The Tao of Charlie Munger by David Clark
Warren Buffett said, “Charlie’s most important architectural feat was the design of today’s Berkshire. The blueprint he gave me was simple: Forget what you know about buying fair businesses at fair prices…. Consequently, Berkshire has been built to Charlie’s blueprint. My role has been that of general contractor, with the CEOs of Berkshire’s subsidiaries doing the real work as subcontractors.”
The advantages of investing in better businesses that didn’t have big capital requirements and did have lots of free cash that could be reinvested in expanding operations or buying new businesses.
Bet only on the long-term economics of a business, not the short-term price swings of its stock price.
“Knowing what you don’t know is more useful than being brilliant.” We should become conscious of what we don’t know and use that knowledge to stay away from investing in businesses we don’t understand.
“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.” Charlie’s investment philosophy is predicated on the theory that a shortsighted stock market will sometimes underprice a company’s shares relative to the long-term economic value of the company. When that happens, he buys into the company, holds it for the long term, and lets the underlying economics of the business eventually lift the stock price. The only thing he has to be careful about is not doing something stupid, which in his case are mostly errors of omission, such as not acting when he sees a good investment or buying too little of it when the opportunity presents itself. Which is actually harder to do than one might think.
“My idea of shooting a fish in a barrel is draining the barrel first.” Sometimes the shortsighted stock market serves up an investment opportunity that is so obvious it is hard to resist. This usually happens when there is a stock market panic and investors are fleeing any and all investments, even the ones with great long-term economics working in their favor. This fleeing of investors is the drawing of the barrel—stock prices drop, which makes it easier for Charlie to see the fish; underpriced great businesses.
Value investing meant buying a stock at below its intrinsic value—which to Graham meant half a book value or at very low price-to-earning ratio.
“Acknowledging what you don’t know is the dawning of wisdom.” The smarter we get, the more we realize how little we actually do know. By acknowledging what we don’t know, we are putting ourselves into a position to learn more: thus, the dawning of wisdom. In Charlie’s world of investing there is what we calls a “circle of competence,” which consists of all the companies he is capable of understanding and valuing. But it also includes all the companies outside the circle that he doesn’t understand and is unable to value. By acknowledging what he doesn’t know, he can either avoid an investment or learn more about the business and see if he can understand it to the point that he can value it, which would put it within his circle of competence. Over the course of Charlie’s life he has increased his circle of competence to include the insurance business, banking, newspaper, television, candy companies, airlines, the toolmaking business, boot makers, underwear manufacturers, power companies, and investment banking. Charlie’s road to all this wisdom began by acknowledging what he didn’t know and then doing something about it.
You get great value for your money by buying into a company with great long term economics working in its favor whose share price is misplaced on the downside. Charlie, by contract, is concerned only about where a company’s underlying economics are headed over the next ten years. It is the discrepancy between the two that creates his misplaced gamble—his buying opportunity.
Charlie discovered that if we invest in companies that have great economics working in their favor, at a reasonable price, we can bring the number of companies we own down to ten or fewer and still be protected against an expected business failure, and have good growth of our portfolio over a ten- to twenty-year period. As the saying goes, too much diversification, and we end up with a zoo. It’s much easier to keep a sharpe eye on our basket if there are only ten eggs in it.
“You should remember that good ideas are rare—when the odds are greatly in your favor, bet heavily.” When are the odds in our favor? When some macroeconomic event causes stock prices to collapse, Charlie buys as much as possible. Remember, in Charlie’s world, as stock prices fall, the odds become more in our favor, provided we invest in companies with good long-term economics working in their favor. When that happens, Charlie recommends that we bet big!
Charlie is telling us that if we invest in an index fund, we will do no better than the average investor. We will never excel beyond the average, and average can also mean losing. In Charlie’s world on buys as others are selling, which is hard to do if one is running with the herd.
He’s just a man looking for a good business he can buy at a fair price. However, the one thing he can predict is that the stock market will have moments of wild exuberance and high stock prices, usually followed by bouts of severe depression and much lower stock prices. But he does know they will happen—he just has to have the patiences to let them happen.
Both Charlie and Warren let cash pile up, waiting for a recession/crash, even if it means getting low rates of return on their cash holdings as they wait for the inevitable. When the crash hits, they make their purchase.
“I think that, every time you see the word EBITDA, you should substitute the word ‘bullshit earnings.’” According to Charlie, if we use EBITDA to determine the earnings of a company, we will get an unrealistic view of the company’s true economic nature.
Charlie’s rule for financial firms is really simple: what looks good on the outside may be seriously rotten on the inside.
Blaise Pascal, the seventeenth-century French mathematician, said, “All humanity’s problems stem from man’s inability to sit quietly in a room alone.” When Charlie and Warren say that they intend to hold an investment forever, they mean forever! That’s one of the reasons Charlie and Warren have never worried about anyone mimicking their investment style—because no other institution or individual has the discipline or patience to wait as long as they can.
“In terms of business mistakes that I’ve seen over a long lifetime, I would say that trying to minimize taxes too much is one of the great standard causes of really dumb mistakes…Anytime somebody offers you a tax shelter from here on in life, my advice would be don’t buy it.” Charlie and Warren have engineered their investment in Berkshire Hathaway so that it is a kind of legal tax shelter. They have accomplished this by having the company never pay a dividend, thus avoiding the tax on the dividend payment, and by holding their Berkshire stock for fifty years. That has allowed the earnings to pile up inside Berkshire. And they used the accumulated profits to build the company by acquiring other companies. The only time they have to pay the tax on their Berkshire holdings is when they sell their stock. In Warren’s case, since all his money is going to a charitable foundation, he will never have to pay a dime of tax on it. Why would Charlie or Warren ever buy a tax shelter when they have Berkshire Hathaway, the ultimate vehicle for avoiding or determining the payment of taxes.
The perfect example of a mediocre business that goes from one problem to another is any airline—which has union problems and fuel cost problems and is in a price-competitive business.
When it comes to stocks, Charlie things of the margin of safety in terms of price and quality—the lower the price, the higher the margin of safety; the higher the quality of the business, the higher the margin of safety. If we buy a high-quality business at the right price, the margin of safety will protect us against long-term losses, and later on the high quality of the business will bring us many profitable surprises as the business continues to grow either internally or through acquisitions.
Charlie learned that as stock prices rise, the odds start going against investors. And when prices fall, the odds start turning in investors’ favor. He also learned that if he stays fully invested in the market as it rises, he won’t have any cash to invest with when the market crashes. It doesn’t matter how good the odds are; if you don’t have any cash to bet with, you are never going to make a dime.
Charlie and Warren’s theory is that a company with a durable competitive advantage has business economics that will expand the underlying value of the business over time, and the more time passes, the more the company’s value will expand. Thus, once the purchase is made, it is wisest to sit on the investment as long as possible, because the longer we own the company, the more it grows in value, and the more it grows in value, the richer we become.
“View a stock as an ownership of the business and judge the staying quality of the business in terms of its competitive advantage.” If we look at investing from the standpoint of buying a fractional interest in a business, we can make a determination of whether we are getting a bargain or paying too much. Charlie begins by figuring out what an entire company is selling for, by multiplying the share price by the number of shares outstanding. The he asks himself what the company is worth as an economic entity from a long-term perspective. If the company is worth a lot more than its market valuation, it is a potential buy. If it is worth less, he gives it a pass, but if it has a “durable competitive advantage,” he will keep an eye on it in the hope that at some future date it will be seeing at a bargain price or even a fair price. Finding a business with a durable competitive advantage means determining whether it has staying power. If we are going to buy and hold a company for twenty years, we don’t want the product it is selling to become obsolete in year five. A great number of Berkshire’s investments have been in companies that have manufactured the same products or provided the same service for fifty or more years. In fact, most of the wonderful businesses that Charlie and Warren own—such as the Coca-Cola Company, Wells Fargo Bank, American Express, Swiss Re, Wrigley’s Gum, Kraft Foods, and even Anheuser Busch before it was bought out—have been selling the same product or service for more than a hundred years! When it comes to the truly great businesses, time is almost always on the investor’s side.
“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent. THere must be some wisdom in the fold saying: “It’s the strong swimmers who drown.’” To Charlie, being stupid means spending more for a business than you get in value.
Charlie believes that if you aren’t buying like crazy when you have the opportunity to buy a business that has a huge potential, it is a big mistake. The key here is to buy aggressively when we have the opportunity. The problem is that to do so, one is usually buying into a tanking stock market and for most people that is a very difficult thing to do.
For one of the most successful of all investment strategies is to be a contrarian investor—to go in the opposite direction—to buy when others are selling. And not being in a hurry is contrary to everyone who is in a hurry, which is just about everyone else in the world. Think of it this way: Charlie isn’t out looking for an investment, he is waiting for the right long-term investment—at the right price—to come to him. Yes, he keeps his eyes wide open to make sure he sees it when it arrives, which is why he reads a lot, to make sure he sees it when it shows up. But if it doesn’t show up, he just keeps on reading.
When a company has a durable competitive advantage in a particular market niche, there are no competitors.
“Successful investing requires this crazy combination of gumption and patience, and then being ready to pounce when the opportunity presents itself, because in this world opportunities just don’t last very long.”
A nation’s descent into hell begins with the collapsing of its economic. That if a democracy can’t find the strength to control its financial institutions, eventually the people will empower a despot who will.
“Capitalism without failure is like religion without hell.”
“Just because it is a free market doesn’t mean it’s honorable.”
Charlie and Warren are so big on insurance companies and banks: not only are they the perfect hedge against inflation, they actually benefit from it. For banks and insurance companies, inflation truly is the gift that keeps on giving.
Our nation is losing its will to work, maybe not because it has grown lazy but because it has lost its fear of not working.
The one thing that all of Berkshire’s businesses have in common is that they are managed by people who are willing to go to great length to keep costs low.
“A great business at a fair price is superior to a fair business at a great price.”
Some brand-name products own a piece of consumers’ minds and don’t have any direct competition. When Charlie and Warren first discovered such companies, they called them “consumer monopolies.”
The business world is a dynamic place. Much like a battlefield, it changes rapidly, and no one has thought more about “master plans” being applied to a dynamic setting than the nineteenth-century Prussian military thinker Carl von Clausewitz, who wrote that battle “is a continuous interaction of opposites” in which “my opponent… dictates to me as much as I dictate to him.” He also wrote that “No war plan outlasts the first encounter with the enemy.” But my all-time favorite quote on this subject is by none other than Prussian field marshal Count Helmuth von Moltke, who wrote, “The material and moral consequences of every major battle are so far-reaching that they usually bring about a completely altered situation, a new basis for the adoption of new measures. One cannot be at all sure that any operational plan will survive the first encounter with the main body of the enemy. Only a layman could suppose that the development of a campaign represents the strict application of a prior concept that has been worked out in every detail and followed through to the very end.” It is far better to keep things simple and improvise as we go along.
“Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Slug it out one inch at a time, day by day. At the end of the day—if you live long enough—most people get what they deserve.”
“Three rules for a career: (1) Don’t sell anything you wouldn’t buy yourself; (2) Don’t work for anyone you don’t respect and admire; and (3) Work only with people you enjoy.”
“I try to get rid of people who always confidently answer questions about which they don’t have any real knowledge.”
“Extreme specialization is the way to succeed. Most people are way better off specializing than trying to understand the world.”
“It’s been my experience in life, if you just keep thinking and reading, you don’t have to work.”
“Being rational is a moral imperative. You should never by stupider than you need to be.”
“We all are learning, modifying, or destroying ideas all the time. Rapid destruction of your ideas when the time is right is one of the most valuable qualities you can acquire. You must force yourself to consider arguments on the other side.”
Reading personal biographies allows one to experience multiple lives and success and failures; reading business biographies allows one to experience the vicissitudes of a business and learn how problems were solved.
If we fix problems promptly and are nice to people, we’ll have fewer legal problems.
The secret to getting friends is to be a friend. The secret to getting help when in need is to give help to those in needs. The secret to learning is to teach. The secret to getting people to excel is to reinforce their positive qualities. When the famed rock musician Bono asked Warren for help in getting the U.S. Congress to assist his African aid project, Warren advised him to appeal not to their sympathies but to their greatness.
“The best armor of old age is a well-spent life preceding it.” A life spent in honorable pursuits, with an inquisitive mind, acting as part of a community, carries over into old age and leads to a very interesting and satisfying life in our later years.
“In my whole life, I have known no wise people who didn’t read all the time—none, zero.”
“I think people who multitask pay a huge price.” Many people believe that when they multitask, they are being super productive. Charlie believes that if you don’t have time to think about something deeply, you are giving your competitors, who are thinking deeply, a great advantage over you. Charlie’s ability to focus intensely and really think about something has been his competitive edge in beating Wall Street at its own game.
“The highest form that civilization can reach is a seamless web of deserved trust—not much procedure, just totally reliable people correctly trusting one another…IN your own life what you want is a seamless web of deserved trust. And if your proposed marriage contract has forty-seven pages, I suggest you not enter.”
“I think the attitude of Epictetus is the best. He thought that every missed chance in life was an opportunity to behave well, every missed chance in life was an opportunity to learn something, and that your duty was not to be submerged in self-pity, but to utilize the terrible blows in constructive fashion. That is a very good idea.”
Thomas Edison once said, “I failed my way to success.”
“Remember Louis Vincenti’s rule: ‘Tell the trust, and you won’t have to remember your lies.’”
“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.”
“If you have enough sense to become a mental adult yourself, you can run things around people smarter than you. Just pick up key ideas from all the disciplines, not just a few, and you’re immediately wiser than they are.”