Wednesday, March 8, 2017

Looking for nuggets of gold in plain sight...

The article about Warren Buffett and Herb Wolf from last week quoted some remarks from Buffett that were included in the book The Snowball
“Herb Wolf was one of the smartest guys I ever met. He could tell the effect on American Water Works’ earnings if somebody took a bath in Hackensack, New Jersey. He was unbelievable. One day Herb said to me, ‘Warren, if you’re looking for a gold needle in a haystack of gold, it’s not better to find the gold needle.’ I had this thing that the more obscure something was, the better I liked it. I thought it was a treasure hunt. Herb got me out of that way of thinking. I loved that guy.”
Looking in a haystack of gold reminded me of a similar thought from Charlie Munger in his "Academic Economics: Strengths and Faults after Considering Interdisciplinary Needs" speech (via Poor Charlie's Almanack):
The late, great Thomas Hunt Morgan, who was one of greatest biologists who ever lived, when he got to Caltech, had a very interesting, extreme way of avoiding some mistakes from overcounting what could be measured and undercounting what couldn't. At that time, there were no computers, and the computer substitute then available to science and engineering was the Friden calculator, and Caltech was full of Friden calculators. And Thomas Hunt Morgan banned the Friden calculator from the biology department. And when they said, "What the hell are you doing, Dr. Morgan?" he said, "Well, I am like a guy who is prospecting for gold along the banks of the Sacramento River in 1849. With a little intelligence, I can reach down and pick up big nuggets of gold. And as long as I can do that, I'm not going to let any people in my department waste scarce resources in placer mining." And that's the way Thomas Hunt Morgan got through life. 
I've adopted the same technique, and here I am in my eightieth year. I haven't had to do any placer mining yet. And it begins to look like I'm going to get all the way through, as I'd always hoped, without doing any of that damned placer mining. Of course, if I were a physician, particularly an academic physician, I'd have to do the statistics, do the placer mining. But it's amazing what you can do in life without the placer mining if you've got a few good mental cricks and just keep ragging the problems the way Thomas Hunt Morgan did.
And earlier in Poor Charlie's Almanack (in Chapter 2 on The Munger Approach to Life, Learning, and Decision Making), the idea above was expanded on a bit when it comes to Munger's Investment Evaluation Process:
As we've noted, Charlie doesn't make a lot of investments. His approach is perhaps best summarized by Thomas Watson Sr., the founder of IBM: "I'm no genius. I'm smart in spots, and I stay around those spots." If Charlie knows anything, he knows his "spots": his carefully identified circles of competence. To stay within these circles, he first applies a basic, overall screen, designed to limit his investment field to only "simple, understandable candidates." As he says, "We have three baskets for investing: yes, no, and too tough to understand." To identify potential "yes" candidates, Charlie looks for an easy to understand, dominant business franchise that can sustain itself and thrive in all market environments. Understandably, few companies survive this first cut. Many investor favorites such as pharmaceuticals and technology, for example, go straight to the "too tough to understand" basket. Heavily promoted "deals" and IPOs earn immediate "no's." Those that do survive this first winnowing are subjected to the screens and filters of Charlie's mental model approach. The process is intense and Darwinian, but also efficient. Charlie detests "placer mining," the process of sifting through piles of sand for specks of gold. Instead, he applies his "Big Ideas from the Big Disciplines" to find the large, unrecognized nuggets of gold that sometimes lie in plain sight on the ground.