At the end of the Berkshire Hathaway Shareholders Meeting, Warren Buffett was asked by a CNBC correspondent what he saw as the biggest threat to the company’s future. He replied “CNBC is the greatest threat to Berkshire — that is, a Chemical, Nuclear, Biological, or Cyber attack.” Beyond being a clever jab at the CNBC News correspondents who had been trying to get a sound bite out of him for the past five hours, the comment says something startling about what the duo who grew up working together in a grocery store have accomplished.
Berkshire has grown so large and become so integral to the U.S. economy that the only conceivable threat to the company is an existential threat to the entire nation-state.
My original fascination with Buffett and Munger is no doubt due to the Gringot’s-esque amount of money they’ve made, but their business has endured because, unlike the majority of the super wealthy, they appear to have used a considerable amount of skill.1
I got the chance to go to Berkshire conference earlier this year and hear them in person. While many of their specific strategies are uniquely suited to succeed in the twentieth century, the principles that underlie them are fundamental and likely to endure. After reviewing my notes from the conference and the half dozen or so books on them that I have read, I’ve attempted to parse out lessons investors and entrepreneurs can carry into the twenty-first century.
1. Thinking Long-term is a Moat
A moat is a term Buffett and Munger use synonymously with sustainable competitive advantage. It’s something that makes it incredibly difficult for an upstart to become a legitimate competitor. In the context of companies, Munger likes to cite Coca-Cola, which combines good management, addictive ingredients (sugar and caffeine), huge amounts of social proof (Coke sponsors and is associated with The Olympics, FIFA, etc.), and availability (you can buy it anywhere). Combined, these form a huge moat. It’s hard to envision anything which could cause major damage to the company in the near future.
What then, is the moat that Buffett and Munger themselves have? What is their sustainable competitive advantage which other investors haven’t been able to replicate?
Listening to the pair speak and having read some of their books, the largest factor in their moat seems to be the ability to think in longer time frames.
“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.” 2
This seems to be the core sustainable competitive advantage of Berkshire compared to Private Equity firms, VC firms3
, hedge funds, and other publicly traded companies. Since Buffett and Munger control a majority position in Berkshire, they suffer no such pressure. Controlling a majority position seems to be the only way to operate on 10 year-plus time frames.
Given a sufficient number of people with some control and influence (shareholders in the public companies, investors in firms or funds), a herd mentality is inevitable.
In Michael Lewis’s portrayal of the 2008 financial crises The Big Short, he recounts the story of Dr. Michael Burry, who successfully bets against the housing market and ends up returning 476% to his investors.
However, he was able to do that only through invoking a special clause in his contract refusing to return money to his investors and dealing with two years of constant emails from them (including regular death threats). It was considered a foregone conclusion to investors in 2006 and 2007 that “housing prices never fall.” Even though he personally saw the long term inevitability of the collapse, his investors weren’t sophisticated enough and only saw their balances go down every quarter.
Given a sufficient number of people, you always get the same herd mentality and as a result you have to operate on shorter time frames. You can’t maintain ten-year-plus time horizons — it’s too contrary to human nature, which is typically most concerned with short-term loss aversion, not long-term gain seeking.4
I talked to a couple people doing similar styles of investing in private markets and this seems to have been the core lesson that they’ve taken from Buffett and Munger. Because as a species we are so short-term oriented, it’s an enormous advantage if you can operate on a longer time horizon than the competition.
In some ways technology is making the model used by Buffett and Munger more difficult — the average tenure of a company on the S&P 500 was over sixty years when they started investing in 1960, and is less than twenty years today5. However, humans are still fundamentally as concerned with looking foolish and as loss-averse as they were fifty years ago.
In that way, the advantages of playing the long game are linked to human nature. This seems most obvious in terms of personal brand and reputation. Having a ten, twenty, and thirty year track record of ethical behavior is an incredibly defensive career position. In Berkshire’s case, that meant treating managers well and not breaking up companies for quick cash, a philosophy which gave them access to deals they would not otherwise have had. If a management wanted to be acquired but still maintain control over their company, there wouldn’t be any better place to look than Berkshire.
Likewise, even an angel investor in high-tech companies can build a reputation for being absurdly helpful that lasts for a lifetime, even if the companies don’t. An individual can build a reputation for being honest and competent even if the companies they are working with don’t.
2. Life, The Universe and Everything are Patently Absurd: Charlie Munger Mental Models
At the end of the interview, an audience member asked where Munger and Buffett got their sense of humor. Warren and Charlie speculated that relative to other people, they seemed to have recognized the inherent absurdity of life and the universe faster than most people.
I suspect it helped them as investors as well.
If you asked the average investor whether they thought a huge portion of Fortune 500 CEOs and hedge fund manager were sociopaths who care more about their social status and egos than the long-term prospects of the country, their company, and its employees, they would likely respond “Of course not, that would be absurd!”
It is patently absurd. It is also true. It is an incredibly profitable skill to be able to see the world as it is and not as we want it to be. No one wants to live in a world in which the people in power are largely amoral and irrational, but only in accepting that reality can we successfully adapt to it.
The notion that true perceptions are fitter perceptions is deeply embedded in our culture, despite being obviously wrong. A very risk averse strategy where someone runs at the slightest chance of danger will lead to false beliefs more often, but will probably lead to a greater ability to reproduce and pass down genes.6
Thankfully, this is no longer the world we live in. None of the risks you take on a day-to-day basis are likely to lead to death and yet we act as though they are. In our world, Ray Dalio’s observation holds true: “Truth—more precisely, an accurate understanding of reality—is the essential foundation for producing good outcomes.”
3. “The future will not be as good as the past but it doesn’t have to be.”
This statement from Charlie summed up their thoughts on public markets. Public markets in the United States over most of the last century (1932-99) were an anomaly.
Even as the population tripled, GDP per capita in the U.S. increased by 600%. A median income household, $57,843 per year in 1999, was better off than that of one of the richest men on Earth, John Rockefeller, who lived at the turn of the previous century. In 1999, average life expectancy was more than a decade longer than Rockefeller, and children had less than a 1% chance of dying before the age of one, compared to a 10% chance7 in Rockefeller’s day.
Public markets in the U.S.8 will not repeat the success of the late 90s again in the 21st century and any investing premise built on that expectation won’t work.9 If you invested $1,000 into the NASDAQ in 1999, you got back to break even in 2015. At no point between ‘32 and ‘99 was that true.
However, you don’t need that much more growth, because standards of living are already so much higher. If you accept the latest research that a doubling of income increases happiness by half a point on a ten point scale10, going from $5,000 GDP per capita in 1900 to $40,000 in 2000 increased well-being three times more than going from $40,000 to 80,000 would have.
The investors I talked to who were achieving 20th century Berkshire-esque returns all seemed to be focused on smaller, private markets, where it’s more difficult to invest and there’s less competition because the markets are more opaque and smaller.
It’s worth noting that low competition and high levels of opacity were the same conditions that public markets were in when Buffett and Munger began investing. Huge advances in communication technology (mostly the internet) and the huge amount of capital created in the second half of the 20th century have created a much more competitive, transparent public market.
4. The Law of the Conservation of Trust is Creating a Seismic Shift in Marketing
In physics, the law of conservation of energy states that the total energy of an isolated system remains constant—it is said to be conserved over time. The same is true of trust.
This principle was discovered by researcher Robin Dunbar who encapsulated it in the eponymous Dunbar’s number: on average, we can only maintain a trusted social group of one hundred and fifty people. That is, we have a fixed amount of trust. We change which people, brands, and ideas we trust over time, but the total amount is conserved.
In 1972, the actual per-capita advertising spend in the U.S. was about $110 per person. By 1997, the comparable number was $880.12 The number has continued to climb.
If you cold-called someone in 1960, there was a legitimate chance they’d never heard of your product and might be interested. If you cold-call someone today, they probably saw it (or a competitor) on Facebook or Google in the last 24 hours. We used to only be exposed to a hundred brands in a year, and are now exposed to hundreds in a day, with no more trust and attention to dole out.
As a result, we’re in the midst of a huge shift in how companies grow and how marketing works. Buffett called it the shift from “push” marketing to “pull” marketing. This dichotomy has been expressed a lot of different ways—outbound versus inbound, advertising versus permission marketing—but all get at the same idea: there is more and more competition over a fixed amount of consumer trust.
In a world where the competition for trust was less fierce, a 30 second commercial, a billboard and a cold call used to be enough. That’s less true everyday.
Buffet contrasted Amazon (pull) with Geico (push). Geico primarily acquired customers through push marketing (by hitting the phones), whereas Amazon has mostly done it through pull. Buffett admitted his ignorance here and basically said it was outside his circle of competence. Paraphrasing: “This is a fundamental shift which we aren’t adapting to and don’t understand well. We can’t beat Bezos at that game and won’t try.”
In the U.S., the first half of the 20th century was largely solving the supply problem in business. Demand for food, shelter, clothing and other goods was already there, and the companies that won in the first half of the century solved the problem of how to efficiently produce goods for existing consumer demand.
Over the course of the second half of the 20th century, the bottleneck shifted from supply to demand. The economy got so good at making stuff that it started to “push” those goods onto consumers using advertising to stimulate consumer demand. That trend is increasing, as production has continued to get easier while trust continues to be static.
In a 2011 conversation with Charlie Rose, Jeff Bezos explained it this way:
“Before if you were making a product, the right business strategy was to put 70% of your attention, energy, and dollars into shouting about a product, and 30% into making a great product. So you could win with a mediocre product, if you were a good enough marketer. That is getting harder to do. The balance of power is shifting.”
Shouting louder is a race to the bottom. We are entering a trust shortage and the individuals and brands which are “long trust” will win.
5. Stick to Your Circle of Competence and Add in a Margin of Safety
Charlie made the comment that “[i]n order to disagree with somebody you must first understand their argument better than they do.”
This is the principle of Chesterton’s Fence: imagine there are two city planners walking down a road. They come to a fence which serves no immediate purpose crossing the road. The first says “I don’t see the use of this; let us clear it away.” The wiser of the two turns to him and says “If you don’t see the use of it, I certainly won’t let you clear it away. Go away and think. Then, when you can come back and tell me that you do see the use of it, I may allow you to destroy it.”13
The most common way people lose money is to dramatically overestimate how smart they are and how much they know. Despite a fifty-year investing career and having read thousands of books and reports each, both Buffet and Munger often read upwards of 500 pages a day each, and they still confine themselves to a small circle of competence where they can explain the other side’s argument better than they can.
They echo the sentiment a section from their 2004 letter to shareholders:
“What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know. An investor needs to do very few things right as long as he or she avoids big mistakes. Second, and equally important, we insist on a margin of safety in our purchase price. If we calculate the value of a common stock to be only slightly higher than its price, we’re not interested in buying.”14
While their particular circle of competence, large industrial companies, isn’t likely to endure, the notion of sticking to a narrow circle of competence and making sure there’s a large margin of safety will.
6. Context is King
At one point in the meeting, Buffett made an offhand comment about how the leadership qualities of JFK and Khrushchev were the primary reason that nuclear war was averted during the Cuban Missile Crisis: “you’re not always going to have leaders like Khrushchev and JFK.”
How many people in history have a data set in their head both longitudinal (through living a long time and reading widely) and latitudinally (across private industries, government, etc.) to be able to understand the context of how JFK and Khrushchev stack up as leaders? A few dozen people in the entire history of the species at most.
This gives them an incredible ability to understand the context around any given company.
This is structured into Berkshire. Their portfolio companies send the cash flow up to Buffett and Munger who have the best perspective and contextual understanding to allocate it.
Whereas the CEO of one of their companies would take that money and start from the perspective of how to make a better tire, Buffett and Munger look out over the entire spectrum of businesses and ask “how do I maximize returns on capital?”
Taking that same pile of money and asking those two questions yield very different results in terms of how to spend it.
Comparing them to their cohort, white dudes born in the early 20th century, the main differentiators I see are: a long term perspective, a commitment to stick to their circle of competence and add in a margin of safety, an ability (and willingness) to see truth’s absurd nature and a huge contextual range.
What are the primary insights you’ve gleaned from Buffett and Munger?
Last Updated on July 30, 2019 by Taylor Pearson
- Though, as with anyone who reaches the level of wealth that they have, luck is a major part of it. Buffett, to his credit, has cited the largest reason for his success as being “born as a white male in the U.S. at the beginning of the largest, longest expansion of capital markets in history.”
- Cunningham, Lawrence A.; Buffett, Warren E. (2013-03-01). The Essays of Warren Buffett: Lessons for Corporate America, Third Edition (Kindle Locations 2268-2269). Carolina Academic Press. Kindle Edition.
- Per my (very limited) understanding, VC firms, compared to the others listed, do tend to think on relatively longer time frames, however, there’s some truth that VCs pressure portfolio companies to show results on a quarterly basis because they are reporting to their own investors quarterly. Since Buffett and Munger own a majority of shares themselves, they don’t have any such pressure.
- Daniel Kahneman – Thinking Fast and Slow
- AEI. 2014. Creative destruction in the S&P500 index. [ONLINE] Available at:https://www.aei.org/publication/charts-of-the-day-creative-destruction-in-the-sp500-index/. [Accessed 15 June 2016].
- Stanovich, K E , 1999. Who Is Rational?: Studies of Individual Differences in Reasoning. 1st ed. Psychology Press: Psychology Press.
- Achievements in Public Health, 1900-1999: Healthier Mothers and Babies. 2016. Achievements in Public Health, 1900-1999: Healthier Mothers and Babies. [ONLINE] Available at:https://www.cdc.gov/mmwr/preview/mmwrhtml/mm4838a2.htm. [Accessed 21 June 2016].
- Or likely anywhere, though Asia is making a run for it that I hope will prove me wrong.
- Probably including the entire U.S. retirement system. See: Marginal REVOLUTION. 2016. The Number of Publicy Traded Firms Has Halved – Marginal REVOLUTION. [ONLINE] Available at: http://marginalrevolution.com/marginalrevolution/2016/04/the-number-of-publicy-traded-firms-has-halved.html. [Accessed 21 June 2016].
- To go from 5k to 40k requires three doublings 5 to 10, 10 to 20, and 20 to 40 whereas going from 40 to 80 requires only a single doubling. Source: 80,000 Hours. 2016. Everything you need to know about whether money makes you happy – 80,000 Hours. [ONLINE] Available at: https://80000hours.org/articles/money-and-happiness/. [Accessed 21 June 2016].
- See also: http://www.ribbonfarm.com/2007/08/22/the-twitter-zone-and-virtual-geography/
- Ries, Al; Trout, Jack (2000-10-30). Positioning: The Battle for Your Mind, 20th Anniversary Edition (Kindle Locations 238-239). McGraw-Hill Education. Kindle Edition.
- G.K. Chesterton’s 1929 book, The Thing.
- Cunningham, Lawrence A.; Buffett, Warren E. (2013-03-01). The Essays of Warren Buffett: Lessons for Corporate America, Third Edition (Kindle Locations 2148-2151). Carolina Academic Press. Kindle Edition.