Tuesday, June 30, 2009

Buffett's Record

Cool interactive chart of Buffett's record going back to the 1950's:

It shows if a person put $10k in the Buffett partnership in the 50's and held until today it would be worth ~$ 300,000,000. Many early investors in the partnership have never sold their shares.

If alternatively, that person decided to put $ 10k into the S&P 500, it would be worth ~$ 1.4 million today.

Multiple studies have shown most professional money managers, in fact, don't even get a return as good as the S&P 500 over the long run.

The problem is that many pros can have a good 5-10 year run...which unfortunately draws money in from investors during a bull market when everyone looks like a genius. Great investors separate themselves during bear markets and over time periods much longer than 5-10 years.

"You make most of your money in a bear market, you just don't realize it at the time." - Shelby Davis

Better to be not too impressed by fund managers boasting about 3, 5 or even 10 year performance.

Check out the chart.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Monday, June 29, 2009

On Bear Markets

From an article on investing when markets are in turmoil:

In his 1961 letter to partners, a 31-year-old investor in Omaha named Warren Buffett told his partners that they should be judging him during times of turmoil and not times of jubilance. "I would consider a year in which we declined 15% and the [Dow Jones Industrial] Average 30%, to be much superior to a year when both we and the Average advanced 20%." Very early on in his career, Buffett was aware that performing well during market turmoil was the key to long-term success as an investor.

It is during bear markets -- when the economic environment is most challenging -- when the real money usually gets made. That's when the biggest discounts to value become available even if buying doesn't feel great at the time. The shares of a good businesses that might, in fact, be cheap (i.e. price is nicely below a conservative estimate of per share intrinsic value) will often go on to become temporarily even cheaper.

So near term price action must be ignored. The focus should be on buying shares of quality businesses at a discount -- on long-term effects and outcomes. Trying to buy at the bottom is futile. Attempts at avoiding the inevitable temporary paper losses generally just leads to missed opportunities.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Sunday, June 28, 2009

Coca-Cola in 1930

Cool blog that each day posts a summary of the Wall Street Journal from the corresponding day in 1930.

Here is one headline from this past Friday in 1930.

Coca-Cola estimates earnings for second quarter $4.50M compared to $3.94M in 1929. Says depression is having little effect on operations. Trying to increase sales in foreign markets; export sales were up 32% in 1929 and 82% in 1928. Now sold in 76 countries, up from 30 in 1926.

Coca-Cola will earn over $ 6 billion in 2009.


Adam


This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Friday, June 26, 2009

Max and the Chauffeur

The following story was told by Charlie in a 2003 speech at the University of California.

By the way there's a famous story about Max Planck which is apocryphal: After he won his prize, he was invited to lecture everywhere, and he had this chauffeur that drove him around to give public lectures all through Germany. And the chauffeur memorized the lecture, and so one day he said, "Gee Professor Planck, why don't you let me try it as we switch places?" And so he got up and gave the lecture. At the end of it some physicist stood up and posed a question of extreme difficulty. But the chauffeur was up to it. "Well," he said, "I'm surprised that a citizen of an advanced city like Munich is asking so elementary a question, so I'm going to ask my chauffeur to respond." - Charlie Munger


In a separate speech in 2007, he added these comments to the above story.

In this world we have two kinds of knowledge. One is Planck knowledge, the people who really know. And then we've got chauffeur knowledge. They have learned the talk. They may have a big head of hair, they may have fine temper in the voice, they'll make a hell of an impression. But in the end, all they have is chauffeur knowledge. I think I've just described practically every politician in the US.
- Charlie Munger

Check out both speeches.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Tiger Woods and Bill Gates

Very different skills, similar advice.

Tiger Woods: Best advice (from his Dad)? Keep it simple.

"My dad's advice to me was to simplify. He knew that at my age I couldn't digest all of golf's intricacies. He kept it simple: If you want to hit the ball to a particular spot, figure out a way to do it. Even today, when I'm struggling with my game, I can still hear him say, "Pick a spot and just hit it." When I'm making adjustments during a round, I know some of the television commentators theorize that I'm changing this or moving that, but really what I'm doing is listening to Pop."

Bill Gates: Best advice (from Warren)? Keep it simple.

"Well, I've gotten a lot of great advice from Warren. I'd say one of the most interesting is how he keeps things simple. You look at his calendar, it's pretty simple. You talk to him about a case where he thinks a business is attractive, and he knows a few basic numbers and facts about it. And [if] it gets less complicated, he feels like then it's something he'll choose to invest in. He picks the things that he's got a model of, a model that really is predictive and that's going to continue to work over a long-term period. And so his ability to boil things down, to just work on the things that really count, to think through the basics -- it's so amazing that he can do that. It's a special form of genius."

I don't know much about golf...but the reasons to invest in a business should be pretty simple:

Something like this is a great investment because the company...
  • owns dominant brands with broad distribution creating a wide economic moat and durable high returns on capital.
  • is selling at a fair price relative to its long-term prospects.
  • has competent management with a solid track record.
  • is built around a conservative capital structure.
I noted in previous posts that Buffett believes there should be little need for tricky calculations* but you need to have the patience to wait for that fair price.

Having that patience is easier said.

Coca-Cola (KO) is a good example. If someone started investing in the mid-1990's and decided KO was a good business back then...that person would not have been able to buy it at a fair price until 2006. Patience is more important than IQ. Seeing that KO was overvalued back then required 4th grade math. It was selling at over $ 80/share in 1998, was earning less than $ 1.00/share yet informed market participants were still buying. Efficient markets? Today KO is selling in the mid to high $ 40's/share and will earn $ 3.00/share this year. So it can be bought at a fair price.

By the way, that's a rock solid $ 3.00/share of earnings that will grow over time. Earnings will not always be smooth but the general direction is up. So KO tripled its earning power per share in slightly more than a decade. Some cyclical businesses** can appear to triple earnings rapidly in an economic upturn but those profits usually get crushed during a downturn. These highly variable, not necessarily durable earnings need to be normalized across a business cycle to get a true picture. Not so for the KO's of the world...that triple in earnings power is the real deal.

With its growth in earnings KO intrinsically has become much more valuable over the last ten years. It's just that the stock price has been a very poor proxy for this increase in intrinsic value.

"I call investing the greatest business in the world because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! and nobody calls a strike on you. There's no penalty except opportunity lost." - Warren Buffett in Forbes


One challenge in investing is the pressure from taking a swing now, but not getting meaningful feedback for many years. Some may say that quarterly earning reports, or the stock price itself provide a scorecard, but I mostly disagree. Quarterly earnings do not tell you whether a competitor will emerge (or a substitute technology) that alters the economics of a business a decade from now. You may see some cracks emerging but that's about it. Being able to see that the moat will be there ten years out or more is what matters. The rest is distraction. At the very least, this differentiates investing from things like golf, other sports and stock speculation where the performance feedback loop is more immediate.

So investing is easier if you can figure out the long-term strength of an economic moat. Things like quarterly earnings and recessions become just noise.

I know the businesses I like. I'm buying those businesses now. If it turns out my judgment is poor on the strength of the moat, it'll be tough without a time machine to make a meaningful adjustment that improves the result.

Traders and speculators live in a different world than this. They swing at many pitches and seem to accept a lot of mistakes as long as the gains are greater than the losses. In contrast, Buffett's approach is to take less swings...make few mistakes...but do your homework until you feel confident of the outcome.

Adam

* Not much complex math is required but as Charlie says: "Anyone with an engineering frame of mind will look at [accounting standards] and want to throw up in the aisle." The deconstruction of income statements, balance sheets, and cash flow statements into something meaningful economically is a bit of an art unto itself. So you need to not only have the ability to read financial statements in your "toolbox", but develop good judgment on what the numbers actually mean.
** There are plenty of good cyclical businesses you just have to take care to normalize the earnings.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Wednesday, June 24, 2009

Stocks Selling Below What Buffett Paid

This Wall Street Journal article mentions that JNJ, COP, KFT, USB have all been bought by Buffett in the past few years but are selling below the price he paid.

An opportunity to buy stocks below Buffett's price has not happened that often (though what this article points out has been true for over a year). They may not outperform in the short run but in the long run, if someone was looking for a guide of what to buy right now...not a bad place to start.

The article doesn't mention two other major positions that he bought in recent years also at higher prices than they are selling at today: BNI and WFC.

Stock/Buffett Paid Price/Current Price
JNJ/62/55
COP/82/41
KFT/33/25
USB/31/17
BNI/75/73
WFC/32/23

Not only did he buy these at prices higher than they are selling at today, all are major positions for Berkshire....anywhere from $ 2 billion to $ 7 billion each.

That's a lot of $'s even for Buffett. Combined the above 6 stocks make up over 40% of his current equity portfolio.

With a holding period that is typically "forever", I'm guessing he believes each of these businesses will be worth multiples of the current prices 20 years from now.

Though not everyone believes it. Recently, one of the regular guests on CNBC called Buffett an "idiot", but then backed off a bit 10 days later.

Here are excerpts of his comments from this article:

He (Dennis Gartman) scoffs at value-oriented, buy-and-hold stock investors who incurred deep losses last year. "Warren Buffett is an idiot," he said, emphatically, in a short interview after the speech. "Shame on Warren Buffett."

...but then backed off later saying the following on CNBC:

Gartman: ...I think that Mr. Buffett made some terrible mistakes last year and when you're down 45 percent for a year, I'm sorry, that's inexcusable.
Melissa (Lee): Right. OK. So maybe not an idiot but maybe some idiotic trading moves. (Laughs).
Gartman: Not an idiot. Clearly he's not. He's a genius trader ...

Some thoughts:
Buffett has never been a trader and doesn't mind if a stock trades down if the long-term prospects for the business remain strong. Many of his best long-term investments initially went down 50% before going up many thousand %. GEICO (initially he owned the stock before buying the company outright), American Express, Washington Post and, of course, Berkshire Hathaway itself are some examples.

Berkshire has been down 50% before on many occasions. A quick history. When it was selling at $ 7/share it dropped 50%...then it rallied to $ 4,300/share (~50,000% gain within 20 years). From $ 4,300/share it then dropped ~40%...then rallied to $ 82,000/share in 1998. From that $ 82,000/share level it again dropped 50% to $ 41,000/share...then rallied recently to over $ 150,000/share in 2007...then it had the 45% drop that Gartman references in his comments. So including this most recent drop Berkshire is still up roughly 1,000,000% during the past 40 years (ie a $ 10k investment grew to $ 100 million...as Puddy would say right on queue: "Yeah, that's right"). A good chunk of that return came from buying concentrated positions in what seem like boring but stable businesses and holding them a long time.

20 years ago when the Berkshire A shares were selling at $ 4,000-5,000/share people were asking how much higher can it go. Well the A shares are now selling at $ 86,000/share. Given its current size, growth will certainly slow in the future. Still, in my view it'll be much higher than its current price in 20 years for a simple reason: Most of the businesses owned by Berkshire Hathaway (both those owned outright like See's Candies or partially owned...like shares in Coca-Cola) have durable high returns on capital.

It's still a compounding machine and it's about investing...not trading.

So that's about as much time as this deserves as far as I'm concerned.

"If you're an investor, you're looking at what the asset is going to do, if you're a speculator, you're commonly focusing on what the price of the object is going to do, and that's not our game." - Warren Buffett in the 1997 Berkshire Annual Meeting

"Even though they are going to be net buyers of stocks for many years to come, they (investors) are elated when stock prices rise and depressed when they fall. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices." - Warren Buffett in the 1997 Berkshire Hathaway Shareholder Letter

"The speed at which a business success is recognized is not that important as long as the company's intrinsic value is increasing at a satisfactory rate. In fact, delayed recognition can be an advantage: It may give us the chance to buy more of a good thing at a bargain price." - Warren Buffett in the 1987 Berkshire Hathaway Shareholder Letter

"I like to go for cinches. I like to shoot fish in a barrel. But I like to do it after the water has run out." - Warren Buffett in 2003 talking with Wharton MBA Students

It's always possible that he messes up this time but seems just a bit unwise to bet on that outcome.

Adam

Long positions in stocks mentioned

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Tuesday, June 23, 2009

Graham and Fisher

"As long as the company behind the common stock maintains the characteristics of an unusually successful enterprise, never sell it." - Philip Fisher in his book Common Stocks for Uncommon Profits

Many are familiar with Benjamin Graham's style of investing. Buying securities below what they were worth then selling them once they were fully priced (so-called "cigar butts"...not much of a puff, but the puff is all profit). He was also great at explaining how to manage the erratic behavior of markets.

Another influential investor was Philip Fisher. He founded a money management company in 1931 and was author of Common Stocks and Uncommon Profits. Philip Fisher's approach was more about growth and durability. He believed you should buy great companies and hold onto them forever.

Sound familiar?

Graham's emphasis was on the quantitative. In contrast, Fisher looked more at intangibles and the qualitative. For him it was about things like: management, product or service, competition, company culture, sales team, research capacity etc. The ideas of both became a significant part of Berkshire's investment approach.

"If a company is of a high quality, then selling it is rather foolish, at almost any price, because of the scarcity of high quality investments. What will you do, with the proceeds from the sale of a world class company?" - Philip Fisher in his book Common Stocks and Uncommon Profits

If long-term prospects remain attractive for a business don't sell even if it gets temporarily somewhat overvalued (though Fisher would appear to take this further than "somewhat").

"...finding the really outstanding companies and staying with them through all the fluctuations of a gyrating market proved far more profitable to far more people than did the more colorful practice of trying to buy them cheap and sell them dear." - Philip Fisher in his book Common Stocks and Uncommon Profits

Fisher did not think all that highly of most value investors who, he felt, were preoccupied with the numbers. 

As a result, in many ways he is at odds with Graham.

For completely different reasons, both have earned influence in modern investing. I find Graham's ideas more useful in understanding the psychology of "Mr. Market", but for picking individual stocks I lean heavily in favor of Fisher's approach. I'd rather pay a little bit more (though not much more) for a clearly superior and durable business.

With "cigar butt" investing, even if it works out, you never establish the kind of minimal transaction near auto-pilot that is possible with the Fisher approach.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Monday, June 22, 2009

Benjamin Graham

Here's an article by Jason Zweig of the Wall Street Journal from this past May.

The article points out that during the crash in 1974, Ben Graham gave a speech and said that investors would be "enviably fortunate" if a long bear market were to occur.

These thoughts from Graham seem similar to the following quote by Shelby Davis:

"You make most of your money in a bear market, you just don't realize it at the time."

Davis was said to have borrowed $100,000 in 1947 and grew it to $800 million by the time of his death in 1994.

Here's another relevant quote by Graham:


"Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you little short of silly.

If you are a prudent investor or a sensible businessman, will you let Mr. Market's daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings…"

In Graham's allegory, Mr. Market is very temperamental. He has a tendency to swing from wild optimism to seemingly bottomless pessimism. As an intelligent investor, you should not fall under Mr. Market's influence, but rather learn to benefit from the irrational behavior.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Friday, June 19, 2009

Enrico Fermi's Rule

Fermi believed the ability to effectively estimate was an important skill for physicists. A good way to solve physics, and other complex problems, was by coming up with simple shortcuts to make approximate, but meaningful, calculations.

Fermi was known for his ability to make good approximate calculations with little or no actual data, hence the name. One well-documented example is his estimate of the strength of the atomic bomb detonated at the Trinity test, based on the distance traveled by pieces of paper dropped from his hand during the blast. Fermi's estimate of 10 kilotons of TNT was remarkably close to the now-accepted value of around 20 kilotons. - Wikipedia 

In physics, it is known as a Fermi problem. Here is an excerpt from an article that applies Fermi's approach to investing.

In competitions named after him (Fermi), engineering contestants were asked to estimate unusual values as closely as they could...tasks where precision is impossible, but where you can quickly estimate a range for the right answer.

So before putting a bunch of effort into measuring with precision, make a rough estimate of the answer, then decide whether it's worth going further. The competitions were meant to teach students the value of making meaningful rough estimations and to help them develop effective estimating skills.

The article also added this:


I've always thought this advice was as good for investing as for physics. And, you may be surprised to learn, Warren Buffett has been using something quite similar...

and...

Indeed, all true value investors do quick value estimations, à la Fermi, to hone in on bargains...

The article also explains a simple method to estimate the intrinsic value* of a business then closes with the following thought:

Better be approximately right than precisely wrong.

Spreadsheets not required. It also notes that that it works best for firms with predictable earnings and a strong business franchise.

Precisely valuing a business is impossible, but approximately estimating the value of a business is straightforward and becomes even easier when you focus on the great business franchises.

The reason? Qualitative judgments you make on a business are more important than the quantitative (brand strength, distribution, management capability etc). Will competition or a new technology adversely impact the economics of this business over the next ten years? Will the strengths of the franchise remain in tact? Let's say you think the economics will remain healthy and the franchise will remain strong for the next decade but you get it wrong. If that happens the detailed calculations you've made won't matter. So the qualitative stuff matters in a big way.

The article makes the point that it is much easier to correctly make those judgments with a proven franchise.

"It means we miss a lot of very big winners. But we wouldn't know how to pick them out anyway. It also means we have very few big losers - and that's quite helpful over time. We're perfectly willing to trade away a big payoff for a certain payoff." - Warren Buffett at the 1999 Annual Meeting

Check out the full article.

Adam

* Intrinsic value will increase over time for a good business franchise. An investor can attempt to estimate the present intrinsic value (a static value snapshot of something inherently dynamic) and then also make a rough judgment as to how that value is likely to change over time. If done well, the estimates should be meaningful even if rather imprecise.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.

Tuesday, June 16, 2009

Michael Porter on Business and Investing

Check out this article from last Friday. In it, Michael Porter provides another view on the current state of business and investing and talks about the damage being done by short-term thinking.

"With so much focus on the immediate value of stocks, and the resulting costs from short-term trading in and out of individual company shares, "the stock market now is a tax on the real economy."

"The financial sector is extracting value from the rest of the economy [through] fees, costs and expenses." 


To me, this take on the impact of today's prevailing investment practices is in many ways similar to the views stated by Munger, Bogle and Buffett (among others) in recent years. Here are a few quotes from previous posts that are consistent with what, I think, Porter is saying.

"And that's where we are today: A record portion of the earnings that would go in their entirety to shareholders - if they all just stayed in their rocking chairs - is now going to a swelling army of HELPERS" - Warren Buffett in the 2005 Berkshire Hathaway Shareholder Letter

"I will join Galbraith in coining new words, first,
'febezzle', to stand for the functional equivalent of 'bezzle' and, second, 'febezzlement', to describe the process of creating 'febezzle', and third “febezzlers” to describe persons engaged in 'febezzlement'. Then I will identify an important source of 'febezzle' right in this room. You people, I think, have created a lot of 'febezzle' through your foolish investment management practices in dealing with your large holdings of common stock.

If a foundation, or other investor, wastes 3% of assets per year in unnecessary, nonproductive investment costs in managing a strongly rising stock portfolio, it still feels richer, despite the waste, while the people getting the wasted 3%, 'febezzlers' though they are, think they are virtuously earning income. The situation is functioning like undisclosed embezzlement..." -
Charlie Munger speaking to investors at the Philanthropy Round Table in 2000

Note: Telling a group of professional money managers that they are the functional equivalent of an embezzler may seem brutal, but I think if you read the whole talk by Charlie you'll see he does a good job of thoughtfully backing it up.

"As stocks became entertainment, perhaps our greatest circus became our financial markets." - John Bogle from his 2005 book "The Battle for the Soul of Capitalism"

"When we should be teaching young students about long-term investing and the magic of compound interest, the stock-picking contests offered by our schools are in fact teaching them about short-term speculation." - John Bogle from his 2005 book "The Battle for the Soul of Capitalism"

"In other words, the burden of paying HELPERS may cause American equity investors to earn, overall, 80% or so of what they would otherwise ean if they just sat still and listened to no one." - Warren Buffett in the 2005 Berkshire Hathaway Shareholder Letter

Changes to prevailing investment practices isn't going to happen anytime soon. Today, what dominates is a high frictional cost approach with an emphasis on speculation, instead of a low frictional cost approach with emphasis on the magic of compounding.

A generation of investors seem to now have these habits and quite a lot of the money management industry's business incentives are built upon it. Tilting investor behavior toward low frictional costs and compounding would seem to be a wise move, but I don't expect it to happen soon.

At a minimum, as an individual investor you gain tremendously by going with this approach (Newton's 4th Law) in the long run. No need to wait for the rest of the world to come around to the Berkshire view of the world. What they do works. Buy durable businesses at a fair price...let high-powered compounding (i.e. by owning shares in high return on capital businesses) work.

As Porter says above, "the stock market is now a tax on the real economy". To me, that is measured both in terms of 1) direct fees, commissions and 2) an ever increasing tendency to attract the best future engineers, mathematicians, and scientists for largely unproductive activities and away from more productive areas. (BTW - I don't blame anyone for wanting to get rich at a hedge fund. As long as the incentives are there I expect them to do it. My inclination is to adjust the incentives so more want to use those talents creating new science and technology.)

"It's my guess that something like 5% of GDP goes to money management and its attendant friction. ...Worst of all, the people doing this are among the best and the brightest. Hundreds and thousands of engineers, etc. are going into hedge funds and investment banking. That is not an intelligent allocation of the brainpower of the civilization." - Charlie Munger at the 2005 Wesco meeting

Moving capital to the ideas that need it most is the purpose of a stock market...it's not meant to entertain us.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Monday, June 15, 2009

John Bogle and Charlie Munger on Frictional Costs

Some excerpts from John Bogle's book: The Battle for the Soul of Capitalism.

"By the latter years of the twentieth century, our business values had eroded to a remarkable extent. Yes, we are a nation of prodigious energy, marvelous entrepreneurship, brilliant technology, creativity beyond imagination, and, at least in some corners of the business world, the idealism to make our nation and our world a better place. But I also see far too much greed, egoism, materialism, and waste to please my critical eye." - John Bogle

"While our nation's largest arena, the stadium at the University of Michigan, holds but 107,501 citizens—one-third the 320,000 capacity of the Circus Maximus—television screens bring U.S. sports and entertainment to worldwide audiences that reach into the billions. As stocks became entertainment, perhaps our greatest circus became our financial markets." - John Bogle


"When we should be teaching young students about long-term investing and the magic of compound interest, the stock-picking contests offered by our schools are in fact teaching them about short-term speculation. And the biggest financial circus of all—today's incarnation of the Circus Maximus—is the garish eight-story NASDAQ MarketSite Tower in Times Square, displaying stock prices on what is proudly billed as the 'world’s largest video screen.' That display, it seems to me, is the visual paradigm of a stock market that has become not only a circus, but a casino for speculators. Yet as Lord Keynes warned us: 'When the capital development of a country becomes the by-product of the activities of a casino, the job is likely to be ill-done.'" - John Bogle


Successfully changing prevailing investing habits from A) today's high frictional cost with an emphasis on speculation, to B) low frictional cost with emphasis on compounding value long-term is, at least based upon recent history, difficult at best. Many market participants -- though, of course, certainly not all -- have developed their skills in, and been influenced by, a system that encourages increasingly short-term oriented behavior. Business incentives and entrenched interests remain that seem likely to keep current norms at least mostly in place. So changing the status quo to any great degree won't be easy. Still, even if it is only by small degrees over the next 20-30 years, it's worth attempting to tilt things in the direction of B). The current way of doing business is a "hidden tax" both in terms of unnecessary frictional costs, and the increased allocation of capable engineers, mathematicians, and scientists toward largely unproductive activities.

Charlie Munger builds upon the term 'bezzle', which was coined by Professor John Kenneth Galbraith to help explain why misappropriated funds can actually be -- even if only in the near-term and, to say the very least, in far less than optimal ways -- economically stimulative:

"Are there important functional equivalents of 'bezzle' that are large and not promptly self-destructive? My answer to this question is yes. I will next describe only one. I will join Galbraith in coining new words, first, 'febezzle', to stand for the functional equivalent of 'bezzle' and, second, 'febezzlement', to describe the process of creating 'febezzle', and third 'febezzlers' to describe persons engaged in 'febezzlement'. Then I will identify an important source of 'febezzle' right in this room. You people, I think, have created a lot of 'febezzle' through your foolish investment management practices in dealing with your large holdings of common stock.

If a foundation, or other investor, wastes 3% of assets per year in unnecessary, nonproductive investment costs in managing a strongly rising stock portfolio, it still feels richer, despite the waste, while the people getting the wasted 3%, 'febezzlers' though they are, think they are virtuously earning income. The situation is functioning like undisclosed embezzlement without being self-limited. Indeed, the process can expand for a long while by feeding on itself. And all the while what looks like spending from earned income of the receivers of the wasted 3% is, in substance, spending from a disguised 'wealth effect' from rising stock prices." - Charlie Munger speaking to investors at the Philanthropy Round Table in 2000.


Munger also added the following back in 2005:

"It's my guess that something like 5% of GDP goes to money management and its attendant friction. ...Worst of all, the people doing this are among the best and the brightest. Hundreds and thousands of engineers, etc. are going into hedge funds and investment banking. That is not an intelligent allocation of the brainpower of the civilization." - Charlie Munger at the 2005 Wesco meeting

As always Munger calls it as he sees it no matter who is in the audience.

The system can still work just fine for those who stick to what they know, focus on the long-term, and avoid the folly

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Thursday, June 11, 2009

Munger on Investing, Money Mgmt, GM, and the Zero-Sum Game

Below are some miscellaneous quotes by Charlie Munger. These are all from the 2005 Wesco annual meeting:*

Investing at Berkshire
Our future prospects are way worse than what they used to be. But I'm 81; I've got bigger problems than diminished returns. (Laughter) - Charlie Munger

What the 15 best deals all have in common is that they all worked.
There were different models – See's Candies was different from Shaw Carpets. But both are good businesses that will generate durable returns for the grandchildren of people sitting in this room. - Charlie Munger


Money Management
It's my guess that something like 5% of GDP goes to money management and its attendant friction. I define it broadly – annuities, incentive pay, all trading, etc. Nobody else has used figures that high, but that's my guess. Worst of all, the people doing this are among the best and the brightest. Hundreds and thousands of engineers, etc. are going into hedge funds and investment banking. That is not an intelligent allocation of the brainpower of the civilization. - Charlie Munger

You're paying a manager a fortune and he has 85% of his assets invested parallel to the indexes. If you have such a system, you're being played for a sucker.

You have these fads in investment management. With so many bodies and minds and computers, I see figures of risk by asset class, but I don't have the faintest idea what they mean. They don't either, but they learned a fad, a way of thinking. If you learn a formula, you can run the numbers and print it up, but it doesn't mean anything. - Charlie Munger

General Motors
I regard GM as such a marvel of human achievement, but also an example of massive management failure. I can't be criticized if I eventually die – I delayed it as long as I could. GM delayed it as long as they could. They had a very tough hand to play, but I would argue that they blew it. - Charlie Munger

The Zero-Sum Game vs Investing
I do think that it's conceivable that some enormously talented person that studied economics and relative value of currencies and devoted his life to it and only bet occasionally, that such a man could do very well [investing in currencies]. It's not my line of talent.

I'd rather do something that's not such a zero-sum game. If I invest in equities – the businesses are growing; for example, Wrigley's will make more gum. It's automatically working for me, even if I do nothing. But if I invest in currencies, it's not working for me. - Charlie Munger


Check out some of Munger's other comments from the meeting. As always, he's often rather blunt and insightful.

Adam

* These comments are based upon notes taken by Whitney Tilson.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Tuesday, June 9, 2009

Sisyphus Meets Seinfeld

In a previous post I said the culture of Wall Street seems to have Sisyphus as its inspiration.

In Greek mythology Sisyphus was a king of Ephyra (now known as Corinth) punished for chronic deceitfulness by being compelled to roll an immense boulder up a hill, only to watch it roll back down, and to repeat this action forever. - Wikipedia

So Sisyphus was forced to roll a huge boulder up a hill, watch it roll back down, and repeat the pattern throughout eternity. As an adjective, Sisyphean can mean an activity that is unending, repetitive, pointless, and unrewarding.

Technical, quantitative, long/short, and options trading strategies, among others, all sound complex and difficult to execute. I'm certain that it takes great skill to implement these approaches effectively. While more than a bit skeptical of the risk/reward of these methods, I'm guessing some actually make it work. Still, this hardly seems a recipe for most investors to build sustainable wealth. It feels Sisyphean to me.

At a minimum, lets just say it's in the witch doctor's interest to convince us that it requires special expertise to make money investing.

"...most professionals and academicians talk of efficient markets, dynamic hedging and betas. Their interest in such matters is understandable, since techniques shrouded in mystery clearly have value to the purveyor of investment advice. After all, what witch doctor has ever achieved fame and fortune by simply advising 'Take two aspirins'." - Warren Buffett in the 1987 Berkshire Hathaway Shareholder Letter

Back to Greek mythology...

Munger quotes 19th century mathematician Carl Jacobi when he says "Invert, always invert" if you want to solve a difficult problem.

"...it is not enough to think problems through forward. You must also think in reverse, much like the rustic who wanted to know where he was going to die so that he'd never go there. Indeed, many problems can't be solved forward. and that is why the great algebraist, Carl Jacobi so often said: 'invert, always invert'. And why Pythagoras thought in reverse to prove that the square root of 2 was an irrational number." - Charlie Munger

Personally, I've never regretted following that advice. It works wonders in problem solving.

So here goes. As an investor, clearly you want to avoid being like the George character from Seinfeld. However, that serial failure George Costanza pulled off one of the great all-time transformations in sit-com history when he decided to do the opposite of every instinct that he had. 

It worked.

"A job with the New York Yankees! This has been the dream of my life ever since I was a child, and it's all happening because I'm completely ignoring every urge towards common sense and good judgement I've ever had." - George Costanza in the Seinfeld episode: "The Opposite"

Sisyphus is basically Costanza (pre-transformation). And through a similar inversion I think you end up with something close to the right inspiration for investing:

The new bizarre Sisyphus does not push that huge boulder up a hill in perpetuity. Following George's lead he trades that high effort/no return activity for a low effort/high return activity. As soon as the opportunity presents itself, he purchases a toll bridge franchise (at a fair price). This new investment essentially allows him to sit comfortably on his ass collecting all the tolls. Net of operating expenses including maintenance, lane expansion etc this activity is very lucrative... something like a 25% profit (the "net pre-tax toll"). Not only are the margins high, but the business requires minimal new capital. What makes the economics so favorable? That bridge (including capacity for lane expansions to accommodate population growth), is built predominantly in today's dollars or yesterday's dollars (even better), while the growing stream of tolls collected will be inflation adjusted future dollars. As a result the long-term return on capital is excellent.

With all the extra dough he pays someone else to push that stupid rock.

Coca-Cola, Philip Morris, Diageo are, in effect, "toll bridge franchises" for daily global beverage, cigarette and alcohol consumption. In this case, the "bridge franchise" is replaced with a global "brands and distribution franchise". And yes...most of these brands and distribution franchise assets are, in fact, built mostly with yesterday's dollars while the growing future profits will always be at least inflation adjusted.

The reason? Great brands with broad distribution become "price setters" through the reputation established with its customers.

"Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price. Consumer franchises are a prime source of economic Goodwill." - Warren Buffett in the 1983 Berkshire Hathaway Shareholder Letter

Price setting franchises generally produce excess returns. The capitalized value of these excess returns is economic Goodwill. Commodities, in contrast, are "price takers" that ride the waves of booms and busts in supply/demand. (i.e. Your favorite Vodka probably didn't drop at all in price during the most recent recession. Most commodities collapsed 50-75%. Of course, they will jump in price again no doubt based upon supply/demand.)

In the long run, when you take into account population growth, expanding brands and distribution of these franchises you are buying a growing stream of cash flows...and the ability to compound at excess rates of return.

As an example, of the many servings of Diageo products (Captain Morgan, Guinness, Smirnoff, Johnnie Walker, Baileys etc) consumed each day, shareholders collect a net pre-tax "toll" of roughly 25 cents on the dollar after deducting all expenses. Since those excess funds are generally not needed to run the existing business, they can be reinvested (after tax) with high returns back into the business to expand distribution and brands or the excess cash can be distributed to shareholders. In contrast, the occasional profits you earn with an airline (even a fast growing one) are illusory; those profits will sooner or later be needed to buy new planes, fight off a competitor and on and on.

The question comes down to whether you want to have to perpetually hunt for the next great trade. Even if you are capable of pulling off trade after trade successfully, you always have to find the next one. There's no self-sustaining autopilot. This approach may work, but seems likely to result in major mistakes and unnecessary frictional costs over the long run. In contrast, the intrinsic value of the Berkshire Hathaway portfolio will likely increase meaningfully over the next decade on autopilot (i.e. if Buffett did not make even a single move within the portfolio).

From a previous post:

...there are many professional money managers and traders (some of them frequently appearing on various business news media outlets) recommending various, sometimes rather complex, investing and trading strategies.

It's easy to imagine and expect with all the expertise on display that quite a few of them must seriously outperform. In particular, some might reasonably expect them to outperform a participant who just buys -- at a reasonable price -- and holds long-term the stocks of companies that make the stuff found in a typical cupboard, refrigerator, and medicine cabinet.
(Well, at least those participants who understand business economics, are able to identify sustainable competitive advantages, have a price vs value discipline, while controlling their emotions during inevitable market fluctuations. Not complicated but, based upon investor behavioral patterns revealed in studies, apparently not easy for many to accomplish either.)

Yet, the verifiable evidence at least suggests that many pros do not, over a long time horizon, beat high quality stocks (or the market as a whole) bought when prices are reasonable or better. Also, for those experts that do outperform, there's just no easy way to separate the future fund "winners" from the mediocre (or worse).

Knowing how to buy shares of great business franchises at the right price and allowing them to compound long-term may not be easy. Yet, by comparison and with some hard work, it seems a more straightforward and doable exercise than some of the other popular methods employed by market participants.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Monday, June 8, 2009

The Growth Myth

I wrote about return on capital (ROC) and its influence on long-term returns in this previous post. More recently, in an interview with Morningstar, Jeremy Grantham talked about the importance of ROC and the widely accepted myth that high growth is correlated with high investment returns.

Grantham: Value Matters In Everything

Intuitively, it seems reasonable that high growth should be correlated with high investment returns but, like many other things, what is intuitive is often not correct. In the short run high growth rates tend to inflate equity values but generally the long-term returns can suffer. This idea is widely misunderstood.

Some excerpts from the interview:

"...in the end, returns in a stock market are overwhelmingly to do with return on capital (ROC). It isn't about top line growth. Nobody believes this but it's true. Growth stocks simply don't beat value stocks. Growth countries, for the record, have no history of reliably beating slower growth countries. Although everyone thinks it's the case it won't stand the test of analysis." (Emphasis added)

He goes on to say that:

"I'm very bullish that China will grow fast."

"I'm very confident they'll put pressure on raw material prices. But I'm not very confident that their earnings per share will be exceptional. And therefore you have to be careful. When you run an analysis of growth rate by country, you find no correlation between growth and return on the market. But when you run a correlation on a country based on starting PE, there is of course a very handsome correlation."

So value matters in everything including the country you choose. Don't expect high GDP to translate into stock returns. Starting point value is the key.

Long-term returns in investing come down to durable high ROC and the price you pay relative to intrinsic value....not growth.

Some investors make the mistake of assuming that an investment in a high growth business (or country) will produce above average long-term investment returns.

Growth, of course, will often have a favorable impact on value. It just happens to be a mistake to think that it always has a favorable impact.

In fact, growth can actually reduce value if it requires capital inputs in excess of the discounted value of the cash that will be generated over time. Sometimes, the highest growth opportunities attract lost of capable competition and capital that ruins the long run economics. Sometimes, high growth requires expensive yet necessary capital raising that dilutes existing shareholders and reduces per share returns.

Finally, even if growth that materializes does have favorable economics, some investors tend to pay a large premium upfront for those growth prospects. That hefty price paid may turn attractive long-term business results into not so attractive investment results.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Thursday, June 4, 2009

Wednesday, June 3, 2009

Charlie Munger Quotes

From the 2007 Wesco annual meeting:

"How did Berkshire's track record happen? If you were an observer, you'd see that Warren did most of it sitting on his ass and reading. If you want to be an outlier in achievement, just sit on your ass and read most of your life. But they fire you for that!
  
Look at this generation, with all of its electronic devices and multi-tasking. I will confidently predict less success than Warren, who just focused on reading. If you want wisdom, you’ll get it sitting on your ass. That's the way it comes." - Charlie Munger


The following excerpts are from a speech that Munger gave to the University of California, Santa Barbara - Economics Department in 2003:

"Economics is in many respects the queen of the soft sciences. It's expected to be better than the rest. It's my view that economics is better at the multi-disciplinary stuff than the rest of the soft science. And it's also my view that it's still lousy..." - Charlie Munger

"As I talk about strengths and weaknesses in academic economics, one interesting fact you are entitled to know is that I never took a course in economics. And with this striking lack of credentials, you may wonder why I have the chutzpah to be up here giving this talk. The answer is I have a black belt in chutzpah. I was born with it." - Charlie Munger

"When Warren took over Berkshire, the market capitalization was about ten million dollars. And forty something years later, there are not many more shares outstanding now than there were then, and the market capitalization is about a hundred billion dollars, ten thousand for one. And since that has happened, year after year, in kind of a grind-ahead fashion, with very few failures, it eventually drew some attention, indicating that maybe Warren and I knew something useful in microeconomics." - Charlie Munger

"Well, Berkshire's whole record has been achieved without paying one ounce of attention to the efficient market theory in its hard form. And not one ounce of attention to the descendants of that idea, which came out of academic economics and went into corporate finance and morphed into such obscenities as the capital asset pricing model, which we also paid no attention to." - Charlie Munger

"The third weakness that I find in economics is what I call physics envy. And of course, that term has been borrowed from....one of the world's great idiots, Sigmund Freud. But he was very popular in his time, and the concept got a wide vogue.

One of the worst examples of what physics envy did to economics was cause adaptation and hard-form efficient market theory. And then when you logically derived consequences from this wrong theory, you would get conclusions such as: it can never be correct for any corporation to buy its own stock. Because the price by definition is totally efficient, there could never be any advantage. QED. And they taught this theory to some partner at McKinsey when he was at some school of business that had adopted this crazy line of reasoning from economics, and the partner became a paid consultant for the Washington Post. And Washington Post stock was selling at a fifth of what an orangutan could figure was the plain value per share by just counting up the values and dividing. But he so believed what he'd been taught in graduate school that he told the Washington Post they shouldn't buy their own stock. Well, fortunately, they put Warren Buffett on the Board, and he convinced them to buy back more than half of the outstanding stock, which enriched the remaining shareholders by much more than a billion dollars. So, there was at least one instance of a place that quickly killed a wrong academic theory." - Charlie Munger

"You've got a complex system and it spews out a lot of wonderful numbers that enable you to measure some factors. But there are other factors that are terribly important, [yet] there's no precise numbering you can put to these factors. You know they're important, but you don't have the numbers. Well practically everybody (1) overweighs the stuff that can be numbered, because it yields to the statistical techniques they're taught in academia, and (2) doesn't mix in the hard-to-measure stuff that may be more important. That is a mistake I've tried all my life to avoid, and I have no regrets for having done that." - Charlie Munger

"The craving for perfect fairness causes a lot of terrible problems in system function. Some systems should be made deliberately unfair to individuals because they'll be fairer on average for all of us. I frequently cite the example of having your career over, in the Navy, if your ship goes aground, even if it wasn't your fault. I say the lack of justice for the one guy that wasn't at fault is way more than made up by a greater justice for everybody when every captain of a ship always sweats blood to make sure the ship doesn't go aground. Tolerating a little unfairness to some to get a greater fairness for all is a model I recommend to all of you. But again, I wouldn't put it in your assigned college work if you want to be graded well, particularly in a modern law school wherein there is usually an over-love of fairness-seeking process." - Charlie Munger


"Many of you probably don't remember what happened after the South Sea Bubble, which caused an enormous financial contraction, and a lot of pain. They banned publicly traded stock in England for decades. Parliament passed a law that said you can have a partnership with a few partners, but you can't have publicly traded stock. And, by the way, England continued to grow without publicly traded stock. The people who are in the business of prospering because there's a lot of stock being traded in casino-like frenzy wouldn't like this example if they studied it enough. It didn't ruin England to have a long period when they didn't have publicly traded shares. - Charlie Munger

"It's a myth that once you've got some capital market, economic considerations demand that it has to be as fast and efficient as a casino. It doesn't." - Charlie Munger


"When I was young everybody was excited by Gödel who came up with proof that you couldn't have a mathematical system without a lot of irritating incompleteness in it. Well, since then my betters tell me that they've come up with more irremovable defects in mathematics and have decided that you're never going to get mathematics without some paradox in it. No matter how hard you work, you're going to have to live with some paradox if you're a mathematician.

Well, if the mathematicians can't get the paradox out of their system when they're creating it themselves, the poor economists are never going to get rid of paradoxes, nor are any of the rest of us. It doesn't matter. Life is interesting with some paradox. When I run into a paradox I think either I'm a total horse’s ass to have gotten to this point, or I'm fruitfully near the edge of my discipline. It adds excitement to life to wonder which it is." - Charlie Munger


If nothing else, Charlie Munger is frequently rather forthright.

Adam

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Munger & Buffett on Diversification

"Some foundations, following the lead of institutions like Yale, have tried to become much better versions of Bernie Cornfeld's 'fund of funds.' This is an amazing development. Few would have predicted that, long after Cornfeld's fall into disgrace, leading universities would be leading foundations into Cornfeld's system." - Charlie Munger in a 1998 speech to the Foundation Financial Officers Group

The above speech covers, among other things, why Munger believes the accepted thinking on diversification is incorrect. More excerpts from the speech:

"I have more than skepticism regarding the orthodox view that huge diversification is a must for those wise enough so that indexation is not the logical mode for equity investment. I think the orthodox view is grossly mistaken. 

In the United States, a person or institution with almost all wealth invested, long term, in just three fine domestic corporations is securely rich. And why should such an owner care if at any time most other investors are faring somewhat better or worse. And particularly so when he rationally believes, like Berkshire, that his long-term results will be superior by reason of his lower costs, required emphasis on long-term effects, and concentration in his most preferred choices. I go even further. I think it can be a rational choice, in some situations, for a family or a foundation to remain 90% concentrated in one equity. Indeed, I hope the Mungers follow roughly this course. And I note that the Woodruff foundations have, so far, proven extremely wise to retain an approximately 90% concentration in the founder's Coca-Cola stock." - Charlie Munger

Munger then added Ben Franklin required this kind of concentration as an investment practice for his own charitable endowment. He continues:

"To conclude, I will make one controversial prediction and one controversial argument.

The controversial prediction is that, if some of you make your investment style more like Berkshire Hathaway's, in a long-term retrospect you will be unlikely to have cause for regret, even if you can't get Warren Buffett to work for nothing. Instead, Berkshire will have cause for regret as it faces more intelligent investment competition. But Berkshire won't actually regret any disadvantage from your enlightenment. We only want what success we can get despite encouraging others to share our general views about reality.

My controversial argument is an additional consideration weighing against the complex, high-cost investment modalities becoming ever more popular at foundations. Even if, contrary to my suspicions, such modalities should turn out to work pretty well, most of the money-making activity would contain profoundly antisocial effects. This would be so because the activity would exacerbate the current, harmful trend in which ever more of the nation's ethical young brainpower is attracted into lucrative money-management and its attendant modern frictions, as distinguished from work providing much more value to others. Money management does not create the right examples. Early Charlie Munger is a horrible career model for the young, because not enough was delivered to civilization in return for what was wrested from capitalism. And other similar career models are even worse.

Rather than encourage such models, a more constructive choice at foundations is long-term investment concentration in a few domestic corporations that are wisely admired.

Why not thus imitate Ben Franklin? After all, old Ben was very effective in doing public good. And he was a pretty good investor, too. Better his model, I think, than Bernie Cornfeld's. The choice is plainly yours to make." - Charlie Munger

As usual, these ideas are at odds with: 1) what is practiced by many professional money managers and, 2) what continues to be taught at most business schools.

"If you can identify six wonderful businesses, that is all the diversification you need. And you will make a lot of money. And I can guarantee that going into the seventh one instead of putting more money into your first one is going to be terrible mistake. Very few people have gotten rich on their seventh best idea." - Warren Buffett speaking at the University of Florida in 1998

Having said that, clearly a number of investors require more diversification. A concentrated portfolio of individual stocks requires a high level of warranted confidence in one's own ability to evaluate individual stocks.

Overconfidence in (or overestimating) abilities usually leads to terrible outcomes.

The fact is that, for many investors, index funds will make a whole lot more sense.

"Most investors, both institutional and individual, will find that the best way to own common stocks (shares) is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) of the great majority of investment professionals." - From the 1996 Berkshire Hathaway Shareholder Letter

Where this all tends to go wrong is that too many participants end up trying to trade in and out of what they own (whether it happens to be individual stocks or mutual funds).

The result? Lots of unnecessary mistakes and added frictional costs along the way.

They behave this way, of course, thinking that it will enhance returns but end up with just the opposite outcome.

In any case, it's important to make a realistic individual assessment. There's just no way around the reality that an appropriate comfort zone is necessarily unique to each investor.

Know limitations and stay well within them.

Adam

Related post:
Munger & Buffett on Diversification - Part II (follow-up)

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
 
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