Munger’s Worldly Wisdom tells us that you can’t really know anything if you just remember isolated facts. “If the facts don’t hang together on a latticework of theory, you don’t have them in a usable form.” According to Munger, multiple models are required from multiple disciplines to be really good at a narrow art like stock picking.
In this 1994 speech given at USC Business School, Poor Charlie offered up his wisdom as it related to investment management and business. We find ourselves still paying particular attention to his views on Quality & Concentration, highlighted below:
Most investment managers are in a game where the clients expect them to know a lot about a lot of things. In investment management today, everybody wants not only to win, but to have a yearly outcome path that never diverges very much from a standard path except on the upside. Well, that is a very artificial, crazy construct. That is really hobbling yourself.
It makes sense to load up on the very few good insights you have instead of pretending to know everything about everything at all times. You’re much more likely to do well if you start out to do something feasible instead of something that isn’t feasible. Isn’t that perfectly obvious?
Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return— even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.
So the trick, according to Munger, is getting into better businesses and loading up on those businesses when Mr. Market offers them at a substantial discount to intrinsic value. Poor Charlie goes on to comparing investing to the pari-mutuel system at the race track. “Everybody goes there and bets and the odds change based on what’s bet. That’s what happens in the stock market.”
The stock market is the same way—except that the house handle is so much lower. If you take transaction costs—the spread between the bid and the ask plus the commissions—and if you don’t trade too actively, you’re talking about fairly low transaction costs. So that with enough fanaticism and enough discipline, some of the shrewd people are going to get way better results than average in the nature of things.
It is not a bit easy. And, of course, 50% will end up in the bottom half and 70% will end up in the bottom 70%. But some people will have an advantage. And in a fairly low transaction cost operation, they will get better than average results in stock picking.
It’s not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it—who look and sift the world for a mispriced bet—that they can occasionally find one.
And the one thing that all those winning betters in the whole history of people who’ve beaten the pari-mutuel system have is quite simple. They bet very seldom.
And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.
And yet, in investment management, practically nobody operates that way. A huge majority of people have some other crazy construct in their heads. And instead of waiting for a near cinch and loading up, they apparently ascribe to the theory that if they work a little harder or hire more business school students, they’ll come to know everything about everything all the time. To me, that’s totally insane. The way to win is to work, work, work, work and hope to have a few insights.
So you can get very remarkable investment results if you think more like a winning pari-mutuel player. Just think of it as a heavy odds against game full of craziness with an occasional mispriced something or other. And you’re probably not going to be smart enough to find thousands in a lifetime. And when you get a few, you really load up. It’s just that simple.
We’ve found a few and we’ve loaded up, with the top ten holdings of our equity book representing more than three quarters of our portfolio today. I’ve never been to the track. Maybe if the rain lets up in NC sometime soon, we’ll schedule a road trip. Thanks Charlie.