Book Recommendation: Fortune’s Formula
I like that book that I recommended [a while ago] in which the guy that explained all of these weird guys at the horse races – a value investing thing with a lot of math in it. What was the name of it? Fortune’s Formula. It’s a very worthy book and you all ought to read it.
In Hong Kong, people are crazy about horse racing and everyone bets on the races, yet somebody was actually able to develop a lot of algorithms such that, in spite of the croupier’s take, he was able to make a lot of money. Some of that is going on in a lot of these hedge funds. Some guy can develop a lot of algorithms and can outwit the other guys’ algorithms. But it’s not for me…
Comments on the Kelly Formula, Which Is Detailed in Fortune’s Formula
[Munger had trouble hearing the question and asked the questioner to repeat it more slowly, saying, “Keep in mind you’re dealing with a slow-witted old man.”]
The first time I read that sizing system, my take is that it seemed plausible to me, but I haven’t run that formula through my head – and I won’t. You couldn’t apply it to the investment operations I’ve run [I think because of Berkshire’s size], but the gist of it in terms of sizing your bet makes sense. Whoever developed that formula has an approach to life similar to mine.
If you could flip a coin and get a 4-to-1 payoff [if you called it correctly], would you invest your house, your net worth, everything? I don’t think so. You only get to live once.
[The person who asked the question answered, “Maybe” [Laughter]]
All I can say is that you remind me of a man who once worked for a contractor I knew. He was very bold and aggressive. The contractor said, “Old Charlie is going to become a millionaire – several times.” [Laughter] I think we’ve identified another Old Charlie. But at least you’re asking the right question and at least you said maybe. Generally speaking, I’m closer to you when you said maybe, at least I was when I was your age.
Point 44. Demosthenes: What a man hopes is what he believes. [Sic: Does Not Mean He’s Right.]
Unrealistic Return Assumptions of Pension Funds
Both Warren and I have said that to predict 9% returns from those pension funds is likely to be wrong and it is irresponsible to allow it. They do it to delay bad news. Look at Berkshire and our paper record, which is obviously much better [than the investment track records of the pension fund managers]: we use 6.5%. For example, the Washington Post has the best record [of virtually any pension fund, yet it assumes a 6.5% annual return]. Do you want to believe the predictions of the people with the best record or do you want to believe the people who are acting in the way Demosthenes predicted when he said the wages of profit are [?]. In other words, what a man hopes is what he believes.
Point 45. Low Yield For Real Estate Is Not Strange
The weirdest things I see are in really good coastal properties. It can’t keep bubbling up like it has been. But when and how it will collapse I don’t know.
Housing Bubble and Likely Future Low Returns from Real Estate
Recently someone paid $800 per square foot for the air rights to build a piece of property in Manhattan. This is driven by the prospect of selling condos for high prices. The condo selling game has already crested in Las Vegas and Miami. In Los Angeles, I don’t think it’s quite crested, but certainly you’re seeing weird prices. I’m not sure it’s crazy. In other words, if you have an apartment building, after costs of maintaining it, assuming no rent control ever, you might earn a 4.5% annual return [if you pay today’s prices for it]. I’m not sure that that’s crazy. It’s not as good as the kind of stocks Berkshire would own, but it’s not crazy. We may be in that kind of world [of low returns]. That’s already happened in Europe where apartment buildings already have 3% yields. Stranger things have happened…
Point 46: interest rates Is Not A Perfect Correlation to Inflation
Interest Rates and Inflation
I have never believed that interest rates have a perfect correlation to inflation. I think there’s some relation, but it’s complex and not easily quantifiable.
Class Action Litigation
It doesn’t affect Berkshire because we don’t offer Directors & Officers coverage, though we do cover product liability. There’s a lot of abusive litigation in the silicosis field. The asbestos lawyers just rewrote the same complaints. [It reminds me of the class action lawyer who, faced with a judge who wasn’t friendly,] said, “By god, I’m getting tired of this harassment and by god I’m going to take my witnesses and go to Chicago!”
The behavior of the class action lawyers [who sue companies] may be quite inappropriate, but the behavior of the people in the corporations may be quite inappropriate as well.
Municipalities’ Bad Accounting for Future Pension and Healthcare Liabilities
They’ve gotten very lucky thanks to the accountants. [My comment: Unlike corporations, which have to account for such liabilities on their balance sheet and in the footnotes to their financial statements – at least in part (there’s massive abuse and understatements here) – a loophole in accounting rules has allowed cities and states across the country to make promises of pension and healthcare payments to municipal employees’ unions totaling hundreds of billions of dollars in present value, yet this doesn’t have to be disclosed or reserved for. The accounting loophole was recently closed and I predict there will be hell to pay as municipalities have to suddenly come up with this money.] If that [continued bad accounting] doesn’t work, then they’ll have to go to Plan B: increase taxes. I predict that whatever disgusts you in this field will continue for a long time.
Point 47. The Newspapers Industry’s Future Is Worse Than The Past
I think their future is way worse than their past.
Dividend Payout Ratio of the S&P 500
I don’t really have a big opinion on the dividend payout ratio of the S&P. To me, it’s within hailing distance with being reasonable…That’s all I have to say. [Laughter]
Point 48. People Who Rise High In Life Have A Duty To Be Exemplar
ADVICE ON LIFE AND OTHER
The Importance of Being an Exemplar
I think people have a duty when they rise high in life to be exemplars. A guy who rises high in the Army or becomes a Supreme Court justice is expected to be an exemplar, so why shouldn’t a guy who rises high in a big corporation act as an exemplar and not take every last penny?
It’s not a problem we’ve had at Berkshire, but look at how far it’s spread. We have about two imitators. [Laughter]
The Future of American Civilization
I’ve said that American society is near its apex. It could be just before or just ahead of that point. Other people are more optimistic; Warren is more optimistic than I am.
We’ve had the most incredible generations. Do you think it can go from generation to generation, from apex to apex? The historical record would give you some caution.
Whether the good behavior and values will outweigh the bad, I don’t know. On my way over here, I stopped to watch the concrete being poured for a new Wesco building. The design is sound. The system for putting it together is sound. The skill of the crews is sound. The inspection process is sound – every single pour of concrete is watched by an inspector paid by the city of Pasadena, and he’s a good, competent man. He watches to make sure every bar of rebar is correct. This building will outlast the pyramids. This system is a credit to our civilization. In contrast, look at the same process in Latin America or Japan, where guys take bribes.
There is a lot that is right in our country. In a recent five-year period, not one passenger died on a major airline. Imagine if other engineering systems were as good. A lot of pilots are recovering alcoholics, yet the system is safe enough to get us around this.
United States Fiscal and Trade Deficits
Regarding currency and oil – this is a very sophisticated crowd [laughter]… Regarding currency, the United States is very peculiar running such a large trade deficit and a fairly big fiscal deficit. [I couldn’t hear his remarks for a few sentences here.] The absurdity of this kind of thing…I’d rather not run such a big fiscal and trade deficit. If we have a war, I’d rather add a blank space on tax returns, asking people to pay 10% more for a national emergency. It wouldn’t be compulsory, but if you don’t pay, we’ll publish your name.
[Laughter] I’d be in favor of that kind of stuff. Maybe I’d [be great?] for the United Jewish Appeal [an extremely successful fundraising organization, in part because it’s very public about who makes big donations – and if you’re a wealthy Jew, you’re shamed if you’re not on the list].
But my ideas aren’t winning. They’re odd, of course. I’m not predicting ruin, but I think it would be more conservative to behave differently.
China’s Growth and Future Pollution
China’s vast growth of GNP of 9-10% per annum is a remarkable thing. I think the government will be smart enough to let the tiger grow and then there will be a big pollution problem – and the United States will be way less important relative to other nations than it is now.
Best-Loved Ideas That He’s Destroyed Recently
[In last year’s annual meeting, Munger talked about the importance of destroying at least one of your best-loved ideas each year, so a shareholder asked which of his best-loved ideas he’s destroyed in the past year.]
I had more scorn for fixed income arbitrage in the past than I do now. I was also more hopeful about troubles in the Middle East than I am now. So I’ve destroyed some of my optimism in favor of more realism. I don’t think there’s a man or woman in the room that thinks they have a better grasp of what going on in the Middle East [now than they did previously]. Doesn’t matter what you think of this administration.
Point 49. The ability to destroy your ideas rapidly instead of slowly when the occasion is right is one of the most valuable things.
The ability to destroy your ideas rapidly instead of slowly when the occasion is right is one of the most valuable things. You have to work hard on it. Ask yourself what are the arguments on the other side. It’s bad to have an opinion you’re proud of if you can’t state the arguments for the other side better than your opponents. This is a great mental discipline.
Point 50. You Can Also Deal With Death Through Humor
Reflections on Looking Back at His Life
I wouldn’t have done a lot in my life different. I think I’ve been a very fortunate man and I don’t think I should be complaining about how my life has worked out. The other day, I was looking back at Berkshire over the past 10 years, since it was recently the 10-year anniversary of the Berkshire B shares. Sure, the rate of growth has come down, but we have added a lot of value and that’s with a tough strategy the past few years. So generally speaking, I have no regrets.
The only regret I have it that I’ll soon be dead. [Nervous laughter] I deal with it through humor. Some people deal with it through religion; I deal with it through humor.
Notes from 2006 Wesco Financial Annual Meeting – By Whitney Tilson