Charlie Munger's 3 Categories of Investment: In, Out & Too Tough

61. Charlie Munger’s Pointer For The Day: DJCO 2013: Part 2 Pointer 7-12

https://www.facebook.com/groups/charliemungersays/
http://www.rbcpa.com/DJCO_Meeting_Detailed_Notes_2013.pdf

Pointer 7: It’s Dumb To Put On Facebook The Dumbest Thing You Ever Did

Which gets into the question of should young people be creating these permanent paper records on Facebook, and so on of the dumbest thing they ever did or thought, so it’s immortal. I think it’s insane. I would hate to have to read the dumbest things I ever said at fifteen years of age — it would be embarrassing for all of us, at least it would be embarrassing for me.

I don’t like the way the world evolved on that. I do think the rating agencies use very poor judgment. I think the people that were issuing the bonds, these are really smart people, much smarter people than the people in the rating agencies. Of course, they paid tremendous penalties. Some of them have gone broke. Others have given them millions and millions in settlement. You’ll reach impairments in reputation, so on and so on.

What happened in the boom and the lousy credit and market spiels, packaged up into lousy securities, mis-rated by mistakes by jerks who believed in mathematical formulas instead of common sense. It was not pretty. People paid a terrible price for it, and the country has paid a terrible price for it. I can’t predict what’s going to happen in the litigation.

Pointer 8: Foregoing money, because it’s sort of tainted, or too close to tainted, or too close to gaming, is a very good thing. Sol Price (founder of Price Club) used to say, success in business came from deciding which business you could intelligently do without.

I can say one thing, the rating agencies would have been way better off if they’d made less money, had been more careful, and thorough, so the extent any of us have decisions to make. Foregoing money, because it’s sort of tainted, or too close to tainted, or too close to gaming, is a very good thing. Sol Price (founder of Price Club) used to say, success in business came from deciding which business you could intelligently do without.

He had a list of business he didn’t want. Those things he didn’t want — he didn’t want business from people who wrote bad checks. He didn’t want business of people who shoplifted. He didn’t want business of people who clogged-up his parking lot without buying very much. He carefully invented a system where he kept those people out, and

succeeded by deciding what he would be better off without and avoiding it. This is a very good way to think, and it’s not all that common. It’s, perfectly, obvious, isn’t it? And it has been of enormous help to the people sitting at this head table. But most people just aren’t trained to do that — if it’s more business, they tend to want it. There’s enormous money and happiness, and better service to be gained, by just deciding, “I’m going to do without that.” Warren used to say, when we were brokers at Solomon, “I’m waiting for a list of the business that we have declined because it was morally beneath us even though it was legal.” People are just so competitive they just want to do every damn thing that can be done, profitably, whereas, we need something beyond that. I’d imagine, he’d behave, just slightly better, than what would take him to prison, in order to get money.

Pointer 9: You should have personal standards that are way better than the criminal law requires.

You should have personal standards that are way better than the criminal law requires. Why should the criminal law determine your behavior? It would be crazy. Who would behave that way in marriage, or in partnership, or anything else? Why should you do it in your general dealing?

I think this mess, and, of course, it’s a little dispiriting to find that many of the people who are the worst miscreants don’t have much sense of shame and are trying to go back as much as they can to the old behavior. The truth of the matter is, once you’ve shouted into the phone, “I’ll take x and y,” and three days later, you have an extra 5 million, once that has happened, the people just become hopeless addicts, and they lose their bearings. You can argue we shouldn’t allow a system where that can happen.

Look at the people who get addicted to poker, both online poker and gambling parlor poker. A huge crowd of people, 50, 60 hours a week and grinding away at these tables, of course somebody who’s making croupier’s profit off the top, and the very shrewd people are taking away money from the less shrewd people. Is this really in the public interest? I don’t think so.

Even if it were in the interest to allow this recreational poker, to turn the public securities markets into a very effective gambling house for the people who think like the poker addicts and behave like the poker addicts — if I were running the world, I would put a lot of people out of business, including several in this room. In other words, I don’t think you necessarily want a huge class of people getting rich in software by being a little cleverer than other people.

Pointer 10: [Sic: Investment Strategies Are Not Cast In Stones.] We changed our point of view as the facts change.

Shareholder: Two questions, if you don’t mind. From 2000 to 2008, Daily Journal seemed to reinvest nearly all of its profits into US Treasury notes and bills. In the last two years, after February 2009, Daily Journal has invested over $30 million into common stock of three companies. Can you discuss the difference between the investment landscape over the last few years versus 2000 to 2008?

Munger: Well, when we’re engaged in something difficult, as we were with our declining main business, we tended to want extra reserves of strength. As we got so much extra money and the opportunities in marketable securities got more extreme, we changed our point of view as the facts change.

Keynes used to say, “When the facts change, do you change your opinion?” (Keynes actual quote was: “When the facts change, I change my mind. What do you do, sir?”)

Well, of course you do. That’s what we did. Our circumstances were different and our opportunities were different, so we behaved differently. What would you do?

Shareholder: Is it any reflection of the investment climate, or purely…

Munger: Yes, of course, that was part of it. The price you pay for some of those securities was ridiculously low. In fact some of that stuff was something that happens once in 40 years or something. Who in the hell keeps money sitting around waiting for one of those opportunities? (A) It might come and go and you may not recognize it, and (B) what do you do during the 40 years you’re waiting?

So I don’t think you should be terribly encouraged by what has happened. It doesn’t indicate that suddenly a recurring stream of money going from people in their 90s. It just means that for one reason or another, we behaved pretty sensibly, and reacted pretty intelligently to opportunities. Other people didn’t do it.

General Motors, out of the profits of their good years, they could have bought, every year, for many years, a big company. They could have bought Eli Lilly one year and Merck the next, and United Technologies. General Motors could own the world. Instead, what they declared to their shareholders was a goose egg. They took the common equity to zero. And they would say it was all somebody else’s fault. The climate was bad, the unions got powerful. Those damn Asians and Europeans were too competitive. The truth of the matter is, their very prosperity made them weak. The dealerships got in the hands of inheritors, and the executives on the sales field, they go around and drink martinis with inheritors, and didn’t pay enough attention to defects in their vehicles. And one thing led to another, and when they were all done the shareholders’ equity went to zero. And that was in a company that at its peak was one of the most admirable companies in the world.

Take the stuff that Boss Kettering (Charles Kettering – head of research at General Motors from 1920 to 1947) had invented in the early days. Kettering was one of the most useful citizens that ever lived in America. A self-starter on a car is a wonderful thing. Under the old system, you frequently broke your arm. You would give it a crank and it would answer back by spinning backwards and breaking your arm. I would much rather push a button than have my arm broken. Nor do I have the opportunity to go and crank in the sleet and snow. Kettering did a lot of inventions like that. In the early days of General Motors, they really made some enormous contributions to civilization. And they are still making contributions, but it is so competitive.

I should tell you people a story, because you are groupies for stories. I talked recently to a man who shall go nameless. But his company was one of the great growth stocks of America. And they had armies of PhDs in there who had mastered very difficult disciplines. And they had patents, and technology, and know-how, what have you — and hard-to-replace plants. What they make is difficult to make in a lot of different categories. And the profits in the business are very mediocre, to put it mildly. And it isn’t that it has been that badly run. It’s just that everybody’s learned how to make these difficult things, and there are too many of them trying to make them. It just gets terrible. And what happens then is, you’re now the CEO of the place and you see it’s getting tough. Your duty, your acquired self-image is a guy that knows how to fix things. You never have a category in your mind of, “It’s too tough to fix,” which is a really stupid idea. You can recognize all kinds of things that are too tough to fix. But if you don’t, then you are a sucker for some narrative to say, maybe there’s some company in your industry that makes something really complicated that other people can’t match. And you say, “Well, I’ll buy that. That solves my problem.” But your friendly investment banker and your friendly management consultant want you to buy it at 30 times’ earnings and 12 times’ book. Of course, at that price, it won’t solve your problems. And you do it anyway. After all, you’ve got consultants, and it gives you hope.

Many of these people buy things the way that people used to go Mexico and ingest apricot pits when they had pancreatic cancer. They wanted something that provided hope, and so they believed in apricot pits. A lot of American industry helped by their friendly investment bankers and consultants of other kinds, they want to believe that in this terrible, tough business, there’s an easy solution. It just requires listening to the siren song and writing the check. Of course, usually it doesn’t work.

Pointer 11: On acquisition: Don’t Assume It’s Easy To Buy Your Way Out Of Trouble.

The ordinary acquisition in corporate American does not work for the shareholder. In other words, on average all the acquisitions together are anti-shareholder. Only occasional ones work, and work well, and it is rather interesting that Berkshire, on average, they work pretty well. What is the difference? Why are Berkshire’s acquisitions, why are they averaged out so well when we pay the prices for whole companies, and the standard experience in America is that the acquisition doesn’t work that well.

There are a number of reasons. Partly they’re that people like buying in their own field? As to a field that is prosperous like newspapers? They keep buying up higher, and higher prices to encourage everybody wants to buy the same thing, so you get in a very bad daisy chain that is anti-shareholder. In its places where you want to believe that there is a simple way to buy your way out of trouble. Why should it be simple to buy your way out of trouble? You get a little pancreatic cancer, are you going to buy your way out of trouble?

I don’t think so. There are all kinds of things you can’t buy your way out of. You have to adapt to them. Part of Berkshire’s secret is that, less than most people, we don’t pour endless treasure into losing hands, on the theory that we’re going to win and do it fast. Berkshire got though this helpful reputation among their group of addicts over a long period of time. It took a long time. It’s a very useful, useful thing to have. Two, I think Berkshire’s been blessed with these big insurance companies. It’s got two things to do. It can buy companies or it can buy securities as insurance companies. Aren’t you going to make better investments, if you can get two reasonable options at all times instead of one? Doesn’t that make sense? That’s another of the reasons.

I don’t see why Berkshire isn’t more copied, except I think people look at it and they look at their culture with its own traditions. They came to power at 58 they’re going to be gone at 63. They don’t see any way of getting from where they are to where we are. How would you change DuPont into Berkshire Hathaway, if you were the CEO of DuPont? It’s addicting. I’ve got right to give up on the problem and not even think about. At any rate, I do think of it as peculiar. This acquisition business — It’s generally a tough game.

Shareholder: I had a second question. The second question was you had mentioned talk about doubling down on the New Dawn acquisition. In 2012, the company also added a supplemental addendum to management incentives, where management should be compensated should Sustain be sold or IPO. I was curious if there’s anything that we should think about if Sustain were a standalone business, if it could have value to another owner that exceeds what’s currently being suggested by the current financials?

Munger: Well, of course Sustain could eventually…Sustain and New Dawn, I’m a total convert to the new product, of course, I think if we’ve succeeded, that would be valuable to other people.

As it is now, it’s not like ordinary software. The people like Oracle and Microsoft, and never wanted to be a mixed businesses too awful. The RFP, the consultants, the bureaucracy, it’s just agony squared, agony cubed. And they like easy money, and they’re right, too. We generally chose this hair shirt, and it is agony and it is hard, but it’s challenging. Eventually, if we succeed, it will do a lot of good in terms of service and efficiency and so on. We went the unusual incentive program, because everybody in software expects some carrot so we were just bending to the wind in the field, really. That explains that.

Shareholder: As a fellow addict, I wanted to comment and then a question, and that has to be why so many people gathered to hear a 90-year-old. I’m reminded of the difference between knowledge and wisdom. We’re here for wisdom. Knowledge is knowing the tomato is a fruit, but wisdom is knowing not to put it in the fruit salad.

Munger: Well, I think there’s some truth in that.

Pointer 12: On Good Governments: I can’t solve your problem. You’re right to be concerned about it. But if you also look around, you’ll find example after example of fabulous good government and various institutions, both private corporations and public. [That’s after he said if you take the whole history of government in the world, it’s a pretty sad story.]

Shareholder: So we hear from the liberals that have commented on had to do with paradigm shifts in management styles and is that the goals in management should be… I’d like you to apply that to the government, because I think the elephant in the room that I haven’t heard that, is all of us share a concern for the leadership … and the consequences of the decisions

Munger: Well, of course, if you take the whole history of government in the world, it’s a pretty sad story. Think of all those years of crazy kings, crazy theocrats, the holy inquisition, populist mobs — Imagine the French mob that cut off the head of the greatest chemist in the world, Lavoisier (Antoine-Laurent de Lavoisier – the father of modern chemistry).

If you look at the history of government in the world, you see just a lot of crazy — Think of Mao killing 20 or 30 million people on some dumb idea about farming. There’s been a lot of horrible… Think of the whole Soviet Union getting so they provide perfect job security. Everybody had a job. The way they described that was, “They pretend to pay us and we pretend to work.” And despite what’s been working for every else the Soviet Union (didn’t want to use that.) The whole history of the government has been bad. Of course, our founders realized there were dangers buried in democracy. It was Ben Franklin who put it in “Poor Richard’s Almanac,” he says, “When citizens of the Republic learn they can vote money, the end of the Republic is nigh.”

Well, not that near, but it’s a very dangerous thing that you learn you can vote yourself money. What’s safe unless everybody’s working their way toward productivity and success. Just ganging up to vote yourselves, money is dangerous. When it’s carried to excess like Greek culture where A), everybody tried to vote themselves money instead of doing anything else or B), so they succeeded from paying taxes or anything else, you’re talking about a very dysfunctional society. It’s not as dysfunctional as the Soviet Union. After all, the sheep farmer in Greece probably was pretty efficient at tending the sheep. In the Soviet Union, nothing was efficient, except the high science. Get a bunch of high IQ people together and give them problem sets — why, you can do that as well in the gulag as you can do it somewhere else.

But short of that, why…I can’t fix the problems of government. There’s so much that’s good, including in government, but I think it’s probably a mistake to concentrate too much on what’s awful but certainly a lot of intelligent people are a bit discouraged by a lot that’s happened. But you wouldn’t have liked the politicians of yesteryear. They built the transcontinental railroads with Congress taking cash bribes from people like Huntington and Stanford. They got the railroad built but it wasn’t pretty.

People were cheating the government way back. The Civil War was full of lousy products sold to the soldiers. I can’t think of any much more heartless. Remember the local druggist who diluted all the cancer drugs so they could make more money. Imagine doing that — That was routinely done in the Civil War by respectable manufacturers. They just cheated the government troops.

There’s a lot of unhappy occurrences in the history of man, and there’s a lot of peculiar government…If you go back to where government was simpler and more honest, then 85 percent of the people were on farms doing backbreaking labor and they could never leave the farm or leave the farm or read anything or see any athletic events. I’d rather have a little sin and not be doing brute labor on the farm.

But at any rate, I can’t solve your problem. You’re right to be concerned about it. But if you also look around, you’ll find example after example of fabulous good government and various institutions, both private corporations and public. I’m very much impressed with the way they run the University of Michigan. It’s a tough hand at the state when there’s nothing but economic squeeze for all a long time. That University has gone up, up, up, better loved, better respected, better serving. If you look around, you’ll find much that’s good in human governments, as well as bad.

Shareholder: what is the company doing today different from yesterday and that could be reflected in the picking of the right software?

Munger: We bought New Dawn, which has a way better sales culture than we have and a bigger installed base and we like the people. That is very different.

Shareholder: Is that proprietary?

Charlie: Well, meaning is it a cinch that we will win? The answer is no. Is it quite possible that we will win? The answer is yes. But it’s quite different. Yeah?