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IFB81:4 Short Charlie Munger Quotes on How He Buys Stocks

charlie munger quotes

[00:00] You’re tuned in to the Investing for Beginners podcast. Finally, step by step premium investment guidance for beginners led by Andrew Sather and Dave Ahern to decode industry jargon, silence crippling confusion, and help you overcome the emotions by looking at the numbers. Your path to financial freedom starts now.

[00:36] All right, folks, welcome to investing for beginners podcast. This is episode 81 tonight. We’re going to do something different for us tonight. We’re going to play you an audio clip and then we’re going to talk a little bit about it. So Andrew and I have talked a lot about how we choose companies, where we find her ideas and things of that nature. And tonight I thought we would go back and show you the original source where we’ve gotten our ideas from and so I’m going to have you listened to an audio clip from Charlie Munger and he’s going to talk about is four filters for choosing an investment.

[01:09] We have to deal with things that we’re capable of understanding and then once we’re over that filter we have to have a business with some intrinsic characteristics that give it a durable competitive advantage and then of course we would vastly prefer a management in place with a lot of integrity and talent and finally, no matter how wonderful it is, it’s not worth an infinite price. So we have to have a price that makes sense and gives a margin of safety considering the natural vicissitudes of life. It’s a very simple set of ideas and the reason that our ideas have not spread faster is there to sample the professional classes, can’t justify their existence if that’s all I have to say. I mean it’s also obvious and so simple. What would they have to do with the rest of the semester?

[02:14] Alright. So that was fascinating. Very interesting guy to listen to. Super smart and a little cranky. So it’s kind of fun at the end. They enter an hour chuckling about that earlier. It’s kind of comical, but. So Charlie being Charlie, so I thought we would break it down and talk a little bit about the different filters there and we can talk a little bit about those ideas and give you guys a little bit better idea of how to find companies to invest in. So filter number one, filter number one, it’s going to be develop an understanding of the business. Andrew, why don’t you chat a little bit about that and I’ll throw my two cents in on that.

[02:55] Yeah, sure. So when I think about business, I think it should always be very, very simple. Business in general, uh, has a purpose. I think it gets lost a lot, especially in the stock market. People think I want to own this business, I want to buy it, I want to buy a piece of it and I want to sell it. Lay there for a higher price. And I think that’s so backwards. I think you buy a business because you want the profits from it. You want this business to make profits and you want to keep some of those profits and that’s why you buy a business. So I invest, that’s the, that’s the goal of the business. I don’t really see another goal. People know I might stir up some feathers by, you know, kind of challenging the idea that uh, the business is about growing and I don’t think that’s the case at all. I understand a lot of entrepreneurs kind of have that mindset, but I, I just think it’s a bit too aggressive and, and you sacrifice a lot of the security that a good business can, can bring you a and you start to separate yourself from where and what defines a business and what it should do for you.

[04:02] So when I think of a business, and if I’m thinking just bare bones, what does a business do? What, what should we look for in a business? It’s obvious. I think you bring money in, you call that revenue, you obviously have to pay some expenses out. Those are liabilities, um, and then you, whatever’s left is your profit. So I think if you think of business in that way, you can start to realize that you can take that approach and you can expand it out to every stock in the stock market because they will post those particular and specific numbers. I think where things start to really, really get kind of diluted and things get really dangerous is when people will take a businesses that that don’t show good numbers and then they’ll weave in there. They’ve around why they think that this business is not doing bad.

[04:59] Even though the numbers show us it’s doing bad. So when I think of an example of that, I think about Tesla. If you want to see the most creative ideas about finances and financial accounting, just go on twitter and search with a Tesla thread and you’ll see people talking about all these different numbers and units and manufacturing, all this kind of stuff that that makes it. It’s like either a, you know, you’re really an expert in this business and you understand that really, really well. Or B, you’re just, it’s such a complicated business and in reality it’s not doing well and you’re just creating all these ideas to why you think it’s doing well. So I think this point where we should understand the business is very, very key. There should, there shouldn’t be 100 million things that need to go right in order for there to be a prophet.

[05:57] And so I think as investors especially starting out, you can really eliminate a lot of worry, headaches, stress and potential mistakes by just looking for the businesses that are already profitable and the ones that, you know, if, if they’re simple and I see green essentially, right? I, I see more revenue than expenses will. That’s a really good sign. I think it’s something to look for.

[06:23] I agree in the simple part of it I think is, is something that sometimes gets lost and a, both Warren Buffett and Charlie Munger talk a lot about this in their letters and their speeches in their meetings about a circle of competency and staying within that realm. And that’s one of the things that I think separates them from a lot of people is that they do an outstanding job of finding companies that they can understand and feel like as they start to dive into the numbers, they understand what it is that they make, what it is that they sell and how that can work.

[07:01] And I’ve. One of the things that I no longer talks a lot about is reading, reading, reading, reading. And when he’s looking at trying to understand a business, he’ll do things like he’ll read the shareholder letters, he’ll look for a letter from the CEO. He will obviously read the 10 k and 10 q and any other financial filings, but who also go to the website of the particular company and see what kind of products they make. Because it’s one thing to look at, for example, Hormel and go, Oh yeah, I’ve heard of them, but do you really know what it is that they produce or what they make? And so by just simply going to the website and perusing the different products that they sell and following that rule logic of just kind of learning as much as you can about the business and understanding what the business is and what it is that they do.

[07:51] Once you start diving into the financials like Andrew was talking about, it makes that much more sense and you’re like, oh, I get it. And I remember a company that I invested in a couple of years ago called Trinity Industries. When I first started discovering it, I did all my filters that I learned from Andrew and I started doing this exact thing. I went to the numbers all look great, but I really didn’t understand what the business did. And so I knew it was a rare railroad rail car company, but I didn’t know the specifics about it. So I went to their actual website and started reading about the company in history of the company and where they started. When they started the CEO of the company and kind of just gave me a really good feel for the company. And then I started looking at things like their, uh, you know, earnings calls and looking at the transcripts of those, listening to a few of them, reading the shareholder letters, reading the letters from the CEO, Wendell weeks and all these things that just gave me so much of a better understanding of what the company did.

[08:54] So then when I went back to the 10 K and started really diving into how they did, you know, where they learned about where they learn, where they, where their money came from. And so I could, when I looked at the different segments, it made more sense because they understood what the products were that they sold. And the same thing applied when I invested in corning, I did the exact same thing. So by simple we don’t necessarily mean that. It’s like, you know, they make trains and that’s all they do. You know, we’re talking about trying to find companies that you can understand and you can wrap your brain around what it is, the products that they sell. And like Andrew was saying, Tesla, sometimes there is so much narrative around what the company does that it gets lost in what they actually do and the key is to try to find businesses that you can understand and that you can, when you start looking at the financials that make sense that this is what they sell, that, that they make this widget and they sell it and as you know or this particular part of their business is really struggling and you look and you see that, well that’s not really a major core part of their business, so it’s ideally not going to affect the earnings and the revenue of the business that much, so all those different things can help you understand the business and I think that’s really a key component to investing because again, you’re buying a business, you’re not buying a piece of paper and not buying the ticker.

[10:24] You’re buying a company, you’re a part owner of the business, and that’s really where they’re coming from. With that,

[10:31] I’d like to add, sorry, I’d like to add one last little quick tip. One way that you can really quickly see a breakdown of how the company’s actually making money is oftentimes they’ll have a. I like to just like control f, I love using control f when I’m looking through a 10 k, it’s just the search function usually on most computers I would imagine. I like to search for segments, segment, something like that. Uh, you can also look at the notes for the income statement. Oftentimes they’ll show, they’ll just show how, what, how the exact numbers break down. So you know, if we have, back to the Hormel example, if we have a refrigerated foods section, we have a chicken section, we have a Turkey section, let’s say, so it will, they will lay out exactly how much revenue, how much profits is coming from each of those segments.

[11:21] And it’s not something that’s like a universally audited like revenue and earnings. So it might be different depending on the business, but that might help you understand to what proportion, certain products that they offer a really contribute to the bottom line. And I think that can be really helpful.

[11:42] Oh, that’s a great tip. That’s, that’s awesome. I actually didn’t know that little trick, so thanks. That’s good.

[11:47] Yup. You’re welcome.

[11:49] That’s going to be helpful. No kidding. All right, so moving a filter. Number two, does the company have a durable competitive advantage? I eat a moat. Andrew, once you take that one. Sure. So we covered this pretty in depth a couple episodes ago that the concepts are really simple.

[12:10] Write it, I’ll explain it a different way today, which I didn’t really touch on before. This is something that I’ve just kind of observed. Um, but when you, I don’t know like how it works at certain other companies, but from what I’ve seen, I think a businesses when they have meetings where they’re kind of informing their employees of how the business is doing.

[12:36] A lot of times I’ve seen businesses talk about the market, they talk about market share. Uh, you should see it and like investor presentations as well, where these businesses talking about market share and what that is essentially as you have a marketplace, uh, let’s, let’s say we have the chicken market and you have a bunch of major players in there and then you know, if, if the whole market is $100, million in revenue and your company’s making $50 million of that, then then you have a 50 percent market share. So when you think about market share and why that’s important and the dogs go off in the background, the reason why marketshare can be really important is, um, it’s, I’ve observed that the businesses that are like one ranked one, two and 3:10 to really kind of stayed that way as a, as an industry matures, a lot of the players kind of get consolidated and it’s usually the leaders and the ones that are right there, like the number two, number three, those are the ones, uh, when the dust settles it, there tends to be three big ones.

[13:45] And a lot of the smaller ones tend to get lost in the wash. That’s not like a perfect scientific observation. That’s just something as a general trend when you, when you talk about the life, the typical lifecycle of companies and industries, this is how a lot of times it can play out. So when you have a company who has a competitive advantage, especially a durable one, I’m being number one in market share. That’s a competitive advantage of its own. And so what that can do obviously is keep a company like the sure financials have been in that position, help a company to stay competitive. And to give another example, let’s say, we’re the number one business and chicken and another company that’s really small comes out and they have the best competitive advantage, a chicken that, that is like selling like hotcakes. Okay.

[14:43] What we can do, because we’re the number one in market share, is we have a lot of the money and we can buy that business out. And now that durable competitive advantages now ours instead of another businesses. So there’s a lot of different ways that a company or a business can have a competitive advantage. I think being the number one player or the global leader, you’ll hear these terms and they’ll talk about it. You know, if a company is a market leader in their industry, they’re not going to be shy about it. They’ll usually put it in one of the first lines of their 10 k went when they’re talking about what their business is about. The often say that we are the leader in manufacturing this and that’s a huge competitive advantage. And so that works both ways too, right? For the big company, small company, the big company has a competitive advantage because it’s big and this the leader and the small company, if they can create a competitive advantage, then they can be bought out.

[15:39] And that’s great for shareholders to. Right? So either way we’re where you’re investing in the business that has a competitive advantage, whether it’s through the product or through their positioning in the market. You as an investor when, because a lot of times when companies get bought out, uh, it comes with a premium. And so as an investor you’re going to get that extra premium has gains. So something to keep in mind, another kind of spin on competitive advantages, um, but it’s, it’s, it’s obviously a great thing to look for. Um, it can be one of those things that that’s a forward indicator where if there’s a competitive advantage, then good results are likely to follow. Assuming everything else is in place, they’re not aggressively leveraged there. They don’t have huge headwinds or anything, but you know, a lot of times a good competitive advantage can lead to great financial results later. And that’s really where I think buffer the monger are talking about to get you good results down the line. Good financials obviously mean good returns at the end. So

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[16:57] Yeah, I would agree with that. The thing that I like about what a Buffet and Munger have done with moats and they talk a lot about modes and what they look for and the different ideas behind moats. Charlie Munger had an interesting story that I was reading about recently. He was talking about modes and he had somebody asked them, how do you identify a mode? And he says, you want me to explain you a difficult subject of identifying boats? It reminds me of the story. One man, one man came to Mozart and asked them to write a symphony, Amadeus, Mozart, obviously various famous guy. Mozart replied, you are too young to write a symphony. The man said you were writing stuff it needs when you were 10 years of age and I am 21. Most of said yes, but I didn’t run around asking people how to do it.

[17:43] So I thought that was kind of an interesting response. Can vary. Charlie monger ask. so, you know, when they talk about modes they talk about they don’t build them and because of Charlie says it’s way too hard to build them. It’s much easier to buy them. And so they spend all their time trying to find companies that create moats and they look for great managers that are going to help build those most because that’s really what it takes is, you know, superior management and a little luck. You think about guys like Bill Gates, Ray Kroc, Sam Walton, Jeff Bezos though, they have all created fantastic businesses that have, you know, amazing moats. But just because a company has a moat doesn’t means it’s going to last forever. I mean, you look at Kmart, you know, in the last recent years in seniors especially, they were king of the world, especially in the low cost arena.

[18:36] But then along comes a Walmart who smarter faster and better and kicks her butt and now it’s gone and Sears has gone. And Kodak, Kodak was king and cameras and film and everything. And then all of a sudden this little thing called the iphone came along and now everybody and their brother can take their own pictures. So just because a company has a moat now doesn’t mean it will forever. And that’s one of the tricks is to try to find a company that you think will have a competitive advantage for a very, very long time. So when you look at apple, when you look at Amazon, some of those companies, you, you anticipate that they’re going to have a boat for a very long time. But you always have to keep in mind it will not last forever. It does not last forever. I mean the Roman Empire fell. Walmart will fall someday too, so I’m not trying to be Mr. Doom and gloom, but just, you know. Well now I’m all done so thank you.

[19:36] All right. So if you want a number on that. Actually I can’t remember where I read this, but it was, it was a good book. I only read good books. Of course. You said something about the average corporation time, like life expectancy I guess is about 40 years. Right. Wow. Okay. That’s pretty amazing when you think about that. That’s really, that’s like a generation if. Yeah. So that is to your point, it’s not forever too, right? Yeah, for sure. I guess another example of that is, you know the book that we referenced a while back, your smp 500 book, when you’re talking about the top 10 companies in the s and p 500 back in the sixties, was it late sixties, sixties or seventies? Yeah. So you look at the top 10 companies back then comparing them to now they’re not there, a lot of them aren’t around anymore. So that was kind of interesting. But anyway, so moving on a filter. Number three is their management in place with integrity and talent. All right, let’s, let’s have you since you have the talent.

[20:51] Sure. Okay. So, uh, when we talk about management in place with integrity and talent, this is a tough one. So what I referenced when I was looking into this, these ideas, Buffet and Munger both talk a lot about this as a very, very important part of their filtering because when they’re going to be investing in a company, they’re going to be coming partners with the people that are running the business now, Buffet and Munger, when they invested companies typically they either invest a large portion of into the company or the buy the company outright. So you and I, I can’t do that. Andrew may be able to someday, but I can’t do that. And so what happens is, is that when they get involved with a company like this, they don’t actually take over the company, they buy it and it’s theirs, but they, they keep management in place because they understand that the management that that has brought the company where it is to the point where Buffet among Munger feel like that this is going to make them money.

[21:58] Then why upset the apple cart, why, why change things? And when you think about activist investors and, and some of the people out there that are kind of taking over companies and it kind of tearing them down or things don’t go as well after they take over the company, a lot of times it’s because they upset what’s already in place. And so two things that buffet and Munger both look for when they’re looking for management is one is the look for skin in the game. So a lot of times a big part of a CEO’s investment or I’m sorry, his compensation is tied up in the performance of the company. I either get stock to compensate them for, you know, being involved with the company. And so the better the company does, the more of the stock goes up, the more money they’re worth. And obviously sometimes this can lead to some not so great decisions or thinking only of themselves as the poorest of the shareholders.

[22:59] But when you’re looking at the overall picture of the management, that is one of the things that they look for is whether these people still have skin in the game. Are they investing in their own company? Are they buying shares of their own company? Are they keeping their stock options or are they selling them? And so all those things will go into their calculations and assessments of what the management is. Then they’re also going to look for people that have integrity and talent, a talent. They’re looking for people that are great capital allocators, so there’ll be looking for people that can take the money that the company is generating it, either use it for dividends to give back to the input to the investors like us or whether they can take those monies that are being made at the prophets and put those back into the company to create more assets.

[23:48] Which is going to create more profit, so the better capital allocators they are, the better that they are at using the money that the company’s making, the more Buffet and Munger are going to be impressed by them. And they have a gentleman who works for them that works in their insurance arm. Uh, that is a buffet, has talked many, many times about what a fantastic allocator. This gentleman isn’t how much money he’s made, Munger and Buffet. And that’s really one of the keys that they look for. And this is not something that gets talked a lot about and this is more of a quote unquote soft skill. So these are the things that are harder to assess via numbers. This is more something that you’re going to have to learn as you go along and reading the letters to the shareholders from the ceos are great ways to get a tone or a feel for what these people are saying and doing.

[24:49] Another great way to do it is to listen to any sort of conference calls that they may have or speeches that they do. Because that gives you a flavor of what kind of people they are, what kind of speakers they are, and obviously as a as people are ceos, they’re generally going to be great salespeople and they’re going to be great at getting everybody pumped up and getting you a great ideas and things of that nature, but you’re also going to be able to develop a feel for what kind of people they are and whether they can stick to their promises. Now, unfortunately, when you think of Elon Musk, he loves to make promises, but do they always get followed through on? No, not really, and so he gets everybody excited because he’s a great communicator and he’s a great educator, but his follow through on his promises, it doesn’t always materialize and so that’s one of the things that would scare me away from the company is the guy promised over promises and under delivers at.

[25:47] One of the things that Buffet and Munger both look for are people that are going to under promise and over perform and that is really a huge aspect of what, what the dive into and look for when they’re looking for management. You mentioned letters to shareholders. Um, how would, if, if somebody wanted to read that, what’s, what’s the resource to go to to you just like Google it or do you have a place you go to read those? A lot of times I just go to the website of the particular company and they will have under the investor relations, so have links to the letters to the shareholders so that you can read them. It’s generally, it’s either a letter to a shareholder or it’s a, you know, a letter from the CEO or it may be an investor letter a, it could be titled any of those three and almost every company has one.

[26:38] I know when I worked for Wells Fargo, they put one out every, every quarter and so something I could read every quarter and I did read it every quarter just because it was, it was interesting and it gave me an insight into what the CEO was thinking and it also could sometimes give me an idea of hey, these are the things that are coming from me as the lay person on the ground and what’s going on, but that’s where I found them. It’s just by going to the website of that particular company, whether it’s Disney, Hormel, Walmart, Amazon, any of those companies. They all do that.

[27:10] That’s I cool. I like that. I don’t have much to add because you covered that really, really well. The only thing I will say is I guess my turn to be a debbie downer, just like we were saying, these businesses don’t last forever, neither do CEO or management, so I just did a quick google and the average CEO tenure is about eight years and board of directors, which you have to think about those when you’re thinking about management. That averages about eight and a half years, looks like eight point seven years for the s and p 1500, so something to keep in mind and maybe something you’d want to check when there is turnover with management, you know, maybe do a reassessment on how strong is this business still strong and still have strong leadership. Now on the flip side, you know, you can look at something and say, well, this, this particular CEO has a much longer tenure than the average. Maybe there’s a good reason behind that. Right? So that can be maybe an indicator in a way that management has more talent than somebody else.

[28:15] Yep, absolutely. And the other back to that as well as, I always think of it a little bit like football coaches and you think about a great football coach. If he does really well with one team and then eventually he either gets bored or things change and he leaves and he goes to another team and they do. Well, obviously he’s developed a system that’s going to produce success and a lot of times that will happen with ceos as well is they will move around. Like you said, the average lifespan is not that long, but a lot of times these guys cut their teeth in other places. Maybe they work in a smaller for a smaller company in the same business realm and then they move up to the big boys, you know, that kind of thing. So yeah, you can also follow the management a little bit as well as you’re looking for other companies, you know, if you’ve invested in a company and the company has done really well and that manager leaves the CEO leaves to go to another company, it would not be a bad idea to investigate that company that he’s taken over and keep an eye on what’s going on because if he’s done, chances are if he’s done well at one company, healer performed well with the other company because he either has a management style or a system that allows them to be successful wherever he goes.

[29:37] Yeah. You think it’s a coincidence that Pete Carrol won championships, you know, use and then Seattle.

[29:44] No, it’s an, it’s not, it is definitely a coincidence for sure. Bill parcells was another one that springs springs to mind as well, and they always did really well wherever he went. So yeah, it’s, you know, they have systems and they figure out what works and they’re able to cross over and do it.

[30:01] So I think Pete Carroll system is going to that beach and getting sun. The, it might have something to do with stereotyping. Bolts are for.

[30:09] Yep. Exactly. All right. So moving on, we have filter number for a business with an attractive price, with a margin of safety. Why don’t you go and tackle that when Andrew? Yeah, sure. So everything we try to do with the podcast, right? Always talking about margin of safety, always talking about price and valuations.

[30:28] In my opinion. This is the most important filter out of the four. Obviously two of them are kind of like the soft skills, like Dave mentioned, two of them are more, um, you know, two of them are more kind of black and white, kind of in your face type of deal and this one is very, very important and it’s not something that’s just unique to monger or just unique to buff it. There’s so many investors with billions of dollars and great track records who all talk about in one way or another, they’re talking about margin of safety, whether they’re talking about just buying undervalued stocks, buying stocks, cheap buying stocks, low being a contrarian investor, however you wanna label it a, that’s the central idea. And the central focus, something that comes to mind is what’s really nice. When you buy something at a cheap price, you’re kind of anchoring your investment in at that price.

[31:26] And so as the compounding happens, you’ve already, uh, started with like a headstart on the starting line. So as you know, the, as, as these cashflows continue to come in, as those grow, as those dividends grow, all of that, when you start at a higher level, you start with a higher dividend yield, you start with a, you know, more earnings as a proportion to how much you’re paying for the investment. You’re just getting a huge advantage and as time goes on, that advantage just increases. And so it’s so, so important where you enter because that can make a very, very big difference in the end, the end result that you get, you, you talk about if you want to, you know, if you’re like a spreadsheet numbers person, you want to go in and play around with what’s the difference between something growing up, let’s say 10 or 15 percent and you star the, uh, you know, at a yield of four percent, you started a yield at like point five percent.

[32:30] There’s going to be a huge difference in how much income you’re receiving over the years and how fast that grows and how fast it really expands and multiplies to two a big amount. There’s a big difference depending on where you start and so when you buy stocks with a margin of safety, those tend to have higher yields, you tend to get, you’re getting more earnings, generally you’re getting more assets, all these things, all these evaluations and those assets, those earnings, those revenues, that’s if you’re a business owner, you have to think of those are yours and so whether that’s dividends now in the present that you’re receiving as a, as a consequence of those prophets or whether that’s the company growing and, and really growing quickly and growing at a better level than other companies, and then maybe paying out the high dividends later, wherever that falls, wherever that may be, really getting in on the ground floor and getting there.

[33:26] Now the great price enables all of that great compounding to happen. So it’s huge. There’s so much data, so many studies done about it and it just makes a lot of sense. If you can get these businesses cheap, you get good businesses, you combine these four filters. I think it’s a great formula for success. Uh, obviously admittedly they’re not as easy as it sounds, but I think these are all things you can learn and experience and you know, could take one thing right, and you could take one simple business and just because you understood it, now all of a sudden, you know, it could be just that one factor that that leads to a stock that just creates all these great profits and gains for you. Or You could happen to just pick a great management and see that right away and because of that one factor, it becomes a fantastic investment.

[34:18] So all things I think to keep in mind and obviously coming from one of the greats, it’s not something to sneeze at.

[34:26] All right, folks that is going to wrap up our discussion for tonight. I hope you enjoyed our discussion on the four filters of Warren Buffet and Charlie Munger. It was a little fun. There’s a lot of fun to do that tonight. I enjoyed listening to the words from the master and then Andrew and I are talking a little bit about it. So I hope you guys weren’t a finger to have a great week. Go out there and invest with a margin of safety. Emphasis on the safety, and we’ll talk to you next week.

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