Tag Archives: Charlie Munger

April 29, 2016 · 8:00 am

Warren Buffett’s 2015 letter to the shareholders of Berkshire Hathaway and 2016 annual shareholder meeting

Every last Saturday of February, a must read for the weekend comes out: Warren Buffett’s letter to the Shareholders of Berkshire Hathaway [PDF, 2.4 MB].

Me at BRK 2011 annual shareholders meeting.

Me at BRK 2011 annual shareholders meeting.

This year’s letter was published on February 27th, and despite the fact that I normally share some lines about it in the blog just after having read it (1), this year I wanted to wait a couple of months before writing this post in order to conveniently share it today, the day before the annual shareholders meeting, to be held tomorrow Saturday April 30th, as it will be streamed live for the first time ever. I had the chance to attend such shareholder meeting in 2011 (see my review here) and I strongly recommend to those who haven’t to take a look at the stream at Yahoo Finance, from 9am Central Daylight Time.

From this year’s letter, I wanted to bring attention to the description of the acquisition at the end of 2015 of Precision Castparts Corp (for 32bn$ cash), the highlight of the year, and to the following quotes or passages on their hands-off management style, on their flexibility to allocate capital, on what a 2% real GDP growth means, on mortgage risk retention on the side of lenders, the discussion on the linkage between productivity and prosperity (a bit too long to be transcribed as an excerpt – from the page 20 of the letter to the 22) and on the need to act on climate change.

***

On their hands-off management style:

After the purchase, our role is simply to create an environment in which these CEOs – and their eventual successors, who typically are like-minded – can maximize both their managerial effectiveness and the pleasure they derive from their jobs. (With this hands-off style, I am heeding a well-known Mungerism: “If you want to guarantee yourself a lifetime of misery, be sure to marry someone with the intent of changing their behavior.”)

On their flexibility to allocate capital:

Our flexibility in capital allocation – our willingness to invest large sums passively in non-controlled businesses – gives us a significant edge over companies that limit themselves to acquisitions they will operate. Woody Allen once explained that the advantage of being bi-sexual is that it doubles your chance of finding a date on Saturday night. In like manner – well, not exactly like manner – our appetite for either operating businesses or passive investments doubles our chances of finding sensible uses for Berkshire’s endless gusher of cash. Beyond that, having a huge portfolio of marketable securities gives us a stockpile of funds that can be tapped when an elephant-sized acquisition is offered to us.

On what a 2% real GDP growth means (2):

America’s population is growing about .8% per year (.5% from births minus deaths and .3% from net migration). Thus 2% of overall growth produces about 1.2% of per capita growth. That may not sound impressive. But in a single generation of, say, 25 years, that rate of growth leads to a gain of 34.4% in real GDP per capita. (Compounding’s effects produce the excess over the percentage that would result by simply multiplying 25 x 1.2%.) In turn, that 34.4% gain will produce a staggering $19,000 increase in real GDP per capita for the next generation. Were that to be distributed equally, the gain would be $76,000 annually for a family of four. Today’s politicians need not shed tears for tomorrow’s children.

On the different views to be taken of certain intangible assets amortization no matter what accounting rules say about them (3):

[…] serious investors should understand the disparate nature of intangible assets. Some truly deplete in value over time, while others in no way lose value. For software, as a big example, amortization charges are very real expenses. Conversely, the concept of recording charges against other intangibles, such as customer relationships, arises from purchase-accounting rules and clearly does not reflect economic reality. GAAP accounting draws no distinction between the two types of charges. Both, that is, are recorded as expenses when earnings are calculated – even though, from an investor’s viewpoint, they could not differ more.

[…] We now have $6.8 billion left of amortizable intangibles, of which $4.1 billion will be expensed over the next five years. Eventually, of course, every dollar of these “assets” will be charged off. When that happens, reported earnings increase even if true earnings are flat. (My gift to my successor.)

I suggest that you ignore a portion of GAAP amortization costs. But it is with some trepidation that I do that, knowing that it has become common for managers to tell their owners to ignore certain expense items that are all too real. “Stock-based compensation” is the most egregious example. The very name says it all: “compensation.” If compensation isn’t an expense, what is it? And, if real and recurring expenses don’t belong in the calculation of earnings, where in the world do they belong?

Wall Street analysts often play their part in this charade, too, parroting the phony, compensation-ignoring “earnings” figures fed them by managements. Maybe the offending analysts don’t know any better. Or maybe they fear losing “access” to management. Or maybe they are cynical, telling themselves that since everyone else is playing the game, why shouldn’t they go along with it. Whatever their reasoning, these analysts are guilty of propagating misleading numbers that can deceive investors.

Depreciation charges are a more complicated subject but are almost always true costs. Certainly they are at Berkshire. I wish we could keep our businesses competitive while spending less than our depreciation charge, but in 51 years I’ve yet to figure out how to do so. Indeed, the depreciation charge we record in our railroad business falls far short of the capital outlays needed to merely keep the railroad running properly, a mismatch that leads to GAAP earnings that are higher than true economic earnings. (This overstatement of earnings exists at all railroads.) When CEOs or investment bankers tout pre-depreciation figures such as EBITDA as a valuation guide, watch their noses lengthen while they speak.

On mortgage risk retention:

Barney Frank, perhaps the most financially-savvy member of Congress during the panic, recently assessed the 2010 Dodd-Frank Act, saying, “The one major weakness that I’ve seen in the implementation was this decision by the regulators not to impose risk retention on all residential mortgages.” Today, some legislators and commentators continue to advocate a 1%-to-5% retention by the originator as a way to align its interests with that of the ultimate lender or mortgage guarantor.

At Clayton, our risk retention was, and is, 100%. When we originate a mortgage we keep it (leaving aside the few that qualify for a government guarantee). When we make mistakes in granting credit, we therefore pay a price – a hefty price that dwarfs any profit we realized upon the original sale of the home. […]

Some borrowers, of course, will lose their jobs, and there will be divorces and deaths. Others will get overextended on credit cards and mishandle their finances. We will lose money then, and our borrower will lose his down payment (though his mortgage payments during his time of occupancy may have been well under rental rates for comparable quarters). Nevertheless, despite the low FICO scores and income of our borrowers, their payment behavior during the Great Recession was far better than that prevailing in many mortgage pools populated by people earning multiples of our typical borrower’s income.

On the need to act on climate change:

This issue bears a similarity to Pascal’s Wager on the Existence of God. Pascal, it may be recalled, argued that if there were only a tiny probability that God truly existed, it made sense to behave as if He did because the rewards could be infinite whereas the lack of belief risked eternal misery. Likewise, if there is only a 1% chance the planet is heading toward a truly major disaster and delay means passing a point of no return, inaction now is foolhardy. Call this Noah’s Law: If an ark may be essential for survival, begin building it today, no matter how cloudless the skies appear.

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(1) See the review I made of 2009, 2012, 2013 and 2014 letters.

(2) In relation to that I recommend reading Thomas Piketty’s “Capital in the 21st Century” (of which I may write a review at a later point in time). There he explains how for most of history, human kind has lived a small growth rate and we may well come back to that.

(3) Every year letter discusses that, always with some variation, I keep recommending a detailed look at it.

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March 1, 2015 · 10:00 am

Warren Buffett’s 2014 letter to the shareholders of Berkshire Hathaway

Every last Saturday of February, a must read for the weekend comes out: Warren Buffett’s letter to the Shareholders of Berkshire Hathaway [PDF, 499KB]. This year, it is the 50th anniversary since Buffett took over the company, and thus together with the letter both him and Charlie Munger, his partner and vice chairman, have included as well two letters describing the last 50 years, what made them so successful and what can be expected in the following years. The 3 letters together make up 42 pages, a strongly recommended read.

From this year’s letter, I wanted to bring attention to the following quotes or passages on simplicity of some transactions, on the sale of TESCO, the distinction between volatility and risk, not using borrowed money to invest, consequences of using shares instead of cash for acquisitions, the synergies announced in M&A, the importance of cash, trust and bureaucracy:

***

On simplicity of some transactions and trust. Last year he introduced the acquisition of Nebraska Furniture Mart, this year is the turn of National Indemnity:

[…] since 1967, when we acquired National Indemnity and its sister company, National Fire & Marine, for $8.6 million. Though that purchase had monumental consequences for Berkshire, its execution was simplicity itself.

Jack Ringwalt, a friend of mine who was the controlling shareholder of the two companies, came to my office saying he would like to sell. Fifteen minutes later, we had a deal. Neither of Jack’s companies had ever had an audit by a public accounting firm, and I didn’t ask for one. My reasoning: (1) Jack was honest and (2) He was also a bit quirky and likely to walk away if the deal became at all complicated.

On pages 128-129, we reproduce the 1 1 ⁄2-page purchase agreement we used to finalize the transaction. That contract was homemade: Neither side used a lawyer. Per page, this has to be Berkshire’s best deal: National Indemnity today has GAAP (generally accepted accounting principles) net worth of $111 billion, which exceeds that of any other insurer in the world.

Offer Letter for National Indemnity (retrieved from BRK 2014 annual report [PDF, 2.2MB])

Offer Letter for National Indemnity (retrieved from BRK 2014 annual report [PDF, 2.2MB])

On the advantages of using an animated character as advertising tool in low cost operations:

[…] No one likes to buy auto insurance. Almost everyone, though, likes to drive. The insurance consequently needed is a major expenditure for most families. Savings matter to them – and only a low-cost operation can deliver these. […]

[…] Our gecko never tires of telling Americans how GEICO can save them important money. The gecko, I should add, has one particularly endearing quality – he works without pay. Unlike a human spokesperson, he never gets a swelled head from his fame nor does he have an agent to constantly remind us how valuable he is. I love the little guy.

On his lack of decisiveness in selling TESCO:

[…] An attentive investor, I’m embarrassed to report, would have sold Tesco shares earlier. I made a big mistake with this investment by dawdling.

At the end of 2012 we owned 415 million shares of Tesco, then and now the leading food retailer in the U.K. and an important grocer in other countries as well. Our cost for this investment was $2.3 billion, and the market value was a similar amount.

In 2013, I soured somewhat on the company’s then-management and sold 114 million shares, realizing a profit of $43 million. My leisurely pace in making sales would prove expensive. Charlie calls this sort of behavior “thumb-sucking.” (Considering what my delay cost us, he is being kind.)

During 2014, Tesco’s problems worsened by the month. The company’s market share fell, its margins contracted and accounting problems surfaced. In the world of business, bad news often surfaces serially: You see a cockroach in your kitchen; as the days go by, you meet his relatives.

We sold Tesco shares throughout the year and are now out of the position. (The company, we should mention, has hired new management, and we wish them well.) Our after-tax loss from this investment was $444 million, about 1/5 of 1% of Berkshire’s net worth.

On volatility versus risk:

Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.

On not using borrowed money to invest:

[…] borrowed money has no place in the investor’s tool kit: Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.

A confession after having introduce the major mistake of acquiring Berkshire (a sinking textile company) out of stubborness:

Can you believe that in 1975 I bought Waumbec Mills, another New England textile company? Of course, the purchase price was a “bargain” based on the assets we received and the projected synergies with Berkshire’s existing textile business. Nevertheless – surprise, surprise – Waumbec was a disaster, with the mill having to be closed down not many years later.

On his initial strategy of buying low priced small companies and why he changed it:

[…] Most of my gains in those early years, though, came from investments in mediocre companies that traded at bargain prices. Ben Graham had taught me that technique, and it worked.

But a major weakness in this approach gradually became apparent: Cigar-butt investing was scalable only to a point. With large sums, it would never work well.

In addition, though marginal businesses purchased at cheap prices may be attractive as short-term investments, they are the wrong foundation on which to build a large and enduring enterprise. […]

On using shares instead of cash for acquisitions:

Consequently, Berkshire paid $433 million for Dexter and, rather promptly, its value went to zero. GAAP accounting, however, doesn’t come close to recording the magnitude of my error. The fact is that I gave Berkshire stock to the sellers of Dexter rather than cash, and the shares I used for the purchase are now worth about $5.7 billion. As a financial disaster, this one deserves a spot in the Guinness Book of World Records.

Several of my subsequent errors also involved the use of Berkshire shares to purchase businesses whose earnings were destined to simply limp along. Mistakes of that kind are deadly. Trading shares of a wonderful business – which Berkshire most certainly is – for ownership of a so-so business irreparably destroys value.

On the trumpeted synergies announced in M&A:

(As a director of 19 companies over the years, I’ve never heard “dis-synergies” mentioned, though I’ve witnessed plenty of these once deals have closed.) Post mortems of acquisitions, in which reality is honestly compared to the original projections, are rare in American boardrooms. They should instead be standard practice.

On cash:

At a healthy business, cash is sometimes thought of as something to be minimized – as an unproductive asset that acts as a drag on such markers as return on equity. Cash, though, is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent.

American business provided a case study of that in 2008. In September of that year, many long-prosperous companies suddenly wondered whether their checks would bounce in the days ahead. Overnight, their financial oxygen disappeared.

At Berkshire, our “breathing” went uninterrupted. Indeed, in a three-week period spanning late September and early October, we supplied $15.6 billion of fresh money to American businesses.

On trust and bureaucracy:

With only occasional exceptions, furthermore, our trust produces better results than would be achieved by streams of directives, endless reviews and layers of bureaucracy. Charlie and I try to interact with our managers in a manner consistent with what we would wish for, if the positions were reversed.

The books that are recommended this year in the letter are:

  • “Where Are the Customers’ Yachts?”, by Fred Schwed,
  • “The Little Book of Common Sense Investing”, by Jack Bogle,
  • “Berkshire Hathaway Letters to Shareholders”, compilation by Max Olson,
  • a new book in preparation commemorating the 50th anniversary of Berkshire Hathaway under present management.

Another article about Jim Ling in D magazine (from 1982) is recommended to understand the mentality of some CEOs running holdings at the time and why some negative perception towards holdings continue to exist today.

Finally, in the two last letters from Buffett and Munger, in which they review the future prospects of Berkshire there is some language that will no doubt stir again the rumours of whether Buffett may step down as CEO and / or chairman anytime soon. We will see.

—

For nostalgic investors, in this year’s annual report it is embedded Berkshire’s 1964 annual report (pages 130-142).

See the review I made of 2009, 2012 and 2013 letters.

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May 22, 2014 · 8:00 am

Transcript of 2014 Berkshire Hathaway Annual Q&A with Warren Buffett and Charlie Munger

Last Saturday, May 3rd, Berkshire Hathaway held in Omaha its annual shareholder meeting, attended by over 30,000 shareholders. The most expected part of that weekend is the Q&A session of the meeting, in which Warren Buffett and Charlie Munger answer to dozens of questions.

The meeting is neither televised, nor recorded or streamed. However, the financial website Motley Fool has done a terrific job publishing a transcript of the session. Find the link here and allow yourself at least a couple of hours to read through it (the Q&A session takes hours itself!). I strongly encourage the reading. As a teaser, find below some of the gems:

“No CEO looks at proxy statements and comes away thinking that I should be paid less.” Warren Buffett.

“We can’t earn same return on capital with over $300 billion market cap. Archimedes said he could move the world with a long enough lever. I wish I had his lever” Buffett

“If you are in any social organization, if you keep belching at the dinner table, you’ll be eating in the kitchen” Buffett (on Boards of Directors)

“Cash or available credit is like oxygen: you don’t notice it 99.9% of the time, but when absent, it’s the only thing you notice” Buffett

“By the standards of the rest, we over-trust. […] because we carefully selected people who should be over-trusted” Charlie Munger

“There’s something about owning a brand to educate yourself about things you might do in the future.” Buffett

“At the beginning, we knew nothing. We were stupid. If there’s any secret to Berkshire, it’s that we’re pretty good at ignorance removal.” Munger

“… if you think you understand, you’re not paying attention.” Munger

“There’s changes going on with all our businesses. We want managers to think about change, what’s going to be needed for the future” Buffett

“Being realistic when realizing your own shortcomings is important.” Buffett (on the circle of competence)

“There’s a point you start getting inverse correlation between wealth and quality of life” Buffett

“I think America made a huge mistake by letting the public school systems go to hell…” Munger

(on home mortgage market) “you had the biggest bunch of thieves & idiots running things, I’m not trusting private industry in this field” Munger

“The net utility from finance majors has been negative.” Buffett

—

Some other readings I recommend in relation to this post:

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December 9, 2013 · 8:00 am

The Titanic: a project management disaster

The Titanic (public domain image, taken from Wikimedia, by F. Stuart).

Few days ago, I attended a conference on an example of a project management disaster: the Titanic, the British ship which sank in its maiden trip from Southampton to New York in 1912 causing the death of above 1,500 passengers, above 2 thirds of those aboard.

[The conference was part of the same cycle of which I attended another one about 2 months ago about the success of the management project for the delivery of the infrastructure, design and construction of buildings, transport and the legacy of the London 2012 Olympic Games (I wrote about it here).]

Learning from a well-known disaster, as opposed to a success, made the audience more eager to listen to Ranjit Sidhu, a consultant who has made extensive research about the Titanic and has written the book “Titanic Lessons in Project Leadership“.

She was going to focus the conference on 3 sides of project management: communication, leadership and teamwork (1), and the problems which each of those originated in the disaster.

Titanic captain E. J. Smith (public domain image, taken from Wikimedia, author: New York Times).

Sidhu started giving an introduction of some of the characters involved in the project to show the kind of power plays and conflicts that took place at the time of taking decisions. Some of those characters were: Bruce Ismay (chairman of White Star Line), Lord Pirrie (chairman of the shipbuilding company Harland and Wolff), J.P. Morgan (American banker who financed the formation of International Mercantile Marine Company, mother company of White Star Line), Alexander Carlisle (chief engineer of the project in Harland and brother-in-law of Pirrie), Thomas Andrews (successor of Carlisle), Captain Smith (sea-captain of the Titanic).

From the beginning of the project the mantra that the Olympic line of boats was going to be unsinkable was created due to some features which indeed made the boats more secure than others at the time, as well as the largest and most luxurious. From that point onwards, several psychological flaws impeded perceptions to be re-evaluated, messages to get across, decisions to be questioned, etc.

For some of the characters (Carlisle and Andrews) safety was the top objective, to the point that when the number of life boats was decided to be reduced against the engineers’ criteria Carlisle resigned as chief engineer of the project and left Harland despite of being a relative of the chairman.

For other characters in the story the emphasis was in the size or the luxury: an ample dinning room, clean views from the cabins (not disturbed by life boats, for instance), etc.

The power play, the financial pressure on the project, the deadlines of both departure and arrival in New York, the image to keep before the press, etc., all made that several decisions were taken despite of compromising technical features (life boats reduction and placement), manufacturing operations (working in increasing shifts due to the delay caused by the repair of the Olympic at the same shipyard), operational decisions (such as short time for sea trial of the ship, radio operators priorities and incentives misalignment…), etc., adding to the diminished safety of the trip.

Some of the psychological flaws that were going on when taking those decisions include: anchoring effect (the image of the Titanic as unsinkable was fixed in the mindset despite of decisions compromising safety), bandwagon effect, confirmation bias (negative signals being filter out vs. acknowledging supporting evidences), conformity to the norm, framing effect, normalcy bias (denial and underestimation of the consequences of the disaster once occurred), etc.

Last minute misfortunes added up to the disaster: missing binoculars for the scouts (due to the departure of a crew component who held them), a shorter rope to perform ice tests, radio messages from the Californian boat not being prioritized by operators to be brought to the main deck…

The end to the story is well-known.

Have we progressed as a society since them?

Today we like to think that yes. More requirements regarding safety are put into projects. Regulations are passed to ensure safety. Risk management is used as part of project management to ensure that the kind of decisions taken at the time of the Titanic today they are taken without overlooking the risks behind them.

However, I would like to bring 3 questions raised by colleagues in the Q&A session that followed the presentation:

  • Of the cited characters, who could have been more proactive to prevent the disaster? Taking into account that Carlisle, the chief engineer, went to the point of resigning without (a seemingly) major effect to the fate of the ship.
  • How can we react to a pressure situation under a powerful sponsor? We can try to find allies, framing the situation as an “us” as a group instead of opposing the sponsor.
  • If the Titanic hadn’t sunk, would it be seen as an example of success in project management instead of a disaster? You may dismiss the point too quickly by thinking “oh, yes, but it happened that it sank!“.

Here, I remembered the theory of the safety in systems seen as layers of safety added one after the other. Each of the layer may have some holes in it just as a portion of cheese (typical image used in aerospace projects). By having several layers, accidents are prevented in most of the cases. However, from time to time the holes in the layers are perfectly aligned and the accident happens (lack of sea trials, radio messages not passed, urgency to reach New York, scouts without binoculars, improper ice tests, power vs. authority struggle in that precise trip in which the chairman of the company travels alongside the captain…).

Cheese model of safety layers in a system.

Cheese model of safety layers in a system.

My takeaways from the conference are:

  • to continuously remind ourselves of the flaws we have in our mental processes (I recommend a couple of books to that respect: “Thinking Fast and Slow” by Daniel Kahneman and “Poor Charlie’s Almanack“, by Charlie Munger),
  • to sharpen our perception of risks (both at work and daily life),
  • to understand that we are a layer (with our own holes) in the safety system (both at work and daily life).

—

(1) She did not enter much into risk management despite of acknowledging that it had not worked (or rather overlooked).

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December 29, 2012 · 8:00 am

My 2012 reading list

At the beginning of the year I set as a personal objective to read at least 15 books. This will be a low number for some of you and a high one for others. To me it looked challenging but achievable… though, I did not achieve it. I completed 10 books and started other 4 which I have not yet finished (they’ll be included in the next year reading list).

See below the list with a small comment for each one, the link to a post about the book in the blog (when applicable), links to Amazon (in case you want to get them) and sometimes to the authors. I have also included a small rating from one to three “+” depending on how much do I recommend its reading:

  1. “This time is different” (by C. Reinhart and K. Rogoff) (++): very interesting book offering a comprehensive book to economic and financial crises since 8 centuries ago. The book is full of graphics, statistics, example, anecdotes… I already wrote three posts about it: “The Republic of Poyais“, “The march toward fiat money” and “¿Cómo le ha ido a España en esta crisis?“. 
  2. “Le Petit Prince” (by Antoine de Saint-Exupéry) (++): even if narrated as a children’s book, it contains several idealistic messages, fine criticisms of how adults behave, etc. The teachings are mainly transmitted through conversations between a child and the prince and encounters with other characters… I wrote a post about it “Le Petit Prince“.
  3. “The consequences of the peace” (by John M. Keynes) (+++): the book was written at the time of the Versailles Conference after the World War I, which he attended as a delegate from the British Treasury. In the book, Keynes explained how the disaster in the making was being produced, due to lack of communication between representatives from USA, UK, France and Italy, and the intention from Clemenceau of taking as much as possible from Germany. Keynes makes a series of estimates of Germany’s production capabilities and that of the regions being taken from it and comparing them with the pretensions that were being included in the negotiations of the treaty. In the book, he warns well in advance the economic and social disaster that the treaty is going to send Germany into. (I have not yet written a specific review of the book, but since I had underlined several passages I don’t discard writing it).
  4. “Le bal des ambitions” (by Véronique Guillermard and Yann le Galès) (+): the book tells the story behind the creation of EADS and its first years. Very much like in a thriller, it gives account about the characters involved, the battles for power, etc. I wrote a post about it “Le Bal des ambitions“.
  5. “Desolé, nous avons raté la piste” (by Stephan Orth and Antje Blinda) (+): The book consists of a series of awkward situations in a flight described by passengers, pilots and cabin crew, mainly miscommunications between the crew and passengers or funny messages received from the cockpit. The book originated after a collection of the anecdotes posted by readers of the online version of Der Spiegel. . See the review I wrote about it “Sorry, I missed the runway“.
  6. “Poor Charlie’s Almanack: The Wit and Wisdom of Charles T. Munger” (by Charlie Munger, compiled by Peter D. Kaufman) (+++): the book is a compilation of Munger’s speeches, quotes, interviews, articles, letters, etc. Some of his speeches are available in Youtube (e.g. this one given for the commencement of USC Law in 2007). One of the main takeaways is the use of several mental models to analyze situations we live in our lives (instead of being stalled in the few models which we are more comfortable with). Another recurring topic is the lack of training in psychology that we get (or even his criticism of how psychology is taught in faculties). I haven’t written a post about the book, but I think I should, if only to share more of his wit and wisdom with you.
  7. “The Peter Principle: Why Things Go Wrong” (by Laurence J. Peter) (+++): the book is a hilarious account of situations that arise in companies and institutions of why and how people are promoted, cornered, etc., or in his words is a treatise on hierarchology. The name of the book comes from the Peter Principle which says: “In a hierarchy, every employee tends to rise to his level of incompetence”. I already wrote about it here.
  8. “2010 Odyssey Two” (by Arthur C. Clarke) (++): the book is a sequel to the famous “2001: A Space Odyssey“, and there is a movie as about this book. The story starts with doctor Heywood Lloyd travelling in a combined Soviet-American mission to Jupiter in order to find the spaceship Discovery One from the previous mission and what went wrong with it… I won’t tell more of the plot to avoid spoiling it for someone. I would say that I liked more this book (and movie) than the first one.
  9. “The Litigators” (by John Grisham) (++): this novel is very much like most of John Grisham. In this one the plot is about a star young lawyer graduated from Harvard Law School who cannot stand the pressure from a big firm and quits it to join a mediocre small firm with two partners who chase victims of small accidents to help them get some  compensation from insurance companies, with the hope of reaching the big class action which could make the rich.
  10. “Soccernomics” (by Simon Kuper and Stefan Szymanski) (+++): the authors use economics’ techniques, plenty of data, statistics, citing several papers, studies, etc., in order to bring up uncovered issues about football (such as transfer market, what makes some nations more successful in football…) or refocus the attention about other ones. See the review I wrote about it.

I also completed two other partial objectives: to read at least 2 books in French and 2 about politics/economy. And as always, on the learning side from reading there is Twitter (a source of information or distraction?), the subscriptions delivered to home of the weekly The Economist and the two monthly magazines Scientific American and Toastmasters.

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April 10, 2012 · 8:00 am

Why do I prefer Coke

Some weeks ago I read an article about why do we prefer Coke over Pepsi by the blogger Farnamstreet (1). It mentioned a marketing initiative by Pepsi some years ago, “The Pepsi Challenge”, in which blind test were organized to see whether consumers preferred one or the other. Pepsi consistently advantaged Coke in the tests.

The article mentions other studies in which it is explained why nevertheless Coke still outsells Pepsi. In the end it seems to be due to the powerful brand Coca Cola has created along history and its association with happiness and satisfaction. This is an extreme case of what Warren Buffett describes as moat:

Definition of ‘Economic Moat’

The competitive advantage that one company has over other companies in the same industry. This term was coined by renowned investor Warren Buffett.

Investopedia explains ‘Economic Moat’

The wider the moat, the larger and more sustainable the competitive advantage. By having a well-known brand name, pricing power and a large portion of market demand, a company with a wide moat possesses characteristics that act as barriers against other companies wanting to enter into the industry.

My preference for Coke

Luca and I did this kind of blind test about 4 years ago when we lived in Madrid. We had heard of these tests and I was sure I could distinguish one from the other.

Normally, I never buy Pepsi (except when you order a “cola” at some place where there is no Coke). For the test we purchased both Pepsi and Coke, and placed them in the fridge for a while. Then I got blinded. Luca took them out of the fridge and poured each in a different glass (same kind of glass) with ice cubes. Then she offered me one glass. I tasted it.

“Ok, I don’t even need to test the other one, this is Pepsi”, I said. Then, I thought “well let’s try the other to confirm my choice”. I tasted the other glass… then I tasted again the first one. I ended up completely lost. I couldn’t tell one from the other. I finally changed my initial decision.

I was wrong in the test. Since then, I have told some friends about the experiment. Most of these friends claim they would indeed distinguish one from the other. They would probably even state that they prefer Coke due to its flavour (of course, I have no friend who prefers Pepsi! Who does?)…

After having done the test, no doubt I continue to buy Coke, but now I am aware that it is partly due to some behavioural trick being played within my mind, the kind of trick explained in the article.

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(1) Farnam Street being the street in Omaha where Berkshire Hathaway HQ are located.

NOTE: You may want to read this case by Charlie T. Munger, Berkshire Hathaway vice chairman, about the compounding effects that led to the tremendous success of this carbonated water drink. The essay was part of a lesson he gave at USC Business School in 1994 and appears in his book “Poor Charlie’s Almanack”.

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October 31, 2011 · 10:00 am

Active investment fund managers

In a previous post I showed the evolution of stock price for EADS and the target price calculated by an investment bank along 34 months. I already stated the misguided recommendations that they provided. A truly “Buy high and sell low”, the quickest way to lose all your savings.

There are many advertisements of investment funds using the term “active” (active management). That’s truly dangerous regarding investing. It not only implies more expenses paid in commissions, but also implies a manager who is acting more.

Imagine that the active fund manager was the same person who had produced the investment bank’s report of EADS that I showed in my previous post. If he had been as active as he recommended his clients to be, he would have bought shares in 6 different moments between 2005 and 2006 and sold them at the beginning of 2007 (*).

As an example, I made the calculation using around 1,000€ as the amount invested in each of those points in time (using the technique called “Dollar cost averaging“). You may see in the table below how many shares those 1,000€ afforded to. You may also see the amount it could cost in commissions (of course, professional brokerage firms would get lower fees – nevertheless, if you omit that commissions, the net result at the end would have been negative as well).

Quick way to lose your savings: follow the advice of an investment bank.

As you can see, after the 7 operations along 2 years, the manager would have lost 268€ on an investment of almost 6,000€, that is losing 4,4% or about 2% a year… It is much better then to leave your money in a savings account.

Nevertheless, what is more worrisome is the fact that in the period of 34 months, the bank produced 15 different target prices, changing its recommendation (i.e., from “buy” to “hold”, etc.) up to 5 times. This urge to produce new figures and even worse, to act upon those new figures is what makes most of professional investment fund managers a truly dangerous species. As Charlie T. Munger wisely says “Resist the natural human bias to act”.

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(*) I would have loved to have performed the same analysis with a newer report, as the price of EADS stock went even below 9€ in the years that followed to reach over 24€ again in 2011… but the last report of EADS (or any other company) that I had with such detailed explanation of target prices was this one (and I’d never pay for such a paper).

EADS share price since its creation.

Note 1: You may think that the negative figures reached with this example are due to the case selected. If you think that is the case, I invite you to take another example and share it with us. I do not have many such reports available, and as I already stated, such a report is not something I would be willing to pay for, I can find many more useful ways to spend money.

Note 2: If you think I was biased by using frequent buys of 1,000€ each one and selling everything at once, I made the same calculation imposing that the manager used the technique “dollar cost averaging” also at the time of selling, that is selling about 1,000€ each time the recommendation was “sell”. The result: at the end of the period he would have 2,962.5€ in cash and 2,114.6€ in stock, having lost this time nearly 16% of the invested amount, even worse than in the first case.

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June 2, 2011 · 8:00 am

My experience at BRK2011

Berkshire Hathaway was a small textile company in Rhode Island. As many other textile companies it was struggling due to cheap labour competition elsewhere. Warren Buffett had already invested in the company before realising that it was headed for the worst. He was about to sell his stake when he felt irritated by an underbid from the managing director, then he decided not only not to sell his shares but to invest until gaining control, sacking the CEO and completing what he later referred to as his worst investment mistake he ever made…

Today Berkshire is a very different outfit: a big conglomerate, with over 130 billion USD in revenues, with a big insurance arm, dozens of operating companies and large investments in securities. Warren Buffett, his current CEO, regarded as the best investor ever.

Berkshire Hathaway annual shareholder meeting (BRK 2011, for this year’s event) is an extraordinary event, widely covered by press and attended by over 30.000 investors and relatives.

I explained in a previous post how I became interested in investing and when and why Luca and I became shareholders of Berkshire, now I want to give a small account of my experience in my baptism in the Woodstock for Capitalists (pictures below)…

… on Thursday 28th April Luca and I picked a rental car in Chicago, from where we would drive 800km to Omaha, Nebraska, with a stop over in Des Moines. Early in the afternoon Friday 29th we arrived at our hotel in Omaha, where the receptionist informed that there was a package waiting for us: our credentials for the weekend (thanks Debra!).

The event is not restricted to just the shareholders meeting, it is composed of a series of events covering the whole weekend. Let me describe them.

Cocktail at Borsheims. On Friday evening several buses would pick shareholders up from an infamous mall to bring us to Borsheims, the group’s jewellery shop. In front of the shop there was a big tent with live music, drinks and food. The shop was open, with re-doubled staffing to attend shareholders in eventual sales (as Buffett says “what better occasion to propose to your girlfriend than at BRK shareholders meeting?”).

Shareholder meeting on Saturday morning. The meeting started at 8:30am, doors opened at 7:00am and Luca and I arrived at 6:45am when there was already a huge queue. The meeting is held at the Qwest Center, a big convention center, which has room for exhibition and a sports indoor arena where the meeting is held. The exhibition area is packed by stands selling all kinds of goods from the group subsidiaries: boots, construction tools, books, sports wear, insurance… anything at a nice discount for shareholders. What better place to go shopping than to your own shop at a discount? To open the day some very funny videos and commercials were displayed. One featuring cartoons of Buffett, Munger and Schwarzenegger as Governator was especially welcomed.

Q&A session. Most of the meeting, until about 15:30 in the afternoon is a questions and answers session. This is when everybody wants to test and listen to the insights from the “Oracle of Omaha”. They made room for approximately 60 questions. Half were selected by 3 journalists from the thousands sent in by shareholders and the other half were drawn just before the meeting from volunteering shareholders in the floor.

This Q&A session is the most widely event reported by media. If you have read anything about the meeting, it was most probably said there. Instead of me telling here again what’s that was said, let me just refer to my first and second favourite accounts from other sources.

Charlie T. Munger. He is the vice chairman of the company and doesn’t get nearly as much coverage in the media as Buffett, however Warren has for him the highest regard. Munger has written a book, “Poor Charlie’s Almanack”, which is a treasure of wit and wisdom (and heavy as a brick).

At the meeting he is sitting side by side Warren all day during the meeting, looking half asleep and eating candies. Every now and then he replies with a “I have nothing to add” whenever Warren asks him for comment, except for a few times when he gets to give his point. That point goes without cosmetics straight to the issue at hand: “Much of the present crisis was caused not so much by evil but by stupidity”, [on financial projections] “seeing them in paper or in a screen makes some people believe they’re something serious”, “It seems both parties are competing to see which can be the most stupid. What it’s worse, they’re topping each other”, “Insurance is a difficult business: there are many temptations to be stupid… like in banking”…. after hours of this is when Warren came with his “If there’s anybody we’ve forgotten to insult, pass a note up and we’ll get to you.”

Business meeting. Just as a reminder I will say that this was a shareholders meeting. I hadn’t been in any other before though I had seen some either by streaming or podcast. Luca had attended one of EADS. At BRK the shareholders meeting itself lasted… 20 minutes? Reports, directors for the next year, etc., were voted in a matter of seconds. The only issue which took longer was a proposal to get all subsidiaries to report their carbon impact anticipating eventual legislation. Several shareholders took the word for and against and it was finally turned down… this is America.

Picnic at the Nebraska Furniture Mart. Once the shareholders meeting was finished, we all headed for NFM to enjoy a very professionally organized picnic as well as to visit the furniture shop (largest one in North America). This is another BRK subsidiary founded by Mrs. Rose Blumkin, a strong woman who emigrated from Russia at the beginning of the XX century and started the business at her place,  and after a disagreement with Warren went on to open a new business well into her ‘90s, being involved in the operations until shortly before her death at 104.

Brunch at Borsheims. On Sunday morning shareholders could go back to the jewellery shop to have a brunch while shopping, playing bridge or chess, seeing the performance of a magician, etc… It sounds all fine for a Sunday morning plan, the singularity comes from that jewels were sold by Warren Buffett himself, you could play bridge with or against Bill Gates, the chess game was against US champion, etc.

Lunch at Gorat’s. On Sunday two steak houses in Omaha closed doors for shareholders of BRK. Luca and I booked a place in both; one for lunch, the other for supper. Both are Buffett’s favourite places and this is why he recommends them (not being part of the group). Food was wonderful, just too much for us to finish everything.

Dinner at Piccolo’s. This would be our last event in the weekend. We had finished lunch just 5 hours before and were not really hungry. In fact, we were not hungry at all, but we went on with the plan. While we were having our burgers, Warren and Bill came in with their entourage to have dinner at a table 2 tables away from ours. It felt awkward to say the least but this how we closed our BRK2011, our first.

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February 26, 2011 · 11:00 am

Resist the bias to act

Some days ago I tweeted about the swings of Mr. Market lately. The consideration of the stock market as Mr. Market is a metaphor that we owe it to Benjamin Graham.

Since a picture is worth a thousand words, I wanted to share a snapshot of the swings of our “J&L” ( 😉 ) portfolio in the past few weeks. One could read the picture as “you have lost 114$ in the past weeks”. That same person on January 28th would have said “you’ve lost 2,000$ in the last 10 days”.

"Resist the human bias to act", Charlie T. Munger

In fact we have not lost a nickel in these weeks, since we haven’t sold any stock. I love a quote from Charlie T. Munger, Berkshire Hathaway vice chairman, which goes: “Resist the natural human bias to act”.

You actually don’t need to buy or sell stock when the market is in the mood. It is as easy as not doing it. You may buy only when you see a margin of safety and sell only when the stock has reached what you considered it to be at its intrinsic value.

You can see that in these 5 weeks we could have lost up to 2,000$ twice; we didn’t. The only tools we counted with: patience and not “listening to Mr. Market”.

Precisely today, it is published the letter of Warren Buffett to Berkshire shareholders. Whether you are planning to invest in stocks or only want to have a fun read, take a look at it.

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May 7, 2010 · 8:00 am

Ethical Banking

I attended yesterday a conference by Joan Melé at EOI Business School. It caught my interest by its title “Dinero y conciencia: ¿A quién sirve mi dinero?” (Money and conscience, who benefits from my money?), even though I didn’t know the presenter nor the bank he works for.

I want to make some reflections of yesterday’s experience:

  • The first one as a Toastmasters member: I applaud the decision of the speaker to stand up, not using notes or a power point presentation and managing to get the focus of the audience on him and his message for over an hour and half… we witness many conferences in which the experience is not so enjoyable.
  • The next reflection is to praise the move by EOI Business School towards web 2.0 made some months ago. As an alumnus of the school I must say that it’s very motivating to see the number of activities organized, the topics covered and it’s very convenient the way they are publicized in the different channels: EOI web and blogs, Facebook, streaming TV channel, Twitter… and because of that, because you can actually watch the whole of the conference or catch a glimpse of the main messages, I will just add very few ideas that I took for reflection and some sources the presenter cited.

Regarding money itself, the speaker structured his speech in the three main uses of money: to buy, to save and to donate.

  • When buying: he proposed the exercise of thinking “what”, “why” and “where” to see how our purchasing decisions affect others (low wages, pollution, exploitation…). He made the case for an economy based not so much in consumption of material things but cultural and intellectual ones: e.g. we happily pay 30 euro for a dinner, would be pay the same to be read poetry?
  • Regarding saving he noted the positive side of it: planning for future expenses. The other side of the coin being “fear of the day of tomorrow”: what will happen that we won’t be able to face? Nothing: Whatever comes, we will be able to face it. This reminds me to Charlie Munger comment on Berkshire Hathaway shareholders meeting when he said that he became comfortable […] after he realized he could survive hardship, “Maybe you should get your feet wet with a little more failure”. We lack some entrepreneurship…
  • The speaker did not want to go in deep about donating, except pointing that handing large inheritances to offspring can be more harmful than positive to them and society.

Some ideas to take away:

  • There are no leaders to solve our problems; it’s the turn of civil society to take action. It’s the time for the Globalisation of conscience.
  • The responsibility for what happens around us is ours, we need to first change ourselves.
  • We are the crisis of 3 billion people since dozens of years ago.
  • Need to bring back the role of banks as agents that relate people: savers with entrepreneurs in order to create wealth with profits as a by-product not as the one and only end.
  • Need to start and epidemic of courage and enthusiasm.

Finally, some reports, articles and documentaries he cited:

One final quote from Charlie Munger to end this post: “The secret to happiness is to lower your expectations.”

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