We Study Billionaires - The Investor’s Podcast Network - TIP718: Buffett & Munger Unscripted by Alex Morris

Starting point is 00:00:00 You're listening to TIP. It's Berkshire Weekend, and today's episode is a special treat as we're covering Alex Morris's new book, Buffett and Munger, unscripted. Each year, tens of thousands of investors make the pilgrimage to Omaha for the Berkshire Hathaway annual meeting. And this year, the 2025 meeting will be my sixth in attendance. For decades, Warren Buffett and Charlie Munger have shared their wisdom with shareholders. And back in 2018, Berkshire began releasing. annual meeting recordings dating back to 1994. This archive of content is now one of the greatest resources available to investors today.

Starting point is 00:00:39 Alex Morris, who runs the Investment Research Service, The Science of Hitting, he recently went through hundreds of hours of meeting footage and compiled the most impactful investing lessons from Buffett and Munger into one single resource. In this episode, I'll highlight the most impactful quotes and takeaways from the book, including their views on business quality, capital allocation, temperament, Mr. Market, investing mistakes, and much more. At the end of the episode, I'll also share details on the TIP summit that we'll be hosting in the mountains of Big Sky, Montana this fall for a select group in our audience. Whether you're a seasoned investor or just getting started, I'm sure you'll find value in

Starting point is 00:01:17 the timeless wisdom from two of the greatest minds in investing. So with that, I hope you enjoy today's episode on Buffett and Munger unscripted by Alex Morris. 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, Playfink. The primary objective in investing, whether buying a single share of stock, or acquiring 100% of a company is straightforward.

Starting point is 00:02:01 To get more than what you pay for. Whereas Buffett puts it, value is getting a lot for the expectation. expectable future cash flows in terms of what you're laying out today. Charlie and I think there is no other kind of investment than a value investment. In other words, we don't know how anybody would invest in a non-value investment. We've always been puzzled by the term value, suggesting it contrasts with growth. Value is getting a lot for the expectable future cash flows in terms of what you're laying out today. Every time somebody characterizes us as value investors, we ask, what other kinds of?

Starting point is 00:02:37 Kind, could there be? That's the opening line to Alex Morris's new book, Buffett and Munger unscripted. Warren Buffett hosted his first Berkshire Hathaway Annual Meeting in 1973, and at the time, it was a small, low-key gathering. Over the decades that followed, it has grown into the massive event it is today, often referred to as the Woodstock for capitalists, attracting tens of thousands of investors from around the world. And here today, we're releasing this episode just before the 2025 annual meeting on May 3,

Starting point is 00:03:07 2025, I'll be there in attendance for my sixth meeting, and the best part is really having the opportunity to connect with like-minded people that I otherwise don't have the chance to see in person throughout the year. If you haven't been to the Berkshire meeting, I would highly recommend considering attending in 2026 if you're able to. Investors from all over the world make the trip, and it's a very common bucket list experience for hardcore value investors and followers of Buffett and Munger. Back in 2018, Berkshire released the annual meeting videos dating back to 1994, which opened up a treasure trove of investing in life wisdom for all of us to access. And thanks to Alex, he sifted through all of the content in writing his book and making it

Starting point is 00:03:46 easier to digest and find the best lessons from the meetings, and he primarily focused on the investing side of things for his book. And if you haven't read Lawrence Cunningham's book, The Essays of Warren Buffett, I would recommend that one as well as it really distills all of Buffett's writings into a really easily digestible form. Alex organizes his book based on a number of different important investment in business themes, including the skills and temperament required to be a successful long-term investor, the art of business valuation, living with uncertainty and market volatility,

Starting point is 00:04:17 defining your circle of competence, and much more. To kick off the section on value investing, he has a couple of wonderful quotes here to get us kicked off, so I'll share those two here. I quote, we're trying to buy businesses we want to own forever. And if you're thinking that way, you might as well look back away and see what has been like to own them forever. Another here, time is the enemy of the poor business and the friend of a great business. When many of us discover value investing in the work of Buffett, we're looking for the magic

Starting point is 00:04:46 formulas that tell us how to win the game of money in the game of investing. We all inevitably find out that there's no magic formula. In achieving good returns is not as easy as we once thought. In investing, to paraphrase canes, it's sufficient to be roughly right, especially if it helps to avoid the risk of being precisely wrong. Investing from Warren Buffett's perspective is not all that complicated. It's all about buying a business for less than its fundamentally worth and understanding how to think about markets.

Starting point is 00:05:16 With this frame of reference, there's no need to learn anything about Cap M models, Blackshould's options pricing, technical analysis, or modern portfolio theory. Buffett stated, we basically look for companies where we think we could understand what the future will look like in 5, 10, or 15 years. That doesn't mean we calculate it to four decimal places, but we need to have a feel for it and know our limitations. We stay away from a lot of things. We just keep reading and thinking and looking at things that come along as Charlie describes

Starting point is 00:05:46 it, comparing Opportunity A with Opportunity B, end quote. So a key insight here from Buffett is that he likely isn't able to accurately assess the future of a lot of businesses, which means that he isn't able to accurately value such businesses. You could have loved Tesla in 2015, but if you can't accurately predict what the company's future is going to look like, then you're forced to speculate on what the intrinsic value of that business is. Another key insight is that he's sticking with businesses he can really understand. Too often, investors can get caught up in the next hot trend that they don't really understand

Starting point is 00:06:22 and they fool themselves into thinking they do in order to catch that next hot trend. In fact, the first question that Buffett asks himself when he's analyzing a business, is can he understand it? Unless he feels that he can understand the business well, then he won't ever bother investing in it. The second question he asked himself is, does the business look like it has good economics? He's looking at returns on capital, the margins, and stability. And this ties in to my next point here. Time and time again, like clockwork, I've met people who tell me they've transitioned from being a cigar butt investor or a net net investor to focusing more on high-quality businesses. Buffett shared that he's had a lot of experience with bad businesses,

Starting point is 00:07:04 and that experience has helped him appreciate the good businesses. In 1998, he stated, I quote, the criteria for selecting a stock is really the criteria for looking at a business. We are looking for a business we can understand. They sell a product that we think we understand or we understand the nature of the competition and what could go wrong over its lifetime. And then we try to figure out whether the economics over the next 5, 10, or 15 years is likely to be good and getting better, or poor and getting worse. Then we try to decide whether we're getting in with people that we feel comfortable being in business with.

Starting point is 00:07:39 And then we try to decide what's an appropriate price to pay for what we've seen up to that point in the business. What we do is simple, but is not necessarily easy. Knowing what you don't know is very important. Knowing the future is impossible in many cases and difficult in others. We're looking for the ones that are relatively easy, end quote. So as Buffett's getting to here, he isn't using complex models or formulas to invest. The greatest investor in the world uses pretty much common sense,

Starting point is 00:08:07 and I think that's a powerful takeaway that we can all use in our own investing approach. Buffett is living proof that buying great businesses at fair prices and holding them for the long term is a sensible approach to investing. The question, though, is, What is a great business? Here's how Buffett defines it. The ideal business is one that earns very high returns on capital and can keep using lots of capital at those high rates.

Starting point is 00:08:31 That becomes a compounding machine. If you can put $100 million into a business that earns 20% on capital, ideally it would be able to earn 20% on $120 million the following year, $144 million the following year after that, and so on. You could keep redeploying capital at these same rates over time. But there are very, very, very few businesses like that." Not only are these types of businesses rare, but they also can be pretty risky as well. Growing at a moderate to high rate for a long period of time is pretty difficult, and high

Starting point is 00:09:06 returns on capital tend to be arbitraged their way with time. And this has led Buffett to investing in many businesses with limited reinvestment opportunities. Seas Candy and Coca-Cola, for example, did not have the ability to reinvest substantially into their businesses, which means that most of their cash flows were delivered back to shareholders, either through share buybacks or dividends. But one of the things that has made Berkshire, such as special investment, is that Buffett and his team at the head office have been the primary capital allocators. So Buffett's able to take those cash flows from, say, Seas Candy, and go and find new

Starting point is 00:09:40 opportunities to reinvest that capital. And Buffett's one of the best capital allocators out there. Some managers try and take a similar approach to Buffett and go out and make big splashy acquisitions, but oftentimes these turn out to be not very value accretive to shareholders. Buffett stated, the temptation is to go out and buy other businesses, but we don't think that the batting average of American industry in redeploying capital has been great. In a sense, we sort of knocked the very procedure that has got us to where we are, end quote. Another attribute of a good business is that it doesn't have high levels of maintenance

Starting point is 00:10:14 If a business makes, say, $1 million per year in gap net income, but the business requires that $1 million to be put back into the business just to keep it in place, this is a very capital-intensive business, and it just personally does not interest me as an investor. This type of business might look cheap and be trading at a P.E. of, say, 5, but the owners of this business will find that the shareholder returns are abysmal, because the business does not generate high returns on incremental capital invested, or are they able to grow and deliver returns to shareholders either through those dividends or buybacks? While there can be money to be made in an average or declining business, I think that most investors are better off

Starting point is 00:10:56 investing in good businesses that see their earnings power increase over time. Munger stated, declining businesses are not worth nearly as much as growing businesses, but they can still be quite valuable if a lot of cash is going to come out of them. And Buffett follows it up. Generally speaking, it pays to stay away from declining businesses. If you really think a business is declining, most of the time you should avoid it. Now, we are in several declining businesses, but that is not where we're going to make real money at Berkshire. The real money is going to be made in growing businesses. That's where the focus should be, end quote. Now, this is something that Buffett had to learn over time, of course, with the help

Starting point is 00:11:35 of Charlie Munger. And when you look at where Berkshire made the vast majority of their money, it's essentially all going to come from the outstanding businesses that they've bought and held for a long time. There's another good piece here from Buffett in the 1997 meeting on owning great businesses and learning from his mistakes, I quote. The biggest thing to do is to understand the business and to get into the kind of businesses where, by their nature, surprises are few. And we think we're largely in that type of business. I've talked about learning from your mistakes. The best thing to do is to learn from other people's mistakes are a pro. is to try and learn vicariously.

Starting point is 00:12:13 But there's a lot of mistakes that I've repeated. I can tell you that. The biggest category over time have been being reluctant to pay up a little for a business I knew was really outstanding, or to continue to buy it at higher prices when I knew it was outstanding. The cost of that has been many, many billions, and I'll probably keep making that mistake. The mistakes are made when there are businesses you can understand and they're attractive, and you don't do something about it. Most of our mistakes have been mistakes of omission rather than commission, end quote.

Starting point is 00:12:44 I recently interviewed Francois VerShaun, and he also shared that his biggest mistakes over time have been these mistakes of omission. The businesses that he knew were fantastic, but he did not buy them because the price was a bit out of his comfort zone. He mentioned that he was a bit lucky that Alphabet was trading at a P.E. of 15 or so in 2011 or 2012, leading him to purchasing shares because if the P.E. would have been 20 or higher, then he likely would have passed. Since that time, shares of alphabet are up by 10 times, generating an average shareholder return of 19% per year. In 1998, Buffett talked a bit about Cigarbat investing,

Starting point is 00:13:22 I quote, it's extremely difficult to get rich by owning a business that earns low returns on equity. We always look at what a business does in terms of what it earns on its capital. We want to be in a good business. Where you really want to be is in businesses that are going to be good and better businesses 10 years from now. And we want to buy them at a reasonable price. Many years ago, we gave up what I've labeled the Cigarba approach to investing, which is where you try and find a kind of pathetic company, but it sells so cheap that you think there's one good free puff left in it. We used to pick up a lot of soggy cigar butts. I had a portfolio full of them. There were free puffs in them, and I made money out of that, but it doesn't work with big money. And we don't

Starting point is 00:14:05 find many cigar butts around that we would be attracted to today. Those companies had low returns on equity. If you have a business that's earning 5 or 6% on equity, and you hold it for a long time, you're not going to do well, even if you buy it cheap to start with. Time is the enemy of the poor business and it's the friend of the great business. And then Munger follows it up here. It's not that much fun to buy a business where you really hope the sucker liquidates before it goes broke. Now, that excerpt there really just encapsulates why I can't ever seem to get interested in a mediocre business that's trading on the cheap. It feels almost against my nature of wanting to own the best of the best businesses.

Starting point is 00:14:42 And I feel that there's this sense of market timing as well, or betting on a short-term catalyst that you don't necessarily know when or if it's exactly going to play out. And I'm also a bit biased toward higher quality businesses because when I look at public equity investors with a track record of beating the market, nearly all of them focus on high-quality companies. That to me is quite telling, and it tells me where I should focus my own attention to generate good returns for my portfolio going forward. I appreciate that Alex Morris also included a section here on capital allocation. Capital allocation is, of course, extremely important at Berkshire, as it's what Buffett is probably one of the best in the world at. He's a master at taking the cash

Starting point is 00:15:25 that his businesses earn in determining the best place to put that cash to optimize returns going forward. Buffett believes that the number one job of a CEO is capital allocation, or deciding how to deploy the company's resources to maximize long-term value for shareholders. So in determining the successor at Berkshire, he's certainly going to try to find the absolute best person he can that is a very talented capital allocator. But I think that many CEOs out there really aren't that graded capital allocators, where they don't fully understand the importance of it in doing their job effectively. In the 2017 meeting, Buffett stated, I've talked about something I call the money mind.

Starting point is 00:16:05 People can have 140 IQs and high scoring abilities on intelligence tests. I've known very bright people who do not have money minds, and they can make very unintelligent decisions. They can do all kinds of other things that most mortals can, but it just isn't the way their wiring works. We want somebody with hopefully a lot of talents, but we certainly do not want somebody who lacks a money mind, end quote. The topic of capital allocation brings the question paying out dividends and allocating capital to share buybacks. When a management team has extra cash, they really have five basic ways they could use that cash. They could reinvest back into the

Starting point is 00:16:44 business, they can pay down debt, make an acquisition, pay a dividend, or buy back their own shares. With regards to how managers should think about share buybacks, Buffett stated, you should buy in your stock when you don't have a use for the money. Once a company has attended to the things that are required or advantageous for the present business, we think repurchasing stock is a very logical thing to consider as long as you don't think you're paying more than the intrinsic value. And obviously, the bigger the discount from intrinsic value, the more compelling that particular use of money is, end quote. So share buybacks are quite attractive. to Buffett and one reason is because they directly increase his percentage ownership of that

Starting point is 00:17:25 business. He stated, we generally like the policy of companies with really wonderful businesses repurchasing shares. There aren't that many super businesses in the world, and the idea of owning more and more of a company like that over time has an appeal to us, and almost an appeal regardless of price. The problem is that most companies that repurchase shares are frequently so-so businesses, end quote. So to put some numbers to this, let's say you buy a stock for $20, and the earnings per share is $1, giving you an earnings yield of 5%. If the earnings of the business don't grow at all over five years, and all those earnings are used to buyback shares, then your earnings per share increase from $1 to $1.29 over those five years,

Starting point is 00:18:10 despite the overall earnings of that business not moving one bit. And that all assumes that, of course, your earnings multiple remains consistent over time. Historically, Berkshire has been pretty opportunistic with regards to buybacks. In 2020 and 2021, they ramped up their share buyback program significantly, and in 2024, that nearly came to a grinding hole. And this is really a helpful indicator if you're a Berkshire shareholder, because if Buffett is buying back shares, you know that he believes that the shares are undervalued at that point in time. 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 00:22:37 today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right. Back to the show. Prior to 2018, Berkshire would generally avoid share buybacks. They had a role where they wouldn't repurchase shares if the stock was trading at more than 120% of book value. So this imposed some price discipline on the managers. Book value became less and less relevant over time, and Buffett found himself with more capital than he was able to deploy, so he adjusted that strategy on buybacks after 2018. One of my favorite sources for understanding Berkshire Hathaway's intrinsic value is Chris Blumstrand. He's the president and chief investment officer at Semper Augustus.

Starting point is 00:23:27 My co-host, Stig Broderson, just published an interview with Bloomstrand on episode 717, and each year Chris shares his comprehensive annual letter. it's over 100 pages long, and in it, he shares his own analysis on Berkshire's intrinsic value. So shares of Berkshire in the past couple of years have done really well. They've appreciated by 15% in 2023 and 25% in 2024. And in 2025 here, the share price has been on a tear, now exceeding Bloomstrand's intrinsic value as spent around a $520 per B share. Based on today's share price, it appears that Bloomstrand has been quite,

Starting point is 00:24:07 right in recent years in believing that Berkshire was trading well below its intrinsic value. In his letter, Bloomsden highlighted that the intrinsic value and the market value are two distinct things. The market value moves up and down based on market sentiment, but the intrinsic value changes with the underlying company's earnings and future prospects. In the past two years, Berkshire's intrinsic value has grown by around 10%. And if they continue that level of growth, then we should expect the stock to compound at about that rate over the long term. That doesn't mean that Berkshire will never have another 50% decline, as Mr. Markets' moot swings can be quite volatile and unpredictable.

Starting point is 00:24:46 If you want a masterclass on understanding Berkshire Hathaway, be sure to tune in to our episode with Chris Bloomstrand and read his letter, which you can find at Semper Augustus's website. Turning here to dividends, Berkshire Hathaway has paid one dividend under Buffett's leadership. In 1967, they paid a 10 cent per share cash dividend. And Buffett has joked that he must have been in the bathroom when that decision was made because at that point, he knew that more shareholder value could be created by retaining the cash and reinvesting it or occasionally buying back shares.

Starting point is 00:25:18 Buffett stated in the 1997 meeting, we don't pay dividends because we think we can turn every dollar we retain into more than a dollar of market value. The only reason for us to keep your money is if it's not. becomes worth more by us keeping it than it would be worth if we gave it back to you. If we can create more than a dollar of market value for every dollar we'll keep, you're better off. Whether you want to take that dollar out by selling a little piece of your stock, or whether you continue to leave it in, that's the test. And I love this comment from Munger in the 2000 meeting.

Starting point is 00:25:52 What's interesting about what Warren is saying about logical dividend policy is that if you went to all the leading business schools of the United States, all the leading economics, departments and all the professors of corporate finance, this wouldn't be the way they would teach the subject. In other words, we're basically saying we're right and all the rest of academia is wrong, end quote. And then there's another quote here on share repurchases that was from 2023 from Buffett. Share repurchases can be the dumbest thing you can do or the smartest thing you can do. So the academic world tends to be more neutral with regards to share buybacks and dividends. And if you assume that the shares are rationally priced, I think that the academics

Starting point is 00:26:31 can favor dividends because it just returns to the cash straight to shareholders, and it signals strong financial health to the shareholders because it's expected that once the dividend is in place, then it's expected to stay there over time. Buffett and Munger are also quite skeptical of your typical management team's ability to make value-acredive acquisitions. They shared the example of Gillette issuing shares to buy Duracell, and the business didn't do as well as the investment bankers had projected. Gaico also tried to buy a few other insurance businesses, and as Buffett stated, those turned out to be disasters. Quoting Buffett here, why when you have an absolutely wonderful business, would you start buying others that are obviously mediocre, where you bring nothing to the party,

Starting point is 00:27:16 but it's very human to want to do that? Charlie and I have no urges like that. We want to buy easy things. We do not have to prove our manhood by doing something terribly difficult, end quote. In a similar vein to how Buffett and Munger have long preached the importance of business quality for long-term investment success, they've also highlighted the impact that management plays. The way Alex puts it here, with time, the interplay between the two draws them closer together. Said differently, best-in-class managers have a knack for positioning their companies well over time. As with many of the key investment and business lessons in this book, there are few examples that show this more clearly than Berkshire itself. What started as a loss-making textile manufacturer that was destined for failure, in due time, evolved over six decades into a thriving conglomerate that has eclips a trillion-dollar market

Starting point is 00:28:09 cap, end quote. In 1994, Buffett shared the two yardsticks he uses to judge management. The first is how well they run their business. You can look at their track record and learn more about their story and the stories of their competitors. Buffett wants to get a sense of how well they've played the hand that they were dealt. The second thing is to figure out how well they treat their owners. He stated, there are many companies somewhere in the 20th to 80th percentile, and it's a little

Starting point is 00:28:36 hard to pick out where they fall. But it's not hard to figure out, say, Bill Gates at Microsoft, Tom Murphy at Capital Cities, Don Keough at Coca-Cola, people like that, that are really outstanding managers. And it's not hard to figure out who they're working for, end quote. One way to get a sense of whether a manager is in it for themselves or for shareholders is to open up the proxy statement, which outlines executive compensation, equity compensation plans, and insider ownership. Ideally, managers should own a lot of stock and not receive excessive salaries and hand out hefty option packages. I would much prefer the CEO with a, say, $2 million

Starting point is 00:29:14 salary that owns $100 million in shares, than the CEO with a $50 million dollar salary with $25 million in shares. Shareholder alignment is certainly important, and that's not to say that some CEOs shouldn't make, say, $50 million, I believe that some high performers might deserve to make what looks like absorbent salaries if they deliver results that nobody else can deliver. Buffett and Munger prefer that managers also buy shares on the open market with their own cash rather than having shares just hand it out to them. It's a very old-fashioned system, but it's served them well. Everyone says that they want managers to think like owners, and it's very easy to think like an owner if you actually are one, especially when you handed over your own cash to become an owner.

Starting point is 00:30:00 And Buffett has a lot of unique experience in assessing managers. He's, of course, a public equity investor. He's bought many private businesses. He spent decades on the boards of companies, and he's a CEO himself. For purchasing private businesses, he wants to buy from managers who absolutely love their business. And he wants to do everything possible to avoid extinguishing or dampening that love. In the 2005 meeting, he also shared, what we're looking for beyond passion is intelligence, energy, and integrity. And if you don't have the last one, the first two will kill you. The last thing in the world you want from someone who lacks integrity is for them to be smart and energetic, end quote. There's another excerpt here from Munger in the 2011 meeting that I just

Starting point is 00:30:44 really resonated with. If you look at the greatest institutions in the world, they select very trustworthy people, and they trust them a lot. It's so much fun to be trusted. There's so much self-respect you get from it when you're trusted and are worthy of that trust, that I think your best compliance cultures are the ones which have this attitude of trust. Some of the ones with the biggest compliance departments like Wall Street have the most scandals. So it's not so simple that you can make your behavior better automatically just by making your compliance department bigger and bigger and bigger.

Starting point is 00:31:17 This general culture of trust is what works. Berkshire hasn't had that many scandals of consequence, and I don't think we're going to get huge numbers either, end quote. Now, the reason I resonated with this is because TIP very much has a trust-based culture. One of our founders, Dick Broderson is the CEO, and he's very hands-on in hiring team members, and our other co-founder is very much hands-off and trust that he's making the best decisions for the company. And I feel that an enormous amount of trust is put into all of the hosts, which, as I

Starting point is 00:31:46 discussed with Lawrence Cunningham back on episode 697, people who are trusted tend to want to vindicate and uphold that trust. This is a win-win for someone like Berkshire because Buffett is able to spend his time on better things and the managers are put in a position to perform better than they would if they worked within a culture with a lot of rules, guardrails, and red tape. And Munger had this amusing line from 1994, I have always preferred the system of retirement where you can't quite tell observing from the outside whether the man is working, or retired. A problem in many businesses, particularly the more bureaucratic ones, is your employees retire, but they don't tell you, end quote. I also appreciate Buffett and Munger's approach

Starting point is 00:32:28 of simply surrounding themselves with people they like, and this rule doesn't have to just apply to business. It can apply to your whole life. They want to work and spend their life with people that they like and people they admire, and it just makes life more fun, and it tends to make the relationship more of a win-win. Business to them is not just about making money, but enjoying the journey as well. Buffett believes that you can't do a good deal with a bad person, and it pays to avoid such people. We've long discussed on the show about how the best companies have a strong culture and a way of doing business that is difficult to replicate. The best companies have a good culture that stands the test of time, and they're easier to hold

Starting point is 00:33:09 on to long-term as shareholders because you know that the management team thinks long-term and treats shareholders well. And they keep themselves from taking the path of least resistance with things like stock options, massaging earnings figures, or not treating employees well. Costco or Hermes, for example, are companies that have created a win-win relationship for everyone. So you have the customers, the employees, the suppliers, the shareholders. and once that system is in place and that culture remains intact, it widens the company's competitive moat over time, making it near impossible for competitors to dislodge it.

Starting point is 00:33:49 On corporate culture, Buffett stated in 2015, I think culture has to come from the top. It has to be consistent. It has to be part of written communications. It has to be lived. And it has to be rewarded when followed and punished when not. And then it takes a very, very long time to really, really become solid."

Starting point is 00:34:09 I wanted to jump ahead here to part 11 titled Seas Candy, Coca-Cola, and Consumer Brands. This section highlights their transition to focusing on great companies at fair prices instead of fair companies at great prices. Alex shares a few great quotes here at the beginning of this section. It's not a great business when you have a prayer session before you raise your prices by a penny. You are in a tough business then. And I would say you can almost measure the strength of a business over time by the agony they go through and determining whether a price increase can be sustained. And then the second one here, the ideal asset is a royalty on somebody else's sales during inflation, where all you do is get a royalty check every month and it's based on their sales volume, end quote.

Starting point is 00:34:54 The second quote here really is especially interesting to me and it reminds me of a toll road business. I think Visa or MasterCard are excellent examples of this type of business as they are just sitting in the middle of trillions of dollars of payments that take place globally. The attractiveness of a royalty type business that Buffett describes here is threefold. First is that, it offers a natural form of inflation protection. As the cost of goods rise, the revenues of this business tend to rise in tandem. The second point here is that there are little to no capital requirements as the infrastructure of the business is already. built, there's no inventory or infrastructure to manage. And then the third attribute here is that the business scales without friction, creating operating leverage. So as the business grows and

Starting point is 00:35:41 earns more revenue, margins increase generating more and more profits with the passage of time. So Visa or MasterCard, for example, they ride the wave of increased commerce globally, but they don't share in the risk or the cost of the growth. When it comes to Seas Candy, this was a key reminder for Buffett that as investors, we must be open to continuing to learn to improve our skill set as investors. In 1972, Berkshire bought Seas Candy for $25 million. They were making pre-tax earnings of around $5 million and had the seller asked for $100,000 more dollars. They likely wouldn't have made the purchase. By 2019, Seas had delivered pre-tax profits of $80 million to Berkshire and had delivered cumulative profits up to that date of

Starting point is 00:36:27 over $2 billion. And then, you know, this represents a return of over 8,000 percent on their initial investment. Recognizing the value of a great brand like Seas led Buffett to also purchase Coca-Cola in 1988. The lesson also helped them avoid the inferior business models that might be trading on the cheap. In 1997, Buffett shared, it worked in the other direction too. I saw in the windmill business, pumps, and second-level department stores, and I found out just how tough it was. You could apply all kinds of energy to them, and it didn't do any good. It made a great deal of sense to figure out what pond to jump in. What pond you jumped in was probably more important than how well you could swim, end quote.

Starting point is 00:37:10 Similarly, in 2017, he shared, there's nothing like the pain of being a lousy business to make you really appreciate a good one. If you just stay out of a bunch of terrible businesses, you're off to a very great start. We've tried them all, end quote. One of the industries that typically has many subpar businesses is airlines. Airlines tend to have high fixed costs, high capital intensity, and low profit margins. They essentially sell a commodity, so price is a major factor in the minds of many customers, which creates a race to the bottom in the industry.

Starting point is 00:37:43 And they don't control one of their primary costs, which is fuel. So a spike in oil prices can crush margins, and to make matters worse, airlines are heavily unionized, making it difficult to control a lot of, labor costs, and the industry is highly regulated, making it difficult to continue to maintain and update their standards. In 2017, Buffett stated, you couldn't pick a tougher industry than airlines. Since Orville Wright went up in that plane, if anybody had really been thinking about investors, they should have had Wilbur Wright shoot him down to save everybody a lot of money for 100 years. Something like 100 airlines have gone bankrupt in the last few decades, Charlie and I were

Starting point is 00:38:21 directors for some time at U.S. Air. People write about how we had a terrible experience in U.S. Air. It was one of the dumbest things I've ever done, end quote. Ironically, Buffett purchased the four largest U.S. Airlines in 2016, and then he sold out of them in April of 2020. So in 2020, he reiterated the competitiveness of the industry, and he shared that even if one percent of their millions of customers were unhappy, it could lead to big headaches for the companies and a lot of negative publicity. Once the future of the industry was no longer clear to Buffett, and he faced a reality that these companies would need to take on billions and billions of dollars of debt. He decided to just cut his losses and move on, and they were taking

Starting point is 00:39:03 on that debt due to COVID, of course. Had Buffett not come to the realization of buying great businesses, Berkshire wouldn't be anywhere near what it is today. Monish Pabri rightly shared on our show on episode 550 that Berkshire's success really comes down. to around 12 decisions over the past 60 years. Over that time period, Berkshire bought more than 80 businesses and 210 stocks, bringing us a total of around 300 key decisions. If we take those 12 winning decisions out of the 300 total decisions, that gives us about a 4% hit rate on what really moved the needle for them. Munger has agreed with this premise, as he said, if you've removed Berkshire's 15 best decisions, then their track record would be useless.

Starting point is 00:39:48 As I discussed in-depth on episode 693, this power law phenomenon isn't just unique to Berkshire. We see it everywhere in the world. The big decisions for Berkshire likely included things like buying Apple, American Express, Coca-Cola, Seas Candy, National Indemnity, Washington Post, and BNSF, as well as partnering with Charlie Munger and a G-Shane. So this section also talks about consumer brands as a whole. In 1999, he talked a bit about Coca-Cola. I quote, it's in Coke's interest to have prosperous countries around the world.

Starting point is 00:40:22 They will benefit from increased prosperity and increased living standards throughout the world. I think people's preferences for Coca-Cola products will do nothing but grow. What I am concerned about is share of market and then what I call share of mind. In other words, what do people think of Coca-Cola now compared to 10 to 20 years ago? What are they going to think about it 10 to 20 years from now? Almost everybody in the world has something in their mind about Coca-Cola products, and overwhelmingly, it's favorable. We want a lot more unit cases sold, and we like the idea of fewer shares outstanding over time. The PE ratio of Coke, like virtually every other leading company in the world, strikes us as being quite full.

Starting point is 00:41:05 That doesn't mean they're going to go down, but it does mean that our enthusiasm for buying more of these wonderful companies is less than if the PE ratios were substantially less. Ideally, those are the kinds of companies we want to buy more of over time, end quote. So these are the types of questions that Buffett would be asking about a consumer branded company like Apple, for example. What did people think of Apple 10 years ago? How has that changed to today? And what might people think of Apple 10 years from now? This strong customer mindshare can create a barrier to entry for competitors.

Starting point is 00:41:41 In 2012, Buffett shared, there are some industries that are never going to have barriers to entry. In those industries, you better run very fast because there are a lot of people who are going to be looking at what you're doing and trying to figure out your weakness or what they can do a little bit better. A great barrier to entry is something like Coca-Cola. If you gave me $20 billion or $30 billion and told me to try to knock off the Coca-Cola company with some new cola, I wouldn't have the faintest idea how to do it. There are billions of people around the world that have something in their mind about Coca-Cola, and you're not going to change that with $20 billion, end quote.

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Starting point is 00:45:44 This customer mindshare that Buffett is talking about here can also be referred to simply as the brand. Great brands become more valuable with time and can become more difficult to dislodge if it's nurtured and well taken care of. To expand further on this in 2015, Buffett shared, a brand is a wonderful thing to own during inflation. The value of any strong branded goods. increases during inflation. Gillette bought the entire radio rights to the World Series in 1939 for $100,000. Think of the number of impressions they made on mines in $1939 for $100,000. They were getting in the minds of young guys like myself, and they did it in those dollars. If you were going to go out and produce a similar number of impressions on millions of mines now,

Starting point is 00:46:31 it would cost a fortune. It was a great investment, which could be made in $1939. that paid off in selling razors and blades in 1960, 1970, and 1980, end quote. I think the key point here is that a strong brand has the ability to raise prices at a rate greater than inflation. So it's a gift that just keeps on giving. If you look at Apple, for example, since the iPhone's debut in 2007, the price of their flagship models have increased at an average rate of 5.8% over the last 14 years. To use round numbers here, if the price of the original model started at $500, the price today

Starting point is 00:47:11 would be around $1,100 at that rate of increase. And it just so happens I recently got a new iPhone and it was just that price, $1,100. Had the prices grown at a rate of CPI, then that phone would have costed just $660. Because of the Apple brand, they're able to position themselves as a premium product and a ton of customers don't really care if the phone costs $1,000 or $2,000. because the iPhone is just what they want for a number of different reasons. Some customers likely also justify the high price by accepting that the features are a little bit better in terms of storage, processing speed, or camera.

Starting point is 00:47:47 I just got a new phone the other day, and really the only reason I wanted to upgrade was because I wanted a good camera to take pictures at our live events for our TIP Mastermind community in Omaha and New York City. I've been a close follower of Alex Morris's research service, The Science of Hitting, and I read all of his articles on Costco prior to my episode on the company back on episode 691. There have been a couple of times that Costco has been discussed by Buffett and Munger. Munger joined the board of Costco in 1997, so they've definitely been familiar with the business for many decades. With regards to Costco, Buffett stated,

Starting point is 00:48:24 Costco is an absolutely fantastic organization. We should have owned a lot of Costco over the years, and I blew it. Charlie was for it, but I blew it. Believe it or not, this line was from the 2000 annual meeting, and since the year 2000, shares of Costco are up by around 30 times, from $30 a share to over $900 a share. You can use this example the next time you feel bad about missing out on the next big winner. I feel that I have to include a quote from Munger on Costco as well, so I picked one out here. Costco is a business that became the best in the world in this category, and it did it with

Starting point is 00:48:58 an extreme meritocracy and an extreme ethical duty, self-imposed to take all of its cost advantages as fast as it could accumulate them and pass them onto customers. And of course, that created ferocious customer loyalty. It's been a wonderful business to watch, and of course, strange things happen when you do that long enough. Costco has one store in South Korea that will do over $400 million in sales this year. These are figures that can't exist in retailing, but of course, they do. And so that's an example of somebody having the right managerial system, the right personnel

Starting point is 00:49:35 selection, the right ethics, the right diligence, etc. That is quite rare. If once or twice in a lifetime you're associated with such a business, you're a lucky person." Next here, I wanted to jump to the section on Mr. Market. This topic is quite timely given the recent volatility in the stock market as a result of the U.S. tariff announcements. Public equities are a powerful tool for wealth creation due to their liquidity profile and low

Starting point is 00:50:01 trading costs. And these features can either be an investor's greatest advantage or an investor's greatest disadvantage. Benjamin Graham shared the wise words that investment is most intelligent when it's most businesslike. It's easy to treat buying and selling stocks as simply shifting around little pieces of paper that really have no real meaning, other than just this piece of paper, having a price quote that changes by the minute. This sort of mindset leads investors to buy what's hot and what's

Starting point is 00:50:29 going up and dump the price quotes that are going down the drain. Alex shares here, maintaining a long-term perspective in the face of daily market trading can be difficult. It requires an ability to react calmly in response to the veggarees presented by Mr. Market. To do so, one must have a clarity of purpose, a well-defined investment philosophy and opportunity set, as well as an underlying rationale for their decisions, otherwise trouble looms. To quote Munger, the fretful disposition is an enemy of long-term performance, end quote. Most times in recent years, the market is in a pretty good mood, with stock prices going up, but occasionally it really throws a fit, presenting opportunities to buy good businesses at lower prices. In March of 2020, the S&P 500, from peak to trough, dropped by 34%.

Starting point is 00:51:19 In the 2022 bear market, it fell by 25%. As of the time of recording, we're nearing around the 15 to 20% range in terms of the drawdown. Nobody knows how long the drop will last or how far prices will drop, but history suggests that all bear markets do come to an end in the share prices of great companies reverse. In the 2012 meeting, Buffett shared, we've run Berkshire now for 47 years. There have been four or five times that we've thought that the stock was significantly undervalued. We saw the price get cut in half roughly four times in fairly short periods of time. I would say this, if you run any business for a long period of time, there are going to be

Starting point is 00:51:58 times when it's overvalued and times when it's undervalued. Continuing here, Tom Murphy ran one of the most successful companies the world has ever seen in capital cities, and in the early 1970s, his stock was selling for a third of what you could have sold the properties for. Berkshire back in 2000 or 2001 was selling at what I thought was a very low price. The beauty of stocks is that they do sell at silly prices from time to time. That's how Charlie and I have gotten so rich. Ben Graham writes about it in Chapter 8 of The Intelligent Investor.

Starting point is 00:52:30 It says that in the market, you're going to have a partner named Mr. Market. And the beauty of him as your partner is that he's kind of a psychotic drunk. He will do very weird things over time, and your job is to remember that he's there to serve you and not advise you. And if you can keep that mental state, then all those thousands of prices that Mr. Market is offering you every day on every major business in the world practically, he's making lots of mistakes and he makes them for all kinds of weird reasons, end quote. So the important thing to remember here is that the stock is not the business and the business

Starting point is 00:53:04 is not the stock. Buffett is coming up with his own estimate of the value of the businesses he owns and he's looking at potentially owning and only purchases when the quoted share price is well below his estimate of value. Many investors naturally equate the quoted share price with value and don't distinguish between the two. When I chat with people about my work here as a host and tell them that I follow the stock market and whatnot, many people will ask me what I think the market will do this year. Now, I don't think people are disingenuous when they ask this question, but I think it's sort of the wrong question to ask because I don't think anyone has a clue about what the market is going to do

Starting point is 00:53:42 this year. The S&P 500 has over 500 takers in it, each with their own business prospects and shareholder bases that have either rosy or doomy futures for them. For someone to say that they know the direction of this assortment combined into one, which we call the S&P 500, is sort of asinine. And I haven't come across anyone who is a macro, short-term-oriented investor that has beaten long-term investors. We study here on the show and interview like Frantreau Robert Sean, Terry Smith, Joel Greenblatt. And this ties into my next quote here from Buffett in the 1999 meeting. Charlie and I don't think about the market.

Starting point is 00:54:19 We look at individual businesses. We don't think of stocks as little items that wiggle around in the newspaper and that have charts attached to them. We think of them as parts of a business. And it is true that currently we have great trouble finding businesses that we both like, we like the management team, and find them at an attractive price. That is not a stock market forecast in any way, shape, or form. We have no idea whether the market is going to go up today, next week, next month, or next year.

Starting point is 00:54:50 We do know that we will only buy things that we think make sense in terms of the value we receive for Berkshire. And when we can't find things, the money piles up. When we do find things, we pile in. But I know of no one who has been successful and really made a lot of money predicting the actions of the market itself. I know a lot of people who have done well picking businesses and buying them at sensible prices. And that's what we're hoping to do, end quote. Now, one of the things that Francois Rochon and I discussed back on episode 626 was his theory of the tribal gene.

Starting point is 00:55:24 His theory states that around 95% of the population has a strong urge to follow the crowd. So when the market is falling and people are fearful, they tend to be fearful as well and have the strong desire to sell their stocks. They simply can't help themselves but follow their natural instincts. Or when you have, say, Nvidia's share price skyrocketing, they have the urge to want to buy in since all the mainstream news is talking about it. If we go back to the hunter-gatherer days, it paid to not question whether or not you should run away from the tigers alongside your peers.

Starting point is 00:55:58 Francois believes that around 5% of the population has this gene missing and they're better equipped to think independently and do the opposite of what the crowd is doing. When the stock market is depressed and everyone is panicking, they are able to identify misprice assets that others are emotionally selling. And this isn't necessarily a question of intelligence. Buffett often talks about how success in investing does not correlate with intelligence. He once said, once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble and investing, end quote. It takes a certain temperament to accept that none of us have any clue what the market is going to do this year.

Starting point is 00:56:41 Humans are generally hardwired to dislike uncertainty, and we would all feel more comfortable if we somehow knew what was going to happen next. Our brains evolved in environments where pattern recognition meant survival, so spotting a lion in the grass or tracking prey would be quite helpful. We carry this pattern-seeking tendency into markets, even when the patterns are noise. As I'm typing up my notes for this episode, the market is going through this turbulence due to the tariff announcements, and after a few days of stocks going down, I'm getting flashbacks to March 2020, where many people sort of assumed that the world was ending and we were

Starting point is 00:57:17 entering into the next Great Depression. And I can sense the level of recency bias that people can have. When stocks are going up, people naturally assume that they'll keep going up, and vice versa, when they're falling. It can be tempting to try and time the bottom of the market, but generally, I think it's best to just dollar cost average your way in to minimize regret. The odds of putting all of your cash in at the bottom is practically zero, so I like to take the approach of buying, say, on a 20% pullback, and also be ready mentally and financially for it to drop further. Markets can drop in bottom as quickly as ever, and we don't know when that bottom is in until we

Starting point is 00:57:55 have the benefit of hindsight. And with the craziness we've seen in the markets in recent years, it's interesting to see some value investors get interested in shorting stocks that they believe are overvalued. Buffett has shared that short selling has ruined a lot of people. When shorting stocks, your downside is unlimited, but your upside is actually only 100%. So it's sort of the opposite of an asymmetric bet. In 2001, Buffett stated, you will see way more dramatically overvalued stocks in your career than dramatically undervalued stocks. It's the nature of the securities markets to occasionally promote various things to the sky so that securities will frequently sell for 5 to 10x what they're worth, and they will

Starting point is 00:58:38 very, very seldom sell for 20% or 10% of what they're worth. So you might think it's easier to make money on short selling. All I can say is that it hasn't been for me, end quote. Munger followed him up there, being short something, which keeps going up because somebody is is promoting it in a half-cricked way and you keep losing while they call for more margin, it just isn't worth it to have that much irritation in life. It isn't that hard to make money somewhere else with less irritation." Another comment that is often shared by people in the investment community is Buffett's thoughts on index funds. He said that the best thing for

Starting point is 00:59:16 most people is to just simply invest in something like the S&B 500. He also mentions that you want to be mindful of the fees you pay with such a fund. There are a host of options out there to give you exposure to the S&B 500. One I'm pretty familiar with is Vanguard's VOO. For example, this has an expense ratio of 0.03%. So it might sound obvious to many of our listeners that if you're going to own a broad-based fund, you should look to minimize your expenses. But I continue to be shocked by the number of people that I meet who put their money in with an investment advisor. and these funds have mediocre performance. They're not even close to the S&P 500.

Starting point is 00:59:56 And on top of that, they have expense fees of 1% or even 2%. It's certainly comforting to have the stamp of approval on passive investing from someone like Buffett for those who don't want to have 100% of their net worth in, say, individual stocks or a broadly active strategy. I've long wanted to do an episode on the benefits of owning an index fund. there are some benefits that I think are quite overlooked by some investors, one of which is that most individual stocks end up delivering a return below that of U.S. Treasuries, which makes stock picking just a really hard game.

Starting point is 01:00:31 The other part is the inherent skewness of the market. So a select few winners tend to deliver the majority of the market's gains, meaning that there's just a tremendous benefit to owning a broad-based fund, because that essentially guarantees that you're going to own a lot of the winners. Another benefit of index funds is that being broadly diversified can make it easier psychologically to weather through drawdowns. A 20% drawdown in the S&P 500 every few years is pretty much par for the course, but when you have a 20% drawdown on an individual stock, you have to wonder about whether you made

Starting point is 01:01:05 a mistake in owning it or not in the first place. Remember that most stocks do underperform treasury bills. Buffett also encourages dollar cost averaging. In 2002, he shared, there's no single metric I can give you or you. or that anybody else can give you, in my view, that will tell you this is a great time to buy stocks or not to buy stocks. It just isn't that easy. That's why you go to an index fund, and that's why you buy over a period of time. Similarly, in 2004, he shared, if you accumulate a low-cost index fund over 10 years with fairly regular sums, I think you will probably

Starting point is 01:01:38 do better than 90% of the people who take up investing at a similar time, end quote. And I think that this is such important advice to share because it's likely not shared often enough simply because there's little money to be made in sharing such advice. Too often, we hear other pitches for active strategies or annuities or life insurance that pay out hefty commissions to the salesperson. While I can appreciate that Buffett and Munger haven't excessively promoted Berkshire in any kind of way, promoting the stock itself, they really don't put their money where their mouth is with regards to index funds. In 2011, Buffett shared that the average person should just buy index funds, but he himself believed that Berkshire Hathaway was a better

Starting point is 01:02:19 bet at the time, and then Charlie shared the opinion that he would be very unhappy to own an index fund because his ambitions are larger. Getting towards the end of the book here, I thought a good way to top off the episode would be to share some of the books that Buffett and Munger have recommended over the years. Buffett was once asked about the best way one could prepare for an investing career, to which he said, read 500 pages every day. That's how knowledge works. It builds up like compound interest. All of you can do it, but I can guarantee not many of you will do it, end quote. Buffett has stated that the most important chapters to read about investing are chapters 8 and 20 from the intelligent investor. In the chapter from the general theory by John Maynard Keynes that related to

Starting point is 01:03:04 markets, the psychology of markets, and the behavior of market participants. For those interested, I actually covered the Intelligent Investor by Ben Graham back on episode 620. But if it also recommends Philip Fisher's common stocks and uncommon profits, which my co-host Kyle Greve recently covered back on episode 646, he also recommended John Trains book, The Money Masters, which is one I personally have not read yet. In 1996, Munger expressed deep interest in biology, recommending the books The Selfish Gene and the Blind Watchmaker.

Starting point is 01:03:35 And in 98, Munger stated, I have recently read a new book twice, which I very seldom do, and that is Guns, Germs, and Steel by Jared Diamond. It's a marvelous book in the way the guy's mind works would be useful in business. He's got a mind that is always asking why, why, why, and he's very good at coming up with answers. I would say it's the best work of its kind I have ever read. Munger also recommended the Warren Buffett portfolio by a friend here of TIP, Robert Haxstrom,

Starting point is 01:04:03 who's been a guest on the show multiple times. He's also a big fan of biographies. He recommended The Titan, which covers the life of John D. Rockefeller. That's a great book. There are a host of other books that they've mentioned, but I'll leave you with just a few more here. One amongers all-time favorites is Influence by Dr. Robert Chaldeini, which dives into the psychology of persuasion, and I actually interviewed Chaldini last year on episode 616. The most recent recommendations in the book are from 2015.

Starting point is 01:04:32 Buffett recommended Adam Smith's, well, thank you. of nations, and Keynes' is where are the customer's yachts. So that wraps up today's episode on Buffett and Munger Unscripted. Again, if you're able to make it to the Berkshire Hathaway annual meeting in 26, I would highly recommend considering attending. We'll be hosting a few in-person events throughout the weekend for our TIP Mastermind community. Also, TIP is hosting another event this fall in 2025 in the mountains of Big Sky, Montana in September. So the events called The Investors Podcast Summit. We'll be gathering around 25 listeners of the show to bring together like-minded people and enjoy great company with a beautiful mountain view. We're looking

Starting point is 01:05:12 to attract thoughtful listeners of the show who are passionate about value investing and are interested in building meaningful connections and relationships with like-minded people. Many of our attendees will likely be entrepreneurs, private investors, or portfolio managers. I'm thrilled to be hosting this special event for our listeners, and I can't wait to hopefully see you there. So to get more information, you can head to our website. We have the pricing, frequently asked questions, and the link to apply to join us. So if this sounds interesting to you, you can check it out at theinvestorspodcast.com slash summit. That's theinvestorspodcast.com slash summit. Again, spots are limited, so be sure to apply soon if you'd like to join us.

Starting point is 01:05:53 So with that, thank you for your time and attention today. And I hope to see you again next week. 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 - TIP718: Buffett & Munger Unscripted by Alex Morris

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