Chapter 145 - Buffett and Munger Unscripted: Three Decades of Investment and Business Insights from the Berkshire Hathaway Shareholder Meetings
Today’s Chapter is based on the book “Buffett and Munger Unscripted: Three Decades of Investment and Business Insights from the Berkshire Hathaway Shareholder Meetings” by Alex Morris.
Warren Buffett and Charlie Munger are well-known to be best friends and business partners at Berkshire Hathaway. During their tenure, they built one of the largest corporations in America and they are known for being incredibly successful value investors.
Here’s what I learned:
Becoming Learning Machines
“In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time—none, zero.”
— Charlie Munger
Warren Buffett and Charlie Munger are perhaps the most public examples of learning machines. In fact, they both attribute a significant portion of their success not to innate genius, but to a relentless, lifelong commitment to reading, thinking, and expanding their knowledge of how the world works. This continuous learning is what allowed them to recognize investment opportunities, and more importantly, to avoid areas where they are likely to make mistakes.
In fact, Munger believes that what success he and Buffett have comes from the fact that they read a lot. He once said, “I think Warren, who was reading everything he could when he was ten years old, became a learning machine, and then he had a very long run when he kept learning. If Warren had not been learning all the while, I’m telling you, having watched the process closely, the record would be a pale shadow of what it is.”
“I’ve watched Warren through all these decades, and he has learned a hell of a lot, even in the last twenty or thirty years... It’s a lifelong game, and if you don’t keep learning, other people will pass you by.”
— Charlie Munger
But Munger mentions that reading alone won’t do it, “you have to have a temperament which grabs the correct ideas and does something with those ideas.” As such, one crucial concept that emerged from their self-education is the circle of competence. This is the mental model of knowing what you truly understand and, more critically, having the intellectual honesty to acknowledge the boundaries of your understanding. The size of the circle is less important than knowing its perimeter. Success comes from operating well within your circle and avoiding the “too hard” pile.
Warren Buffett warns us that “The biggest thing is not how big your circle of competence is, but knowing where the perimeter is. You don’t have to be an expert on 90% of businesses, or 80%, 70%, or even 50%. But you do have to know something about the ones that you actually put your money into—and if that’s a very small part of the universe, that still is not a killer.”
This learning process is what allowed Berkshire Hathaway to increase their circle of competence and to evolve. If they had remained frozen in the knowledge of their youth, the company would be a pale shadow of itself. For example, Buffett first started with a Graham approach to investing, but quickly changed his investing strategy after learning from Charlie Munger about investing in high quality businesses. He explains, “I owe a great deal to Ben Graham in terms of learning about investing. And I owe a great deal to Charlie, in terms of learning a lot about business. I’ve also spent a lifetime looking at businesses, seeing why some work and why some don’t. As Yogi Berra said, ‘You can see a lot just by observing.’ That’s pretty much what Charlie and I have been doing for a long time.”
“I think the one thing that we did that’s worked best of all is we were always dissatisfied with what we already knew and we always wanted to know more. Berkshire—if Warren and I had stayed frozen in time, particularly Warren—would have been a terrible place. It’s what we kept learning that made it work, and I don’t think that will ever stop.”
— Charlie Munger
Another valuable lesson we can learn from Charlie Munger and Warren Buffett is the concept of avoiding mistakes. As Buffett explains, “The record of Berkshire Hathaway, to the extent it’s been good, has not been because we’ve done brilliant things, but because we’ve done fewer dumb things than most. Why smart people do things that are against their self-interest is really puzzling.”
This reminds me of the power of inversion which we have previously learned from Charlie Munger. In fact, Munger is well-known for promoting the concept of keeping things simple. He once said that “If something is too hard, we move on to something else. What could be simpler than that?” In fact, when it comes to investing, Munger explains that at Berkshire Hathaway, they have three baskets(in, out and too tough) in which they classify new investment ideas. And most often then not, ideas tend to go into the too tough pile. As Buffett once said, “I don’t look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.”
As a matter of fact, I believe that this concept of Munger of keeping things simple comes from the power of inversion that was inspired by the famous mathematician Jacobi, who often solved complex issues by inverting the problem. Similarly, Munger came up with the concept that one can succeed in life by avoiding stupidity by using the power of inversion. Munger gives the example of a professional tightrope walker for 20 years. He is successful in his art because he knows what he cannot do, because he knows that if he gets it wrong, he won’t survive.
Similarly, Munger understands that to succeed in life, one must avoid taking stupid paths. For one, Charlie Munger mentions that “three things ruin people: drugs, liquor and leverage.”
“We all know talented people who have ruined their lives abusing either alcohol or drugs—and often both.”
— Charlie Munger
“So we’ve had to learn a different game. And that’s a lesson for all the young people in the room. If you’re going to live a long time, you have to keep learning. What you formerly knew is never enough. If you don’t learn to constantly revise your earlier conclusions and get better, you’re like a one-legged man in an ass-kicking contest.”
— Charlie Munger
Thinking Long-Term
“If we think long term, we can accomplish things that we wouldn’t otherwise accomplish. Time horizons matter. They matter a lot.”
— Jeff Bezos
In a world overwhelmingly focused on the short term, Buffett and Munger stand as monuments to patience. In fact, they repeatedly advocate for a long-term horizon, viewing investing as a marathon where patience compounds money. They criticize short-term thinking and favour investing in businesses with a durable moat that can thrive for decades.
Buffett explains that “The world is overwhelmingly short-term-focused. If you go to a quarterly call, they’re all trying to figure out how to fill out a sheet to show earnings for the current year, and the management team is interested in feeding them expectations that will be slightly beaten. That is a world that is made to order for anybody just trying to think about what you can do that should work over five, ten, or twenty years. I would love to be born today, to go out with not too much money and—hopefully—turn it into a lot of money. Charlie would, too, actually. He would find something to do, I guarantee you. It wouldn’t be exactly the same as before, but he would end up with a big, big, big pile.”
In fact, Munger and Buffett believes that most investing opportunities happen because of the market’s tendency to focus on the short-term. As Benjamin Graham once said, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” On this note, Buffett mentions that “What gives you opportunities is other people doing dumb things. And I’d say that in the fifty-eight years that we’ve been running Berkshire, there’s been a great increase in the number of people doing dumb things.”
By consequence, Buffett and Munger understands the importance of staying invested in wonderful companies despite short-term troubles or irrational movement to the stock price. Buffett says that “If you get into a wonderful business, the best thing to do is usually to stick with it. Coca-Cola and Gillette both experienced disappointments, below what they anticipated twelve to eighteen months ago and below what we anticipated. But that will happen. It happens with some of our wholly-owned businesses from time to time. Sometimes they do better than we anticipate, too.”
“Generally speaking, trying to dance in and out of the companies that you really love on a long-term basis has not been a good idea for most investors. We’re quite content to sit with our best holdings.”
— Warren Buffett
Similarly, their patient approach extends on how they decide to invest in companies. Rather than having a diversified portfolio, Munger and Buffett suggests to wait patiently in order to invest in no-brainer opportunities. As Buffett explains, “You wait for the fat pitch. Ted Williams wrote about it in a book called The Science of Hitting. The most important thing in being a good hitter is to wait for a pitch in the sweet spot.” Similarly, Munger mentions that “I would say that the chief lesson would be that you’re unlikely to find very many great investments in a whole lifetime. And when you find one in which you really have thought it out and have confidence, for God’s sakes, don’t do it in a niggardly fashion. The idea that very smart people with investment skills should have hugely diversified portfolios is madness. It’s a very conventional madness. It’s taught in all of the business schools. But they’re wrong.”
This reminds me of what we have learned from Ted Williams on the importance of discipline and selectiveness. As a baseball hitter, Williams was known for his exceptional ability to wait for the right pitch, the one in his “happy zone” where he could maximize his chances of success. He believed that even the greatest hitters couldn’t be successful if they swung at bad pitches.
As a matter of fact, Williams notes that “a good hitter can hit a pitch that is over the plate three times better than a great hitter with a questionable ball in a tough spot. Pitchers still make enough mistakes to give you some in your happy zone. But the greatest hitter living can’t hit bad balls good.“
“The first rule in the book... is to get a good ball to hit.”
— Ted Williams
Similarly, this concept of waiting for the right pitch is directly applicable to investing. In the world of finance, there are countless opportunities to invest, but not all of them are worth swinging at. Investors often make the mistake of chasing every market trend or jumping on every stock that seems to be rising. However, like Williams, successful investors know the value of being selective. They don’t invest in every opportunity that comes their way; rather, they wait for the right opportunity.
Finding Young Elephants
“Within the spectrum of value investing we prefer investing in great businesses, that can grow for a long time. We call these candidates young elephants.”
— Matthias Riechert
Finally, Buffett and Munger’s ultimate goal is to find compounding machines, businesses that not only earn high returns on its existing capital but can also continuously reinvest large amounts of incremental capital at those same high rates. These businesses are exceedingly rare, but they are the holy grail of long-term investing, especially if you can find them small. As Munger once said, “Small-cap investing doesn’t work for Berkshire because we’ve got too much money. But I regard finding them small as a perfectly intelligent approach for somebody to try with discipline.”
Buffett explains that finding a good investment opportunity starts by finding a great business. He mentions that “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 with it over time. And then we try to figure out whether the economics, the earnings power, over the next five, ten, or fifteen 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 with. And then we try to decide what’s an appropriate price for what we’ve seen up to that point in the business.”
In Buffett and Munger’s philosophy, the best businesses are those that earn a high returns on capital and a high reinvestment opportunity due to their strong competitive advantages. A great example of such company is NCR, the National Cash Register. Munger mentions, “I always cite the early history of National Cash Register (NCR); it was created by a fanatic who bought all the patents, had the best salesforce, and had the best production plants. He was a very intelligent man and passionately dedicated to the cash register business. And it was a godsend to retailing when cash registers were invented. Cash registers were the pharmaceuticals of a former age. If you read an early annual report prepared by John Henry Patterson, who was CEO of National Cash Register, any idiot could see this was a talented fanatic who was very favorably located-and, therefore, the investment decision was easy.“
“The ideal business is one that earns very high returns on capital and can keep using lots of capital at those high returns. 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, and so on. You could keep redeploying capital at these same returns over time. But there are very, very, very few businesses like that.”
— Warren Buffett
What makes Berkshire Hathaway great, in my opinion, is their ability to allocate capital at a high return for a very long time. In fact, since such perfect compounding machines are scarce, most great businesses, while highly profitable, eventually hit a ceiling on how much capital they can profitably absorb in their core operations. This is where Berkshire Hathaway’s unique structure provides a massive advantage. They can acquire businesses that generate huge amounts of cash but have limited internal reinvestment opportunities (like See’s Candies or The Buffalo News) and then allocate that excess capital elsewhere.
However, by serving as a central capital allocator, Berkshire ensures that the high returns generated by its subsidiaries are not wasted on low-return internal projects but are instead moved to the best available external or internal opportunities. This ability to move cash freely is the engine of Berkshire’s long-term growth. Buffett explains that “Most of the great businesses generate a lot of money; they do not generate lots of opportunities to earn high returns on incremental capital. We can deploy X at See’s and earn a lot of money, but if we put 5x in we don’t earn any more money to speak of. We can earn high returns on X at The Buffalo News, but if we try to make it 5× we don’t earn any more money. They just don’t have the opportunities to use incremental capital. We look for them, but they don’t exist…”
“The best business is one that gives you more and more money every year without putting up anything to get it, or putting up very little to get it. The second‐best business is one that takes more money [required reinvestment to grow], but the rate at which you reinvest for that growth is a very satisfactory rate. The worst business of all is the one that grows a lot, and where you’re forced, in effect, to grow to stay in the game at all, and where you’re reinvesting the capital at a very low rate of return. Sometimes people are in those businesses without knowing it.”
— Warren Buffett
Furthermore, another key aspect of Berkshire Hathaway is their concept of investing along intelligent fanatics. In fact, they place enormous weight on investing along management with integrity and with the right incentives in place.
In their experience, intelligence and energy are valuable, but without integrity they can destroy value. Conversely, a high-quality business can survive mediocre management, whereas great managers cannot always rescue structurally poor businesses. Buffett once said, “What we’re looking for beyond this passion is intelligence, energy, and integrity—and if they don’t have the last one, the first two will kill you. If you hire somebody without integrity, you really want them to be dumb and lazy, don’t you? The last thing in the world you want from someone who lacks integrity is for them to be smart and energetic…”
Their approach to incentive is quite simple to understand: compensation should align the management’s interest with those of the shareholders. They want their managers to think like an owner. As Munger once said, “The basic rule on incentives is you get what you reward for. So, if you have a dumb incentive system, you will get dumb outcomes.”
As we have previously learned, Munger explains how important incentives are in running a business. My favourite example on the power of incentives from Munger come from Federal Express:
“The heart and soul of the integrity of the system is that all the packages have to be shifted rapidly in one central location each night. And the system has no integrity if the whole shift can’t be done fast. And Federal Express had one hell of a time getting the thing to work.
And they tried moral suasion, they tried everything in the world, and finally somebody got the happy thought that they were paying the night shift by the hour, and that maybe if they paid them by the shift, the system would work better. And lo and behold, that solution worked.”
— Charlie Munger
Charlie Munger also provided an interesting case study on how Les Schwab tire store was able to come out ahead despite competing with the bigger tire companies such as Goodyears and later on, with huge price discounters like Costco and Sam’s Club. How did he do so? Munger believes that a big part of this is due to the fact that he “must have a very clever incentive structure driving his people. And a clever personnel selection system, etc.”
Similarly, we have also learned from Paul Orfalea, the founder of Kinko’s how a great incentive structure led this company to success. In fact, Orfalea realized that the workers behind the counter at Kinko’s were the true heroes of the company.
As a matter of fact, being in the retail copy centers business, Orfalea had plenty of competitors considering it is an industry with no barriers to entry. As such, if he wanted to beat his competitors, he would have to make Kinko’s a great place to work; he would have to create an incredible corporate culture and make it a competitive advantage. This starts by setting the right incentives in place. In fact, Orfalea mentions that it is a lot easier to manage the work environment than the people in a store. He once said that “when people are properly motivated, they will essentially manage themselves.”
Beyond the Book
Read "Become A Learning Machine" by Farnam Street
Read "Mastering Success: Navigating Within Your Circle of Competence" by Farnam Street
Read "Inversion and The Power of Avoiding Stupidity" by Farnam Street
Read "The Power of Incentives: The Hidden Forces That Shape Behavior" by Farnam Street
If you enjoy reading my newsletter, please consider becoming a paid subscriber. You’ll be able to keep this newsletter going! Here’s what you get when you upgrade:
Voting on polls: you’ll get to vote on who I should write about next.
Requesting biographies: you can request a biography for me to read and write about next.
Supporting my next book purchase: all payments received will be used to purchase a new biography.