6 Insights from Charlie Munger At The 2023 Daily Journal Annual Meeting
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If Charlie Munger’s opinions are strongly worded, it is because his confidence in his views has been earned through decades of successful investing experience. There is always something that you can learn when he speaks, and the 2023 Daily Journal annual meeting was no exception:
1. We are all in denial
“Well, if I had to name one factor that dominates human bad decisions? It would be what I call denial. If the truth is unpleasant enough, people’s minds play tricks on them and they think it isn't really happening.”
The mind works hard to protect itself from harm and from anything that would threaten your identity. This means that it tends to disregard evidence that contradicts your self-image.
It doesn’t have to be this way. Knowing this tendency you can try to systematically seek out evidence that threatens your most cherished beliefs about yourself and your abilities. The goal isn’t to make you feel bad about yourself – it’s to help you grow. And you can’t grow until you realize that there is plenty of growth to be had.
2. Avoid financial leverage (unless you are old and wise, but probably even then)
“I think most people should avoid leverage, but maybe not everybody need play by those rules. I have a friend who says, ‘The young man knows the rules, and the old man knows the exceptions.’ At least if he's lived right, he knows them.”
Wise people, just like all other people, tend to think that they are just slightly wiser than they really are. So while you might be tempted to think that Charlie’s exception gives you the green light to lever up and make even more money off of your amazing investing insights – don’t do it. Wisdom is sometimes best combined with humility.
3. Amazing companies run by great founders can be… awful investments sometimes.
“I regard Alibaba as one of the worst mistakes I ever made. In thinking about Alibaba, I got charmed with the idea of their position on the Chinese internet. I didn't stop to realize it was still a G-d-damn retailer. It's going to be a competitive business, the internet. It's not going to be a cakewalk for everybody.”
The irony, of course, is that old and wise Charlie Munger (see #2 earlier) actually levered up to invest in Alibaba. Oops. Even the wisest among us can make mistakes, and even when they think they are most likely to be right.
Two lessons that jump out for me from this mistake. First, it’s important to be very honest with yourself about your circle of competence. It seems like Charlie thought he was inside it, but he actually wasn’t.
Second, perhaps there is just a chance that Charlie overestimated his understanding of China. It’s tempting to project similar motives on to others as you possess yourself. However, it’s possible that the role of government in China in influencing the outcomes of investments is bigger and less predictable than Charlie would like to think.
4. Shorting is the hardest way to make a little money.
“I don't short. I have made three short sales in my entire life, and they're all more than 30 years ago. And one was a currency, and there were two stock trades. In the two stock trades, I made a big profit on one and made a big loss on the other, and they canceled out. And in my currency bet I made a million dollars, but it was a very irritating way to make a million dollars. I've stopped.”
Unfortunately, if you haven’t tried shorting securities you will be tempted. I read tons about how it’s too hard, how it’s not compatible with a value investor’s long-term time horizon, etc. And yet during the recent bubble I saw such egregious overvaluations, that I was tempted anyway.
Luckily I didn’t use leverage inherent in shorting securities outright, but even with the safer tools of limited-risk options, it was still a quite painful experience. I was right on 90%+ of the securities… and made money on something approaching 10% of them. Oops.
5. All businesses get worse and fail eventually, even the best ones.
“Practically every business that Disney is in has gotten tougher than it used to be. Again, welcome to human life. Think about Disney – it once owned the world. Lion King was running a long run in the theater district of New York. They went from triumph to triumph, marching, marching, marching. All of a sudden, on practically every front it's more difficult. This is what happens. Imagine Kodak, which totally dominated photography and the world, and they invented this new technology. Kodak wiped out its common shareholders.”
When a company is at the peak of its popularity, it’s nearly impossible to imagine what could bring it down. Think of yourself as living in the glory days of Polaroid, IBM, Intel, etc. Do you really think you could specifically identify what would make them falter?
That’s what makes glamorous blue chip stocks frequently overvalued. Everyone knows them. They seem unstoppable. Nothing could possibly derail their success.
And yet, every business that has been unassailable, or at least widely perceived as such, has eventually lost its luster. Yes, the ones you think are unassailable right now will also eventually lose their luster.
That doesn’t mean you shouldn’t invest in them. Just make sure they are not priced for perfection. That’s one outcome that isn’t attainable in the real world no matter how potent a company seems to you in the moment.
6. Everyone wants a great business with amazing management, but these are rarely priced to be great investments.
“So a great business, that would be what you'd like, and of course you'd like a great management too. And occasionally we've had both to ride together for a long, long period. But of course, everybody's looking for the same thing. And the trouble with it is you will find when you get into those good businesses, in a place that's picked over, analyzed as American stocks are, you can imagine the amount of time spent thinking about American stocks. You will find by and large in America, if it's really a great business, it's at least 25 times earnings and maybe 30 or 35 or something. And that makes it much harder, of course, because if something goes wrong, you can lose a lot of your investment. And of course, that's what makes investment so difficult is the fact that the good businesses don't stay cheap. You got to somehow recognize a good business before it's recognizable as a good business. That's very hard to do. Some people get good at it, but not many.”
Many investors are all too eager to quote some version of Warren Buffett’s “buy great businesses at a fair price” mantra. Investors also rightly credit Charlie with influencing Warren to appreciate quality in businesses and to move away from the “cigar butt” style of value investing that he practiced earlier in his career.
That’s all well and good. Of course we want great businesses. And it would be wonderful if they were managed by able, honest and motivated managers. What’s the problem?
You can have all of that and still have a poor rate of return on your investment in the stock. Why? Because the stock price is a discounting mechanism. If it discounts an even better future than the likely very good one of this attractive company, your returns will actually be subpar. Even if the company performs just as well as you expect.
This is a hard concept for many to grasp. For others, their hubris won’t allow them to admit that hunting in some of the most efficiently priced capital markets in the world and insisting on only investing in the top 0.01% of quality companies might lead them to encounter too much competition.
This isn’t to say that you should buy bad businesses or not look for good ones. Just be aware that it’s not how good a business is that determines your outcome as an investor, it’s how good it is compared to how good the stock price discounts it to be.
Happy hunting!
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