Wall Street Recap: Part 1

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

ROE & Customer Ignorance

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

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

Ignorance removal may occur with:

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

Examples of Ignorance Removal

Honeywell (Increasing Competition)

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

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

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

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

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

The resistance to the new helmet comes from:

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

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

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

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

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

Investment Lesson

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

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

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

Checklist Question

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

Drive for Efficiency Gains

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

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

Such strategies include;

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

Examples of Companies Seeking Efficiency Gains following a Slowdown

Lego

Problem: First Sales Decline after 13 years of growth.

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

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

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

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

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

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

Eli Lilly

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

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

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

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

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

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

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

Unilever & Nestle

Problem: Experiencing Shifting Consumer Tastes and Declining Sales.

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

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

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

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

VW

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

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

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

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

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

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

Aerosoles

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Investment Implications

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

Investment Lessons

Lesson 1: Insist on thinking things through.

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

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

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

Checklist Question

Question: Has anything changed in a big way?

Standard Causes of Human Misjudgment

Disliking Bias

Why China Can’t Stop Hating Japan (link)

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

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

Reciprocation: Role Theory

Why China Can’t Stop Hating Japan (link)

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

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

Bitcoin: Reinforcement & Social Proof

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

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

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

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

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

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

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

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

Pre-suasion: Fear of Missing Out

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

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

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

Uncertainty & Extra-Vivid Evidence

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

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

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

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

Incentive Caused Bias

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

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

Economic Warfare: Companies in the Crossfire

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

Examples of Recent Activity

Germany & Turkey: Germany threatens to cut aid to Turkey

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

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

Saudi Arbia & Qatar:

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

USA & North Korea:

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

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

(De)Commoditized Flights

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

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

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

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

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

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

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

Various Fascinating Excerpts

Flood Insurance: Highly Skewed Losses

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

The Economics of Politics

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

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

Demand Excellence

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

Censoring Social Media in China

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

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

Future of Augmented Reality

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

China credit expansion

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

Hilarious Foot-in-mouth moment

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

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

Russell Westbrook: The Non-Quantifiable Draft Pick

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

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

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

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

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

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

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

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

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

Investment Lessons:

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

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

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

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

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

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

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

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

Fireside Chat with Charlie Munger: Full Transcript

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

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

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

If you do not receive a copy within 24 hours of subscribing,  please email me directly at rlewis@latticeworkinvesting.com.

Event Info

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

Event: Informal Fireside Chat following the DJCO Annual Meeting

Date: February 15, 2017

Start of Transcript

(Video 1 of 22 0:27)

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

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

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

(Video 2 of 22 0:04)

(Video 3 of 22 0:28)

Question: What’s your reading habits every day?

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

Question: What are your four newspapers?

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

(Video 4 of 22 1:14)

Question: (Question Regarding deferred gratification)

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

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

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

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

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

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

Charlie: Well you can’t.

(Video 5 of 22 0:41)

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

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

(Video 6 of 22 0:51)

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

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

(Video 7 of 22 2:35)

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

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

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

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

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

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

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

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

(Video 8 of 22 2:22)

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

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

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

(Video 9 of 22 1:44)

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

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

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

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

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

(Video 10 of 22 8:14)

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

Question: Charlie, anything thoughts on Apple Corporation?

End of Sample Transcript

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Wall Street Journal Recap: February 20-26, 2017

My full notes and analysis on the Wall Street Journal from the past week: February 20-26, 2017 (Week 8).  Please Enjoy.

Donald Trump: Pre-Suasion genius?

Is Donald Trump a Pre-Suasion genius?  He is constantly criticized for being too vague about the details of his plans and chronically leaving people in a state of uncertainty.  But that might just be the key to his success.

Stock markets typically reject uncertainty as a negative force.  But in the case of President Trump, markets have embraced a sort of “positive uncertainty”.  In his book Pre-Suasion, Robert Cialdini provides a compelling insight which may explain Trump’s strong positive influence on the stock market:

“During the experiment, the men who kept popping up in the women’s minds were those whose ratings hadn’t been revealed, confirming the researchers’ view that when an important outcome is unknown to people, “they can hardly think of anything else.”  And because we know, regular attention to something makes it seem more worthy of attention, the women’s repeated refocusing on (the guys whose ratings remained unknown to the women) made them appear the most attractive.” – Robert Cialdini

Now let’s look at an excerpt from an article the other week titled “Federal Reserves Eye Aggressive Rate Increases.” (link)

“President Donald Trump’s plans for tax cuts, new spending and deregulation have buoyed market hopes of faster economic growth and higher corporate profits.  But Fed officials at the meeting underscored their uncertainty about the details and effects of the potential policy changes, according to the minutes.”

“A few policy makers also worried that investors betting on tax cuts “which might not materialize” had pushed up equity prices too much.”

Post-Mortem: Glencore and Copper (link)

Copper prices surged more than 30% in the last year and shares in Glencore have more than tripled in the past 12 months.  The two biggest drivers in copper prices over this time-period were:

1) China Stimulus: “The metal’s resurgence partially has been driven by a government economic stimulus program in China, where over 40% of the world’s copper is consumed.”

2) Labor Disputes: There have also been “snags at two of the world’s largest copper mines-labor problems at Chile’s Minera Escondida, and a permit dispute with the Indonesian government for Freeport-McMorRan Inc.’s Grasberg mine.”

So I’m curious…how many investors in Glencore identified “China Stimulus” and “Labor Disputes” as the main parts of their investment thesis?  My guess is very few.

“Histogram Management”

Charlie Munger once mused about The Kellogg Company that there’s nothing keeping cereal producers from going crazy over market share and tearing each other apart. (link)  So when investing in an industry, you have to seriously consider; What force is maintaining rational economic decision-making in this industry?

The CEO of Glencore appeared to be surprised and upset when his competitors weren’t acting rational in the wake of declining commodity prices.

“(Glencore) CEO has long criticized his competitors for ramping up supply in the face of falling prices.” (link)

Such a reaction seems to indicate a lack of understanding of human psychology and the forces that drive rational economic behavior.  After all, there are many reasons management would ramp up production in the face of declining prices.  Here are four such reasons:

1) Incentive-caused biases linked to executive compensation or job security.

2) Prisoner’s dilemma and the Fear of Missing Out.  Which explains why two rational individuals might not cooperate, even when doing so is in their best interest.

3) Social Proof.  You look around and no one is cutting production, so this must be the right thing to do.

4) A genuine economic desire to survive.  i.e. They keep producing at a loss in order to cover massive fixed costs.

Expanding upon the first point of Incentive-caused bias, management may have a personal economic incentive to manage earnings based on compensation packages.  I like to think of this behavior as “Histogram Management.”

When commodity prices are declining, the easiest way for a mining company to show stable and growing profits is to rapidly increase sales in the wake of declining margins.  This strategy of channel stuffing may provide stable earnings figures in the short-term, but it will exacerbate the problem for the entire industry over the long-term.

(Image via Latticework Investing)

Investment lessons:

1) Management often won’t behave in economically rational ways.  Therefore, watch out for industries which allow for competition to intensify to the point of mutually ensured destruction.

2) Poorly designed executive compensation can make or break a company/industry.

In other words, don’t give them the rope with which to hang you.

Car Sales Eating into Macy’s Business?

Macy’s CEO said that record U.S. car sales indicate consumers have spent a bigger portion of their budget on bit-ticket items lately.

“At some point in time you’ve got to believe that everybody’s going to have a brand-new car,”…”There’s dollars that are going to be freed up for other categories of spending.” (link)

It makes sense too.  Car purchases are highly interest rate sensitive.  A majority of new cars are purchased with debt.  Today the APR on an auto-loan starts at 3.12%.  Meanwhile the APR on a Macy’s credit card is 24.5%.  It’s no wonder that sales of goods that can be bought with debt have done well, while cash-based retailers have struggled.

(Image via Interest.com)

Market Developments:

1) Home sales booming on historically low inventory (link)

January home sales reach highest level since February 2007, on the back of the lowest inventory levels on record (circa 1999).

Home sales rose in January to the highest level since February 2007, a sign that last year’s momentum extended into 2017 despite a limited supply of properties for sale and rising prices.”

“Inventory rose 2.4% at the end of January from the end of December, when supply hit the lowest level since the Realtors association began tracking all types of supply in 1999.

2) Banks Retreat from Apartment Market (link)

Apartment supplies are growing rapidly, as a result, loans are getting more expensive and harder to come by, and rent growth is slowing.

Swelling supplies of apartment units are prompting big banks to pull back from new projects, forcing developers to scramble for capital.”

I haven’t seen anything this seismically different since 2008, when credit dried up.”

fresh supply is beginning to overwhelm demand.  More than 378,000 new apartments are expected to be completed in 2017, a 30-year high,”

“Commercial mortgage brokers said they are seeing and uptick in mezzanine loans…(and) a rise in preferred equity, which also come with higher payments than bank loans…”

“Other developers are turning to smaller regional banks, such as Bank of the Ozarks, which can command higher rates,”

3) Corporate Bonds: (link)

All around the world, corporate debt has proved a popular investment class so far this year…

Asia: “Nowhere is the trend more surprising than in Asia, where money has kept flowing into even the riskiest debt.  The extra yield, or spread, investors demand for holding both investment-grade and high-yield Asian corporate debt versus risk-free U.S. Treasuries has narrowed since the U.S. election last November and is heading towards its tightest levels since 2008,”

U.S.: “U.S. corporate-bond spreads are at their tightest in two years.”

Europe: “In Europe, investors also have continued to pile into corporate credit in countries like Germany and France, despite uncertainty created by key elections…”

Areas where I see potential problems with corporate debt demand:

1) Naive Extrapolation of past default rates in Asia: “The default rate on high-yield corporate bonds was lower in Asia than in the U.S. last year at 1% versus 3.6%.”

2) “Risk on”: The voracious search for higher yields: “With interest rates globally still low by historical standards, cash-rich investors are on the lookout for higher-yielding assets.  Total household wealth is growing more rapidly in Asia than elsewhere globally, up 4.5% in 2016 to $80 trillion,”

4) China developments

Two fascinating highlights on China:

1) “Of the more than 11,000 public-private partnerships that China has announced since 2014-inwhich companies finance, build and manage commercially viable state ventures-88% remain in preliminary stages and none are complete,” (link)

2) “Since coming to power in late 2012, Mr Xi has eroded the consensus-driven, collective-leadership model of his recent predecessors, taking personal charge of the military, the economy and most other levers of power.” (link)

5) Equity Markets

Two fascinating highlights on China:

1) “The declines paused a rally that has sent the index to 19 fresh highs in 2017-its most records in a year since 1999,” (link)

2) “Companies in the S&P 500 traded at about 22 times their past 12 months of earnings as of Wednesday, above their 10-year average of 15.8,”

3) “The S&P 500 has a forward price/earnings ratio of 17.6, the highest multiple since 2004 and above the averages of the past five, 10, 15 and 20 years.“(link)

Organic Farming: The high labor cost problem

U.S. farmers are quite good at conventional farming where emphasis is placed on efficiency.  But consumer demand has been shifting towards organic food, which is less efficient to farm, and requires higher labor costs.

(Data source: UC Davis)

Naturally countries with cheap labor will have a competitive advantage on the U.S.   Consequently, U.S. farmers have been feeling the pressure from international organic farmers.

“Organic grain is flooding into the U.S., depressing prices and drawing complaints from domestic organic farmers…” (link)

Specifically, the article talks about pressure from Turkish farmers.

“Turkey vaulted ahead to become by far the biggest supplier of organic corn and soybeans to the U.S. last year…(they) shipped to the U.S. 400,000 metric tons of organic corn, nearly quadrupling its prior-year total, while soybean shipments climbed by more than eight times,”

It’s beneficial to dwell on Turkey for a moment because Turkish farming data helps highlight the competitive challenges that U.S. organic farmers face.  Firstly, Turkey’s minimum wage is $6,000/year giving them a competitive advantage in labor-intensive crop production.  Secondly, the barriers to entry into organic farming are nearly non-existent.  From 2002 to 2014 Turkey’s Organic Farming area increased at an annual growth rate of 22.56%.

And from 2005 to 2012, organic production went from 421,934 tons to 1,750,127 tons. (link)

(Data Source: USDA)

It would seem that the shift to organic farming is akin to switching from industrial production lines to hand craftsmanship.  The countries with the cheapest labor would naturally have the upper hand.

Note: Additional factors which have added to the pain for U.S. organic farmers include a strong U.S. dollar, and accusations that international organic farmers face weaker regulatory oversight.

Activist Defense Strategy?

Management can sometimes react poorly to unwanted activist investors, leading them to make poor economic/ethical decisions.  The following case got me thinking about the possibility that management may revert to unscrupulous methods to increase revenue at a poorly performing unit in order to save it from activist pressures.

ABB Hit by Fraud in South Korea (lInk): “The disclosure (of stolen funds) adds to the pressure on CEO Ulrich Spiesshofer as he tries to fend off Swedish activist shareholder Cevian Capital.  ABB  in recent weeks announced a string of large orders at its power-grid unit, including a $640 million project to deliver an electricity-transmission link in India, but Cevian has been urging ABB to sell the unit.

From the management’s perspective, it would be easier to defeat activist shareholders if the under-performing unit started “out-performing”.  Incentives of this kind may increase the likelihood of unethical revenue enhancement tactics like

  1. Channel stuffing or
  2. Signing sweetheart contracts that are overly generous to clients.

Both of these tactics would make the unit appear more successful just long enough to win over shareholder support and stave off activist shareholders.

I’m not saying that ABB is doing this, but from a standpoint of “incentive-caused bias”, it’s more apt to happen.  I’d like to see a study on this topic.

Don’t try to “out-Bezos Bezos”

“We’re not going to out-Bezos Bezos,” Buffett said, in response to a question about the effect of online retail on traditional retailers.

It feels like a lot of retailers are trying to out-Bezos Bezos these days.

Wal-Mart: “The retail behemoth is investing billions to raise U.S. store worker wages, lower prices and expand e-commerce sales to better compete with Amazon.com Inc.” (link)

Target: “Target’s CEO vowed to invest billions of dollars to lower prices and remodel hundreds of stores, an admission that the retailer’s focus on trendy merchandise wasn’t enough to attract shoppers.” (link)

Charlie Munger: Slime Pricing Theory

Great example of pricing theory under pavlovian association and information inefficiencies.

Knead Slime? These Business Girls Can Fix you Up (link)

“Just now, she is puzzling over price theory.  She asks 50 cents an ounce-a generous handful-but some friends charge more than twice that.  ‘They’re getting more sales and I’m not sure why,’ says the seventh-grader in Issaquah, Wash. ‘My slime is the same quality'”

Charlie Munger: Bias from pavlovian association

“In many cases when you raise the price of the alternative products, it’ll get a larger market share than it would when you make it lower than your competitor’s product. That’s because the bell, a Pavlovian bell — I mean ordinarily there’s a correlation between price and value — then you have an information inefficiency. And so when you raise the price, the sales go up relative to your competitor. That happens again and again and again. It’s a pure Pavlovian phenomenon.” (link)

Social Change becomes Economically Viable

Corporations are rarely agents for social change…even if they pretend like they are.  Rather they’re economic agents who weigh supply and demand issues carefully.  Demand for a socially beneficial product or service usually needs to hit critical mass (aka “The Tipping Point“) before companies “make that change“.  Here are some social changes which have reached critical mass and have become economically viable.

1) Large increases in organic farming (link)

2) Coca-Cola reducing its sugar footprint (link)

3) Tyson eliminating antibiotics (link)

Charlie Munger: The prognosticator of Brazilian graft

I read this article on Brazilian graft and I couldn’t help but be reminded of a talk Charlie Munger gave back in 2003.  The scenario he gave for bribing a purchasing agent is almost identical to the problems which were uncovered in Brazil 12 years later.

Charlie Munger:

“Now tell me several instances when, if you want the physical volume to go up, the correct answer is to increase the price?…Suppose you raise that price, and use the extra money to bribe the other guy’s purchasing agent?” (link)

Now here’s what happened in Brazil…

“As part of Operation Car Wash, Brazilian prosecutors have accused executives from Petrobras, the state-run oil company, and some of the nation’s largest construction firms of colluding for more than a decade to inflate the price of contracts, kicking back a portion of the ill-gotten gains to lawmakers and other political officials.”(link)

Caution: A.I. will be programmed to exploit your psychological biases

Watch out for a future where Artificial Intelligence is programmed to exploit your psychological biases better than any human can.  Charlie Munger warns heavily about this kind of psychology manipulation:

“Now if the human mind, on a subconscious level, can be manipulated that way and you don’t know it, I always use the phrase, “You’re like a one-legged man in an ass-kicking contest.” I mean you are really giving a lot of quarter to the external world that you can’t afford to give.” (link)

It has already started on a small scale:

“Stanford University found a male computerized voice was perceived to be a better teacher of computers, while a female one was preferred for guidance on love and relationships.” (link)

“There’s also the potential subconscious influence.  Are we more likely to buy Alexa’s Valentine’s Day gift suggestions if they’re delivered by a female voice?  Will a male voice convince us to spring for an expensive leaf blower?”

Teens Use Video Chat to Hang Out (link)

Fascinating insights into teen smartphone use:

“73% of teens have access to a smartphone…Those teens are checking their phones on average more than 80 times a day,”

“Packed schedules, helicopter parenting, and the decline of walkable neighborhoods…The net effect is that teens are spending more time indoors, and les active, than ever.”

“Young people today are sedentary for more than 10 hours a day,”

“Gracie says she’ll turn off the TV and talk to friends if they turn up on Houseparty ‘because that’s just better.’

“who wouldn’t want to be able to check in with their best friends whenever they felt like it?

Quote of the week:

“There were no negative tweets, so that’s a good sign.” – Portfolio Manager in response to Bayer’s CEO meeting with Mr. Trump. (link)

Charlie Munger: Full Transcript of Daily Journal Annual Meeting 2017

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

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

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

I hope you all enjoy!

(Note: You will find that I frequently summarized the questions to Charlie, but as for Charlie’s and Gerry’s answers to the questions, I translated them verbatim and as accurately as possible.)

Charlie Discussing the Daily Journal Corporation:

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

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

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

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

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

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

Charlie Begins Q&A:

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

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

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

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

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

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

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

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

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

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

Question 4: Can you comment on Wells Fargo?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Charlie: Of course.

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

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

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

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

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

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

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

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

Charlie: Well, my favorite industry is taking care of my own affairs. (laughter) And it’s fun it’s creative, it’s the job that life has given me, and I think that you should do the job well that life gives you.  A lot of the places where the industries are doing a great job for the world, it’s very hard to make money out of it.  Because these wild enthusiasms come into it.  I don’t have a favorite industry.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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