Nugget 25: Paying thirty times earnings for the kind of business you wish you had, instead of the one you’ve got may not ne a good idea.
I would hate the job, personally, of investing, say, in positions of a billion dollars each in 200 different stocks in America and outperforming the averages. I would shrink from that with horror. Peter Kaufman said something interesting to me the other day. He runs a very profitable company [Glenair, Inc.] that has very good returns on capital. He said, “You know, if somebody bought my company for three times sales, I wouldn’t run it anymore, because I’d have a hard time justifying that price with anything I could do.” He’s already rich, why should he do something that difficult? He doesn’t have to.
I think that’s what happened in America. People know their own business is lousy. They know another business that is way better. But it’s not better if you have to pay thirty times earnings for it. It gets so difficult that it doesn’t work. I figured this out, but the consultants and investment bankers keep selling the same nostrum that you can save yourself by paying thirty times earnings for the kind of business you wish you had, instead of the one you’ve got.
Berkshire has been a huge exception. In this year’s annual report Warren intends to deal extensively with: Why did it happen at Berkshire? Will it continue? We’ve reached a size and the record is interesting enough that those are very important questions. If the rest of the world is as smart as I think it is, it will look at this report with great interest.
Part of what we did should be done by others, but it isn’t. There are vast institutional pressures on people to do it differently. Will it continue? I think Berkshire’s going to continue way better than most people think. Way better. But there’s so much power in what we already have. Part of the reason we have a decent record is that we pick things that are easy. Other people think they’re so smart, they can take on things that are really difficult, and that proves to be dangerous.
You have to be very patient, you have to wait until something comes along, which, at the price you’re paying, is easy. That’s contrary to human nature, just to sit there all day long doing nothing, waiting. It’s easy for us, we have a lot of other things to do. But for an ordinary person, can you imagine just sitting for five years doing nothing? You don’t feel active, you don’t feel useful, so you do something stupid.
You’ll find this year’s Berkshire annual report very, very interesting. Three failing businesses together created Berkshire Hathaway. There are about the same number of shares outstanding now as they were then. I can’t think of anything like it at this scale. You’d think people would be paying more attention to it than they do. I think it looks so peculiar that they can’t handle it.
Nugget 26: If something is too good to be true, it probably is. Unless you wrote a great article and Charlie Munger sends you $20,000 ….. it’s your lucky day!
I read an article once by a famous man. I liked it so well (this was twenty-five years ago) that I sent him whatever I could send him without paying gift tax. I sent him $20,000 dollars and said, “I really liked your article, here’s a token of my respect.” He sent the money back. So, I called him and said, “Why are you sending it back to me. I don’t care if you give it to your charwoman or the graduate student who works under you. For God sake’s, keep the damn money.” Whereby, he took my money and gave it to some graduate student. His basic attitude was, if it was that easy, there must be something wrong with it.
I think that’s part of the trouble with Berkshire Hathaway. It looks so damned easy, they think there must be something wrong with it. The people there don’t work that hard. They have all these outside interests – Warren’s playing bridge twelve hours a week (laughter). They just keep spinning and winning and it just looks too easy. So it’s confusing. There must be something wrong with it. (laughter)
Nugget 27: Elon Musk Is A Genius. Says who? Says Charlie Munger!
Q: What are your thoughts about Elon Musk [CEO of Tesla, SpaceX, SolarCity] and what he’s doing?
Munger: I think Elon Musk is a genius and I don’t use that word lightly. I think he’s also one of the boldest men that ever came down the pike. Put me down as saying I’ve always been afraid of the guy whose IQ is 190 and he thinks it’s 250. I like to think there’s a little of that risk with Elon. He is a certified genius.
Nugget 28: If you are not interested in what you are doing, it’s unlikely that you’ll succeed even if you are smart.
Q: What daily habits would you recommend practicing?
Munger: I have never succeeded very much in anything in which I was not very interested. If you can’t somehow find yourself very interested in something, I don’t think you’ll succeed very much, even if you’re fairly smart. I think that having this deep interest in something is part of the game. If your only interest is Chinese calligraphy I think that’s what you’re going to have to do. I don’t see how you can succeed in astrophysics if you’re only interested in calligraphy.
Q: If you were to start another Berkshire, in what form or structure would establish this. A partnership or a C-corp?
Munger: That’s a very intelligent question. Berkshire happened by accident. Having a lot of marketable securities inside a corporation with 35% taxes on every gain: No investment vehicle chooses that. It’s insane. We just stumbled into it. Now we made it work, but it’s a huge disadvantage. It just shows that odd things can happen. The bumble bee shouldn’t have been able to fly as well as it did, but it did.
We bought a lot of things that we just held, including a whole lot of private companies, so no capital gains taxes there. No dividend taxes. And, buying so many marketable securities that we just sat on. Not that we don’t pay a lot of taxes, but we have a lot of capital gains taxes that are accrued but not paid on the balance sheet.
We made it work, but is it an intelligent system? No, it’s insane. The correct system is to have a partnership. That is such an easy question, I’m surprised you asked it. Maybe you’re promoting private partnerships and you knew what my answer would be. (laughter)
Q: Can you tell us about your method?
Nugget 29: Even The Rational Guru Is Allowed An Occasional Crochet
Munger: Let me show you how my system works. Floated into my account yesterday, some old retirement IRA or something. I got a call: there’s 120 thousand lying here, what do you want to do with it? Something I had forgotten about it. You know what I said, the great investor? “Give me your number and I’ll call you back.” I wanted to invest this money in U.S. Securities. I couldn’t think of a no brainer security in my whole brain. I have plenty of things I can do that are okay, but I don’t have a big no-brainer.
I think it’s hard on the big securities, now. Take Costco [ticker: COST]. Is Costco worth 25 times earnings? I think: Yes. Am I ready to sell any Costco? No. Would I buy more Costco at 25X earnings? I’m probably wrong, but I’d certainly rather buy Costco at 25X earnings than 90% of the other stocks. But I’m so spoiled it’s hard for me to buy anything at 25X earnings.
There’s no rule I can’t have crochets [crochet: a highly eccentric or individual opinion or preference, perhaps akin to ‘heuristic’ – PD]. I don’t have to be totally rational. Don’t we all do that? We probably should, as a matter of fact. Certainly a crochet that says this is too hard for me, I’m not going to try to understand it. That’s a very useful crotchet.
Nugget 30: It’s silly to teach the capital asset pricing model taught as if it were a principle of physics.
Q: You mentioned the academic and financial illiteracy in the U.S. There seems to be a reluctance to begin teaching these principals in the education system. What are the possible solutions?
Munger: I think if you expect totally rationality either in humans or human institutions, you’re expecting what’s not going to happen. What is a little surprising is how stupid academia could be. The capital assets pricing model is taught as gospel.
I could understand teaching the Bible as Gospel if you’re a Christian, but why is the capital asset pricing model taught as if it were a principle of physics? To teach that stuff and have students actually work out problems, the way they would in algebra. Of course it’s twaddle. There’s a lot of silliness in economics.
Take a simple case. Japan, a modern nation, tried every Keynesian and monetary trick. They print money like crazy. You can’t find a pothole in Japan on the side of a mountain, they’ve got so much stimulus. They had 25 years of stasis. Every economist in the world would have said that’s impossible. They have all these tricks we taught them, they’re playing our tricks, and they’re befuddled. They’re trying to solve their problem within this little narrow construct that somebody taught them.
What happened was that Japan rose as an export powerhouse. Right behind them were a bunch of people who were starving in subsistence agriculture and crowded them out of their own market. Think it’s fun for Japan to compete with Korea? And China? Of course it got harder in Japan. But of course, the economists can’t figure it out. They’re looking only at Economics 101. If you’re a prosperous businessman and some tough competitor opens across the street, is that good for you? It’s not very complicated, you just have to keep an open mind and examine all the possibilities.
Nugget 30: Not All Markets Are Efficient
Q: What do you think is a pragmatic number of companies to own in a portfolio?
Munger: I don’t think there’s any one answer to that. It all depends. Obviously if you run an index fund and are scraping money off the top, there’s no limit to what you can own. That is a pretty good business. They deserve the success they’ve had because they outperform people who use the conventional methods.
I talked to a very smart money manager not long ago. I ordinarily don’t talk to money managers. I met with this guy because he agrees with me on practically everything, so he must be very smart. (laughter) He told me that he indexes the U.S. equities and he hires managers to work everywhere else. He regards the big time U.S. market as so tough that he’s better off just indexing it. He finds more inefficient markets in other parts of the world. I think that’s a very intelligent response.