04 January 2024

On today’s episode, Clay shares a tribute to Charlie Munger since we just crossed what would have been his 100th birthday on January 1st, 2024.

Charlie Munger was vice chairman of Berkshire Hathaway, the conglomerate controlled by Warren Buffett. Buffett described Munger as his closest partner and right-hand man. At the time of his death, Munger had an estimated net worth of $2.6 billion.

Charlie has had an enormous impact on the value-investing community, and this episode is dedicated to him to honor his contributions to the community and his worldly wisdom.

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  • The importance of simplicity in investing and life.
  • The three foundational principles to how Buffett and Munger invest.
  • Why Charlie focused on minimizing standard stupidities to win in life.
  • How Munger used his setbacks in life as opportunities to learn and grow as an individual.
  • Munger’s thoughts on the shortcomings of GAAP accounting.
  • The tremendous importance of incentives.
  • Munger’s lessons on living a meaningful and fulfilling life.
  • How Charlie helped Warren Buffett become a better investor.
  • An overview of Charlie’s investment in Costco and his admiration for the business.
  • The top investment lessons from studying Charlie Munger.
  • And so much more!


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

[00:00:00] Clay Finck: The game of life is the game of everlasting learning. At least it is if you want to win. Charlie Munger. This concept of lifelong learning has carried over into the work we do here at TIP. For nearly the past 10 years, we’ve been creating content originally starting with weekly episodes back in 2014, and transitioning to create more content as Preston and Stig brought on William Green, Kyle Grieve, and myself on board at We Study Billionaires.

[00:00:28] Clay Finck: On today’s episode, I wanted to share a tribute to Charlie Munger since we just crossed what would have been his 100th birthday on January 1st. I wanted to break this episode more generally into two different segments. The first half will be life advice I found to be most impactful from Charlie Munger.

[00:00:45] Clay Finck: In the second half, I wanted to talk more about his investment approach. I think both areas are very interesting and important, and this episode will serve as a tribute to his contributions to the value investing community. My cohost, William Green, also shared an episode with clips of many of his guests talking about their learnings from Munger and then William also shared some insights in his own personal interactions with Munger, such as when he interviewed him for his book, Richer, Wiser, Happier.

[00:01:11] Clay Finck: That episode is number 37 on the Richer, Wiser, Happier show, which is on this feed, and it was released back on December 10th. During this episode, some of the things I’m going to touch on include the power of simplicity in investing and life. Inverting problems to minimize standard stupidities. How Munger used his setbacks in life as opportunities to learn and grow.

[00:01:33] Clay Finck: The tremendous importance of understanding incentives. And then also my biggest takeaways from studying Munger’s investing career, which largely focuses on investing in high quality businesses. With that, I bring you today’s episode chatting about Charlie Munger.

[00:01:51] Intro: You are listening to The Investor’s Podcast where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.

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[00:02:11] Clay Finck: All right, so Charlie Munger is highly regarded as someone who is wise and constantly in the pursuit of worldly wisdom. I wanted to start out by touching on the subject of simplicity. Munger stated, take a simple idea and take it seriously. Oftentimes investors are attracted to what is seemingly complex or maybe even what’s sexy.

[00:02:32] Clay Finck: The get rich quick option strategy, the obscure cryptocurrency that nobody’s ever heard of, or the hot new AI company that’s trending in the news. Investments that are extraordinarily complex are typically really hard to make any money from in any reliable or dependable way. Munger has stated, If something is too hard, we move on to something else.

[00:02:53] Clay Finck: What could be simpler than that? That’s not to say that all investing is easy, especially if you’re investing in individual stocks or constructing a portfolio of your own. To simplify, we can break down a complex subject into pieces that are much more easier to digest and wrap our arms around. It can be helpful to ask questions such as, What is truly most important to me in life?

[00:03:17] Clay Finck: What will lead to more fulfillment? How can I be a better friend or partner? What is it that drives investment returns? What are the two or three most important things that matters most in the business I’m analyzing? These questions get to the essence of a problem and understanding the simple and elegant way that we can approach it.

[00:03:37] Clay Finck: Peter Bevlin writes in his book, Seeking Wisdom, that by focusing on finding decisions and bets that are easy, avoiding what is hard, and stripping away anything that is extraneous, Munger believes that an investor can make better decisions by tuning out folly and swatting away unimportant things so your mind isn’t cluttered with them.

[00:03:57] Clay Finck: You’re better able to pick up a few sensible things to do, said Munger. Focus enables both simplicity and clarity of thought, which in Munger’s view leads to a more positive investing result. With so much noise in the world, it’s really empowering to be able to recognize the few key things that really matter and really move the needle, whether that be in your relationships, your work, your investments, or really anything else.

[00:04:23] Clay Finck: What is it that really moves the needle and really matters is such a powerful question to help us simplify this complex world. Munger has stated, quote, Part of having uncommon sense, I think, is being able to tune out folly as distinguished from recognizing wisdom. You’ve got whole categories of things you just bat away so your brain isn’t cluttered with them.

[00:04:45] Clay Finck: That way, you’re better able to pick up a few sensible things to do, end quote. To simplify what is most important in investing, Warren Buffett has said if you understand chapters 8 and 20 of the Intelligent Investor and chapter 12 of the General Theory, you don’t need to read anything else and you can turn off your TV.

[00:05:06] Clay Finck: The first chapter he mentions here is the mood swings of Mr. Market, and we should become somewhat agnostic to the price quotes and focus more on the underlying value. The second chapter he mentions explains that after we determine a company’s intrinsic value or what the company is worth, which is the present value of the future cash flows that an asset produces, then we should only purchase with a large margin of safety, meaning that the price is significantly below the intrinsic value.

[00:05:34] Clay Finck: And then the third chapter he mentioned discusses the importance of having a long term view. and not trying to make short term forecasts, which seem to be relatively unpredictable. I like to think that once we have a good idea of the price and the value, we can utilize patience to have a behavioral edge over most other investors.

[00:05:53] Clay Finck: This is a topic I’ll be talking more about in the latter half of this episode. These three basic concepts alone, when applied intelligently, can put you way ahead of so many other investors in my opinion. Most investors are swayed by Mr. Market. You don’t want to become a slave to Mr. Market. Most investors don’t spend time thinking carefully about what the intrinsic value of an asset is.

[00:06:17] Clay Finck: They don’t understand that you should purchase only when the price is trading well below the underlying value. And most investors think fairly short term, they’re thinking one quarter out instead of one decade out. They get excited about quick short term gains while losing sense of the bigger picture.

[00:06:34] Clay Finck: As it relates to simplicity, we want to seek simplicity to the maximum degree we can. We want to focus on problems that we’re equipped to handle and are within our circle of competence and be able to recognize what is unimportant so you don’t waste any time or energy in that area. Monish Pabrai has said the simple ideas with intensity of pursuit is what gets you to the promised land.

[00:06:57] Clay Finck: The thing is that most people get turned off by simplicity. They think it’s boring and that investing successfully just can’t be that simple. Monish Pabrai writes in his book, The Dondo Investor, simplicity is a very powerful concept. Henry Thoreau recognized this when he said, our life is frittered away by detail.

[00:07:17] Clay Finck: Simplify. Simplify. Albert Einstein also recognized the power of simplicity, and it was the key to his breakthroughs in physics. For Einstein, simplicity was simply the highest level of intellect. Everything about Warren Buffett’s investment style is simple. It is the thinkers like Einstein and Buffett who fixate on simplicity through triumph.

[00:07:37] Clay Finck: The genius behind E equals MC squared is simplicity and elegance. Charlie was a master at simplifying. Buffett had said that Charlie can analyze and evaluate any kind of deal faster and more accurately than any man alive. Munger has said, we have a passion for keeping things simple. If something is too hard, we move on to something else.

[00:08:01] Clay Finck: What could be more simple than that? One simple idea that we talk about on the show quite often is to embrace the true power of compounding. In the newest version of Poor Charlie’s Almanac, Warren Buffett wrote the foreword and said the following, Charlie consistently practiced what he preached. Ben Franklin and his will created two small philanthropic funds that were designed to teach the magic of compound interest.

[00:08:27] Clay Finck: Early on, Charlie decided that this was a subject far too important to be taught through some posthominous project. Instead, he opted to become a living lesson in compounding, eschewing frivolous expenditures that might sap the power of his example. This idea of simplicity also ties into the idea of avoiding standard stupidities.

[00:08:47] Clay Finck: Munger has stated, quote, I think part of the popularity of Berkshire Hathaway is that we look like people who have found a trick. It’s not brilliance, it’s just avoiding stupidity. You understand it better if you go at it the way we do. Which is to identify the main stupidities that do bribe people in, and then organize your patterns for thinking and development so that you don’t stumble into those stupidities, end quote.

[00:09:10] Clay Finck: This quote is from an interview from back in 2010, and he says that academia is one place that has failed and fallen for some of these standard stupidities. The first of which he mentions is the efficient market hypothesis. If the efficient market hypothesis were true, then Berkshire Hathaway would not have been able to buy the Washington Post on the open market for one fifth of what they conservatively believed it to be worth.

[00:09:35] Clay Finck: The second teaching in academia that he deems to be insane is CAPM models. He states, you don’t have to make this stuff up. Life will constantly surprise you with these ridiculous examples which teach important lessons, end quote. Munger has of course popularized this idea of mental models on investing in companies and interacting with the world more broadly.

[00:09:55] Clay Finck: There’s this quote from John Muir. When we try to pick out anything by itself, we find it hitched to everything else in the universe. And that is what Munger has discovered in his life as well. It’s that he needs to understand all of these various disciplines in order to understand all of the inner workings that are at play within a business.

[00:10:14] Clay Finck: And then you have everything that’s going on in the business and then how the business itself interplays with the environment it’s in and its competitive landscape. As written in Poor Charlie’s Almanac. Charlie’s models supply the analytical structure that enables him to reduce the inherent chaos and confusion of a complex investment problem into a clarified set of fundamentals.

[00:10:35] Clay Finck: Again it gets back to that idea of simplicity, the world is full of this chaos and we need to be able to sift through the noise in order to figure out the primary drivers of the issues at play. I quote here again from the book. It is this signature approach backed by Charlie’s formidable intellect, temperament, and decades of relevant experience that have made him the virtuoso of business pattern recognition so valued by Buffett.

[00:11:00] Clay Finck: Like a chess grandmaster through logic, instinct, and intuition, He determines the most promising investment moves, all the while projecting the illusion that the insight came easily, even simply. But make no mistake, this simplicity comes only at the end of a long journey towards understanding, not at the beginning.

[00:11:20] Clay Finck: His clarity is hard won, the product of a lifetime of studying the patterns of human behavior, business systems, and a myriad of other scientific disciplines. I’m reading this and thinking, I sure know I wouldn’t want to go head to head with this intellectual maverick. Munger believes that a successful investment career comes down to just a handful of decisions.

[00:11:41] Clay Finck: He makes a very large bet, and then he just sits on this for a very long time. He refers to this as sitting on your ass investing. Charlie says you’re paying less to brokers, you’re listening to less nonsense, and if it works, the tax system gives you an extra 1, 2, or 3 percentage points per annum. Charlie is also well known for inverting his problems.

[00:12:02] Clay Finck: I have my co host William Green’s voice in my head because I feel like he’s said this so many times. Invert. Always invert. If you want to get something in life, instead of figuring out how to get what it is you want, start by thinking about the worst thing you can do. When asked how to live a successful life, Munger stated, don’t do cocaine, don’t race trains, and avoid the age situation.

[00:12:25] Clay Finck: In the book Poor Charlie’s Almanac, it states, Many would dismiss his seemingly flippant answer as merely humorous, which it certainly was, but in fact, it faithfully reflects both his general views on avoiding trouble in life and his particular method for avoiding missteps in investing. Often, as in this case, Charlie generally focuses first on what to avoid, that is, on what not to do.

[00:12:48] Clay Finck: before he considers the affirmative steps he will take in any given situation, end quote. And then this also reminds me of one of Charlie’s famous lines, all I want to know is where I’m going to die, so I’ll never go there. So instead of asking, how can I make money? Ask yourself, how can I lose money? If you focus on preventing the downside, the upside will take care of itself.

[00:13:09] Clay Finck: Instead of asking, what is this stock going to be worth? Instead, ask yourself, what is this stock worth? If you can identify a cheap price for a stock, it’s far easier to make any money in it. Instead of asking what the growth drivers are, ask yourself what can go wrong. Too often people are focused on the potential upside, when they should be more focused on the potential downside.

[00:13:32] Clay Finck: Munger also frequently stated that him and Warren’s career was made by making a lot fewer stupid decisions than others. Even some of the smartest investors out there at times make deeply irrational decisions. One of my interviews in 2023 on We Study Billionaires, it was with John Jennings, and he told a story of how one of his smartest friends on Wall Street was selling stocks near the bottom of the great financial crisis, and he was going out and seeking safety in assets such as gold.

[00:13:59] Clay Finck: Now this really smart investor, he truly believed with near a hundred percent certainty that stocks were not the place to be. And the overall market at that time had declined by over 50%. So of course this guy might’ve been right in the future may have played out how he might’ve expected it to, but it points to how some of the smartest people on the planet.

[00:14:19] Clay Finck: can become so overconfident and become too sure of themselves and they really get caught up in the heat of the moment and what’s happening at that specific time point. Charlie has said, it’s fun to sit there and outthink people who are way smarter than you are, because you’ve trained yourself to be more objective and more multidisciplinary.

[00:14:37] Clay Finck: Furthermore, there is a lot more money in it, as I can testify from my own personal experience. What I also admired about Buffett and Munger is just their sheer generosity. Munger has said the best thing a human being can do is to help another human being know more. Buffett and Munger both believe that part of living a good life is being generous and giving to others.

[00:14:59] Clay Finck: Not just with your money, but with your time and your knowledge as well. Making a positive impact on others is a really great way to derive more happiness and fulfillment out of life. Munger was a firm believer in good karma. He stated how you behave in one place will help you in surprising ways later.

[00:15:16] Clay Finck: This points to the tremendous benefits that can be gained from continuously giving to others with no expectation of getting anything back in return. One guest here on the show referred to this as good acts contributing to the bank of karma. I’m amazed when I reach out with questions to people here in the value investing community and how often I get this outpouring of assistance from those I reach out to.

[00:15:38] Clay Finck: People in this community are almost always open to giving without any expectation of receiving, and this is likely for a good reason. I’m also reminded of Munger’s ability to learn from his mistakes and continually adapt to the ever changing environment. All of us are going to inevitably run into times in our life where we’re going to be tested and we’re going to hit that period of failure.

[00:16:02] Clay Finck: The wisdom here is that it’s how you react to that failure that matters. You can let failures bring you down, or you can use these failures as an opportunity to learn and grow. Munger believes that adversity causes some people to transform themselves into a victim, as he states, Whenever you think that some situation or some person is ruining your life, it’s actually you who’s ruining your life.

[00:16:26] Clay Finck: It’s such a simple idea, feeling like a victim is a perfectly disastrous way to go through life. If you just take the attitude that however bad it is in any way, it’s always your fault and you just fix it as best you can, the so called iron prescription, I think that really works. Joshua Kennan wrote in his blog about Munger’s life experiences and the adversities Munger’s went through that I’ll read here as well, and this is just a story that’s really stuck with me.

[00:16:55] Clay Finck: In 1953, Charlie was 29 years old when he and his wife got divorced. He had been married since he was 21. Charlie lost everything in the divorce. His wife keeping the family home in South Pasadena, Munger moved into dreadful conditions at the university club and drove a terrible yellow Pontiac. Shortly after the divorce, Charlie learned that his son, Teddy, had leukemia.

[00:17:19] Clay Finck: In those days, there was no health insurance, you just paid everything out of pocket and the death rate was near 100 percent since there was nothing doctors could do. Rick Gurin, Charlie’s friend, said Munger would go into the hospital. Hold his young son and then walk the streets of Pasadena crying. One year after the diagnosis, in 1955, Teddy Munger died.

[00:17:40] Clay Finck: Charlie was 31 years old, divorced, broke, and burying his 9 year old son. Later in life, he faced a horrific operation that left him blind in one eye with pain so terrible that he eventually had his eye removed. It’s a fair bet that your present troubles pale in comparison. Get over it. Start over. He did it and you can do it too.

[00:18:05] Clay Finck: I also find it helpful to think about what it is we can control in life and what we can’t control. People tend to put too much focus on the latter and not enough on the former. I think that letting go of the things that we can’t control is one of the most liberating things that we can do for ourselves.

[00:18:24] Clay Finck: To apply this simple idea to investing, we can’t control the Fed’s actions, we can’t control interest rates, stock prices, how other people act, how rich other people are getting, whether we enter a recession or not, etc. We can control our entry price into companies or into funds, the managers we choose to partner with, The types of business models we choose to buy into, our holding period, the fees we incur, our level of diversification, et cetera.

[00:18:54] Clay Finck: Focus on what you can control and don’t worry so much about the things you can’t. Transitioning here to another topic, Adam Mead, a friend of ours here at TIP and an expert on Berkshire Hathaway, he shared what are called outstanding investor digests, which are back from the 1990s. And I’ll be sure to link here in the show notes.

[00:19:13] Clay Finck: In the 1995 edition, Munger expands on the use of mental models to become a superior investor. And the piece on accounting here really stood out to me. He stated, obviously you have to know accounting. It’s the language of practical business life. It was a very useful thing to deliver to civilization, but you have to know enough about it to understand its limitations, because although accounting is the starting place, it’s only a crude approximation, and it’s not very hard to understand its limitations.

[00:19:43] Clay Finck: For example, everyone can see that you have to just more or less guess at the useful life of a jet airplane or anything like that. Just because you express the depreciation rate in neat numbers It doesn’t make it anything you really know. End quote. And I thought this was such an important point to highlight here, because for me, understanding the shortcomings of accounting can really help you identify ripe opportunities that a lot of other investors are prone to overlook.

[00:20:09] Clay Finck: Adam Ziesel’s book, Where the Money Is, does a really great job expanding on this, and I’ll touch on some examples here. Munger mentioned a depreciation rate, which is shown as an expense line item on the income statement. Accountants might assume, for example, that the machinery that’s used in a business has a five year life.

[00:20:26] Clay Finck: But in reality, those machines might typically last something like 15 or 20 years. So to get to an earnings figure that better reflects economic reality, then you’re going to need to manually adjust the earnings yourself to better reflect the true earnings that are happening within the business.

[00:20:43] Clay Finck: Another example is a holding of mine in my portfolio, Constellation Software. Many investors see Constellation Software and they see, oh, it’s trading at a PE of 90 or 100, and they think there’s no way they’ll ever buy a stock that expensive. But the PE doesn’t do this company justice and it doesn’t really reflect economic reality.

[00:21:03] Clay Finck: In the case of this business, there are amortization charges because accountants are assuming that these acquisitions that they’re making are going to degrade over time. But in reality, these businesses have organic growth rates in the low single digits. Thus, it’s reasonable to add back those amortization charges, which really helps bring down the multiples significantly before some other adjustments are made as well.

[00:21:25] Clay Finck: In full disclosure, I do own shares. In Constellation software. One more shortcoming I wanted to mention with a PE is that it doesn’t tell you the amount of capital that’s required to maintain a business’s operations. A commodity business like ExxonMobil might look really cheap when you just look at the PE.

[00:21:43] Clay Finck: But when you take out the capital expenditures just for the maintenance of the business, then it might not look near as cheap as you think it is. Our brains take these shortcuts to come to conclusions, which isn’t necessarily a bad thing, but we need to be mindful of when these shortcuts are useful and when they aren’t useful.

[00:22:01] Clay Finck: Just because a company has a low P. E. doesn’t make it cheap, and just because a company has a high P. E. doesn’t make it expensive. So that point from Munger there, has really had a big impact on me and how I think about investing and have continued to develop over the years. I also need to mention one of the key lessons that Munger that has had a really big impact on me in terms of life.

[00:22:23] Clay Finck: And this is understanding the importance of incentives. Munger regards incentives as one of the most powerful forces that drive human behavior. The basic idea of understanding incentives is that you get what you reward for, and avoid that for which you are punished. Munger has stated that if you get a dumb incentive system, then you get dumb outcomes.

[00:22:44] Clay Finck: Gottem Babe’s chapter on incentives and the joys of compounding is by far one of my favorites as he really nails home this point so well. There’s a few quotes from the book that I wanted to read here as it relates to incentives. Benjamin Franklin stated, If you want to persuade, Appeal to interest, not to reason.

[00:23:02] Clay Finck: And Jesse Livermore said, My main life lesson from investing is that self interest is the most powerful force on earth, and can get people to embrace and defend almost anything. End quote. It’s a great point here from Livermore. Incentives can really cause people to do some really bizarre things. Decent people can do terrible things if they are given the incentives to do and otherwise terrible people can make decent decisions if they’re given the incentive to do gautam writes, the real power of incentives is the ability to manipulate the cognitive process. Buffett shared the example of GEICO and how he cared about the employees growing the business through policies in force and growing through areas of the businesses that were profitable. So they put together a bonus structure that incentivized that behavior amongst their employees.

[00:23:49] Clay Finck: So that way the interests of the owners are aligned with the interests of the employees. Nassim Taleb also has a quote here. Never ask anyone for their opinion, forecast, or recommendation. Just ask them what they have or don’t have in their portfolio. And I’m as aware as anyone that we talk about different stocks on the show, and I talk about stocks in our TIP Mastermind community, and I’m biased towards these companies, at least to some degree, if I own them and I’m public about them.

[00:24:17] Clay Finck: And it makes it even more difficult to change my mind if the facts change after I talk about them on the show. This is my way of saying that you shouldn’t ever own something just because someone else owns it, because if the facts change, that person might sell that company without you even knowing. I’m fully aware that any of the companies I own, I might change my mind next quarter.

[00:24:37] Clay Finck: Next year, and if the fundamentals change materially enough, then hopefully I’m humble enough to admit it and recognize it and take action. Gotham also writes here, it’s imperative that we think deeply about the incentive systems we create because ignoring the second or third order effects of an incentive system.

[00:24:54] Clay Finck: often leads to unintended consequences, also known as the Peltzmann effect. Anderson writes, An example is monetary rewards offered to help exterminate unwanted animals such as rats and snakes. What authorities failed to foresee was that people would start to breed the rats and snakes.

[00:25:15] Clay Finck: Munger has also told the story of FedEx and how they couldn’t for the life of them figure out how to get employees to move this luggage from the airplanes between the airplanes without causing delays. And they tried everything and they really couldn’t solve it until they switched the employees pay from by the hour to by the job.

[00:25:34] Clay Finck: So once the job was finished, they could just go home and both parties ended up getting what they wanted. FedEx ended up eliminating the delays with this new incentive structure and then employees got their compensation and probably got to go home early a lot of times from work because they’re finished when the job was done.

[00:25:51] Clay Finck: Stig here at the investors podcast is also really big on incentives as well. Earlier this year, we had launched our TIP mastermind community, which is a paid community that our audience can be a part of. In his mind, it’s great that we can start this new business unit within the company and have a new source of revenue.

[00:26:08] Clay Finck: And it’s not directly tied to advertising, which we are pretty heavily relying on to cover our expenses. But the community it can’t intrude or podcast because we study billionaires is really the foundation of everything we do here at TIP. So in his mind, he’s trying to figure out what sort of incentive structure really makes sense.

[00:26:28] Clay Finck: It incentivizes the growth of a new business unit without negatively impacting the long term viability of the investors podcast overall. I also like to look at this in terms of the management teams of public companies I invest in. Stig and I just discussed this topic in episode 596. Generally, it’s better to invest with managers who have a lot of skin in the game.

[00:26:51] Clay Finck: They became wealthy through the ownership of their shares rather than getting stock options or giant bonuses based on metrics that aren’t really helpful to shareholders. Munger cautions that managers who are incentivized with stock options aren’t necessarily aligned with shareholders. This is because they get the benefit of the upside, but they don’t bear any of the downside risks.

[00:27:12] Clay Finck: It’s like a free lottery ticket for the managers and it might lead them to taking on bigger risks than what you would prefer as shareholders. And then managers who own a lot of stock, on the other hand, they benefit from the upside just like you do as shareholders, but they also have to handle the pain of the potential downside.

[00:27:28] Clay Finck: And then another key point here is thinking about family run companies tend to have a lot of insider ownership. And since the family has built their wealth through the ownership of the business, oftentimes they think really long term, they take conservative bets. And then when these really great opportunities come along, they tend to really take advantage of them.

[00:27:49] Clay Finck: Munger has said an example of a really responsible system is the system the Romans used when they built an ark. The guy who created the arc stood under it as the scaffolding was removed. It’s like packing your own parachute, end quote. Incentives encourage desirable behavior and disincentives prevent them.

[00:28:08] Clay Finck: Personally, I want to own companies I can sit on for 10 years, maybe more. And I want to know that the management team is going to do their best to deliver a handsome return. And managers who purchase stock themselves on the open market and hopefully have a track record of being shareholders for a long time, track record of being shareholder friendly.

[00:28:27] Clay Finck: I think they’re incentivized to continue to do what they’ve been doing for so long. And then there’s also the issue of choosing an investment manager. If you’re picking a fund to invest in, Seth Klarman said in his book, Margin of Safety, You probably would not choose to dine at a restaurant whose chef always ate elsewhere.

[00:28:45] Clay Finck: You should be no more satisfied with a money manager who does not eat his own cooking. End quote. In the best case scenario, you’re going to be invested with a manager that has the vast majority of their net worth invested in the funds that they manage. That way you know that they’re always going to be thinking long term, not taking excess risk and they’re being extra thoughtful in their decision making.

[00:29:05] Clay Finck: Oftentimes, financial advisors. They’re gonna be incentivized to sell products that really aren’t good for their clients. It’s pretty easy to justify selling something like that when you earn a hefty commission that pays out for the next 10 or 20 years. Transitioning here to another topic, Charlie also reminds me of what it means to live a good life.

[00:29:26] Clay Finck: Charlie’s life was very simple to a large extent. He built his life in a way that suits him and suits the way he really wanted to live. He surrounded himself with people he regarded as great people. These people made him better every day better through their interactions. Even as smart as Charlie was, he chose to partner with Warren Buffett, knowing that he was probably not going to be the head honcho or be the front of the spotlight like Warren was for decades.

[00:29:53] Clay Finck: Regarding partnerships, Munger is a testament to the idea that quality relationships with good, trustworthy people make life really special. He stated that if you want to have a good partner, friend, or spouse, then you need to be one in return. Munger has always put a high priority on surrounding yourself with honorable people you admire and you want to spend your life with.

[00:30:15] Clay Finck: I think one of the best upgrades you can make in your life is to surround yourself with people who are seemingly really high quality. Charlie believes that life is much more than just accumulating vast amounts of wealth. And that you shouldn’t worry so much about what other people are doing getting rich through methods that you don’t deem to be ethical or just something that doesn’t align with your values.

[00:30:36] Clay Finck: He was also big on living out a pretty conservative financial lifestyle living within your means, not buying extraordinary things, avoiding debt the best you can, and then continue to seek out ways to increase your income, just basic ways to build wealth that we all know we should be doing. And it’s just a helpful reminder looking at someone like him.

[00:30:55] Clay Finck: In the age of social media where people are always sharing the frivolous things they’re buying or the trips they’re taking in order to be truly free and to be able to structure your life in a way that suits you. Munger is a good example of achieving financial independence. Being financially independent allows you to say no to things you’d rather not do.

[00:31:15] Clay Finck: I think about how nowadays so many people can find themselves in a situation where they have a lot of debt, they rely on their employer to pay them so they have to make the payments on their loans and put food on the table. And of course, pretty much everyone is in this position at some point in their lives.

[00:31:30] Clay Finck: But if you work towards financial independence, then eventually you know, you can make those decisions and have that freedom to design a life of your own. True wealth is not having a lot of money, but owning your time. One of Munger’s favorite books when it comes to financial independence is The Richest Man in Babylon.

[00:31:47] Clay Finck: It’s such a simple book, but it’s so important to absorb these basic concepts like don’t outspend your income, consistently save a portion of every dollar you earn, avoid the trap of the hedonic treadmill, etc. I think Munger was also highly influenced in this regard by Benjamin Franklin. Franklin wrote about the virtues of frugality and a strong work ethic, and he used financial independence to make the most of his limited time here on Earth.

[00:32:12] Clay Finck: Franklin had written a letter to his mother saying that he would rather have people say about him that he lived usefully than he died rich. To learn more about the importance of financial independence, there are a lot of books out there on this topic. I think The Richest Man in Babylon is a good one, and then the chapter in Gautam Bade’s book, The Joys of Compounding, is also really good, and I highly recommend if you’re interested in learning more about that.

[00:32:35] Clay Finck: Next, I wanted to transition to talk more about how Charlie approached investing. And what I think is most important in this regard, Warren Buffett said back in 1988, I’ve been shaped tremendously by Charlie. Boy, if I had listened only to Ben Graham, would I be ever a lot poorer? In 2015, Buffett wrote that Munger taught him.

[00:32:56] Clay Finck: Forget what you know about buying fair businesses at wonderful prices. Instead, buy wonderful businesses at fair prices. Buffett did just fine by purchasing cigar butt businesses that were ridiculously cheap, but the problem in Munger’s mind is that the investment model wasn’t able to scale. Munger had said that buying great businesses that were temporarily under pressure changed everything for the better for Berkshire, as it allowed them to scale up enormously.

[00:33:23] Clay Finck: One of the earliest examples of this was their purchase of See’s Candy in 1972. Berkshire Hathaway paid 25 million and only paid a multiple of 6 times earnings, and in the 2019 annual meeting, Buffett had said that the See’s Candy purchase alone had made Berkshire over 2 million. 2 billion in profits. I really resonate with Munger’s tremendous focus on business quality.

[00:33:45] Clay Finck: And I’m reminded of his quote that has really stuck with me throughout my time here at TIP. I quote, over the longterm, it’s hard for a stock to earn a much better return than the business, which underlies it earns. If the business earned 6 percent on capital over 40 years and you hold it for 40 years, you’re not going to make much different than a 6 percent return.

[00:34:05] Clay Finck: even if you originally buy it at a huge discount. Conversely, if a business earns 18 percent on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with one hell of a result. End quote. I can’t help but talk about probably Munger’s favorite business that he’s ever invested in, probably outside of Berkshire Hathaway, and this is Costco.

[00:34:26] Clay Finck: Munger admired the quality of this business so much that he claimed he would never sell a share, and he claimed himself to be a total addict of this business. Outside of Costco’s CEO, Munger was the second largest shareholder of the company. According to Business Insider, Munger owned over 187, 000 shares in Costco, which was worth over 110 million.

[00:34:48] Clay Finck: Charlie served as the director of the company since 1997, and at that time, shares of Costco traded around 15 a share, and at the time of recording, the shares traded around 600, representing a 40x increase in the stock price over 26 years, which equates to an average annual return of around 15. 2 percent per year.

[00:35:09] Clay Finck: Now, 15 percent might not sound like a home run investment, but when you take a moderate rate of return like 15 percent and you extend that out over 10 or even 20 or more years, you really end up with a nice result as an investor. According to Costco’s 1997 annual report, The company had 268 warehouses, most of which were in the U.

[00:35:30] Clay Finck: S. and 21 billion worth of sales. Flash forward to the end of 2022. The company’s main focus is still in the U. S., but they also have a much larger international presence. In 2022, they add 226 billion in revenues. That’s over a 10X increase from 1997. Nick Sleep famously described the Costco business model as a model of scale economy shared.

[00:35:54] Clay Finck: We dove into and covered Nick Sleep’s amazing letters in episode 492 on this podcast. What’s amazing about Costco is this virtuous cycle that they have in place that continually expands their moat with each passing day. Costco has a number of warehouses that sells these big box goods, and they’re a hundred percent committed to providing low prices.

[00:36:12] Clay Finck: And then because of those low prices, this attracts a lot of customers. And this in turn gives them a lot of traffic and a lot of volume per store. And since they’re such a popular place to shop, this gives them bargaining power with suppliers and any price decreases that Costco is able to get, they just simply pass that down to the customer.

[00:36:29] Clay Finck: And then the further Costco’s prices are from competition, the more value customers are getting through those lower prices. And then the cycle continues. The Costco business model reminds me of what Munger calls the Lollapalooza effect. I quote, You get Lollapalooza effects when two, three, or four forces are all operating in the same direction.

[00:36:49] Clay Finck: And frequently, you don’t get simple addition. It’s often like critical mass in physics where you get a nuclear explosion if you get to a certain point of mass, and you don’t get anything much worth seeing if you don’t reach that mass. You have to realize the truth of biologists, Julian Huxley’s idea that life is just one damn relatedness after another.

[00:37:09] Clay Finck: So you must have the models and you must see the relatedness and the effects from the relatedness end quote. There are just so many factors that play into the success of the Costco model, including their customer loyalty, the downstream effects of their membership model, the impact of their limited selection, et cetera.

[00:37:27] Clay Finck: One of the bigger themes that sticks out to me as it relates to Costco and its quality is the durability of the business. I’m sure from Munger’s point of view, it’s a company that is nearly certain to become a stronger business one year after the next. Part of that is because the business model is just so good.

[00:37:43] Clay Finck: And the other part is that the management team just thinks super long term and they aren’t willing to make any short term sacrifices to appease Wall Street or appease shareholders. Munger has also said the difference between a good business and a bad business. Is that good businesses throw up one easy decision after another, bad businesses throw up painful decisions time after time.

[00:38:04] Clay Finck: For Costco, they constantly think, what is the high quality decision? What is the best thing for customers? Knowing that the best thing for customers is also the best thing for shareholders long term. Everyone wins in the Costco model. Just the moat of Costco is also really interesting to me. It’s not only important for a company to have a moat, or in other words, protection against competitors stealing market share, but it’s also important that the moat is continually widening to provide that enduring protection.

[00:38:31] Clay Finck: It gives investors the peace of mind that with each passing day, The business is becoming stronger and they’re not becoming weaker and they’re just continually making it more and more difficult for competitors to catch up with them and steal that share. Poor Charlie’s Almanac states, over their long business careers, they have learned sometimes painfully that few businesses survive over multiple generations.

[00:38:53] Clay Finck: Accordingly, they strive to identify and buy only those businesses with a good chance of beating those tough odds, end quote. I’m also reminded of Munger mentioning the enormous value of scale. He’s stated that in terms of which businesses succeed and which fail, advantages of scale is ungodly important, which is of course a key factor in Costco’s success as well.

[00:39:14] Clay Finck: So that’s the first part that I wanted to mention here and related to his investment approach is focused on businesses that are high quality with managers that think long term and they’re nearly certain to have their intrinsic values increase over time as their moats widen. Remember that time is the friend of a wonderful business and the enemy of a poor business.

[00:39:33] Clay Finck: I recently saw a post from a friend where he said that he used to dread earnings reports of subpar businesses he used to own. He was just waiting for that one that would just totally make him regret owning a low quality or poor business. Now that he’s transitioned to owning high quality businesses, he sleeps much better at night and that earnings reports tend to surprise to the upside in general.

[00:39:54] Clay Finck: The second part that stands out to me about Charlie Munger’s investment approach is how he truly embraces. a long term view. Munger started purchasing shares in Berkshire Hathaway in 1962 at around 7 or 8 per share. And of course those are A shares. Today, the A shares of Berkshire Hathaway are worth around 540, 000.

[00:40:15] Clay Finck: So from that first initial purchase that Munger made, The share price is up by over 72, 000x. Just think about how much compounding that is, and then just how much discipline it is to hang onto the shares in light of how much money you’ve made on that investment. Munger has that quote that rings so true in the investment world.

[00:40:37] Clay Finck: The big money is not made in the buying or selling. But in the waiting, and I just absolutely love that quote. The key was not only that he bought at the right time, but he was willing to sit on owning a fantastic business for over 60 years. He clearly understood the power of patience and the power of deferred gratification.

[00:40:55] Clay Finck: He once stated, if you’re glued together and honorable. And get up every morning and keep learning every day, and you’re willing to go in for a lot of deferred gratification all your life, you’re going to succeed. End quote. It also reminds me of the mugger quote that the first rule of compounding is to never interrupt it unnecessarily.

[00:41:14] Clay Finck: So if you’re patient. and you’re thoughtful in your business selections of which businesses you’re going to own. In my opinion, you’re pretty heavily stacking the odds in your favor. Buffett said that the stock market is a device that transfers money from the impatient to the patient. And the good news is that every great business at least once in its history is going to be trading down for very short term reasons.

[00:41:34] Clay Finck: This in turn presents opportunities for patient investors who are willing and able to hold through that volatility and short term uncertainty. It also reminds me of one stock I own that’s just an amazing business. I believe it’s trading well below its intrinsic value and it’s trading around a market multiple growing like a weed has a huge moat.

[00:41:53] Clay Finck: And frankly, the stock has been pretty boring to hold over the past few months as it’s remained cheap. Fortunately, it stayed down long enough for me to build a position and I’m willing to see what happens over the next few years. And if I was right in assessing that the business will continue to be able to execute and grow the way it has.

[00:42:09] Clay Finck: In years past Berkshire Hathaway, the 72,000 bagger has also had their fair share of drawdowns too. Their stock has been cut in half, at least three times since Buffett and Munger took over the company and related to this patient’s Munger’s also willing to sit on some cash and wait for that pitch that he can really knock outta the ballpark.

[00:42:29] Clay Finck: He points out that truly amazing opportunities are quite rare. During a previous shareholder meeting, he stated, The game in our kind of life is being able to recognize a good idea when you rarely get it. And I think that is something you have to prepare for a long period. There’s the old saying that opportunity comes to the prepared mind.

[00:42:48] Clay Finck: That’s the game. End quote. And these great opportunities, sometimes they’re just so obvious and they’re staring right in front of you. Just think about Berkshire buying Apple in 2015 or 2016 when it was trading at 10 or 12 times earnings. How many people could clearly see Amazon massively disrupting the retail industry?

[00:43:06] Clay Finck: And I don’t think it took genius to realize that Costco was very well positioned to grow over a really long period of time. Munger had related this point to the newspaper industry and how it was just so clear that so many towns had one newspaper that was essentially a monopoly in the city.

[00:43:23] Clay Finck: And then there’s also that story about Munger and how he’d been reading the Barron’s magazine for more than 50 years, and he only found one actionable idea in it. It was a cheaply valued auto parts company, and he bought it for 1 per share, and then he ended up selling that stock a few years later for 15 a share, so 15x his money on it, earning him 80 million in profits.

[00:43:45] Clay Finck: And then Munger gave that 80 million to Li Liu, and Li Liu turned that 80 million into 400 million. So You know, that patience, that consistency just was a really good example of the use of compounding and patience in Munger’s life. Gautam Bade writes in his book here, The Joys of Compounding, this example illustrates the significance of extreme patience, deferred gratification, and displaying a strong decisiveness at the right moment.

[00:44:12] Clay Finck: It is why Munger has stated, it takes character to sit there with all that cash and do nothing. I didn’t get to where I am today by going after mediocre opportunities, end quote. This also reminds me of the point that Chris Mayer made in my interview with him a few months back. I mentioned how Chris is similar to Buffett and Munger in that he’s spending so much of his time reading, thinking, studying his businesses, studying new opportunities, and so much of Munger’s investment approach is just simply waiting.

[00:44:40] Clay Finck: This means waiting for the next great opportunity or simply waiting for your investments to compound and just let that magic of compounding work for you. After you found some of those opportunities to buy poor Charlie’s almanac states here This habit of committing far more time to learning and thinking than to doing is no accident It is the blend of discipline and patience exhibited by true masters of a craft, an uncompromising commitment to properly playing the hand.

[00:45:07] Clay Finck: Like world class bridge player Richard Zeckhauser, Charlie scores himself not so much on whether he won the hand, but rather how well he played it. While poor outcomes are excusable in the Munger Buffett world, given the fact that some outcomes are outside of their control. Sloppy preparation and decision making are never excusable because they are controllable, end quote.

[00:45:27] Clay Finck: When I come across a new investment, we should always consider our opportunity cost as well. I may come across an idea and it may seem compelling to add to it, but it has to be compared to our current opportunity set. Within my own portfolio, I have a couple of names that I think are pretty great ideas.

[00:45:43] Clay Finck: So when I come across a new name, the question I’m asking myself Is this new name, not only slightly better than my existing opportunity set, but is it a lot better? When you continually add companies of the highest quality at attractive valuations, you’re continually raising the bar in your portfolio, and making it easier to say no to at least 95 percent of new opportunities that come your way.

[00:46:07] Clay Finck: Munger also believes that not much diversification is needed when buying and holding very high quality businesses. He stated that even a portfolio of just three companies is enough diversification for him. This also ties into his belief that truly great opportunities are rare, as I mentioned, so in order to really make them count, you need to have some level of concentration, given you’re very knowledgeable on the company, as Munger is when he’s entering these positions.

[00:46:32] Clay Finck: So you definitely need to be mindful of where you’re at in terms of experience and competence. You don’t want to concentrate into three to five positions just because you heard on a podcast that it’s the right thing to do. Munger, even after decades of being at this game, admits that he still made major mistakes later on in his career.

[00:46:47] Clay Finck: So we shouldn’t be too foolish to believe that we aren’t prone to making Similar mistakes as well. Poor Charlie’s Almanac had this piece on why he’s so focused on very little activity in terms of buying and selling and having this highly concentrated, highly focused approach. Munger stated, we’re partial to putting out large amounts of money where we won’t have to make another decision.

[00:47:08] Clay Finck: If you buy something because it’s undervalued, then you have to go think about selling it when it approaches the calculation of your intrinsic value. That’s hard. But if you can buy a few great companies, then you can sit on your ass. That’s a good thing. End quote. So that concludes so much of what I’ve learned from Charlie Munger.

[00:47:25] Clay Finck: I mentioned many of the lessons that apply more to life in the first half of this episode. And then I touched on the high level things I’ve learned from Charlie in the second half here. And I wanted to close out this episode with a final quote from Munger. And that’s to take a simple idea and take it seriously.

[00:47:42] Clay Finck: So what’s one simple idea that you can take away from Charlie Munger or this episode that you can seriously implement into your own life? It’s so easy to just listen to podcasts and feel like we’re being productive listening. What really matters is using that knowledge, using what you learn and actually implement it into your life.

[00:48:00] Clay Finck: I’d love for you to let me know one thing you’ve learned from Charlie Munger or one thing you’ve learned from this episode that you just found to be really impactful. Or it’s changed the way you’ve thought you can feel free to tweet at me at clay underscore Fink, or you can always email me clay at the investors podcast.

[00:48:14] Clay Finck: com. I’d love to hear from you. Thanks for tuning in to today’s episode, and I hope to see you again next time.

[00:48:37] Outro: Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by The Investor’s Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or re-broadcasting.


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