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Sunday, May 9, 2010

Unifying Theory of Success and Other Learnings from Charlie Munger & Warren Buffett

Among 40,000 people, I paid homage to Charlie Munger and Warren Buffett in Omaha, Nebraska last weekend at the Berkshire Hathaway 2010 shareholder meeting. Imagine 40,000 people traveling from all over the world to attend a shareholder meeting. Unbelievable! Just like previous meetings, this one was a lot of fun. See the notes below:

1. Warren Buffett's message to all Berkshire Hathaway (BH) employees, " Lose money for the the firm and I'll be understanding. Lose a shred of reputation and I'll be ruthless."

2. Make Decisions based on the opportunity cost. Applying this lesson to finding a life partner, "marry the best who will have you."

3. The secret of Warren Buffett and Charlie Munger brilliance is avoiding stupidity.

4. Comcast executive, Steve Burke, has joined the board of BH [think about the diversity on BH board]

5. BH doesn't care about EPS (Earnings Per Share). It is focused on building value.

6. Measuring EBIDTA Quarter over Quarter means Nothing.

7. EPS measurement every quarter derives wrong human behavior. According to the SEC rules, a company can round off EPS to the next digit if the post decimal digit is 5 or higher. So, every quarter, there is creative accounting done to get to the next digit. For example, if the internal numbers are landing up to EPS of 59.4 cents per share, the accountants find 0.1 cent somewhere so that the reported earnings are 60 cent per share. For more details, see http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1474668

8. When the company is in reputation crisis, it should follow 4 steps to reputation management:

i) Get it right
ii) Get it fast
iii) Get it out
iv) Get it over

9. When premiums are high, people take more risks.

10. BH has been in business with Goldman Sachs for 44 years.

11. If Charlie Munger was leading the financial system reform, he would make Paul Volcker look like a sissy.

12. Complexity in the financial system is counterproductive. We need a new version of Glass-Steagall act.

13. If you let people do whatever they want, they will do a lot of stupid things.

14. BH is not too big to fail i.e. if BH goes under, it would not pose a risk to the financial system. The current Derivative Collateral Requirements being discussed will not impact BH because the derivative positions BH has are ~1% of what other banks/financial institutions have.

15. As it relates to doing business, BH is currency-agnostic.

16. US used credit to win WW II and to rebuild Germany and Japan. Recently, US has been using credit too much so it is going through a correction period. However, there is no risk for US to default on its credit because the credit is issued in US$. It can just print more US$ and pay back the loans. Other countries do not have this advantage. Japan is the only other country which borrows in its own currency.

17. Greece represents an interesting problem. A sovereign country without its own currency is something very new to the economic world. The Greece debt crises is just the beginning. We don't know how this movie ends. It is going to be a good drama.

18. All currencies will go down in value in future.

19. Running a budget with deficits at 10% of GDP is not sustainable.

20. We are not close to what humans are capable of achieving. In the history of mankind, there has been no better time to be born than today.

21. BH did not buy Harley stock and bought debt instead because Warren Buffett did not know enough about the business to value the company. However, he knew that a company whose name people tattoo on their chests is not going out of business.

22. Buffett will visit India for the very first time in March next year in relation to the Iscar business.

23. China is growing faster than India because the Chinese government does not cause paralysis for businesses.

24. Since 1930, US$ has declined 90% and we are doing OK.

25. Inflation will definitely go higher in future. Munger said, "I am nearly dead [at age 86] and if I am optimistic about the future then you can handle a little bit of inflation."

26. Teaching kids financial discipline at an early age is very important for them to become fiscally responsible adults.

27. McDonalds has succeeded better than the education system to teach people about work and life. Working for McDonalds, a kid who has never worked before, learns to show up on time, learns to be responsible, and learns the importance of teamwork, etc.

28. Any institute that gets a threat from the outside, it not only deals with the threat but also with the threatener.

29. 90% of Dairy Queen outlets are franchise. BH does not tell its operating companies to do business with each other. Hence, many Dairy Queen locations do not accept American Express cards [another firm partially owned by BH].

30. All employees should think and work like owners of the business they work in. If you do that, you might become the owner one day.

31. When BH acquired Geico Insurance, it had 2% market share and now it has 8.5% market share.

32. Sprite outsells Coke 2 to 1 in China.

33. China is just starting to unleash its potential. In 1790, US had 4M people and China had 250M people. US has had open economic environment for 200+ years and China has had it for ~30 years. You will see China become more dominant economic power in the coming years.

34. China is setting up a record for fastest human advancement.

35. One should convert one's IRA to Roth IRA to save money.

36. Newspapers used to be the Fourth Estate. They played an important role in the society and their strong position helped them to play that role. The demise of newspapers is not good for the society.

37. If you manage/invest moderate amount of money, you can do very well. There are plenty of opportunities for small investors.

38. People make the same mistakes over and over again.

39. Opportunity comes around. Be ready!

40. Take the high road. It is not very crowded. Or, as they say in Washington D.C., there is no traffic at the high road.

41. The biggest worry for a bond insurer is contagion.

42. If the undisciplined are not punished then everyone imitates their behavior.

43. For a long term investor [10+ years], equities are still the best investments.

44. Warren Buffett has $7B in carry-forward losses on his latest income tax returns. These losses are mainly from his charitable donations.

45. Trend is not destiny.

46. Talent does not get inflated. Currency will!

47. BH does not engage with compensation consultants. Every BH operating company has different compensation structure. There are some BH companies which a monkey can run and there are others Alfred Sloan will have trouble running. Hence, compensation at BH operating companies is based on complexity of the business and value the executives are adding to the business.

48. BH does not buy any company for synergy with its current businesses.

49. There is no HR [Human Resources] department at BH corporation.

50. BH has decentralized policy of operating the business. Guiding principles, like treat people fairly, are provided by the headquarters. Running the business is left to the operating companies.

51. Headquarters are usually hated in the field.

52. BH pays its managers for widening the moat [strengthening the Durable Competitive Advantage] that separates BH from its competitors.

53. Warren Buffett only sends out one piece of communication every year to the managers of BH operating companies. This annual communication asks BH business managers to name their potential successors with pros and cons for each.

54. If the only reason you are doing something is because everyone else is doing it then don't do it.

55. The BH idea is to celebrate wealth when it is fairly won and wisely used.

56. Railroads have been improving consistently for the last 40 years.

57. Usefulness of derivatives is overrated.

58. Everyone should read Chapter 12 of John Maynard Keynes' The General Theory of Employment, Interest and Money. It explains the state of Long Term Expectation.

59. S&P made derivative trade popular around1982. Buffett opposed it at the time by writing to letter to the congress. Tax treatment of derivatives is unfair. If I buy a derivative at 2:00PM and sell it at 2:01PM, I can show 60% of my gain as Long Term Capital gain.

60. You should not watch sausage making and legislation making. It is very ugly.

61. Rating agencies are still a very good investment.

62. It is hard to think contrary to the crowd.

63. Oil is only 150 year old. It was the energy source that propelled the economic growth. However, moving forward, oil does not have to be the main energy source.

64. Charlie Munger believes in Freeman Dyson's view of the world re future energy sources. Freeman Dyson is not worried about the energy problem and hence Charlie Munger is not worried.

65. People buy companies to get into new markets, which they do not understand, because they are tired of being in a highly competitive environment.

66. Integrity is terribly important in business.

67. FASB came out with a good rule that options should be shown as expense in the income statement. However, it was vigorously opposed by businesses and the Congress, which is influenced by business lobby, was able to pressure FASB [which is not right] to change the rule to allow two options. Option 1- FASB prefers that companies expense options. Option 2- It is acceptable that companies do not show options as expense. 498 companies in the S&P 500 use option 2. Warren Buffett spoke with CEOs of many of these 498 companies, everyone says that they can not do it if the others don't.

68. When creating a system, one should create a system which minimizes the human weakness and builds a culture of accountability.

69. Be greedy when others are fearful.

70. To be successful, you should get your feet wet with failures first.

71. Solar energy is coming. It may sound ironic but the best thing for the consumers is to sit and wait because the prices will continue to fall.

72. Corn fuel is a stunningly stupid idea.

73. Buffett likes the medium of TV to communicate with the public because he can keep record of what he says. In newspaper, you are always reading someone's interpretation of what Buffett said.

74. Don't spend time with people who will be disappointed with you in future.

75. BH does not have an Investor Relations department.

76. BH investment philosophy is simple. Value the business based on Durable Competitive Advantage and invest with a margin of safety. And, stay within your Circle of Competence. That's it! It amazes Charlie Munger that people have tough time following this method.

77. It is very important to know the boundaries of your Circle of Competence. Size does not matter. However small it is, you will be amazed how little or no competition you will find.

78. Keep learning! Everyday go to bed a little wiser than when you got up. In time, you are sure to rise!

79. Think about why some businesses are working and why others are failing. You will learn a lot.

80. Most good consumer businesses have low capital operating requirements. For example, magazine business runs on negative capital because the business gets your money in advance of supplying the product.

81. There is nothing like following your passion. Find your passion and don't let anyone stop you.

82. Nebraska Furniture Mart, a BH operating company, was started with $500 in annual sales. Today, it sells more than $400M per year. Mrs. B who ran the business until she was 104 was unable to read, write, or sign her own name. She was following her passion.

83. The unifying theory of success which BH follows is Pragmatism. Repeat what works!

84. Warren Buffett addressed the BH Goldman Sachs investment, which is generating $15/second for BH, with explaining how the business of bond insurance works. In his opinion, Goldman did not do anything wrong and SEC inquiry is unjustified. When you agree to insure a bond, it should not matter who is on the other side of the trade, it should be an independent decision by the insurer. Buffett does not have sympathy for ACA Management which made a dumb deal. If you are not familiar with the SEC vs. Goldman case, please see http://blogs.wsj.com/deals/2010/04/16/sec-v-goldman-acas-tale-of-woe/tab/article/. Ironically, Goldman troubles are helping BH since Goldman can not pay BH loan back due to current crises and government intervention. The loan is making a lot of money for BH in interest.

85. Standard in business should not be what is legal or convenient. It should be what is moral.

86. Charlie Munger gave an example of how the world works. A rich man asked his wife, "honey, will you still love me if I lose all my money?" The wife replied, "of course, I will love you and I will miss you terribly."

My question to Munger and Buffett was that how do you change culture of an organization. Buffett said that it is really hard. He tried it at Salomon Brothers and it did not work without changing the people. Munger was flattered with the question. However, he said that the BH failure rate of culture change is 100%.

Enjoy and try to attend the meeting next year!