Listening to Warren Buffett, Charlie Munger and other smart investors over the course of the weekend surrounding the Berkshire Hathaway meeting in Omaha is always informative. Below I examine my 10 insights from this year’s trip, which are a combination of new ideas and helpful reminders about those from the past that are still important today.
1. “A lot of other people are trying to be brilliant and we are just trying to stay rational. And it’s a big advantage.”[i] – Charlie Munger
I am frequently asked what my competitive advantage as an investor is. One friend even went as far as to tell me (only half-jokingly) that he wished that I had some special satellite that could look into the parking lots of companies to predict demand. I do not have such a satellite, nor do I think it would be particularly useful to the kind of long-term value investing that I do. One’s competitive advantage in investing usually comes from a combination of things, and Charlie reminded us that one of the most important is temperament. Many people can articulate a good investment approach in theory. It is far more difficult to remain rational and execute it under conditions of uncertainty and real-world pressures. Those of us who can fully stick to our investment process despite external turbulence possess an important edge over those who cannot.
2. “People tend to act too frequently in the stock market because stocks are so liquid. There are no called strikes, so ignore people yelling at you ‘Swing you bum!’” – Warren Buffett
The pressure to do something is one of the many behavioral biases affecting investors. Imagine if instead of investing in liquid public-market securities you were investing in private businesses. Would you be as quick with your decisions? I suspect many people would not be, and would be better off with the less frenetic pace of activity. Applying this insight in the context of the current investing environment, many investors might be succumbing to the infamous Fear Of Missing Out (FOMO) as they see stock prices march steadily higher. We should take care to practice behavioral defense to guard against such influences.
3. “Every time you appoint a new person who never had capital allocation experience, it’s like rolling the dice.” – Charlie Munger
There is an old saying: “When a man with money meets a man with experience, the man with the money leaves with experience and the man with experience leaves with the money.” Many people can articulate an intrinsic value philosophy. “I buy businesses that are worth $100 for $50 or $60.” Sounds easy, right? Well, it’s not easy. It requires a lot of judgement – judgement to choose the right businesses to value, judgement to understand how their future economics might be different from the past, judgement to assess management and its capital allocation process, among other things. While experience alone is not sufficient, neither is just book knowledge. Combining a good investment philosophy and process with experience of applying it over several economic cycles allows one to improve in a way that would be impossible to do without having applied the process in the real world over a long period of time.
4. “If you pick out the last 10 years and you go back to May of 2007, I would say that we have probably compounded intrinsic value at about 10%. I think that will be tough to achieve, in fact almost impossible to achieve, if we continue in this interest rate environment. On the other hand, if I were to look over the whole range of probabilities on interest rates, I would say that the 10% rate of compounding might be somewhat aspirational, but it might be doable.” – Warren Buffett
As I have written in Silver Ring Value Partners’ Owner’s Manual, the U.S. stock market has historically generated annual returns equal to approximately inflation + 6.5%. However, that rate of return is very unlikely from the current starting point over the intermediate-term for a number of reasons, including starting valuation, where we are in the cycle and the current low interest rate environment. I believe a mid-single digit nominal rate of return over the next 5-10 years in the current interest rate environment would be a somewhat optimistic outlook for U.S. stock market returns. Buffett’s comments about what he thinks he can do as far as the rate of compounding at Berkshire Hathaway over the next decade are consistent with that view. He has delivered a return approximately 5% above the market over the last 10-20 years, and a 10% return for Berkshire Hathaway would likely imply a return for the market in the mid-single digits if that outperformance continues.
For context, here is a historical perspective on 10-year rolling real rates of return based on the data from Robert Shiller of Yale:
5. “I estimate that Jack Bogle [founder of Vanguard and index fund pioneer], has at a minimum left in the pockets of investors without hurting their performance tens and tens of billions of dollars.” – Warren Buffett
Buffett is right to praise Jack Bogle. Arguably, Bogle has helped the greatest number of investors by the greatest amount by bringing a theoretical concept, passive investing through index funds, into everyday life. As I have argued in a previous article, Why Passive Investing Is an Excellent Default Choice – an Active Investor’s View, many investors would be better off with a passive approach.
6. “In investing, if you stay away from a bunch of terrible businesses, you are really off to a good start. […] I think you learn a whole lot more about business by actually struggling with a terrible business for a couples of years than by getting into a very good one.” – Warren Buffett
When I started investing professionally over 15 years ago, I had little appreciation for business quality. It was all about valuation back then – finding stocks that were trading at low multiples of earnings and free cash flow. After all, wasn’t that what the father of value investing, Benjamin Graham, taught us in his Security Analysis? As I have learned and evolved through hard-earned experience, I have come to appreciate the importance of business quality. The economics of some businesses are just much more predictable over the long-term than those of others.
Early on in my career I found a chemical company that I thought was statistically cheap and a good investment. My analysis was based on estimating the future mid-cycle profitability of the business. Looking back more than a decade later, it turns out that I was off in my forecast… by a factor of 10! Lessons such as this one with tough businesses have made me avoid businesses of below average quality in my investing. Factors such as the presence of a stable and attractive industry structure, a durable competitive advantage, and a management team that is both competent and aligned have become much more prominent in my investment process as a result.
7. “One of the questions I ask the CEO of every public company that I meet is what would you be doing differently if you owned it all yourself? And the answer, you know, is usually this, that and a couple of other things. If you would ask us, the answer is, we are doing exactly what we would do if we were to own all the stock ourselves.” – Warren Buffett
The importance of management is hard to over-emphasize, yet it is equally hard to quantify. To the degree that a management team deviates from taking actions that maximize long-term intrinsic value per share, it has the potential to lower long-term returns for the company’s shareholders. Many management teams succumb to these pressures, either through not knowing what to do to maximize value, because of mis-alignment of incentives or because of pressure to optimize for shorter-term or more optically pleasing results than those that would maximize long-term value. Nobody is perfect, and small differences between actual and desired behavior are unlikely to materially lower long-term intrinsic value. However, if the difference in behavior from what a competent management would do if they owned the whole business were material, this is a substantial red flag that could warrant passing on investing in the stock.
8. “When you go out in the world, look for the job that you would take if you didn’t need a job. I mean, don’t postpone that sort of thing. […] You really want to think about what will make you feel good when you get older about your life, and you, at least generally, want to keep going in that direction.” – Warren Buffett
Not everyone in the world is fortunate to be able to pick a job based on how much they enjoy it rather than based on the need to provide for their family. However, many of us who do have that choice would do well to remember Buffett’s advice. Especially if the path that makes you happiest is the one that defies conventional norms or expectations of others, it might seem like the risky one to take, and many don’t take it. Yet, is it really riskier to avoid going after what you really want to do in life if your circumstances permit it, or to chance the regret later on due to never taking that opportunity?
9. “Everyone says that they are patient on good days, but you will only really find out if they are on bad days.” – Tom Gayner, CEO of Markel
Having a long-term time horizon can be a meaningful source of competitive advantage for an investor. There are many behavioral and incentive-driven pressures on both individual and institutional investors to adopt a shorter-term perspective. In How and Why to Be a Long-Term Investor I described the methods and benefits of long-term investing. For someone responsible for allocating the capital of others, it can be extremely difficult to maintain a long-term investing approach if the people who have entrusted him with their capital do not share that time horizon. That is why it is so important to seek out aligned partners who will be able to maintain their long-term thinking not only when times are good, but also when times are tough.
10. It is very important to evolve.
Buffett, Munger and Gayner all echoed this theme. Buffett himself is a model of evolving as an investor. Having studied under Benjamin Graham and used his cigar-butt approach to investing, he was able to evolve under the influence of ideas from Phil Fisher and Charlie Munger. Amazingly, he continues to learn and evolve at the age of 86, improving his understanding of technology-related business models like Apple and Google, and re-examining old biases against industries such as the airline industry. Forcing yourself to continually evolve in important ways is not easy; one of the best books that I have read on this topic that has helped me is Joshua Waitzkin’s The Art of Learning. Buffett’s ability to evolve, discard old biases and re-examine ideas with the benefit of new insights is an inspiration to me, and I hope it can be an inspiration to you as well.
[i] All quotes in this article are based on my notes, my memory and the Thomson Reuters and Bloomberg transcripts of the Berkshire Hathaway Annual Meeting. While I made every effort to be accurate, it is possible that there may be errors, omissions or inaccuracies despite my best efforts to avoid them.