Four lessons from Warren Buffett and Charlie Munger

“I believe in the discipline of mastering the best others have ever understood. I don’t believe in just sitting around and trying to figure it all out yourself. Nobody is that smart. —Charlie Munger

As market volatility escalated along with the uncertainty, the timing seemed perfect to revisit some timeless lessons from Warren Buffett, CEO and Chairman, and Charlie Munger, Vice Chairman of Berkshire Hathaway (BRK/A, BRK /B). Although Buffett and Munger probably need no introduction, their partnership in managing Berkshire produced arguably the most remarkable extended performance for investors ever. Since they began operating Berkshire in 1965, the stock has grown at an annualized rate of 20.1%. The S&P 500 had an annualized return of 10.5% over the same period. Even over a shorter period, Berkshire has significantly outperformed the S&P 500. As a proxy indicator of growth in the company’s intrinsic value, book value growth has also significantly outpaced S&P 500 appreciation.

While there are countless lessons to be learned from Buffett and Munger, this article will distill their wisdom into four timeless insights.

Invert, always invert. –Charlie Munger

Munger argued in favor of using inversion for tough investment questions. Munger borrowed this idea from 1800s German mathematician Carl Gustav Jacob Jacobi. He believed that the solution to many thorny problems in mathematics could be solved if reversed. This idea of ​​inversion is just one of the mental models Munger uses to make better decisions, but it’s arguably one of the most powerful.

An example of the application of this maxim might be how to select the best investment manager. So instead of focusing on what works, one could look at what doesn’t work and avoid it. Empirical evidence has shown that the traditional use of a manager’s three-year performance to make diligent decisions leads to underperformance. Interestingly, many institutional and individual investors still use a manager’s three-year outperformance to hire or underperformance to fire a manager as part of their due diligence process.

While not every idea that arises from using inversion leads to the opposite result, the facts surrounding manager selection do point to one. Investors should either ignore a manager’s short-term relative performance or even favor managers who have recently underperformed as part of a robust manager selection process. Finally, answering a question at the annual meeting about how to find your calling, Munger used inversion. Munger’s response was to “find out what you’re bad at and avoid it all”. Here you will find more highlights from the recent annual meeting.

We never want to rely on the kindness of strangers to meet tomorrow’s obligations. When forced to choose, I won’t trade even a night’s sleep for the possibility of additional profits. –Warren Buffett

In addition to their investment results, one thing that stands out with Buffett and Munger is their ability to produce such good returns over such a long period of time. The investment industry is littered with shooting stars that have had great returns only to die out, sometimes dramatically. Risk management continues to be a feature of the Berkshire model. Buffett has pledged to keep at least $30 billion in cash on Berkshire’s balance sheet to never worry about meeting obligations. For example, Berkshire had more than $94 billion in cash at the end of the first quarter, the vast majority of it in US Treasuries. During extreme market turbulence like the global financial crisis, others may rightly worry about the safety and liquidity of bond holdings, even in the short term. Buffett spoke about holding treasuries again at the annual meeting this year, and you can find more information on Berkshire’s balance sheet and earnings here. Buffett chooses not to take additional risk with the cash position to earn more yield, so he has dry powder to make acquisitions, and counterparties can rely on Berkshire to complete any agreed-upon transaction. This position allowed Berkshire to make investments during high market stress, which added to its long-term track record and reduced the risk of ruin.

Time is the friend of a wonderful business, the enemy of the mediocre. warren buffet

While Buffett started his investing career by buying “cigar butts,” shoddy but cheap companies with a “puff” more, he evolved to focus on higher quality companies with the Munger influence. Buffett now says that “it’s much better to buy a great business at a fair price than a fair business at a great price.” Evaluation always matters; as Munger notes, “in our way of thinking, any smart investment is a value investment.” Some of Buffett’s biggest and most successful investments, like Coca-Cola

KO
(KO) and Apple

AAPL
(AAPL) clearly fit that mold.

These aren’t just empty words, as a groundbreaking analysis of the source of Berkshire’s investment performance found that Buffett’s “focus on cheap, safe, quality stocks” was the main driver of his success. outperformance. Yields were also boosted by Buffett’s decision to structure Berkshire Hathaway as an insurance company. The two most essential concepts in insurance investing are “free float” and underwriting profit. An underwriting profit means that the insurance premium exceeds all insurance claims and expenses. Simply put, the float is created for insurance companies because insurance premiums are paid before any claims are made by the insured. Before insurance losses are reimbursed, insurance companies like Berkshire can invest the float, sometimes for years. Berkshire has a tradition, unlike many insurance companies, of making an underwriting profit, which means that their float costs them nothing and makes them money in addition to allowing them to make a profit by investing the float.

If you own your stocks as an investment – ​​just like owning an apartment, house, or farm – think of them as a business. –Warren Buffett

Benjamin Graham, Buffett’s mentor, taught him a lot about value investing, but one of the key truths was to analyze stocks like a business and not react to short-term swings in the listed price. ‘an action. Buffett said chapters eight and twenty of Benjamin Graham’s book “The Intelligent Investor” are the foundation of his investment process. This year, Buffett mentioned the book again at the annual meeting and noted that “it changed my life.”

Graham believed that investors should view stock holdings as holding a part of various businesses, like being a “silent partner” in a private company. Therefore, stocks should be valued as part of the company’s intrinsic value, not as something whose price is constantly changing on the stock market. An investor should take advantage of the stock market’s volatile view of a company rather than allowing it to dictate what to do. Pricing stocks like a business and buying stocks with a “margin of safety” allows investors to ignore the ups and downs of the market. For Graham, “margin of safety” meant buying at less than “stated or appraised value”, which should allow an investment to provide a reasonable return even if there are errors in the analysis.

The recent market turmoil has made this the perfect time to revisit the first principles of investing. Given the growing downside risk to the economy and the current inflationary environment, investors should follow the duo’s lead and focus on quality companies with pricing power when looking for opportunities. during this massive sale. Quality is defined as a high return on capital, consistent earnings, and low level of debt, which should help the company weather any economic downturn.

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