We Study Billionaires - The Investor’s Podcast Network - TIP598: A Tribute to Charlie Munger

Starting point is 00:00:00 You're listening to TIP. The Game of Life is the game of everlasting learning. At least it is if you want to win. Charlie Munger This concept of lifelong learning has carried over into the work we do here at TIP. For nearly the past 10 years, we've been creating content originally starting with weekly episodes back in 2014 and transitioning to create more content as Preston and Stig brought on William Green, Kyle Grieve and myself on board at We Study Billionaires.

Starting point is 00:00:31 On today's episode, I wanted to share a tribute to Charlie Munger since we just crossed what would have been his 100th birthday on January 1st. I wanted to break this episode more generally into two different segments. The first half will be life advice I found to be most impactful from Charlie Munger, in the second half, I wanted to talk more about his investment approach. I think both areas are very interesting and important, and this episode will serve as a tribute to his contributions to the value investing community. My co-host William Green also shared an episode with clips of many of his guests

Starting point is 00:01:04 talking about their learnings from Munger, and then William also shared some insights in his own personal interactions with Munger, such as when he interviewed him for his book, Richer Wiser Happier. That episode is number 37 on the Richer Wiser Happier Show, which is on this feed, and it was released back on December 10th. During this episode, some of the things I'm going to touch on include the power of simplicity in investing in life, inverting problems to minimize standard stupidities, how Munger used his setbacks in life as opportunities to learn and grow,

Starting point is 00:01:36 the tremendous importance of understanding incentives, and then also my biggest takeaways from studying Munger's investing career, which largely focuses on investing in high-quality businesses. With that, I bring you today's episode chatting about Charlie Munger. You are listening to The Investors Podcast. Since 2014, we studied the financial. financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.

Starting point is 00:02:08 Now for your host, Clay Fink. All right, so Charlie Munger is highly regarded as someone who is wise and constantly in the pursuit of worldly wisdom. I wanted to start out by touching on the subject of simplicity. Munger stated, take a simple idea and take it seriously. Oftentimes investors are attracted to what is seemingly. meaningly complex, or maybe even what's sexy. The Get Rich Quick Option Strategy, the obscure cryptocurrency that nobody's ever heard of,

Starting point is 00:02:46 or the hot new AI company that's trending in the news. Investments that are extraordinarily complex are typically really hard to make any money from in any reliable or dependable way. Munger has stated, if something is too hard, we move on to something else. What could be simpler than that? That's not to say that all investing is easy, especially, if you're investing in individual stocks or constructing a portfolio of your own. To simplify, we can break down a complex subject into pieces that are much more easier to digest and

Starting point is 00:03:18 wrap our arms around. It can be helpful to ask questions such as, what is truly most important to me in life? What will lead to more fulfillment? How can I be a better friend or partner? What is it that drives investment returns? What are the two or three most important things that matters most in the business I'm analyzing. These questions get to the essence of a problem in understanding the simple and elegant way that we can approach it. Peter Bevelin writes in his book, Seeking Wisdom, that by focusing on finding decisions and bets that are easy,

Starting point is 00:03:52 avoiding what is hard, and stripping away anything that is extraneous, Munger believes that an investor can make better decisions. By tuning out folly and swatting away unimportant things, so your mind isn't cluttered with them. you're better able to pick up a few sensible things to do, said Munger. Focus enables both simplicity and clarity of thought, which in Munger's view leads to a more positive investing result, end quote. With so much noise in the world, it's really empowering

Starting point is 00:04:21 to be able to recognize the few key things that really matter and really move the needle, whether that be in your relationships, your work, your investments, or really anything else. What is it that really moves the needle and really matters is such a little? a powerful question to help us simplify this complex world. Munger has stated, quote, part of having uncommon sense, I think, is being able to tune out folly as distinguished from recognizing wisdom. You've got whole categories of things.

Starting point is 00:04:50 You just bat away so your brain isn't cluttered with them. That way, you're better able to pick up a few sensible things to do, end quote. To simplify what is most important in investing, Warren Buffett has said if you understand chapters 8 and 9. of the intelligent investor, in Chapter 12 of the general theory, you don't need to read anything else and you can turn off your TV. The first chapter he mentions here is the mood swings of Mr. Market, and we should become somewhat agnostic to the price quotes and focus more on the underlying value.

Starting point is 00:05:24 The second chapter he mentions explains that after we determine a company's intrinsic value or what the company is worth, which is the present value of the future cash flows that an asset produces, then we should only purchase with a large margin of safety, meaning that the price is significantly below the intrinsic value. And then the third chapter he mentioned discusses the importance of having a long-term view, and not trying to make short-term forecasts, which seem to be relatively unpredictable. I like to think that once we have a good idea of the price and the value, we can utilize patience to have a behavioral edge over most other investors.

Starting point is 00:06:00 This is a topic I'll be talking more about in the latter half of this episode. These three basic concepts alone, when applied intelligently, can put you way ahead of so many other investors in my opinion. Most investors are swayed by Mr. Market. You don't want to become a slave to Mr. Market. Most investors don't spend time thinking carefully about what the intrinsic value of an asset is. They don't understand that you should purchase only when the price is trading well below the underlying value. And most investors think fairly short-term. They're thinking one-quarter out instead of

Starting point is 00:06:36 one decade out. They get excited about quick short-term gains while losing sense of the bigger picture. As it relates to simplicity, we want to seek simplicity to the maximum degree we can. We want to focus on problems that were equipped to handle and are within our circle of competence and be able to recognize what is unimportant so you don't waste any time or energy in that area. Monish Pabriah said, The simple ideas with intensity of pursuit is what gets you to the promised land. The thing is that most people get turned off by simplicity. They think it's boring in that investing successfully just can't be that simple.

Starting point is 00:07:14 Monish Pabrii writes in his book, The Dondo Investor, Simplicity is a very powerful concept. Henry Thoreau recognized this when he said, Our Life is Frittered away by detail. Simplify, Simplify. Albert Einstein also recognized the power of simplicity, and it was the key to his breakthroughs in physics. For Einstein, simplicity was simply the highest level of intellect. Everything about Warren Buffett's investment style is simple.

Starting point is 00:07:40 It is the thinkers like Einstein and Buffett who fixate on simplicity through triumph. The genius behind E equals MC squared is simplicity and elegance. End quote. Charlie was a master at simplifying. Buffett had said that Charlie can analyze. and evaluate any kind of deal faster and more accurately than any man alive. Munger has said, we have a passion for keeping things simple. If something is too hard, we move on to something else.

Starting point is 00:08:09 What could be more simple than that? One simple idea that we talk about on the show quite often is to embrace the true power of compounding. In the newest version of Poor Charlie's Almanac, Warren Buffett wrote the foreword and said the following. Charlie consistently practiced what he preached. Ben Franklin and his will created two small philanthropic funds that were designed to teach the magic of compound interest. Early on, Charlie decided that this was a subject far too important to be taught through some posthumous project.

Starting point is 00:08:41 Instead, he opted to become a living lesson in compounding, as stewing frivolous expenditures that might sap the power of his example, end quote. This idea of simplicity also ties into the idea of avoiding. standard stupidities. Munger has stated, quote, I think part of the popularity of Berkshire Hathaway is that we look like people who have found a trick. It's not brilliance. It's just avoiding stupidity.

Starting point is 00:09:05 You understand it better if you go at it the way we do, which is to identify the main stupidities that do bribe people in and then organize your patterns for thinking and developments so that you don't stumble into those stupidities, end quote. This quote is from an interview from back in 2010, and he says that academia is one. one place that has failed and fallen for some of these standards stupidities. The first of which he mentions is the efficient market hypothesis. If the efficient market hypothesis were true, then Berkshire Hathaway would not have been able to buy the Washington Post on the open market for one-fifth of what they conservatively believed it to be worth. The second teaching in academia

Starting point is 00:09:44 that he deems to be insane is cap-m models. He states, you don't have to make this stuff up. Life will constantly surprise you with these ridiculous examples which teach important lessons." Munger has of course popularized this idea of mental models on investing in companies and interacting with the world more broadly. There's this quote from John Muir, when we try to pick out anything by itself, we find it hitched to everything else in the universe. And that is what Munger has discovered in his life as well. It's that he needs to understand all of these various disciplines in order to understand all of the inner workings that are at play within a business. And then you have everything that's going on in the business, and then how the business itself

Starting point is 00:10:26 interplays with the environment it's in and its competitive landscape. As written in poor Charlie's Almanac, Charlie's models supply the analytical structure that enables him to reduce the inherent chaos and confusion of a complex investment problem into a clarified set of fundamentals. Again, it gets back to that idea of simplicity. The world is full of this chaos, and we need to be. need to be able to sift through the noise in order to figure out the primary drivers of the issues at play. I quote here again from the book, it is this signature approach backed by Charlie's

Starting point is 00:10:59 formidable intellect, temperament, and decades of relevant experience that have made him the virtuoso of business pattern recognition so valued by Buffett. Like a chess grandmaster through logic, instinct, and intuition, he determines the most promising investment moves, all the while projecting the illusion that the insight came easily, even simply. But make no mistake, this simplicity comes only at the end of a long journey towards understanding, not at the beginning. His clarity is hard one, the product of a lifetime of studying the patterns of human behavior, business systems, and a myriad of other scientific disciplines, end quote. I'm reading this and thinking, I sure know I wouldn't want to go head to head with this intellectual maverick. Munger believes that a

Starting point is 00:11:45 successful investment career comes down to just a handful of decisions. He makes a very large bet, and then he just sits on this for a very long time. He refers to this as sitting on your ass investing. Charlie says, you're paying less to brokers, you're listening to less nonsense, and if it works, the tax system gives you an extra one, two, or three percentage points per annum. Charlie is also well known for inverting his problems. I have my co-host William Green's voice in my head because I feel like he's said this so many times. Invert. Always invert. If you want to get something in life, instead of figuring out how to get what it is you want, start by thinking about the worst thing you can do. When asked how to live a successful life, Munger stated,

Starting point is 00:12:28 don't do cocaine, don't race trains, and avoid the age situation. In the book, Poor Charlie's Almanac, it states, many would dismiss his seemingly flippant answer as merely humorous, which it certainly was. But in fact, it faithfully reflects both his general views on avoiding trouble in life and his particular method for avoiding missteps in investing. Often, as in this case, Charlie generally focuses first on what to avoid, that is, on what not to do, before he considers the affirmative steps he will take in any given situation, end quote. And then this also reminds me of one of Charlie's famous lines, all I want to know is where I'm going to die, so I'll never go there. So instead of asking how can I make money, ask yourself, how can I lose money?

Starting point is 00:13:12 If you focus on preventing the downside, the upside will take care of itself. Instead of asking, what is this stock going to be worth? Instead, ask yourself, what is this stock worth? If you can identify a cheap price for a stock, it's far easier to make any money in it. Instead of asking what the growth drivers are, ask yourself what can go wrong. Too often, people are focused on the potential upside, when they should be more focused on the potential downside. Munger also frequently stated that him and Warren's career was made by making a lot fewer stupid decisions than others. Even some of the smartest investors out there at times

Starting point is 00:13:49 make deeply irrational decisions. One of my interviews in 2023 on We Study Billionaires, it was with John Jennings, and he told a story of how one of his smartest friends on Wall Street was selling stocks near the bottom of the great financial crisis, and he was going out and seeking safety and assets such as gold. Now, this really smart investor, he truly believed with near 100% certainty that stocks were not the place to be. And, you know, the overall market at that time had declined by over 50%. So, of course, this guy might have been right and the future may have played out how he might have expected it to, but it points to how some of the smartest people on the planet can become so overconfident and become too sure of themselves and they really get caught up in the

Starting point is 00:14:32 heat of the moment and what's happening at that specific time point. Charlie has said, it's kind of fun to sit there and outthink people who are way smarter than you are because you've trained yourself to be more objective and more multidisciplinary. Furthermore, there is a lot more money in it, as I can testify from my own personal experience, end quote. What I also admired about Buffett and Munger is just their sheer generosity. Munger has said the best thing a human being can do is to help another human being no more. Buffett and Munger both believe that part of living a good life is being generous and giving to others,

Starting point is 00:15:07 not just with your money, but with your time and your knowledge as well. Making a positive impact on others is a really great way to derive more happiness and fulfillment out of life. Munger was a firm believer in good karma. He stated how you behave in one place will help you in surprising ways later. This points to the tremendous benefits that can be gained from continuously giving to others with no expectation of getting anything back in return. One guest here on the show referred to this as good acts contributing to the Bank of Karma.

Starting point is 00:15:37 I'm amazed when I've reached out with questions to people here in the value investing community and how often I get this outpouring of assistance from those I reach out to. People in this community are almost always open to giving without any expectation of receiving, and this is likely for a good reason. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every

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Starting point is 00:20:05 I'm also reminded of Munger's ability to learn from his mistakes and continually adapt to the ever-changing environment. All of us are going to inevitably run into times in our life where we're going to be tested and we're going to hit that period of failure. The wisdom here is that it's how you react to that failure that matters. You can let failures bring you down, or you can use these failures

Starting point is 00:20:28 as an opportunity to learn and grow. Munger believes that adversity causes some people to transform themselves into a victim, as he states, whenever you think that some situation or some person is ruining your life, it's actually you who's ruining your life. It's such a simple idea. Feeling like a victim is a perfectly disastrous way to go through life. If you just take the attitude that however bad it is in any way, it's always your fault and you just fix it as best you can, the so-called iron prescription. I think that really works. Joshua Kenan wrote in his blog about munger's life experiences and the adversities mungers went through that I'll read here as well. And this is just a story that's really stuck with me. In 1953, Charlie was

Starting point is 00:21:15 29 years old when he and his wife got divorced. He had been married since he was 21. Charlie lost everything in the divorce. His wife keeping the family home in South Pasadena. Munger moved into dreadful conditions at the university club and drove a terrible yellow Pontiac. Shortly after the divorce, Charlie learned that his son, Teddy, had leukemia. In those days, there was no health insurance. You just paid everything out of pocket and the death rate was near 100% since there was nothing doctors could do.

Starting point is 00:21:47 Rick Gurran, Charlie's friend, said Munger would go into the hospital, hold his young son and then walk the streets of Pasadena crying. One year after the diagnosis in 1955, Teddy Munger died. Charlie was 31 years old, divorced, broke, and burying his 9-year-old son. Later in life, he faced a horrific operation that left him blind in one eye with pain so terrible that he eventually had his eye removed. It's a fair bet that your present troubles pale in comparison. Whatever it is, get over it.

Starting point is 00:22:19 Start over. He did it and you can do it too. I also find it helpful to think about what it is we can control in life and what we can't control. People tend to put too much focus on the latter and not enough on the former. I think that letting go of the things that we can't control is one of the most liberating things that we can do for ourselves. To apply this simple idea to investing, we can't control the Fed's actions, we can't control interest rates, stock prices, how other people act, how rich other people are getting, whether we enter a recession or not, et cetera. We can control our entry price into companies or into funds, the managers we choose to partner with, the types of business models we choose to buy into, our holding period, the fees

Starting point is 00:23:08 we incur, our level of diversification, etc. Focus on what you can control and don't worry so much about the things you can. Transitioning here to another topic, Adam Meade, a friend of ours here at TIP, and an expert on Berkshire Hathaway, he shared what are called Outstanding Investor Digest, which are back from the 1990s. And I'll be sure to link here in the show notes. In the 1995 edition, Munger expands on the use of mental models to become a superior investor.

Starting point is 00:23:38 And the piece on accounting here really stood out to me. He stated, obviously, you have to know accounting. It's the language of practical business life. It was a very useful thing to deliver to civilization, but you have to know enough about it to understand its limitations, because although accounting is the starting place, it's only a crude approximation. And it's not very hard to understand its limitations. For example, everyone can see that you have to just more or less guess at the useful

Starting point is 00:24:06 life of a jet airplane or anything like that. Just because you express the depreciation rate in neat numbers doesn't make it anything you really know, end quote. And I thought this was such an important point to highlight here, because for me, understanding the shortcomings of accounting can really help you identify ripe opportunities that a lot of other investors are prone to overlook. Adam Ziesel's book, Where the Money Is, does a really great job expanding on this, and I'll touch on some examples here. Munger mentioned that depreciation rate, which is shown as an expense line item on the income statement. Accountants might assume, for example, that the machinery that's used in a business

Starting point is 00:24:44 has a five-year life. But in reality, those machines might typically last something like 15 or 20 years. So to get to an earnings figure that better reflects economic reality, then you're going to need to manually adjust the earnings yourself to better reflect the true earnings that are happening within the business. Another example is a holding of mine in my portfolio, Constellation Software. Many investors see Constellation Software and they see, oh, it's trading had a PE of 90 or 100, and they think there's no way they'll ever buy a stock that expensive. But the PE doesn't do this company justice, and it doesn't really reflect economic reality. In the case of this business, there are amortization charges because accountants are assuming that these acquisitions that they're making are going to degrade over time.

Starting point is 00:25:30 But in reality, these businesses have organic growth rates in the low single digits. Thus, it's reasonable to add back those amortization charges, which really helps bring down the multiples significantly before some other adjustments are made. made as well. In full disclosure, I do own shares in Constellation Software. One more shortcoming I wanted to mention with a P.E. is that it doesn't tell you the amount of capital that's required to maintain a business's operations. A commodity business like ExxonMobil might look really cheap when you just look at the P.E. But when you take out the capital expenditures just for the maintenance of the business, then it might not look near as cheap as you think it is. Our brains take these shortcuts to come to conclusions, which isn't necessarily a bad thing, but we need to be mindful of

Starting point is 00:26:16 when these shortcuts are useful and when they aren't useful. Just because a company has a low PE doesn't make it cheap, and just because a company has a high PE doesn't make it expensive. So that point from Munger there has really had a big impact on me and how I think about investing and have continued to develop over the years. I also need to mention one of the key lessons at Munger that has had a really big impact on me in terms of life, and this is understanding the importance of incentives. Munger regards incentives as one of the most powerful forces that drive human behavior. The basic idea of understanding incentives is that you get what you reward for and avoid that for which you are punished.

Starting point is 00:26:57 Munger is stated that if you get a dumb incentive system, then you get dumb outcomes. Godham Bates chapter on incentives and the joys of compounding is by far one of my favorites, as he really nails home this point so, so well. There's a few quotes from the book that I wanted to read here as it relates to incentives. Benjamin Franklin stated, if you want to persuade, appeal to interest, not to reason. And Jesse Livermore said, my main life lesson from investing is that self-interest is the most powerful force on earth and can get people to embrace and defend almost anything, end quote. It's a great point here from Livermore. incentives can really cause people to do some really bizarre things.

Starting point is 00:27:39 Decent people can do terrible things if they are given the incentives to do so, and otherwise terrible people can make decent decisions if they're given the incentive to do so. Gottem writes, the real power of incentives is the ability to manipulate the cognitive process. Buffett shared the example of GEICO and how he cared about the employees growing the business through policies and force and growing through areas of the businesses that were profitable. so they put together a bonus structure that incentivize that behavior amongst their employees. So that way the interests of the owners are aligned with the interests of the employees. Nassim Taleb also has a quote here, never ask anyone for their opinion, forecast, or recommendation.

Starting point is 00:28:19 Just ask them what they have or don't have in their portfolio. And I'm as aware as anyone that we talk about different stocks on the show and I talk about stocks in our TIP Mastermind community. And I'm biased towards these companies, at least to some, to go. if I own them and I'm public about them. And it makes it even more difficult to change my mind if the facts change after I talk about them on the show. This is my way of saying that you shouldn't ever own something just because someone else owns it because of the facts change, that person might sell that company without you even knowing.

Starting point is 00:28:51 I'm fully aware that any of the companies I own, I might change my mind next quarter, next year. And if the fundamentals change materially enough, then hopefully I'm humble enough to admit it and recognize it and take action. Goddum also writes here, it's imperative that we think deeply about the incentive systems we create because ignoring the second or third order effects of an incentive system often leads to unintended consequences, also known as the Peltzman effect. Anderson writes, an example is monetary rewards offered to help exterminate unwanted animals

Starting point is 00:29:23 such as rats and snakes. What authorities failed to foresee was that people would start to breed the rats and snakes. human beings have a tendency to game systems for their benefit, end quote. Munger has also told the story of FedEx and how they couldn't for the life of them figure out how to get employees to move this luggage from the airplanes between the airplanes without causing delays. And they tried everything and they really couldn't solve it until they switched the employees pay from by the hour to buy the job.

Starting point is 00:29:52 So once the job was finished, they could just go home. And both parties ended up getting what they wanted. FedEx ended up eliminating the delays with this new incentive structure, and then employees got their compensation and probably got to go home early a lot of times from work because they were finished when the job was done. Stig here at the Investors podcast is also really big on incentives as well. Earlier this year, we had launched our TIP Mastermind Community, which is a paid community that our audience can be a part of. Well, in his mind, it's great that we can start this new business unit within the company and have a new source of revenue. And, you know,

Starting point is 00:30:28 it's not directly tied to advertising, which we are pretty heavily relying on to cover our expenses. But the community, you know, it can't intrude or come at a hindrance to the podcast because we study billionaires is really the foundation of everything we do here at TIP. So in his mind, he's trying to figure out what sort of incentive structure really makes sense. You know, it incentivizes the growth of a new business unit without negatively impacting the long-term viability. of the Investors' Podcast overall. I also like to look at this in terms of the management teams of public companies I invest in. SIG and I just discussed this topic in episode 596.

Starting point is 00:31:05 Generally, it's better to invest with managers who have a lot of skin in the game. You know, they became wealthy through the ownership of their shares rather than, you know, getting stock options or giant bonuses based on metrics that aren't really helpful to shareholders. Munger cautions that managers who are incentivized with stock options aren't necessarily aligned with shareholders. This is because they get the benefit of the upside, but they don't bear any of the downside risks. It's kind of like a free lottery ticket for the managers and it might lead them to taking on bigger risks than what you would prefer as shareholders. And then managers who own a lot of stock, on the other hand, they benefit from the upside

Starting point is 00:31:42 just like you do as shareholders, but they also have to handle the pain of the potential downside. And then another key point here is thinking about family-run companies. Family-run companies tend to have a lot of insider ownership. And since, you know, the family has built their wealth through the ownership of the business, oftentimes they think really long term, they take conservative bets. And then when these really great opportunities come along, they tend to really take advantage of them. Munger has said an example of a really responsible system is the system the Romans used when they built an arc. The guy who created the ark stood under it as the scaffolding was removed.

Starting point is 00:32:18 It's like packing your own parachute, end quote. incentives encourage desirable behavior and disincentives prevent them. Personally, I want to own companies I can sit on for 10 years, maybe more. And I want to know that the management team is going to do their best to deliver a handsome return in managers who purchase stock themselves on the open market and hopefully have a track record of being shareholders for a long time, track record of being shareholder friendly. I think they're incentivized to continue to do what they've been doing for so long. And then there's also the issue of choosing an investment manager, you know, if you're picking a fund to invest in. Seth Claremann said in his book,

Starting point is 00:32:57 Margin of Safety, you probably would not choose to dine at a restaurant whose chef always ate elsewhere. You should be no more satisfied with a money manager who does not eat his own cooking, end quote. In the best case scenario, you're going to be invested with a manager that has the vast majority of their net worth invested in the fund that they manage. That way, you know that they're always going to be thinking long term, not taking excess risk, and they're being extra thoughtful in their decision-making. Oftentimes, financial advisors, they're going to be incentivized to sell products that really aren't good for their clients, but it's pretty easy to justify selling something like that when you earn a hefty commission that pays out for the next 10 or 20 years.

Starting point is 00:33:38 Transitioning here to another topic, Charlie also reminds me of what it means to live a good life. Charlie's life was very simple to a large extent. He built his life in a way that suits him and suits the way he really wanted to live. He surrounded himself with people he regarded as great people. These people made him better every day, better through their interactions. Even as smart as Charlie was, he chose to partner with Warren Buffett, knowing that he was probably not going to be the head honcho or be the front of the spotlight like Warren was for decades.

Starting point is 00:34:11 Regarding partnerships, Munger is a testament to the idea. that quality relationships with good, trustworthy people make life really special. He stated that if you want to have a good partner, friend, or spouse, then you need to be one in return. Munger has always put a high priority on surrounding yourself with the honorable people you admire and you want to spend your life with. I think one of the best upgrades you can make in your life is to surround yourself with people who are seemingly really high quality. Charlie believes that life is much more than just accumulating vast amounts of wealth in that you shouldn't worry so much about what other people are doing, you know, getting rich

Starting point is 00:34:50 through methods that you don't deem to be ethical or just something that doesn't align with your values. He was also big on living out a pretty conservative financial lifestyle, you know, living within your means, not buying extraordinary things, avoiding debt the best you can, and then continue to seek out ways to increase your income, just basic ways to build wealth, that we all know we should be doing. And it's just a helpful reminder looking at someone like him in the age of social media, you know, where people are always sharing the frivolous things they're buying or the trips they're taking. In order to be truly free and to be able to structure your life in a way that suits you,

Starting point is 00:35:26 Munger is a good example of achieving financial independence. Being financially independent allows you to say no to things you'd rather not do. I think about how nowadays so many people can find themselves in a situation where they have a lot of debt, They rely on their employer to pay them so they have to make the payments on their loans and put food on the table. And of course, pretty much everyone is in this position, you know, at some point in their lives. But if you work towards financial independence, then eventually, you know, you can make those decisions and have that freedom to design a life of your own. True wealth is not having a lot of money, but owning your time. One among her's favorite books when it comes to financial independence is the richest man in Babylon.

Starting point is 00:36:06 It's such a simple book, but it's so important to absorb. these basic concepts like don't outspend your income, consistently save a portion of every dollar you earn, avoid the trap of the hedonic treadmill, etc. I think Munger was also highly influenced in this regard by Benjamin Franklin. Franklin wrote about the virtues of frugality and a strong work ethic, and he used financial independence to make the most of his limited time here on earth. Franklin had written a letter to his mother saying that he would rather have people say about him that he lived usefully, then he died rich. To learn more about the importance of financial independence,

Starting point is 00:36:40 there are a lot of books out there on this topic. I think the richest man in Babylon is a good one, and then the chapter in Godham Bade's book, The Joys of Compounding, is also really, really good, and I highly recommend if you're interested in learning more about that. Next, I wanted to transition to talk more about how Charlie approached investing, and what I think is most important in this regard. Warren Buffett said back in 1988,

Starting point is 00:37:04 I've been shaped tremendously by Charlie. Boy, if I had listened only to Ben Graham, would I be ever a lot poorer? In 2015, Buffett wrote that Munger taught him, Forget what you know about buying fair businesses at wonderful prices. Instead, buy wonderful businesses at fair prices. Buffett did just fine by purchasing cigar but businesses that were ridiculously cheap, but the problem in Munger's mind is that the investment model wasn't able to scale. Munger had said that buying great businesses that were temporarily under pressure changed everything

Starting point is 00:37:37 for the better for Berkshire, as it allowed them to scale up enormously. One of the earliest examples of this was their purchase of Seas Candy in 1972. Berkshire Hathaway paid $25 million and only paid a multiple of six times earnings, and in the 2019 annual meeting, Buffett had said that the Seas Candy purchase alone had made Berkshire over $2 billion in profits. I really resonate with Munger's tremendous focus on business quality, and I'm reminded of his quote that has really stuck with me throughout my time here at TIP. I quote, over the long term, it's hard for a stock to earn a much better return than the

Starting point is 00:38:14 business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for 40 years, you're not going to make much different than a 6% return, even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive-looking price, you'll end up with one hell of a result, end quote. I can't help but talk about probably Munger's favorite business that he's ever invested in, probably outside of Berkshire Hathaway, and this is Costco. Munger admired the quality of this business so much that he claimed he would never sell a share, and he claimed himself to be a total addict of this business.

Starting point is 00:38:54 Outside of Costco's CEO, Munger was the second largest shareholder of the company. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform. So whether you're prepping for a SOC2 or running an enterprise,

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Starting point is 00:42:50 Now, 15% might not sound like a home run investment, but when you take a moderate rate of return like 15%, and you extend that out over 10 or even 20 or more years, you really end up with a nice result as an investor. According to Costco's 1997 annual report, the company had 268 warehouses, most of which were in the U.S., and $21 billion worth of sales. Flash forward to the end of 2022, the company's main focus is still in the U.S., but they also have a much larger international presence. In 2022, they add $226 billion in revenues. That's over a 10x increase from 1997. Nick Sleep famously described the Costco business model as a model of scale economy shared. We dove into and covered Nick Sleep's amazing letters in episode 492 on this podcast.

Starting point is 00:43:41 What's amazing about Costco is this virtuous cycle that they have in place that continually expands their moat with each passing day. Costco has a number of warehouses that sells these big box goods, and they're 100% committed to providing low prices. And then because of those low prices, this attracts a lot of customers, and this in turn gives them a lot of traffic and a lot of volume per store. And since there's such a popular place to shop, this gives them bargaining power with suppliers and any price decreases that Costco is able to get, they just simply pass that down to the customer. And then the further Costco's prices are from competition, the more value customers are getting

Starting point is 00:44:15 through those lower prices, and then the cycle continues. The Costco business model reminds me of what Munger calls the Lala Paloosa Effect. I quote, you get Lalaplusa effects when two, three, or four forces are all operating in the same direction. And frequently, you don't get simple addition. It's often like critical mass in physics where you get a nuclear explosion if you get to a certain point of mass, and you don't get anything much worth seeing if you don't reach that mass. You have to realize the truth of biologists Julian Huxley's idea that life is just one damn relatedness after another.

Starting point is 00:44:51 So you must have the models and you must see the relatedness and the effects from the relatedness, end quote. There are just so many factors that play into the success of the Costco model, including their customer loyalty, the downstream effects of their membership model, the impact of their limited selection, etc. One of the bigger themes that sticks out to me as it relates to Costco and its quality is the durability of the business. I'm sure from Munger's point of view, it's a company that is nearly certain to become a stronger business one year after the next. Part of that is because the business model is just so good. And the other part is that the management team just thinks super long term. and they aren't willing to make any short-term sacrifices to appease Wall Street or appease shareholders.

Starting point is 00:45:34 Munger has also said, the difference between a good business and a bad business is that good businesses throw up one easy decision after another, bad businesses throw up painful decisions time after time. For Costco, they constantly think, what is the high-quality decision? What is the best thing for customers? Knowing that the best thing for customers is also the best thing for shareholders long-term. Everyone wins in the Costco model. Just the moat of Costco is also really interesting to me.

Starting point is 00:46:01 It's not only important for a company to have a moat, or in other words, protection against competitors, stealing market share, but it's also important that the moat is continually widening to provide that enduring protection. It gives investors the peace of mind that with each passing day, the business is becoming stronger and stronger, and they're not becoming weaker. And they're just continually making it more and more difficult for competitors to catch up with them and steal that share. Poor Charlie's Almanac states,

Starting point is 00:46:27 Over their long business careers, they have learned, sometimes painfully, that few businesses survive over multiple generations. Accordingly, they strive to identify and buy only those businesses with a good chance of beating those tough odds, end quote. I'm also reminded of Munger mentioning the enormous value of scale. He's stated that in terms of which businesses succeed and which fail, advantages of scale is ungodly important, which is of course a key factor in Costco's success as well. So that's the first part that I wanted to mention here and related to his investment

Starting point is 00:46:59 approach is focus on businesses that are high quality with managers that think long term and they're nearly certain to have their intrinsic values increase over time as their moats widen. Remember that time is the friend of a wonderful business and the enemy of a poor business. I recently saw a post from a friend where he said that he used to dread earnings reports of subpar businesses he used to own. He was just waiting for that one that would just totally make him regret owning a low quality or poor business. Now that he's transitioned to owning high quality businesses, he sleeps much better at night and that earnings reports tend to surprise to the upside in general. The second part that stands out to me about Charlie Munger's investment approach is how he truly

Starting point is 00:47:40 embraces a long-term view. Munger started purchasing shares in Berkshire Hathaway in 1962 at around $7 or $8 per share. And of course, those are A shares. Today, the A shares of Berkshire Hathaway are worth around $540,000. So from that first initial purchase that Munger made, the share price is up by over 72,000 X. Just think about how much compounding that is and then just how much discipline it is to hang on to the shares in light of how much money you've made on that investment. Munger has that quote that rings so true in the investment world, the big money is not

Starting point is 00:48:19 made in the buying or selling, but in the waiting. And I just absolutely love that quote. The key was not only that he bought at the right time, but he was willing to sit on owning a fantastic business for over 60 years. He clearly understood the power of patience and the power of deferred gratification. He once stated, if you're glued together and honorable and get up every morning and keep learning every day, and you're willing to go in for a lot of deferred gratification all your life,

Starting point is 00:48:47 you're going to succeed, end quote. It also reminds me of the mugger quote that the first, rule of compounding is to never interrupt it unnecessarily. So if you're patient and you're thoughtful in your business selections of which businesses you're going to own, in my opinion, you're pretty heavily stacking the odds in your favor. Buffett said that the stock market is a device that transfers money from the inpatient to the patient. And the good news is that every great business, at least once in its history, is going to be trading down for very short-term reasons. This in turn presents opportunities for patient investors who are willing and able to hold

Starting point is 00:49:20 through that volatility and short-term uncertainty. It also reminds me of one stock I own that's just an amazing business. I believe it's trading well below its intrinsic value. And it's trading around a market multiple, growing like a weed, has a huge moat. And frankly, the stock has been pretty boring to hold over the past few months as it's remained cheap. Fortunately, it stayed down long enough for me to build a position and I'm willing to see what happens over the next few years.

Starting point is 00:49:45 And if I was right in assessing that the business will continue to be able to execute and grow the way it has in years past. Berkshire Hathaway, the 72,000 bagger, has also had their fair share of drawdowns, too. Their stock has been cut in half at least three times since Buffett and Munger took over the company. And related to this patience, Munger is also willing to sit on some cash and wait for that pitch that he can just really knock out of the ballpark. He points out that truly amazing opportunities are quite rare.

Starting point is 00:50:15 During a previous shareholder meeting, he stated, the game in our kind of life is being able to recognize a good idea when you rarely get it. And I think that is something you have to prepare for a long period. There's the old saying that opportunity comes to the prepared mind. That's the game, end quote. And these great opportunities, sometimes they're just so obvious and they're staring right in front of you. You know, just think about Berkshire buying Apple in 2015 or 2016 when it was trading at 10 or 12 times earnings. How many people could clearly see Amazon, you know, massively disrupting the,

Starting point is 00:50:47 retail industry. And I don't think it took genius to realize that Costco was very well positioned to grow over a really long period of time. Munger had related this point to the newspaper industry and how it was just so clear that so many towns had one newspaper that was essentially a monopoly in the city. And then there's also that story about Munger and how he'd been reading the Barents magazine for more than 50 years. And he only found one actionable idea in it. It was a cheaply valued auto parts company, and he bought it for $1 per share. And then he ended up selling that stock a few years later for $15 a share. So $15 is money on it, earning him $80 million in profits. And then Munger gave that $80 million to Lee Liu. And Lee Liu turned that $80 million into $400 million.

Starting point is 00:51:33 So that patience, that consistency just, you know, was a really, really good example of the use of compounding in patients in Munger's life. Godham Bade writes in his book here, the joys of compounding, this example illustrates the significance of extreme patience, deferred gratification, and displaying a strong decisiveness at the right moment. It is why Munger has stated it takes character to sit there with all that cash and do nothing. I didn't get to where I am today by going after mediocre opportunities, end quote. This also reminds me of the point that Chris Mayer made in my interview with him a few months back. I mentioned how Chris is similar to Buffett and Munger and that he's spending so much of his time reading,

Starting point is 00:52:14 thinking, studying as businesses, studying new opportunities, and so much of Munger's investment approach is just simply waiting. You know, this means waiting for the next great opportunity or simply waiting for your investments to compound and just let that magic of compounding work for you after you found some of those opportunities to buy. Poor Charlie's Almanac states here, this habit of committing far more time to learning and thinking than to doing is no accident. It is the blend of discipline and patience exhibited by true masters of a craft, an uncompromising commitment to properly playing the hand. Like world-class bridge player Richard Zekhouser, Charlie scores himself not so much on whether he won the hand, but rather how well he

Starting point is 00:52:55 played it. While poor outcomes are excusable in the Munger Buffett world, given the fact that some outcomes are outside of their control, sloppy preparation and decision-making are never excusable because they are controllable, end quote. When I come across a new investment, we should always consider our opportunity costs as well. I may come across an idea, and it may seem compelling to add to it, but it has to be compared to our current opportunity set. Within my own portfolio, I have a couple of names that I think are pretty great ideas. So when I come across a new name, the question I'm asking myself, is this new name not only

Starting point is 00:53:30 slightly better than my existing opportunity set, but is it a lot better? When you continually add companies of the highest quality at attractive valuations, you're continually raising the bar in your portfolio and making it easier to say no to at least 95% of new opportunities that come your way. Munger also believes that not much diversification is needed when buying and holding very high quality businesses. He stated that even a portfolio of just three companies is enough diversification for him.

Starting point is 00:53:59 This also ties into his belief that truly great opportunities are rare, as I mentioned, so when order to really make them count, you need to have some level of concentration, given you're very knowledgeable in the company, as Munger is when he's entering these positions. So you definitely need to be mindful of where you're at in terms of experience and competence. You don't want to concentrate into three to five positions just because you heard on a podcast that's the right thing to do. Munger, even after decades of being at this game, admits that he still made major mistakes later on in his career.

Starting point is 00:54:29 So we shouldn't be too foolish to believe that we aren't prone to making similar mistakes as well. Poor Charlie's Almanac had this piece on why he's so focused on very little activity in terms of buying and selling and having this highly concentrated, highly focused approach. Munger stated, we're partial to putting out large amounts of money where we won't have to make another decision. If you buy something because it's undervalued, then you have to go think about selling it when it approaches the calculation of your intrinsic value. That's hard. But if you can buy a few great companies, then you can sit on your ass. That's a good thing, end quote. So that concludes so much of what I've learned from Charlie Munger. I mentioned many of

Starting point is 00:55:08 the lessons that apply more to life in the first half of this episode. And then I touched on the high level things I've learned from Charlie in the second half here. And I wanted to close out this episode with a final quote from Munger. And that's to take a simple idea and take it seriously. So what's one simple idea that you can take away from Charlie Munger or this episode that you can seriously implement into your own life? It's so easy to just listen to podcast. and feel like we're being productive listening, what really matters is using that knowledge, using what you learn,

Starting point is 00:55:39 and actually implement it into your life. I'd love for you to let me know, one thing you've learned from Charlie Munger, one thing you've learned from this episode that you just found to be really impactful or it's changed the way you've thought. You can feel free to tweet at me at Clay underscore Fink or you can always email me Clay at theinvestorspodcast.com.

Starting point is 00:55:56 I'd love to hear from you. Thanks for tuning in to today's episode, and I hope to see you again next time. Thank you for listening to TIP. Make sure to subscribe to millennial investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only.

Starting point is 00:56:21 Before making any decision consult a professional, this show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting. Thank you.

We Study Billionaires - The Investor’s Podcast Network - TIP598: A Tribute to Charlie Munger

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