This is my 150th blog post and probably my last one in the Charlies Munger series. If I get some good questions I might be persuaded to write a few more in the future.
If I had to boil down Charlie Munger’s investment approach to a single phrase it would be: the best way to be smart, is to not be stupid. In other words, stay away from investments where you do not have a significant advantage. This has been a hard idea for me to convey sometimes since it seems counter-intuitive. Most people think that the way to get ahead with investing is to be more clever than other investors. The better approach is to realize that real risk comes from not knowing what you are doing. Avoiding standard stupidity in all of its many forms is the key to better investing.
Placing a focus on knowing and learning what not to do baffles some people. It almost seems un-American. Academics in particular seem upset by this idea. They ask: “Do you mean to say that you spend much of your time figuring out what not to do? You attend conferences and read books and papers to learn more about what you can’t predict?” Yes.
The best investors are humble when it comes to anything not within their circle of competence. But they also pounce aggressively when they see an opportunity inside their circle and the bet has odds that are substantially in their favor.
Buffett and Munger place a big emphasis on knowing what not to do. Most people are so focused on the inverse objective that they can’t imagine the Berkshire approach. Munger says: “Berkshire is in the business of making easy predictions. If a deal looks too hard, the partners simply shelve it.”
High-technology for Munger and Buffett is too hard, so they avoid it. When Munger jokes: “I just want to know where I will die so I can just not go there” he is humorously making a broader point about avoiding certain areas in investing.
“Warren and I don’t feel like we have any great advantage in the high-tech sector. In fact, we feel like we’re at a big disadvantage in trying to understand the nature of technical developments in software, computer chips or what have you. So we tend to avoid that stuff, based on our personal inadequacies. Again, that is a very, very powerful idea. Every person is going to have a circle of competence. And it’s going to be very hard to advance that circle. If I had to make my living as a musician – I can’t even think of a level low enough to describe where I would be sorted out to if music were the measuring standard of the civilization.”
Charlie Munger makes several important points in the previous quote, but two in particular that stick out are:
1. Only invest when you have a substantial advantage considering all alternatives available to you; and
2. Stay within your circle of competence, since risk comes from not knowing what you are doing.
All Berkshire businesses use technology. Munger and Buffett are not averse to technology generally. Munger and Buffett just shy away from businesses that are high tech and are more pure play technology in nature. Google and Microsoft are high tech. Iscar and Burlington Northern are not high tech, but they do use lots of tech.
Buffett says: “We have no religious belief that we will not invest in tech, just can’t find one where we think we know what the bush will look like in ten years or how many birds will come out of the bush.” Both Munger and Buffett have said that if they were young today they would acquire a technology circle of competence. But they are not young today. What they are looking for is an unfair advantage when they invest and in high-technology they have no such advantage. Munger says:
“For a security to be mispriced, someone else must be a damn fool. It may be bad for the world, but not bad for Berkshire.”
In short, with a high-tech investment Buffett and Munger worry that they will be the damn fool.
Munger appreciates a good moat held by a high-technology business. For example, he has said: “Google has a huge new moat. In fact I’ve probably never seen such a wide moat.” But he is not going to invest in a high-tech firm. In 2015 he said “if you put a gun to my head and told me I had to buy a tech stock, I would pick Google.” That it would take putting a gun to his head to get him to buy a high-tech stock is saying a lot.
At the same meeting in 2015 Munger said on venture capital, versus what he does for a living: “It’s a really difficult honest way to make a living. It’s not like shooting fish in a barrel, which is how I’ve made my living.” Venture capital is not within his circle of competence. So he avoids it which is not a tragedy since he has other opportunities.
What he is saying is that other people have a different circle of competence and for them investing in high-tech can be their best opportunity. Buffett puts it this way:
“Charlie and I put money in things we understand and think we’ll know what it’ll look like in 5, 10 or 20 years. Bill being on the board doesn’t change this. I’ll listen to any idea of his and, in fact, our investment ideas overlap quite a bit. I still wish I’d bought Microsoft when I’d first met him. You cannot buy high tech companies at prices like, say, you were able to buy pharmaceutical companies for in the beginning of the 1990’s. If I had to bet on anyone, it would be Microsoft. But I don’t have to bet. If anyone has superior knowledge and confidence, they can make such an investment. And they deserve to profit from it. We’re willing to trade away a big payoff for a certain payoff. Bill Gates told me two tech companies in 1991 that he’d buy if he went to a desert island. We would have made a ton of money in them if we’d bought them, maybe more than in Coke. But he also named Coke as a third one, and we were happy to stick with that. The Dilly Bar has more certainty of being around in ten years than any software company. There are dozens of software companies selling at prices that imply they’ll make $200 million or more per year in a few years – and that doesn’t happen very often. Only a dozen or so companies move into that category each year in the S&P 500. Look at the biotech companies: how many of them ever grew into the valuations they were given in the early 1990’s? Technology is clearly a boost to business productivity and a driver of better consumer products and the like, so as an individual I have a high appreciation for the power of technology. I have avoided technology sectors as an investor because in general I don’t have a solid grasp of what differentiates many technology companies. I don’t know how to spot durable competitive advantage in technology. To get rich, you find businesses with durable competitive advantage and you don’t overpay for them. Technology is based on change; and change is really the enemy of the investor. Change is more rapid and unpredictable in technology relative to the broader economy. To me, all technology sectors look like 7-foot hurdles.”
A key point to keep in mind about something like cloud technology or machine learning is that both will create both winners and losers, even in technology itself. Munger puts it this way:
“The great lesson in microeconomics is to discriminate between when technology is going to help you and when it’s going to kill you. And most people do not get this straight in their heads.
There are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that’s still going to be lousy. The money still won’t come to you. All of the advantages from great improvements are going to flow through to the customers.”
“New technology will be very disruptive to many people. Retailing in particular is facing major threats. It is changing the world. It will hurt a lot of people. Berkshire is by and large in good shape.”
The other point to keep in mind is that changes in technology are not linear. Changes in the next ten years will be even faster than changes in the past ten years since the rate of change is exponential. Tech has evolved very fast in recent years but it will evolve even faster going forward. People tend to think: “Well I’ve been around for the past five years. I have a good idea what the next five will bring.” No, actually they very likely do not have a good sense of what the next five years will bring.
The impact of changes in an environment which is composed of a nest of complex adaptive systems is always going to produce surprises. Munger calls these outcomes lollapaloozas. In these cases the whole is greater than the sum of the parts as I explained in a recent blog post.
“The reason we have not in high tech businesses is that we have a special lack of aptitude in that area. And, yes– low tech business can be plenty hard. Just try to open a restaurant and make it succeed… why should it be easy to get rich? In a competitive world, shouldn’t an easy way to get rich be impossible?”
Munger’s view on technology investing is better understood by looking at a specific case. For example, Why did Berkshire invest in IBM? We can conclude from their comments in the above discussion that Buffett and Munger do not feel IBM is high–tech.
Buffett described his due diligence this way:
“We went around to all of our companies to see how their IT departments functioned and why they made the decisions they made. And I just came away with a different view of the position that IBM holds within IT departments and why they hold it and the stickiness and a whole bunch of things. It’s a company that helps IT departments do their job better. But, you know, we work with a given auditor, we work with a given law firm. That doesn’t mean we’re happy every minute of every day about everything they do but it is a big deal for a big company to change auditors, change law firms. The IT departments, I—you know, we’ve got dozens and dozens of IT departments at Berkshire. I don’t know how they run. I mean, but we went around and asked them and you find out that there’s—they very much get working hand in glove with suppliers. And that doesn’t—that doesn’t mean things won’t change but it does mean that there’s a lot of continuity to it. And then I think as you go around the world, IBM, in the most recent quarter, reported double-digit gains in 40 countries. Now, I would imagine if you’re in some country around the world and you’re developing your IT department, you’re probably going to feel more comfortable with IBM than with many companies.”
I believe Buffett did not get a representative view of what businesses are buying today in this due diligence process. In other words, they received an incomplete view of the transition of information technology to the cloud due to the unique nature of their portfolio at Berkshire. For example, insurance companies, manufacturers of commodity products and railroads will likely be be some of the last firms to move to the cloud. Buffett and Munger may have reached a different conclusion if they had talked to more companies outside of the Berkshire portfolio.
How has the Berkshire IBM bet worked out so far? Buffett has said in the past that his cost basis in IBM is roughly $170. Trading in IBM shares closed yesterday at ~135.
As of November 9 of 2015:
“Berkshire Hathaway announced that it has lost $2 billion on its IBM investment. That’s 15% of the more than $13 billion worth of IBM’s stock that Berkshire has purchased over the past four-plus years.”
Could he be right in the end and me wrong. Absolutely. He’s Warren Buffett and I am clearly not.
An important point about something like cloud is that it will create both winners and losers. Munger puts it this way:
“The great lesson in microeconomics is to discriminate between when technology is going to help you and when it’s going to kill you. And most people do not get this straight in their heads. …There are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that’s still going to be lousy. The money still won’t come to you. All of the advantages from great improvements are going to flow through to the customers.”
“New technology will be very disruptive to many people. Retailing in particular is facing major threats. It is changing the world. It will hurt a lot of people. Berkshire is by and large in good shape.”
I do agree with Munger that Berkshire is in good shape, but disagree on the IBM stock holding.
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