Peter Kaufman on The Multidisciplinary Approach to Thinking: Transcript

/ Richard Lewis / 24 Comments

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

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

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

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

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

Transcript: Peter Kaufman on The Multidisciplinary Approach to Thinking

0:00 Talk Begins

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

0:26

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

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

2:33

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

6:15

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

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

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

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

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

13:04

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

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

14:59

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

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

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

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

19:37

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

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

21:57

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

24:53

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

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

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

28:30

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

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

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

31:08

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

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

34:14

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

37:15

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

39:01

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

42:05

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

44:00

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

End of Transcript

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

Furthermore, if you’d like to be informed of future posts, transcripts, or events, please subscribe.

Sincerely,

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

Links to additional Transcripts:

Charlie Munger: Full Transcript of Daily Journal Annual Meeting 2018

/ Richard Lewis / 13 Comments

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

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

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

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

I hope you all enjoy!

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

2018 Daily Journal Meeting Transcript

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

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

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

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

4:33 “Pontification” Begins

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

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

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

9:00

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

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

12:26

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

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

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

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

16:55

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

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

21:00

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

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

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

23:58

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

Charlie: Do we ever! (laughter)

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

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

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

27:23

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

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

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

34:56 Q&A Begins

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

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

36:49

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

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

37:53

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

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

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

40:56

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

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

45:15

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

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

46:33

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

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

48:26

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

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

49:04

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

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

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

52:50

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

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

53:46

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

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

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

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

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

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

1:00:13

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

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

1:02:37

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

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

1:07:15

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

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

1:09:13

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

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

1:11:47

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

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

1:13:13

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

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

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

1:17:24

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

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

1:19:02

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

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

1:19:49

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

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

1:21:05

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

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

1:23:40

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

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

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

1:25:32

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

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

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

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

1:28:07

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

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

1:31:50

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

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

1:34:04

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

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

1:35:30

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

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

1:36:54

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

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

1:39:16

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

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

1:43:08

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

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

1:46:02

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

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

1:47:46

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

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

1:51:11

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

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

 1:52:51

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

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

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

1:55:19

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

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

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

1:58:38

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

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

2:01:05

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

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

2:04:30

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

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

2:05:23

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

End of Transcript

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

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Sincerely,

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

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Wall Street Recap: September 17-23, 2017

/ Richard Lewis / Leave a comment

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

Investing in “Hot” Industries

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

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

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

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

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

Two key reasons:

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

Examples of “hot” industries from the last century:

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

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

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

Mental Model: Viscosity

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

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

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

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

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

Investment Lessons:

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

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

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

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

“Hot” Industries: In the News

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

Netflix

Facebook

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

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

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

Apple

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

Disney

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

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

Tesla

VW

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

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

Mercedes, Smart, BMW

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

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

Nissan-Renault-Mitsubishi alliance

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

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

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

Blue Apron

Albertsons

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

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

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

Psychology of Human Misjudgment

Confirmation Bias

Anti-Soros conspiracies sweep the globe (link)

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

Deprival Super-Reaction Syndrome

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

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

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

Over-Influence by Authority

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

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

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

Say-Something Syndrome

Instragram video of weapons leads to an arrest (link)

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

Forgetting what one is really trying to do

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

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

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

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

Simple Psychological Denial

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

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

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

Tattoos: Lollapalooza Effect

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

Consistency and Commitment:

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

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

Liking Tendency

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

Incentive-Caused Bias

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

Social Proof

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

Mental Model: Parkinson’s Law

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

Trump champions UN while urging reform (link)

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

Various Fascinating Excerpts

A test of compassion (link)

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

Japan Post share sales faces uncertain journey (link)

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

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

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

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

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

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

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

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

Wall Street Recap: Part 2

/ Richard Lewis / 2 Comments

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

The “Burned Cat” Phenomenon

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

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

1) Depressed asset prices

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

Elon Musk

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

2) Severe under investment in new supply

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

Ethiopian Famine

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

Ireland Housing

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

As the Financial Times described: (link)

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

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

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

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

Misjudgment underpinning the Burned Cat Phenomenon:

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

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

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

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

Standard Causes of Human Misjudgment

Social Proof: Rationalized/Normalized Terrible Behavior

At Home Among the Giants (link)

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

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

Social Proof: Fear of Missing out

Leveraged Loans too Popular (link)

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

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

Deprival Super-Reaction Syndrome

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

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

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

Contrast Caused Distortion

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

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

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

Incentive Caused Bias 

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

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

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

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

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

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

Consistency & Commitment Tendency

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

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

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

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

Lesson: Beware of commitments, even seemingly harmless ones.

Lollapalooza Effect: Examples

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

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

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

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

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

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

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

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

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

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

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

“Better safe than sorry, said one wrestler.”

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

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

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

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

Wall Street Recap: Part 1

/ Richard Lewis / 2 Comments

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

ROE & Customer Ignorance

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

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

Ignorance removal may occur with:

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

Examples of Ignorance Removal

Honeywell (Increasing Competition)

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

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

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

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

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

The resistance to the new helmet comes from:

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

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

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

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

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

Investment Lesson

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

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

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

Checklist Question

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

Drive for Efficiency Gains

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

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

Such strategies include;

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

Examples of Companies Seeking Efficiency Gains following a Slowdown

Lego

Problem: First Sales Decline after 13 years of growth.

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

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

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

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

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

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

Eli Lilly

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

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

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

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

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

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

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

Unilever & Nestle

Problem: Experiencing Shifting Consumer Tastes and Declining Sales.

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

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

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

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

VW

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

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

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

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

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

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

Aerosoles

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Investment Implications

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

Investment Lessons

Lesson 1: Insist on thinking things through.

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

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

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

Checklist Question

Question: Has anything changed in a big way?

Standard Causes of Human Misjudgment

Disliking Bias

Why China Can’t Stop Hating Japan (link)

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

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

Reciprocation: Role Theory

Why China Can’t Stop Hating Japan (link)

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

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

Bitcoin: Reinforcement & Social Proof

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

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

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

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

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

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

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

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

Pre-suasion: Fear of Missing Out

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

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

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

Uncertainty & Extra-Vivid Evidence

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

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

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

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

Incentive Caused Bias

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

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

Economic Warfare: Companies in the Crossfire

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

Examples of Recent Activity

Germany & Turkey: Germany threatens to cut aid to Turkey

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

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

Saudi Arbia & Qatar:

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

USA & North Korea:

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

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

(De)Commoditized Flights

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

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

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

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

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

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

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

Various Fascinating Excerpts

Flood Insurance: Highly Skewed Losses

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

The Economics of Politics

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

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

Demand Excellence

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

Censoring Social Media in China

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

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

Future of Augmented Reality

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

China credit expansion

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

Hilarious Foot-in-mouth moment

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

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

Wall Street Journal Recap: April 10-16, 2017

/ Richard Lewis / Leave a comment

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

The Wealth Transfer Mechanism

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

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

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

Investment Lesson:

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

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

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

Gaming Capitalism: How Communists Exploit Free Markets

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

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

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

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

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

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

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

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

Standard Causes of Human Misjudgment

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

Wells Fargo: (link)

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

United Airlines: (link)

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

Commins & Columbus, Indiana: (link)

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

Lotte: (link)

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

“Greater than 0%”

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

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

Causes of Thyroid Cancer

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

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

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

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

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

The Subordinated Investor: Challenges with International Investing

/ Richard Lewis / 2 Comments

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

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

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

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

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

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

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

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

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

Reasons for “Economic Persecution”:

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

Brazil: Sue the heck out of foreign corporations.

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

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

Reasons for “Economic Persecution”:

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

Russia: Force foreign investors to sell.

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

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

Reasons for “Economic Persecution”:

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

Tombstones

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

Investment Lessons

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

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

Russell Westbrook: The Non-Quantifiable Draft Pick

/ Richard Lewis / Leave a comment

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

/ Richard Lewis / 19 Comments

Following the 2017 Daily Journal meeting, Charlie Munger treated everyone who stayed to an informal fireside chat.  For over two hours, he graciously answered any questions.  I transcribed this fireside chat verbatim and as accurately as possible. It was transcribed from this fantastic 1 hour and 48 minute recording of the talk.  Below is the transcript in its entirety.

Event Info

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

Event: Informal Fireside Chat following the DJCO Annual Meeting

Date: February 15, 2017

Start of Transcript

(Video 1 of 22 0:27)

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

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

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

(Video 2 of 22 0:04)

(Video 3 of 22 0:28)

Question: What’s your reading habits every day?

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

Question: What are your four newspapers?

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

(Video 4 of 22 1:14)

Question: (Question Regarding deferred gratification)

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

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

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

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

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

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

Charlie: Well you can’t.

(Video 5 of 22 0:41)

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

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

(Video 6 of 22 0:51)

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

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

(Video 7 of 22 2:35)

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

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

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

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

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

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

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

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

(Video 8 of 22 2:22)

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

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

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

(Video 9 of 22 1:44)

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

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

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

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

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

(Video 10 of 22 8:14)

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

Question: Charlie, any thoughts on App

Question: Charlie, any thoughts on Apple Corporation?

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

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

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

Question: Can you talk a bit about BYD?

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

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

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

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

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

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

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

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

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

Question: So it’s mostly qualitative?

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

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

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

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

 

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

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

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

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

(Video 11 of 22 7:31)

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

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

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

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

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

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

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

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

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

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

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

Question: How about a Munger Library somewhere?

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

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

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

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

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

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

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

(Video 12 of 22 6:56)

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

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

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

Charlie: No, I had cash.

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

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

Question: Charlie, what about TransDyne?

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

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

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

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

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

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

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

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

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

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

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

(Video 13 of 22 6:45)

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

Charlie: Well not for a long time.  

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

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

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

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

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

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

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

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

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

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

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

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

Question: Which idea was that?

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

Question: Was that K&W?

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

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

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

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

Charlie: Maybe a couple of years.

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

Charlie: Oh, about an hour and a half.  

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

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

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

(Video 14 of 22 9:21)

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

(Video 15 of 22 5:44)

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

Question: So that’s “great” then.

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

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

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

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

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

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

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

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

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

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

Question: Charlie, were you surprised on election day?

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

Question: Did you lose sleep for a few days?

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

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

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

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

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

(Video 16 of 22 9:06)

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

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

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

Question: What do you want to give it to?

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

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

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

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

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

Question: What is your hope for your grandchildren?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

(Video 17 of 22 7:09)

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

(Video 18 of 22 6:31)

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

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

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

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

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

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

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

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

(Video 19 of 22 8:43)  

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

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

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

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

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

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

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

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

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

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

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

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

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

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

(Video 20 of 22 7:39)

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

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

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

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

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

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

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

(Video 21 of 22 4:36)

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

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

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

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

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

(Video 22 of 22 9:01)

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

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

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

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

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

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

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

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

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

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

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

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

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

End of Transcript

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Richard Lewis, CFA

 

 

White Stork Asset Management LLC

Partner, Investments

 

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