This is to continue on the earlier 5 parts of the same subject.
Most investment managers are in a game where clients expect them to know a lot about a lot of things. At Berkshire Hathaway, fortunately, they are not governed by such notion. And instead Berkshire came to this notion of finding a mispriced bet and loading up when they are very confident that they are right. So they are less diversified and system is miles ahead.
However, in all fairness, a lot of money managers could not successfully sell their services if they used Berkshire system. But if you’re investing for 40 years in some pension fund, what difference does it make if the path from start to the finish is a little more bumpy or a little different than everybody else so long as it’s all going to work out well in the end? So what if there’s a little extra volatility.
In investment management today, everyone wants not only to win, but to have a yearly outcome path that never diverges very much from the standard path except on the upside. Oh man, that is a very artificial and crazy construct. That’s the equivalent in investment management to the custom of binding the feet of Chinese woman. It’s the equivalent of what Nietzsche meant when he criticized the man who had a lame leg and was proud of it.
It is really hobbling oneself. Now, the investment managers would say, “We have to be that way. That’s how we’re measured.” And they have the right in terms of the way the business is now constructed. But from the viewpoint of a rational customer, the whole system is bonkers and draws a lot of talented people into socially useless activity.
However, the Berkshire system is not bonkers. It’s so damned elementary, simple that even bright people are going to have limited, really valuable insights in a very competitive world when they’re fighting against other very bright people.
And it makes sense to load up on the very few good insights you have instead of pretending to know everything about everything at all times. You’re much more likely to do well if you start out to do something feasible instead of something that isn’t feasible. Is that perfectly obvious?
How many of you have 56 brilliant ideas in which you have equal confidence? Raise your hands please. How many of you have two or three insights that you have some confidence in? I rest my case. Berkshire system is exactly the same where it adapts to the nature of the investment problem as it really is.
Berkshire made the money out of high quality businesses. In some case, they bought the whole business. In other, they bought just a big block of stock. But when you analyze what happened, the big money has been made in the high quality businesses. And most of the other people who’ve made a lot of money have done so in high quality businesses.
Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for 40 years, you’re not going to make much different than a 6% return – even if you originally buy it at a huge discount. Conversely, if a business earns a 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.
So the trick is getting into better businesses. And that involves all of these advantages of scale that you could consider momentum effects.
How do you get into these great businesses? One method is what Charlie Munger call the method of finding them small get them when they’re little. For example, buy Wal-Mart when Sam Walton first goes public and so forth. And a lot of people try to do just that. And it’s a very beguiling idea. Finding them small is a perfectly intelligent way. But at Berkshire, it doesn’t work anymore because they’ve too much money. They can’t find anything that fits their size parameter that way.
Then finding them big obviously is very hard because of the competition. It gets even harder each year for Berkshire.
Ideally, you should get into a great business which also has a great manager because manager matters. For example, it’s made a great difference to General Electric that Jack Welch came in instead of the guy who took over Westinghouse.
And some of it is predictable. It does not take a genius to understand that Jack Welch was a more insightful person and a better manager than his peers in other companies. Nor it does not take a genius to understand that Disney had basic momentums in place which are very powerful and that Eisner and Wells were very unusual managers.
So you do get an occasional opportunity to get into a wonderful business that’s being run by a wonderful manager. If you don’t load up when you get those opportunities, it is a big mistake.
These people do come along and in many cases, they are not all that hard to identify. If they have got a reasonable hand – with the fanaticism and intelligence and so on that these people generally bring to the party - then management can matter much.
However, averaged out, betting on the quality of a business is better than betting on the quality of management. In other words, if you have to chose one, bet on the business, 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.
Most investment managers are in a game where clients expect them to know a lot about a lot of things. At Berkshire Hathaway, fortunately, they are not governed by such notion. And instead Berkshire came to this notion of finding a mispriced bet and loading up when they are very confident that they are right. So they are less diversified and system is miles ahead.
However, in all fairness, a lot of money managers could not successfully sell their services if they used Berkshire system. But if you’re investing for 40 years in some pension fund, what difference does it make if the path from start to the finish is a little more bumpy or a little different than everybody else so long as it’s all going to work out well in the end? So what if there’s a little extra volatility.
In investment management today, everyone wants not only to win, but to have a yearly outcome path that never diverges very much from the standard path except on the upside. Oh man, that is a very artificial and crazy construct. That’s the equivalent in investment management to the custom of binding the feet of Chinese woman. It’s the equivalent of what Nietzsche meant when he criticized the man who had a lame leg and was proud of it.
It is really hobbling oneself. Now, the investment managers would say, “We have to be that way. That’s how we’re measured.” And they have the right in terms of the way the business is now constructed. But from the viewpoint of a rational customer, the whole system is bonkers and draws a lot of talented people into socially useless activity.
However, the Berkshire system is not bonkers. It’s so damned elementary, simple that even bright people are going to have limited, really valuable insights in a very competitive world when they’re fighting against other very bright people.
And it makes sense to load up on the very few good insights you have instead of pretending to know everything about everything at all times. You’re much more likely to do well if you start out to do something feasible instead of something that isn’t feasible. Is that perfectly obvious?
How many of you have 56 brilliant ideas in which you have equal confidence? Raise your hands please. How many of you have two or three insights that you have some confidence in? I rest my case. Berkshire system is exactly the same where it adapts to the nature of the investment problem as it really is.
Berkshire made the money out of high quality businesses. In some case, they bought the whole business. In other, they bought just a big block of stock. But when you analyze what happened, the big money has been made in the high quality businesses. And most of the other people who’ve made a lot of money have done so in high quality businesses.
Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for 40 years, you’re not going to make much different than a 6% return – even if you originally buy it at a huge discount. Conversely, if a business earns a 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.
So the trick is getting into better businesses. And that involves all of these advantages of scale that you could consider momentum effects.
How do you get into these great businesses? One method is what Charlie Munger call the method of finding them small get them when they’re little. For example, buy Wal-Mart when Sam Walton first goes public and so forth. And a lot of people try to do just that. And it’s a very beguiling idea. Finding them small is a perfectly intelligent way. But at Berkshire, it doesn’t work anymore because they’ve too much money. They can’t find anything that fits their size parameter that way.
Then finding them big obviously is very hard because of the competition. It gets even harder each year for Berkshire.
Ideally, you should get into a great business which also has a great manager because manager matters. For example, it’s made a great difference to General Electric that Jack Welch came in instead of the guy who took over Westinghouse.
And some of it is predictable. It does not take a genius to understand that Jack Welch was a more insightful person and a better manager than his peers in other companies. Nor it does not take a genius to understand that Disney had basic momentums in place which are very powerful and that Eisner and Wells were very unusual managers.
So you do get an occasional opportunity to get into a wonderful business that’s being run by a wonderful manager. If you don’t load up when you get those opportunities, it is a big mistake.
These people do come along and in many cases, they are not all that hard to identify. If they have got a reasonable hand – with the fanaticism and intelligence and so on that these people generally bring to the party - then management can matter much.
However, averaged out, betting on the quality of a business is better than betting on the quality of management. In other words, if you have to chose one, bet on the business, 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.
1 comment:
This was a great post.
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