From the Mouth of Munger.

February 15, 2016

Some are smart. Some wise. Some both.
Charlie Munger, Warren Buffett's right-hand man at Berkshire Hathaway, is such a man. When he speaks, you do not simply listen. You take notes.
Mr. Munger recently spoke at the annual meeting of a small legal-publishing software company in Los Angeles. Munger, vice chairman of Berkshire Hathaway, has been the chairman of this small concern since the mid-seventies. He attends the company's annual meeting each year. Dispenses wisdom. Waxes poetic. And like a small-scale version of Berkshire's famous investor conference in Omaha, investors cross the country to attend each year.

This year was no different. He spoke for two hours. Denigrated the financial services industry. Wondered at the promise of China. And dispensed common-sense advice. His core message? Investors can achieve their fullest potential only by thinking for themselves.
"If you stay rational yourself," he explained, "the stupidity of the world helps you."
Munger was asked about the merger of Burger King and Tim Horton's, and the controversial relocation to Canada. Responding, he praised 3G Capital, the Brazilian private equity firm seeking to merge the two companies. Described 3G's team as "probably the best in the world" at making "companies function better at lower cost."
"Ultimately," he added, "I think we don't do the world a favor by employing more people than we need for companies to run efficiently."
Which, in my estimation, is the reason corporations are usually efficient. And government entities are not. Consider that FedEx made $33 billion in gross profit last year. While the U.S. Postal Service lost $5 billion.
We've long contended that government can never be an efficient capital allocator. When the well is endless, your credit limit extends infinitely.
Following the credit crisis, the only growth sector in the United States was the public sector. Shortly thereafter, Washington D.C. surpassed Silicon Valley as the wealthiest area in the nation. A travesty. But, I digress.
Mr. Munger went on to discuss the success he and Buffett have had with Berkshire Hathaway. His incredulity over how two men could take an array of fading textile mills, stagnant department stores and a trading stamp company and transition it into the fifth-largest company in the U.S. One with a market cap of $337 billion. Larger than General Electric. IBM. And Coca Cola.
To what does Munger attribute their success?
First, he credits the company's policy of keeping great talent in place. Explaining that companies like GE "long had a history of moving division leaders around internally, and that's like asking an oboe player in the symphony to perform on the piano and expecting the quality of the music not to suffer."
Berkshire's talented managers remain where there talent is needed most.
Next, Munger added, "I think we have had a temperamental advantage: Warren and I know better than most people what we know and what we don't know. That's even better than having a lot of extra IQ points."
In fact, human beings tend to suffer from a number of biases that stand in the way of clarity and insight. This is especially true of investors.
There's confirmation bias. Shunning the need for research and due diligence, investors tend to begin with the answer, and then search for evidence to back it up.
Then there's the backfiring effect. When presented with information that counters their viewpoints, investors tend to reject challenging opinions, often doubling down on wrongful views.
Painfully, there's the skill bias, causing us to place a higher premium on individual skills and abilities than they actually merit. In fact, the average person overestimates his intelligence, training and education. Often to his detriment.
Or, one might consider the illusion of control. Whereby we believe our decisions and skill led to a desired outcome, when luck was the primary factor. For traders, this causes many to assume increasing amounts of risk. Until the reality of the situation presents itself. Usually in the form of large trading losses.
One might suffer from the escalation of commitment. The classic "throwing good money after bad." Causing us to double down on a plunging stock. Not because you believe in its bright future. But because you desperately wish to recoup your losses.
Then there's the ostrich bias. The risk-perception bias. The negativity bias. The list goes on.
Human beings were designed to fight or flee at the first sign of trouble. The careful calibration of risk, and the strategic decision as to how one should proceed even as a situation deteriorates are not biological strengths. While overcoming a million years of evolution is no small feat.
According to Munger, successful investing requires "this crazy combination of gumption and patience, and then being ready to pounce when the opportunity presents itself, because in this world opportunities just don't last very long."
Perhaps no other event underscores that reality better than the recent financial meltdown.
Investors, fearing rampant volatility and uncertainty, sold in droves - even as the S&P 500 descended beneath the 1,000 level for the first time in a decade. Following, they froze, even as the market bottomed and then ripped higher. And higher. For six years. In fact, the problem with the current bull market is the idea that many average Joes have failed to participate.
Investors feel comfortable when they're standing within the herd. There's comfort in numbers. Accordingly, when the market has risen steadily and is much closer to a top than a bottom, investors pour in. Feeling safe amid the enthusiasm.
Conversely, as the market fell 50 percent off the highs, shock and panic reigned. The average investor wanted nothing to do with the market. Even as it offered a once-in-a-lifetime opportunity. $10,000 invested in an S&P 500 index in March, 2009, would be worth more than $29,000 today.
Today, many investors remain on the sidelines. Sitting in cash, or in underperforming fixed-income instruments.
As Misters Buffett and Munger would attest, most humans don't have the temperament for effective investing. They incorrectly predict their future emotions. Fail to realize how commonplace volatility is. And constantly try to forecast what stocks will do next. Even as forecasting with any degree of accuracy has proven impossible. Even so-called professionals exhibit no skill whatsoever.
In 2005, investment bank Dresder Kleinwort published a study of aggregate professional forecasts of stock prices, interest rates and GDP growth.
Overall, the forecasts were horrendous. Interestingly, the researchers found an almost perfect lag between forecasts and results. Analysts would wait until stock prices rose and then forecast that stocks were about to rise. When interest rates fell, analysts would forecasts that rates were about to drop.
"Analysts are terribly good at telling us what has just happened but of little use in telling us what is going to happen in the future," researchers concluded. Yet, even with empirical evidence attesting to their inability, our appetite for forecasts remains insatiable. Positive, negative, bullish or bearish - investors love when someone tells them the future. Even incorrectly.
This tendency, that of the herd's incessant need of a shepherd, explains why there will always be investment opportunities for patient, thoughtful investors.
Of course, nobody explains it better than Mr. Buffett himself.
"When the price of a stock can be influenced by a "herd" on Wall Street with prices set at the margin by the most emotional person, or the greediest person, or the most depressed person, it is hard to argue that the market always prices rationally. In fact, market prices are frequently nonsensical. Ships will sail around the world but the Flat Earth Society will flourish. There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham and Dodd will continue to prosper."
Sometimes, successful investing is simply the byproduct of patience. Knowing when to act. Or to sit patiently, until the proper opportunity arrives. Investing, like most of life's endeavors, rewards those with the ability to defer gratification.
We cannot control machinations of the market. But, we can control our reaction. Sometimes, one must act quickly. Other times, patience is rewarded.
Of course patience is a challenge. Ancestral man, Australopithecus, was not in the game of deferred gratification. Hunt. Gather. Fight. Flight. Eat. Procreate. Whatever came to mind, he did. Was biologically programmed to do. Only with great difficulty can we overcome that flaw in our evolutionary software. As Munger explained in Los Angeles.
"It's waiting that helps you as an investor, and a lot people just can't stand to wait," he said. "If you didn't get the deferred-gratification gene, you've got to work very hard to overcome that."
Now, had Mr. Munger ever evaded a hungry saber tooth, he might feel differently.

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