Charlie Munger Interview

He speaks his mind. Lots of wisdom:
http://www.gurufocus.com/news/278472/charlie-munger-interview-

"During the Daily Journal annual meeting, he said that he hasn't added an investment to his personal account in at least two years."

He added, “One person said to me, ‘I have a list of 300 potentially attractive stocks, and I constantly watch them, waiting for just one of them to become cheap enough to buy.’ Well, that’s a reasonable thing to do. But how many people have that kind of discipline? Not one in 100.”

Munger said what it takes for successful investing, this crazy combination of gumption and patience, and then being ready to pounce when the opportunity presents itself, because in this world opportunities just don’t last very long.”

He continued, “It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait,” he said. “If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.”

“How the hell does this thing end up blowing past GE?” Charlies Munger in shock that Berkshire Hathaway surpassed GE in market cap.

He talked about how General Electric (GE) and other companies long history of moving around leaders.

“long had a history of moving [division leaders] around internally, and that’s like asking an oboe player in the symphony to perform on the piano and expecting the quality of the music not to suffer.”

He added “I think we have had a temperamental advantage: Warren and I know better than most people what we know and what we don’t know. That’s even better than having a lot of extra IQ points.”

He went on to say, “People chronically misappraise the limits of their own knowledge; that’s one of the most basic parts of human nature. Knowing the edge of your circle of competence is one of the most difficult things for a human being to do. Knowing what you don’t know is much more useful in life and business than being brilliant.”

During the Daily Journal annual meeting, he said that he hasn't added an investment to his personal account in at least two years.

He added, “One person said to me, ‘I have a list of 300 potentially attractive stocks, and I constantly watch them, waiting for just one of them to become cheap enough to buy.’ Well, that’s a reasonable thing to do. But how many people have that kind of discipline? Not one in 100.”

Munger said what it takes for successful investing, this crazy combination of gumption and patience, and then being ready to pounce when the opportunity presents itself, because in this world opportunities just don’t last very long.”

He continued, “It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait,” he said. “If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.”

Interview with Jason Zweig

On how Warren Buffett (Trades, Portfolio) influenced him:

Warren talked me into leaving the law business, and that was a very significant influence on me. I was already thinking about becoming a full-time investor, and Warren told me I was far better suited to that. He was right. I would probably have done it myself, but he pushed me to it. I have to say, it isn’t an easy thing to work very hard for many years to build up a significant career, as I had done, and then to destroy that career on purpose. [Mr. Munger left the law firm he founded, Munger, Tolles & Olson LLP, in 1965 to serve as Mr. Buffett’s right-hand man at Berkshire and to run a private investment partnership.] That would have been a lot harder to do if not for Warren’s influence on me.It wasn’t a mistake. [Laughter.]

It worked out remarkably well for both of us and for a lot of other people as well [the investors in Berkshire].

On Benjamin Graham, the great investor who was Warren Buffett (Trades, Portfolio)'s revered mentor:

I don’t love Ben Graham and his ideas the way Warren does. You have to understand, to Warren — who discovered him at such a young age and then went to work for him — Ben Graham’s insights changed his whole life, and he spent much of his early years worshiping the master at close range. But I have to say, Ben Graham had a lot to learn as an investor. His ideas of how to value companies were all shaped by how the Great Crash and the Depression almost destroyed him, and he was always a little afraid of what the market can do. It left him with an aftermath of fear for the rest of his life, and all his methods were designed to keep that at bay.

I think Ben Graham wasn’t nearly as good an investor as Warren Buffett (Trades,Portfolio) is or even as good as I am. Buying those cheap, cigar-butt stocks [companies with limited potential growth selling at a fraction of what they would be worth in a takeover or liquidation] was a snare and a delusion, and it would never work with the kinds of sums of money we have. You can’t do it with billions of dollars or even many millions of dollars. But he was a very good writer and a very good teacher and a brilliant man, one of the only intellectuals – probably the only intellectual — in the investing business at the time.

On firms like Berkshire partner 3G Capital, which takes big companies and streamlines them:

I’m sensitive to the issue of cutting costs, which usually means a lot of people losing jobs. Rich people end up getting richer and a lot of people get fired. But ultimately, I think we don’t do the world a favor by employing more people than we need for companies to run efficiently. On the whole we advance civilization when companies run better.

On what he and Mr. Buffett call "the circle of your competence":

Confucius said that real knowledge is knowing the extent of one’s ignorance. Aristotle and Socrates said the same thing. Is it a skill that can be taught or learned? It probably can, if you have enough of a stake riding on the outcome. Some people are extraordinarily good at knowing the limits of their knowledge, because they have to be. Think of somebody who’s been a professional tightrope walker for 20 years – and has survived. He couldn’t survive as a tightrope walker for 20 years unless he knows exactly what he knows and what he doesn’t know. He’s worked so hard at it, because he knows if he gets it wrong he won’t survive. The survivors know.

Knowing what you don’t know is more useful than being brilliant.

On how innovative Berkshire Hathaway has been:

There isn’t one novel thought in all of how Berkshire is run. It’s all about what [Mr. Munger’s friend] Peter [Kaufman] calls ‘exploiting unrecognized simplicities.’ We [Messrs. Buffett and Munger, their shareholders and the companies they have acquired] have selected one another. It’s a community of like-minded people, and that makes most decisions into no-brainers. Warren and I aren’t prodigies. We can’t play chess blindfolded or be concert pianists. But the results are prodigious, because we have a temperamental advantage that more than compensates for a lack of IQ points.

Nobody has a zero incidence of bad news coming to them too late, but that’s really low at Berkshire. Warren likes to say, ‘Just tell us the bad news, the good news can wait.’ So people trust us in that, and that helps prevent mistakes from escalating into disasters. When you’re not managing for quarterly earnings and you’re managing only for the long pull, you don’t give a damn what the next quarter’s earnings look like.

On how he sank tens of millions of dollars into banks stocks in 2009:

We just put the money in. It didn’t take any novel thought. It was a once-in-40-year opportunity. You have to strike the right balance between competency or knowledge on the one hand and gumption on the other. Too much competency and no gumption is no good. And if you don’t know your circle of competence, then too much gumption will get you killed. But the more you know the limits to your knowledge, the more valuable gumption is. For most professional money managers, if you’ve got four children to put through college and you’re earning $400,000 or $1 million or whatever, the last thing in the world you would want to be worried about is having gumption. You care about survival, and the way you survive is just not doing anything that might make you stand out.

On accounting:

Accounting firms now [in the wake of regulatory requirements under the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act of 2010] have had to hire so many people that they have had to go way down in the bucket to get all these new employees. The government is asking accountants to be policemen, but the number of people smart enough to be qualified for policing is too low. We shouldn’t be expecting accountants to do the policing. Firms should have the ethical gumption to police themselves: Every company ought to have a long list of things that are beneath it even though they are perfectly legal. Every time you increase the antagonism of the audit by making the auditors the policemen, you increase the tension between the accountants and the clients. More things end up getting hidden, costs go up, everyone ends up worse off.

On the decline of newspapers:

The role that newspapers played in this country has been absolutely remarkable. The Fourth Estate functioned for decades like another, almost better form of government in which many newspapers were run by people of the highest ethical standards and a genuine sense of the public interest. With newspapers dying, I worry about the future of the republic. We don’t know yet what’s going to replace them, but we do already know it’s going to be bad.

On the absurdity of most of the money-management industry:

Back in 2000, venture-capital funds raised $100 billion and put it into Internet startups — $100 billion! They would have been better off taking at least $50 billion of it, putting it into bushel baskets and lighting it on fire with an acetylene torch. That’s the kind of madness you get with fee-driven investment management. Everyone wants to be an investment manager, raise the maximum amount of money, trade like mad with one another, and then just scrape the fees off the top. I know one guy, he’s extremely smart and a very capable investor. I asked him, ‘What returns do you tell your institutional clients you will earn for them?’ He said, ‘20%.’ I couldn’t believe it, because he knows that’s impossible. But he said, ‘Charlie, if I gave them a lower number, they wouldn’t give me any money to invest!’ The investment-management business is insane.

On rapid trading of derivatives and stocks by institutions and individuals:

It’s like the slaughter of the innocents. It makes the people who run Las Vegas seem like good people.

Interview Wall Street Journal: http://blogs.wsj.com/moneybeat/2014/09/12/a-fireside-chat-with-charlie-munger/?mod=WSJBlog 

Hail to the Chiefs

http://www.hedgefundletters.com/chieftain-capital-management-brave-warrior-advisors/

Chieftain Capital Management / Brave Warrior Advisors

The original Chieftain hedge fund was founded by Glenn Greenberg and John Shapiro in 1984 in New York City with a capital of 40 million dollars mostly from their family. In the first five and a half years of their operations, they averaged a compounded annual return of 28% for their investors. The media noticed and CNN compared the duo to Warren Buffett and his partner Charles Munger. The chemistry of the team – Mr. Greenberg brought a certain passion to the stock selection process and Mr. Shapiro tempered the passion with detached skepticism – and unanimous decision making accounted for the outsized returns.

From inception through end of 2006, they multiplied their investors’ money 100 times by compounding the funds over 23% annually. In 2008, however, they had their first significant downturn (reportedly 25%). Due to disagreements regarding management, the duo announced they will be splitting the 2 billion dollar plus fund in late 2009 and in January 2010 Mr. Shapiro started the new Chieftain and Mr. Greenberg renamed his own fund Brave Warrior Advisors.

Today Mr. Shapiro’s fund has 1.5 billion dollars assets under management and Mr. Greenberg’s fund has 1 billion dollars. From their latest filings, both funds hold 12 positions each, with the top five positions commanding more than 50% of the assets and the top position amounting to 14% and 17% respectively. This concentrated style validates their statement that they did not split the fund because of any differences in investment philosophy but rather managerial issues. The investment philosophy that helped them garner the impressive streak of returns for their investors continues to dominate their separate funds.

At the outset in 1984, the original Chieftain was founded on some basic rules as to how it would be run. First and foremost, both the partners would dedicate the majority of their time to doing their own ideation and research and portfolio management.  That meant brokerage firms were not allowed to call them with their ideas – in the rare instance if either of the partners needed outside research they would place the outbound call.

Secondly, the firm would not engage in marketing their fund as that would take time away from their core competency of managing money. Instead, they would concentrate on growing the assets organically through competent security selection. They would get new clients from word of mouth and the client would independently choose to invest with them. That ensured a good match between their investment philosophy and the client’s expectations.  They practically had no redemptions until the tumultuous year of 2008.

Thirdly, whatever they bought in the fund would also be bought in their own and families’ portfolios. The dictum of eating their own cooking would ensure alignment of interests with their clients and focus them on making the right investments as their money would always be on the line also.

Armed with this focused procedure that eliminated unnecessary distractions from the business of managing money, the matter of portfolio construction was addressed. In order to outperform the general markets, the portfolio has to be concentrated – alpha is generated by differentiation, far from the all too familiar “management” style of index closeting.

More specifically, every position should command at least 5% of the portfolio, and if the conviction is amiss to take the said stake then the investment should be eschewed altogether.  This construct also ensures that only high quality businesses with limited probability of uncapped downside make it into the portfolio.  The psychological corollary to this is that in a down market one holds on to the stocks as the probability of losing money permanently has been removed as much as possible – this in turn leads to having the patience and fortitude to hold companies for the long term which is often needed to achieve above average returns.  True to this, both the original Chieftain and the two new funds usually have the majority of assets allocated to ten or so stocks and are open to holding the portfolio for the long haul.

As to the actual business of stock picking within this frame, there are three elements that are crucial. 1. The management of the company.  2. The business model of the company. 3. The valuation of the company. All three have to be favorably aligned in order to be investment worthy. Actually, only about 1% of the companies they research make the cut.

In regards to the executive management of the company, first they have to be simply shareholder-oriented for the long term. For this to truly happen, the management has to be mainly interested in running the business well. Simplistic as these requirements are, they are not easily met thanks to many managers’ emphasis on achieving quarterly earnings or not understanding the ground level realities of their industry.

In today’s information overload in the financial analysis of publicly-traded companies, the management is faced with a barrage of questions and the important one’s get leveled or buried with the insignificant ones. The astute analyst pays attention to a maximum of three most key questions to see if the management has an essential understanding of their domain. For instance, prior to making an investment in Abbot Labs, when meeting with the management  the fund established that the management had a satisfactory strategy to address the fact that their top selling product (accounting for fifty percent of their revenue) was approaching maturation.  (In the case of Comcast, however, after the fund had acquired a significant stock position in what it believed was a good business model, it was disappointed in the management of the company and in an activist manner demanded the ouster of the CEO.)

Moving on to the second crucial element of the security selection, the business model they seek is consistent with their emphasis on downside protection. They are not attracted to brand new frameworks where the growth might indeed be higher than established businesses but the risk of the new business disappearing altogether is a very real possibility.

Instead they look for companies falling into any of these four business models: (1) One which enjoys a local monopoly in a field, (2) Has the advantages of low cost in a commoditized market, (3) Is engaged in a basic and essential service that will not stop growing in the near future, or (4) A company in a steady industry that is growing so slowly that there are no new competitive entrants.

Their investment in Quest Diagnostics which administers medical tests was a good example combining some of the outlined business models. It was in a mature business that was growing at a steady rate, yet not with such speed that it attracted too many new entrants. Additionally, any new competitor would have had a tough time in scaling up and penetrating the company’s already established reimbursement arrangements with the medical community. These barriers to entry resulted in the company enjoying extremely high and well protected metrics in regards to return on capital, free cash flow, and profit margins.

The third leg of the investment stool is the market valuation of the company. As Mr. Greenberg puts it, the aim is to get growth at an “unjustifiably” low price. A decent, not necessarily great, business generating about 10% of free cash flow and a 3% to 5% growth, adds up to an expected return of 13% to 15%, as opposed to the expected 6% to 8% of overall market growth.

While it is important to build one’s own financial projections, one has to be careful not to extend the estimates beyond three years. This is so because it is unreasonable to truly predict anything beyond that time horizon and also because one has to be wary of getting too involved in the complexities of financial modeling to the point where the competitive advantage of the company is overwhelmed by abstract number crunching.

When the fund started the valuation mispricings existed because of lack of information and today the computer driven markets pay too much heed to miniscule numbers that do not affect the long term prospects of the company. In both scenarios, the mispricings usually exist in the large cap companies of boring industries which is indeed the hunting grounds of the fund.

Ultimately the market recognizes the mispricing, but it can sometimes take five to seven years or longer for the actualization. For example, when the fund bought Freddie Mac during the Gulf War down market, they held on to the stock for nine years and realized a twenty times gain. Interestingly, the stock was not sold simply because it was a twenty bagger; rather, they saw the deterioration in the business fundamentals as Freddie Mac began to delve into riskier mortgages. While the higher valuation of the business also played a role in the selling of the position, more importantly it was the risk of Freddie Mac undergoing a dramatic change in its business trajectory.

In the instance of the cable industry in the early nineties, they found the mispricing driven by analyst exaggeration of the threat of satellite television.  While the latter was indeed going to compete for market share in the television, the cable companies were going to have higher growth in the DSL internet space and continue to command a good share in the television business (especially since the satellite companies were having their own technical rollout troubles). In any case, the cable companies they bought (at one point up to 40% of the fund’s portfolio) were definitely deemed to be undervalued as they were trading at an average EBITDA multiple of 5. By the late nineties, the multiples expanded to 15x and they sold for five time their original investment (with the exception of Comcast).

On top of all the filtering analysis inherent in their investment philosophy, an additional layer of risk management is added by limiting the buys to the US domestic market only, thereby both removing the risk of currency fluctuations and being exposed to unfamiliar accounting or regulatory issues. As for missing out on the faster macro growth being enjoyed by other markets, many US conglomerates now derive significant revenue from these markets.  In any case, the macro US or global predictions are only incidental to their concentrated hand-picked micro portfolios.

Manager Biographies:

Prior to co-founding the original Chieftain Capital Management, Mr. Shapiro worked at Central National Corporation and Merrill Lynch & Co. He graduated with an MBA from Columbia Business School and a BA from Wesleyan University. He made a donation of 3.5 million dollars to the Creative Writing Center at Wesleyan as he had aspired to be a writer when studying there but was, in his own humble words, “stymied by insufficient talent and a lack of discipline”.

By the time he co-founded the original Chieftain, Mr. Greenberg had garnered ten years of experience in the finance industry: First five as an analyst at Morgan Guaranty (now JP Morgan Chase) and the other as a research analyst at a small private investment firm. He has an MBA from Columbia Business School and a BA in English from Yale University.

Mr. Greenberg’s father was the famous baseball player “Hammerin’ Hank” Greenberg of the Detroit Tigers.

His son Spencer started an artificial intelligence driven quant hedge fund in 2007. The fund is tellingly named Rebellion.

---

QUOTES

“Although Chieftain’s partners remain committed to the firm’s investment philosophy, differences on internal firm matters have led us to decide to separate”. (This quote is from a letter to investors announcing the break up, the rest below are from Mr. Greenberg.)

”That way [by making joint decisions on stock selection] we avoid blaming each other for our losers. We try to be competitive with the rest of the world, not with each other.”

“The firm broke up at the end of last year, and I started Brave Warrior with the same precepts”.

“So the question is why should a decent quality or good quality business be priced to give you a 13-15% return when the market is priced to give you a return of about half that? Eventually somebody discovers this, somebody wakes up – it is not necessarily that the boring company with a double-digit cash flow yield has got some major trick up its sleeve; it just gets recognized as mispriced relative to the market. I would say that even though the equity market has run up quite a bit, there are still a lot of those companies around.”

“Going for too much certainty can hold you back – there is no certainty”.

“But, the world looks a lot better today than it did [in the financial crisis of 2008]; the worst didn’t happen and stocks have done brilliantly. If you listened to people back then, you would have thought that not only were corporate profits going to collapse, but that there would be no recovery and stocks were a terrible place to have your money. That is what they call conventional wisdom – it may be that very brilliant minds come to the same conclusion, but it still becomes conventional wisdom and it does not mean that it is right”.

“I would say our edge is the willingness to take a longer view of a business”.

“This idea of an intrinsic value implies that all investors, or average investors, will insist on a certain rate of return. I don’t even know what the term fair value means and that seems to be bandied about a lot. I do not think we could agree upon what the fair value of the market is because we all have different return requirements”.

“I have never seen anyone who could predict the market or predict the macro economy with any degree of consistency”.

So You Want To Be The Next Warren Buffett? How ís Your Writing?

http://www.manualofideas.com/files/sellers.pdf

This essay by Mark Sellers is one of the best on investing.   However, it is easy to talk the talk, but hard to walk the walk. The last point the author stressed:

"And finally the most important, and rarest, trait of all: The ability to live through volatility without changing your investment thought process. This is almost impossible for most people to do; when the chips are down they have a terrible time not selling their stocks at a loss.."

But when the chips were all down in the dark days of 2008, Sellers sold out his positions in his funds and handed his investors huge losses.  It is ironic but it is also understandable.

So at the end of the day, it is not the brain or writing, but stomach, that determines one's investment success.

Read 500 pages everyday - this is the secret to success

http://www.farnamstreetblog.com/2013/05/the-buffett-formula-how-to-get-smarter/

When asked how to get smarter, Buffett once held up stacks of paper and said “read 500 pages like this every day. That’s how knowledge builds up, like compound interest.”

An Interview With Portfolio Manager Jason Donville

http://www.investingthesis.com/interviews/investing-professionals/an-interview-with-portfolio-manager-jason-donville-of-donville-kent-asset-management/

"We consider Return on Equity (ROE) to be the key starting point for any company we look at because we believe the key value driver of any company is its ability to earn a return on equity that is substantially higher than its cost of equity. "

"We look at working capital management because we find that there are times when it is difficult to be objective about a company’s management. Working capital management (inventory days, accounts receivable management, etc) is like a form of DNA for a company – its their signature of how good they are as managers that they cant hide."

"We tend to hold highly concentrated positions but we also tend to buy stocks on the way up. We rarely if ever average down and we never buy a large position all at once. We want to see the upward movement in the stock validate that we are correct in assuming that the said company is undervalued."

All these invaluable  nuggets of wisdoms!  There are more in the full interview.

The single best stock to own of the last 50 years

"The single best stock to own of the last 50 years was cigarette giant Altria (NYSE: MO). Its stock compounded at an average of nearly 20% a year for half a century – enough to turn $1,000 into more than $8 million.

The last 50 years was the era of technology, when the world went from abacus to iPad. Yet the single best company to own sells the same product today as it did 100 years ago. Part of this is because Altria is a successful company, of course. But its secret is that it's been a modestly successful company for an immodest amount of time. Lots of companies earned 20% annual returns for shorter periods of time, but Altria has earned them for decades. That enabled compound returns to go from impressive to extraordinary."

http://www.fool.com/investing/general/2014/07/18/i-prefer-to-keep-things-simple.aspx

Concentration is Key for the Active Investor

Concentration is Key for the Active Investor

"It is important to note that mispriced investments will happen more often that once or twice a year as a whole, but the only mispriced investment that is important to you is one that falls within an area in which you are very competent. The smaller the area in which you apply your time and effort to being competent, the more likely is that you will genuinely spot the opportunities. If you try to be competent in all areas and you will never be smart enough to find these investment opportunities."