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

125. DJCO Annual Meeting 2015: Part 3: Erudition 13-18

Erudition 13. People are trying to be smart – all I am trying to do is not to be idiotic, but it’s harder than most people think.

How did you get an idea of investing in good quality companies instead of cigar butts?

Everyone has the idea of owning good companies. The problem is that they have high prices in relations to assets and earnings, and that takes all fun out of the game. If all you needed to do is to figure out what company is better than others, everyone would make a lot of money. But that is not the case. They keep raising the prices to the point when the odds change. I always knew that, but they were teaching my colleagues that the market are so efficient that no one can beat it. I knew people in Omaha who beat parimutuel system. I never went near a business school, so my mind wasn’t polluted by this craziness. People are trying to be smart – all I am trying to do is not to be idiotic, but it’s harder than most people think.

Erudition 14. If incentives are wrong the behavior will be wrong.

As a chairman of a major hospital, could you speak to us about Obamacare?

It’s one of the most complex subjects on the Earth. It is amazing what had been done in medicine from vaccine for children to whatsoever. A lot of people now take many benefits for granted, but I lived in the world where many children died, where every city had a tuberculosis sanatorium, and half of the people who had tuberculosis died. It is amazing how well medicine works. On the other hand, comparing to some other systems American system is peculiar. It is very hard to fix because on one hand you create incentives saying we will pay you so much amount for taking care of people and everything that is saved is yours. On the other hand we could be dealing with convalescent homes. Convalescent homes is a great name – you convalesce at home. This creates a huge incentive to provide care and keep money. If we didn’t have that system, all people would pay for themselves fixed cost which is the only feasible solution. The rest of the world is going that direction because the cost is raising. If Government is going to pay «A» anything it wants for selling services to «B» who doesn’t have to pay anything, of course the system is going to create a lot of unnecessary tests and procedures. I think it will get addressed more and we will probably end up with the system of convalescent homes. If incentives are wrong the behavior will be wrong.

I am curious why despite a large Asian population in the US only few end up at the top?

Arithmetic plays against you. 99% of the population is going to end up in the bottom 99%, and 1% of the population will end up at the top 1%.

Erudition 15. Indexing has gained a lot, and rightfully so, because it is quite rational way to invest. If you think about it there are only about 5% of rational people and 95% shamans and faith healers.

What do you think of 3G Capital?

3G through enormous discipline, enormous will and intelligence, adopted zero based budgeting system which is far more extreme than anyone else’s, and yet they have been able to do it time after time. During financial crisis companies were firing 8-10% of people, and I know no example when they didn’t work better after such cuts. You need someone tough enough and shrewd enough to make right decisions. Of course you need someone who is smart enough to cut something that is not needed and 3G is great at doing that. I actually think that they would probably even increase the sales. 3G is teaching us something about reality. Jerry would you comment on that?

Jerry Salzman (CEO): I don’t think we ever had extra costs. We used to have about 300 employees and now we have about 150. We have taken direction of the company and sized it accordingly. During the period significant growth in revenue through the crisis (due to advertising required by law), we added 1.5 people. When we moved the other direction we eliminated 1.5 and actually a little bit more. We try to be ahead of the game by anticipating what could happen and by using technology, and that is the only way we would be able to handle a particular sequence of events.

You mentioned in the past that if everyone is indexing it is not going to work.

Of course. It is far away from happening, so I don’t spend time thinking about it. Indexing has gained a lot, and rightfully so, because it is quite rational way to invest. If you think about it there are only about 5% of rational people and 95% shamans and faith healers.

What are the chances that the Singapore’s culture would sustain itself without Lee Kwan Yew?

Chances are great. LKY left the base. He eliminated the corruption, made it hard to get in, and paid government people very well. But of course when he was doing all great things, China wasn’t. Now it has changed and Singapore has strong competition.

What about Singapore’s decision to allow casinos to come to their country?

I wouldn’t allow that. But if you think about it you make so much money running the casino, with no inventory and headaches. It is like a license to print money. People just can’t stand the temptation. But LKY was no longer in power when that happened. He wouldn’t allow it. I do not think it is desirable in the USA to have casinos everywhere. But damn politicians solved that way their short term problems by bringing in this poison – they deserve to be on a lower circle of hell. I can hardly see any place in the country where you don’t have a casino. And the advertising on TV with all these happy people is ridiculous.

Erudition 16. Trust is so useful. Having to deal with the people you trust is the right way of living. You asses trustworthiness by experiments. The simplest way to be trusted is to keep deserving it.

How do you deal with failures?

I have only a few of them.

There is a lot of talks about importance of trust. How do you assess people’s trustworthiness?

Trust is so useful. Having to deal with the people you trust is the right way of living. You asses trustworthiness by experiments. The simplest way to be trusted is to keep deserving it. Not like those happy people on TV advertising casinos. By the way a lot of our major financial institutions are just casinos. If you think of what derivative desk is it is a casino in drag. People who work there make witch doctors look good.

Erudition 17. (Buyouts) Some of them used leverage and of course they had high returns. I wouldn’t do it because I don’t like balance sheet swelling with leverage.

Endowments following David Swensen’s approach putting more money in Private Equity and Hedge Funds. Didn’t you comment that if you ran endowment you would hold stocks?

I don’t manage endowment funds and of course it is very difficult to manage multibillion fund. David Swensen is very successful at Yale, and of course that system has spread. Any successful system would spread by example. The other system that has spread is leveraged buyout. Those people actually have an advantage in the world that we have. Your common stock is yielding 10% average over time pretax. But here you have a different way investing in common stocks using leverage, and you also eliminate some unnecessary costs like 3G does. Of course you have a wonderful experience. I guess hedge funds, where Warren was famously skeptical, manage billions and billions. I think he is right and there will be a lot of very bad experiences. There are also going to be good experiences. Some of them used leverage and of course they had high returns. I wouldn’t do it because I don’t like balance sheet swelling with leverage.

Erudition 18. I don’t know much about Internet and the new world with networks. The only thing I can say is that the desire to get rich fast is pretty dangerous.

What is your advice for young tech entrepreneur?

I don’t know much about Internet and the new world with networks. The only thing I can say is that the desire to get rich fast is pretty dangerous.

Source: http://www.valuewalk.com/2015/04/charlie-munger-daily-journal-2015-meeting-notes/