"Checklist routines avoid a lot of errors. You should have all this elementary [worldly] wisdom and then you should go through a mental checklist in order to use it. There is no other procedure in the world that will work as well." -- Charlie Munger - 2007
If I wasn't such an obvious introvert and would have had the chutzpah to get up and ask Charlie Munger (and Mr. Buffett as well) a question at the Berkshire Hathaway meeting this year it would have been, “Can you give some of examples of the checklists you use everyday that you think are the most important?” I don’t know if Charlie would have answered it because I think he believes a lot in coming to your own conclusions, although he's been gracious enough to prescribe and describe some of his mental models over the years. The only real examples I can remember him giving of process related checklists are:
Charlie Munger’s Two-Track Analysis:
1. First, what are the factors that really govern the interests involved, rationally considered?
2. And second, what are the subconscious influences where the brain at a subconscious level is automatically doing these things – which by and large are useful, but which often misfunction.
One approach is rationality – the way you’d work out a bridge problem: by evaluating the real interests, the real probabilities and so forth. And the other is to evaluate the psychological factors that cause subconscious conclusions – many of which are wrong.
And
Charlie Munger’s “ultra-simple general notions”:
1. Solve the big no-brainer questions first.
2. Use math to support your reasoning.
3. Think through a problem backward, not just forward.
4. Use a multidisciplinary approach.
5. Properly consider results from a combination of factors, or lollapalooza effects.
Peter Bevelin has some checklists in his book Seeking Wisdom: From Darwin to Munger that may also be worth a look to all interested persons.
Wednesday, May 23, 2007
Thursday, May 17, 2007
Charlie Munger - USC Law School Commencement - May 13, 2007
Here are my notes from Charlie Munger's keynote address. I didn't originally intend for it to be a semi-transcript but I had to take Charlie's advice: "Deliver to the world what you would buy if you were on the other end." And so that's what I did.
UPDATE: The full video of the speech is now posted online, HERE.
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Charlie Munger - USC School of Law Commencement - May 13, 2007
Safest way to get what you want is to deserve what you want.
Deliver to the world what you would buy if you were on the other end.
There is huge pleasure in life to be obtained from getting deserved trust. And the way to get it is to deliver what you would want to buy if the circumstances were reversed.
There’s no love that’s so right as admiration based love and that love should include the instructive dead.
Wisdom acquisition is a moral duty. It’s not something you do just to advance in life. As a corollary to that proposition which is very important, it means that you are hooked for lifetime learning. And without lifetime learning, you people are not going to do very well. You are not going to get very far in life based on what you already know. You’re going to advance in life by what you learn after you leave here.
I constantly see people rise in life who are not the smartest, sometimes not even the most diligent, but they are learning machines. They go to bed every night a little wiser than they were when they got up and boy does that help, particularly when you have a long run ahead of you.
Just as civilization can progress only when it invents the method of invention, you can progress only when you learn the method of learning.
Nothing has served me better in my long life than continuous learning.
I went through life constantly practicing (because if you don’t practice it, you lose it) the multi-disciplinary approach and I can’t tell you what that’s done for me. It’s made life more fun, it’s made me more constructive, its made me more helpful to others, its made me enormously rich. You name it, that attitude really helps. Now, there are dangers in it because it works so well that if you do it, you will frequently find you’re sitting in the presence of some other expert, maybe even an expert superior to you (supervising you), and you’ll know more than he does about his own specialty, a lot more. You’ll see the correct answer and he’s missed it. That is a very dangerous position to be in. You can cause enormous offense by being right in a way that causes somebody else to lose face. And I never found a perfect way to solve that problem. My advice to you is to learn sometimes to keep your light under a bushel.
Marcus Cicero is famous for saying that the man who doesn’t know what happened before he was born goes through life like a child. That is a very correct idea. If you generalize Cicero, as I think one should, there are all these other things that you should know in addition to history. And those other things are the big ideas in all the other disciplines. It doesn’t help just to know them enough so you can [repeat] them back on an exam and get an A. You have to learn these things in such a way that they’re in a mental latticework in your head and you automatically use them for the rest of your life. If you do that I solemnly promise you that one day you’ll be walking down the street and you’ll look to your right and left and you’ll think “my heavenly days, I’m now one of the of the few most competent people in my whole age cohort.” If you don’t do it, many of the brightest of you will live in the middle ranks or in the shallows.
The way complex adaptive systems work and the way mental constructs work is that problems frequently get easier, I’d even say usually are easier to solve if you turn them around in reverse. In other words, if you want to help India, the question you should ask is not “how can I help India”, it’s “what is doing the worst damage in India? What will automatically do the worst damage and how do I avoid it?”
In life, unless you’re more gifted than Einstein, inversion will help you solve problems.
Let me use a little inversion now. What will really fail in life? What do you want to avoid? Such an easy answer: sloth and unreliability. If you’re unreliable it doesn’t matter what your virtues are. Doing what you have faithfully engaged to do should be an automatic part of your conduct. You want to avoid sloth and unreliability.
Another thing I think should be avoided is extremely intense ideology because it cabbages up one’s mind. You see it a lot with T.V. preachers (many have minds made of cabbage) but it can also happen with political ideology. When you’re young it’s easy to drift into loyalties and when you announce that you’re a loyal member and you start shouting the orthodox ideology out, what you’re doing is pounding it in, pounding it in, and you’re gradually ruining your mind. So you want to be very, very careful of this ideology. It’s a big danger. In my mind, I have a little example I use whenever I think about ideology. The example is these Scandinavia canoeists who succeeded in taming all the rapids of Scandinavia and they thought they would tackle the whirlpools of the Aron (sp) Rapids here in the United States. The death rate was 100%. A big whirlpool is not something you want to go into, and I think the same is true about a really deep ideology. I have what I call an iron prescription that helps me keep sane when I naturally drift toward preferring one ideology over another and that is: I say that I’m not entitled to have an opinion on this subject unless I can state the arguments against my position better than the people who support it. I think only when I’ve reached that state am I qualified to speak. This business of not drifting into extreme ideology is a very, very important thing in life.
Another thing that does one in, of course, is the self-serving bias to which we’re all subject. You think the true little me is entitled to do what it wants to do. And, for instance, why shouldn’t the true little me overspend my income. Mozart became the most famous composer in the world but was utterly miserable most of the time, and one of the reasons was because he always overspent his income. If Mozart can’t get by with this kind of asinine conduct, I don’t think you should try.
Generally speaking, envy, resentment, revenge and self-pity are disastrous modes of thoughts. Self-pity gets fairly close to paranoia, and paranoia is one of the very hardest things to reverse. You do not want to drift into self-pity. It’s a ridiculous way to behave and when you avoid it, you get a great advantage over everybody else or almost everybody else because self-pity is a standard condition, and yet you can train yourself out of it.
Of course the self-serving bias is something you want to get out of yourself. Thinking that what’s good for you is good for the wider civilization and rationalizing all these ridiculous conclusions based on this subconscious tendency to serve one’s self is a terribly inaccurate way to think. Of course you want to drive that out of yourself because you want to be wise, not foolish. You also have to allow for the self-serving bias of everybody else because most people are not going to remove it all that successfully, the human condition being what it is. If you don’t allow for self-serving bias in your conduct, again you’re a fool.
The correct answer to situations like [the Saloman case] was given by Ben Franklin, “If you would persuade, appeal to interest not to reason.”
Another thing, perverse incentives. You do not want to be in a perverse incentive system that’s causing you to behave more and more foolishly or worse and worse - incentives are too powerful a control over human cognition or human behavior. If you’re in one, I don’t have a solution for you. You’ll have to figure it out for yourself, but it’s a significant problem.
Perverse associations, also to be avoided. You particularly want to avoid working under somebody you really don’t admire and don’t want to be like. We’re all subject to control to some extent by authority figures, particularly authority figures that are rewarding us. Getting to work under people we admire requires some talent. The way I solved that is I figured out the people I did admire and I maneuvered cleverly without criticizing anybody so I was working entirely under people I admired. You’re outcome in life will be way more satisfactory and way better if you work under people you really admire. The alternative is not a good idea.
Objectivity maintenance. Darwin paid particular attention to disconfirming evidence. Objectivity maintenance routines are totally required in life if you’re going to be a great thinker. There, we're talking about Darwin’s special attention to disconfirming evidence and also about checklist routines. Checklist routines avoid a lot of errors. You should have all this elementary wisdom and then you should go through a mental checklist in order to use it. There is no other procedure in the world that will work as well.
The last idea that I found very important is that I realized very early that non-egality would work better in the parts of the world that I wanted to inhabit. What do I mean by non-egality? I mean John Wooden when he was the number one basketball coach in the world. He just said to the bottom five players that you don’t get to play. The top seven did all the playing. Well the top seven learned more, remember the learning machine, they learned more because they did all the playing. And when he got to that system he won more than he had ever won before. I think the game of life, in many respects, is about getting a lot of practice into the hands of the people that have the most aptitude to learn and the most tendency to be learning machines. And if you want the very highest reaches of human civilization, that’s where you have to go. You do not want to choose a brain surgeon for your child from 50 applicants where all of them just take turns doing the procedure. You don’t want your airplanes designed that way. You don’t want your Berkshire Hathaway’s run that way. You want to get the power into the right people.
[Told the story 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].
In this world we have two kinds of knowledge. One is Planck knowledge, the people who really know. They’ve paid the dues, they have the aptitude. And then we’ve got chauffeur knowledge. They have learned the talk. They may have a big head of hair, they may have fine temper in the voice, they’ll make a hell of an impression. But in the end, all they have is chauffeur knowledge. I think I’ve just described practically every politician in the United States.
And you are going to have the problem in your life of getting the responsibility into the people with the Planck knowledge [and away from the people with the chauffeur knowledge]. And there are huge forces working against you. My generation has failed you a bit…..but you wouldn’t like it to be too easy now would you?
Another thing that I found is that an intense interest in the subject is indispensable if you’re really going to excel in it. I could force myself to be fairly good in a lot of things but I couldn’t be really good at anything where I didn’t have an intense interest. So to some extent, you’re going to have to follow me. If at all feasible, drift into something where you have an intense interest.
Another thing you have to do, of course, is to have a lot of assiduity. I like that word because it means: sit down on your ass until you do it. Two partners that I chose for one little phase in my life had the following rule when they created a design, build, construction team. They sat down and said, two-man partnership, divide everything equally, here’s the rule: if ever we’re behind in commitments to other people, we will both work 14 hours a day until we’re caught up. Needless to say, that firm didn’t fail. The people died very rich. It’s such a simple idea.
Another thing, of course, is that life will have terrible blows in it, horrible blows, unfair blows. And some people recover and others don’t. And there I think the attitude of Epictetus is the best. He said that every missed chance in life was an opportunity to behave well, every missed chance in life was an opportunity to learn something, and that your duty was not to be submerged in self-pity, but to utilize the terrible blow in constructive fashion. That is a very good idea. You may remember the epitaph which Epictetus left for himself: “Here lies Epictetus, a slave maimed in body, the ultimate in poverty, and the favored of the gods.”
I’ve got a final little idea because I’m all for prudence as well as opportunism. [He talked about his grandfather, Judge Munger, who under spent his income all his life and left his grandmother in comfortable circumstances, which he had to because there were no pensions for federal judges back then. Along the way, he bailed out Charlie’s uncle’s bank back in the ‘30s by taking over 1/3 of his good assets in exchange for bad assets of the bank. He remembered his grandfather’s example in college when he came across] Housman’s poem:
The thoughts of others
Were light and fleeting,
Of lovers’ meeting
Or luck or fame.
Mine were of trouble,
And mine were steady,
So I was ready
When trouble came.
You can say, who wants to go through life anticipating trouble? Well I did. All my life I’ve gone through life anticipating trouble. And here I am, going along in my 84th year and like Epictetus, I’ve had a favored life. It didn’t make me unhappy to anticipate trouble all the time and be ready to perform adequately if trouble came. It didn’t hurt me at all. In fact it helped me.
The last idea I want to give to you…..is that this is not the highest form that a civilization can reach. The highest form a civilization can reach is a seamless web of deserved trust. Not much procedure, just totally reliable people correctly trusting one another. That’s the way an operating room works at the Mayo Clinic. So never forget, when you’re a lawyer, that you may be rewarded for selling this stuff but you don’t have to buy. What you want in your own life is a seamless web of deserved trust. And so if your proposed marriage contract has 47 pages, my suggestion is you not enter.
Well that’s enough for one graduation. I hope these ruminations of an old man are useful to you. In the end I’m like an Old Valiant for Truth in The Pilgrim’s Progress. “My sword I leave to him who can wear it.”
Safest way to get what you want is to deserve what you want.
Deliver to the world what you would buy if you were on the other end.
There is huge pleasure in life to be obtained from getting deserved trust. And the way to get it is to deliver what you would want to buy if the circumstances were reversed.
There’s no love that’s so right as admiration based love and that love should include the instructive dead.
Wisdom acquisition is a moral duty. It’s not something you do just to advance in life. As a corollary to that proposition which is very important, it means that you are hooked for lifetime learning. And without lifetime learning, you people are not going to do very well. You are not going to get very far in life based on what you already know. You’re going to advance in life by what you learn after you leave here.
I constantly see people rise in life who are not the smartest, sometimes not even the most diligent, but they are learning machines. They go to bed every night a little wiser than they were when they got up and boy does that help, particularly when you have a long run ahead of you.
Just as civilization can progress only when it invents the method of invention, you can progress only when you learn the method of learning.
Nothing has served me better in my long life than continuous learning.
I went through life constantly practicing (because if you don’t practice it, you lose it) the multi-disciplinary approach and I can’t tell you what that’s done for me. It’s made life more fun, it’s made me more constructive, its made me more helpful to others, its made me enormously rich. You name it, that attitude really helps. Now, there are dangers in it because it works so well that if you do it, you will frequently find you’re sitting in the presence of some other expert, maybe even an expert superior to you (supervising you), and you’ll know more than he does about his own specialty, a lot more. You’ll see the correct answer and he’s missed it. That is a very dangerous position to be in. You can cause enormous offense by being right in a way that causes somebody else to lose face. And I never found a perfect way to solve that problem. My advice to you is to learn sometimes to keep your light under a bushel.
Marcus Cicero is famous for saying that the man who doesn’t know what happened before he was born goes through life like a child. That is a very correct idea. If you generalize Cicero, as I think one should, there are all these other things that you should know in addition to history. And those other things are the big ideas in all the other disciplines. It doesn’t help just to know them enough so you can [repeat] them back on an exam and get an A. You have to learn these things in such a way that they’re in a mental latticework in your head and you automatically use them for the rest of your life. If you do that I solemnly promise you that one day you’ll be walking down the street and you’ll look to your right and left and you’ll think “my heavenly days, I’m now one of the of the few most competent people in my whole age cohort.” If you don’t do it, many of the brightest of you will live in the middle ranks or in the shallows.
The way complex adaptive systems work and the way mental constructs work is that problems frequently get easier, I’d even say usually are easier to solve if you turn them around in reverse. In other words, if you want to help India, the question you should ask is not “how can I help India”, it’s “what is doing the worst damage in India? What will automatically do the worst damage and how do I avoid it?”
In life, unless you’re more gifted than Einstein, inversion will help you solve problems.
Let me use a little inversion now. What will really fail in life? What do you want to avoid? Such an easy answer: sloth and unreliability. If you’re unreliable it doesn’t matter what your virtues are. Doing what you have faithfully engaged to do should be an automatic part of your conduct. You want to avoid sloth and unreliability.
Another thing I think should be avoided is extremely intense ideology because it cabbages up one’s mind. You see it a lot with T.V. preachers (many have minds made of cabbage) but it can also happen with political ideology. When you’re young it’s easy to drift into loyalties and when you announce that you’re a loyal member and you start shouting the orthodox ideology out, what you’re doing is pounding it in, pounding it in, and you’re gradually ruining your mind. So you want to be very, very careful of this ideology. It’s a big danger. In my mind, I have a little example I use whenever I think about ideology. The example is these Scandinavia canoeists who succeeded in taming all the rapids of Scandinavia and they thought they would tackle the whirlpools of the Aron (sp) Rapids here in the United States. The death rate was 100%. A big whirlpool is not something you want to go into, and I think the same is true about a really deep ideology. I have what I call an iron prescription that helps me keep sane when I naturally drift toward preferring one ideology over another and that is: I say that I’m not entitled to have an opinion on this subject unless I can state the arguments against my position better than the people who support it. I think only when I’ve reached that state am I qualified to speak. This business of not drifting into extreme ideology is a very, very important thing in life.
Another thing that does one in, of course, is the self-serving bias to which we’re all subject. You think the true little me is entitled to do what it wants to do. And, for instance, why shouldn’t the true little me overspend my income. Mozart became the most famous composer in the world but was utterly miserable most of the time, and one of the reasons was because he always overspent his income. If Mozart can’t get by with this kind of asinine conduct, I don’t think you should try.
Generally speaking, envy, resentment, revenge and self-pity are disastrous modes of thoughts. Self-pity gets fairly close to paranoia, and paranoia is one of the very hardest things to reverse. You do not want to drift into self-pity. It’s a ridiculous way to behave and when you avoid it, you get a great advantage over everybody else or almost everybody else because self-pity is a standard condition, and yet you can train yourself out of it.
Of course the self-serving bias is something you want to get out of yourself. Thinking that what’s good for you is good for the wider civilization and rationalizing all these ridiculous conclusions based on this subconscious tendency to serve one’s self is a terribly inaccurate way to think. Of course you want to drive that out of yourself because you want to be wise, not foolish. You also have to allow for the self-serving bias of everybody else because most people are not going to remove it all that successfully, the human condition being what it is. If you don’t allow for self-serving bias in your conduct, again you’re a fool.
The correct answer to situations like [the Saloman case] was given by Ben Franklin, “If you would persuade, appeal to interest not to reason.”
Another thing, perverse incentives. You do not want to be in a perverse incentive system that’s causing you to behave more and more foolishly or worse and worse - incentives are too powerful a control over human cognition or human behavior. If you’re in one, I don’t have a solution for you. You’ll have to figure it out for yourself, but it’s a significant problem.
Perverse associations, also to be avoided. You particularly want to avoid working under somebody you really don’t admire and don’t want to be like. We’re all subject to control to some extent by authority figures, particularly authority figures that are rewarding us. Getting to work under people we admire requires some talent. The way I solved that is I figured out the people I did admire and I maneuvered cleverly without criticizing anybody so I was working entirely under people I admired. You’re outcome in life will be way more satisfactory and way better if you work under people you really admire. The alternative is not a good idea.
Objectivity maintenance. Darwin paid particular attention to disconfirming evidence. Objectivity maintenance routines are totally required in life if you’re going to be a great thinker. There, we're talking about Darwin’s special attention to disconfirming evidence and also about checklist routines. Checklist routines avoid a lot of errors. You should have all this elementary wisdom and then you should go through a mental checklist in order to use it. There is no other procedure in the world that will work as well.
The last idea that I found very important is that I realized very early that non-egality would work better in the parts of the world that I wanted to inhabit. What do I mean by non-egality? I mean John Wooden when he was the number one basketball coach in the world. He just said to the bottom five players that you don’t get to play. The top seven did all the playing. Well the top seven learned more, remember the learning machine, they learned more because they did all the playing. And when he got to that system he won more than he had ever won before. I think the game of life, in many respects, is about getting a lot of practice into the hands of the people that have the most aptitude to learn and the most tendency to be learning machines. And if you want the very highest reaches of human civilization, that’s where you have to go. You do not want to choose a brain surgeon for your child from 50 applicants where all of them just take turns doing the procedure. You don’t want your airplanes designed that way. You don’t want your Berkshire Hathaway’s run that way. You want to get the power into the right people.
[Told the story 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].
In this world we have two kinds of knowledge. One is Planck knowledge, the people who really know. They’ve paid the dues, they have the aptitude. And then we’ve got chauffeur knowledge. They have learned the talk. They may have a big head of hair, they may have fine temper in the voice, they’ll make a hell of an impression. But in the end, all they have is chauffeur knowledge. I think I’ve just described practically every politician in the United States.
And you are going to have the problem in your life of getting the responsibility into the people with the Planck knowledge [and away from the people with the chauffeur knowledge]. And there are huge forces working against you. My generation has failed you a bit…..but you wouldn’t like it to be too easy now would you?
Another thing that I found is that an intense interest in the subject is indispensable if you’re really going to excel in it. I could force myself to be fairly good in a lot of things but I couldn’t be really good at anything where I didn’t have an intense interest. So to some extent, you’re going to have to follow me. If at all feasible, drift into something where you have an intense interest.
Another thing you have to do, of course, is to have a lot of assiduity. I like that word because it means: sit down on your ass until you do it. Two partners that I chose for one little phase in my life had the following rule when they created a design, build, construction team. They sat down and said, two-man partnership, divide everything equally, here’s the rule: if ever we’re behind in commitments to other people, we will both work 14 hours a day until we’re caught up. Needless to say, that firm didn’t fail. The people died very rich. It’s such a simple idea.
Another thing, of course, is that life will have terrible blows in it, horrible blows, unfair blows. And some people recover and others don’t. And there I think the attitude of Epictetus is the best. He said that every missed chance in life was an opportunity to behave well, every missed chance in life was an opportunity to learn something, and that your duty was not to be submerged in self-pity, but to utilize the terrible blow in constructive fashion. That is a very good idea. You may remember the epitaph which Epictetus left for himself: “Here lies Epictetus, a slave maimed in body, the ultimate in poverty, and the favored of the gods.”
I’ve got a final little idea because I’m all for prudence as well as opportunism. [He talked about his grandfather, Judge Munger, who under spent his income all his life and left his grandmother in comfortable circumstances, which he had to because there were no pensions for federal judges back then. Along the way, he bailed out Charlie’s uncle’s bank back in the ‘30s by taking over 1/3 of his good assets in exchange for bad assets of the bank. He remembered his grandfather’s example in college when he came across] Housman’s poem:
The thoughts of others
Were light and fleeting,
Of lovers’ meeting
Or luck or fame.
Mine were of trouble,
And mine were steady,
So I was ready
When trouble came.
You can say, who wants to go through life anticipating trouble? Well I did. All my life I’ve gone through life anticipating trouble. And here I am, going along in my 84th year and like Epictetus, I’ve had a favored life. It didn’t make me unhappy to anticipate trouble all the time and be ready to perform adequately if trouble came. It didn’t hurt me at all. In fact it helped me.
The last idea I want to give to you…..is that this is not the highest form that a civilization can reach. The highest form a civilization can reach is a seamless web of deserved trust. Not much procedure, just totally reliable people correctly trusting one another. That’s the way an operating room works at the Mayo Clinic. So never forget, when you’re a lawyer, that you may be rewarded for selling this stuff but you don’t have to buy. What you want in your own life is a seamless web of deserved trust. And so if your proposed marriage contract has 47 pages, my suggestion is you not enter.
Well that’s enough for one graduation. I hope these ruminations of an old man are useful to you. In the end I’m like an Old Valiant for Truth in The Pilgrim’s Progress. “My sword I leave to him who can wear it.”
Tuesday, January 30, 2007
A Reminder on American Express
I thought it would be a good time to remind readers what Joel Greenblatt had to say about American Express (AXP) last summer. Although I haven't done the valuation work yet and thus haven't invested in AXP, there are 2 things I do know: (1) American Express is one of the few really great businesses in the world; and (2) Joel Greenblatt is one of the greatest investors in the world.
At the Ira W. Sohn Investment Research Conference last year, Mr. Greenblatt presented his investment thesis for American Express. He stated that he believed the company would earn between $3.70 and $3.75 per share in 2008 and is conservatively worth 20-22 times earnings. That would give a share price 2 years out of mid-$70s to low-$80s. He also mentioned the fact that American Express only has to reinvest about 25% of its earnings for growth, so they get to give shareholders back 75% of their earnings, either through stock buybacks or dividends.
So, although AXP is up from the $51-$52 share price last summer, the recent pullback and current price of about $58 per share certainly looks like something worth taking a further look, especially since AXP is still growing its intrinsic value at a very attractive rate. Afterall, the earnings yield is pretty close to the risk free rate and if that is anywhere close to your opportunity cost, which one would you rather own?
*This is not a recommendation to buy or sell a security. Please do your own research before making an investment decision.
At the Ira W. Sohn Investment Research Conference last year, Mr. Greenblatt presented his investment thesis for American Express. He stated that he believed the company would earn between $3.70 and $3.75 per share in 2008 and is conservatively worth 20-22 times earnings. That would give a share price 2 years out of mid-$70s to low-$80s. He also mentioned the fact that American Express only has to reinvest about 25% of its earnings for growth, so they get to give shareholders back 75% of their earnings, either through stock buybacks or dividends.
So, although AXP is up from the $51-$52 share price last summer, the recent pullback and current price of about $58 per share certainly looks like something worth taking a further look, especially since AXP is still growing its intrinsic value at a very attractive rate. Afterall, the earnings yield is pretty close to the risk free rate and if that is anywhere close to your opportunity cost, which one would you rather own?
*This is not a recommendation to buy or sell a security. Please do your own research before making an investment decision.
Monday, January 29, 2007
So, What's Berkshire Worth Anyway?
It seems to be pretty clear to most value investors that Berkshire Hathaway is a bargain. But, how big of a bargain is it and how much can we expect to make over the next few years by purchasing a stake in Warren Buffett's masterpiece today?
I view the value of Berkshire as consisting of 2 parts: (1) the investments per share (which includes a massive amount of cash on hand and also includes part ownership of some of the best businesses in the world -- Coca-Cola, American Express, Washington Post, etc.), and (2) the value of the operating businesses.
So what are the 2 parts worth? Total cash and investments per share should be a little over $80,000 per share at the end of 2006, so we'll value these at the market value of $80,000. Now, pre-tax income is going to be very good in 2006 because there was very little hurricane activity. Since we are going to be putting a multiple on these earnings, it is necessary that we normalize them. If we assume that 2004 was a normal year, which I feel is conservative because this was the second worst year ever (after 2005) for hurricane losses, then normalized earnings this year should still be about $5,000 per share. So what is a conservative multiple for these earnings? I think considering the quality of the businesses producing these earnings and the current interest rate environment, a 12 multiple on the pre-tax earnings is a safe number, especially since Berkshrire is still one of the fastest growing large caps in the world. So $80,000 in investments per share + ($5,000*12) = $140,000 value per A share ($4,667 per B share).
So, if we assume investments per share grow at an average rate of 8% over the next 3 years and operating earnings grow at an average rate of 10% over the next 3-5 years (both of which I feel are very conservative -- but remember, Berkshire's growth can be a little lumpy), then we get a value 3 years out of about $180,000 per share and 5 years out of about $215,000 per share. This would yield an annual rate of return of about 15-20% per year over the next 3-5 years by purchasing shares around today's price of $108,000 per A share ($3,600 per B share).
What's the best part about this investment? No, it's not that you are getting a very attractive return and the chance to buy into a business with huge competitive advantages and a rock-solid balance sheet at a 20-30% discount to intrinsic value (although that is very nice). The best part about this investment is that you are getting that 20-30% discount without having to pay a penny in premium for the capital allocating ability of Warren Buffett. You're getting a great business, at a very good price, and you're getting "The Great One" for free.
*This is not a recommendation to buy or sell a security. Please do your own research before making an investment decision.
I view the value of Berkshire as consisting of 2 parts: (1) the investments per share (which includes a massive amount of cash on hand and also includes part ownership of some of the best businesses in the world -- Coca-Cola, American Express, Washington Post, etc.), and (2) the value of the operating businesses.
So what are the 2 parts worth? Total cash and investments per share should be a little over $80,000 per share at the end of 2006, so we'll value these at the market value of $80,000. Now, pre-tax income is going to be very good in 2006 because there was very little hurricane activity. Since we are going to be putting a multiple on these earnings, it is necessary that we normalize them. If we assume that 2004 was a normal year, which I feel is conservative because this was the second worst year ever (after 2005) for hurricane losses, then normalized earnings this year should still be about $5,000 per share. So what is a conservative multiple for these earnings? I think considering the quality of the businesses producing these earnings and the current interest rate environment, a 12 multiple on the pre-tax earnings is a safe number, especially since Berkshrire is still one of the fastest growing large caps in the world. So $80,000 in investments per share + ($5,000*12) = $140,000 value per A share ($4,667 per B share).
So, if we assume investments per share grow at an average rate of 8% over the next 3 years and operating earnings grow at an average rate of 10% over the next 3-5 years (both of which I feel are very conservative -- but remember, Berkshire's growth can be a little lumpy), then we get a value 3 years out of about $180,000 per share and 5 years out of about $215,000 per share. This would yield an annual rate of return of about 15-20% per year over the next 3-5 years by purchasing shares around today's price of $108,000 per A share ($3,600 per B share).
What's the best part about this investment? No, it's not that you are getting a very attractive return and the chance to buy into a business with huge competitive advantages and a rock-solid balance sheet at a 20-30% discount to intrinsic value (although that is very nice). The best part about this investment is that you are getting that 20-30% discount without having to pay a penny in premium for the capital allocating ability of Warren Buffett. You're getting a great business, at a very good price, and you're getting "The Great One" for free.
*This is not a recommendation to buy or sell a security. Please do your own research before making an investment decision.
Friday, January 26, 2007
What will this blog be about?
I suppose a logical first post on a blog would be to describe the general direction it will take. So, what will this blog be about? Will it be about investing? Of course. Will it be about value investing? Of course. Will it include a whole lot of other stuff of which I currently have no idea what that other stuff might be? Most definitely.
I hope, above all else, that this blog will represent rationality. I will ask many questions about many things and answer those in which I believe I can provide rational answers. I will discuss some of my investment ideas and research and anything else that may be of interest to me at the time. Most importantly, I will always be open to being proven wrong and to being introduced to new, better ways of thinking. My thinking heroes are, and always will be, Warren Buffett and Charlie Munger. They saved me from remaining part of the herd when it comes to conventional rationality and I could never thank them enough.
I hope, above all else, that this blog will represent rationality. I will ask many questions about many things and answer those in which I believe I can provide rational answers. I will discuss some of my investment ideas and research and anything else that may be of interest to me at the time. Most importantly, I will always be open to being proven wrong and to being introduced to new, better ways of thinking. My thinking heroes are, and always will be, Warren Buffett and Charlie Munger. They saved me from remaining part of the herd when it comes to conventional rationality and I could never thank them enough.
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