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

70. Wesco Financial Annual Meeting 2005: Lessons Learned – Part 3 – Points 13-18

Excellent Book: Charlie Munger For All Seasons

Point 13. [In 2005] Difficult Environment To Find A Bargain

So that’s where we’re at. Meanwhile, it’s like an Easter egg hunt with too many hunters and not enough eggs. So you value investors, look around the room. There are a lot of hunters. So if you’re having trouble, please join the club.

I regard that as a very interesting development. I don’t think I’ve ever seen in my whole life – it’s hit all asset classes together. Real estate is priced very high by past standards. Stocks are priced very high by past standards. Fixed income is priced very high by past standards. All of these asset classes have been hit. And all of these people accounting for a vast part of GDP want to get rich, and they will likely push.

This could end up in two ways: keep going up or there could be a classic bust, as occurred in Japan.

The competition to buy companies is heating up. The private equity firms will rationalize almost any price. My friend buys warehouses and for months he’s been unable to buy anything. He says, “All I do is raise the price paid to the owner of the warehouse.” So my friend stopped trying to buy warehouses.

Point 14. Emergence of the Orient. Kids go to school all day and then the tutor comes – and the kid is three!

Take the vast improvement of conditions in the Orient – that is really something. At Berkshire Hathaway we do not like to compete against Chinese manufacturers. They learn fast and are good at getting things to you. They’re coming up fast.

The amount of talent in the Asian populations is amazing. They were held down by ridiculous systems — first ruled by autocrats and then by communists – but now under capitalism, the potential is awesome.

My test is I look at symphony orchestras. For the hardest instruments, that require the most dedicated training, 80% of the faces are Asian. This was not true years ago. They are a very talented, driven ethnic group. A good thing about the U.S. is that they come here. Look around this room – look how many Asians are here. 20 years ago at the Wesco meeting, this was not true.

Go to the UC Berkeley engineering department – you’d think you were in Asia.

My grandchildren may be displaced [by Asians]. If so, that’s too damn bad for the Mungers. I’m all for meritocracy.

The economic implications are huge when you have a population base so large, so intrinsically talented, with family values so good. I don’t know an Asian family that doesn’t kill itself for education. In Korea, one of the biggest businesses is tutors. Kids go to school all day and then the tutor comes – and the kid is three! (Laughter)

We’re getting a taste of meritocracy. It does not mean you can just go invest in China, however. The first movers can get killed. There’s a saying in Indonesia: “What you’re calling corrupt is Asian family values.” (Laughter)

Point 15. Size Can Hurt Returns

There may be implications for the rest of you. Something weirdly bad can happen, so prepare for it. Or we could be in for a period with no calamity, but lousy returns. There have been long periods when this was the case – most recently, the 15 years ending in 1981. But now everyone is conditioned to expect high returns. Read the committee reports from Harvard and Yale – they see no reason not to do better than average. After all, they have done so historically.

I think size will hurt returns. Look at Berkshire Hathaway – the last five things Warren has done have generated returns that are splendid by historical standards, but now give him $100 billion in assets and measure outcomes across all of it, it doesn’t look so good.

We can only buy big positions, and the only time we can get big positions is during a horrible period of decline or stasis. That really doesn’t happen very often. You people are lucky to not have a lot of money. We have a lot of money and we’ll endure. (Laugher)

Well, that’s the investment climate.

Point 16. Berkshire Operates With a Seamless Web of Deserved Trust. A Great Football Team Does The Same.


Berkshire Operates With a Seamless Web of Deserved Trust

Everybody likes being appreciated and treated fairly, and dominant personalities who are capable of running a business like being trusted. A kid trusted with the key to the computer room said, “It’s wonderful to be trusted.” That’s how we operate Berkshire – a seamless web of deserved trust. We get rid of the craziness, of people checking to make sure it’s done right. When you get a seamless web of deserved trust, you get enormous efficiencies. It’s what the Japanese did to beat our brains out in manufacturing: suppliers, employers, the purchasing company, management – all created a seamless web of deserved trust. That’s why we have firms – they create a seamless web of deserved trust. It’s the same with good football teams.

Berkshire Hathaway is always trying to create a seamless web of deserved trust. Every once in a while, it doesn’t work, not because someone’s evil but because somebody drifts to inappropriate behavior and then rationalizes it. Our basic attitude is to create a seamless web of deserved trust.

How can Berkshire Hathaway work with only 15 people at headquarters? Nobody can operate this way. But we do. Take Wesco. Every once in a while we get surprised by something – maybe once a decade. It’s what we all want. Who in the hell would not want to be in a family without a seamless web of deserved trust? We try for the same thing in business. It’s not rocket science; it’s elementary. Why more people don’t do it, I don’t know. Perhaps because it’s so elementary. We didn’t copy the Japanese until they were clobbering us – and they copied from us!

Point 17. Buying With Reduced Expectations At Berkshire Hathaway

At Berkshire Hathaway, we’ve lowered our standards a little – we’re willing to invest with lower standards than in the past. We’re not waiting for 1974 or even 1984. If you have the money, you have to invest it somewhere. It may well be that you have to take something that obviously promises a lower return than you were used to.

I think the people who say “I need more” and therefore try to get more than they need, are likely to get into terrible trouble. I know a man who owned his house free and clear, had $5 million of securities and lived on the income from those securities. But this left him a little short of what he wanted, so he said to himself, “I’ll go do a little work to get my return up,” and he sold puts, backed by his entire account. At the time, the highest price was on naked puts on Internet stocks and in due course he lost all of his money and now works in a restaurant.

Warren said at the annual meeting that with most of our present holdings, we’re not buying or selling. And when we do buy, it’s not, “Oh boy! A lollapalooza!” We buy with reduced expectations. How else can one behave? Would anyone want us to reduce Berkshire Hathaway’s assets to cash and sit around waiting for a calamity so Berkshire can put the cash to work?

Point 18: By No Means Have Not We Given Up on Putting Our Cash to Work

Warren answered this at the [Berkshire] annual meeting. By no means have we given up on putting our cash to work. And if we don’t, the money is not going away.

Notes from 2005 Wesco Financial Annual Meeting – May 4, 2005 – By Whitney Tilson