We Study Billionaires - The Investor’s Podcast Network - TIP683: The Evolution of a Legend: Lessons from Charlie Munger’s Life and Investments w/ Kyle Grieve

Starting point is 00:00:00 You're listening to TIP. Charlie Munger is well known for helping Warren Buffett understand the importance of owning quality businesses. On the topic of Charlie Munger and quality, I wanted to really improve my understanding of why Charlie arrived at this conclusion about quality in the first place. And I think the book, Damn Right by Janet Lowe, does just a marvelous job explaining enough pertinent background information on Charlie Munger's life to really help deepen my understanding. And today, I want to share these lessons with you. For instance, Charlie made some mediocre investments in his formative years. During these experiences, he learned why he didn't want to invest in specific business categories. The most apparent category was businesses that were a headache to own and run.

Starting point is 00:00:45 I'll go over this investment in detail and discuss some of the obstacles that he had to overcome to just break even. But more importantly, we're going to discuss some of the lasting impacts that this investment had on Charlie's perception of quality. Even though Charlie helped run his law office for a few short years, he learned a heck of a lot about business during those days. Whether it was about learning who he did and did not want to work with, making some lasting business connections that he found from working with wonderful clients, or how to run a meritocratic business, he took a lot of lessons from these experiences that he had in law. In typical Charliemonger fashion, he continued to live by these principles and adapted them

Starting point is 00:01:21 into his life and investing framework with flawless execution. Another area of Charlie's life that I think I kind of misunderstood was his insatiable focus. This aspect of his life kind of made him look like an absent mind of professor. But in reality, it was a big reason for Charlie's success. Charlie's focus was so intense in certain instances that many social conventions were just thrown out of the window to allow Charlie to focus on the task at hand. I'll also discuss some of the striking similarities between Charlie Munger and Warren Buffett's mentor, Benjamin Graham. While many observers will correctly link Warren's evolution to Charlie Munger, Munger did share some qualities that were very similar to Benjamin Graham, which I think probably led to Warren and Charlie's very deep intellectual connection. If you want to sharpen your knowledge of Charlie Munger's life experiences and better understand where he came from, I know you'll enjoy the lessons from this episode.

Starting point is 00:02:12 Now, without further ado, let's get right into this week's episode. Since 2014 and through more than 180 million downloads, we've studied the financial markets, and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now for your host, Kyle Greve. Welcome to the InVestors podcast. I'm your host, Kyle Greve, and today we'll be discussing Charlie Munger's excellent biography,

Starting point is 00:02:52 Damn Right, by Janet Lowe. So Charlie Munger is a person who I can very easily say has heavily influenced me, and probably many of the other hosts that you listen to here regularly on TIP. So I'm ecstatic to share my thoughts and learnings from the book, Damn Right, behind the scenes with Berkshire Hathaway billionaire Charlie Munger. This book was very well done and was written with the aid of Charlie Munger. Now, I want to start this episode by discussing the first chapter, which details the similarities and differences between Charlie Munger, Warren Buffett and Benjamin Graham. First off, Warren Buffett considered Charlie Munger to be one of the influences that helped him kind of get away from Buffett's devalue approach. Lou Simpson, the former stock picker for Geico's insurance float, said that Charlie was actually a lot more like Benjamin Graham than maybe Charlie thought.

Starting point is 00:03:38 Lou pointed out that Charlie, like Graham, took an academic approach to investing and other areas of life. But he also took an interest in many different things. Lou said, in his reading, his tastes are eclectic. Now, when you consider that Graham was offered professorships at Colombian English, math, and philosophy, you can pretty easily see that he was interested in learning from, a variety of different subjects. I would also add that both Benjamin Graham and Charlie Munger were most likely geniuses. Benjamin Graham graduated from Columbia in only three and a half years around the age of 19. And Charlie said he got radically high score on Army IQ tests.

Starting point is 00:04:15 Another striking similarity between Munger and Buffett, especially, I think, in their early days, was their passion to get rich. But their reasoning for getting rich deferred as they had different career backgrounds. In Charlie's case, he sought financial independence. He didn't necessarily care much for the buying of nice things due to being wealthy, although he definitely did have a much more opulent lifestyle compared to Warren Buffett. But as part of his career in law, which will cover in more detail, he thought, quote, it was undignified to have to send invoices to other people.

Starting point is 00:04:44 I don't know where I got that notion from, but I had it, unquote. Now, another similarity between the two is just their interest in being very, very private people. Charlie Munger even attempted to actually stay out of the limelight as much as possible, so get this. at 76, he said his goal was to stay just below the wealth line that made him eligible for the Forbes list of wealthiest Americans. But unfortunately, the strategy didn't work. The book's author, Janet Lowe, shared that the Munger family didn't really actually want

Starting point is 00:05:10 to have their life in the open for this book. But Lowe told Charlie that she was going to write the book anyway, and it would probably portray him and his family much better if she had his and his family's input. So Charlie's son, Hal Borthwick, made a very interesting observation saying that the Munger that we used to see on the stage at Berkshire Hathaway annual meetings wasn't necessarily the real Charlie Munger. Hal said it was more of a persona that Charlie portrayed as kind of part of an image that he created. Charlie's ambivalent personality helps make Warren look that much more cheerful and approachable. Hal added that to him, Charlie was, quote, a dedicated stepfather, a mentor, and someone

Starting point is 00:05:48 who has made life a real adventure, unquote. Now let's have a look at some of their different personality traits. Whereas Warren prefers simplicity in his statements and vocabularly, Charlie takes a completely different approach. Loe writes, quote, whereas Buffett specializes in simple language, folksy stories, and allegory, munger grants nothing to small words. If he can use a big word when a small one will do, he spends the syllables, unquote. I completely agree with the statement, and although I resonate with Buffett's simple use of the English language, I can actually appreciate that Charlie would often share the meaning behind some of the words that he would use, even if they or maybe a little bit more advanced.

Starting point is 00:06:24 Another difference is their appreciation of some of the finer things. For instance, Lowe says that Munger is a natty dresser. Warren still lives in his first house that he'd ever bought and only has done one remodeling over the years. Compare this to Charlie who owns seven homes in all. Now, I really enjoyed Charlie's thoughtful words on the cliche that opposites attract. Charlie said opposites don't attract.

Starting point is 00:06:46 Everyone who does complicated work needs kind of colleagues to express their thoughts and communicate them to somebody else. He said this was a very, very useful tool. Now, let's go back in time and visit Charlie's early days. While Charlie was unique, the book does an excellent job of showing some of the significant familial influences he had that helped mold him into what he would eventually become. One passage year really stuck out to me. Charlie had a very loving family, but, you know, not much money was passed down to him.

Starting point is 00:07:13 He said where his family helped him was in giving him a very, very good education and giving him good role models to best understand how people should behave. He said in the end, that was more valuable than all the money that he ever made. Now, this is just such a powerful concept, I think, to think about. Charlie was widely successful and made much of his money through his business adventures. But as he mentions, understanding how to properly treat people and behave was more valuable than money. I think this is a great display of how nearly anybody can create wealth using some of the

Starting point is 00:07:44 fundamental knowledge that they learn from their parents. I personally very much resonate with a statement, while both of my parents are not necessarily business people, the most impactful thing that they've taught me are kind of similar to Charlie is just how to be a good person and also how to treat other people fairly. When Warren talks about the importance of doing business with people you like, you can tell that being well liked and easy to get along with probably makes it a lot more likely that others are going to actually want to do business with you. Now, I much prefer this kind of way of doing business. When you contrast it with someone like Steve Jobs, who, you know, berated employees

Starting point is 00:08:17 and had numerous rocky relationships, you can see that. that both methods can work, they both succeeded. But I'd much prefer to utilize the method where I'm a net positive to the people that I associate with. I'd rather not be in a win-lose situation. We're going to cover many of Charlie's great examples of his win-win examples that he went through in his life. Now, Charlie's family name Munger comes from the German word Monger, which means a person who sells a commodity such as fish or iron. His grandparents loved Robinson Crusoe. They forced their children to read it, which was then passed on to Charlie. Charlie mentioned that his grandparents loved it because they admired the conquering of nature through discipline. Now, when I first read that

Starting point is 00:08:59 sentence about the conquering of nature through discipline, I immediately thought of Ralph Waldo Emerson. Emerson also had a massive impact on Warren Buffett. In one of Emerson's essays on nature, he wrote, quote, nature is a discipline of the understanding in intellectual truths, unquote. This short sentence, I think captures exactly what I think Charlie Munger chased for much of his life, which was chasing intellectual truths. He solved problems using many of nature's laws in his multidisciplinary thinking process. Now, to give you an idea of the type of discipline Charlie's grandfather Thomas lived by, Charlie Munger's sister, Molly said that he was anti-gambling, anti-saloon, financially conservative, and underspent his income. And I think that Charlie emulated many of these

Starting point is 00:09:44 characteristics throughout his lifespan as well. Now, Charlie's father, Al Munger, was another person that Charlie held in very high esteem. Charlie said, quote, he was one of the happiest men who ever lived and achieved exactly what he wished to achieve. No more, no less. He faced all troubles with less fuss than either his father or his son, each of whom spent considerable time for seeing troubles that never happened. He had exactly the marriage and family life that was his highest hope.

Starting point is 00:10:11 He had palsy loved and who loved him, including one and 10,000 types like Ed Davis and Grant McFadden. He owned the best hunting dog in Nebraska, which meant a lot to him. I don't see my father as less successful in the sense that really matters. He was just differently aimed and lived in a time when lawyers made less money. Interestingly, Charlie's early education taught him how to befriend the eminent debt. During this time, he learned from people like Brent Franklin and Thomas Jefferson. He mentioned reading them at just the age of seven or eight, so very, very young.

Starting point is 00:10:42 He also discussed some of the other family values that he picked up, such as the importance of getting ahead through discipline, knowledge, and self-control. Now, you know, this probably doesn't come as a surprise to you, but Charlie was a little bit peculiar as a kid. For instance, he said that Dr. Ed Davis, who was his father's best friend, became a very good friend of Charlie when he was just a kid. He said they got along very well and understood each other. You may recall Ed Davis is one of the first investors into Warren Buffett's partnerships. He told Buffett that he invested in him specifically because he reminded him so much of Charlie Munger. Now, if Ed Davis had been so close to Charlie since he was such a young age, I think he probably would have had some of the best insights possible into the type of person that Charlie Munger was.

Starting point is 00:11:24 Now, I want to leave this section on Charlie Munger's childhood with a concept that he took from working at the Buffett family store that I really enjoyed. So Munger mainly learned that working there meant long, arduous hours. And it was experiences like these long, arduous hours that he had to put in at the Buffett family store that helped Charlie realize that he definitely wanted an easier and much more lucrative career. Now let's chat more about Charlie Munger's years leading up to and after the Second World War. Charlie was interested in learning when he was a child, as I've already kind of discussed here. And as you can probably guess, his interest in acquiring wisdom did not stop in university. So while at the University of Michigan, he enrolled in an introductory physics course.

Starting point is 00:12:04 Now, Charlie is a master at memorizing and understanding concepts from all sciences. But he said that his physics course was a real eye-opener, and what caught his attention was how physicists solved problems. It was so impactful, it left just an indelible mark on him. Charlie says, the tradition of always looking for the answers in the most fundamental way available, that is a great tradition. And it saves a lot of time in this world. And of course, the problems are hard enough that you have to learn to have what some

Starting point is 00:12:34 some people call aciduity. Well, I've always liked that word because to me, it means that you sit down on your butt until you've solved your problem. So here, Charlie is reflecting on lessons in his 70s that he learned in his late teens. I find this just incredibly thought-provoking. Even though it's a constant struggle for me to try and think in a lattice work of mental models, when I think of some of the models that I use as metaphors to solve problems, I'm often actually really surprised that some of the narratives that happened 20 plus years ago that I think are still relevant today and that I can still use as a mental model to help me make better decisions. Now, while Munger, I don't think, has ever talked directly in meditation, he has definitely

Starting point is 00:13:11 spoken at length about thinking. For instance, in the University of Berkshire Hathaway, it says, quote, Munger got the idea to add a mental compound interest as well. So he decided he would sell himself the best hour of the day to improve his own mind. And the world could just buy the rest of the time. He said it may sound selfish, but it worked. quote. Now, maybe he didn't call this meditation, but to me, I think this is probably the time that he took to self-reflect and use his prior experiences and knowledge to help solve current problems that he was probably thinking about. After attending the university for a little over a year, he joined the Army at 19. Now, since he didn't like the idea of marching around

Starting point is 00:13:53 everywhere, he decided to join the Army Air Corps. Due to his high intelligence, he quickly rose to become an officer. He ended up being a weatherman and was stationed in Nome, Alaska. Now, one of the really interesting lessons that I've taken from Charlie's military experience was how he utilized lessons from playing poker during those times. I personally have played hundreds of thousands of poker hands over the year, and I'm not sure that I personally had the brain power to synthesize what I learned from playing poker into my everyday life. But I think when Charlie mentioned some of his learnings, they instantly resonated with me. His primary lessons were concerning, you know, things like knowing when to fold and, you know, when the odds were against you. and then alternatively, also knowing when to go all in when you had a very, very significant edge.

Starting point is 00:14:35 He said, opportunity comes, but it doesn't come often. So seize it when it comes. This metal model has been one of Charlie's most expensive superpowers during his investing career. My favorite story of Charlie using this power of patience and aggressiveness probably comes from his example of reading Barron's, the magazine. So he said that he'd been reading that magazine for about 50 years and only ever got one actionable idea from it, which was a business called 10.

Starting point is 00:15:00 He bought shares in the business in the $1.50 to $2 range. He then sold these shares in a few years for $15. From there, he gave the capital from that investment to Lilu of Himalaya Capital. And in 2017, that was worth about $500 million from his initial investment of $80 million. Another great example here that comes to mind is Charlie's mistake of not making a big enough bet in a business that was called Belridge Oil. So there was a broker who contacted Charlie with an offer to buy 300 shares of this business Belridge oil for about $150 per share. So Charlie took it.

Starting point is 00:15:34 It was just an excellent deal. The business was selling for only one fifth of the price of comparable oil companies. It owned all of its land, was training at one third of liquidation value, and had vast, vast oil reserves. A couple days later, the broker called Charlie again and now this time offered about 1,500 shares. And unfortunately, Charlie didn't have the funds and I guess didn't want to move things around, so he actually had to decline this second investment.

Starting point is 00:15:59 The stock ended up climbing to about $3,665 per share in the next year and a half. Now, obviously this was a pretty big win, right, for Charlie, but he admitted that counting the opportunity costs of not investing more actually made it a boneheaded decision. So here's kind of what happened with that entire investment. That investment turned into about $1.1 million. he then used the proceeds from that investment to buy Berkshire Hathaway shares at about $375 each. Now as of May of 2020, that investment was worth about $1.45 billion on just outstanding 28% compound annual growth. But if Munger had purchased the additional 1,500 shares selling around

Starting point is 00:16:36 the same time, he would have had about $6.6 million, which if he invested back into Berkshire, would be worth about $8.7 million again as of May of 2023. So the lesson that he shared from this experience was, don't be timid with a sure opportunity, go at life with courage and gumption. Now let's get back to his life. After the war, he eventually took up law after graduating from Harvard and starting a family. The marriage, unfortunately, with his first wife, didn't last for reasons that I'm not going to get into. But one of his life's biggest tragedies, unfortunately, was about to happen. So his son, Teddy Munger, unfortunately, passed away. While this must have been just an absolutely excruciatingly painful experience for Charlie, he learned a very precious

Starting point is 00:17:18 lesson from it that he shared. You should never, when facing some unbelievable tragedy, let one tragedy increase to two or three through your failure of will. Now, a few other significant insights from his years as a lawyer that I had were based around his work ethic. For instance, depending on the age of the children that the book's author Janet Lowe spoke to, Charlie either worked a lot or had a lot of time for his family. So, you know, the truth was a little more complex and nuanced to get to. But regardless, it seemed like Charlie was a pretty good father. And, you know, he made time to be with his kids, went on regularly family vacations. He disciplined them when needed and he helped pass on his most cherished values to his children. Now, one thing that has always kind of puzzled

Starting point is 00:18:01 me while reading this book was how Charlie could read a book while being around his kids. Now, I've tried doing this with just my one son around and I actually find that almost impossible to focus on. And he did it with eight. Janet Lowe writes, quote, Charlie habitually did several things at once. He would sit in a chair in the evening and read a book at the same time following and interjecting comments into family conversations. So, you know, you would assume that he had some epic levels of multitasking, but as you'll soon learn, he definitely did not. So one life lesson that he passed on to his kids was do the best you can do, never tell a lie. If you say you're going to do it, get it done. Nobody cares about an excuse. Leave for meetings early. Don't be late. And if you are

Starting point is 00:18:43 L8, don't bother giving people excuses. Just apologize. They do the apology, but they're not interested in an excuse. By the way, those are very useful rules, especially for people who've decided to go into service businesses. People are paying for your services with their own money. Return your calls quickly. The other thing is a five second no.

Starting point is 00:19:01 You've got to make your mind up. You don't leave people hanging. Now, I really liked hearing about this five second rule, which made me think of this Warren Buffett quote about Munger having the quickest 30 second mind of anybody that he ever met. perhaps Charlie just taught himself how to do this over time. Now, another fascinating insight from his second wife, Nancy Munger, was about being in a hurry to get rich. I was actually really surprised from this because, you know, I had this impression of Charlie

Starting point is 00:19:25 as being this patient, stoic type. But his wife did say that when he was young, he was in a hurry. Now, it's ironic that she said this, given that Charlie has said that part of his success was patience and that one of the failures of his really good friend, Rick Garron, was that Rick actually wanted to get rich really quick, while Charlie and Warren could accept getting rich slowly. Now, this was maybe just a sign of Charlie becoming more and more patient as he got a little bit older. It could also be related to just the difference between managing one's own money and managing outside money. I think most investors would tell you that there'd be a lot more willing

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Starting point is 00:24:17 All right. Back to the show. Now, there are two big lessons I wanted to share from Munger's days in his law firm. The first was around working with clients that he didn't enjoy working for. Charlie tells us great story about his father, Al Munger, who also was a lawyer,

Starting point is 00:24:30 and how Charlie asked why his father didn't have more clients like Grant McFadden, who you might recall, was one of the really good friends of his father. Charlie observed that McFadden, you know, treated his suppliers and his employees right. His father told Charlie, unfortunately, that a lawyer's family would starve

Starting point is 00:24:45 if all of his clients behaved like McFadden because there wouldn't be any work to do. Charlie added to this lesson, the lesson helped me prefer McFadden types his clients and McFadden behavior as a right example for myself. Now, I just love this insight because it just shows how powerful working with the right people is. But as Munger showed,

Starting point is 00:25:04 there is really a conflict of interest in doing this when your profession technically punishes you for doing it. In Charlie's case, he couldn't work with people who shared his value system. If he had, he wouldn't have gotten any work. I think that his understanding of this was just a powerful motivator that really helped him exit the law business over a pretty short period of time. Now, the second lesson learned from practicing law was more of a series of lessons. Now, let's review a little bit of the backstory first. As part of Charlie's hard work in law, he began accumulating more and more savings. He had a short history of legal work in a small transformer business in Pasadena.

Starting point is 00:25:40 He liked the client and hoped that they liked him enough back that he would, you know, maybe get some more business from them in the near future. Now, on the way to work one day, he decided to be proactive and just drop in on them. He chatted up the business owners and ended up getting more work and establishing an ownership stake in the business. Now, his first formal partner in the deal was a man named Ed Hoskins. Now, this business was not a great business. They had a ton of struggles to own the entire time.

Starting point is 00:26:03 time that he owned it. On top of that, the company had significant debt that needed to be paid down. And unfortunately, there was the ongoing problem of an oversupply of semiconductors in the military industry. Now, they eventually sold the business and ended up with a respectable return on the investment. But what caught my attention from the story was a few key insights that Charlie ended up sharing. There was three of them. One, Munger was in a partnership with Hoskins for about a decade here. But he realized after this experience that he would never return to investing in high-tech businesses again. Number two, Charlie realized the downside of buying low-quality businesses, which I think he considered this business to be. Regarding the semiconductor business, he eventually sold,

Starting point is 00:26:43 he said, it's not that much fun to buy a company that you hope liquidates out of profit just before it is destined to go broke. And number three, he learned about what kind of defined a good business. He said, quote, the difference between a good business and a bad business is that a good business throws up one easy decision after another. The bad business throw up painful decisions time after time. Now, I'd like to briefly touch on this third point about how Munger defined just an excellent business. I think the idea of quality is very essential. But I also think the definition of quality changes based on who you ask. One person may have a list of qualitative aspects that they look for that help them define what a quality business. These things might be

Starting point is 00:27:27 things like high margins, high capital efficiency, competitive advantage, which make it hard to compete with, or, you know, superstar management teams that are well incentivized, aligned, and trustworthy. Now, while these are all solid attributes to look for in a business, I think Charlie gave probably even simpler description that I think does away with much of the quantitative part of investing. A quality business makes it easy to make good decisions. A poor business makes decisions painful. You can support this decision-making framework by doing simple things like looking at what decisions of management team or business has made in the past. Have they made decisions that seem simple and produced high returns? Well, that's a great signal. Or have they

Starting point is 00:28:11 been forced to make decisions that have destroyed value? You want a business where easy choices are easy to come by and hopefully avoid painful decisions as much as possible. Now, I don't think any company can always avoid painful decisions, but if the good decisions outweigh the bad ones, you'll probably have a very solid investment. Now, I want to switch gear and discuss more about how Charlie made his first million dollars. Before that, I want to mention an interesting character quirk of Charlie Munger. So the book's author talks about a time when she and Charlie went for a meal. The waiter was taking their payment at the till, and Charlie asked the waiter if that person, had been their waiter.

Starting point is 00:28:48 Yes, sir, the waiter responded. Then Charlie handed him a bill with a sizable tip and ended up leaving. Then Janet asked Charlie if he hadn't recognized a waiter. And Charlie said that he never looks at waiter's faces and therefore doesn't recognize them. He said it was a terrible habit that I lived with. Now, I wanted to add this because I think it says a lot about how focused Charlie is or was. His levels of focus were so high that he didn't have enough brain power to look people in the eye to remember later. Now, this isn't a character trait of Munger that I'd personally emulate, but I just think it

Starting point is 00:29:22 really goes to show how focused Charlie really was on a subject when he was talking to someone about something in particular. Now, Charlie's first real estate partner, Otis Booth, said, Charlie has enormous powers of concentration. When he concentrate, everything goes away. Now, Otis Booth was Charlie's kind of accidental partner. Charlie had been doing legal work for Mr. Booth. Charlie basically convinced Booth to hold on to and develop a piece of property.

Starting point is 00:29:49 And Otis told Charlie he would do it if Charlie fronted some of the money and became his partner on the deal. It ended up being a great deal for both of them. They earned a combined 500K on the deal with an initial investment of only 100K. Now, after this deal was done, they found another group of apartments that they thought they could develop. The apartments were close to 1900-era mansions. They had an interesting observation from their first deal, which I think kind of helped guide

Starting point is 00:30:13 them on their future deals. And that was that the first floor apartments sold out really quickly while the upper floor sold like molasses. So this next project, they made just a one story project and they made a much higher price tag for each unit just because obviously they weren't building on top of one another, meaning that the efficiency of land use wasn't as good. But they nailed it on this one. Even with the higher price tag, the condos sold out very, very quickly. They repeated this strategy on a third, a fourth, and fifth project and made profits on all of their deals. When all was said done, Charlie made about $1.4 million from his real estate projects. This was enough money to fund his experience and becoming an independent investor.

Starting point is 00:30:54 Now, he admitted that his real estate deals were hard to do as a part-time activity. Keep in mind he was working as a lawyer full-time here. He also said that part of the reason he stopped was that he wasn't a fan of the leverage that was needed in order to have continued success in the real estate investing and development industry. Now, this part of his life kind of think illuminated his need to dedicate pretty much all of his time to investing if he really wanted to scale that part of his life and make more money and be more successful. It showed that he didn't think highly of using leverage in his investing career, although I will say later in his life, he did end up using leverage on his Alibaba bet, which didn't

Starting point is 00:31:29 work out. But importantly, he also didn't risk enough while using leverage to ever kind of put himself for The Daily Journal, which was the vehicle he used to invest it in. He made it so that they had no chance of going broke if he was wrong. Now, let's take a short break here and following the chronological order of Buffett's life and once again touch on the relationship between Charlie Munger and Warren Buffett. So this part of the book was short, but I think had many really good highlights. So I think it's worth chatting with you about some of the significant insights from this chapter. So Charlie's daughter, Molly, mentioned that Charlie in his early years was just really focused

Starting point is 00:32:04 on buying small companies. But when he combined force with Warren, they were forced to make larger deals due to their larger capital base. Now, I've always enjoyed learning about Warren and Charlie's early lives because, you know, they used capital that I think resonates more

Starting point is 00:32:19 with the average person. Warren's partnership did 30% per atom from 1957 to 1969. Charlie's partnership did 24% from 1962 to 1975. Now, these both have outperformed the long-term performance of Berkshire Hathaway,

Starting point is 00:32:32 due, I think, to the smaller sums of capital that they were managing at the time. Now, I think this is an excellent example of why investors managing smaller sums should maybe take a page out of Charlene and Warren's early days and look at smaller businesses. Another great insight from this chapter was how Charlie was willing to be subordinate to Warren Buffett at Berkshire Hathaway. Here's what Charlie said. You can be a dominant partner, subordinate partner, or a collaborative, equal partner. I've done all three.

Starting point is 00:33:00 People couldn't believe that I suddenly made myself a, subordinate partner to warn. But there are some people that it's okay to be a subordinate partner too. I didn't have the kind of ego that prevented it. There are always people who will be better at something than you are. You have to learn to be a follower before you become a leader. People should learn to play all roles. You can divide up in different ways with different people. The next lesson from this chapter focused on some of Munger and Graham's similarities. They were both known for admiral qualities like integrity and dedication to objectivity and realism. Graham told students that there were two keys to success on Wall Street.

Starting point is 00:33:37 The first is to think correctly and the second is to think independently. Munger also valued independent thought. He said, if in your thinking you rely entirely on others, often through purchases of professional advice, whenever outside a small territory of your own, you will suffer much calamity. Now regarding specialists, Charlie will listen to them, but he didn't. doesn't take them entirely at their words. Quote, he considers what they say, continues his research, seeks other opinions, and finally reaches his own conclusion, unquote. Now, this independence of thought

Starting point is 00:34:09 is incredibly crucial in investing. There's going to be many people who are going to try to sway you into making a decision that may be different from what you initially thought. So, you're going to need to develop confidence and conviction in what you think and what you believe. Now, while you should keep your mind open to being wrong, you definitely need to try. to be objective on that front. The last key concept from this chapter was the importance of owning good businesses while avoiding bad businesses. Munger had already formed these opinions from his prior experiences even before meeting Buffett.

Starting point is 00:34:42 The first time Warren and Charlie kind of combined their minds to find a good business was in Seas Candies. Although one could argue that it started even earlier on Blue Chip Stamps. Blue Chip Stamps was an excellent way for Charlie and Warren to utilize float. However, the underlying business of Blue Chip Stamps was just not good. And revenue for the business ended up cratering, but the company had expanding assets due to its investments in other businesses. Buffett said he slowly came around to Munger's point of view.

Starting point is 00:35:10 Quote, I evolved. I didn't go from ape to human or human to ape in a nice, even manner, unquote. And to add to that insight, Buffett said, boy, if I had only listened to Ben, I would ever be a lot poorer. So, you know, while Charlie helped unlock the fundamental quality, characteristics in Buffett's investing strategy, I would say he definitely shared a lot more in common with Benjamin Graham than people give him credit for. Now, let's transition here a little bit to chat about some of the critical lessons that Charlie Munger learned from the law firm that he was

Starting point is 00:35:42 part of, which was called Munger Tolls and Olson, which I'm going to refer to as MTO from here on out. I have a few notes in this chapter that he utilized for the remainder of his life, you know, decades after practicing law. So Rod Hills, who was a gentleman who helped create the firm, noted a few fundamental characteristics in Charlie Munger. He doesn't accept things at face value. His interest in things is so intense that he gains perspective that others do not have. He's fair. And he has a great understanding of the prejudices and weaknesses of other people.

Starting point is 00:36:13 At one point, Charlie said to Rod, quote, Why do you insist on being just a traditional lawyer? You guys were first in your class at Harvard, Yale, and Michigan. Many of you clerked in federal court. do things that other people aren't doing, unquote. Now, everyone following Munger knows that many of these characteristics were very readily expressed, I think, through his investing life. Munger, just like Buffett, accepts that they will sometimes be right when everyone else is wrong. This is why they can enter investments that others are just too scared to touch.

Starting point is 00:36:45 Having this stance requires a different perspective than others. Another very interesting point from this chapter was just how far Charlie Munger was how far Charlie Munger was ahead in his sky-high levels of wisdom, even at a pretty young age. So Charlie's partner, Ron Olson said, quote, gee, he's an old man. He was in his 40s. For years, his mother probably told him, Charlie, you should act your age, meaning you should be more mature. Charlie, from the first day I met him, was the most wise, most mature, most sensible man I'd ever met. Now his chronological age is just catching up with the wisdom he accumulated very early in his life, unquote. interesting point on fairness and excellence that Munger helped instill into MTO is that Charlie's

Starting point is 00:37:29 own daughter, Molly, applied to MTO, but actually wasn't accepted due to not having the credentials that were up to MTO standards. So MTO would do things like go back to your undergrad years to check your grades. And if you just weren't excelling back then, they'd find someone who was. So there's just no room for nepotism at MTO. Now, my final big takeaway from this chapter was a democratic and unique compensation structure that was installed. It was a true meritocracy where partners earn different incomes, up to five times as much as a lowest paid partner, depending on how much value they added to the firm. Here's kind of how that process worked. At the beginning of the year, all partners would get a ballot, listing the names of all the partners with a blank

Starting point is 00:38:09 next to each name. At the bottom of the ballot was printed the firm's net income. Each partner then fills in what they think every other partner should make. There is no extra weight given for seniority. At the end, everyone gets to see how everyone else voted. Now, I'm not entirely sure how involved Charlie was in creating Berkshire's compensation systems, but I think it had many similarities to MTO. At Berkshire, you know, managers are paid depending on their involvement with a specific business that they manage. If, let's say, Berkshire Hathaway as a whole does poorly, but one of its subsidiaries does really well, then the manager of the well-performing subsidiary will earn a bonus. Now, after only about three years of

Starting point is 00:38:48 founding MTO, Charlie ended up dropping out. In typical Charlie fashion, he said, I preferred making decisions and gambling my own money. I usually thought I knew better than the client anyway. So why should I have to do it his way? So partly, it was having an opinionated personality, and partly it was a desire to get resources permitting independence. So once he was done with MTO, Munger, and a poker friend who was named Jack Wheeler created an investment partnership called Wheeler Munger and company. Their beginning was very, very Spartan. They worked out of just a tiny office that was closed to Skid Row section of Los Angeles. They share a pipe riddled front office while their secretary worked in a very small room that was right next to the toilet.

Starting point is 00:39:30 The office had two windows that were overlooking a filthy alley. But, you know, rent was cheap at $150 a month, including utilities. So there's some interesting figures about Charlie's net worth and his living expenses at the time because he didn't need to be in such a cheap area. So at the formation of Wheeler, Munger, Munger had a net. worth of $300,000. The book points out that this was about 10 times his annual expenses. Now, this is very good information for anyone considering managing their own money, I think. I heard of various numbers, but it's usually some sort of multiple of net income or your expenses. Now, just to give some background info on the cost of living in, let's say, 20 major U.S. cities.

Starting point is 00:40:10 So CNBC says you need about 275,000 of expenses for a family of four. Now, remember, this includes higher demand cities in states like California, New York, and Hawaii. So if we use a similar multiple to Munger today, that would mean you need at least around $3 million. Now, personally, I think upping that to probably 20 times expenses is probably a lot safer and allows you to really focus on investing even if things end up going wrong. In that case, you need $6 million. So Al Marshall eventually replaced Wheeler.

Starting point is 00:40:39 But to make sure Wheeler held no ill will towards Charlie, he kept him part of the partnership to a certain degree and as he shared some of the profits as well. Now, this time, Munger was managing pretty small sums of money. So, as a result, they were investing in small opportunities. One such business was a automated chemicals company that was called K&A products. So the original owner had passed away and in order to make this business work, he'd actually had to borrow $80,000 each from two ants to help him start this business. When he passed away, his wife was left the estate, which had to be able to,

Starting point is 00:41:14 the stock as its only asset. But for some reason, the mistress that he had was the executor. So the ants were supposed to be paid interest payments on their loans, but hadn't received any in multiple years. So Munger and another one of his associates, Rick Garon, purchased the notes from the two ants for $80,000 a piece. Now, under most circumstances where this is kind of a distressed asset, their notes would have been purchased at a pretty steep discount. But Charlie, who always lived by this creed of doing the right thing, wanted to do right by them. So Charlie and Garan ended up buying the notes and eventually traded them for ownership of the business. Their ownership got up to about 50% of the entire company.

Starting point is 00:41:53 And at one point, needed to get out. And so he had a deal with Charlie where if one of them needed out, the other one would just buy them out. But again, here, Charlie revealed, I think, his very high levels of fairness. So he told Garron to write a number that he felt would be fair for his shares in the business. Garen thought about it, wrote down a number, Charlie looked at it, it was $200,000. Charlie then said, no, you're completely wrong about that. It's worth $300,000 and then wrote him a check for $300K. So Charlie is well known for making some very concentrated bets even later in his life.

Starting point is 00:42:27 Most of his net worth was tied up in businesses like Berkshire Hathaway, but he also had money managed by Lee Liu in Himalaya Capital and he owned stock in Costco and the Daily Journal. But in his younger days, he was still, very concentrated. Here's what Warren Buffett said about Charlie's portfolio during Charlie's partnership days. Charlie's portfolio was concentrated in very few securities and therefore his record was much more volatile, but it was based on the same discount from value approach. He was willing to accept greater peaks and values of performance and he happens to be a fellow whose whole

Starting point is 00:42:59 psyche goes towards concentration, with results shown. Now, what did Charlie do for himself and his partners while managing their money in terms of returns. He did exceptionally well, especially in the year's 1962 to 1969. Before the general partner override, he made 37.1% per annum. But in the 1969 to 1972 period, returns dropped to just 13.9%, which sound pretty good to me. Still, he topped the Dow's 12.2% during the exact same period. Now, between 1962 and 1969, Munger only had one down year, which was 1969, when the returns that year were only a paltry negative 0.1%. By comparison, the Dow had three down years during that same period. But unfortunately, he was hit pretty hard in 1973 and 1974 with returns of negative 31.9% and negative 31.5%. Now, Warren Buffett had the

Starting point is 00:43:52 feeling that returns would no longer be very good in 1969. And that's part of the reason why he exited his partnership at that time. Unfortunately, Charlie was a little bit late. In regards to those two years, Munger said, we got drubbed by 1973 to 1974 crash. Not in terms of true underlying value, but by quoted market value, as our publicly traded securities had to be marked down to below half of what they were really worth. It was a tough stretch, 1973 to 1974. It was a very unpleasant stretch. 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

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Starting point is 00:47:44 All right. Back to the show. Since Munga was so concentrated, his poor performance was the result of two underperforming holdings. These two holdings were the New America Fund and Bluefield. Chip stamps. So New America Fund had been partially bought with leverage and the shares were bought for about $9.22 in 1972. By 1974, they were trading for $3.75. But interestingly, the net asset value of the New America Fund was still $9.28. Blue Chip Stamps was bought for about $7.50 and it actually

Starting point is 00:48:14 had gone up to over $15 in 1972, then dropped to about $5 in 1974. Now, 84 percent of the fund in 1974 were invested in these two names. So this speaks, I think, to the importance of two things. One, diversification and two, being able to deal with market volatility. Now, if Munger had been more diversified, he wouldn't have had these painful downswings, but he also wouldn't have had these euphoric upswings that preceded them. Munger admitted that he found managing his money just easier than telling others about the losses that he got for them. But, you know, he also understood what he owned very well, probably at a much higher level. than his partners did.

Starting point is 00:48:55 Now, just looking at these two stocks and what they ended up doing, by the 1980s, the New America Fund turned into about $100 in cash and securities, and the fund's blue chip stamp shares turn into 7.7% of a Berkshire Hathaway Common Share, resulting in about 38,889 shares of Berkshire stock. Today, as of November 15th, that would be worth $27 billion. Now, when all was said and done, Munger accumulated about $3 million from Wheeler, munger and about $2 million from real estate. So he ended up doing just incredibly well through his partnership years despite the pain that happened at the end. Now the last part of this chapter that I found

Starting point is 00:49:32 interesting was Charlie's average cost basis on Berkshire, which was $40. It's impossible to know how many shares of Berkshire Charlie held at his apex. But when he passed away, he held around 4,033 shares. But in 1996, he owned 18,829 shares. Much of the shares have been eroded through, you know, charitable donations. Before 1996, I can only imagine how many shares he owned. Now let's go over Seas Candy because it was just vital to learning for Warren Buffett and for Charlie Munger. Buffett and Munger bought Seas Candy with a few very interesting stipulations. They wanted to pay a low price and they had to find new management. The cheap price part was probably more of a challenge for Buffett than it was for Munger. They ended up buying it for about three times book value.

Starting point is 00:50:17 Now for Buffett, this was unheard of. But the business had some very unique characteristics. For one thing, it was earning about $4 million in pre-tax profit per year. So they only ended up paying about seven times pre-tax profits. Additionally, the business was just not capital intensive, so a premium to book value was warranted. Now, with this business, Charlie helped show Warren the strength of high-quality businesses. Seas Candy was a type of businesses that continuously produced profits while not requiring capital. Additionally, the business could increase its revenues by charging more without changing the input costs. This is the power of brand that Warren learned from purchasing the business.

Starting point is 00:50:55 Now, the second problem was that C's current CEO was set to retire. Warren and Charlie ended up getting Chuck Huggins to become the next CEO. And once they knew that he would be the CEO, Warren and Charlie pulled the trigger and bought the business. Now, I didn't know this, but C's actually had a bit of a rough patch immediately after being acquired by Blue Chip Stamps, which was run by Charlie Warren and Rick Aaron. Because Blue Chip Stamps had just encountered this highly publicized events that painted it in bad light, C's customers were kind of uneasy about shopping there. Now, here's what Chuck Huggins said about the business.

Starting point is 00:51:26 People didn't have a lot of respect for the company. They'd just been through this antitrust case and they looked bad. This was blue chip stamps. That left a bad taste in the mouths of our most faithful customers. In 1972 and 1973, I spent a lot of my time dealing with customers who were concerned, mad that the family had sold and now it was in the hands of a company that would ruin C's. Suddenly, we got a lot of hate mail, people claiming the candy had changed. But Charlie Warren and Garan had put the right man in charge, and he did an excellent job

Starting point is 00:51:55 easing customers' mind and getting C's back on track. Another great example, I think, of C's strength of their brand was when Russell Stover attacked their business. So Russell Stover actually just took a page from Charlie Munger's book and just cloned C's as much as humanly possible, attempting to steal their customers away. So they copied C's checkered floors. They copied their lattice in the windows. They copied their old-fashioned pictures that they hang on the wall.

Starting point is 00:52:23 They thought that essentially by copying C's, they could beat C's out of their market. But Charlie knew that this wasn't the right way of going around business, ended up using one of the top lawyers from MTO, which then went to Russell Stover, scared the heck out of them, and it forced them to basically quit the copycott strategy. After owning C's candy, Munger & Buffett realized just how great of an experience it was to own a high-quality business, even if it had a heftier price tag, than maybe they would have paid for in the past.

Starting point is 00:52:52 It showed them that a great business was easier and more pleasant to own. It also contrasted the differences in owning a struggling business that required additional time, energy, and capital just to set right. This is a great way, I think, to view business quality. Charlie said the difference between a good business and a bad business is that a good business throws up one easy decision after another. The bad business throw up painful decisions time after time. even if you're an investor in public equities, I think this is an excellent framework.

Starting point is 00:53:23 I know from owning a few public businesses that the ones that I enjoy owning the most are the ones that are easy to own. Being easy to own for me means that the business rolls along at a steady pace. You know, management always impresses me. The business rarely stumbles. And there just isn't that much fear that their operations are going to be disrupted by competitors. Warren learned much of this from Charlie as part of the C's experience. And I really think it helped. Berkshire Hathaway understand businesses better, which helped to, you know, investing in winners like Coca-Cola and Apple. Now, for me, the highest quality business that I own is probably Topicus, which is a

Starting point is 00:53:58 business that Clay, my co-host covered on TIP 549. It's an excellent business. But to be fair, I paid quite a bit for it. But it kind of strikes all the checkmarks above for being easy to own. And as a bonus, since the company is so good, I've also earned a return well above my hurdle rate. Now, let's transition to some of the obstacles that Charlie had to deal with over his lifetime. During a lawsuit concerning his purchase of the Buffalo Evening News, he realized that he was having

Starting point is 00:54:26 problems, unfortunately, reading these legal documents. It was bad enough that he had to pass these duties on to someone else. He learned that he was suffering from rapid and severe cataracts. He underwent cataract surgery knowing that he would lose complete vision in the eye. Now, to make things even worse, he actually developed another issue afterwards that caused his surgically repaired eye, immense amounts of pain. Because he didn't want to withstand the pain anymore, he had doctors just remove the eye altogether. Now, the following story in this book discusses some of the details of Westcoe financial, which Berkshire Hathaway partially owned.

Starting point is 00:55:01 Like Berkshire Hathaway, Westco was a holding company that Charlie Munger helped build. At the end of 1999, Westco's consolidated balance sheet had about $2.8 billion in marketable securities. Forty-seven percent of its net income came from realized gains on the securities that it held. So here are some of the businesses that Westco held. Freddie Mac was valued at $1.9 billion and was purchased in 1988 for $71.7 million. It also held other high-quality businesses like Coca-Cola, the Gillette company, Travelers, U.S. Airways, American Express, and Wells Fargo. Now, there was a quote at the end of the chapter here that I really resonated with,

Starting point is 00:55:39 and it was in regards to Westco's share price dropping 30% over a 14-month period. ending in year 2000. I'm 76 years of age. I've been through a number of down periods. If you live a long time, you're going to be out of investment fashion some of that time. Now, I love this quote because it shows the importance of equanimity in investing. Berkshire Hathaway suffered four drops of 30% or more while Bunger owned the stock, and he never sold his shares due to fear of the stock price.

Starting point is 00:56:08 While equanimity is essential, it's also vital to utilize it on businesses that deserve it. I've made the foolish mistake of stubbornly holding onto a stock because I thought the stock price would recover. This wasn't necessarily the foolish mistake. The foolish mistake was not taking into account the inability of the business's fundamentals to reaccelerate, which would obviously be the catalyst to make the stock price go back up. Now, for those of you wondering, yes, I am talking exactly about Alibaba, a business that Charlie Munger also owned for some time. Now, I couldn't do this episode justice without mentioning a business that Charlie was very well known for, which was the Daily Journal.

Starting point is 00:56:45 Now, the Daily Journal wasn't a home run for Charlie, like some of the other investments he made, but he enjoyed owning the business in his own way. Now, in terms of returns, they were pretty modest. So Charlie Munger and Rick Garron bought it for about $2.5 million in 1977. I'm not sure how many shares Charlie and Rick owned at that time. But as of November 15, 2024, the market cap is about $770 million. That's a compounded annual gain of about 10.5% per year. So pretty good over a very long time period.

Starting point is 00:57:13 Now, through the years of owning it, there were actually many, many potential buyers for the Daily Journal, but Munger didn't really want to get rid of it. He said the Daily Journal was a vehicle that allows him to be socially constructive. In the book, Rick Garron says that they owned it, both of the love of journalism and for the money. Darren also added concerning the daily journal, we're lucky enough to be in things because we want to be. None of us, Charlie, Warren or himself, have to do anything that we don't want to do. Charlie and I love owning it. It's great fun. We think we're serving the justice system, if you will.

Starting point is 00:57:47 It does make money and is gaining in value every year. We try to make it better. Now, let's transition to the chapter in Damn Right that discusses some of Charlie's thoughts on philanthropy. Charlie said the early Charlie Munger is a horrible career model for the young because not enough was delivered to civilization in return for what was arrested from capitalism. I find this fascinating because I find there's kind of this. push pull between making yourself wealthy and sharing it with others. When you have smaller amounts of wealth, it's easier to brush away philanthropy until you reach higher levels of wealth.

Starting point is 00:58:21 But as Charlie points out here, he thinks that he should have started a lot earlier. It's a thought-provoking idea, and I don't think there's necessarily a right or wrong way to go about it. But I think it's a very, very good lesson, especially for those who might be on the fence about whether or not to start sharing parts of their wealth. Now, an interesting angle on how Charlie viewed his involvement in his community was as an atonement for making more wealth than he believed that he deserved. Charlie said, I do my outside activities to atone. And Warren uses his investment success to be a great teacher.

Starting point is 00:58:52 So as Charlie points out, you know, you can use your success to do different things. Warren also, of course, uses his success as an investor to give back as he plans on giving about 99% of his wealth away once he passes. So Warren has said that the money is going to be dispersed among a few charitable. donations, including the Bill and Melinda Gates Foundation, the Susan Thompson Buffett Foundation, Sherwood Foundation, Howard G. Buffett Foundation, and the Novo Foundation. Now, the final story on philanthropy I want to share with you is about an event which affected the Good Samaritan Hospital, which was an institution that Charlie was on the board of. So after the 1994 earthquake devastated much of California, many hospitals in the same area as Good Samaritan attempted to maximize

Starting point is 00:59:31 the funds that they could extract from the federal emergency management agency or FEMA. So the book insinuates that some hospitals maybe were making claims with little or no damage that was actually done to their property. Now, Munger decided not to make a claim at all after having the Good Sam buildings examined and left the funds for others who actually needed them. Andrew Lika, who was Good Sam's president, said, quote, he won't do anything just for money. He'll go into a business such as health care special services, even if he knows it will lose money, if it is the right thing to do, unquote. There's the same theme that I think we've seen throughout Charlie's life, doing the right thing. Now, I think it's a significant value to live by and has a lot to do with

Starting point is 01:00:12 why Charlie Munger, while maybe being kind of prickly to some, was also widely liked by the people that were closest to him. Now, to finish this episode, I want to discuss Charlie's life regarding Berkshire Hathaway and some of the most insightful lessons that he discusses in the book around investing and thinking as well. The first thing that I want to discuss is that there was never really a master plan at Berkshire, which I find captivating. But I also think that this was part of their advantage. Empire builders run many, many businesses and corporations. But these are people that care more about their reputation and maybe the legacy that they're

Starting point is 01:00:46 leaving than creating value for shareholders. I think Berkshire Hathaway never having a grand plan has probably been a really big reason why their shareholders regard Warren and Charlie with such a high regard. Now, Charlie said, our rule is pure opportunity. We do not have a master plan. If there is a master plan somewhere in Berkshire, they're hiding it for me. Not only do we not have a master plan, but we don't have a master planner. So, you know, Charlie wasn't trying to build the next General Electric Ford or National Cash Registry. He was just looking for whatever opportunities made the most sense to him. Because he knew that opportunity

Starting point is 01:01:21 didn't come around often, he knew the importance of two key attributes, patience and betting big when the odds are in your favor. I think the patience part probably came easier for him, given his upbringing. He also learned some of the advantages of patients through his investing experiences. He noted, there are huge advantages for individuals to get into a position where you make a few great investments and just sit back. You're paying less to brokers, you're listening to less nonsense. If it works, the governmental tax system gives you an extra one, two, or three percentage points per annum with compound effects. But Charlie admits, although he was more concentrated most, he still needed to be diversified enough to take advantage

Starting point is 01:02:01 of multiple opportunities. He said several ideas led to a success, not just one. If you master a few important concepts, you will find opportunities. It's up to you to seize them because they are not unlimited. Now, another insight in this book was how a high-quality business can shield you from mistakes. For instance, Berkshire Hathaway missed an opportunity to own a part of the New Yorker. But Berkshire Hathaway was also such a high-quality business so they could make these mistakes of omission and still succeed. One crucial area was how vital investing in companies with tailwinds is over investing in companies that have headwinds.

Starting point is 01:02:37 Now, not only did Charlie help Warren see the importance of owning great businesses, but he also showed him the importance of owning businesses with growing earnings power. Charlie wanted high-quality companies that would remain high-quality for long periods of time. Buffett points out that some businesses have this, you know, hypothetical earnings power, which obviously should be avoided at all costs. Buffett listed Polaroid as an example of this. The best example, in my opinion, of a high-quality business that Charlie is known for outside, of course, of Berkshire Hathaway is Costco.

Starting point is 01:03:07 Charlie understood the strength of Costco far before many, many other investors did. And as a result, he had the privilege of riding that business up for a couple of very, very successful decades. Now, the interesting thing about Costco is that he actually shared this idea with Warren. And Berkshire even actually owned shares in the business for a time. But they made a mistake in not buying more. Warren said, we actually negotiated to buy more. I made the most common mistake that I make.

Starting point is 01:03:34 We started buying it and the price went up and instead of following it up, we failed to buy more. If Costco had stayed at about $15 a share or so where we were buying it, we would have bought a lot more. But instead, it went to 15 and an 8th. And who could pay 15 than an 8th when they'd been paying 15 for it? That wasn't quite that bad, but I have made that mistake a lot of times and it's very irritating. Now, this is an interesting quote because it shows how Ward has made this mistake more than once. Over the past years, I've also focused on loosening my purse strings in this area. It's really

Starting point is 01:04:07 easy to get anchored to your initial buy price. But the problem with many high quality businesses is that they spend a lot of time making new all-time highs. So if you want to make a significant position in a very high-quality businesses, you may only get one opportunity to buy it at a specific price. So right now, I think I might be making this mistake with a few of my holdings. So I have two high quality businesses in my portfolio that I'd love to own more of. But I've been kind of easing my way into them, not making a full position right off the bat. So these are both positions that I'd love to have, you know, 10% waiting in. And unlike the Buffett example above where the price only went up 2%, which isn't that much, the price on these two names as of today have sort of 31% and 73%. So because

Starting point is 01:04:53 of this, it's been really challenging decision for me on whether or not I want to add. So time will tell whether or not this is a mistake, but we'll see. So another great insight that I enjoyed learning more about was the impact of size on your investing strategy and returns. Munger and Buffett have been very transparent about forward returns in the past. They have warned that Berkshire will have a lot of difficulty maintaining their historical growth rates as it increases in size. And this will therefore impact the growth in share price. Munger said that size unfortunately ends up becoming an anchor which slows things down. Now my biggest takeaway from this is that, you know, as an investor with small amounts of capital, I personally should probably take advantage of the ability to invest in

Starting point is 01:05:38 businesses that investors with large pools of capital can't invest in. Now, one area that I found fascinating about Charlie and Warren is that they rarely mention the weighted average cost of capital in their investment discussions. I believe a big reason for this is probably that they just did not need to borrow as they've been very, very conservative in borrowing over their careers. And then add to the fact that Berkshire right now has hundreds of billions of dollars in liquidity, borrowing isn't really necessary. Now, it wasn't always like this, of course, but throughout their history, they've had a lot

Starting point is 01:06:09 of cash on their balance sheet mainly due to their involvement in insurance businesses. Now, according to Charlie and Warren, the simplest way to think about the cost of capital is displayed by Warren in this excellent quote. If we're keeping $1 bills, that would be worth more in your hands than in ours, then we failed to exceed our cost of capital. Now, this is why I like to look at how much value of business has created with the money that it has kept rather than paying it to shareholders. Now, if you want to do this yourself, it's very, very simple. There's only a few key numbers that you actually need. First, you need the difference between retained earnings X years ago and today. So retained earnings is just a line item you can find in shareholders' equity.

Starting point is 01:06:47 on the balance sheet. And then the second number you need is just the difference between the market cap value of a business the same years ago and the market cap today. So if a business has retained a billion dollars over the last 10 years, it should have provided an additional billion dollars of market cap value to its shareholders. Otherwise, you know, as Buffett would say, it's not doing a good enough job of capital allocation. So let's do a quick exercise on this for Berkshire Hathaway over the last decade. Since 2014, they've retained about $513 billion. And between 2014 and today, they've created about $641 billion in shareholder value. That's the change in their market cap. So they pass the one dollar test. Now, this point leads to another great insight I want to share on volatility.

Starting point is 01:07:27 See this framework and say it doesn't do a good job just because, you know, market caps fluctuate based on the market's mood. And that isn't necessarily a good view to see the capital allocation of what managers are actually doing. Let's use an example of, let's say tomorrow, Berkshire Hathaway suffers a 30% drop in a share price from today. In that sense, they would have only increased shareholder value by about $339 billion in the period that was lifted above. And in this case, they would actually fail that $1 test.

Starting point is 01:07:59 But I think what's kind of overlooked is just the Ben Graham principle that in the long term, the market is a weighing machine. And what that means is if you use this. framework over long time periods, you should get a reasonably good viewpoint of how much value has been created by a business. If you're using this framework over one year, yeah, it's probably going to be pretty useless because, you know, if you're going into a bull market, it's going to look like management has created a lot of value. If you're going into a bare market, you're going to be observing management, destroying shareholder value. But I think, again, over, you know, probably three

Starting point is 01:08:34 to five year, five years, probably better, minimum is a really good tool to use. Now, let's get back to volatility, which, you know, Munger felt was a benefit, not necessarily a negative. He felt the emphasis on volatility and financial academia was just nonsense. He said, let me put it this way. As long as the odds are in our favor and we're not risking the whole company on one throw of the dice or anything close to it, we don't mind volatility in results. What we want are the favorable odds. We figure the volatility over time will take care of itself at Berkshire. Now, pretty much all value investors, I think agree with this notion because they understand that markets are usually, but not always, efficient. Therefore, you should occasionally expect volatility in the stocks that you own and

Starting point is 01:09:19 hopefully exploit this inefficiency when offered excellent opportunities. Now, to finish this episode off, I want to share a final insight that I found very inspiring. So Molly Munger, Charlie's daughter, shared it. So she said, he is very distrustful of emotions. We heard a lot of messages about how emotions can lead you to do dumb things. I'm trying to think of a time he said, you know, go with your gut, feel the vibes, lose yourself in the moment. That's not where he is. Yet Molly says there were always signs that her father could be frivolous. At the same time, that kind of dry of a person wouldn't have had that spring in his step. After something is checked out and you can feel safe, he gets very, very devoted to people. A good argument can be made that

Starting point is 01:10:03 he's actually a very emotional person, that is actually an achievement that he brought a large psyche under control, a unique mix of an emotional personality under wraps. Now, I think this just speaks volumes about Charlie's ability to stay rational throughout his entire life. Humans are all emotional beings, but Charlie trained himself to try and bypass some of the errors that he knew he'd make as a human. If you take one lesson away from today's episode, I think you should clone Charlie in this respect and try to avoid some of the biggest mistakes. humans make by making yourself aware of your own common biases. That's all I have for you today. If you want to interact with me on Twitter, please give me a follow at Irrational MRKTS or on LinkedIn.

Starting point is 01:10:47 If you enjoy my episodes, please feel free to let me know how I can make your listening experience better. Thanks again for tuning in. Bye-bye. Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only, 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.

We Study Billionaires - The Investor’s Podcast Network - TIP683: The Evolution of a Legend: Lessons from Charlie Munger’s Life and Investments w/ Kyle Grieve

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