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

71. Wesco Financial Annual Meeting 2005: Lessons Learned – Part 4 – Points 19-24

Point 19: Some Success We Predicted. Some were fortuitous.

Did You Predict Berkshire’s Success?

Well, some of our success we predicted and some of it was fortuitous. [Regardless,] like most human beings, we took a bow. (Laughter)

Point 20: [On Investment] Patience and aggressive opportunism is what you need.

Some eventualities came to pass. What the 15 best deals all have in common is that they all worked. There were different models – See’s Candies was different from Shaw Carpets. But both are good businesses that will generate durable returns for the grandchildren of people sitting in this room. The reason I keep talking about the record without the 15 best deals is that it shows how few deals you need in a lifetime. The people who need a deal every month, by and large, they all crater. Patience and aggressive opportunism is what you need – an odd combination, but it’s what works best.

Point 21: Good Days Ahead For Berkshire (This was said in 2005)

Berkshire and Wesco Buying Back Stock?

Buffett answered this question [at the Berkshire annual meeting]. At some price, we’d buy back Berkshire, but it’s quite a bit less than the price that currently exists. We’re not looking for the chance to gleefully buy out shareholders at a substantial discount to its value. We like to behave so this doesn’t happen.

As for Wesco, because you people have created this cult, it always trades at a premium to its liquidation value.

Despite my words, I’m a bull on Berkshire Hathaway. There may be some considerable waiting, but I think there are some good days ahead.

[I missed the rest of the sentence, but at one point Munger said: “…the stocks [plural] that we’re buying today…”]

Problem of Buffett Foundation Having to Eventually Sell Berkshire Stock

I regard that as so easily solvable that I don’t give two seconds to it. If the foundation has to sell 5% of its stock [every year to comply with the law that says all foundations must give away 5% of their assets each year], then Berkshire could pay a dividend or buy back the stock. It wouldn’t bother me – we’re drowning in cash. The needs of any one shareholder are easily dealt with in our current circumstances. You lead a very favored life if you worry about things like that.

Advantage of Berkshire’s AAA Credit Rating In Insurance

There’s a little price tiering – there’s a difference among insurers based on their credit worthiness. But is there enough difference? The answer is no. Do I expect a cascade of business to Berkshire Hathaway? No. But there’s a modest and increasing trickle.

People are not as credit-leery as they should be.

Pricing Super-Cat Insurance Policies

We’re very peculiar. We don’t have a department where we trust people to do it on their own. All decisions must be approved by Ajit Jain and Warren, and neither of them uses standard actuarial tables. In other words, after a long period with no hurricanes, the actuarial tables would tell you that the hurricane risk has gone down – that’s not how they think at Berkshire Hathaway. There’re very rational. We don’t use standard actuarial tables, just as we start with [companies’] reported financials, but then go from there.

You don’t need dozens of people to write super-cat policies. So there’s our plan: get Ajit Jain, add Warren Buffett working for free and then raise tens of billions of dollars because people trust you and there you go. (Laughter)

Point 22. You’ve also have to have a compensation system that’s satisfactory to the people running them. (Sic: Keep Them Simple.)

It isn’t enough to buy the right business. You’ve also have to have a compensation system that’s satisfactory to the people running them. At Berkshire Hathaway, we have no [single] system; we have different systems. They’re very simple and we don’t tend to revisit them very often. It’s amazing how well it’s worked. We wrote a one-page deal with Chuck Huggins when we bought See’s and it’s never been touched. We have never hired a compensation consultant.

Point 23: If you let people on sales commission set the credit standards for people using margin, you create a disaster. It’s like mixing oxygen and hydrogen and lighting a match.

The recent historical experience of mobile homes – actually, it’s “manufactured”; they’re not manufactured to move – is that you had a bunch of no-good nut cases and a balloon of unfortunate, commission-sales-driven activity. Any time you let people on sales commission set the credit standards for people using margin [e.g., debt to buy the home], you create a disaster. It’s like mixing oxygen and hydrogen and lighting a match.

The homes deteriorated… It was an absolute disaster. If it hadn’t been, we wouldn’t have been able to buy [Clayton Homes]. [The distress in the industry was so great that] they were losing their securitization capacity. Clayton was the best, but even they were at risk so they sold to us.

What do you know about foreclosing on a house in a trailer park? And what do you do with it? We’re now the largest in the country. I think it will work quite well for Berkshire and Clayton. If Clayton were an independent company, they’d have trouble.

The people who claim we underpaid for it are out of their minds. It’s amazing how many people think they know more than the people selling it.

Cort benefited from the venture-capital-financed, new-company boom. You could argue that we made a macro mistake. These companies went away for a while and Cort was affected. But you can see in the first quarter earnings that it’s coming back. There’s a class of people that just want to rent, not own. They are trying to be the Enterprise Rent-A-Car in the furniture rental business. It’s not a gold mine, but we think it’ll be successful over time.

Point 24: If You Pay A Manager  A Fortune To Invest Almost Parallel To The Index, You’re A Sucker.

If you’re an investment manager and they’re going to fire you if you don’t keep up with your benchmark, that can cause some weird things to happen in the markets as a whole.

That’s the world that we live in, whether you like it or not. It has some perverse consequences – for one thing, closet indexing. You’re paying a manager a fortune and he has 85% of his assets invested parallel to the indexes. If you have such a system, you’re being played for a sucker.

You have these fads in investment management. With so many bodies and minds and computers, I see figures of risk by asset class, but I don’t have the faintest idea what they mean. They don’t either, but they learned a fad, a way of thinking. If you learn a formula, you can run the numbers and print it up, but it doesn’t mean anything.

http://www.valuewalk.com/wp-content/uploads/2014/05/Charlie-Munger-2005-2013-minus-Harvard-Westlake.pdf

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