Summary “Poor Charlie’s Almanac” book

by Charlie Munger, life-long partner of Warren Buffet at Berkshire Hathaway

Book is kinda big, 530 pages. Lot’s of illustrations and photos. Book is 2005, take into account this timing. Can be bought here: http://amzn.to/2uOPOzi

He is 93 y.o. now.

Book is more on life and not only investing.

VC / Tech

• This is my business, so I was kinda surprised: Bill Gates on Munger: … When discussing venture capitalists who defend stock options he deems them “no better than the piano player in a whorehouse”.
• “Speculative tech and biotech stocks” :-/
• Avoided this space in late 1990s as it was really far from fundamentals

Personal features

• Ethical.
• Hard working.
• Smiles a lot on his own jokes.
• Reading a lot, all the time. “Book with legs”.
• Trained himself to focus and not being distracted, to the extent of being rude/arrogant with his ignore of friends/colleagues etc. when he is mentally into something.
• Used famous people’s biographies to inspire and to learn for himself. Cicero, Ben Franklin, etc.
• Franklin was a role-model for him as a cross disciplinary person.
• Cicero’s things: 1) Life-long self-development 2) Support rejections of conventional point of views.

Biography

• Married 2 times, 4 children.
• Born in 1924. From family of lawyers etc. Impressed but didn’t suffer in Great Depression.
• Studied maths, physics for couple of years, worked in meteorology, then law at Harvard (master’s).
• Started as a lawyer in LA, then established a partnership with colleagues. Client marketing? “Your best marketing tool is the job on your table”.
• Started investing in real estate projects together w/ real estate customers, made around $1.5m in 8–10 years (in 1960s, so this is around $7–10m in today’s dollars)
• Met Buffet in mid 30’s (they were very impressed by the intelligence of each other) and then in couple of years they partnered, with smaller share for Munger.

He is hyper-rational. Ultimate reductionist.

• Key idea: many multidisciplinary models should be used in business — collect them and use.
• Life has everything interrelated, feature of the Universe. Thinks about anything as something a part of the bigger ecosystem.
• If there are 20 factors and they interact — you need to learn them. That’s the way the world is. It is not easy, but analyse step by step with curious persistence.
• Learn to discard models from time to time (one your best model per year).
• Grab core big ideas from major big disciplines / develop fluency in these models.
• “You are the easiest person to fool”.
• He says he has around 100 models from history physics biology psychology to economics statistics engineering mathematics etc.

Examples:

• Redundancy/backup system model from engineering.
• Compound interest from mathematics (“understanding both power of compound interest and the difficulty of getting it is the heart and soul of understanding of a lot of things”.)
• The breakpoint/autocatalysis from chemistry/physics.
• Modern Darwinian synthesis from biology.
• Cognitive misjudgment from psychology.
• Variety of models is required. His famous diagnosis for narrow specialisation: “for the man with a hammer the world looks like a nail”.
• You need different check lists for different companies.
• Academia is a fatal disconnectedness now. People in each dept. don’t see the big picture. Professors should know models from other disciplines.
• Learned these models by himself.
• Combination of models AND application of them together = critical mass, they reinforce and amplify each other. (“Lollapalooza effect”).
• Clarity is the end, not starting point. It is the result of his long thinking, many iterations of thinking, etc.
• Buffet: “fooling yourself is easy, apply logic to avoid. Charlie Munger will not accept anything I say just because I say it, although most of the world will” =]

Investing

• Eliminate universe of what NOT to do + multidisciplinary attack what remains + be patient, but act decisively only when right circumstances.
• “Preparation, patience, discipline, objectivity”.
• 3 stocks per year, doesn’t see value in the diversification, focused approach works.
• Screening and selection of business into 3 investments per year is like a survival in a ruthless Darwinian process in the ecosystem.
• Patience. Classic value investing in Ben Graham’s tradition — sit on cash, wait, sometimes bet big. May wait for years in gov. or municipal bonds waiting for the right time for stocks. Patience = sit on lots of cash and do nothing. If you swing too much, then when you will see really great opportunity — you will have simply all your capital busy to load it into really important big swing. (And asset management industry preferred to be fully loaded all the time).
• Focuses first on what to avoid = freeing time and attention for “more productive regions of the chess board”.
• Simplification is great, but avoid “physics envy” (human desire to reduce enormously complex&interacting systems (e.g. economics) to one-size-fits-all Newtonian formulas).
• Core model for investing is a psychology of human misjudgment. So you not only:

(1) analyse world’s driving forces rationally (even try to estimate probabilities),

but

(2) also analyse how your subconscious automatically forming conclusions and (a) by large they are useful but (b) some are malfunction.

• Value investing: bet on a horse with 1/2 chance to win but if win then do 3 to 1 pay off. You are looking for misplace gamble.
• Buy when everybody fears.
• Businesses with competitive advantages, which can survive fluctuations in environment. Avoided promoted deals and IPO’s.
• Balance sheet is OK, accounting is OK, but competitive advantage is a very broad thing: from regulatory climate and labor/supplier/customer relationships to potential impact of technology/prices/competitors to exposure to the hidden risks.
• Key idea is to find businesses with WIDENING moats (moat = virtual physical barrier against incursions).
• Competitive destruction is fierce. Out of blue chip 50 stocks in 1911 only General Electric survived as as a standalone company.
• Top management is trustworthy if allocates cash intelligently on behalf of owners, not pursuing ego-oriented growth for growth’s sake.
• It is important to understand boundaries of your competence, your circle of competence.
• Need passionate interest in why things are happening. If kept over long periods — improves ability to focus on reality. More important than I.Q.
• Checklist helps to be disciplined.

Beta/CAPM/diversification:

• This is nonsense that volatility measures stock’s risk. How academia can teach this?
• The idea of excessive diversification is madness
• Cost of capital is misleading. If you need to borrow — you probably can calculate your cost of capital. If you are not leveraged — how you can know? Academics are bonkers here… They say if you make 100% on your equity, you cannot invest into 80% income projects — this is nonsense.

Ethics

• Doing right things paid them off all the time.
• They say now in USA status quo is that you can do anything for which you wouldn’t be imprisoned = degradation of ethical standard in USA

Berkshire Hathaway

• Free cash from insurer Wesco before they need to repay premiums to insured customers, at 3%/year. Berkshire invested at 13% pre-tax
• Leverage is almost zero for many decades. If used leverage half of Murdoch’s, they would be 5x larger
• Founder of NetJets in 1990s was an inventor of fractional ownership for private jets
• Do not distract CEO’s of their acquired companies, they focus solely on businesses
• We have three baskets: in, out, and too tough. We have to have a special insight or we put to “too tough” basket.
• Focus on the areas of your competence. If you have a competence, you know the edge and boundaries.
• IPOs — probably you can select a few per year. But for us they are (a) too small or (b) too high-tech — we don’t understand high-tech.
• Liquidity of some asset often leads to crazy booms in it. E.g. small abs. price of share (and Berkshire’s stock costs thousand dollars per share).
• Stocks are valued on the spectrum:
• (a) like bonds (some prediction on the future income) or
• (b) like Rembrandt paintings (price is going up because it was going up in the past).
• Prediction of price of Rembrandt paintings is really hard: how far, how high, how long it will last?
• November 2000: If stocks compound at 15%/year going forward, it will be big “Rembrandt effect”.
• e.g. Dotcom bubble was the same craze.
• e.g. Stocks in Japan were traded at multiple of 50–60 to earnings, and then had 10 years of depression.

Asset management etc.

• An idea on Wall Street that quarterly results matter make an enormous pressure on the stock prices, misleading in all ways.
• Asset management industry adds zero net value. General public sucks from it and from brokers, by a few % per year charges.
• Index investing is much better and costs less than 1%/year of charges.
• If almost everybody will stick to index investing, it will suck. But for the long time from now it would be just fine.
• Investment banks gone to deteriorated morale.
• Arthur Andersen was a problem because they were a partnership, and partnerships should be more ethical.
• Creative accounting is an absolute curse for the civilisation
• When you hear EBITDA, substitute it with “bullshit earnings”
• Black-Scholes is “know nothing system”. It is OK for <90 days time horizon and if you know ONLY price. Otherwise it is meaningless.
• Options produce terrible behaviour. If CEO made a company, and in his sixties, how an option would help? Would Mayo doctors or lawyers at Cravath in their sixties work harder if they had options?
• Options cannot have no cost. This led to many nations-wide excessive distortions and accounting games.
• Options are both expense AND dilution.
• Financial institutions make all us nervous because they are too leveraged.
• Risk management is crazy for sure.
• People don’t think about consequence of consequences.
• People start trying to hedge against interest rate changes, which is very difficult and complicated. Then reported profits look lumpy. Then they use new derivatives to smooth it. Now you’ve morphed into lying.
• Political power of plaintiffs’ bar is increasing. Supreme Court judges are for life — what can jeopardise them? Only anger of groups like plaintiffs’ bar…

Personal life

• How to find good spouse? The best single way is to deserve good spouse.

Other

• Ethos of not fooling yourself is very important
• Avoid personal debts. You cannot get ahead paying 18%.
• Japanese are workers by culture. Chinese are gamblers by culture. (On Japan recession and Hong Kong bubbles).
• Japan had recession for 1990–2000 with minus one interest rate and no growth. If you describe this situation to Harvard economists, they would say this is impossible. =]

Humor

• When I moved to California, there was a part-time legislature controlled by gambling/racetrack/liquor distributors who wined and dined the legislators. I think I prefer that to today’s full-time legislature.

Now these 150 pages stop, and 11 of his speeches follow.