Links

Jim Collins Interviews Jorge Paulo Lemann (video) [H/T George] (LINK)

A good comment from Jim Collins around the 13:45 mark: "Most of us come at life as a series of 'What' questions. What am I going to do? What career? What company? It's about what...What? What? What? And I think what Jorge Paulo shifted to early in his life was that the first questions are always 'Who?'. Who are you going to allow to mentor you? Who do you want to spend your time with? You can be doing a lot of 'Whats' with your life, but if you're not doing it with people you love doing it with, it's really hard to have a great life." [Lemann follows up with some comments about this and Warren Buffett at the 16:30 mark.] 

And another good Collins quote around the 36-minute mark: "Luck favors the consistent. You're going to have good hands and bad hands in life. And you might get a bad hand early. You might go broke at 26. You might have come from a difficult place. If you see life as coming down from a single hand, then it's very easy to lose. Because what if that's a bad hand? But if you look at it as 'Life is a series of hands', and the key is to play every hand to the best of your ability; sometimes you get good hands, and sometimes you get bad hands. But you've got to stay at the table. You've got to stay in the game and keep playing."

Related book: DREAM BIG

How the Internet works: Submarine fibre, brains in jars, and coaxial cables [H/T Techmeme] (LINK) [This reminded me of the book Tubes: A Journey to the Center of the Internet.]

a16z Podcast: Startups and Pendulum Swings Through Ideas, Time, Fame, and Money (LINK)

Sir Karl Popper's "Science as Falsification" (audio) [H/T @SpaceWeather101] (LINK)

Related book: Conjectures and Refutations

Links

Oaktree’s Howard Marks touches on oil investments and social-media stocks at the London Value Investor Conference (LINK)

Howard Marks, co-chairman of Los Angeles–based Oaktree Capital Group , who appeared at the conference by video link, said he has taken the plunge and invested in oil-related assets. He also suggested that shares of social-media companies are too rich for the value crowd. 

Marks, addressing about 450 attendees at London’s Queen Elizabeth II Conference Centre, blamed lower interest rates for distorting valuations. “Lower base interest rates have made all assets relatively more attractive than they otherwise would have been,” he said. 

The manager said he doesn’t consider oil a value investment because it is impossible to calculate its intrinsic value. But he said he has made “oil-related investments,” which he wouldn’t specify, since January, when West Texas Intermediate, the U.S. benchmark crude, slipped below $30 a barrel. 

..... 

There was plenty of talk about emerging markets. James Montier, on the asset-allocation team at GMO, says they are genuinely cheap versus developed markets, especially after resources and financial stocks are stripped out. Jean-Marie Eveillard, formerly a portfolio manager at First Eagle Investment Management and now a board trustee, sees potential in India. “I am much more positive in the long term about India than I am about China,” he said. 

Investing By Design - by Chris Pavese (LINK)

The Afterlife of Polaroid [H/T @chriswmayer] (LINK)

Marc Andreessen on the Tim Ferriss podcast (LINK)

a16z Podcast: Trade, Commerce, Manufacturing, Immigration, & Cuba — with Penny Pritzker (LINK)

Farnam Street: 12 Things Lee Kuan Yew Taught Me About the World (LINK)

The Selfish Gene turns 40 (LINK)

Related book: The Selfish Gene

Book of the day [H/T Scott Adams]: Impossible to Ignore

Kristian Siem on investment and valuation

From the book Concentrated Investing: Strategies of the World's Greatest Concentrated Value Investors:

Siem Industries made numerous successful investments since it became a publicly traded company in 1987, growing its shareholders’ equity from $5.3 million in June 1987 to over $2.01 billion at the end of 2014, growing at a compound rate of 25 percent. Siem has been instrumental to the success for many of the company’s investments, being named as chairman of the investee company in almost every instance for the purpose of enacting the strategies he outlined. It is a testament to his hands on, industrial investment philosophy. 

Siem on Valuation 

Siem’s success in the oil and gas drilling and shipping industries points to an unconventional facility for identifying and valuing investment opportunities there. How does he find those opportunities, and what does he look for when presented with an investment? He has worked his entire career in oil and gas drilling and shipping, with a particular focus on offshore drilling and other services. His first investments were made in individual assets, and he was fully concentrated in each of those deals, investing all of his capital into a single asset. Siem argues that such a huge concentration of capital was warranted because he had done his homework. The downside risk, from his perspective, was relatively small because he knew the industry so well. He also notes that he was young and “didn’t have the experience to see all the potential pitfalls that come with age, and the problem when you have old people deciding is that you get the benefit of their experience, but also they may lack the courage at times.” He says that, though he didn’t have a lot of experience at the time that he acquired the Haakon Magnus, his first investment, he had spent all of his working life in the oil and gas offshore drilling industry, and knew it well: 

I knew all 118 submersible rigs in the world by name, where they were, and their contracts. I came young into a young industry, so I had a very good grip and understanding of all the dynamics in this industry, and therefore the quality of my judgment was high. I saw it as a fantastic opportunity to put all my wealth and energy into it. 

His view is that the best way to get the valuation right is to have industry knowledge that can only come from experience. This knowledge gives him context to understand how each asset develops, its earning capability, and the state of the market for the asset’s services. This leads to an instinctive valuation. He knows the market value and cost to replace all the vessels, rigs, and other hardware that he depends on as operating assets. He also knows the earning capability as a yield on each of those assets. Siem’s favorite metric for calculating that yield is the earnings before interest, taxes, amortization, and depreciation (EBITDA) in proportion to the investment or capital expenditures (CapEx): 

It’s a simple calculation. It’s basically EBITDA in relation to the CapEx. And it’s amazing what that simple calculation can do. I always do it myself when I sit in boards, whether it’s Transocean or Subsea or smaller companies. Management often present reams of calculations, internal rates of return, and so forth. And I have been surprised at some fellow directors who say, “Yeah, the internal rate of return looks fine, and it’s better than our weighted average cost of capital, so let’s go for it.” But you need to examine the model’s assumptions. How is the internal rate of return defined? What is the residual value that you put into that calculation, for instance? That makes all the difference. 

With an idea of the cost to replace each asset, its market value, and its likely EBITDA yield after backing out operating CapEx, Siem calculates the asset’s earnings power. He looks at what it is currently yielding, and what he thinks it is likely to earn in the future based on how he, and management, see the market for its services developing. He says that some of the best asset plays he has done have been based on no income at all. If he can find an asset that has been laid off—not operating—it will have negative EBITDA because the owners have to pay the layoff costs. Those assets can often be acquired very cheaply. His first, the Haakon Magnus, was such a deal. 

Siem says that having a permanent source of capital provided by the public company has allowed him the requisite time to complete many projects. A problem for many investors in terms of expressing their own investment philosophy is that they don’t have this access to permanent capital. A source of permanent capital, whether his own money or that of Siem Industries, is dedicated for the long term and allows him to invest for the long term. He can think differently about an investment than another investor, like the more typical fund manager, who has two tasks: (1) to produce returns and (2) keep the investor base happy. Siem believes that his long time horizon has been central to his success: 

Industry, by nature, is long term, and the fund management business, by nature, is short term. Financial investors come in and out: They can push a button any day and get out. The principal industrial investors don’t have that luxury. They have to think for the long term. I believe indeed the success of industry is that you always think long term, so even if incidents like mergers or takeovers cause you to be out in the shorter term, you take the long-term decision as if you were to be the owner forever, that is healthy for the industry, and therefore also for its shareholders. I think that has been the success of our operation.

Links

Latticework of Mental Models: Bayes Theorem (LINK)

Related book: The Theory That Would Not Die: How Bayes' Rule Cracked the Enigma Code, Hunted Down Russian Submarines, and Emerged Triumphant from Two Centuries of Controversy

Q&A: Wilbur Ross On China, Yuan, Debt & Trump [H/T @williamgreen72] (LINK)

Interview with Tom Jacobs Regarding the Complete Works of Maurece Schiller (LINK)

Exponent Podcast: Episode 080 — Multiple Full Circles (LINK)

Jim Clark on Productivity: Don’t Spend Your Day on Social Media, Instead Spend Your Day Building the Next Big Thing (LINK)

Sean Carroll: "The Big Picture" | Talks at Google (LINK)

Related book: The Big Picture: On the Origins of Life, Meaning, and the Universe Itself 

Sheryl Sandberg Commencement Speech, University of California at Berkeley, May 2016 (Transcript) (LINK) [The video is available HERE.]

Howard Marks Memo: Economic Reality

Link to Memo: Economic Reality

In 1977, responding to the difficult energy outlook brought on by the Arab Oil Embargo, President Jimmy Carter created the position of Secretary of Energy and chose James Schlesinger as America’s first “energy czar.”  Previously Schlesinger had served as Chairman of the Atomic Energy Commission, Director of Central Intelligence, and Secretary of Defense, and in his early days he taught economics at the University of Virginia.  I was tickled by a story – undoubtedly apocryphal – about his days in academia that made the rounds when Schlesinger was in his new energy post.  

As the story went, Schlesinger was such a convincing evangelist for capitalism that two students in his economics class decided to go into business after graduation.  Their plan was to borrow money from a bank, buy a truck, and use it to pick up firewood purchased in the Virginia countryside, which they would then sell to the grandees in Georgetown.  Schlesinger wholeheartedly endorsed their entrepreneurial leanings, and they proceeded with great enthusiasm.  From the start of their venture, the former students could barely keep up with the demand. 

Thus it came as quite a shock when their banker called to tell them the balance in their account had reached zero and the truck was about to be repossessed.  They contacted Schlesinger, and he listened attentively as they recounted their experience: they had, in fact, been able to acquire vast amounts of wood for $50 a cord, and they’d been able to sell all they had for $40 a cord.  How could they be broke?  Where had they gone wrong?  Schlesinger puffed on his ever-present pipe and said: “The answer’s obvious: you need a bigger truck.”

Links

Newspapers haven't 'cracked code,' Buffett says (LINK)

Sugar Is So Scarce in Venezuela That Coca-Cola Will Stop Production (video plays) [H/T @rationalwalk] (LINK)

Insurers Seek Big Premium Boosts: Large health plans in some states are seeking to raise rates by 20% or more (LINK)

SEC to Alibaba: “Open (your books) Sesame!” (LINK)

Peter Thiel, Comic Book Hero - by Ben Thompson (LINK)

Video clip of 1967 Reagan-RFK debate (10 mins.) [H/T @BeschlossDC] (LINK)

Meerkats Mysteriously Know to Outgrow Rivals (LINK)

A Shocking Find In a Neanderthal Cave In France (LINK)

Book of the day [H/T @iancassel]: Shoe Dog: A Memoir by the Creator of Nike

Links

As a reminder, tomorrow (the 26th) is the last day for the Audible $4.95 Sale.

A Unique Behind-the-Scenes Look into Warren Buffett's Investment Process [H/T @Wexboy_Value] (LINK)

What is the Future of Insights: Caddies, Librarians, Explorers Or Consultants? [video webinar put on by one of Boyles' newest investment positions] (LINK)

The Price of Regret (LINK)

Links

Jamie Dimon on the Recode Decode podcast (LINK)

How Warren Buffett’s Son Would Feed the World (LINK)

The Ideal Investment: Companies That Don’t Invest [H/T @jasonzweigwsj] (LINK)

Related book: Capital Returns

Hedge-Fund Star Kyle Bass Slips on Oil [H/T Will] (LINK)

Jim Grant: No rate hike this year (video) [H/T ValueWalk] (LINK)

a16z Podcast: Automation, Jobs, & the Future of Work (and Income) (LINK)

The Curse of Culture - by Ben Thompson (LINK)

The implications of this definition are profound: culture is not something that begets success, rather, it is a product of it. All companies start with the espoused beliefs and values of their founder(s), but until those beliefs and values are proven correct and successful they are open to debate and change. If, though, they lead to real sustained success, then those values and beliefs slip from the conscious to the unconscious, and it is this transformation that allows companies to maintain the “secret sauce” that drove their initial success even as they scale. The founder no longer needs to espouse his or her beliefs and values to the 10,000th employee; every single person already in the company will do just that, in every decision they make big or small. 

As with most such things, culture is one of a company’s most powerful assets right until it isn’t: the same underlying assumptions that permit an organization to scale massively constrain the ability of that same organization to change direction. More distressingly, culture prevents organizations from even knowing they need to do so. 

..... 

Related book: Organizational Culture and Leadership

Malcolm Gladwell at TIBCO NOW 2014: The Right Attitude (video) [H/T David] (LINK) -- [I don't think I'd seen this before. As usual, Gladwell tells his story featuring a real person, in this case Malcolm McLean. To hear more about McLean from someone who knew him, see the 4th question in the video Five Good Questions for Gene Hoots.]

The Deliberate Creative (LINK)

Monkeys can run up vertical cliffs on just their hind legs (video) (LINK)

Jeff Bezos quote

"There [are] a couple of things that seem to be a pattern match for people who are right a lot. One is that people who are right a lot listen a lot. Another one is that people who are right a lot change their mind a lot.... People say that you should change your mind when the data changes; but I change my mind even when the data doesn't change, because I reanalyze the situation every day and sometimes I just come to a better analysis. And I think actually what I said yesterday I don't believe anymore.... You should not change your mind on your principles or your ideals or your vision. You should be stubborn on those things. But most of what we do every day is very tactical...and you should be very, very focused on the details and on changing your mind very frequently. And then finally--and this is the one that humans are the worst at--is [that] you have to have deep convictions, but then always work to disconfirm them. And you won't usually. Most of your convictions are going to be right for long periods of time, but you should always be saying 'Here's something I really, really believe is true, and then am I wrong about this? Am I wrong about this?'. And then look for ways to disconfirm. The natural human behavior is confirmation bias." -Jeff Bezos

[Source: From the video embedded HERE, starting around the 20:38 mark. The question and answer that discusses failure, starting around the 41:08 mark, is also exceptionally good.]

Warren Buffett on buying wonderful companies

An excerpt from the 1989 Berkshire letter that I like to review when I start getting tempted to spend too much time on non-wonderful businesses with stock prices that look tempting. Even if they aren't necessarily "cigar butts" I've found that it is often an area most prone to having competitive forces, many of which might not be knowable ahead of time, turn what appeared to originally be a cheap stock into a fair or even overvalued one. The wisdom from Mr. Buffett:

If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the “cigar butt” approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the “bargain purchase” will make that puff all profit. 

Unless you are a liquidator, that kind of approach to buying businesses is foolish. First, the original “bargain” price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces—never is there just one cockroach in the kitchen. Second, any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realize a high return. But the investment will disappoint if the business is sold for $10 million in ten years and in the interim has annually earned and distributed only a few percent on cost. Time is the friend of the wonderful business, the enemy of the mediocre.  

You might think this principle is obvious, but I had to learn it the hard way—in fact, I had to learn it several times over. Shortly after purchasing Berkshire, I acquired a Baltimore department store, Hochschild Kohn, buying through a company called Diversified Retailing that later merged with Berkshire. I bought at a substantial discount from book value, the people were first-class, and the deal included some extras—unrecorded real estate values and a significant LIFO inventory cushion. How could I miss? So-o-o—three years later I was lucky to sell the business for about what I had paid. After ending our corporate marriage to Hochschild Kohn, I had memories like those of the husband in the country song, “My Wife Ran Away With My Best Friend and I Still Miss Him a Lot.”  

I could give you other personal examples of “bargain-purchase” folly but I’m sure you get the picture: It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner. But now, when buying companies or common stocks, we look for first-class businesses accompanied by first-class managements.

Links

Charlie Munger Q&A at the Berkshire Hathaway Annual Meeting [H/T ValueWalk] (LINK)

Importance of ROIC: “Reinvestment” vs “Legacy” Moats (LINK)

Middleby Corporation (MIDD): Case Study of an Intelligent Fanatic Led 100-Bagger - by Ian Cassel (LINK)

The Remarkable Iscar Story [H/T Linc] (LINK)

Related book: Habit of Labor: Lessons from a Life of Struggle and Success

Ajit Jain’s Memo About the New CEO at Berkshire’s Gen Re [H/T Linc] (LINK)

To understand something, write about it (LINK)

Related book: All I Want To Know Is Where I'm Going To Die So I'll Never Go There

Bill Gates: 5 Books to Read This Summer (LINK)

The books: 1) Seveneves; 2) How Not to Be Wrong; 3) The Vital Question; 4) The Power to Compete; 5) Sapiens

Jeff Bezos wants to see an entrepreneurial explosion in space (LINK)

8 Big Ideas from a Super Investor: Philip Fisher (LINK)

Latticework of Mental Models: Winner’s Curse (LINK)

Latticework of Mental Models: Pari-mutuel System (LINK)

A Dozen Things Learned from Steven Crist About Investing and Handicapping Horses (LINK)

Chris Davis on WealthTrack (video) [H/T Will] (LINK)

Uber as a predatory lender (LINK)

FT Alphachatterbox podcast: The life and times of Paul Volcker (Part 1, Part 2)

Ryan Holiday talks to Shane Parrish on The Knowledge Project podcast (LINK)

Related books: The Obstacle Is the Way; Ego Is the Enemy

Google’s Go-to-Market Gap - by Ben Thompson (LINK)

Exponent Podcast: Episode 079 — Twerk the Algorithm (LINK)

Talks at Google - James Grant discusses The Forgotten Depression: 1921: The Crash That Cured Itself (video) (LINK)

Talks at Google - Steve Case discusses The Third Wave: An Entrepreneur's Vision of the Future (video) (LINK)

Talks at Google - Chris Anderson discusses TED Talks: The Official TED Guide to Public Speaking (video) (LINK)

Niall Ferguson's BBC series based on his book Civilization (videos) (LINK)

Hussman Weekly Market Comment: The Coming Fed-Induced Pension Bust (LINK)

Last week, I observed that based on the most reliable measures we identify (those having the strongest correlation with actual subsequent 10-12 year investment returns across history as well as in recent cycles), “the expected return on a traditional portfolio mix is actually lower at present than at any point in history except the 1929 and 1937 market peaks. QE has effectively front-loaded realized past returns, while destroying the future return prospects of conventional portfolios, at least as measured from current valuations. As a result, the coming years are likely to see a major pension crisis across both corporations and municipalities because the illusory front-loading of returns has encouraged profound underfunding.” 

On Thursday, Chicago’s Municipal Employees Annuity and Benefit Fund reported that its net pension liability soared to $18.6 billion, from $7.1 billion a year earlier, as a result of new accounting rules that prevent governments from using aggressive investment return assumptions (thanks to my friend Mike Shedlock for his post on this news). But here’s the kicker - the rules only apply after pension funds go broke. In Chicago’s case, pension return assumptions had been optimistically set at 7.5%, and the city had vastly underfunded its obligations. Still, this isn’t a Chicago problem. It’s a national, even global problem, and it’s going to get much worse. See, Chicago’s assumptions were actually below the national 7.62% average. The following chart is from the National Association of State Retirement Administrators (NASRA). Chicago is essentially the rule, not the exception.

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While on vacation, I listened to the book When Breath Becomes Air, which I highly recommend. I also started the book The Gene, which was recently released and should be a good addition to the mental model bookshelf.

Audible $4.95 Sale

As I work on getting caught back up after some time away, I noticed Audible is having another $4.95 sale with some great books included on the list. The sale ends on May 26th. Below are the titles that stood out to me: 

Charlie Munger: The Complete Investor

HBR's 10 Must Reads on Managing Yourself

The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance

The Pleasure of Finding Things Out: The Best Short Works of Richard P. Feynman

Make It Stick: The Science of Successful Learning

The Virgin Way: Everything I Know about Leadership

The Willpower Instinct: How Self-Control Works, Why It Matters, and What You Can Do to Get More of It

Misbehaving: The Making of Behavioral Economics

Superforecasting: The Art and Science of Prediction

Superintelligence: Paths, Dangers, Strategies

The Courage to Act: A Memoir of a Crisis and Its Aftermath

The Financial Crisis and the Free Market Cure: Why Pure Capitalism Is the World Economy’s Only Hope

The Boom: How Fracking Ignited the American Energy Revolution and Changed the World

The Fish That Ate the Whale: The Life and Times of America's Banana King

Red Notice: A True Story of High Finance, Murder and One Man's Fight for Justice

Alibaba's World: How a Remarkable Chinese Company Is Changing the Face of Global Business

Junkyard Planet: Travels in the Billion-Dollar Trash Trade

Hackers: Heroes of the Computer Revolution: 25th Anniversary Edition

Origins: Fourteen Billion Years of Cosmic Evolution

A Universe from Nothing: Why There Is Something Rather Than Nothing

What If?: Serious Scientific Answers to Absurd Hypothetical Questions

Alan Turing: The Enigma

Wizard: The Life and Times of Nikola Tesla: Biography of a Genius

What It Is Like to Go to War

The Last Lion: Winston Spencer Churchill, Volume 3: Defender of the Realm, 1940-1965

The Path to Power: The Years of Lyndon Johnson

Dynasty: The Rise and Fall of the House of Caesar

God's Bankers: A History of Money and Power at the Vatican

The Sports Gene: Inside the Science of Extraordinary Athletic Performance

The Rise of Superman: Decoding the Science of Ultimate Human Performance

The Theory of Evolution: A History of Controversy

Understanding Genetics: DNA, Genes, and Their Real-World Applications

What Is Life?: How Chemistry Becomes Biology

The Meaning of Human Existence

Warren Buffett and Charlie Munger on portfolio concentration, and having the right temperament for it

More from the excellent book Concentrated Investing: Strategies of the World's Greatest Concentrated Value Investors...

A short quote from Warren Buffett in 2008 (similar to his 1998 comments):

If you are a professional and have confidence, then I would advocate lots of concentration. For everyone else, if it’s not your game, participate in total diversification. If it’s your game, diversification doesn’t make sense. It’s crazy to put money in your twentieth choice rather than your first choice. . . . [Berkshire vice-chairman] Charlie [Munger] and I operated mostly with five positions. If I were running $50, $100, $200 million, I would have 80 percent in five positions, with 25 percent for the largest.

And then a longer excerpt from the book about Charlie Munger's style:

In the book Damn Right!, Buffett told Munger’s biographer Janet Lowe that Munger initially followed the fundamentals of value investment established by Graham, but was always far more concentrated than other traditional value investors like Walter Schloss: 

Charlie’s portfolio was concentrated in very few securities and therefore his record was much more volatile but it was based on the same discount-from-value approach. He was willing to accept greater peaks and valleys of performance, and he happens to be a fellow whose whole psyche goes toward concentration, with results shown.  

Munger defines “very few securities” as “no more than three:”  

My own inquiries on that subject were just to assume that I could find a few things, say three, each which had a substantial statistical expectancy of outperforming averages without creating catastrophe. If I could find three of those, what were the chances my pending record wouldn’t be pretty damn good. I just sort of worked that out by iteration. That was my academic study—high school algebra and common sense. 

Munger’s rationale for holding so few stocks was based on practical considerations—“How could one man know enough [to] own a flowing portfolio of 150 securities and always outperform the averages? That would be a considerable stump.” He believes that securities are mostly appropriately valued: 

[T]he people that came up with the efficient market theory weren’t totally crazy, but they pushed their idea too far. The idea is roughly right with exceptions. 

That observation, and his own research, pressed him to seek only the handful of situations where he might have an edge: 

It would not be too much to say it was obvious to me that I could not have a big edge over everybody else and all securities. In other words, it was also obvious to me that if I worked at it, I would find a few things in which I had an unusual degree of competence. It was natural for me to think in terms of opportunity costs. So once I owned three securities—A, B, and C—I wasn’t going to buy any other security. I had actually studied them. I don’t know how much diversification would be necessary over a long period of time. I worked it out with pencil and paper as a matter of probabilities. If you are going to operate for 30 years and only own 3 securities but you had an expectancy of outperforming averages of say 4 points a year or something like that on each of those 3 securities, how much of a chance are you taking when you get a wildly worse result on the average. I’d work that out mathematically and assuming you’d stay for 30 years you’d have a more volatile record but the long-term expectancy was—in terms of disaster prevention—plenty good enough for 3 securities. I had worked that out in my own head using just high school algebra. 

In seeking his edge, Munger pursued small, unknown stocks that wouldn’t be of interest to the bigger investors: 

I tended to operate, as so many successful value investors do, not looking at Exxon and Royal Dutch and Procter & Gamble and Coca-Cola. Most of the value investors, if you analyze who’ve been successful over a long time, have operated in less followed stocks. 

Like Simpson, Munger likes “financial cannibals,” companies that buy back a lot of stock: 

[W]hat those [successful] companies had in common was they bought huge amounts of their own stock and that contributed enormously to the ending record. Lou, Warren, and I would always think the average manager diversifying his company with surplus cash that’s been earned more than half the time they’ll screw it up. They’ll pay too high a price and so on. In many cases they’ll buy things where an idiot could see they would have been better to buy their own stock than buy this diversifying investment. And so somebody with that mind-set would be naturally drawn to what Jim Gibson used to call “financial cannibals,” people that were eating themselves. 

Munger often refers to the value “mind-set.” He considers temperament a crucial element to holding a concentrated portfolio. When Buffett installed Lou Simpson as GEICO’s chief investment officer, Munger recognized in him the right temperament, and a kindred spirit: 

Warren has this theory that if you’ve got a lot of extra IQ points in managing money you can throw them away. He’s being extreme of course; the IQ points are helpful. He’s right in the sense that you can’t [teach] temperament. Conscientious employment, and a very good mind will outperform a brilliant mind that doesn’t know its own limits and so on and so on. Now Lou happens to be very smart but I would say his basic temperament was a big factor. He has the temperament of the kind of investor we like and we are.

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For those curious about what kind of upside vs. downside one would need to justify Munger's 3-stock portfolio according to the Kelly Formula, I touched on this in a post last year: 

If you're assuming 50/50 odds of being right (which is hopefully conservative), then you'd need a 3x upside vs. downside ratio over your investing timeframe before investing. 

As an example, if you are following Kelly and assuming 50/50 odds of being right, you'd need a 150% (2.5x) expected return if your worst-case downside is a 50% loss. And to repeat some of my thoughts on Kelly, I don't think one should try and use it precisely because you can't know the exact odds or payoffs when making an investment. But I think it's a useful tool to use when thinking about position sizing and the attractiveness of a given investment. And its usefulness reminds me of one of my favorite quotes from Munger:

"I could see that I was not going to cope as well as I wished with life unless I could acquire a better theory-structure on which to hang my observations and experiences. By then, my craving for more theory had a long history. Partly, I had always loved theory as an aid in puzzle solving and as a means of satisfying my monkey-like-curiosity. And, partly, I had found that theory-structure was a superpower in helping one get what one wanted. As I had early discovered in school wherein I had excelled without labor, guided by theory, while many others, without mastery of theory failed despite monstrous effort. Better theory I thought had always worked for me and, if now available could make me acquire capital and independence faster and better assist everything I loved."

As I wrote previously, a high level of concentration is only good "if you are willing to put in the significant effort required to deeply understand each investment." There is a big difference in the amount of work necessary to run a 5-10 stock portfolio (or less in Munger's case), and the amount of work needed to run a 20-30 stock portfolio. And as Buffett recommends, if you aren't willing to put in the work necessary in either of those cases or don't have the skill to find capable managers that do, then indexing is probably the way to go.

Lee Kuan Yew quote

Lee Kuan Yew's reply to a question about his perspective on the meaning of life:

"Life is what you make of it. You are dealt a pot of cards. Your DNA is fixed by your mother and your father....Your job is to make the best of the cards that have been handed out to you. What can you do well? What can you not do well? What are you worse at? If you ask me to make my living as an artist, I'll starve; because I just can't draw.... But if you ask me...to argue a point out, I'll get by. [Those are] the cards I was handed out, and I make use of them. Don't try and do something you are not favored by nature to do."

(Video Source, ~ 9-minute mark)

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Related books:

From Third World to First: The Singapore Story - 1965-2000

The Wit and Wisdom of Lee Kuan Yew

Warren Buffett on culture

Via Peter Bevelin's All I Want To Know Is Where I'm Going To Die So I'll Never Go There:

Culture, more than rule books, determines how an organization behaves. 

I think we have a very good culture virtually everyplace in Berkshire. I hope it’s everyplace. This is what we are looking for, and it’s more a question of culture than controls. If you have a good culture, I think you can make the rules pretty simple.

Charlie Munger, risk, and the too hard pile

From Charlie Munger: The Complete Investor:

The theory behind Munger’s very different approach to dealing with risk is worth examining in detail. As a review, risk is the possibility of suffering a loss (not price volatility). The way Berkshire deals with risk is by buying what they feel is a conservatively valued asset with no risk at a discount price. Their focus is on having protection against mistakes that they may make during that process. What they do not do is increase the interest rate used in the computation to deal with risks inherent in the business. If there are significant risks inherent in the business itself, they put the decision in the too hard pile and move on to other potential opportunities.

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This also reminded me of something I mentioned in a previous post where, in an interview with my friend Miguel, Alice Schroeder mentioned this in regards to Warren Buffett’s filtering process:

Typically, and this is not well understood, his way of thinking is that there are disqualifying features to an investment. So he rifles through and as soon as you hit one of those it’s done. Doesn’t like the CEO, forget it. Too much tail risk, forget it. Low-margin business, forget it. Many people would try to see whether a balance of other factors made up for these things. He doesn’t analyze from A to Z; it’s a time-waster.

Charlie Munger quote

"To us, investing is the equivalent of going out and betting against the pari-mutuel system. We look for a horse with one chance in two of winning, and that pays three to one. In other words, we’re looking for a mispriced gamble. That’s what investing is, and you have to know enough to know whether the gamble is mispriced." -Charlie Munger 

[H/T Charlie Munger: The Complete Investor]

Knowing vs. Memorizing

A good excerpt [slightly edited for clarity] from James Altucher's podcast discussion with Anders Ericsson about his book Peak: Secrets from the New Science of Expertise:

James Altucher: ...I always think the way to really retain the information from a book is if I go and tell someone "I just read this great book, here are the five things I've learned that are going to help improve myself."... I think that's the way I remember things later. By actually saying it out loud to somebody...I'm able to better remember the book as opposed to just trying to remember it without doing anything else. 

Anders Ericsson: I think that's kind of the key that I see in all sorts of experts: their ability of actually mentally sort of think about things through reason and be able to now kind of work with it as opposed to this idea of just absorbing a lot of knowledge; and I guess the extreme case is just memorizing where you might be able to actually reproduce a book without understanding the main ideas. But I would argue that the real expert, they're extracting the main ideas--exactly like you were talking about--and making those ideas their own by relating it now to everything else that they know, and sometimes maybe even finding things that [they know] that seem to be in conflict with their generalization. And then I guess that leads to more thinking and discussion.

The excerpt above reminded me of the (apocryphal) story Charlie Munger likes to tell of  Max Planck and his chauffeur. After winning the Nobel Prize, Planck toured around giving a speech. The chauffeur memorized the speech and asked if he could give it for him (pretending to be Planck) in Munich and Planck would pretend to be the chauffeur. Planck let him do it and after the speech someone asked a tough question. The real chauffeur said that he couldn’t believe someone in such an advanced city like Munich would ask such an elementary question and as such, he was going to ask his chauffeur (Planck) to reply.

As Charlie Munger mentioned in his 2007 USC Law School Commencement speech (Talk Ten in the Third Edition of Poor Charlie's Almanack):

In this world I think we have two kinds of knowledge: One is Planck knowledge, that of the people who really know. They’ve paid the dues, they have the aptitude. Then we’ve got chauffeur knowledge. They have learned to prattle the talk. They may have a big head of hair. They often have timbre in their voices. They make a big impression. But in the end what they've got is chauffeur knowledge. I think I’ve just described practically every politician in the United States.

And it also reminds me of Richard Feynman's discussion of the difference between really knowing something and just knowing the name of something (VIDEO HERE).

John Maynard Keynes' move away from market timing

From Concentrated Investing: Strategies of the World's Greatest Concentrated Value Investors:

As he had demonstrated in the early 1930s wrestle with the board of the P.R. Finance Company, Keynes began by explaining why he no longer believed in market timing driven by his credit cycling theory: 

We have not proved able to take much advantage of a general systematic movement out of and into ordinary shares as a whole at different phases of the trade cycle. Credit cycling means in practice selling market leaders on a falling market and buying them on a rising one and, allowing for expenses and loss of interest, it needs phenomenal skill to make much out of it.   

. . .   

As a result of these experiences I am clear that the idea of wholesale shifts is for various reasons impracticable and indeed undesirable. Most of those who attempt to sell too late and buy too late, and do both too often, incurring heavy expenses and developing too unsettled and speculative a state of mind, which, if it is widespread has besides the grave social disadvantage of aggravating the scale of the fluctuations. 

(In a note to his student Richard Kahn that accompanied the letter sent, Keynes mourned the failure of market timing strategies based on credit-cycling, writing, “. . . I have seen it tried by five different parties . . . over a period of nearly twenty years. . . . I have not seen a single case of success.”) He went on in the letter to King’s College to describe the core of his philosophy in three principles that he believed would result in sound investing. He proposed: 

1. A careful selection of a few investments (or a few types of investment) having regard to their cheapness in relation to their probable actual and potential intrinsic value over a period of years ahead and in relation to alternative investments at the time;    

2. A steadfast holding of these in fairly large units through thick and thin, perhaps for several years, until either they have fulfilled their promise or it is evident that they were purchased on a mistake;   

3. A balanced investment position, i.e., a variety of risks in spite of individual holdings being large, and if possible, opposed risks.

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Related previous post: John Maynard Keynes' change in investment philosophy

All economic moats are either widening or narrowing...

"What we refer to as a “moat” is what other people might call competitive advantage . . . It’s something  that differentiates the company from its nearest competitors – either in service or low cost or taste or some other perceived virtue that the product possesses in the mind of the consumer versus the next best alternative . . . There are various kinds of moats. All economic moats are either widening or narrowing – even though you can’t see it." -Warren Buffett (Outstanding Investor Digest, June 30, 1993, via "Measuring the Moat")

Warren Buffett quote

From his partnership letters:

We don't buy and sell stocks based upon what other people think the stock market is going to do (I never have an opinion) but rather upon what we think the company is going to do. The course of the stock market will determine, to a great degree, when we will be right, but the accuracy of our analysis of the company will largely determine whether we will be right. In other words, we tend to concentrate on what should happen, not when it should happen.

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Related book: Warren Buffett's Ground Rules: Words of Wisdom from the Partnership Letters of the World's Greatest Investor

Phil Fisher on examining sentiment

From Common Stocks and Uncommon Profits and Other Writings:

This...example brings into clear relief what the common stock investor must do if he is to purchase shares to his greatest advantage. He must examine factually and analytically the prevailing financial sentiment about both the industry and the specific company of which he is considering buying shares. If he can find an industry or a company where the prevailing style or mode of financial thinking is considerably less favorable than the actual facts warrant, he may reap himself an extra harvest by not following the crowd. He should be extra careful when buying into companies and industries that are the current darlings of the financial community, to be sure that these purchases are actually warranted—as at times they well may be—and that he is not paying a fancy price for something which, because of too favorable interpretation of basic facts, is the investment fad of the moment.

Bill Gates on Expertise: 10,000 Hours and a Lifetime of Fanaticism

Good clip from 5 years ago...

Bill Gates responds to Malcolm Gladwell's theory that it takes 10,000 hours of deliberate practice to master a skill. Apart from acknowledging luck, timing and an open mind, Gates suggests that a successful person survives many cycles of attrition to make it to 10,000 hours of experience. "You do have to be lucky enough, but also fanatical enough to keep going," explains Gates.

Link to video

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Related books:

Outliers: The Story of Success

Peak: Secrets from the New Science of Expertise

Related previous post: Bill Gates quote from Charlie Rose interview (or, how the world's best companies are built by fanatics)

Phil Fisher quote

From Common Stocks and Uncommon Profits:

The fact that a stock has or has not risen in the last several years is of no significance whatsoever in determining whether it should be bought now. What does matter is whether enough improvement has taken place or is likely to take place in the future to justify importantly higher prices than those now prevailing. 

Similarly, many investors will give heavy weight to the per-share earnings of the past five years in trying to decide whether a stock should be bought. To look at the per-share earnings by themselves and give the earnings of four or five years ago any significance is like trying to get useful work from an engine which is unconnected to any device to which that engine's power is supposed to be applied. Just knowing, by itself, that four or five years ago a company's per-share earnings were either four times or a quarter of this year's earnings has almost no significance in indicating whether a particular stock should be bought or sold. Again, what counts is knowledge of background conditions. An understanding of what probably will happen over the next several years is of overriding importance. 

The investor is constantly being fed a diet of reports and so-called analyses largely centered around these price figures for the past five years. He should keep in mind that it is the next five years' earnings, not those of the past five years, that now matter to him. One reason he is fed such a diet of back statistics is that if this type of material is put in a report it is not hard to be sure it is correct. If more important matters are gone into, subsequent events may make the report look quite silly. Therefore, there is a strong temptation to fill up as much space as possible with indisputable facts, whether or not the facts are significant. However, many people in the financial community place emphasis on this type of prior years' statistics for a different set of reasons. They seem to be unable to grasp how great can be the change in just a few years' time in the real value of certain types of modern corporations. Therefore they emphasize these past earnings records in a sincere belief that detailed accounting descriptions of what happened last year will give a true picture of what will happen next year. This may be true for certain classes of regulated companies such as public utilities. For the type of enterprise which I believe should interest an investor desiring the best results for his money, it can be completely false.

Howard Marks quote

"I came across a quote from Warren Buffett...and he says: 'We pay a high price for certainty.' In other words, when people are confident, asset prices escalate. That's a bad time to invest. The confident times feel like a good time to invest, but people who want to buy bargains should prefer uncertainty." -Howard Marks 

[Source]

Lou Simpson and portfolio construction

From Concentrated Investing: Strategies of the World's Greatest Concentrated Value Investors:

Simpson thinks that investment portfolios should be constructed as a collection of pieces of businesses that are reasonably valued, where the investor has confidence that they will be bigger, and more profitable, three to five years from now. 

...Though he doesn’t follow any magic formula for investing, believing that investors should keep an open mind about valuation, his favored metric for valuation is price to free cash flow measured on a per share basis. He seeks out those positions in which he thinks the valuation is reasonable, and there will be continued top and bottom line growth such that there’s a better chance of the valuation moving up rather than down over a period of time. While he favors free cash flow, he doesn’t like to be restricted to any single metric. He holds to some basic principles that he has refined over time, requiring a discount from intrinsic value, a high-quality company, and high-quality management. In assessing management, he examines their capital allocation record, their integrity, and whether the business is run for owners or whether the managers are hired guns looking to make money for themselves. This distinction often manifests in the chief executive’s willingness to undertake buybacks when the stock is undervalued. 

Simpson believes that companies should buy back stock where it’s appropriate to do so—when the stock is undervalued. He hopes that his positions enjoy a double hit—partially from fundamental growth and partially from buying back stock—leading to an increased valuation on a per share basis.

Some insight on Lou Simpson and how he works

From Concentrated Investing: Strategies of the World's Greatest Concentrated Value Investors:

Buffett has described Simpson as having “the rare combination of temperamental and intellectual characteristics that produce outstanding long-term investment performance.” In particular, Buffett admired Simpson’s ability to invest in stocks with below-average risk, and yet generate returns that were the best in the insurance industry, a hallmark of Buffett’s. Simpson’s investing for GEICO often paralleled Buffett’s efforts at Berkshire. And students of Buffett’s style will recognize his influence in Simpson’s process: seek undervalued businesses with proven track records, strong management, a high likelihood of continued steady growth, pricing power, financial strength, and a history of rewarding shareholders. “He has this great ability to understand what’s going to be a good business,” said Glenn Greenberg, a longtime friend who is now managing partner at Brave Warrior Capital Management. (Simpson considers Glenn an excellent investor and they have ended up owning the same stocks numerous times over the past 30 years.) “And it’s concentrated because there aren’t that many really good businesses.” 

Simpson has an unassuming manner and puts people at ease. He has a wide circle of acquaintances, which assists in gaining insights into companies and industries he is researching. He is also a master of understatement, so much so that in conversation the import of his observations aren’t understood until long after the discussion is over. Like the man, Simpson’s office is unassuming. It is situated in a low-key, nondescript office building in Naples, Florida, an 8- to 10-minute drive from his home. A passerby would have no clue about the business being transacted in it. It is also unusually quiet. He says that he has always tried to block out as much noise as possible. There are no interruptions; no ringing phones, no Bloomberg in the office—Simpson keeps it in the entranceway, separate from the office, so that he has to stand up from his desk to look something up if he needs it. “If I have the Bloomberg on, I find I am looking at what the market is doing,” he said. “I really like to be the one who is parsing the information, rather than having a lot of irrelevant information thrown at me.” His desk, like the rest of his office, kitchen, and meeting rooms, is clutter free. 

His work life is similarly low key. He is disciplined about exercising before work, and arrives at his office long before market hours. Simpson reads everything he can find about companies that have caught his eye. He doesn’t search for investments in analyst reports, or by speaking to sell-side researchers.

Links

I will be without internet for about the next week and a half. I have some quotes and book excerpts scheduled, but this will be the last compilation of links during that time.

Forbes on Warren Buffett [H/T Corner of Berkshire & Fairfax] (LINK)

Larry Cunningham's Museum of American Finance videos [H/T Kristin]:

Part 1: What Will Happen to Berkshire After Buffett?
Part 2: The Beauty of the Berkshire Model
Part 3: The Blemishes of the Berkshire Model
Part 4: Audience Q&A Session 1
Part 5: Audience Q&A Session 2

On Note Taking (LINK)

Related book: Where Good Ideas Come From

Related quote: "One of the most important commitments I've learned is that anytime you learn anything, and you find it has any form of value, the most important thing you want to do is--while you're still in state, while it's still important, while it's still in your mind--you want to take some form of action.... Write down two or three key principles that you want to remember, or action items, and ideally do something to share it or do something to act on it today. Remember, knowledge is not power. Knowledge is potential power. If you really look at what makes someone successful versus not, it all comes down to execution. Execution trumps knowledge every day of the week." -Tony Robbins (source)

The Rise and Fall of American Growth (audio) (LINK)

Related book: The Rise and Fall of American Growth

Dimon Says Online Lenders’ Funding Not Secure in Tough Times (LINK)

SALT 2016: Kyle Bass, Leon Cooperman Diverge On Economy (LINK)

SALT Conference Notes 2016: Griffin, Cooperman, Burbank, Chanos & More (LINK)

Nassim Taleb at SALT 2016 (Bloomberg video clips) (LINK)

Jim Chanos: Oil E&P Model in North America Isn't Economic (video) (LINK)

Jim Chanos: We're Looking at Aramco (video) (LINK) [Mentions a few industries where companies are more finance companies than what they really appear to be.]

Whole Foods’ Scaled-Down 365 Store Has Robots, but No Tattoo Parlor [H/T Abnormal Returns] (LINK)

Nuggets of Wisdom by Guy Spier (short video clips) (LINK)

The Importance of Learning How to Fail (LINK)

Links

Google Fiber is the most audacious part of the whole Alphabet [H/T @marketfolly] (LINK)

A summary of Kerrisdale Capital's short thesis on DISH Network (LINK)

The Tony Robbins Podcast - Episode 9: Mastering sales (an old interview with the late Chet Holmes) (LINK) [I couldn't help but think of J.C. Penney and the Ron Johnson era after hearing this bit from Chet Holmes (edited a bit for clarity): "The biggest mistake people make when they here these ideas is they go and change everything at their company all at once and their sales go down. When you're introducing something new you have to do it in a very controlled and a very tested way. Figure it out before you go and have everybody do it....Where I've seen some of these ideas fail is where the boss goes 'We're going to switch everybody over to this...']"

Related book: The Ultimate Sales Machine

Brain Pickings: The Source of Richard Feynman’s Genius (LINK)

Related book: Genius: The Life and Science of Richard Feynman

Book of the day: Connectography: Mapping the Future of Global Civilization

Links

GMO Quarterly Letter: 1Q 2016 (LINK)

In “Keeping the Faith,” Ben Inker discusses why he believes that in the long run, no factor is as important to investment returns as valuation. He reviews the challenges faced by long-term value investors over the past five years and offers several reasons why a value-based approach should outperform over the long term. Part 2 of the Letter features Jeremy Grantham looking back over the previous few years and addressing lessons learned on the topics of oil, finite resources, and food production. He closes with updates on the equity markets, the oil price, and the potential effects of rapidly accelerating temperature changes globally.

Warren Buffett 1998 Talk at University of Florida - By John Huber (LINK)

The Value of Active Management: A Journey Into Indexville (LINK)

The Real Problem With Facebook and the News - by Ben Thompson (LINK)

a16z Podcast: The Blockchain, Open for Business (LINK)

Related book: The Business Blockchain: Promise, Practice, and Application of the Next Internet Technology

As Lending Club Stumbles, Its Entire Industry Faces Skepticism (LINK)

Raghuram Rajan: Rethinking the Global Monetary System (audio and podcast) (LINK)

How Breakfast Became a Thing (LINK)

TED Talk - Jennifer Kahn: Gene editing can now change an entire species — forever (LINK)

Strange seaweed rewrites history of green plants (LINK)

Peter Bevelin's new book, All I Want To Know Is Where I'm Going To Die So I'll Never Go There, is now available on Amazon (from the publisher in the 'See All Buying Options' section) as well as on the Poor Charlie's Almanack site.

Links

Larry Cunningham's latest is now released: The Buffett Essays Symposium: A 20th Anniversary Annotated Transcript

Also just released: The FINTECH Book: The Financial Technology Handbook for Investors, Entrepreneurs and Visionaries

Warren Buffett and Charlie Munger: The Omaha ties that bind (5-minute video clip from CNBC in Omaha) [H/T Will] (LINK)

Here's the email Bill Ackman sent to Charlie Munger to complain about Munger's Valeant comments [H/T Linc] (LINK)

A Dozen Things Learned from Bernard Baruch about Investing (LINK)

Square: Learning Banking Truths the Hard Way [H/T @BrattleStCap] (LINK)

Investors in financial-technology firms seeking to disrupt the business of lending are waking up to a basic fact: The money for loans has to come from somewhere.

What happens when the Bank of Japan owns everything? (LINK)

Freakonomics Radio: How to Become Great at Just About Anything (LINK)

Related book: Peak: Secrets from the New Science of Expertise

Angela Duckworth: "Grit: The Power of Passion and Perseverance" | Talks at Google (LINK)

Related book: Grit: The Power of Passion and Perseverance

Destroying one's previous ideas...

Here was one of my favorite nuggets of wisdom from the Berkshire Hathaway Annual Meeting this year (which occurs at the 4:39:39 mark of the webcast). Munger has discussed these things many times before, but it is always good to review:

Charlie Munger: We try and avoid the worst anchoring effect which is always your previous conclusion. We really try and destroy our previous ideas. 

Warren Buffett: Charlie says that if you disagree with somebody, you want to be able to state their case better than they can. 

Charlie Munger: Absolutely. 

Warren Buffett: And at that point you’ve earned the right to disagree with them. 

Charlie Munger: Otherwise you should keep quiet. It would do wonders for our politics if everybody followed my system. 

Links

There’s a High Price for ‘Low Volatility’ - by Jason Zweig (LINK)

"60 Minutes" on the Fintech industry (video) [H/T Abnormal Returns] (LINK)

It's being called the financial technology, or fintech, revolution. Lesley Stahl meets some of the fintechies challenging the establishment, seeking to reinvent nearly every aspect of modern banking

Using ‘Inflection Points’ to Overcome Fintech Startup Distribution Challenges (LINK)

Latticework of Mental Models: Loser’s Game (LINK)

Why the billionaire founder of Sam Adams still flies coach and has his executives do the same (LINK)

Dyson Wants to Create a Hair Dryer Revolution [H/T The Big Picture] (LINK) [James Dyson's autobiography and appearance on Charlie Rose are also recommended.]

Stan Druckenmiller's Sohn Conference Transcript And Slides (LINK)

Exponent podcast: EPISODE 078 — BENDING TREES (LINK)

HBR IdeaCast (podcast): Let Employees Be People (LINK)

Related book: An Everyone Culture

Nature Podcast: 05 May 2016 – negative results, brain energy, ketamine, embryos and Rhino IVF (LINK)

Sean Carroll recommends five books on Biology [H/T The Browser] (LINK)

The books: (1) The Eighth Day of Creation: Makers of the Revolution in Biology; (2) Darwin: The Life of a Tormented Evolutionist; (3) The Man Who Found the Missing Link; (4) The Statue Within: An Autobiography; (5) The Song of the Dodo: Island Biogeography in an Age of Extinction; And Carroll's recent book is The Serengeti Rules: The Quest to Discover How Life Works and Why It Matters.