Charlie Munger: Buffett’s ‘Abominable No-Man’

September 24, 2015 at 06:56 AM

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Sharp as a tack and blunt as Lenny Bruce, Charlie Munger, Warren Buffett's peppery longtime business partner, is the not-so-secret sauce in the Oracle of Omaha's extraordinary investing success.

Munger, the curmudgeonly 91-year-old vice chairman of Buffett's holding company, Berkshire Hathaway, is a humorous, deep-thinking billionaire whose judgment has been indispensable to growing Berkshire into a $360 billion-plus enterprise. Indeed, last year it picked up $18.3 billion in net worth.

Now comes "Charlie Munger: The Complete Investor" (Columbia University Press-Columbia Business School Publishing), by Tren Griffin, a book that neatly ties together the astute nonagenarian's investing acumen in just under 200 pages.

Studded with Munger wit, it serves up the financier's wisdom verbatim, as spoken publicly or in shareholder letters and other writings over the years, along with Griffin's explanatory comments and financial insights.

A software strategist, Griffin, 60, is a senior director at Microsoft and former partner of private equity firm Eagle River. He writes the popular blog www.25iq.com, focusing chiefly on the market and technology.

In an interview with ThinkAdvisor, Griffin discussed the top Munger and Buffett value-investing tenets responsible for making the two men market legends.

"If there's any secret to Berkshire, it's that we're pretty good at ignorance removal," Munger quipped at Berkshire's 2014 annual shareholders meeting.

Certainly, wide-ranging savvy and endless self-education are ingredients; but the real trick to making rational investment decisions is being patient and aggressive simultaneously, according to Munger. That means: strike while the iron is hot — meanwhile, restrain yourself and keep studying.

Los Angeles-based Munger, who like Buffett, 85, was born in Omaha, Nebraska, learned business skills playing poker in the Army, then refined them in his initial career as a lawyer. He ran his own investment firm in the 1960s and 70s, and in 1978 joined Buffett as vice chairman. By that time, the pair had been conferring for some 20 years. From 1984 to 2011, Munger was also chairman of Wesco Financial, now a Berkshire subsidiary.

Today, Buffett's partner still wears a collection of different hats: He is chairman of the Daily Journal Corp., a director of Costco and a real estate developer, too.

ThinkAdvisor chatted recently with Seattle-bred Griffin about Berkshire's investing approach and why Buffett calls his candid collaborator "The Abominable No-Man." Here are excerpts:

ThinkAdvisor: How much do Warren Buffett and Charlie Munger rely on forecasts to make their investment decisions?

Tren Griffin: They scrupulously stay away from them. Warren and Charlie try to avoid bets where you have to predict something with specificity. The future is a probability distribution and can't be predicted. If you make a bet that's going to pay off only if oil goes back to $100, the bet is contingent on predicting that event. Their bets tend to be: It doesn't matter if oil is $100 or $40 or $70 – we're going to do OK.

For example?

Warren just bought Phillips 66, an oil refiner. A refiner will make money regardless of [big fluctuations] in the price of oil because that oil must be made into something. Munger tries to invest only where he has an unfair advantage; otherwise, "he wants to do nothing," you write. That's real discipline!

It's the key. Making rational decisions requires discipline and a long attention span. You need to be patient and aggressive at the same time. In 2008, when everybody was selling everything, that was the time to be aggressive.

So what did Munger buy?

He made a bet on Wells Fargo [early in 2009] with cash that the Daily Journal Corp. [was sitting on]. It was an unbelievable home run. He saw that dollars were on sale for 65 cents. That's key in the Munger approach: Buy a dollar's worth of value at a 65-cent price. He concurs with Benjamin Graham [originator of value investing] that the market is bipolar: Sometimes price and value diverge in a really significant way.

How is the market bipolar; that is, manic-depressive?

This is hugely important in the short term: People are ruled by emotions, and emotional swings create opportunity for investors. But you want to be fearful when others are greedy, and greedy when others are fearful, Buffett says. When other people are scared, you're going to be aggressive. When others are aggressive, you're going to be scared.

What should investors do when Mr. Market is down in the dumps?

That's the greatest opportunity to purchase assets. But this requires discipline because as a result of evolution, we're likely to follow the crowd.

What broad investing approach do Buffett and Munger use?

Buffett analyzes all decisions according to: What's my most attractive opportunity? If you say, "I want you to buy X stock," he won't think, "Should I buy X stock?" Instead, he thinks: "Is X stock the best investment I can make of all the investments I can make in the world?"

What's the most important lesson to be learned from Munger?

Price and value are very different things. You want to buy an asset that's substantially mispriced – greatly undervalued – because you can make a mistake and still do well.

Where's the rub?

Those opportunities don't arrive very often. Only occasionally, like [during the financial crisis], do assets become available at prices where you can make a mistake and still do great.

What's a chief variable in Munger's seven bedrock principles of investing?

How much you diversify. Warren does diversify some. But Munger said that he'd be happy with just Berkshire and Costco. In an [equity] portfolio, he's very comfortable with a small number of stocks, though he can have some cash and bonds, too.

So Munger isn't a fan of diversification.

No. In fact, he thinks one of the saddest things is when people who think they're active investors have so many stocks that they've become what he calls "closet indexers."

What's Berkshire's system of "focus investing"?

Charlie and Warren believe that there's a small number of people who, through diligent application of work and thought, can beat the market. For those, diversification doesn't make sense. But very few people know what they're doing, and most overpraise their investing talent. The focus system is designed, in part, for investments to outperform in up markets and overperform in down markets. Please explain.

To outperform the market, you must be different from the market – because if you are the crowd, you can't beat the crowd. Therefore, at times you must be willing to be a contrarian – and you also must be right.

What's the upside and downside to being a contrarian?

You're not going to ride along in the bubble phase. A value investing system will underperform when the crowd is euphoric. But in the flat and the down phases, you'll do better.

Is there an area where Buffett and Munger diverge in their investing philosophy?

The way they calculate intrinsic value is slightly different. And Charlie is much more likely to say no than Warren. Buffett calls Charlie "The Abominable No-Man." He has an incredibly quick mind, and he's probably harsher than Warren. Charlie will tell you why things might not work. My guess is that Warren calibrates Charlie: If he's only slightly negative, that might be positive. Some of Charlie's [cantankerous] personality is probably theatrical. I think Warren has that calibrated, too.

Munger said "Investing is the equivalent of betting against the pari-mutuel system. We look for a horse with one chance in two of winning and that pays three-to-one. We're looking for a mispriced gamble."

Right. You can go to the track and win! You're not necessarily betting on the best or the most popular horse; you're betting on the horse with the best odds and best payoff. Poker is the same. But for the wager to make sense, you need to have substantial probability that you'll have a winning bet. If you bet only occasionally, when presented with a wonderful opportunity you're going to do well. So you should bet seldom. But when you do, Munger says, bet big.

Buffett and Munger stick to investing in their "circle of competence" only; that is, businesses and industries they know well and deeply understand. Please elaborate.

Munger's Rule No. 1: Don't lose money. Rule No. 2: The way not to lose money is to know what you're doing. You need to be inside your circle of competence to know what you're doing, because not knowing what you don't know is most dangerous.

Is that why Buffett and Munger don't jump into high tech?

Yes. They both say that if they were young today, they'd go into technology. But [at this late date], they're not going to fool themselves into believing that they can acquire a competitive edge. You need to play where the competition is the weakest, they say. You want your level of confidence to be high and that of your competitors to be low.

And not deviate from that approach.

Munger says to find areas where you're absolutely dominant, where you're a Yankees-level player in the minor leagues. That's where you'll make the most money and how you'll accumulate a record like they have. Just what do they look for in a business?

First, a sustainable, competitive advantage, or what they call a "moat": Some limit on the level of supply of whatever you're [providing]. This creates scarcity, generating better margins and value. The other thing is management that has skill and integrity.

Munger believes that in investing, passion is more important than brain power – yet he also says investors should be dispassionate. Please clarify.

You have to be passionate about acquiring the input and methodology to make wise decisions. But in making the decisions, you have to be passionately dispassionate; that is, be careful because most mistakes are emotional. It's the whole idea of being patiently aggressive.

Talk about Ben Graham's concept that Mr. Market should be your servant, not your master. Munger agrees.

In the short term, the market is not wise. When you treat Mr. Market as wise, you're in big trouble. Some days he's going to give you a bargain; other days, he'll offer you something that's overpriced. In the short term, the market is a popularity contest, and that creates mispricing. Extreme libertarians think the market is perfect, that it can never be wrong. Rubbish!

What about long term?

The market is wise. Buffet says that in the long term, it's a weighing machine, not a voting machine.

The partners' view is that long term, risk can't be fully measured by price volatility.

Munger strongly believes that for the long-term investor, volatility is not equal to risk. That the two are [synonymous] is complete nonsense, he says. Volatility is one risk but not all risk. There are many other risks.

Munger and Buffett maintain that the way to reduce risk is to think broadly. Not surprisingly, they're both serious thinkers.

In order to think about investing, you must think about thinking. Warren and Charlie purposely clear their calendars for extended periods so that they can just sit and think. Without exception, all the [great] investors are broad thinkers. And they read constantly because to do what investing really requires, you need to know a lot about a lot.

Is this where Munger's "Lattice of Mental Models" comes in?

Right. There are at least 10 fundamental models [across] all disciplines, including history, physics, philosophy, sociology, psychology, that are super-powerful; for example, return to the mean, compounding, evolution – all of which you should be thinking about at the same time. That way, you'll produce the lollapalooza called wisdom.

Munger's strategy is to buy businesses or a portion of a business and own them virtually forever.

Correct, because there are only about 20 times in a lifetime that you're likely to find something that's really, really great. And when you do, you're going to want to put a lot of bets behind that choice.

But even Buffett and Munger have made mistakes. Haven't they?

Dexter Shoe was a very bad purchase. The shoe business was going bad faster than they had imagined. [Mistakes] usually occur when you misjudge the competitive nature of [an industry]. They also made plenty of mistakes in retail, namely with department stores. And they took big losses on silver. But it's the magnitude of correctness, not the frequency of correctness [that counts]. A sound process is what matters. In the long term, that's what determines results. You write that Munger doesn't go for gold. And with their experience in silver, I trust they aren't big on commodities in general?

Charlie and Warren agree that the value of an appreciating business – like [their] See's Candies – will always outperform a hunk of precious metal. As a hedge against inflation, Munger would rather buy a business – that is, an asset that's productive.

They bought See's in 1972. Was that a milestone acquisition?

It was seminal in their journey as investors. See's flows mountains of cash, requires almost no capital to open stores and has brand power.

What went into their decision to buy the candy maker?

Munger said, "This is a great quality business and has pricing power," meaning they could raise prices every year, and people would still want to deliver that box of See's Candies.

Do you personally use Munger's investing system?

I do.

How successful have you been?

Very successful.

"If you buy [just] a few companies, you can sit on your ass," Munger says. How about you?

I do that: I buy great companies and keep them. But the majority of my wealth comes from working rather than investing. Most people should think in that way.

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