On Munger
caveat emptor - buyer beware
If the facts don’t hang together on a latticework of theory, you don’t have them in a usable form. You’ve got to have models in your head. And you’ve got to array your experience both vicarious and direct on this latticework of models. – Charlie Munger
Genius does not consist in one domain, it is better to be a Fox than a Hedgehog. One should strive to be a multi-disciplinary thinker, one that leverages multiple disciplines to navigate life. Doing so, increases one’s probability of success in whatever avenue one pursues whether that be finance or parenting.
The iron rule of life is that only twenty percent of the people can be in the top fifth. Charlie Munger spent a lifetime studying why humans make horrible decisions so others don’t have to.
Allowing for the difficulty of predicting the future, people should have just a few reasonably predictable variables that will dominate their outcomes. In the words of Warren Buffett, “There are all kinds of businesses where we have no idea what they’ll earn this year, let alone any future year.” Look for boring investments, sexy is usually complicated and full of competition. Look for what’s staying the same.
Focused investment of only one hour a day can double your lifetime output. - Richard Hamming
Learning things that (1) change slowly and (2) apply to a wide variety of situations could be a better use of time than learning something incredibly time-consuming, rapidly changing, and of limited application. This is why Munger states: “We don’t read other people’s opinions. We want to get the facts, and then think.” And when it gets to the thinking part, for Buffett and Munger, there’s no one better to think with then their partners. “Charlie can’t encounter a problem without thinking of an answer,” posits Warren. “He has the best thirty-second mind I’ve ever seen. I’ll call him up, and within thirty seconds, he’ll grasp it. He just sees things immediately.”
Charlie, as a very young lawyer, was probably getting $20 an hour. He thought to himself, “Who’s my most valuable client?” And he decided it was himself. So he decided to sell himself an hour each day. He did it early in the morning, working on these construction projects and real estate deals. Everybody should do this, be the client, and then work for other people, too, and sell oneself an hour a day.
Munger states: “We read a lot. I don’t know anyone who’s wise who doesn’t read a lot”. But that’s not enough: One has to have a temperament to grab ideas and do sensible things. Most people don’t grab the right ideas or don’t know what to do with them. Another way to get smarter, outside of reading, is to surround oneself with people who are not afraid to challenge ideas.
Multi-disciplinary
The following are areas Munger feels one should be well versed in to increase one’s odds of lifetime success.
Mathematics. Quantities, arithmetic, compound interest, permutations, and combinations. The Fermat/Pascal system. Decision Tree Theory. Gaussian distribution.
Statistics: In probability theory, an ergodic dynamical system is one that, broadly speaking, has the same behavior averaged over time as averaged over the space of all the system's states in its phase space. In physics the term implies that a system satisfies the ergodic hypothesis of thermodynamics.
A random process is ergodic if its time average is the same as its average over the probability space, known in the field of thermodynamics as its ensemble average. The state of an ergodic process after a long time is nearly independent of its initial state. The sequence matters.
Accounting. Double entry bookkeeping. Who, what, when, where, and why. Every item must be entered twice, once as a credit and once as a debit. According to some scholars, its spread led to what we now call “capitalism”.
Engineering: quality control. Back up systems. Normalization of deviance is the idea that things are designed and limits are calculated. We can go this fast, this hard, this hot, this cold, this heavy. But we always want to optimize. We want to do things cheaper, quicker, more at once.
Human psychology. Biases and heuristics. Herding. Cognitive dissonance. Psychology of misjudgment. Avoid psychological manipulation. 1) What are the factors that really govern the interests involved, rationally considered? 2) what are the subconscious influences where the brain at the subconscious level is automatically doing these things - which, by and large, are useful but which often mis function? Pavlovian associations - the mad hatters tea party, only hearing and seeing things one agrees with.
Microeconomics. The economy is an ecosystem. Advantages of scale - cost reduction and the experience curve. Informational advantage - branding and reliability. Social proof - influences by what others do and approve of. Cascade to overwhelming dominance through widespread distribution. Specialization within the firm. Purchasing power. Patents, trademarks, and exclusive franchises. Competitive destruction - buggy whips, good business operators can “surf” the new waves of innovation.
Establish the invariants in each system. The things that do not change or change slowly. Recognize core competencies and be self disciplined.
Concepts
Franchise – another word for moats, a product or service that: is needed or desired; is thought by its customers to have no close substitute and; is not subject to price regulation. These three allow a company to regularly price its product or service to earn high ROC. The test of a franchise is what a smart guy with a lot of money could do it if he tried. The real test of a business is how much damage a competitor can do, even if he is stupid about returns
If one had $1b, could one compete? – silver bullet question (ask CEOs if they could kill one competitor, who would it be and why?)
When speaking with management ask “If roles reversed, what would one ask if running the business?
Northern Pike Model – if one introduces a dominant species, they will soon take over (as WalMart did early on).
Curiosity
We like to call other species curious, but we are the most curious of all. Without the human curiosity instinct, science and technology would not be present. Even before there were direct incentives to innovate (capitalism), humans innovated out of curiosity.
Reward and Punishment
We are driven both conciously and subconsciously by incentives and tend to drift into immoral behaviour as a result. “Never, ever, think about something else when one should be thinking about the power of incentives.”
Spend less than one makes, always be saving something. Put it into a tax deferred account. Deploying cash requires evaluating 4 commonsense questions based on information rather than rumor
The probability of the event occurring
The time the funds will be tied up
The opportunity cost
The downside if the event does not occur
Useful financial statements must enable a user to answer 3 basic questions about a business
Approximately how much a company is worth
Its likely ability to meet its future obligations
How good a job its managers are doing in operating the business
Owner earnings –> cash flow = operating earnings + depreciation expense and other non-cash charges – required reinvestment in the business (average amount of capitalized expenditures for PPE that the business requires to fully maintain its long-term competitive position and its unit volume)
Intrinsic value = the discounted value of the cash that can be taken out of a business during its remaining life
Risk
Don’t risk what one has and need for what one doesn’t have and doesn’t need
Risk – we continually search for large business with understandable, enduring and mouth-watering economics that are run by able and shareholder-oriented managements
The certainty with which the long-term economic characteristics of the business can be evaluated
The certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash flows
The certainty with which management can be counted on to channel the reward from the business to the shareholders rather than to itself
The purchase price of the business
The levels of taxation and inflation that will be experienced and that will determine the degree by which an investor’s purchasing-power return is reduced from his gross return
If you won’t own a business for 10 years, don’t own it for 10 minutes – materially higher earnings in 5-10 years is what you’re looking for
You don’t have to make it back the way you lost it.
4th Law of Motion
For investors as a whole, returns decrease as motion increases. a hyperactive market is the pickpocket of enterprise. Avoid small commitments – if something is not worth doing at all, it’s not worth doing well.
In a trade, what you give is as important as what you get.
The goal of each investor should be to create a portfolio (in effect, a “company”) that will deliver him other the highest possible look-through earnings a decade or so from now. An approach of this kind will force the investor to think about long-term business prospects rather than short-term market prospects, a perspective likely to improve results. It’s true, of course, that, in the long run, the scoreboard for investment decisions is market price. But prices will be determined by future earnings. In investing, just as in baseball, to put runs on the scoreboard one must watch the playing field, not the scoreboard
Things are often cheapest when people are fearful and pessimistic
Liking/Loving
We judge in favor of people and symbols we like, or ignore their faults. When dealing with those who clearly benefit from your liking, check whether you've been influenced.
Don't distort the facts of a situation to comply with your liking.
Disliking/Hating
We distort facts to facilitate hatred or disdain. Take opinions and behaviours at face value rather than in the veil of your disliking or hatred for someone or something.
Think logically about arguments, not emotionally about senders of arguments.
Envy is the stupidest of all the deadly sins, because it’s the only one you can’t have any fun at - Charlie Munger
Doubt/Avoidance
The tendency to make quick, poorly thought-out decisions during stressful situations. We feel pressure to remove doubt, and this causes ill-informed choices.
When stressed, control this by scheduling deliberate delays to strategize before reaching a decision.
Inconsistency-Avoidance
We like to be consistent in everything we do, say, and everything we are. To save energy, we are often reluctant to change our habits, especially bad ones.
These patterns lead to cognitive errors, limiting our choice of actions in life.
Kantian Fairness
We pursue and believe in perfect fairness in the world. Stop expecting the world to be fair and adjust your behaviour accordingly.
Bad things happen to good people and good things happen to bad people: this is the way of the world.
Occam’s razor
Things should be made as simple as possible, but no simpler. The very successful say no to almost everything – you must keep control of your time.
Knowing what you ultimately want to accomplish makes it easier for you to decide what is and is not important
Good question for field you know little about – “can you give me a very simple example and explanation for what you’re talking about?”
To speak/write clearly is to think clearly – orangutan test
Iron rule of nature is you get what you reward for
No need for extra analysis – just know what you need to know
Attractive opportunities come from capitalizing on human behavior (fear, pessimism, greed)
Understanding a business should always be filter #1
Best way to understand moats and their key factors and permanence is to study companies who have achieved them
Almost always easier to figure out who loses (short horses rather than long autos)
Jealousy/Envy
We dislike those who make us feel our own inferiority. Jealousy involves a triangle of relationships. Envy involves the self and another.
It is not greed that drives the world, but envy. - Warren Buffett
Reciprocation
The tendency to reciprocate actions others have done towards us. A culturally and societally enshrined phenomenon: "One should treat others as they would like to be treated."
Beware of ill-intentioned actions or relationships that feel transactional.
The best thing a human being can do is to help another human being know more. - Charlie Munger
Influence-from-Mere-Association
We perceive people or things differently depending on who/what they are associated with, or from our past experiences with them. Treat things on face value, not associations.
Everything has the right to an independent evaluation.
Simple, Pain-Avoiding Psychological Denial
We distort facts for our own psychological comfort. This psychological comfort is known as cognitive dissonance.
We should face the truth more often: It's better to deal with problems before they become bigger problems.
Excessive Self-Regard
We naturally tend to overestimate our own abilities. A healthy amount of humility can keep you from assuming you know everything.
It helps to cultivate relationships with people who aren’t afraid to tell you when you’re wrong or need to check yourself.
Overoptimism
We tend to have blind faith in a good outcome or we don't pay enough attention to the potential for a bad outcome. Optimism motivates us to pursue our goals but must be balanced with pragmatism.
Consider what could go wrong and plan accordingly.
Deprival-Superreaction
If our freedom, status, money or anything we value is lost, we will over-react in a negative manner. This effect is even greater when we almost have something but then lose it.
Don't let your reaction cloud your judgement of the next best steps.
Social-Proof
In the face of uncertainty, we look to others for answers as to how we should behave, what we should think and what we should do. Occurs due to our natural desire to 'fit' in with the crowd.
However, we should always question whether the crowd is wrong.
Contrast-Misreaction
We 'see' and 'perceive' less with simultaneous exposure to two objects of lesser or greater value in the same dimension. Think of two product pricing options side-by-side.
Antidote: Evaluate people and objects individually and not by their contrast.
Stress-Influence
Stress is good, up to a point, but will then amplify the other biases. Light stress can slightly improve performance—say, in examinations—whereas heavy stress causes dysfunction.
Limit your major decisions while over-stressed, or de-stress first.
Availability-Misweighing
We rely on information that is easy to recall or top of mind when making decisions. When decision-making, gain different perspectives and relevant statistical information rather than relying purely on first judgments and emotive influences.
Use-It-or-Lose-It
Our skills and knowledge decline over time if unused. Skills and knowledge that have been mastered will depreciate more slowly than skills that haven't.
You can prevent this tendency by constantly using what you can’t afford to lose.
Ballast for the Storm
Look for a sustainable balance sheet, given the capricious nature of the world. Past bad events do not predict future bad events. Sometimes inefficient balance sheets allow companies to survive by positioning them for all environments, not just optimizing for one.
Different and Hard to Match
Candidates must occupy a structurally profitable, indefinitely sustainable business niche, allowing for the truism that all moats are subject to being crossed eventually. There must be an element of mystery.
Operational Soundness
Reliable execution of the “blocking and tackling” of operations is a must. Getting this wrong always costs big, and can ruin a good niche.
Long Runway
You should be able to foresee an indefinite period of growth ahead, through so¬me combination of market creation, market penetration, and pricing power.
Priced Attractively
Stock should be priced so that stock returns >= business returns, always including a margin for error in forward-looking estimates.
Drug-Misinfluence
Substance addiction—or overuse—can lead to an extremely unrealistic denial of reality. When influenced, people tend to believe that they remain in respectable condition, with respectable prospects.
Stay away from situations or people that could lead here.
Senescence-Misinfluence
As we get older, our mental abilities decline. It’s going to happen to all of us—there's no stopping it.
However, it may be possible to slow the decline by continuing to think and learn as you age, so make a commitment to never stop learning.
Authority-Misinfluence
We trust and are influenced by leaders or authority figures too much. Experts aren't always right. Influencers don't always have valuable opinions. Your boss doesn't own your thinking.
Take opinions on their logic, not their sender.
Twaddle
Humans waste a lot of time talking about nothing at all or by scrolling through Instagram, Facebook and Twitter, and suddenly realizing an hour has passed.
Value your time. Create artificial barriers to time wasting if you need to get serious work done.
Reason-Respecting
We treasure the importance of reasons regardless of their credibility. Providing meaningless or incorrect reasons will increase compliance with directions or requests.
When requesting something, add on "because" and watch compliance go up.
Operant conditioning.
Aristotle said one can avoid envy by working to create a superior brand, service, and product. Thus, making one deserving of the accolades and acclaim. Earned success.
Lollapalooza
Extreme consequences arising from combinations of psychological biases acting in favor of a particular outcome.
For example, auctions can generate foolish behaviour (ending in regret), because of social proof, loss aversion (FOMO), commitment, and action bias.
Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day. - Charlie Munger
Don’t fool yourself, you are the easiest to fool. Know the big disciplines first.Spend each day trying to be a little wiser than you were when you woke up.
On what doesn’t work
Find and marry a lousy person
Turn our body and mind into a wreck
Only learn from your own terrible experiences
Use a hammer as your only tool and approach every complex problem as if it was a nail
Go through life with unreasonable expectations
Only take care of your own interest
Blindly trust and follow the recommendations of advisors and salesmen
Mindlessly imitate the latest fads and fashions
Overly care what other people think about you
Let other people set your agenda in life
Live above your means
Go heavily into debt
Go down and stay down when bad things happen
When in trouble, feel sorry for yourself
Be envious
Be unreliable and unethical
Be a jerk and treat people really badly
Have a job that makes you feel miserable
Work with something that goes against your nature and talent
Believe you know everything about everything
Associate with assholes
Distort your problems so they fit your wishes
Stick to, justify and rationalize your actions no matter how dumb they are
Be an extreme ideologue
Make it easy for people to cheat, steal and behave badly
Risk what you have and need, to get what you don’t need
Only look at the sunny upside (over stress the downside)
Don’t be too heavy ideologically. Avoid making wishes beliefs and mental realities. Incentives cause real bias and are a prime motivator of many people. Heed the advice of Munger and become a multi disciplinary thinker. The Fox is superior to the Hedgehog when it comes to the complex adaptive landscape we all find ourselves within.