XRX - Charlie Munger Passes Away At 99: Wisdom From An Investing Legend

2023-11-29 15:08:22 ET

Summary

• Charlie Munger, Warren Buffett's right-hand man, passed away this week.
• Munger had a unique combination of patience and the ability to make huge bets when the odds favored him.
• By not following the herd, betting big when it was appropriate to do so, and properly aligning incentives, Buffett and Munger built Berkshire Hathaway into a company worth $780 billion.
• What we can learn from Munger's life and work.

Charlie Munger passed away in Santa Barbara this week, a month shy of his 100th birthday. A lawyer by profession, Munger built a formidable reputation over the years as Warren Buffett's right-hand man and confidant, with a sharp wit and a good nose for value. Munger passed away with an estimated net worth of $2.6 billion. He was born in Omaha, and grew up a few blocks from Warren Buffett's current home there. Though they didn't meet as children, both worked at Buffett's grandfather's grocery store. Munger worked as a meteorologist for the U.S. Army during World War II, where he was stationed in Alaska and reportedly crushed everyone at poker. He met Warren Buffett at an Omaha dinner party in 1959 – Munger was in his 30s and practicing law in California, while Buffett was in his late 20s and running investments in a partnership. Buffett convinced Munger that managing money was a good business to be in, and Munger soon made a small fortune from real estate development and investing in public securities.

After running separate investment partnerships throughout the 1960s and 1970s, Buffett and Munger joined forces at Berkshire Hathaway (BRK.A) ( BRK.B ) in 1978. The rest is history.

1. The Importance Of Aligning Incentives

In my mind, Warren Buffett's and Charlie Munger's greatest strength is their aptitude for aligning incentives for various stakeholders they do business with. From dating apps to life insurance contracts, today's world is full of adverse selection and various types of moral hazard .

As a lawyer and corporate executive, Munger had a front-row seat to understanding which kinds of incentives did and didn't work. When FedEx ( FDX ) had a problem with getting packages moved fast enough on the night shift, Munger noted that the employees were paid by the hour, creating a disincentive to working fast. FedEx switched to paying for the shift and the problem magically disappeared. Xerox ( XRX ) cut the sales commission on its new machines but left the higher commission intact on the old ones. As a result, they started selling tons of old copiers.

Well, I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther.

-Charlie Munger

I think it's incredibly instructive to look at every interaction that you have and find what the potential conflicts of interest are. Is your financial advisor pushing a new fund because it's the best for you or because they're getting a commission on it?

Looking at incentives helps you understand what's going on at a higher level. Salespeople sell what they get the highest commission on. Tipped employees have an incentive to be friendly. Social media apps want you scrolling, not to be happy. If you pay your lawyers by the hour, they'll bill you for a ton of hours. If you're being approached to make investments, chances are the sweetheart deals already went to insiders and private equity, you're getting the leftovers at best. Ditto for IPOs. And never trust an attractive girl sitting by herself at a hotel bar.

The iron rule of nature is: You get what you're rewarded for. If you want ants to come, you put sugar on the floor.

-Charlie Munger

More than virtually any other company, Berkshire excels at aligning incentives so smart people can prosper and stay for the long term. This is in large part due to Charlie Munger's legacy. Copy it in your own life and you'll also live long and prosper.

2. Bet Big When The Odds Favor You

The wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.

-Charlie Munger

Another area where Berkshire has consistently excelled is in not pumping large amounts of money into middling opportunities. Berkshire always has plenty of cash on hand, which helped them make a killing in the 2008 financial crisis. Buffett and Munger think alike here. Buffett even closed his investment partnership in 1969 due to what he felt like was a lack of opportunities in stocks after an irrational bull run. Munger kept his fund open longer, partly due to a philosophical difference that he imprinted on Buffett, which was to invest in companies not only for deep value but for quality and long-term growth potential.

Short-term value is obvious at times, long-term value less so because investors are overall rather impatient. Munger convinced Buffett to buy See's Candies in 1972 for somewhere in the neighborhood of 12-15x its post-tax earnings. That's not a textbook deep-value bargain, but the investment has since earned over $2 billion in sales off of a $25 million purchase price.

Due to disposition effects , shares in the very best companies have a long-term tendency to be cheaper than their fundamental value, while basket case turnarounds will tend to be overvalued on average. Munger understood this implicitly and got Warren Buffett to buy in, putting them on the path from millionaires to billionaires.

Despite their reluctance to publicly discuss investing based on macroeconomic trends, Berkshire's philosophy has very much been to stockpile cash and wait for opportunities. This has the effect of making Berkshire countercyclical. They're willing to deploy large amounts of cash on short notice in times of crisis. This rewards their patience and makes up for the times when stocks surge on panic buying and speculation. Indeed, we see that Berkshire performed strongly after the 1960s bubble, the dot-com bubble, and the 2008 financial crisis. Berkshire currently has $157 billion in cash, and when the business cycle turns and the cash is finally deployed, it's likely to be put to great use. Munger and Buffett's patience and long-term outlook have also greatly contributed to Berkshire's success.

On patience in investing:

It takes character to sit with all that cash and to do nothing. I didn’t get to be where I am by going after mediocre opportunities.

Charlie Munger , from Poor Charlie's Almanack.

Having both patience and willingness to make aggressive bets when you have a big advantage is an exceedingly rare combination. Many people who are patient are also too passive, while many aggressive risk takers tend to lose too much money on bad bets and poor money management.

3. Don't Follow The Herd

Mimicking the herd invites regression to the mean (merely average performance).

-Charlie Munger

Throughout his life and career Munger did an excellent job of charting his own path without getting sucked into manias and panics. Some of this can be attributed to relationships. Munger held a Daily Journal annual meeting on Valentine's Day in 2019 and shared how important choosing the right spouse is, either by luck or foresight. Munger married twice, the second time for 54 years until his wife's passing in 2010.

This sentiment echoes the wisdom of older people I've met who are successful. Thirty-year-olds tend to prescribe their success entirely to themselves as heroes in their own personal movies, while 80-year-olds seem to think more like historians, placing importance on meeting the right people at the right time and taking a few dozen trips around the sun with them. The typical person lives paycheck to paycheck, treats their body poorly, and close to 50% of marriages end in divorce. In light of that, how much downside is there really from going against the herd and living a life of calculated risk taking?

This is important because the stock market is a zero-sum game. For you to outperform the market, someone else has to underperform. It's not an accident that low-key and patient investors like Berkshire ended up beating the market over time, while mutual fund managers gambling to get a big year-end bonus end up trailing. Just as patience and aggression are a rare but brilliant combination, so too is a healthy level of skepticism combined with an optimistic outlook on life.

Bottom Line

The investing world will greatly miss Charlie Munger's wit and wisdom. Munger was a great investor, a good teacher, and endlessly quotable. His and Buffett's work made (conservatively) tens of thousands of Berkshire investors and employees into multi-millionaires. As we learn about his life, it's only appropriate to examine our own for lessons that can help us have a long and prosperous life.

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