The Best Investment Quote of All Time is from…Napoleon?

Could the best investment quote of all time come from Napoleon?  Quite possibly.  It was in the unlikely place of Napoleon Bonaparte’s personal diary that I found one of the best investment passages I’ve read.  Bursting with investing wisdom, it would be understandable to mistake Napoleon for Warren Buffett.  Although he’s writing about the art of war, the insights apply to investing just as well.

Interpretation

Below I dissect Napoleon’s journal entry to ascertain its valuable investing insights.

Importance of mathematics & probabilities:

To be a good general a man must know mathematics; it is of daily help in straightening one’s ideas.  Perhaps I owe my success to my mathematical conceptions

Beware of forecasts.  Buffett & Munger don’t invest in a company if they can’t see its strength displayed through history:

a general must never imagine things, that is the most fatal of all.

Eliminate psychological biases & crude heuristics which skew one’s perception of reality:

My great talent, the thing that marks me most, is that I see things clearly;

Identify the main issues and ask the right questions:

it is the same with my eloquence, for I can distinguish what is essential in a question from every angle.

Practice Bayesian updating:

The great art in battle is to change the line of operations during the course of the engagement; that is an idea of my own, and quite new.

Keep it simple. Stick to the fundamentals and common sense: 

The art of war does not require complicated maneuvers; the simplest are the best and common sense is fundamental.  From which one might wonder how it is generals make blunders; it is because they try to be clever.  The most difficult thing is to guess the enemy’s plan, to sift the truth from all the reports that come in.  The rest merely requires common sense;

Stay curious.  Do a lot of reading & research lots of companies.  Eventually you’ll come across a good idea: 

it’s like a boxing match, the more you punch the better it is.

Know how to read financial statements: 

It is also necessary to read the map well.”

“La victoire appartient aux plus persévérants.”

Investment Lessons from a Master Sushi Chef

The best investment book I read this year didn’t come from a Wall Street whiz or hot shot finance professor, rather it came from Jiro Ono, a Master Sushi Chef. Yes, “the Jiro”, the one from the acclaimed documentary “Jiro Dreams of Sushi.”

While in Japan this past September I picked up his book titled “Jiro Philophosy” and was quite surprised. Unlike most investment books, Jiro doesn’t talk about investing at all. In fact, it isn’t even an investment book. Rather Jiro Philosophy simply describes Jiro’s personal work-ethic.

2016-12-17-19-25-01As I read this book, I quickly came to realize just how closely Jiro’s philosophy mirrors that of Warren Buffett, Charlie Munger, and Ben Graham. It was quite surprising to see that the same principles which lead to mastery in Sushi can also lead to mastery in investing.

As a result, I have distilled the book “Jiro Philosophy” down to its 12 core principles and relate each one to the investment philosophy of Buffett, Munger, and Graham.

1. Stick to the fundamentals. Stay grounded.

Jiro

If you stray from the fundamentals – say, trying to set yourself apart from other chefs – you will completely stray off track.  I believe that by adhering to the fundamentals and continuously striving to create delicious flavors, you will be able to be innovative.”

“If you continue to do things the right way, it’s a given that your sushi will turn out delicious.” 

Investing

stick-to-the-fundamentalsMarket manias and bubbles all have two things in common;  an abandonment of fundamental investment principles and an endless series of rationalizations.

Ben Graham understood the immense rationalization power of markets very well.  He experienced it first hand during the lead up to the great depression.  It was his understanding that as markets move higher, investors don’t become more reserved, but rather they invent knew valuation metrics to justify paying any price whatsoever.  As been Graham observed, “We can find no evidence that…investors as a class have sold their holdings because PE ratios were too high.”

Consequently, Ben Graham developed an immutable investment philosophy based on strict fundamental analysis to keep investors from “completely straying off track”.  And much like Jiro Ono, investors who have stuck to Ben Graham’s fundamentals of investing have delivered “delicious” results.

With this, I’m reminded of Lou Manheim ‘s advice to Bud Fox in the movie Wall Street, “Stick to the fundamentals…good things, sometimes take time.”

2. Gain Mastery.

Jiro

“You’ve got to master some skills to reach the next stage.”

“You won’t advance to the next level all on your own.  You need to train properly up to a certain point.  In the case of Jiro, after a decade of training, a craftsman will have mastered everything from preparation to making sushi.  He will be ready to strike out on his own.”

Investing

Warren Buffett pursued and achieved mastery over Ben Graham’s investment philosophy before advancing to the next level.  Warren’s path to mastery took on the following steps:

  • Discovered Ben Graham’s book “The Intelligent Investor” at the age of 19.
  • Read Graham’s 700+ page book, Securities Analysis, at least 12 times.  
  • Attended Columbia so that he could study under Ben Graham.
  • Worked for Ben Graham at his investment fund.
  • Invested using Ben Graham’s investment principles at the Buffett Partnership.

3. Put Knowledge into Practice.

Jiro

“People will teach you new things and ideas, but if you don’t try them out you will not change.”

“No matter how good the teaching, unless you actually put it into practice, you won’t be able to progress.  You will only have the knowledge.  People passionate about their work are always trying to improve upon what they’ve made.  It’s enjoyable and rewarding.”

“Because of this, we can keep trying new things every day.”

Investing

Throughout his life, Warren Buffett has shown an amazing willingness and ability to put knowledge into practice.   This includes applying the teachings of Ben Graham as well as the four hour educational interview he had with GEICO executive Lorimar Davidson in 1950.

Much of Warren’s success simply boils down to seeking out the best knowledge and putting it into practice.  Warren recommends you do the same thing:

“You need to fill your mind with various competing thoughts and decide which make sense. Then you have to jump in the water – take a small amount of money and do it yourself. Investing on paper is like reading a romance novel vs. doing something else. You’ll soon find out whether you like it. The earlier you start, the better.”

4. Improve upon what you’re taught.  Otherwise you will always be an apprentice.

Jiro

“Just doing as you’re taught is the same as being an apprentice.  I tell my young apprentices that they should think about how to achieve good flavor on their own, improve it and then experiment.  I always tell them if they don’t, they will be apprentices for life.”

Investing

Although Warren Buffett began his career as Ben Graham’s apprentice, he did not simply stick to his teaching.  Rather he modified and improved upon Graham’s teachings over time.  As Charlie Munger describes it:

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

5. Practice Beginner’s Mind. (Shoshin)

Shoshin (初心) is a concept in Zen Buddhism meaning “beginner’s mind“. It refers to having an attitude of openness, eagerness, and lack of preconceptions when studying a subject, even when studying at an advanced level, just as a beginner in that subject would. (Wikipedia)

Jiro

screen-shot-12-17-16-at-07-37-pm“That said, once they’ve become independent they should still pursue improvement just like an apprentice.

“Feeling you can still evolve is important.”

Investing

Both Warren Buffett and Charlie Munger are enthusiastic learners who enjoy the process.  In fact, Charlie has said that he and Buffett are “dissatisfied with what they know.”  As a result, they are always seeking to learn, adapt, and evolve.

Charlie further explains the importance of this mindset,

“Warren Buffett has become one hell of a lot better investor since the day I met him, and so have I. If we had been frozen at any given stage, with the knowledge we had, the record would have been much worse than it is. So the game is to keep learning, and I don’t think people are going to keep learning who don’t like the learning process.”

6. The way you do the small things reflects how you do the big things.

Jiro

Through Jiro’s Philosophy, he stresses the importance of the small things.  From cleanliness, to hot towels, to the preparation process, rice, etc.  All the smallest details are given the greatest care.  The way you do the small things reflects how you do the big things.

Investing

Likewise, Buffett has a keen eye for detail as displayed by the following two stories:

Story 1:

Buffett also liked Cathy’s attention to detail.  “When I asked her on the phone how many employees she had, she replied ‘504.’  I love this,” said Buffett.  “Not ‘about 500.’ I think she has 505 now and is doing considerably more business.  She won’t be happy until she has 100 percent market share.”  (From the book “The Women of Berkshire Hathaway: Lessons from Warren Buffett’s Female CEOs”)

Story 2:

The following is an excerpt from the Q&A session at the 2016 Berkshire Hathaway Annual Meeting:

Warren Buffett: Yes, sloppy thinking in one area probably indicates there may well be sloppy thinking elsewhere. I have been a director of 19 public corporations. I’ve seen some very sloppy operations and I’ve seen a few really outstanding business operators, and there’s a huge difference. If you have a wonderful business, you can get away with being sloppy. We could be wasting a billion Dollars a year, at Berkshire, you know $640m after tax, that would be four percent of earnings, and maybe you wouldn’t notice it….

Charlie Munger: I would.

Warren Buffett: Charlie would notice it… It’s the really prosperous companies that well….the classic case were the tobacco companies many years ago. They went off into this thing and that thing, and it was practically play money because it was so easy to make. It didn’t require good management, and they took advantage of that fact. You can read about some of that in ‘Barbarians of the Gate’.

7. Listen to good advice.

Jiro

“I take customers’ advice when it makes sense.”

“Even when you think you are right often that’s not the case.  No matter what kind of business you are in, if you only work in an inflexible way, you won’t find success.”

“If (a customer’s advice) makes sense, I will adopt it, otherwise I will never evolve.”

Investing

Warren Buffett and Charlie Munger have exhibited an open mind and willingness to listen to good advice throughout their careers.  In fact, if it weren’t for some timely advice they might not have bought See’s Candies.  As Charlie Munger recounts,

“[Munger’s friend] Ira Marshall said you guys are crazy — there are some things you should pay up for, like quality businesses and people. You are underestimating quality. We listened to the criticism and changed our mind. This is a good lesson for anyone: the ability to take criticism constructively and learn from it. If you take the indirect lessons we learned from See’s, you could say Berkshire was built on constructive criticism.

8. Preserve your main asset…You.

Jiro

screen-shot-12-17-16-at-07-50-pmIn his 40’s, Jiro recognized that his most critical asset as a Sushi Chef was the sensitivity in his finger tips.  As a result, he began wearing gloves in order to preserve the long-term integrity of his hands.  

This might seem like a mildly trivial matter, but for anybody looking to achieve and maintain success in their profession, follow Jiro’s example: Identify the physical or mental attribute that is necessary for success in your field and take measures to preserve it.

Investing

Warren Buffett identifies the most important trait of an investor as “emotional stability”.  As Warren explains,

“To be a successful investor, you don’t need to understand higher math or law. It’s simple, but not easy. You do have to have an emotional stability that will take you through almost anything. If you have 150 IQ, sell 30 points to someone else. You need to be smart, but not a genius. What’s most important is inner peace; you have to be able to think for yourself. It’s not a complicated game.”

Similar to Jiro’s practice of wearing gloves to protect his hands, here are some routines and strategies which Buffett uses to maintain emotional stability, inner peace, and independent thought.

  • An alert and fresh mind: 
    • Warren gets good sleep and takes naps when necessary
    • He plays bridge many hours every week.
  • A temperament uncorrupted by outside influences:
    • He Lives in Omaha
    • Maintains a Clear Schedule
    • Keeps a quiet office where he can think.
  • Health:
    • “My diet, though far from standard, is somewhat better than usually portrayed. I have a wonderful doctor who nudges me in your direction every time I see him. All in all, I’ve enjoyed remarkably good health — largely because of genes, of course — but also, I think, because I enjoy life so much every day.”

Furthermore, Warren explains the importance of preserving and enhancing yourself through life:

“Imagine that you had a car and that was the only car you’d have for your entire lifetime. Of course, you’d care for it well, changing the oil more frequently than necessary, driving carefully, etc. Now, consider that you only have one mind and one body. Prepare them for life, care for them. You can enhance your mind over time. A person’s main asset is themselves, so preserve and enhance yourself.”

9. Be a craftsman. Pursue work to satisfaction.

Jiro

“Pursuing work to satisfaction is the pride of a craftsman.  No matter how time consuming, I will leave no task to others.  I will do them all myself until satisfied.  Even as I get older, I still do all the work, even if it’s bothersome.  I feel very pleased when I develop and create something from a new idea of my own.”

Investing

Likewise, Buffett takes pleasure in doing all the investment analysis himself.  He does not have a team of analysts working for him.

10. Be passionate about what you do.

Jiro

“People who love their work passionately want to continue working.  I’m no exception.  Although I’m 90 years old, I’d like to keep on going.  That’s why I don’t find investing time in my work troublesome.”

Investing

At 86 years old, Buffett still tap-dances to work.  He derives great enjoyment from researching different companies.  He compares it to researching different species of animals.

11. Adapt to changing circumstances.

Jiro

screen-shot-12-17-16-at-07-41-pm“Since all sushi toppings are changing, sushi craftsman must now factor this in when working out flavors.”

“The oceans are quickly changing.  For example, the season for katsuo (skipjack tuna) now starts six months later.  But we have to serve the best of what’s in season.  Fish and shellfish were tastier in the past and it is difficult to find their intense flavors.  The next generation of sushi chefs will face challenges in trying to find ways to bring out and enhance fish flavors.”

Investing

Likewise, in investing you cannot wish for something which doesn’t exist.  You must play the hand that you’re dealt.

When Warren Buffett started investing, he could find net-net investments everywhere.  But the investment ocean quickly changed and he had to adapt to the circumstances.  Over the years, Buffett has invested in a broad range of investment classes including, bonds, common equity, preferred stock, warrants, options, commodities, and special situations.  He doesn’t wish for something that doesn’t exist, rather he adapts himself to whatever asset is on sale below his intrinsic value.

At the same time, Warren will never abandon his core principles and rationalize new investments.  During the “Nifty 50” stock market, he declared that he couldn’t find any cheap stocks and refused to invest.  Later Buffett refused to invest in tech stocks during the tech boom of the 90’s.  In each case Warren has been rewarded for his patience and sticking to the fundamentals.

This leads to a crucial point.  Although you must adapt to changing environments, you must also remember to stay true to the fundamentals.  As it says in rule number 1, “If you stray from the fundamentals…you will completely stray off track.”

So remember: Adapt, but do not abandon.

12. It’s never too early to prepare

Jiro

“It’s never too early to prepare.  You can start preparation way in advance.”

Jiro began working at a local restaurant from the age of seven.

Investing

Likewise, Warren Buffett recalls his youthful experience: “By the age of 10, I’d read every book in the Omaha public library about investing, some twice.”

Furthermore, Buffett said he read the 10Ks of IBM for fifty years before ultimately making an investment in the company.  That’s fifty years of “preparation.”

Jiro Philosophy: Distilled

jiro-philosophy

Haiku Review: Deep Value by Tobias Carlisle

Inspired by a recent trip to Japan, here are my 7 main insights distilled from Deep Value by Tobias Carlisle, in Haiku form.  Arigatou gozaimasu.

Japanese Painting

1. Risk: “A Bundle of Twigs Cannot Easily Be Broken”

Stocks perceived risky,

Find resilience when bundled.

Have fewer down years.

2. Return: Buy the “Ugliest of the Ugly”

Deep Value defies

Investment Intuition.

Ugly is Better.

3. Trust in Mean Reversion & Avoid Naive Extrapolation

Trust Mean Reversion.

Naive Extrapolation

Ignores the Base Rate.

4. Expand Your Time Horizon

Seeking to avoid

Short-term underperformance,

They’re captured by it.

5. Behavioral Biases: Your Intuition is Killing You

Three Crude Heuristics,

Lead us to poor decisions.

What feels right is wrong.

6. Use a Statistical Approach: Focus on Simple & Effective Techniques

Ben Graham’s approach:

Stick to a few Techniques and

Simple Principles.

7. Stay out of the Way: Overconfidence Leads to Reduced Performance

Our judgment misleads,

We find broken legs abound.

Stay out of the way.

number 7 japanese

Deep Value’s 7 Main Takeaways

Deep Value by Tobias Carlisle reads somewhat like an investment version of “Mom’s” classic question, “If your friends jumped off a cliff, would you?”  Wall Street is filled with people jumping off cliffs and the people who follow.  The question is, why would so many people consistently invest in a way that’s bad for their well-being?  The answer lies largely within the errors of our intuition.  Carlisle warns that, often times, “the incorrect decision feels right, while the correct decision feels wrong.”

If our investment intuition is so often wrong, then the first step to becoming a better investor should be to recognize that we are naturally wired to jump off investing cliffs.  The next step involves giving counter-intuitive ideas a chance.   After all, as Einstein said, “The definition of insanity is to keep trying the same thing while expecting a different result.”  Insanity in this case, is relying on our intuition to help us make wise investment decisions.deep-value-tobias-carlisle-6

Consequently, we can view Deep Value as a sort of counter-intuitive survival guide to overcoming our self-destructive investment tendencies.  (aka “How to stop jumping off of cliffs”)

Next to here you will find the summary of my seven main takeaways from Deep Value.  Please feel free to print it out and re-read these points whenever your intuition tries to lead you off a cliff.

Risk:” A Bundle of Twigs Cannot Easily Be Broken”

Within traditional finance, risk is commonly defined as “the currency by which we pay for returns”.  Meaning that if we want higher returns, we must bear greater risk.  This intuitively makes sense if the markets are efficient.  But Deep Value discredits this intuitive assumption.

Throughout the book, Carlisle focuses on two groups of stocks that exist at the opposite ends of the spectrum.  Value Stocks and Glamour Stocks.  Value stocks are considered risky investments.  They are typified as companies that you wouldn’t want to own.  They are often down and out companies that exist in unfavorable industries and have poor prospects.  Meanwhile, glamour stocks are considered safe investments.  These are companies that generally have high returns on capital, seemingly endless growth prospects, exist in favorable industries, and are widely admired. (i.e. companies you’d love to own)

On an individual basis, value stocks are indeed the riskier prospect.  Value Stocks, as defined here as net-nets, lose 90% or more in a single year 5% of the time, versus only 2% of the time for all stocks.

But the nature of value stocks changes dramatically when they are bundled together.  In fact, they have fewer down years than the market.  In a study, net-net stocks only had 3 down years in 26 versus 6 down years for the market.

This investment phenomena mirrors a quote by Tecumseh, Native American leader of the Shawnee.  He said, “A single twig breaks, but the bundle of twigs is strong.”  A value stock by itself is like a twig that easily breaks, but finds strength when bundled together.

twig-analogy

Return: Buy the “Ugliest of the Ugly”

If value stocks have less risk than glamour stocks, then traditional finance states that they should have lower returns.  But yet again, Carlisle proves this notion to be wrong.  In fact, he shows that value stocks generate superior returns to their riskier glamour stock counterparts.

Deep Value presents many studies which show that returns for value stocks are significantly greater than glamour stocks.  But perhaps most surprising is Carlisle’s case that the ugliest stocks provide the best returns.  The nature of this counter-intuitive element is steeped in Behavioral Finance.  Everyone in their pursuit of safety, shun companies that look risky, which creates bargains.

The ugliest of the ugly phenomena extends to countries as well.  The countries with the poorest recent performance outperform countries with the best recent performance.

solitude-poemThis investment bias towards glamour and value stocks is perfectly capture by a poem I encountered by Ella Wheeler Wilcox titled Solitude.  In it she wrote, “Be glad, and your friends are many; Be sad, and you lose them all”.

Furthermore, this poem explains why value investing is a successful strategy.  The very nature of investing in value stocks is contrarian because you’re willing to do what very few will.  Value Investors immerse themselves in grief, woe, gall, fasting, and pain.  As a result of these counter-intuitive actions, value investors  get counter-intuitive returns.

Put another way, value investors get pleasurable returns for hanging around companies in sorrow.  While typical investors get sorrowful returns for hanging around companies in pleasure.

Trust in Mean Reversion & Avoid Naive Extrapolation

Deep Value contrasts two starkly different predictive assumptions about the future.  The most commonly used assumption is naive extrapolation, whereby the past performance of a company is extrapolated out into the future.  The less commonly used assumption is mean reversion, whereby a company’s financial performance will  eventually revert towards the mean.

Carlisle demonstrates that, of the two methods, investors should rely on mean reversion.  The importance of mean reversion should not be understated.  Ben Graham identified mean reversion as the phenomenon that leads value strategies to beat the market.   Furthermore, Carlisle writes, “An appreciation of mean reversion is critical to value investment.”

Mean Reversion is built upon a fundamental economic truth that;

  1. Competition naturally eats away at high returns over time. “In most cases competition and other corrective forces work on the highly profitable business to push its return back to the mean.”
  2. Low returns will more often than not, revert towards the mean. “Stocks with big market price losses and historically declining earnings tend to see their earnings grow faster, and outperform the market.”

On the other hand, naive extrapolation makes the assumption that past results will generally continue undeterred into the future.  While this appears to be mathematically sounds, it ignores the “Base Rate”.  The Base Rate  shows that this simplifying assumption is not true for most companies.

As a results, predictions using naive extrapolation often disappoint, while predictions using mean reversion are the more likely outcome.  The chart below provides a good visualization of these two methods at work.

mean-reversion2

Mean reversion appears to have an element of Biblical faith to it.  It reminds me of a Bible Verse, Hebrews 11:1, which says, “Now faith is confidence in what we hope for and assurance about what we do not see.”  Likewise, value investors have confidence in what they hope for (anticipating mean reversion in both fundamentals and valuation) and assurances (base rate, invisible hand) about what they do not see.  Whereas most investors mistakenly invest based on what they see (historical figures), but shouldn’t expect (naive extrapolation).

Expand Your Time Horizon

To be a value investor, you must expand your time horizon.  Mean reversion often takes time.  In fact it can take 3-5 years, during which time, you may experience years of poor performance.  Most investors don’t have this kind of patience.  Wall Street generally isn’t kind to short-term underperformance.

Consequently, many fund managers will chase short-term performance at the expense of long-term success.  Quarter on Quarter and Year on Year is their focus.  But as Carlisle writes, “by attempting to avoid short-term underperformance, they are captured by it.”

Behavioral Biases: Your Intuition is Killing You

Behavioral Bias is really a dual sided topic.  First, you must understand the various Behavioral Biases which contribute to your poor investment decisions.  Secondly, you must recognize that even after understanding these biases, it remains difficult to overcome them.

Carlisle writes,

“Kahneman and Tversky found that we make decision about uncertain future events based on three heuristics…Each leads us to make poor decisions about uncertain events because it leads us to consider irrelevant evidence, and in so doing diverts us from considering the underlying probabilities about the events.”

The three biases as identified by Tversky & Kahneman are:

  1. Anchoring & Adjusting: Causes us to stick with our first impression, even when evidence arrives that conflicts with our view.
  2. Representativeness: We use stereotypes to make simplifying assumptions.
  3. Availability: Only consider things that are quickly brought to mind.

It has been shown that people still fall victim to these three biases despite working to prevent them.

“No matter how well trained we are, humans tend to have difficulty with probabilistic, uncertain, and random process.  Confronted with problems requiring an intuitive grasp of the odds in an unfamiliar context, even the best investors and behavioral finance experts flounder.  If mere awareness that our judgment is clouded by our nature does little to correct the errors we make, how then can we protect against them?

So then, what can we do about it?

Use a Statistical Approach: Focus on Simple & Effective Techniques

Carlisle offers a solution to this behavioral bias dilemma: Remove yourself from the equation.

You can accomplish this by using a statistical based approach.  Ben Graham found that the best investment approach is one that follows simple and effective techniques.

Tobias covers three value investing formulas in Deep Value which follow simple and effective techniques.  They are:

  1. Net-Nets by Ben Graham (http://www.libertyinvesting.com/benjamin-grahams-checklist/)
  2. The Magic Formula by Joel Greenblatt (www.magicformulainvesting.com)
  3. The Acquirer’s Multiple by Tobias Carlisle (http://acquirersmultiple.com/)

Net-Nets are excellent when you find them, but they are heavily exploited, illiquid, and there’s a limited opportunity set.  Meaning that you can’t grow the strategy beyond a certain size.

The Magic Formula attempted to derive Buffett’s investment strategy down into two elements, and has had great results.

  1. Quality of Business: ROIC = EBIT/(net working capital + net fixed assets).
  2. Attractive Price: Earnings Yield/Enterprise Value

The Acquirer’s Multiple, developed by Carlisle, is an evolution of the Magic Formula.  Carlisle finds that the Quality of Business element in the formula only serves to detract from overall returns.  He finds that the formula can simply be boiled down to “Attractive Price”, as defined as (Enterprise Value/Operating Earnings).

Stay Out of the Way

After Choosing your statistical approach, you may be tempted to alter the results using your subjective judgment, but this should be avoided.

self-reflexivity-2Carlisle demonstrates that the returns of the model are a ceiling from which we detract.  Not a base from which we add.  The reason being twofold:

  1. We are largely over-confident in our abilities.
  2. We find more broken legs than there really are.

In a sense, we want to de-correlate our thinking from that of the markets.  But when we introduce our subjective judgment, we begin using more intuition and thereby increase our correlation with the market.  Thus reducing returns.

Summary

The Deep Value strategy can be summarized in four steps:

  1. Create a simple & effective statistical model using counter-intuitive value investing insights, including mean-reversion.
  2. Remember, you are investing based on an expected group outcome, so don’t over-concentrate your portfolio in any one stock.
  3. Expand your time horizon to 3-5+ years.
  4. Recognize your limitations, and, for the most part, stay out of the way.

Despite many findings that demonstrate the soundness and relatively safe nature of a value portfolio, investment professionals largely shun value stocks.  The reason for their reluctance is largely centered around self-preservation.

Managers must defend their investments to clients who are usually emotional, impatient, and unsophisticated.  So if a manager invests in a group of poor companies which are undervalued, he’ll likely have to answer to his clients who see those investments as risky and imprudent.  Especially if there’s any prolonged period of underperformance.

On the other hand, it is much easier for a manager to appear prudent by simply investing in a portfolio of slightly overvalued glamour stocks that look safe.  Since the portfolio looks safe, clients will sleep well at night under the belief that the manager is acting prudently.  The manager too will sleep well because he has less stress and greater job security.  So be aware, appearances of prudence can be deceiving.

I recently came across an interview with Walter Schloss, the late great value investor, who gave an example of such a dilemma that he faced;

People have certain emotions, and they wanted to not lose money.  So we didn’t tell people what we owned, and one guy said, ‘You know Walter, I can’t stand it not knowing what we own.’  He was an old man, so I said, ‘Well we own some bankrupt bonds of the Pennsylvania Railroad.’  Which  actually turned out very well later, and he said, ‘I can’t be in your partnership knowing that, it makes me too upset.’  So he withdrew.  So people act emotionally, and if they know what you own, then they look at it and say, ‘Oh I don’t like that stock.’  Then they call you on the phone and say, ‘Well why do you own it?’  I don’t want to hear people complaining.  They trusted me with their money, and that’s what a lot of hedge funds do, they don’t disclose what they own.”

Event Notes: Cybersecurity Challenges & Preparedness for Emerging Managers

Cybersecurity is not a subject that comes racing to mind when thinking about hedge funds.  I certainly hadn’t given it much thought before today.  But upon discovering an HFA event on this topic, I was eager to expand my understanding.

Hosted at the British Consulate General in San Francisco, I was fascinated to learn about cybersecurity and some of the real issues that face fund managers today.  Here are my 12 takeaways:

  1. Firms should guard against “Reputational Risk”. i.e. the risk that a client’s trust in a firm or institution is irreparably damaged with a hack.
  2. Even mere pieces of client information is valuable on the dark web, where it can be pieced together to build a more complete, and potentially damaging profile.
  3. The Average hack takes 208 days.
  4. Hackers can potentially frame, bribe, or coerce employees into participating.
  5. Some hacks aren’t what you’d expect.  For example:
    1. One hacker actually took over a corporations’s infrastructure in order to produce Bitcoin.
    2. Another hacker broke into a firms biometric system to add finger prints to the system.
    3. And yet another involved vending machines at a company that uploaded employee information to the cloud without the firm’s knowledge or approval.
  6. Insurance on hacks can be purchased “quite cheaply”
  7. It’s surprising how many people keep passwords in files or documents named, “passwords”.
  8. A specific hedge fund was using cybersecurity as a way to differentiate themselves.
  9. AITEC: This is a society for hedge fund CTO’s.  Who knew?
  10. If you get hacked, contact the FBI right away.  There’s no reason not to.  And there’s a much higher chance of catching the hacker if you do.
  11. The number of “attack surfaces” is multiplying.  Particularly due to smart devices.
  12. Various Recommendations:
    1. Disable automatic links.  That link to 1-800-Flowers you see may be a trap.  Copy and Pasting URL’s creates an extra step with which to prevent hacks.
    2. Use encrypted emails with clients to guard against sensitive information.
    3. Use two cell phones.  One for Uber and one for sensitive information.
    4. Password Keeper has been shown to be an effective tool.

Lewis Screener: Abercrombie & Fitch and Michael Kors

Abercrombie & Fitch (ANF)

featuring Michael Kors (KORS)

Note: This analysis of ANF and KORS leans heavily on my personal stock screener.

Summary

Last weekend I took a look at Abercrombie & Fitch and Michael Kors with the aid of my stock screener.

Given ANF’s poor performance in recent history, I approached it as a case of mean reversion.  ANF appears as relatively cheap to its peers, but is not “undervalued”, as defined by my screener.  At $22.55 per share, ANF is still within its predicted valuation range of $18.48 to $70.05 per share.

Still, there are a few ways to invest based on the findings.  First, you can write put options at a strike price outside of the predicted range.  Second, you can simply wait and take advantage of a sudden pull back in the stock price.

KORS meanwhile appears “undervalued”.  At a price of $50.78 per share, KORS falls well outside of its predicted range of $61.84 to $108.93 per share.  This range is based on KORS’s current ROE of 42.1%.

It’s likely however that the market expects a coming decline in ROE.  The market expectations derived from the screener show that KORS’s ROE will decline to somewhere between 14.9% to 31.9%, with a central prediction of 23%.  This is a sharp drop from its historical average of 45.2%.

First Screen: Abercrombie & Fitch

To determine if Abercrombie & Fitch (ANF) is currently “undervalued”, I utilized the aid of my personal stock screener.  For this screen the pairing multiple of Return on Equity and Price to Book is used.  The regression made on ANF and its peers results in a rather high R^2 of 0.92.

Brief explanation: The stock screener uses a simple linear regression to find “Undervalued” stocks.  An “Undervalued” stock, as defined by the screener, is any stock that fall two standard errors below the regression line.  An “Undervalued” stock in this context is assumed to provide a statistical margin of safety.

As seen in the regression below, ANF falls just slightly above the blue trend line. This indicates that ANF is trading slightly above fair value.  But when we consider the inputs used in this screen, it becomes clear that there’s a problem that needs to be addressed.

Note: Any stock that falls outside of the “regression channel” created by the red and blue lines can be considered mis-priced by the market.
1 start

Note: The peer companies included in the screen were; related in nature, dividend paying, with a market cap greater than $100 million, and an ROE between 0% and 60%.

ROE Problem

This first screen used the trailing 12 month Return on Equity data from Yahoo Finance.  This creates a problem in two ways:

  • First: Using a single period ROE has the implicit assumption that financial performance of a company is rather consistent from year to year. This assumption may be reasonable for a company like Coca-Colca, but Abercrombie & Fitch has too much fluctuation in its business to make use of a single period ROE.
  • Second: Using a depressed ROE in the screen will result in a stock appearing as more expensive than it truly is. Given ANF’s recent poor financial performance, it will experience this form of screening bias.

The alternative to using a trailing 12 month figure is to use a historical average which we will look at next.

Mean Reversion

In forecasting the future, there are often two paths one can take; extrapolation of current trends, or mean reversion.  As just discussed, the trailing 12 month figure is based on extrapolating the present while a historical average is based on mean reversion.

In his book, “Deep Value”, author Tobias Carlisle explains that the process of extrapolation feels natural to the human mind, but is often misleading.  We instinctively want to reward good companies and punish bad ones.  But as we carry this out, we become blind to one of the most powerful elements in investing; Mean reversion.

Among Carlisle’s counterintuitive insights includes this quote;

“Stocks with big market price losses and historically declining earnings tend to see their earnings grow faster, and outperform the market.” Meanwhile, “Stocks with big market price gains and historically high rates of earnings growth tend to grow earnings more slowly in the future, and underperform the market.”

Carlisle explains, “The better bet is the counterintuitive one: deep undervaluation anticipating mean reversion.”  Consequently, given Abercrombie’s poor recent history, I thought it appropriate to look at ANF as a mean reversion candidate.  This leads me to the second screen.

Second Screen: Abercrombie & Fitch

To account for mean reversion, I made the simple assumption that ANF will mean revert to its 10 year average ROE.  Using Morningstar data, I calculated ANF’s 10 year average ROE as 11.9%.  Using this new ROE for ANF, I re-ran the original screen.

In this new screen, ANF goes from being mildly overvalued to one of the cheapest stocks.  Despite this move, AFN is still not “undervalued”.  Thus we cannot reject the hypothesis that the market has mis-priced AFN.

Note: In the following graph notice that ANF has shifted closer to the lower green line, but has not crossed.

2 mean

Solving for X

Through the use of the stock screener, we have concluded that although ANF may appear relatively cheap, it is not undervalued.  Now we move on to answer three important question:

  1. ROE: At what ROE is ANF undervalued?
  2. Price: At what price is ANF undervalued?
  3. Profit: Can we profit from this today?

1. ROE: At what ROE is ANF undervalued?

Given ANF’s current Price to Book Value, I want to know what ROE assumption would make ANF undervalued today.  We will call this ROE the “Undervalued ROE”.  Within the regression, the “Undervalued ROE” is the lowest expected ROE where ANF drops out of the regression range and becomes undervalued at today’s price.

As seen in the graph below, it’s found that that ANF’s “Undervalued ROE” is 14.1%.  Meaning that if we believe ANF will earn an ROE greater than or equal to 14.1% moving forward that we should invest today.

3 test

It might be tempting to convince ourselves that ANF can achieve a 14.1% ROE moving forward.  Especially after looking at ANF’s ROE from 2004 to 2009.  Or after considering that the median ROE of companies in the screen is 14.8%.  But there are three reasons to be cautious about expecting a 14.1% ROE moving forward.

Screen Shot 08-24-16 at 01.41 AM

First: ANF only averaged an 11.9% ROE for the past ten years.

Second: The last time ANF’s Fiscal Year ROE exceed 14.1% was 2009. It was 15.72%.

Third: High long-term ROE is achieved by businesses that build wide and durable competitive moats, and then rigorously maintain them.  In my cursory readings of ANF’s 10k, moat building did not appear high in their priorities for the past 7 years.  Rather their plans for the future were largely based in making a swift return to the past.  i.e. Their chief focus was restoring gross and operating margins to historical levels through cost cutting.

It’s challenging to expect ANF to enjoy great returns when they haven’t laid the ground work.  This reminds me of a quote I read in the WSJ about Yahoo recently, “What Yahoo is going through today is not because of decisions they made three years ago.  It’s because of decisions they made 10 years ago.”

2. Price: At what price is ANF undervalued?

Using the earlier mean reversion screen (which assumed an 11.9% ROE),  we can find the share price at which ANF is undervalued.  This price is $13.68, which is a 39% discount from its close of $22.55 on Friday (08/19/2016).

Screen Shot 08-23-16 at 10.15 PM

Before moving on however, I’d actually  like to refine this regression a little further.  In the “mean reversion screen” conducted earlier, JWN and GPS appeared as Over and Under-valued respectively.  This tends to exact a significant influence on the regression.  Sometimes it can prove to be quite informative to remove them, which is what I did in the chart below.

4 without

 

Once removed, the predicted PBV of the lower trend line moves from 0.76 to 1.00.  This results in an undervalued price of $18.48, or an 18.05% discount from the current share price.

The Price to Book trend data and predicted values for both screens are show below.  Notice that the screen gives you the price at which a stock is undervalued (Lower), fairly valued (Trend), and Overvalued (Upper).  This feature can assist with both buying and selling decisions.

Screen Shot 08-24-16 at 01.43 AM

Note: Not all stocks that appear as under or over-valued within the screen are indeed good or bad investments.  There are quantitative and qualitative elements which the screen misses.  The screen is generally meant to be an aid which is best used in unison with an investor’s knowledge, insight, and research .

3. Profit: Can we profit from this today?

While ANF’s share price does not provide that statistical margin of safety that we require, there are still a few way to implement these findings today.

Write Put Options: An alternative strategy to invest in ANF is to sell put options with an exercise price near or below the “undervalued” price.

For example, one could sell a January 2017 put option with a $19 strike price and take in a $1.70 premium.  Then, if you get put the shares at expiration, you’d effectively be buying them for $17.30.  Well below the undervalued price of $18.48 per share.

Wait: Understanding the range where ANF is undervalued, we can opportunistically use this information if stock price should decline.  But periodic updating of the screen results will be necessary.

Recap: Abercrombie & Fitch

The regression analysis found that ANF is not currently “undervalued” at its Friday close price of $22.55.  Rather you may say it becomes undervalued somewhere below 18.48.  But that’s ok.  It’s still possible to wait and buy ANF if it becomes undervalued.  Additionally, it is possible to write uncovered put options with a strike near or below the undervalued price and benefit accordingly.

Michael Kors

Note that when I ran the ANF screen earlier, I excluded all non-dividend paying stocks.  This meant that stocks like Michael Kors (KORS) did not appear.  So after I finished, I doubled back and ran another screen to include these non-dividend paying stocks.

The result: Michael Kors appears as undervalued.  In the screen below, KORS appears significantly below the lower green trend line.  This means that we can reject the hypothesis that KORS is fairly valued given a 42.09% ROE.

kors

The lowest valuation that is justified by the regression is $61.84 per share, which is an 18% discount from its current share price of $50.78.  In fact, the regression predicts a valuation range for KORS of $61.84-$108.93.

Screen Shot 08-24-16 at 01.45 AM

These predicted values are contingent upon KORS’s future returns on equity resembling its past.  The market on the other hand, likely believes the future will be worse.  Exactly how much worse is what I want to know.  For that, we can go back to the screen.

Earlier, we found the “Undervalued ROE” that would make ANF fall outside of the “regression channel”.  This time, we want to find the range of ROE’s that would make KORS fall within the “regression channel”.

Screen Shot 08-24-16 at 01.46 AM

Doing this we find the that the market expects a future ROE in the range of 14.9% to 31.9%, as shown above.  This is in contrast to KORS’ historical ROE of 45.2% and trailing 12 months ROE of 42.1%.  This implies that if an investor expects Michael Kors’s future ROE to resemble the past, or be higher than 31.9%, then KORS offers considerable value at today’s price of $50.78 per share.

The News Distilled: “The Worst…Since 2008”

I’ve been having a serious case of “financial headline” déjà vu.  Over the past month I’ve been seeing the phrase, “the worst…since 2008”, repeated over and over throughout various economic and financial articles.  The repetitive nature of this ominous headline seemed glaring.  But was it really as pervasive as I thought?  Or was I just seeing something that wasn’t there?

Fueled by this “Neo”-like  curiosity, I decided to look into it further.  I searched for any article from the past month that said, “worst” + “since 2008”, “since the Great Recession”, “since the financial crisis”.

This search yielded rich results of news articles which confirmed my observations.   Without much surprise, these articles painted a gloomy picture of the global economy, reminiscent of 2008.

Despite the one-sided nature of this search, it’s generally “not good” to draw strong parallels with the Great Recession.  If the global economy continues down this path, we could end up experiencing an economic déjà vu.   Only this time we may be faced with the truth of reality as we come to realize that “Blue Pills” are suddenly hard to find.

Image Credit: Matrix.Wikia.com
Image Credit: Matrix.Wikia.com

The articles below summarize some fascinating insights into various economic struggles around the world.

Asia

China
China stocks saw Worst Jan since 2008(Monday, 1 Feb 2016)

The benchmark Shanghai Composite index tanked more than 24 percent last month while the Shenzhen Composite tumbled 27 percent, taking the title of Asia’s worst-performing indices in what has been a tumultuous start to the year.

Japan
Nikkei Suffers Worst Weekly Decline Since 2008(February 12, 2016)

For the week, the Nikkei dived 11.1 percent, the biggest weekly drop since October, 2008.

Worst Asian Junk Bond Start Since 2008 Limits Lippo Debt Revamp. (February 1, 2016)

Standard & Poor’s has eight Indonesian companies on negative outlook or on review with negative implications, the highest level since 2009.

Japan’s exports suffer Worst post-crisis fall as Chinese demand slows (February 18, 2016)

Japan’s annual exports in January fell the most since the global financial crisis as demand weakened in China and other major markets…Exports fell 12.9% year on year in January in their fourth straight month of declines…led by a slump in shipments of steel and oil products.

Indonesia
Indonesian GDP, Worst since 2008/09 crisis. (February 5, 2016)

On quarterly basis, GDP, however contracted by 1.83%, again a bit better than 1.93% expected contraction. Economists expect, Indonesian GDP growth to stick around 4.5% in first half of 2016 due to slowdown in China.

India
India: FFI (Foreign Institutional Investor) selloff in Jan Worst since 2008(Jan 27, 2016)

Foreign institutional in vestors (FIIs) have net sold equities to the tu ne of nearly Rs 10,700 crore so far in January , making it he worst start to a New Year (worst January) since 2008 when the global financial crisis roiled the markets across the world.

Taiwan
Taiwan logs slowest annual growth since ’09 (Jan 29, 2016)

The island nation’s gross domestic product expanded 0.85 per cent in 2015, the slowest rate since 2009. Meanwhile, GDP dipped 0.28 per cent in the final three months of 2015 — the second-straight month of contraction.

Taiwan’s exports could suffer as in financial crisis: official (2016/02/17)

Exports have sustained a double-digit drop for eight consecutive months, the Worst since the 2008-2009 financial crisis Yeh said Tuesday, adding that exports in the first three months of the year could all be negative. If this is the case, Taiwan will experience again the longest decline in exports of 14 consecutive months, which occurred during the financial storm, Yeh said.

Australia

Australian consumer confidence just had its Worst start to a year since 2008(Feb. 1, 2016)

Ominously, ANZ note that the last time sentiment fell in January was in 2008, right before the onset of the global financial crisis.

U.S.
Fitch: High-yield defaults Worst since financial crisis (Feb 19 2016)

Eleven U.S. high-yield bond defaults have occurred this month, according to Fitch- the highest one-month count since September 2009.

U.S. Public Pensions Post Worst Returns Since Market Crash(February 2, 2016)

Government-worker retirement plans had 0.36% return last year…the smallest advance since 2008.  State and local pensions count on annual gains of 7 percent to 8 percent to pay retirement benefits for teachers, police officers and other civil employees. When pensions don’t meet their targets, governments have to put more taxpayer money into the funds to make up the difference. The need to do so has led to credit-rating cuts for New Jersey, Chicago and Illinois, which are being squeezed by rising retirement bills.

HFR: CTAs Shina as Hedge Funds Post Worst Start Since 2008(Feb 5 2016)

Hedge fund performance since the start of the year has been the worst since 2008, according to new data from Hedge Fund Research.

Worst 12 months for high-yield bond funds since financial crisis (February 12, 2016)

Fewer than one in 10 US high-yield bond funds delivered positive returns last year

No Inflation in Sight, Say Two Bond Masters (February 20, 2016)

Personal consumption, which accounts for more than two-thirds of U.S. GDP…according to the fourth quarter estimate…was the Worst year-end showing, year over year, since just after the 2008-09 recession ended.

This has been the Worst quarter for company earnings reports since 2009 (Feb 16, 2016)

The fourth-quarter earnings season, currently wrapping up, is shaping up as the worst quarter for earnings growth since the financial crisis, Bank of America analysts said

 Restaurant Industry Suddenly Tanks, Worst Plunge since the Beginning of the Financial Crisis (February 3, 2016)

The Current Situation Index had hit an all-time high of 103.8 last July, at a time when the restaurant industry, while keeping a worried eye on the market turmoil and the slowdown, was still optimistic that restaurants were independent from it all, that Millennials would pull through, and that consumers in general were still hanging in there. Since then, the Current Situation Index has plummeted 4.2%, on par with the worst 5-month plunge during the Financial Crisis. Back then, the index started out at a lower point, from 102 in early 2007, dropped for two entire years, in all 6.3%, to hit 95.7 in early 2009, before edging back up.  So this is not a good sign. These kinds of plunges only occur when something big is going on.

Europe

European banking sector records Worst performance since 2008 amid global turmoil. (February 8, 2016)

Fears over a sell-off in the European banking sector have gathered pace after the Stoxx Europe 600 Banks Index, the gauge of the banking sector in Europe, recorded its sixth consecutive weekly decline, the worst streak since 2008.

Worst Earnings Letdown Since Crisis Add to Europe Stock Woes. (February 16, 2016)

Europe’s earnings season is only half-way through, but so far even stable profit generators are showing signs of capitulation.

UK

UK productivity gap widens to Worst level since records began (Thursday 18 February 2016)

The gap – up one percentage point on the previous year – was the widest since 1991 and showed a particularly marked deterioration since the onset of the financial crisis and deep recession of 2007-09….Productivity among all the G7 countries deteriorated since the so-called great recession, but the ONS said Britain had been hit hardest.

Canada

 Alberta job losses last year Worst since early 1980s recession: Statscan (January 26, 2016)

Alberta’s job losses last year were 19,600…those losses exceed the 17,000 jobs Alberta shed in the Great Recession in 2009.  It’s the worst year since, 1982, when the province lost more than 45,000 jobs, amid the double-whammy of a global recession and the notorious NEP, a federal government program that capped prices, raised taxes and dramatically discouraged investment in the oil patch.

Canada: Retailers just endured their ‘worst year’ (February 19, 2016)

“[2015] was the Worst year since the Great Recession for Canadian retail,”
It’s been 13 months since Target Canada filed for bankruptcy protection in an Ontario court on Jan. 15, 2015, capping one of the most disastrous expansions in the history of the retail business.

Russia

Russian economy has Worst year since financial crisis (Jan 25 2016)

Russia’s economy shrank 3.7 percent in 2015, the worst drop since the depths of the global financial crisis, as the country struggled with a drop in the price of its oil exports and international sanctions

Charlie Munger: Full Transcript of Daily Journal Annual Meeting 2016

This week I had the great pleasure of hearing Charlie Munger speak at the Daily Journal Annual Meeting .  It was my first time attending this mini-Berkshire style meeting.

For just under two hours Charlie captivated the audience with his wisdom, quick whit, and great sense of humor.  After the meeting, Charlie was very gracious with his time as he stayed for nearly an hour to talk with attendees and take pictures.

I transcribed the event from my Audio recording which you may find below.  If you’d like to listen to an audio recording of the event I recommend: Charlie Munger – DJCO Annual Meeting 2016

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

I hope you all enjoy!

(Note: I endeavored to achieve a high level of accuracy in transcribing the event, but please be aware that minor discrepancies may exist due to errors in hearing and typing.)

20160210_100158

Charlie Discussing Daily Journal’s Business:

So we had this newspaper which formally had monopolistic qualities, and like many newspapers, it was a fine business.  It required some management, but it was fool proof.  And of course the world changed for us, as for other newspapers.  A million a year pre-taxes is what we have left.  In other words, whether we’ll keep going down or hold there I don’t know.  But if you’re holding this stock because you want that newspaper to come back to its former glory, I’ve suspect you’ve developed some sort of different rational.

What we did as we were in the same position as other newspapers were in where they were shrinking towards oblivion, was we made a lot of money out of the foreclosure boom.  We had more than 80% of the foreclosure notice business, and it was like being an undertaker in a plague year.  It provided huge prosperity for us, coming at a time when everyone else was in total agony.  Well that gave us a lot of money and we used that money to buy securities at low prices during the panic.

Aided by that peculiar response to the deterioration of our newspaper business we have entered the software business.  And that has been a slow expensive troublesome thing.  Now we have written off practically everything we spent on it.  And we had plenty of taxable income to do that with.  What’s happened now is that we now have more software revenues than we have print revenues.  And that business is way better.  Now it’s not doing better in terms of reported earnings, but on the sales field, we’re just keep doing better and better and better because our product, we honestly believe, is way better than our main competitors.  And there’s a endless market for software in these (publications).  District Attorneys, Adoption Agencies, Courts, etc.  You could hardly imagine anything more sure to keep flourishing and to keep needing more and better software systems.

Now it’s agony to do business with a whole bunch of public bodies and their consultants and their bureaucracies and so on.  And it’s such agony that a lot of big companies that are in software don’t come near it.  If you’re Microsoft, you’re use to easy money.  And this just looks like agony.  The really big boys find our niche in the software market such absolute agony that they tend to stay out of it.  And I think our products are probably better than those of our main opposition.  But of course our opposition has way more of the market.

What you people have now is a sort of venture capital operation in the software business with the (tag-end) remnants of a newspaper attached.  And the stock may be reasonable if you like highly valued venture capital investments, but for you old time Ben Graham groupies, you’re in a new territory.  I’m not saying it won’t work, but if it works, you don’t really deserve it.

Charlie Begins Taking Questions:

Question 1: Could you tell us one or two opportunities that you’re excited about for journal technologies?  And also, in the next year, what are one or two hurdles or threats?

Answer: The one that I’m most excited about, in Daily Journal technologies, was getting the contract from the Los Angeles courts.  It’s one of the biggest court systems on earth and that was, as far as I was concerned, a crucial milestone.  And you can stop and think about it.  If we succeed in saturating California, with a huge success, it may well spread elsewhere.  And we bought this little nothing of a software company…and it turns out that they’re really good at all this service to all of these clients that need to have the service.

We’ve crossed over into a new business.  And the new business is interesting because it’s a big market.  It’s a big market.  And I think if you ever get entrenched in it, it will be a very sticky business.  Which has occurred to us as we suffered all of this agony.  At least we were suffering agony in an attempt to get into a position from which we’d be hard to dislodge.

And the main threat or hurdle is that we want to be the most important player in this new niche, which is a big, big, niche.  And of course we’re concerned about that.  I don’t regard that battle as won.  I regard it as going well, but not won.  In fact I’d even say going very well, but not won.

Question 2: In investing, you talk about how you want to stay in your circle of competence.  A few years ago, Warren Buffett decided to buy IBM.  And he’s still very optimistic.  But some people say that he went out of his circle of competence.  What is your comment about this investment, and what do you think of its future?

Answer:  Well IBM was a lot like us, they had a traditional business that was very large and it was very sticky.  And of course, the world changed, and a lot of what flourished in the new world, they were not the leader.  Up came Oracle and Microsoft and all kinds of other people who were formerly not so large.  And of course they didn’t do well in personal computers even though they well started it.

IBM is a position that is lot like us where they have an old business from which cash continues to flow, but they want a new product that’s a hit.  Now the product that they’ve chosen to back is this…I call it an “automated checklist”.  Well an automated checklist is a very good idea and it may be particularly useful in things like medicine, but is it the kind of super market that may replace a lot of what made IBM great?  And I would say the jury is out on that.  I don’t really have an opinion.  In other words, I’m neither a believer or a disbeliever, I regard it as a mystery.  It could happen and it could not happen as far as I’m concerned.  I do think that the old business of IBM is very sticky and will die slowly.

It’s not a cinch.  The truth of the matter is that at Berkshire’s size, where we have to make great big bets and hold them for long periods, that’s a tough game and we have to make bets that are not the kind of shooting fish in a barrel kind of bets that we use to make.  And that’s one of them.

So…the answer my friend is blowing in the wind.  It may work in a mediocre way, it may work big, I just don’t know.

Question 3: What advice do you give to your grandchildren?

Answer: Well regarding the grandchildren, I was not able to change my children very much.  My situation reminds me what Clarence Darrow said when he read the great poem that ended, “I am the master of my fate, I am the captain of my soul.”  Clarence Darrow said, “Master of my fate?  Hell, I don’t even pull an oar!”  That’s the way I feel about changing the children.  And regarding the grandchildren, thank God they’re somebody else’s problem. (Big laughter)  I served my time.

Question 4: Do you have a favorite investment story?

Answer: Well, investment stories from my younger days…I’ll tell a story I’ve never told before.  Years ago, 1962, my friend Al Marshall came to me and said, “I want your help in bidding for some oil royalties.”  They were being put up by auction.  I soon realized that under the peculiar rules of an idiot civilization, the only people who were going to bid for these oil royalties were oil royalty brokers who were scroungy, dishonorable, cheap bunch of bastards.  I realized that none of them would ever bid a fair price.  So I said, “We just need to bid high enough to get some of these royalties.  You can’t possibly fail in an auction where they excluded everybody but kind of shady, difficult, cheap bastards.”  So we bid for those oil royalties and we financed the thing with a down payment.  We each put up a thousand dollars, and for many, many, years, the Mungers were getting $100,000 a year, 50 years later.  More than 50 years later.  Out of a thousand dollar investment.  The problem with that story is that it only happened once. (Laughter)  That’s true with most good investment stories.  You don’t get very many.  It isn’t like that kind of opportunity comes along every day.  The trick in life is when you get the one, or two, or three that your fair allotment for a life is that you’ve got to do something about it.  So that’s my story from my youthful days.

Question 5: How is the current energy environment compared to the early 80’s when you were running Wesco are there any notable similarities or differences this time around?

Answer: Well of course we owned Wesco for a long time.  What’s interesting about both Blue Chimp Stamps, which controlled Wesco, and Wesco is that they eventually were some of the most successful investments in the history of mankind.  What’s interest about those outcomes is that it was only 5 or 6 transactions that carried all the freight.  Really heavy freight.  Now that is really interesting when you stop and think about it.  You try and do a zillion little acquisitions…it’s hard.  But by just doing a few things over a long period of time and having them work out well, those little nothing companies…  They were all doomed.  The trading stamp business.  The savings and loan association.  The savings and loans are pretty long gone.  And yet they worked out fairly well.  There again, just a few good decisions over a long period of time.

Some great investment success once said, “You make your money by the waiting.”  Now that doesn’t mean sitting around for the next depression, you can’t do that, but a fair amount of patience is required in some of these good investment records.  Patience followed by pretty aggressive conduct when the time comes.  Imagine sitting there, were having all of this money rolling in with the foreclosure boom, and then deploying it in like one day.  At the bottom tick for some of those stocks.  Now that was luck.  And it was luck that we had caught the bottom tick.  It wasn’t luck that we had the money on hand when other people didn’t and were willing to deploy it when other people were running for cover.

Question 6: What other business models did Berkshire Hathaway try/consider, but ultimately did not pursue?

Answer: Well we were always optimistic.  We wanted to buy the best thing that was conveniently available and that we could understand.  In the early days, we thought we had a special advantage as investors in our little securities, so we tended to look carefully at float businesses.  Nowadays of course, we’ve got enormous float and it hasn’t been that much use to us.  Such is the nature of life.  We made so much money on those float businesses that it was obscene in the early days.  And it’s not a tragedy that now our float businesses don’t get much advantage about the float.  Berkshire’s cash which is large is not getting much of a return.  In Europe, the rates are negative.  Japan the rates are negative.

Question 7: What do you think about the attractiveness of the software business versus industrial franchises?

Answer: Software based businesses, some of them have become some of the most profitable businesses on earth.  Other software companies are failing and shrinking.  So it’s like the rest of capitalism.  It has its good spots and its bad spots.  And as I’ve said, the one we’re pursuing will be sticky if we succeed in it.

Question 8: Other competing businesses in the journal tech space are growing faster.  Why is that? And they seem to be selling for higher multiples.  Would you ever consider selling Daily Journal Technologies at a high multiple?

Answer: Well, nobody has offered us a high multiple.  It’s a peculiar part of the software business involving a lot of agony now for a payoff way later.  You can’t judge it as a normal business.  It’s venture capital.  It just happens to be located in a publicly traded company.  If venture capital works, it could gradually evolve into a pretty huge business.  But of course, everybody’s trying to evolve into a pretty huge business, and only a few succeed.  But we’re not like a normal software business.  And those little companies were not acquisitions like Berkshire Hathaway makes acquisitions, those were not established companies that were sure to succeed and relatively fool proof.  If we were going to make our venture capital type assault on this kind of peculiar part of the software market, we needed momentum from other sales forces and service operations and so forth.  So we just bought them.  But don’t judge those things by the standards of normal corporate acquisitions.  Those are part of venture capital.

Question 9: If you were to design CEO compensation for an insurance company or bank, how would you do that?

Answer: Well both Berkshire and the Daily Journal have our own way of doing things and we don’t follow anybody else’s.  We just try to do whatever makes sense under the circumstances.

Question 10: What’s your expectations about BYD for the next 10 years?

Answer: Well, we allow questions on all subjects, and I suppose that one is a legitimate question.  BYD has 220,000 employees.  That is a big company.  That too was venture capital when we went into it.  That company has done amazing things.  The man who created that company was like the eighth son of a peasant.  He went to engineering school, got a PHD, and started off by borrowing $300,000 from the Bank of China.  And going into the small batteries for cell phones and so forth which was totally dominated by high-tech Japanese firms.  And he succeed in grabbing about a third of that market from a standing start of zero.  And he won the intellectual property rights of the litigation.  And that litigation happened in Japan.  He was a very remarkable man doing an almost insanely ambitious thing.  And out of that, he has 200 and some thousand employees and a huge lithium battery plant.  Last month he sold 10,000 electric cars in China which is more than Tesla sold.  And of course nobody’s hardly heard of BYD.

It’s an interesting company.  Berkshire doesn’t do this kind of venture Capital stuff.  And I hope the Daily Journal will work out half as well as I expect BYD to work out.

BYD is in a position, on purpose, to benefit from this electrification trend in the world.  It’s been very helpful to them that people are dying on the streets of Beijing because they can’t breathe the air.  They have to go to electric cars in Beijing.  And BYD is ahead in terms of efficient manufacturing.

They’re very well located.  That’s a very interesting venture capital investment.  Now was it an accident?  Sort of.  Berkshire departed from its standard methods and did that one.  I would say that I only wish our prospects were as good as BYD’s.  And by the way, they might be, but it’s not the way to bet.

Question 11: When you value a company, what discount rate should we use?  Warren Buffett has used a risk free rate and sometimes makes some adjustments.  And I’ve read that you use an opportunity cost approach of your next best investment.  Which one of these are correct?

Answer: Well, they’re both correct.  Obviously it’s relevant what the return you get on a government bonds is.  That affects the value of other assets (in the general climate).  And obviously your opportunity cost  should govern your own investment decision making.  If you happen to have rich Uncle who will sell you a business for 10% of what it is worth, you don’t want to think about some other investment.  Your opportunity cost is so great that you forget about everything else.  And most people don’t pay enough attention to opportunity costs.

Bridge players know about opportunity costs.  Poker players know about opportunity costs.

Question 12: When you arrive at the valuation number using the discount rate, does that mean that between the two rates…

Answer: We don’t use numeric formulas that way.  We take into account a whole lot of factors.  It’s a multifactor thing and there’s a trade-off between factors, and it’s just like a bridge hand.  You have to think of a lot of different things at once.  There’s never going to be a formula that will make you rich just by going through some numerical process.  If that were true, every mathematical nerd that gets A’s in algebra would be rich. (laughter)  That’s not the way it works.

You’ve got to be comfortable thinking about a lot of different things at once, and correctly thinking about a lot of different things at once.  You don’t have a formula that will help you… and all that stuff is relevant.  Opportunity cost of course is crucial.  And of course the risk free rate is part of a factor that determines how attractive some common stock is.

Question 13: Do you use the same discount rate for different businesses.  For example, an IBM or a Coca-Cola?

The answer is, no, of course not.  Different businesses get different treatments.  They all are viewed in terms of value and you weigh one against another.  But of course we’ll pay more for a good business than a lousy one.

We don’t really want any lousy businesses anymore.  We use to make money by (buying) lousy businesses and kind of wringing money out of them.  That is a painful difficult way to make money if you’re already rich. (laughter) We don’t do much of it any more.  Sometimes we do it by accident because one of our businesses turns (on us)… and we deal with those businesses the best we can, but we’re not looking for new ones.

Question 14: I have a mental models question for you.  You talk about these quick, cut to the chase, algorithms that you use, do you arrive at that fluency only after having gone through your entire mental model checklist over a long period of time?  Or is it simply a matter of, for example, knowing you’re looking at a social situation and so the psychology checklist might be appropriate.

Answer: Well, if you’re talking about multiple models, that means you’re thinking about many different models.  That’s the nature of reality particularly if your an investor with a wide variety of human activities, and there’s no way to make that easy.

Look, you all are in the business, do you find it easy? (laughter) Anybody who finds it easy is wrong.  You’re living in a delusion.  It’s not easy.  You occasionally will get an easy one.  But not very many.  Mostly it’s hard.

How many people find it hard to make those investments right now?  (Most people raise their hands)  Yeah, yeah, it’s an intelligent group of people.  (laughter)  We collect them.

Question 15: You talk about making an effort to reduce standard errors and doing so by not taking part in auction processes.  In terms of your daily habits or life habits, what you do that most people don’t, to reduce standard errors.

Answer: Well, there are two things Warren and I have done, and Rick Guerin has done too.  One is that we spend a lot of time thinking.  Our schedules are not that crowded.  And we’re constantly…We look like academics more than we do like businessmen.  So our system has been to sift life for a few opportunities and seize a few of them.  And we don’t mind long periods in which nothing happens.

And Warren is exactly the same way.  Warren’s sitting on top of an empire, and you go to his schedule sometimes and there’s a haircut! (laughter) “Oh, there’s a haircut today.”  That’s what created one of the most successful business records in history.  He has a lot of time to think.

And that brings me to the subject of multi-tasking.  All of you people have got very good at multi-tasking, and that would be fine if you were the chief nurse in a hospital, but as an investor, I think you’re on the wrong road.  Multi-tasking will not give you the highest quality of thought that man is capable of doing.  Juggling two or three balls at once where people come at you on their schedule, not yours, is not an ideal thinking environment.

But I do think that the constant search for wisdom, and the constant search for the right kind of temperamental reaction towards opportunity, I think that will never be obsolete.  And you can apply that to your personal life too.  Most of you are not going to get five opportunities to marry some wonderful person.  Heck, most of you aren’t going to get one.  (laughter) You’re just going to have to make do with an ordinary result.

Question 16: Question regarding  Daily Journal and its purchase of Wells Fargo stock.  Wells Fargo was a levered institution and you bought it at a time when banks were failing.  How did you arrive at that decision?

Answer: Well that’s a good question.  I’ll take you back to one time before.   When Berkshire bought Wells Fargo, the world was coming unglued in banking panic, and again real estate lending had been the source of it.  And Wells Fargo had been huge in real estate lending…  But the answer was, we knew that the lending officers at Wells Fargo were not normal bank lending officers.  They had come up, a lot of them, from the garment district, and they had this cynical view of human life.  They were appropriate careful.  And when they needed to intervene strongly they did so because they learned that was the right way to run a garment lending business.   And they were just better.  And so we knew they weren’t going to lose as much money as everybody thought they were with that big real estate portfolio.  Because they had chosen it better and they had managed it better, etc. etc.  So we had an information advantage just based on general thinking and collecting data…We were aware that they had that special capacity.  Well that gave us a big advantage so we bought heavily.  That was one.

Now number two; the Daily Journal Company.  When the world was coming unglued when the Daily Journal bought Wells Fargo stock.  But we again, we knew that the bankers at Wells Fargo were more rational than ordinary bankers.  It was a different kind of superiority and rationality.  It wasn’t this big real estate portfolio on a shrewd way of handling developers.   But it was still a shrewder way of being in banking.

I don’t think anybody could ever buy a bank who doesn’t having a feeling for how really shrewd the management is.  Banking is a field where it’s easy to delude yourself into reporting big numbers that aren’t really being earned.  It’s a very dangerous place for an investor.  Without deep insight into banking, you should (avoid it).

Question 17: Two powerful mental models are the concept of specialization, and the multi-disciplinary approach.  Do you have any advice on synthesizing them?

Answer: Saying you’re in favor of synthesis is like saying you’re in favor of reality.  Synthesis is reality because we live in a world with multiple factors and models.  And of course you’ve got to have synthesis to understand a situation when two factors are intertwined.  So of course you want to be good at synthesis.  And it’s easy to say that you want to be good at synthesis, but it’s not what the reward system of the world pays for.  They want extreme specialization.  And by the way, for most people, extreme specialization is the way to succeed.  Most people are way better off being a chiropodist than trying to understand a little bit of all the disciplines.  I don’t want a chiropodist who’s trying to be a poet.  I want somebody who really knows a lot about feet.  And the rest of the world is that way.  And so this model of being good at synthesis across a lot of disciplines it’s very helpful to some people.  But it’s not the correct career advice for most people.  For most people the correct career advice is figure out some clever specialty and get very, very good at it.  The trouble of it is, is if that’s all you do, you make terrible mistakes everywhere else.

So synthesis should be your second attack on the world.  And it’s really defensive.  Without synthesis, you’ll be blindsided in all the other parts of your life that aren’t “chiropity”.

Question 18: What advice could you give for a person to improve their own rationality.

Answer: Well start working at it young and keep doing it until you’re as old as I am.  That’s a very good idea, and it’s a lot of fun.  Particularly if you’re good at it.  I can hardly think of anything that’s more fun.

You don’t have to be the Emperor of Japan to get fun out of rationality.  If you can avoid a lot of hopeless messes and you can help other people (avoid) a lot of their messes, you can be a very constructive citizen.  If you’re always rational.

Being rational means that you avoid certain things, it’s like “I don’t want to go where I’m going to die.”  I don’t want to go where the standard result is awful.  Where is the standard result awful?  Try anger.  Try resentment.  Try jealousy.  Envy.  All of these things are just one way tickets to hell.  And yet some people just wallow in them.  And of course, it’s a total disaster for them and everybody around them.

Another one that is just awful is self-pity.  If you’re dying of cancer, don’t feel sorry for yourself.  Just chin up, and suck it up.  Self-pity is not going to improve anything, including (cancer).  Self pity is just…forget about it.  Get it out of your repertoire.

Question 19: Some people have not found the ROI on marriage to be worth it.  What’s your valuation on the investment of marriage.

Answer: Well, I think different folks can live in different ways, but I think all the evidence is that marriage is the best practical alternative for most people.  And the statistics show it.  They live longer.  When you measure happiness, physiologically and so forth.  Considering how difficult the world is, it’s your best chance for most people.  And of course it should be valued.

That’s one of the things I like about the Asian cultures.  The Confusion idea that the family is really important.  It’s a very sound idea.  If we ever lost the family values, we’d have one hell of a lousy civilization.

Question 20: Happy belated 29th birthday.

Answer: Yes.  Very belated.

Question: Why purchase real estate in Utah, rather than deploying it in the technology business?

Answer: We think we’re going to be in Logan, Utah for a long time.  We have a very happy bunch of employees there.  They like their work, they like their community, they like everything about it.  And it’s part of a business operation.  We’ve got customers who come there and it’s a very presentable building.  I’ve never seen it, but it’s got a river that flows by.  Of course we’re glad to own it.  We own this real estate.  We bought it cheaply, we built it cheaply, it’s a nice piece of property.  The neighborhood around it has steadily upgraded and gentrified it as we expected.  Nothing wrong with owning a little real estate.  Our way of getting ahead was not to be real estate operators.  But we don’t mind owning real estate, it’s part of the business.  And it simplifies life. 

Question 21: Do you think a person who can’t make money running a New Jersey casino is qualified to be President of the United States?

Answer: Well, he did make money for quite a while.  My attitude is that anybody who makes his living running a casino is not morally qualified to be President of the United States.  I regard it as a very dirty way to make money.

Question 22: What has given you the greatest sense of accomplishment?

Answer: Well, my family life has been more important to me than wealth or prominence.  On the other hand, I hated poverty and obscurity. (laughter) I tried to get out of them and it has given me some satisfaction that I came a long way from where I’ve started.  I think most people who’ve come a long way from where they’ve started feel pretty good about it.  I think most the people who’ve finally sat atop of Everest, even though they’ll only stay there for 15 seconds…  And so, I think that’s good.  Cicero use to say that ‘one way to be happy in old age is to remember a lot of achievements in your past.’  Now some people say that’s too damn self-centered and you should be thinking about God or something, but I agree with Cicero.  It’s ok to live that kind of a life if you’re kind of pleased with it when you’re old and look back.

Question 23: If you had any advice to give to a younger version of yourself, what would it be?

Answer: Well my advice is always so trite.  The good behavior, being dependable, and morality.  It makes your life easier.  It makes it work better.  You don’t have to remember your lies which gets complicated if you keep lying all of the time.  In fact, it gets so complicated that you’re sure to fall off and you’ll be recognized as a liar.  So, I think all the old fashioned morality works.  The old fashioned discipline works.  The old fashioned good behavior and a little generosity.

We all know people who have people come to their funeral just to make sure they’re dead.  (laughter)  You don’t want to be in that crowd.  You want to live your life so that some people will actually miss you when you’re gone.

I think Kiplings’s ‘if’, is a great poetry.  Kiplings doesn’t exist in the modern college anymore.  It wasn’t politically correct.  So I think Kiplings’s “if” is great poetry and it’s great advice.  “If you can keep your head when all about you are losing theirs”.  What’s wrong with that?  And the quote, “Be a Man my son!”  Why don’t you want to be a man?  You want to be some idiot child all your life?  Some angry twit?  There’s so many of them already.  There’s so much to be gained by never being an angry twit.  In fact I think anger is just…If you want to be philosophical, this political situation we all face now, of course it’s disgraceful, a lot of these people.  I mean, it’s bad that a leading civilization has candidates for a high office many of them like those we were talking about.  And they’re not all in one party.  You don’t want to get angry.  After all, politicians have been politicians for a long, long, time.  And, you want to operate constructively?  Vote constructively.

Anger.  There’s so much anger in politics right now.  So much automatic hatred.  How could any of us really know whether the United States will be better 50 years from now because we vote Republican or vote Democrat in the next election?  Who can tell what the exact mix is between compassion and something else?

All of those things were in the old behavior rules.  By the way, the Muslim behavior rules read a lot like the Old Testament.  Which of course they copied.  They claim they came directly from God, but really they stole them from the Jews.

Question 24: What is the relationship between oil prices and economic growth?

Answer: I think it’s obvious that if oil had been a little cheaper and easier, the growth would have been greater than mankind had.  In that sense, if oil gets very expensive and we still need it desperately, it  will make life harder, and so there is that correlation between oil prices and economic growth.

On the other hand, some very peculiar things happen.  When you take Exxon and Chevron and so forth.  What’s happened to make those things good investments over the long term, is the damn price of oil went up faster than their production went down.  Now name me another business where you get richer and richer where your production of real units, keep going down, down, down.  So, not everybody would have predicted that in advance including most of the economists.  It’s a complicated subject…

And there’s another trick to it.  People who really have a lot of free energy, like the people of the middle east?  They have very dysfunctional economies.  They’re (like) a bunch of rich people spending their capital and not knowing how to do anything that anybody else wants to buy.  Maybe in that sense, having a tougher hand has been good for us.

My answer to your question reminds me of what my old Harvard Law professor who use to say to me, “Charlie, let me know what your problem is and I’ll try and make it harder for you.”  I’m afraid that’s what I’ve done for you.

Question 25: How do you understand a new business or new industry that you are trying to get into where the dynamics are different?  How do you get deep insights into the specific domain?

Answer: The answer is barely.  I just barely have enough cognitive ability to do what I do.  And that’s because the world promoted me to the place where I’m stressed.  And if you’re lucky, that will happen to you.  That’s where you want to end up is stressed.  You want to have your full powers called for.  And believe you me, I’ve had that happen to me all my life.  I’ve just barely been able to think through the right answer time after time after time.  And sometimes I’ve failed.

Question 26: Last year, you had some very pointed comments concerning Valeant, and I want to know, do you have…

Answer: It’s caused me nothing but trouble. (laughter)

Question 27: Do you have any update regarding Valeant?  Do you have any areas where you have similar concerns?

Answer: It probably wasn’t wise for me to inject myself, I have no dog in that hunt.  I have no interest in the pharmaceutical business.  I have no interest in Valeant.  It’s just that you people have come so far…(laughter)…to tell you amusing stories about life and make comments about current affairs.  And Valeant was such an extreme example of misbehavior.

It ended up with one of the Valeant shareholders saying that Warren Buffett was a sinner because he owned Coca-Cola.  I drew retaliation to Warren.  By the way, that’s a good place, if you’re anybody that’s mad at me today, why (not get) mad at Warren?  He can handle it, he’s a very philosophical man.

It is true that these crazy false values, and these crazy excess, is, it’s bad morals and it’s bad policy.  It’s bad for the Nation.   It’s just bad, bad, bad.  And there’s a lot of it.  And of course there’s a lot of it is in American Finance…   The truth of the matter is that Elizabeth Warren would not agree with me on many subjects and I wouldn’t agree with her on many subjects, but she is basically right when she says that American finance is out of control and has too much evil and folly.  And it isn’t good for the rest of us.  Both Elizabeth Warren and Bernie Sanders, not two of my favorite people on earth, are absolutely right on that subject.  And the extent that you all see it.  You all see what all goes on in finance with the craziness…It’s very bad for all of us that we have this huge overdevelopment of finance.  And yet, it’s pretty hard to do anything about it.

What happened was, you look back to say Edwardian England, or a little before.  And maybe 300 people owned half the land in England and they had nothing to do.  What did they do?  They went into the clubs of London and they sat around the card tables and they played (card games) for high stakes.  And that’s what human nature does when people have a lot of leisure and so on.

Fade in, fade out, and multiply the wealth per capita of the world by 30 or so and now we got all kinds of people who are like the Lords of England who had all that time to sit around and play cards against one another and enjoy thrills and games of gambling.

We have a vast gambling culture and people have made it respectable.  Instead of betting on horses or prize fights, they bet on the price of securities, or the price of derivates relating to securities.  Of course you can bet on athletic contests.  We have a huge amount of legalized gambling.  And of course the public market that operates every day with transactions is an ideal casino.  And there’s a whole bunch of people who want to own the casino and make a lot of money without losing money on inventories or credit risks, or any other irritating parts of business.  Just to sit there and have every night gold go higher and higher.  Who doesn’t want to be croupier at a casino?  And very respectable people get drawn into it if they see other people getting rich at it.  There’s way too much of that in America.  And too much of the new wealth has gone to people who either own the casino or they’re good at playing others in the casino.  And I don’t think the exhalation of that group has been good for (the public generally).

And I am to some extent a member of that group… and I’m always afraid that I’ll be a terrible example for the youth that I think will just want to make a lot of money with soft white hands and not do much for anybody else, I just wanted to be shrewd in buying little pieces of paper.  Even if you do that honestly, I don’t consider it very much of a life.  Just being shrewd about buying little pieces of paper, shrewder than other people, is not an adequate life.  It’s not a good example to other people.  And it’s the reason that people like Warren and me (are charitable and are) running businesses.  We’re not just buying little pieces of paper.

So I think that we have something going in our nation that is really very serious and very bad.  And I hate to agree with Elizabeth Warren on this subject, but she’s right.  I don’t see a way of stopping it except with some big legislation changes.

And you’ll say, “What difference does it make?”  Well, what happens is, as the cyclicality of the gambling with securities and other assets goes on, what happens is, the big busts hurt us more than the big booms help us.  And we say that when the great depression ended and the rise of Adolf Hitler.  A lot of people think that Hitler rose because of the great Weimar inflation.  But you know Germany recovered pretty well from Weimar inflation.  What they did is they destroyed the currency.  They just issued a new currency.  It’s really interesting.  They said, (‘oh people who got rid of their old mortgages we’ll replace them with new mortgages and they’ll owe us the new currency back.’)  But what really enabled Hitler to rise was the Great Depression.  You put it on top of the Weimar inflation the Great Depression and the people were just so demoralized that they were subject to being snookered by a guttersnipe like Adolf Hitler.  So I think this stuff is deadly serious in that these crazy booms should be (nipped in the bud)…  People like Alan Greenspan, he’s an amiable man but he was an idiot! (laughter)

You do not make the head of the Federal Reserve, the governor of all banking, somebody whose hero is Ayn Rand!  Who believed in no government at all!  It’s a very unlikely place to look for correct decision making.  And it’s probably not the kind of decision making that we observe.  I think he’s an honest and amiable man, but of course he didn’t see reality the way that it was.  A lot of people think that if an ax murder happens in the free market that it has to be all right because free markets are all right.  A lot of those people are in my party by the way.

Question 28: Is the Automobile Industry meaningfully different today than it was (10) years ago? Does GM make sense in the Berkshire portfolio?

Answer: The second one is easy.  General Motors is in our Berkshire portfolio because one of our young men likes it.  And Warren lets the young men do as they please.  Warren, when he was a young man, didn’t want any old man telling him what to do.  So he delivers that kind of freedom to his young men.

I haven’t got the faintest idea of why that young man likes GM.  It is true that it’s statistically cheap and it may be affected by the federal government in the end.  So it may be a very good investment.  But the auto industry is about as brutally competitive an industry now as I have ever seen it.  Everybody knows how to make good cars.  Everybody.  And they rely on the same suppliers.  And the cars last a long time with very little service.  And everybody leases them at cheap rents, and has all kind of incentives.  It has all of the earmarks of a very commoditized, difficult, super competitive market.  So I don’t think the auto industry is going to be a terribly easy place.  And it may actually shrink one of these days.  In other words, the culture of everybody having three or four cars could actually shrink.  And so, I think that the auto industry is not a cinch.  If I were investing in the auto industry, I’d want some place that I thought was way the hell better competitor than the others, and that’s hard to find.

Question 29: For most of the oil market’s history there’s been some entity enforcing production controls.  But today Saudi Arabia (operates) more as a base load producer than controlling OPEC’s production.  Would you suspect that this will result in protracted negative impact on the economics of all those related to oil production?  Or is the way to bet that some entity will eventually re-emerge for production control.

Answer:  I would not have predicted that oil would be at its present price.  In fact, if you forced me to bet, I would have bet that what has happened wouldn’t have happened.  But it did.  I think that it’s generally true that with these commodities you can get periods of extreme high prices, like we had in iron ore, and extreme low prices, like we now have with iron ore.  So I think that commodities do strange things both up and down in terms of prices.  And of course they have macroeconomic consequences.  And huge consequences if you’re in Australia having these commodities going way down is terrible.  If you’re in the tar sands area of Canada having oil prices go down to where they are now…I don’t even know how economic it is to produce tar sands oil at $30 per barrel.  My guess is that it’s not very attractive.  And it may not work at all.  You’re in a weird period.

But I think it’s the nature of the human condition that with free markets in stuff like iron ore and oil, you’re going to have weird periods high prices and weird periods of low prices.  I’ve never been able to predict accurately, or make money predicting accurately those swings.  We’ve tended to get into good businesses and then take the bumps as they fall.

Question 30: Would you please recommend some books that you’ve enjoyed lately?

Answer: Well you people send me books, like 30 a week.  That I tend to skim them so rapidly that I no longer develop the joy of reading I use to when I picked a few books of my own to read. (laughter) So you’re ruining my judgment of books.  I can’t resist reading the damn things when you send them to me.  No I skim a lot of them, and I like each one in its way, because it’s different from anything else I normally do.  But I’m no longer a good book source.

Question 31: Regarding philanthropic work, what inspired you and what results do you look for?

Answer: Well, I never wanted to tackle problems like world peace.  I read enough biographies.  Carnegi thought he was so smart and so rich, so he thought that he’d use his money to create world peace…I watched Carnegie try to do it and I decided that if he couldn’t do it, then I’m going to leave it alone.  So I don’t take up those big subjects.

I like to create dormitories, science teaching facilities, stuff like that.  It’s a pretty modest activity, but it’s interesting to me, and it’s easy to do them better than most people do them.  I have no feeling that I have any advantage about bringing about world peace, but I am pretty good at dormitories.  So I do what I’m good at, and I suggest that all of you do the same thing.

Question 32: 

Mr. Buffett has stated that he believes that income inequality is an issue that needs to be addressed.  With Senator Sanders, he has built his campaign around this issues.  And with so many from my generation starting to “feel the Bern”, how would you address this issue?

Answer:

Well, that’s a very good question because it’s…we’ve had Piketty and then Sanders.  My attitude is that both Sanders and Piketty are a little nuts.  People who really were passionate about egality and wanted to bring it about by government action, gave us things like the Soviet Union, with all the death and agony and the poverty they have now in spite of (having egality).  And Communist China, they got egality, and think of the unnecessary deaths.  North Korea?

I’m suspicious for all of this passion for egality that has such bad examples.  On the other hand, if you want to look at what non-egality brings us.  Let’s just take Communist China.  Communist China had egality, meaning that three fourths of their people were dirt poor, subsistence level poor.  But they had the advantage of being equal.  They were all struggling to get enough to eat.  And of course when they adopted private property and more property rights, and so on, what they got was living standards that had advanced by a factor of 10 or so more quickly than anyone ever had.  But of course they had a lot more inequality.  You have all of these rich Chinese.   I think it’s been a very good bargain for the Chinese to have.

In other words, I don’t think Bernie Sanders understands this at all.  He doesn’t want to understand it.  He has a religion.  He’s had it for 30 years.  He’s a Johnny one note.  It doesn’t matter.  As an intellectual he’s a disgrace.  I think that we’d all be glad to have him marry into the family, but as a thinker he’s…pretty bad.  Now I don’t think he’s any worse than some of our Republicans, but at least they’re crazy in a different way.

But the egality has one effect in a democracy, which Aristotle comments on, people will cheerfully tolerate considerable differences of outcome if they seem deserved.  Nobody minds the fact that Tiger Woods has a big income because he’s the best golfer who’s ever lived.  Or you find somebody who invents something wonderful, or a surgeon who’s way better than other surgeons, etc , etc.  But differences in outcomes that are perceived as undeserved tend to disrupt democracy.  That’s why Aristotle commented on it in one of his most well known observations.

And of course who is getting the undeserved money in America now?  Good question.  It is not Bill Gates, it is not the people who create the new companies…  We don’t resent their success.

I think we have a lot of underserved wealth that causes a lot of envy.  And to some extent, well, I think envy is always a bad idea.  I think it’s also inevitable that we’re going to have a lot of it.  There’s a lot of undeserved wealth in the financial class.  In a lot of cases for doing nothing, or being counterproductive.  So I think that fixing the obviously undeserved wealth of a lot of people would be a constructive thing.  If you take the ordinary investment partnership, not only do they get capital gains on what for anybody else would be ordinary income, but they don’t pay any income tax at all.  Because it’s unrealized appreciation that gradually shifted to the general partner and he can take securities out when he leaves the business and not recognize the gain.  They have enormous liquid fortunes being made on paying no taxes at all.  Naturally that’s resented.  It would be resented even more if people understood it.  But that’s not very complicated to understand.  And so, I think by and large, feeling unhappy with inequality…Inequality is the natural outcome of a successful civilization that is improving for everybody.

Most of these guys (wealthy individuals) are not that interested in politics.  People like to talk about the terrible influence of the rich on politics.  But when you’re rich, you realize how little influence the rich really have.

I think that these people who are raging about inequality, like Picketty and Sanders are wrong.  But I think that the people who say that the undeserved wealth deserves some attention, I think they’re right.  I think a huge source of the undeserved wealth is coming from the old finance.

Question 33: You mentioned Wells Fargo earlier and its culture and the reason that you bought it back in the 80’s.  Daily Journal Corporation owns U.S. Bank as well.  You also own Bank of America and its culture is a little different.  And I’m curious if the decision to buy Bank of America was driven by its low price or if you also see the compounding element.

Answer:  Bank of America was bought through the way that we use to buy securities.  It just got pounded so hard that it was selling for less than it was worth.  Way less.  And there’s a lot in the Bank of America which is sound.

Question 34: I’m pretty excited about the prospect of self-driving cars over the next 10-20 years.  It seems like the technology is moving very quickly.  As a Berkshire shareholder I’m worried about the implications about the entire auto insurance if accidents, hopefully, become a thing of the past.  That’s good for civilization, bad for the auto insurance business.  I would love to hear your thoughts on that.

Answer: Well you’re right.  If all the cars run around without drivers, it will be bad for Geico.  And I don’t think it’s going to happen very quickly.  In fact I think it’s going to be quite slow.  But in the auto industry…the first thing that people did when they got new wealth was (buy) more cars.  I think that even if we don’t get self-driving cars, that culture may be waning.  Not so much in the third world, but in places like America.

Question 35: Could you publish a personal book list of the books in your library?

Answer: I don’t want to be a book recommender.  (laughter)  It would be quite time consuming.  So I’m afraid you’ll have to (ask another question).

Question 36: A lot of people here have the ability to do well, but they don’t have the opportunity to meet the right people.  Ronald Burkle credits you with give him credibility when he was starting to acquire grocery stores at age 30.  Who was your mutual acquaintance and how was Ron Burkle able to meet you in the early 1980s.

Answer: In those days, we (Berkshire Hathaway) had a lot of declining businesses and one of them was trading stamps.  And our last big trading stamp customer was the company that Ron Burkle’s father controlled.  And that’s where I met Ron Burkle.  It was an attempt to preserve that customer.  The last customer we had.  And in due course I failed.  Ron Burkle on the other hand left that occasion and did nothing but succeed.  So maybe you should ask him.

Question 37: What’s your view on the Unicorn companies like Airbnb, Uber, etc.  Do you think those companies have such high valuations can ever go public?

Answer: Well, my attitude is that I have a circle of competence.  And that does not include correctly predicting which new companies in Silicon Valley, or dependent on Silicon Valley, are going to succeed.  So I tend to avoid the subject entirely.  I’ve paved my way in other passions.  However I will comment on one thing.  Manipulated Finance.

As these venture capitalists, who are part of the finance industry, the constructive ones.  These are the people who make their living more honorable than the rest of the people in finance because they’re actually allocating capital to new businesses.  So the venture capitalists are useful members of finance.  But they don’t escape their share of sin.  What they’ve gotten in the habit of doing is creating these rounds of financing.  And each new one is at a higher value.  But they just sneak a little clause in saying, that nobody who previously bought into the venture gets anything until the new guys are preferred.  Well that is sort of like a ponzi scheme.  It’s a disgusting, tricky, dishonorable thing to do.  Particularly since it’s obscured.  And of course it’s being deliberately obscured.

So even our most reputable part of finance has dirty sleazy activities creeping in.  Large amounts of easy money cause regrettable human behavior.  That’s Munger’s rule.

Question 38: Apparently the environment that we invest in today is very different from when you started.  With high frequency trading, momentum trading, and all of that, do you think that fundamental value investing is losing relevance?

Answer: I don’t think that fundamental value investing will ever be irrelevant because of course to succeed in investing you have to buy things for less than they’re worth instead of more than they’re worth.  You have to be smarter than the market.  That will never go out of style.  I mean that is like arithmetic it’s always going to be with us.

Now as far as high frequency trading, that is a complicated subject.  I think that high frequency traders of the world, many of whom are personally admirably and honorable people, I think they have all made contributions to the American economy like a bunch of rats do in a granary. (laughter) They’re just sucking some of the resources out for themselves while contributing nothing to the civilization.

Question 39: Do you have a specific approach to spending quality time with your family?

Answer: Well, I don’t think I want to (promote) myself as some wonderful example of family life.  I did the best I could…

Question 40: Do you think that Coach Nick Saben shares qualities with Sam Walton?

Answer: I don’t know anything about Coaching.  I’m better at Ballet.

Question 41: Could you name a few people in history that you admire?

Answer: Well of course there’s a lot of historical people that I admire.  One of the advantages of being a reader is that you can consort with some of the best people who have ever lived.  So that’s what I do with a lot of my time.  But I admire a lot of people, take surgeons who get way the hell better than other surgeons…or take some actor who gets to be the best actor in the world, and moves and entertains a lot of people.  And there are a lot of people who are constructive, intelligence, generous and improve the world for the rest of us.  And there are a lot of people who are good examples.  And I spent some time, because he was on the Costco board for a long time, with Dan Evans who was Senator and Governor in the state of Washington.  Generally admirable, sensible, high-grade, politician.  There’s so few politicians like Dan Evans.

But when you do find a Dan Evans you really admire him and like him.  And I think there will always be admirable people.  That’s what we all want to be.  We all want to be admirable.  What you want to be is the kind of people, other people name in their will to raise their children if they die unexpectedly.  When a lot of people are doing that, you’ll know you’re doing something right.  People are very shrewd about guessing who will be good at raising their children. 

Question 42: When you were an attorney, you sold your most important client an hour a day.  And I’m guessing that you spent that time reading and thinking, or did you do some other activity for an hour.

Answer: No, no, that was the most important client, myself, you’re right about that.  It was reading and thinking.  The beauty of doing a lot of reading and thinking is that if you’re good at it, you don’t have to do much else.

Question 43: Question about fear.  I was once given the advice that it’s really important to conquer fear.  Could you speak to your relationship with fear and whether you’ve conquered it.

Answer: Well generally I’ve avoided circumstances which automatically cause people fear.  My son Philip is in the audience.  When he was young, he had a saying, he would say, “If at first you don’t succeed, well, so much for hang gliding.” (laughter)  And so I don’t seek out fear to get thrills.  I don’t even seek out the appearance of fear when it’s really safe.  Generally I’m not a big lover of danger or even the appearance of danger.  So that’s not my thing.  I don’t think I’ve felt much fear for a long time.  I’ve just lived a long time.  I had fears when I was younger, but they gradually melted away.

Question 44: Question about Coke.  Sweetened beverages are on the decline.  Does Berkshire’s ownership give Coke some leeway about addressing the declining nature of their business?

Answer: Well, that’s an easy one.  Coke for many decades, the basic product, full sugar Coke, grew every year.  It was like the inevitable march of time.  In recent years, full sugar coke is declining.  Now fortunately the Coca-Cola company has amassed distribution infrastructure business in a lot of other products.  Coca-Cola as an individual product is declining some, instead of going up the way it always did before.  The rest of the businesses are on average rising.  So I think Coke is still a pretty strong company and it will be a respectable investment.  But it’s not like it use to be when it was like shooting fish in a barrel.

I guess that does it.

Distilled: The Education of a Value Investor by Guy Spier

Distilled Series Introduction:

Welcome to the Distilled series where I’ll take some of the most influential and powerful books and concentrate their core ideas down to their most essential points.

The first book in this series proved to be quite influential on my life in 2015.  For that reason, I’m excited to present The Education of a Value Investor by Guy Spier, Distilled.

Distilled: The Education of a Value Investor

The Education of a Value Investor Distilled Virtuous Cycle & Tilt the Playing Field:

The following section expands on the ten core elements.  When reading, keep in mind that although these core elements are listed as discrete and definable concepts, they are not entirely independent of each other.

Each element interacts with the others in the form of a virtuous cycle.  Meaning that when you make a positive change in one point, it will positively influence another point, which may then positively influence another point, and so on through the whole system.

Additionally, Guy emphasizes the importance of doing things that tilting the playing field in your advantage.  Like a casino, you only need to have an imperceptibly small advantage.  But given that enough ‘bets’ are places over time, you will come out far ahead.  These ten points capture the general process Guy used to tilt the playing field in his advantage.

Expanded: The Education of a Value Investor

  1. Commit Yourself Completely

Guy doesn’t embrace ideas with half measures.  He has shown that whether it came to both his academic and financial pursuits early in his life, or a Value Investing career later in life, he takes things to the nth degree.

“Life can change in a heartbeat.” A goal that seems impossible can become entirely possible if we’re willing to commit every ounce of energy to it.

This is certainly one of his main strengths.  Few possess the capacity to commit themselves so completely to an idea or a pursuit.  We should strive to do the same.  For as W.H. Murray wonderfully stated;

“Until one is committed, there is hesitancy, the chance to draw back, always ineffectiveness.  Concerning all acts of initiative, there is one elementary truth the ignorance of which kills countless ideas and splendid plans: that the moment one defiantly commits oneself, the providence moves too.”

  1. Imagine Your Future

This point was only briefly referenced, but it’s certainly a critical element to both his re-education process and pursuit of an investing career.

I’ve often found that we have to imagine our future before it can happen

  1. Brainwash Successful Habits

Guy talks favorably about brainwashing  successful habits.  Specifically he talks about needing to re-wire himself after his brief career at D.H. Blair.

This re-wiring process, by way of brainwashing successful habits, can aid the switch from a life dictated by an external scorecard to one defined by an internal scorecard.  Guy calls these positive habit changing techniques a powerful tool in reconfiguring our consciousness.

“When your consciousness or mental attitude shifts, remarkable things begin to happen.”

  1. Create the Right Environment & Network

Guy talks extensively about the importance of the Right Environment & Network.  Your environment has a massive influence on you, and the importance to set up a positive environment cannot be stressed enough. This includes arranging your work space, choosing the city where you live and work, and the people you associate with.

In fact, he left New York to go to Switzerland where his environment would be more insync with his personality, personal limitations, and career.

Our environment is much stronger than our intellect. Remarkably few investors-either amateur or professional-truly understand this critical point.

Guy says “Nothing, nothing at all, matters as much as bringing the right people into your life.”  Specifically, he espouses the benefits of being involved in a Mastermind group.  Seemingly all influential people participate in one.  Benjamin Franklin had “the Junto”, Warren Buffett has “the Graham Group”, and Guy Spier has “the Latticework Club”.

More generally, he writes how critical it is to get into the orbit influential people and other like-minded, motivated, and giving people.

It’s really a question of choosing to have certain people in your life (however tangentially) who embody the values you admire… creating the right environment or network helps to tilt the playing field subtly in the right direction so that you can become far more likely to succeed.  Advantages are often created imperceptible step by imperceptible step, so it makes a difference to enter the universe of a firm like Ruane Cunniff.

Furthermore, he stresses the value being a giver, as well as the need to surround yourself with people who are givers and matchers, while weeding out the “takers”.

  1. What Would Buffett Do?

Tony Robbins calls this process “modeling”.  A related process is known as “Matching and Mirroring”.  Guy said that sitting down at his desk and actively imagining what Warren Buffett would do if he were him was one of the biggest elements which helped him get unstuck early in his Value Investing journey.

“Desperate to figure out how to lead a life more like his, I began constantly to ask myself one simple question: “What would Warren Buffett do if he were in my shoes?…The minute I started mirroring Buffett, my life changed.  It was as if I had turned in to a different frequency.  My behavior shifted, and I was no longer stuck.

He suggests using matching and mirroring to bring mentors into your life which you may not have immediate access to.  You can do this by imagining them in as much detail as possible, even down to how they’d breath, walk, and act.  This involves gaining a detailed understanding of them.

Choose teachers that have come to learn the truths that you still need to learn. “If you apply this lesson, I’m certain that you will have a much better life, even if you ignore everything else I write.”

  1. Play the Value “Lottery”

Guy really prescribes a lot of value to this concept.   He has described how most people misattribute his success, preferring to believe that it came from the elements like the fact that he went to Harvard & Oxford.  Instead, Guy prescribes a large portion of his success to playing the Value “Lottery”.  Guy describes this process as;

Doing something with an uncertain but potentially high upside. The payoff may be infrequent, but sometimes they’re huge.  And the more often I pick up these lottery tickets, the more likely I am to hit the jackpot.  Doing this will subtly tilt the playing field in your advantage.

The payoff follows an exponential path.  At the beginning, it looks like you are accruing no value, but in the long run, you experience large benefits.  He says that you often have to do these things for 5 to 10 years before you start to see the true benefits from them.

“Over a lifetime, a myriad of simple actions like these can accumulate to create big reputational and relationship advantages. It’s not about luck.  It’s about working harder to get these things right so that it becomes more likely that something good will happen.”

The value lottery generally involves taking small actions which will benefit you on the margins.  By far his favorite way to play the value lottery is through writing thank you notes.   Guy started this program over a decade ago where he forced himself to write three thank you notes a day, five days per week.   He now estimates that he’s written over 30,000 thank you notes in his life.

Every letter I wrote was an invitation for serendipity to strike. To many people, it might seem like a waste of time.  But I couldn’t win the lottery without a ticket, and these tickets were almost free.  In a sense, this is a value investing approach to life: pick up something cheap that may one day prove to be precious.”

For more on this topic, you can also listen an interview with The Investor’s Podcast and a talk at Google where he elaborates further.

  1. Take the Inner Journey: Be Authentic & Use an Inner Scorecard

It’s like that Guy focuses on this concept the most.  It’s a critical concept if you hope to be a successful investor.  He attributes temperament to being the main reason for his investing success.  Likewise, Warren Buffett says that investing is 90% temperament, and that if you had an IQ of 160, you can sell 30 of your IQ points because you don’t need them.

One of my favorite quotes of the book falls under this section of the book.  It explains the need for investors to undertake this inner-transformation quite elegantly:

The goal is to become more self-aware, strip away your facades, and listen to the interior.  For an investor, the benefits are immeasurable because this self-knowledge helps us to become stronger internally and to be better equipped to deal with adversity when it inevitably comes.  The stock market has an uncanny way of finding us out, of exposing weaknesses as diverse as arrogance, jealousy, fear, anger, self-doubt, greed, dishonesty, and the need for social approval.  To achieve sustainable success, we need to confront our vulnerabilities, whatever they may be.  Otherwise, we are building our success on a fragile structure that is ultimately liable to fall down.

Guy states that it’s not only important to becoming a good investor, it’s reward is something greater.

But the real reward of this inner transformation is not just enduring investment success.  It’s the gift of becoming the best person we can be.  That, surely, is the ultimate prize.

  1. Know your limitations & work around them

The element of knowing your limitations comes from both an understanding of ones self, as well as a general acceptance of the short-comings of the human mind.  Only then can an investor structure a process to work around these flaws.

“The real challenge, in my view, is that the brain itself-which got us to where we are-is the weakest link. It’s like a little boat, adrift in a sea of irrationality and subject to unexpected storms.

Specifically, this involves creating the right environment where you can think rationally and developing an investment process using checklists that can help you avoid making classic (subconscious) mental mistakes.

The goal isn’t to be smarter. It’s to construct an environment in which my brain isn’t subjected to quite such an extreme barrage of distractions and disturbing forces that can exacerbate my irrationality.  For me, this has been a life-changing idea.

  1. Pursue Practical Knowledge

Guy learned about many sophisticated economic and financial models during his time at Harvard and Oxford, but he found them to be totally inadequate at explaining how the real world works.  Beyond entertaining people at dinner parties, they were essentially useless.

“The trouble is, economic theories like these tend to be based on intellectually elegant assumptions about how the world operates, not on the messy reality in which we actually live.”

Instead, his “Second MBA” focused on pursuing practical knowledge that explained how the world actually works.  This concept was likely formed out of Charlie Munger’s concept of a Latticework of Mental models.  Charlie states that this kind of education isn’t rewarded in the academic world, but is invaluable when it comes to investing.

“For a while, these books (Think and Grow Rich, How to Win Friends and Influence People, Tony Robbins) became my life instruction manuals.  I wasn’t reading them to sound intelligent at dinner parties; I was mining them for useful ideas to implement in my life.  They provided me with critical first steps in my education as a value investor and businessman, exposing me to a more practical way of thinking about human nature and how the world really works.”

  1. Just Do It.

Guy only briefly talks about this topic, but it was a key element to his success.  Continually throughout the book, Guy opted to take action rather than “pontificate in the library”.  This is an important lesson for for anyone else who struggles with perfectionistic tendencies and/or procrastination habits.

“Robbins hammered into my head the idea that, if you want to get somewhere, anywhere, and you’re stuck, “Just Do It! Just make a move. Any move!” This might be obvious to many.  Hell, it was obvious to me.  But my bias toward analysis-paralysis meant that it was easier for me to pontificate in a library than to act.  Robbins convinced me that I had to break the patterns of negative thought, push through my fears, and get moving.”

Reviewed: The Education of a Value Investor

The Omaha Effect:

On May 2nd, 2015, I attended my first Berkshire Hathaway Annual Shareholder’s Meeting in Omaha, Nebraska.  I happily flew 1,300 miles and committed 4 days of my time and money for this moment.  Why would I do this?  Simple.  I read The Education of a Value Investor by Guy Spier.

The Education of a Value Investor by Guy Spier

My admiration for Warren Buffett stretches back to the mid-nineties, where Berkshire Hathaway’s lofty share price first caught my attention and imagination.  And yet, even after two decades of admiration for Buffett, I never foresaw attending the Berkshire Annual Meeting.  That changed after I read The Education of a Value Investor.

This book caught my imagination, much like BRKA’s share price in the mid 90’s.  As a result, I  began to change the way I thought and acted.  This included my attitude towards attending the Annual Meeting.  It was no longer an intriguing idea, but rather a necessity.

In this matter, I was not alone.  While in Omaha, I attended the Yellow BRKers meeting at the DoubleTree hotel.  In his book, Guy affectionately writes about Yellow BRKers and the influence of this endorsement was immediate felt.  Alex Bossert, the host of the event, stated that 2015 was Yellow BRKers largest crowd to date.  He went on to directly link Guy Spier’s book as the likely cause.

Upon talking with Yellow BRKer attendees, I found that there was a general air of reverence surrounding The Education of a Value Investor.  He had obviously struck a cord.  I even encountered several people who, like myself, after reading Guy’s book, were inspired to attend the Annual Meeting for the first time.

It’s not often that you find a book that influences people in this way.  Here in Omaha I’d found a group of people that were inspired enough to act on the the advice and insights they’d read.  This group of value investing enthusiasts and professionals were the best endorsement a book could receive.

This year, I will be returning to Omaha to attend the Berkshire Hathaway Annual Meeting for the second time, and it all started with reading the Education of a Value Investor.

Honesty, Influence, and “the Value Investing Life”:

How then does a book make such a big influence on so many people?  Likely in the same way that both Tony Robbins and Warren Buffett managed to influence Guy Spier so effectively.  Honesty.  Guy embraced the teachings and values of both of these men because they were honest and authentic.  Now, Guy has managed to resonated with his readers by following the same path.

Accordingly, the book addresses the importance of taking the “inner journey”.  About playing by an inner scorecard and being authentic.  But these elements aren’t simply about how to live a better life.  Instead, they are essential for anyone wishing to become a successful investor.  That’s because you cannot hope to outperform the market if you live your life defined and dictated by external forces.  You must first make an internal change, and only then are you prepared to be a successful investor.

Warren Buffett Insights:

Guy provides unique insights into the investing genius and life of Warren Buffett.  He was able to accomplish this because he approached Warren with great reverence.  He paid close attention to even the smallest details and mined Warren’s life for the elements of success which he could then mirror in his own.

As a results, reading this book will introduce the reader to insights which most people tend to overlook.

The Second MBA:

Guy’s journey to becoming a value investor was not a linear path.  Instead, he spent his youth and early career pursuing prestigious academic degrees, a prestigious wall street job, and the success that goes along with them.  His life only started to change after he experienced something of a career existential crisis.

Upon finishing his Harvard MBA  he began working for D.H. Blair, an investment bank which he later discovered was a morally compromising environment (akin to the infamous Stratton Oakmont).  Up until that point, he had been living his life dictated by an “external scorecard”.  For that reason, he lamented that he wasn’t able bring himself to leave his compromising employer as soon as he should have.  After 18 months, he quite his job and began what he referred to as his “Second MBA” (aka “The Education of a Value Investor”).

Spend a lot of time Sitting & Thinking. Warren Buffett ‘demands’ it!

Buffett ‘Demands’ It

The following quote is perhaps my favorite saying from Warren Buffett.  It’s a simple yet powerful formula that dictates most of his day.

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

Read. Sit. Think.  It doesn’t get much more straightforward than that.   And yet, it’s easy to overlook this quote or simply take it as mere suggestion.  But the key word in his statement is ‘insist’.  That’s a far cry from an off-handed recommendation.  In fact, Websters dictionary defines ‘insist’ as, “to demand that something happen or that someone do something.”

In other words, Warren Buffett demands it.  He demands it!  For anyone looking to learn from the investing wisdom of Warren Buffett, this is a good place to start.

That’s why I made the picture below and hung it on my wall.  It’s a reminder every day that this isn’t a recommendation.  I must spend a lot of time reading and thinking.

Sit and Think
Sit and Think

Cloning and Greatness

There’s a second reason why I love this quote; it’s unoriginal.  In fact, you can trace the origins of this quote back through a long line of great men who unapologetically copied each other.

I like to imagine that Warren derived this insight from Ben Franklin, whom both he and Charlie Munger admire greatly.  A quote mirroring Warren’s is found in Poor Richard’s Almanac where Ben Franklin wrote;

Reading makes a full man, mediation a profound man, discourse a clear man. – Benjamin Franklin

But the wisdom copying machine doesn’t end there.  Ben Franklin openly admitted that most of his Poor Richard’s quotes were unoriginal.  His typically strategy was to rewrite classic wisdom and proverbs into catchy sayings.  In turn, Ben Franklin likely derived his famous quote from John Locke whose writings were a big part of Franklin’s self-education.   John Locke wrote;

Reading furnishes the mind only with materials of knowledge; it is thinking that makes what we read ours. – John Locke

Once again, John Locke likely derived this statement from influential thinkers he studied, such as Thomas Hobbes, Descartes, Cicero, Aristotle, and Plato.  All of whom wrote extensively on the importance of thinking and meditating.

There’s a distinct pattern to this.  Great men, copy the wisdom of great men who came before them.  Or as Charlie Munger puts it;

I believe in the discipline of mastering the best that other people have ever figured out. – Charlie Munger

This process is also known as “cloning”.   Warren is a Grandmaster at cloning.  In his life, Warren has notably;

  • Mastered the fundamental principles of value investing from Ben Graham.
  • Mastered the fundamentals of the insurance business from Lorimer Davidson.
  • Evolved as an investor by embracing the ideas of Charlie Munger and Phil Fisher.

Warren Buffett has an uncanny ability to learn the best ideas that already exist and adopt them completely into his own knowledge and philosophy.

This speaks volumes to the value of “cloning”.  As investors, we should endeavor to do the same and master the best of what Warren Buffett has learned.  We can start here.

Read. Sit. Think.