s reliance on the U.S. is by entering China.”

I’m Curious. Is this an Accounting Illusion, Real, or Both?

Railroad Mavrick Buoys Investors (link)

I’m curious about this case.  I wonder if Mr. Harrison’s operating efficiencies are real or are merely accounting related.  After all, he’s able to do what no one else in the industry is capable of doing, which should raise some questions.

“Each time the message was similar: Mr. Harrison has proved himself able to cut costs and improve operations and is a better executive than you current team.”

 Irrational Exuberance

On the backs of the second longest bull-market in history, artificially low interest rates have created intense competition among investors for any yield whatsoever.  Furthermore, ultra-low interest rates have incentivized land-lords not to sell, which has reduced supply and intensified competition further.

  1. Texas Billionaires Joined to Strike Deal (link)

Plano Texas’s raw land has gone from $8 to $10 a square foot a few years ago to $60 today.  Due to growing appeal to corporate tenants.

“The property attracted the attention of about 40 investors.”

Ultimately it was won by the investor able to secure a high loan to equity ratio.

It’s unusual for an investor group to be able to borrow such a high percentage of a deal’s value, as Mr. Ware’s group did.

Participants said it worked because the bank will get an equity like return if the group hits the “jackpot” with the new leasing and land development.

  1. Investors Pump In Cash But Supply Is Lacking (link)

Investors piling money in: “Investors are piling money into real estate funds, but fund managers are finding it challenging to spend it.”

Hunt for returns in an Ultra low interest rate environment: “The record level of dry powder comes as investors increasingly have turned to commercial real estate in a hunt for returnsUltra low interest rates at global central banks have made returns on offices and shopping malls look attractive compared with other asset classes such as bonds.

On par with 2005 to 2008: “Global fund managers have raised $446 billion for commercial property in the past four years, on par with the total raised from 2005 to 2008 in the run-up to the global financial crisis,”

Fierce competition for few properties: “With competition for deals fierce, “it has been much more challenging to invest,”…”There are very few forced sellers,”

Landlords aren’t willing to sell.  Their low debt levels and readily available bank financing have made it easy to hold on to properties longer in hopes of reaping bigger paydays later,”

Increasing demand: Deflation & Inflation

  1. ‘Rideables’ Could Curb Car Ownership (link)

Increased demand can have either an inflationary effect or a deflationary effect.  Which way it goes is largely dependent upon two factors:

1) The speed at which supply can expand to meet demand and

2) economies of scale.

In the case of electric vehicles, increasing demand has had a deflationary effect:

“…the rapid expansion of the market has led to demand for parts, making them in turn cheaper and more available, much like what happened with mobile phones.”

“batteries are getting cheaper at 4% to 8% a year, and that compounding over the last five years has had a massive impact” on the electronic-vehicle industry.

Meanwhile, increasing demand has had an inflationary effect on price of oil and gas service providers (link).

Significant Housing Developments

  1. Mortgage Lending Shift Spurs Worry Over Risk (link)

There’s been a big shift in the FHA lending market for single-family mortgage market over the past 10 years.

Topped $1 trillion:Bonds backed by certain risky single-family mortgages topped $1 trillion for the first time in November, crossing that threshold amid warnings about that corner of the U.S. housing market.”

Banks have all but stopped participating: “The result: In the first three quarters of 2016, banks accounted for 9% of mortgage dollars originated by the FHA’s top 50 lenders, versus 62% for all of 2010, according to Inside Mortgage Finance. Nonbank lenders accounted for 80% of mortgage bonds backed by single-family FHA loans in July 2016, versus 9% the same month in 2010…This is the biggest shift in mortgage lending since the savings-and-loans debacle in the 1980’s.”

“It’s too costly to originate”: “J.P. Morgan Chase & Co., the nation’s largest bank by assets, isn’t among the 50 largest FHA lenders.  In 2013, it was the third largest,”…”It simply is too costly and too risky to originate these kinds of mortgages,” Jamie Diamon wrote.

FHA share of the mortgage market has tripled: the FHA share of the overall mortgage market is larger than during the last housing boom.  In the years leading up to the housing bust, FHA loans accounted for less than 5% of annual mortgage volume.  Since the meltdown, the share has ranged from 11% to 15% of originations.

FHA loans under Ginnie Mae has Quadrupled since 2007: “That growth has boosted the amount of bonds Ginnie Mae backs. The $1 trillion of outstanding FHA single-family loans in November that it guaranteed compares with $272 billion at the end of 2007. Overall, Ginnie Mae now backs more than $1.7 trillion in bonds, which includes loans backed by other agencies such as the Department of Veterans Affairs as well as the FHA.”

Nonbank lending creates market risks: “The funding issue arises because nonbanks don’t hold deposits. So they rely on short-term financing, often from banks, mostly to originate new loans. That can dry up in stressed times.”

As Power Changes Hands, HUD Makes Swift Move (link)

The Trump administration seems likely to curb large housing affordability programs which make mortgages more accessible to lower income families, but at the same time distort free market dynamics.  This would likely put downward pressure on home prices.

Challenges Lurk in the Economy (link)

“The U.S. home ownership rate is near a 50-year low, and the average debt load for college students is rising.”

The Confidence Illusion

There’s a lot of certainty and confidence going on.  Investors are feeling much more confident, the fed is feeling much more confident, consumers are feeling much more confident, etc.  But should we trust them?  Caution would be the prudent advice.

The article, “Don’t Let Others Sway You When Making Investment Decisions” (link), points out that we can be heavily influenced by people with an intense belief in ignorant views.

“We’re biologically equipped with the potential to allow more-confident people to have greater sway over our own beliefs,”

“In a paper published in 2000, Prof. Shiller showed that confidence varies, often going up after the market rises and falling after it goes down.  The confidence of individual investors rose 4% in July 2008, for instance, right before the market got sucked into the black hole of the financial crisis.

“So you could visualize the stock market as a poltergeist or hobgoblin who takes a twisted delight in play pranks on the expectations of the investing public.”

1. Treasury Yields Resume Ascent (link)

Janet Yellen is viewing things positively.

“In a speech Thursday at Stanford University, Ms. Yellen said she doesn’t see the U.S. economy at risk of overheating and doesn’t expect growth to pick up much soon,”

But be careful to give too much weight to her comments.  Remember that after the financial crisis, Alan Greenspan wrote:

“In the run-up to the crisis, the Federal Reserve Board’s sophisticated forecasting system did not foresee the major risks to the global economy.  Nor did the model developed by the IMF, which concluded as late as the spring of 2007 that “global economic risks [had] declined” since 2006 and that “the overall U.S. economy is holding up well…[and] the signs elsewhere are very encouraging.” (link)

Service Providers with High Fixed Costs

  1. For Shale Drillers, Rising Oil Prices Also Come With Rising Costs (link)

Interesting story for a case study:

During a dramatic drop in oil prices, oil & gas companies get a sort of mini-bailout by their service providers.  These service providers effectively absorb some of the losses from oil & gas companies, thereby shielding them and making the decline more manageable.

But the effect is a two-way street.  When oil price rebound, service providers are quick to raise prices and dampen the benefits of rising prices.

Why does this happen?

The service providers have high fixed costs.  Upon declining oil prices, oil & gas companies cut demand for their services.  Because service providers have high fixed costs, they will continue to provide services at a loss, sometimes just as long as their variable costs are covered.

I believe you could say that, to some extent, the fixed costs of your service providers or suppliers act as a shield in bad times.  They will/must lower their service fees,  thereby making the hard times more tolerable.

What should we learn from this?

1) We should look at service providers and suppliers and determine the level of their fixed costs and variable costs.

2) Oil & Gas companies should really position themselves better to take advantage of a decline in oil prices.

Before the decline in oil & gas prices, the whole industry had positioned themselves aggressively.  When the crash came, no company was in a position to exploit the lower costs offered by service providers.  Or buy oil assets at discounted prices.

Instead, they all waited for a rebound in prices to start working again, at which point, they completely missed out on compelling market opportunities.

The problem with that strategy is that it’s hard to do.  But as Charlie Munger says, “It takes character to sit there with..cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.”

Government Corruption & Lee Kuan Yew’s Advice

  1. Scandal Rocks Samsung (link)

“(President Park Geun-hye) was impeached last month over allegations that her confidante, Choi Soon-sil, sought to shake down the country’s biggest conglomerates for donations in exchange for political favors.”

There’s just so much corruption being exposed in governments around the world right now.  If you’re interested in learning more about the roots of corruption and how to stop it, I suggest reading the chapter “Keeping the Government Clean” from Lee Kuan Yew’s book, “From Third World to First”.  Here are a few great quotes:

“Human ingenuity is infinite when translating power and discretion into personal gain.” – Lee Kuan Yew

“A precondition for an honest government is that candidates must not need large sums of money to get elected, or it must trigger off the cycle of corruption.  The bane of most countries in Asia has been the high cost of elections.  Having spent a lot to get elected, winners must recover their costs and accumulate funds for the next election.  The system is self-perpetuating.” – Lee Kuan Yew