- Charlie Munger taught Warren Buffett that some businesses are worth paying a premium for, hence causing Warren to seize the hunt for cigar butts. Such ‘premium businesses’ are those that generates tons of cash, possess wide moats and continually expand its intrinsic value (remember Warren’s mantra: “Time is the friend of the wonderful business, and the enemy of the mediocre.”)
- The difference between a good business and a bad one can be explained easily: “The difference between a good business and a bad business is that good businesses throw up one easy decision after another. The bad businesses throw up painful decisions time after time.”
- Remember, if you disagree with Charlie Munger, you should probably have a second look at things. Charlie fancies saying: “Think about it a little more and you’ll agree with me, because you’re smart and I’m right.”
Janet Lowe has written a few other books I’ve covered here on dhandho.dk, i.e. Warren Buffett Speaks and Value Investing Made Easy. Damn Right! is not a biography of Warren’s right-hand-man, Charlie Munger, per se, but more a tale of how Berkshire Hathaway’s deputy commander built his wealth and help shape the planet’s largest holding company.
Certain businesses are worth paying up for
Prior to meeting Charlie, Warren religiously followed Benjamin Graham’s investment philosophy (read The Intelligent Investor and Security Analysis). Namely, Warren was always on the lookout for cigar butts; those discarded, disgusting and unloved stocks with no identifiable basis for future operations – however, they had one last puff left in them. These cigar butts were often net nets, i.e. those businesses that were trading at less than the value of its current assets less all liabilities. Warren or other activists could thus acquire the business, pay off the creditors and profit from the proceeds of the liquidation.
Though this strategy was (very!) profitable, Charlie wasn’t – and isn’t – a fan. Charlie knew – and knows – that certain businesses are worth paying a premium for (a price (sometimes well-above) that of a given business’ intangible assets). Charlie puts it as follows: “The investment game always involves considering both quality and price, and the trick is to get more quality than you pay for in price” (p. 78) First time Charlie convinced Warren to walk down this “quality-premium”-path of investing, was with Berkshire’s purchase of See’s Candies. The business was and proved to continue being a tremendous cash-cow with a wide moat, namely a brand that’s synonymous with chocolates of uncompromising quality. The See family who owned the business wanted $25 million, three times the book value of See’s. Warren was close to opting-out, but Charlie convinced the Oracle of Omaha that the price was fair, justified by its moat and excellent economics. Since the purchase till 2015, the business has generated $2 billion in earnings, which Warren has been able to allocate elsewhere – again, of course, at high rates of return.
The See’s Candies purchase was an epiphany, which put Warren down a path that led him to his most profitable investments such as GEICO, Coca-Cola and Gillette.
The difference between a good business and a bad one
In length of the previous section, Charlie taught Warren that ‘good businesses’ are far less demanding than poor businesses. Back in the day, Warren bought the crisis-stricken textile factory Berkshire Hathaway. The business was getting squeezed by foreign competitors who enjoyed the benefits of much cheaper labor. American producers succumbed to the pressure, and closed-up shop one after the other. Warren acquired Berkshire despite these challenges due to its cigar butt characteristics. The years that followed proved difficult to Warren who wasn’t able to orchestrate a turn-around. Hence, liquidation was inevitable; an act, which caused resentment towards Warren by the local community that dependent on Berkshire as an employer
Contrary to the Berkshire Hathaway purchase, the partners have made much more rosy buys since, i.e. Coca-Cola and Gillette as well as their wholly-owned subsidiaries like See’s Candies, GEICO and Nebraska Furniture Mart. These businesses are generating tons of cash, possess wide moats and are run by capable management teams. With a point of departure in these enviable characteristics, it’s not surprising that Charlie describes the difference between good and poor businesses as such: “The difference between a good business and a bad business is that good businesses throw up one easy decision after another. The bad businesses throw up painful decisions time after time.” (p. 59)
Two types of costs: Capital and opportunity
If you’ve read my summary of Per Juul’s Find the best stocks, you might remember the formula ROIC > WACC = $. In short, investors and business managers wish to achieve a return on invested capital (ROIC) that exceeds the weighted average cost of capital (WACC). The more technical explanation can be found in aforementioned book summary, but Warren explains it simply: “If we’re keeping $1 bills that would be worth more in your hands than in ours, then we’ve failed to exceed our cost of capital.” (p. 229) Since Warren and Charlie has been able to compound capital at market-beating levels, Berkshire doesn’t pay-out dividends. Anyways, the cost of capital could be (overly simplified) described as such: The returns that are otherwise widely available to investors.
Opportunity costs are another central theme in Damn Right! This concept can be explained as such: When an investor chooses to allocate capital to an investment idea it happens at the expense of another idea. For instance, if I choose to acquire $10,000 worth of stock in Apple, I have actively decided not to invest in Amazon, Facebook, Tesla or any other opportunity in the vast universe of stocks, bonds, commodities, derivatives, crypto currencies etc.
It’s clear from Damn Right! that missed opportunities rankles Warren and Charlie. They knew they should have invested in Fannie Mae when it was going through tough times, but the partners chose to “suck on their thumb.” Investments that have resulted in permanent loss of capital troubles them most, however. The capital that was lost or stood idle could have been placed in one of their profitable ideas. And that’s the essence of opportunity costs.
Charlie colorfully describes opportunity costs as such: “Life is a whole series of opportunity costs. You’ve got to marry the best person who is convenient to find that will have you. An investment is much the same sort of process.” (p. 45)
Humility is a virtue, but it’s not something for Charlie
Charlie is famous for having said “In my whole life, nobody has ever accused me of being humble. Although humility is a trait I much admire, I don’t think I quite got my full share.” (p. 203) It’s clear from the statements presented in the book that Charlie’s self-assessment isn’t off target. People close to Charlie recall a mantra he enjoyed repeating whenever a disagreement of opinions arose: “Think about it a little more and you’ll agree with me, because you’re smart and I’m right.” (s. 99) Another great quote comes from Charlie’s secret to succes in the financial markets: “Think independently, and think correctly.” (p. 77)
It’s safe to say that Charlie isn’t exactly the humblest soul. But why should he be when he’s been a vital part of building the world’s greatest holding company, which have transformed $10,000 I 1965 into $51 million. by 1998? (p. 172)
April 12, 2020 by Madhava Endlur
Enjoyed reading your writings. Thank you.