The book University of Berkshire Hathaway resumes the relevant lessons learned from the Shareholder meetings of Berkshire Hathaway. I got some very good insights into Warren Buffett’s and Charlie Munger’s wisdom from this little book.
About the author’s
After graduating with a philosophy degree — Daniel Pecaut, the author of this book — started to work at a family business. He made his first experience with trading. He went into options trading and tried for a year to develop a successful trading strategy. But after a year he made only a hundred bucks. Calculating the amount of time he spent, he made only about 10 cents an hour. That wasn’t worth the time, Daniel realized that he needed a better approach.
When he read the book The Money Masters by John Train, he learned about great investors like John Templeton and Warren Buffett. A light bulb switched on and he went back to school. But this time the investors were his professors. His curriculum, everything they say and write.
From that point onward he saw his function in the firm mostly like a learning organism. He realized that the more he learned the better his decision-making would be and the better he would be able to serve his clients.
Among the many investors, he learned from, Warren Buffett and Charlie Munger from Berkshire were the most instructive. Then he bought a single share of Berkshire which enabled him to assist the Shareholder meetings and learn from the over a 30 year period. In this book, he shares his insight.
Using float to build a wealth-compounding machine
In investing, the problem is always running out of money to invest. When Warren Buffett first started out he too quickly invested all his money. Because once he invested it was for the long term he couldn’t use it to make new investments. The solution was to generate float with the insurance industry. Insurance creates a big reserve of money through premiums, this cash can then be used as a leverage to investing, converting it into a platform to compounding wealth.
If you can generate float at a low cost and you can grow it over time, you have built a wealth-compounding machine. As Munger once put it, “Basically, we’re a hedgehog that knows one big thing. If you generate float at 3% per annum and buy businesses that earn 13% per annum with the proceeds of that float, we have figured out that’s a pretty good position to be in.” Few investors know that float is one of the secrets to Berkshire’s success.
A good brand is a potent cash generator
Warren became very successful thanks to the value investing philosophy of Benjamin Graham. He first learned about his strategy from his books, The Intelligent Investor and Security Analysis. Later he became Graham’s student at Columbia.
Graham’s approach consisted of finding businesses which were more valuable than their stock price. This strategy, also called Cigar Butt investing, brought him a long way but had some scaling issues. Once Warren had a lot of money he found it increasingly harder to find enough cigar butts to put his money to work. The solution was high-quality businesses at a higher price. He learned this new way of investing from Charlie Munger.
In 1972 Berkshire bought See’s Candy. While Buffet bought more than he normally would, he discovered how powerful a cash generator a good brand like See’s is. His new acquisition taught him about the virtues of companies with a good brand, that doesn’t require a lot of capital to grow.
Those two pieces — the insurance company as a platform and high-quality brands as cash generators — built the base for the wealth-compounding machine that is Berkshire Hathaway.
Be Humble and know your area of competence
All great investors seem to emphasize this point, Templeton spoke of being humble as the gateway to understanding. The CEO of Capital Cities/ABC considered by Buffett to be the best business manager in the country prays every day to be humble. Munger noted that his and Buffett’s success resulted from that “we’ve had a very low opinion of our abilities.”
He said that he’d rather be with a guy with an IQ of 130 who thinks it is 128 than a guy with an IQ of 190 who thinks it is 240.
Beware of False Precision
Buffet values simplicity. He thinks that if you need to carry it out to three decimal places, it is too complicated. He sees no improvement in the breed of investment managers despite the technological advancement in the last 35 years, they make things more difficult than they are.
Munger noted that the worst mistakes are made from the nicest graphs annd what is really needed is “enlightened common sense.”
Ignore macroeconomics and economic projections
Buffet, Munger and John Templeton share similar thoughts about macroeconomics. Rather than worry about economic projections, they focus on finding good businesses at bargain prices.
It is far more fruitful to decide whether a product can sustain itself than make economic predictions.
Questioned about what books to read, Munger replied that he is a biography nut and heartily recommended biographies as a way to “make friends among the eminent dead.”
Munger said that biographies give you a marvelous experience, extend your range and may even improve the quality of your friends. He recommended Golden Arches and The Big Store for great lessons on business.
Do what you enjoy and work with people you admire
Buffet gave some great advice to MBA Graduates. “Do what you enjoy the most. Work for people you admire. You can’t miss if you do that.”
Rebutting modern portfolio theory
Buffet and Munger are known for their views on modern portfolio theory. Buffet noted with fascination that what is thought about investing has gone backward over the last 40 years. Munger claimed that it is because professors are so enamored by modern portfolio theory and for the man with a hammer, every problem looks like a nail.
Buffet noted that because computers can generate huge amounts of data, modern portfolio theorists end up looking for answers in chicken tracks. They ignore the simple fact that when you buy a business, you own a business.
Buffet mused that he and Charlie should support the study of MPT because “If you are in the sailing business, you want to set up flat-earth scholarships.”
Don’t wait for market conditions
Buffet invested $10.000 when he graduated despite his father and Benjamin Graham telling him that it was a bad moment. He says that if he’d waited for the right market conditions, he would still have $10.000.
Munger noted: “We’re predicting how people are going to swim against the current. We’re not predicting the current itself.”
Keep accounting simple
Berkshire once got a lawsuit because some of its business paperwork was very confusing. The government agency took that as a sign of corruption. Warren and Charlie learned their lesson and Warren now notes that when accounting appears confusing, avoid the company. The confusion may be intentional (unlike the case of Berkshire) and reveal the character of the management.
Diversification is a protection against ignorance
Buffet’s shot against modern portfolio theory was his critique of diversification. He likes to put a lot of money in things he feels strongly about and diversification makes no sense for someone who knows what they are doing. “To buy number one on your list equally with number 37 strikes us as madness. Diversification is a protection against ignorance, a confession that you do not know the business you own.”
Buffet proceeded to explain that three wonderful businesses is more than you need in this life and would serve you much better than 100 average businesses.
Filters are simple to use and will help your decision-making process
Buffett claims that he can answer on a prospective acquisition in five minutes because he is most familiar with most of the large companies and most importantly, he uses filters to simplify his decision-making process. Munger noted people under-rate the importance of a few big ideas. Here are some of the filters Charlie and Warren use:
- Opportunity Cost
Which investment will bring you the biggest returns? You must choose the best opportunity you can understand.
- Quality People
Buffet looks for the wonderful people and avoids the awful. He sticks with those who take their promises seriously.
- Good Business
Look for businesses with a sustainable edge.
The best investment you can make is in yourself
When Buffett talks to students, he tells them what a valuable asset they have in themselves. He says you should be developing your mind and talent.
Buffett says that you are successful if the people you hope love you, do love you. He agreed with Charlie that money is no replacement for friendship and happiness.
How to protect against inflation
Buffett stated that the first line of defense against inflation is to increase one’s earning power. The second line of defense is to own businesses which can price through inflation and have low capital expenditures to maintain the business. Munger added that avoiding to have a lot of silly needs in life is another great defense.
Temperament is more important than intelligence in investment
Munger and Buffett stated that intelligence is helpful but asserted that having the right temperament is far more critical.
Buffett emphasized the need to spend a lot of time looking at companies and building your business understanding. Charlie added that one must read a lot to be wise but curiously, few of those who read a lot have the right temperament. Most get confused by the mass of information.
Buffett added that successful investing requires not extraordinary intellect but extraordinary discipline.
How to measure opportunity cost
Munger noted that to measure opportunity cost, take your best available opportunity and versus all other options. Then concentrate on your best ideas.
“That’s why modern portfolio theory is so asinine.” – he added.
Buffett stated that the key is to follow logic rather than emotion. Focus on what is important and knowable rather than on public opinion. The market is there to serve you, not instruct you.
Become a learning machine
Munger often extolled Buffett’s relentless thirst for learning, calling him a learning machine. Buffett agreed and stated that good investors should read everything they can.
He said that by the age of 10 he’d read every book in the Omaha public library on investing, some twice. Fill your mind with competing ideas, and see what makes sense to you. At age 19 Buffett read The Intelligent Investor and he is still running through the same thought processes he learned from the book.
Charlie said he read the book The Richest Man in Babylon when he was young and that it taught him to underspend his income and invest the difference. Lo and behold, he did this and it worked. He also decided to add a mental compound interest as well, so he would sell himself the best hour of the day to improving his own mind, and the world could buy the rest of his time.
Buffett noted that if he were teaching business school he would make it shockingly simple. Teach
- How to Value a Business
- How to think about market fluctuations. The market is there to serve you, not influence you.
It is important to have emotional stability, an inner peace about your decisions. It is important to think for yourself and to make good decisions over time.
The key to markets is that you cannot allow yourself to be forced to sell and that you must not sell in a panic mode, emotionally pulling the rug out from under yourself.
When asked about advice for life, Munger responded “Pragmatism!” Do what suits you and what works better with experience. Do what works and keep doing it. Repeat what works.
Also published on Medium.