Charlie Munger (Berkshire Hathaway Vice Chairman) – Daily Journal Annual Meeting (Jun 2017)

Chapters

Abstract

Navigating the Investment Landscape: Charlie Munger’s Wisdom on Capital, Reading Habits, and Business Strategies

In a series of insightful talks, Charlie Munger, the veteran investor and vice chairman of Berkshire Hathaway, shared his profound wisdom on various topics, ranging from investment strategies to the importance of continuous learning. His insights offer valuable lessons on return on invested capital versus equity, the effectiveness of a single-payer healthcare system, the significance of understanding human emotions like envy and jealousy, and the complexities of different investment areas such as real estate, stocks, and diverse businesses. Furthermore, Munger delves into the intricacies of judging character in business partnerships, the lessons learned from his time at Salomon Brothers, and the rationale behind Berkshire Hathaway’s investment in companies like Apple. His talks also encompass broader themes, including the role of immigration in the US economy and the crucial aspects of the agricultural revolution, shedding light on his holistic understanding of business and economics.

Investment Strategies and Financial Metrics:

Charlie Munger makes a clear distinction between return on invested capital and return on equity, drawing attention to the latter’s heightened sensitivity to leverage. He credits Berkshire Hathaway’s success to its diversified investments in various sectors, such as stocks and real estate, while showing a skeptical stance towards industries like cable and movies, favoring businesses with sustainable advantages. He elaborates that leverage doesn’t necessarily enhance return on invested capital, though it typically boosts return on equity.

Continuous Learning and Reading Habits:

Munger places great emphasis on the importance of continuous education and shares his own practice of reading multiple newspapers and books concurrently. This habit, involving three or four newspapers and two or three books at any given time, underlines his philosophy of staying well-informed before making any investment decisions.

Healthcare System Critique:

Munger criticizes the inefficiencies of the current healthcare system, advocating for a more streamlined single-payer system. He believes such a system would be more effective than the present one and anticipates its eventual implementation. His perspective on healthcare reflects his broader concern for systemic efficiency and effectiveness.

Human Emotions in Business:

Acknowledging the difficulty of avoiding emotions like envy and jealousy, Munger advocates focusing on self-improvement rather than attempting to change others. His reflections on the negative culture fostered by easy money and excessive leverage at Salomon Brothers underscore the significance of ethical considerations in business.

Real Estate vs. Stocks:

Munger considers real estate a more straightforward investment compared to stocks, but he cautions against the challenges posed by specialized competitors and misleading practices. He emphasizes the importance of observing people’s behavior and recognizing everyone’s flaws, rather than relying solely on quantitative factors.

Character Judgment in Business Partnerships:

Munger stresses the critical role of assessing character and capability when selecting business partners. He discusses his criteria for evaluating potential collaborations, focusing on integrity and competence. Munger and Warren Buffett’s knowledge of noble individuals and their genetic advantages have been instrumental in their success in judging people.

Investment Challenges and Opportunities:

Munger notes the growing difficulty in finding attractive investment opportunities and the necessity to adapt by choosing the best available options. He recognizes the success of index fund investing for its ability to match or surpass averages. At 93 years old, he believes focusing on anything other than an endgame is unwise.

Influential Business Figures:

Munger acknowledges the contributions of individuals like Wang Chun-Fu, Jeff Bezos, and Elon Musk to their respective industries. He holds Jeff Bezos in high regard for his brilliance and ambition. However, he contrasts Elon Musk and Wang Chun-Fu, suggesting Musk overestimates his abilities while Wang Chun-Fu maintains a realistic understanding of his limitations.

Agricultural Revolution and Technological Advancements:

Munger emphasizes the crucial role of the agricultural revolution, particularly the remarkable 300% increase in productivity over a few decades. He stresses its importance in supporting the world’s population and the need for ongoing advancements, such as gene splicing and hothouse farming.

Immigration and Its Economic Impact:

Munger views immigration, particularly from countries like China and India, as beneficial to the US economy. He encourages young people to focus more on learning and less on agitating for change.

Food Safety and Business Trust:

Emphasizing the importance of trust in businesses, especially in the food industry, Munger cites Costco’s commitment to maintaining food safety. He acknowledges the detrimental effects of intensive farming practices and extensive chemical use on land.

Ethics in Business Practices:

Munger advises against unethical practices, such as cheating in defense contracts, emphasizing the long-term benefits of maintaining ethical standards in business. He disapproves of deceptive practices, such as those employed by chain letter operators.

Reflecting on Munger’s Legacy

Charlie Munger’s talks provide a comprehensive overview of his investment philosophy, ethical standards, and broad understanding of economics and human behavior. His insights reflect a deep commitment to ethical business practices, continuous learning, and an appreciation for the complexities of different investment domains. Munger’s legacy, in partnership with Warren Buffett, has significantly influenced the world of investing, yet he acknowledges the persistence of outdated theories, indicating a continuous evolution in the field. His reflections serve as a guide for investors, business leaders, and individuals seeking to navigate the complex and ever-changing business landscape.

Supplement Update – Key Additions

1. Preparation and Opportunity:

Munger stresses the importance of preparation to seize opportunities. He cites his experience of investing in the Daily Journal by buying a significant amount of stock in a short period. His extensive knowledge and understanding of the banking sector enabled him to make informed decisions.

2. Chipotle’s Food Safety Issues:

Munger warns against the perils of compromising food quality, especially in industries where trust is paramount. He uses the example of Chipotle’s food safety issues to illustrate the consequences of carelessness in maintaining high standards. Moreover, he emphasizes the strict measures undertaken by Costco to prevent food safety issues.

3. Importance of Food Safety in China:

Munger refers to the example of the fried chicken company Yum Brands in China, which suffered greatly due to food safety scandals. He underscores the significant consequences of food adulteration, citing the Chinese government’s swift and severe actions against individuals responsible for harming infants with contaminated baby formula.

4. Defense Contracts and Potential for Deception:

Munger expresses caution when dealing with defense contracts, cautioning against unethical practices such as cheating or fraud. He notes the temptation to exploit government contracts, including suppliers and their suppliers, if an environment of cheating is prevalent.

5. The Peculiar Character of Sumner Redstone:

Sumner Redstone’s driven and shrewd personality often resulted in a lack of likability, including within his own family. Munger used Redstone as an example of what not to do in life, emphasizing the importance of maintaining positive relationships.

6. The Movie Business:

Munger views the movie industry as challenging, acknowledging the difficulty in creating successful projects like Star Wars and House of Cards. He avoided ventures he wasn’t adept at, highlighting Netflix’s acquisition of House of Cards after HBO’s rejection.

7. Fragility of Business Moats:

Munger observed that business moats can be fragile over time, citing examples like DuPont, General Motors, Kodak, and Xerox losing their once impregnable positions. He emphasized the constant need for adaptation and innovation to remain competitive.

8. The Airline Industry:

Munger noted the increased concentration in the airline industry and the lack of viable substitutes for air travel. He acknowledged the past challenges and bankruptcies in the sector but saw potential in the industry’s rationalization and turnaround.

9. Investing Insights:

Patience and persistence are crucial for successful investing. Munger highlighted a rare investment opportunity he found in Barron’s over 50 years ago, leading to significant returns through Lee Lou’s management.

10. Defining the Circle of Competency:

Understanding one’s strengths and limitations is essential for successful investing. Munger emphasized the importance of avoiding situations with unfavorable odds and focusing on areas of expertise.

11. Snapshot of Munger’s Insights:

The learning experience in investing is enjoyable, but playing against the odds is not desirable. Event arbitrage in the past offered 20% per annum returns due to irrational selling by stockbrokers, though these opportunities have diminished due to increased competition and complexity. John Malone’s success in the cable industry is attributed to his genius, fanaticism, and tax aversion. Munger’s reservations about the cable and movie industries stem from their moral complexities and his personal disinterest. Berkshire Hathaway’s focus on ethical business practices and satisfying regulators is evident in the acquisition and subsequent overhaul of Northern Natural Gas. Iowa’s utility rates are notably lower due to Berkshire’s efficient management and focus on customer satisfaction. Solar energy is seen as a sustainable long-term energy source, and home-based electricity generation is unlikely to significantly threaten traditional utility revenue models. The incentive structure for Berkshire’s new investment managers, Ted and Todd, hasn’t notably altered their behavior. Automobile dealerships can provide steady income when well-managed, but Munger prefers focusing on exceptional businesses. The complexities of self-driving cars have long-term implications for insurance, scrap value, and resale value. Munger acknowledges the impact of Warren Buffett and himself on investing and thinking, but notes the persistence of the efficient market theory, which he describes as “physics envy” and likens to a mob at a football game. Munger recognizes Norbert Lew’s successful hedge fund, Punch Card Capital, which follows the “Munger system” and has outperformed the market.

Notes by: Random Access