Gavin Brown’s Kindle Notes & Highlights for Charlie Munger: The Complete Investor (Columbia Business School Publishing)

Charles T. Munger, Berkshire Hathaway’s vice-chairman, and I really have only two jobs. … One is to attract and keep outstanding managers to run our various operations. The other is capital allocation. —WARREN BUFFETT, THE ESSAYS OF WARREN BUFFETT, 2011

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serenely

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The best place to see the Berkshire compensation philosophy set out is in the Berkshire Owner’s Manual, which can be found on the Berkshire web site: http://www.berkshirehathaway.com/owners.htm

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Moat-Widening Skills

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… Averaged out, betting on the quality of business is better than betting on the quality of management. In other words, if you have to choose one, bet on the business momentum, not the brilliance of the manager. But, very rarely, you find a manager who’s so good that you’re wise to follow him into what looks like a mediocre business. —CHARLIE MUNGER, USC BUSINESS SCHOOL, 1994

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Munger wants managers of the business who have an ownership mentality toward the business, not just the attitude of manager.

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Nassim Taleb

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Buffett repeatedly had pointed out that a reputation gained over a lifetime can be lost in less than a second.

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Munger believes: Remember that reputation and integrity are your most valuable assets—and can be lost in a heartbeat. —CHARLIE MUNGER, POOR CHARLIE’S ALMANACK, 2005

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ecosystem.

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BERKSHIRE MATH IN MAKING AN intrinsic value calculation, Berkshire uses the long-term (30-year) U.S. Treasury rate as the discount rate. This is not a typical approach, and many people do not fully understand why Berkshire uses this rate. Buffett explained: We use the risk-free rate merely to equate one item to another. In other words, we’re looking for whatever is the most attractive. In order to estimate the present value of anything, we’re going to use a number. And, obviously, we can always buy government bonds. Therefore, that becomes the yardstick rate … to simply compare all kinds of ...more

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However, to provide a cushion against mistakes, they will not actually buy an asset without at least a 25 percent discount in intrinsic value (this discount is their margin of safety).

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The way Berkshire deals with risk is by buying what they feel is a conservatively valued asset with no risk at a discount price.

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The focus of the investing process at Berkshire is on return on equity (ROE), not earnings per share (EPS).

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Note that Berkshire does not use price to earnings multiples in calculating value. Owner’s earnings is a very specific type of earnings, and they stick to that set of figures.

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in the aftermath of that success. There were many times in history when railroads were very lousy investments. Regarding the impact of supply-side economies of scale, Munger has pointed out: In some businesses, the very nature of things cascades toward the overwhelming dominance of one firm. It tends to cascade to a winner-take-all result. And these advantages of scale are so great, for example, that when Jack Welch came into General Electric, he just said, “to hell with it. We’re either going to be number one or two in every field we’re in or we’re going to be out.” That was a very ...more

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2. Demand-Side Economies of Scale (Network Effects)

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company in the Berkshire portfolio with network effect benefits; the more merchants that accept their card, the more valuable the service gets, and the more people who use the card, the more valuable the services are for merchants. Munger has said: It would be easier to screw up American Express than Coke or Gillette, but it’s an immensely strong business. —CHARLIE MUNGER, BERKSHIRE ANNUAL MEETING, 2000 A company having beneficial network effects is only one dimension that impacts profit. Sometimes, network effects exist but the market is small because it is a niche. Amazon’s market is ...more

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Because box candy sales are highest during holiday seasons, the financial results of the company are also very lumpy. See’s Candies generates losses two quarters a year and makes all its profit in the other two quarters around three holidays. Buffett talks about the fact that building some brands took many decades: When you were a 16-year-old, you took a box of candy on your first date with a girl and gave it either to her parents or to her. In California the girls slap you when you bring Russell Stover, and kiss you when you bring See’s. … I don’t think See’s means anything to people on the ...more

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How would you try to create a brand that competes with Disney? Coke is a brand associated with people being happy around the world. That is what you want to have in a business. That is the moat. You want that moat to widen. —WARREN BUFFETT, VANDERBILT VISIT NOTES, 2005

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4. Regulation

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5. Patents and Intellectual Property

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Companies that have been granted a patent, trademark, or other type of intellectual property by the government have in effect been given a legal monopoly.

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In order for this “seamless web of deserved trust” system to work, you must have great managers and have the right incentives in place.

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Because Buffett and Munger are Graham value investors, Berkshire uses an investing approach designed to outperform in “up” markets and overperform in “down” markets. The goal of a value investor is superior absolute performance, not relative performance. Buffett put it simply: “We will underperform in strong years, we will match in medium years, and we will do better in down years. We will outperform over a cycle, but there’s no guarantee on that.”

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Howard Marks pointed out the following rules for a value investor: “Rule No. 1: Most things will prove to be cyclical. Rule No. 2: Some of the greatest opportunities for gain and loss come when other people forget Rule No. 1.”8 Buffett has his own version of this which states: “Rule No. 1 is never lose money. Rule No. 2 is never forget rule number one.”

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Michael Mauboussin, in what is arguably the best essay ever on moats, wrote: Companies generating high economic returns will attract competitors willing to take a lesser, albeit still attractive, return which will drive down aggregate industry returns to the opportunity cost of capital. —MICHAEL MAUBOUSSIN, “MEASURING THE MOAT,” 2002

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Given the inevitability of relentless competition, the question to ask, according to Munger, is as follows: How do you compete against a true fanatic? You can only try to build the best possible moat and continuously attempt to widen it. —CHARLIE MUNGER, POOR CHARLIE’S ALMANACK, 2005 Jim Sinegal of Costco is just such a fanatic; that’s why Munger serves on their board. The founder of Nebraska Furniture Mart, Rose Blumkin (“Mrs. B”), would be another fanatic.

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To test whether you have a moat with a given company, determine if you are earning profits that are greater than your opportunity cost of capital (OCC). If that level of profitability has been maintained for some reasonable period (measured in years), then you have a strong moat. If the size of the positive difference between return on invested capital (ROIC) and OCC is large and if that spread is persistent over time, your moat is relatively strong. Exactly how long the moat must persist to meet this test is an interesting question. If it is not a period of at least two years, you are taking ...more

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Eisner and Wells

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A company that has a return on capital significantly greater than its opportunity cost over time has a moat, whether they know it or not.

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Identifying a moat others have created is something that people like Munger and Buffett can do. Munger admits that he and Buffett buy moats rather than build them, because building them is not something they do particularly well. In addition to a moat, Munger insists that there be a talented management team already in place. For investors who buy moats instead of creating one, the existence of a moat has special value because they can sometimes survive financially, even if management talent does not deliver as expected or if they leave the business.

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Eugene Fama

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Warren Buffett, The Superinvestors of Graham and Doddsville, 1984. 11. Benjamin Graham, Forbes, 1932. 12. Howard Marks, Oaktree Memo, 2012. 13. Benjamin Graham, Security Analysis, 1934. 14. Warren Buffet, “Buy American,” 2008. 15. Warren Buffett, Fortune, 2001. 3. Worldly Wisdom 1. Robert Hagstrom, Latticework, 2000. 2. Philip Tetlock, Long Now, 2007. 3. Bill Gates, Poor Charlie’s Almanack, 2005. 4. Warren Buffett, Forbes Magazine, 1996. 5. Farris Samarrai, “Doing Something Is Better Than Doing Nothing,” 2014. 6. Warren Buffett, “Working Together,” ...more