Latest / The Dutch Investors / #66 | Lesson from Charlie Munger and Warren Buffett on value investing | Superinvestors Ep. 1

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#66 | Lesson from Charlie Munger and Warren Buffett on value investing | Superinvestors Ep. 1 · The Dutch Investors

0:00
SPEAKER_00: Welcome back to the Dutch investors.
0:02
SPEAKER_00: This episode kicks off a brand new series where we dive into the ideas, habits, and philosophy of the greatest investors of all time.
0:12
SPEAKER_00: And of course, we have to start with the best of them all, Warren Buffett and Charlie Munger.
0:20
SPEAKER_00: Welcome to part one of Lessons from Buffett and Munger.
0:25
SPEAKER_00: Today we're going back to where it all began to talk about something everyone's heard of, a few truly understand.
0:33
SPEAKER_00: Value investing.
0:36
SPEAKER_00: It sounds simple, but behind those two words lies a lifetime of wisdom about patience, discipline, and understanding what you actually own.
0:47
SPEAKER_00: So enjoys today's episode, Lessons from Super Investors, Buffett Amonger, Part 1.
1:08
SPEAKER_00: Let's begin with how they describe value investing themselves.
1:14
SPEAKER_02: Charlie and I think there is no other kind of investment than a value investment.
1:18
SPEAKER_02: In other words, we we don't know how anybody would invest in a non-value investment.
1:23
SPEAKER_02: And so we we've always been puzzled by the term value and saying that contrasts with growth or anything.
1:30
SPEAKER_02: Value relates to getting a lot for the expectable flow of cash in the future in terms of what you're laying out today.
1:38
SPEAKER_02: So we we we've always, every time somebody characterizes us as value investors, we we always ask them what other kind can there be.
1:46
SPEAKER_00: The primary objective in investing, whether you're buying a single share or stock or taking control of an entire company, is really quite simple.
1:55
SPEAKER_00: You want to get more than what you pay for.
1:59
SPEAKER_00: That's it.
2:00
SPEAKER_00: The essence of investing.
2:03
SPEAKER_00: Warren Buffett once put it neatly: value investing is getting a lot for the expectable future cash flows in terms of what you're laying out today.
2:13
SPEAKER_00: The truth is, many investors begin their journey chasing a perfect formula, some magic equation that will always point to the right answer.
2:23
SPEAKER_00: But that search, as experience teaches us, is a fool's errand.
2:29
SPEAKER_00: Value investing is often treated as a special category, something distinct from other forms of investment, like growth investing, for example.
2:40
SPEAKER_00: But for Buffett and Munger, the distinction is meaningless.
2:44
SPEAKER_00: To them, all intelligent investing is value investing.
2:49
SPEAKER_00: He argues that the core of the idea is incredibly simple and applies whether you're buying an entire business or a single share.
2:57
SPEAKER_00: It's about figuring out how much you're getting for what you're paying for.
3:02
SPEAKER_00: The idea that value is distinct from growth is silly, because growth is a component of value.
3:10
SPEAKER_00: Growth only adds value if the capital put into the business today yields a return later on that is significantly higher than current interest rates.
3:21
SPEAKER_00: If a business grows but requires a lot of capital just to achieve that growth, it can actually destroy value.
3:29
SPEAKER_00: The classic case of bad growth, as Buffett points out, is the airline business.
3:35
SPEAKER_00: The essential lesson here goes back centuries to the philosopher ASOP.
3:40
SPEAKER_02: Well, the question about growth and value, as we've we've addressed in past annual reports, but in in in there they are not two distinct categories of business.
3:49
SPEAKER_02: Every business is worth the present.
3:52
SPEAKER_02: If you knew what it was going to be able to disgorge in cash between now and judgment day, you could come to a precise figure as to what it is worth today.
4:01
SPEAKER_02: But there is no distinction in our minds between growth and value.
4:06
SPEAKER_02: Every business we look at as being a value proposition, the potential for growth and the likelihood of good economics being attached to that growth are part of the equation.
4:22
SPEAKER_02: First investment permitter that I know of was delivered in about 600 B.C.
4:28
SPEAKER_02: by Aesop.
4:30
SPEAKER_02: And Aesop, you'll remember, said, a bird in the hand is worth two in the bush.
4:35
SPEAKER_02: Incidentally, Aesop did not know it was 600 B.C.
4:38
SPEAKER_02: He was smart, but he wasn't that smart.
4:42
SPEAKER_02: Now, Aesop was on to something, but he didn't finish it.
4:46
SPEAKER_02: Because there's a couple of other questions that go along with that.
4:49
SPEAKER_02: But it is an investment equation.
4:51
SPEAKER_02: A bird in the hand is worth two in the bush.
4:53
SPEAKER_02: He forgot to say exactly when you were going to get the two in the from the bush.
4:59
SPEAKER_02: And he forgot to say what interest rates were that you had to measure this against.
5:03
SPEAKER_02: But if he'd given those two factors, he would have defined investment for the next 2,600 years.
5:10
SPEAKER_02: Because a bird in the hand is, you know, you will trade a bird in the hand, which is investing, you lay out cash today, and then the question is, as an investment decision, you have to you have to evaluate how many birds are in the bush.
5:24
SPEAKER_02: You may think there are two birds in the bush or three birds in the bush, and you have to decide when they're going to come out and when you're going to acquire them.
5:31
SPEAKER_00: A bird in the hand is worth two in the bush.
5:34
SPEAKER_00: That is the basis of all investment.
5:36
SPEAKER_00: The complication comes with when the two factors ASOP left out, when you get the birds, and what the prevailing interest rates are that you have to measure them against.
5:48
SPEAKER_00: But if the definition is that simple, why is investing so incredibly difficult?
5:54
SPEAKER_00: It has been proven that over 80% of all investors don't beat the index long term.
6:00
SPEAKER_00: Munger argues that the difficulty comes from the way investment is taught.
6:05
SPEAKER_00: They both criticize business schools for focusing on complex, mathematical-based concepts like modern portfolio theory, diversification, which, as Munger notes, are just trying to imitate the supposed precision of physics, what he calls physics envy.
6:25
SPEAKER_00: Because the truth is, investing is not about advanced mathematics.
6:30
SPEAKER_00: Let's listen in.
6:37
SPEAKER_02: I think they've taught the students a lot of nonsense about investments, but but I don't think that's been the cause of great societal problems.
6:44
SPEAKER_02: What do you think?
6:45
SPEAKER_01: No, but it was a considerable sin.
6:52
SPEAKER_01: Well, you want to elaborate on what was the more sinful No no I think business school education's improving.
7:04
SPEAKER_02: Is the implication from a low base or I'd agree with that.
7:16
SPEAKER_02: Now in investing, I would say that the silliest stuff that we've seen taught at major business schools probably has been in maybe it's because it's the area that we operate in, but has been in the investment area.
7:29
SPEAKER_02: It is astounding to me how uh the schools have focused on sort of one fad after another, and and it's usually been very mathematically based.
7:40
SPEAKER_02: When it's become very popular, it's almost impossible to resist if you're if you if you hope to make progress in in faculty advancement.
7:48
SPEAKER_02: You know, really investing is not that complicated.
7:51
SPEAKER_02: I would have, you know, a couple of courses.
7:54
SPEAKER_02: I would have a course on how to value a business, and I would have a course on how to think about markets.
8:00
SPEAKER_02: And I think if people grasp uh the basic principles in those two courses, that they would be far better off than if they were exposed to a lot of things like modern portfolio theory or option pricing.
8:13
SPEAKER_02: I mean, who needs option pricing to be in an investment business?
8:16
SPEAKER_02: And that uh they've tried to make it a lot more difficult, and of course, that's what the high priests in any in any particular arena do.
8:24
SPEAKER_02: They have to convince the the laity that that the priests have to be listened to.
8:28
SPEAKER_02: Charlie?
8:29
SPEAKER_01: Well, the the folly creeps into the accounting too.
8:33
SPEAKER_01: A very long-term option.
8:35
SPEAKER_01: On a big business, you understand the stock of a big business that you understand, or even a stock market index, the optimal way to price it is not by using black shoals.
8:46
SPEAKER_01: And yet the accounting provision does that.
8:49
SPEAKER_01: They want some kind of a standardized solution that requires them not to think too hard.
8:53
SPEAKER_01: And and they have one.
9:01
SPEAKER_02: Is there anybody we've forgotten to offend if the field send a note up?
9:07
SPEAKER_00: It's kind of incredible how smart and funny this buffet and monger combination was.
9:13
SPEAKER_00: But as they elaborated on, the real key to success isn't having an high IQ or having access to complex models.
9:22
SPEAKER_00: It's much more about temperament, about patience, but also about avoiding those big mistakes.
9:30
SPEAKER_00: And by avoiding those big mistakes, they mostly mean not losing so much money that you get wiped out.
9:38
SPEAKER_00: Buffett's famous analogy is that he looks for one foot bars to step over, not seven foot bars to jump over.
9:46
SPEAKER_00: Part of this simplicity involves knowing what you don't know.
9:50
SPEAKER_00: What Buffett calls divining your circle of competence.
9:54
SPEAKER_00: Let's listen.
9:57
SPEAKER_02: I mean, uh I think it was Tom Watson Sr.
10:00
SPEAKER_02: said, I'm genius, but I'm smart in spots, and I stay around those spots.
10:03
SPEAKER_02: There's a lot to that.
10:04
SPEAKER_02: And knowing your circle of competence is where that perimeter is, is enormously important.
10:09
SPEAKER_02: There are all kinds of things I can't do.
10:11
SPEAKER_02: And there's plenty of companies I can't analyze, but I don't have to worry about that.
10:15
SPEAKER_01: Well, part of our secret is that we don't attempt to know a lot of things.
10:19
SPEAKER_01: We have a I have a pile on my desk that solves most of my problems.
10:25
SPEAKER_01: It's called the too hard pile.
10:27
SPEAKER_01: And I just keep shifting things to the too hard pile.
10:31
SPEAKER_01: And every once in a while, an easy decision comes along and I make it.
10:35
SPEAKER_01: That's my system.
10:36
SPEAKER_01: Everything was the too hard pile, except for a few easy decisions which I make promptly.
10:44
SPEAKER_00: If you have to work hard to understand an investment, just put it in the too hard pile.
10:51
SPEAKER_00: Just like Munger did to most companies.
10:54
SPEAKER_00: He didn't worry about things that were too difficult.
10:58
SPEAKER_00: He could have spent hours learning new industries or technologies, but he just focused on what he did know and what he could understand.
11:06
SPEAKER_00: That's what worked.
11:07
SPEAKER_00: So why change a winning formula?
11:10
SPEAKER_00: For both Buffett and Munger, the circle of competence means they avoid businesses where change is rapid, like technology.
11:19
SPEAKER_00: It means that sometimes you should be willing to trade the possibility of a big payoff for a certain payoff.
11:27
SPEAKER_00: For many, that's a no-go or very difficult.
11:30
SPEAKER_00: But investing is a game of concentrating on a fat pitch.
11:36
SPEAKER_02: The most important thing is to be able to define which ones you can come to an intelligent decision on and which ones are beyond your capacity to evaluate.
11:47
SPEAKER_02: You don't have to be right about thousands and thousands of thousands of companies.
11:51
SPEAKER_02: You only have to be right about a couple.
11:53
SPEAKER_02: I m I met Bill Gates on July 5th, 1991.
11:56
SPEAKER_02: We were out in Seattle, and Bill said, you've got to have a computer.
12:01
SPEAKER_02: And I said, why?
12:03
SPEAKER_02: And he said, well, he said, you can do your income tax on it.
12:06
SPEAKER_02: I said, I don't have any income.
12:08
SPEAKER_02: Bercher doesn't pay a dividend.
12:10
SPEAKER_02: He said, well, you can keep track of your portfolio.
12:13
SPEAKER_02: And I said, I only have one stock.
12:14
SPEAKER_02: I said, I mean he says it's going to change everything.
12:19
SPEAKER_02: And I said, well, will it change whether people chew gum?
12:23
SPEAKER_02: And he said, well, probably not.
12:25
SPEAKER_02: And I said, well, will it change what kind of gum they chew?
12:29
SPEAKER_02: I said, well, then I'll stick to chewing gum and you stick to computers, you know.
12:33
SPEAKER_02: I don't have to understand all kinds of business.
12:36
SPEAKER_02: There's all kinds of business I don't understand.
12:38
SPEAKER_02: But there's thousands of opportunities there.
12:41
SPEAKER_02: Ted Williams wrote a book called The Science of Hitting.
12:44
SPEAKER_02: And in the science of hitting, he's got a diagram, shows him at the plate, and he's got the strike zone divided into 77 squares, each the size of a baseball.
12:54
SPEAKER_02: And he says, if I only swing at pitches in my sweep zone, which he shows there, and he has what his batting average would be, which is 400.
13:03
SPEAKER_02: If he had to swing at low outside pitches, but still in the in the strike zone, his average would be 230.
13:09
SPEAKER_02: He said the most important thing in hitting is waiting for the right pitch.
13:12
SPEAKER_02: Now he was at a disadvantage because if the count was 0 and 2 or 1 and 2 or so on, even if that ball was down where he was only going to bat 230, he had to swing at it.
13:21
SPEAKER_02: In investing, there's no called strikes.
13:24
SPEAKER_02: People can throw Microsoft at me and you know, you you name it, any any stock, General Motors, uh, and I don't have to swing.
13:32
SPEAKER_02: And nobody's gonna call me out on called strikes.
13:35
SPEAKER_02: I only get a strike called if I swing at a pitch and miss.
13:38
SPEAKER_02: So I can wait there and look at thousands of companies day after day, and only when I see something I understand and when I like the price at which it's selling, then if I swing, if I if I hit it fine, if I miss it, it's uh it it's it's it's a strike.
13:53
SPEAKER_02: But it's an enormously advantageous game.
13:55
SPEAKER_02: And it's a terrible mistake to think you have to have an opinion on everything.
13:59
SPEAKER_02: You only have to have an opinion on a few things.
14:02
SPEAKER_02: In fact, I've told students if when they got out of school they got a punch card with 20 punches on it, and that's all the investment decisions they got to make in their entire life, they would get very rich because they would think very hard about each one.
14:17
SPEAKER_02: And you don't need 20 right decisions to get very rich.
14:20
SPEAKER_02: You know, four or five will probably do it over time.
14:23
SPEAKER_00: So we've heard what investing is, and that all investing is value investing.
14:30
SPEAKER_00: We've learned that growth is a component of value investing, and that we should keep things as simple as possible and stick to what we know and can understand.
14:39
SPEAKER_00: And once we find something attractive that we can understand, we have to swing at the opportunity.
14:47
SPEAKER_00: Useful stuff so far.
14:49
SPEAKER_00: But I think it's useful to go a bit deeper and really understand why they don't want to invest in the next big thing and stick to what they know.
15:00
SPEAKER_00: But also why they sort of deviated from it when they invested in Apple, because if you look at it objectively, it's a technology company, something Buffett wanted to stay away from this is what they said uh Apple you know has a position with consumers where they're paying, you know, maybe they pay fifteen hundred bucks or whatever it may be for a phone, and these same people pay thirty-five thousand dollars for having a second car.
15:33
SPEAKER_02: And if they had to give up a second car or give up their iPhone, they'd give up their second car.
15:38
SPEAKER_02: I mean, it's it's an extraordinary.
15:40
SPEAKER_02: Probably we don't have anything like that that we own a hundred percent of, but we're very, very, very happy to have 5.6 or whatever it may be percent, and we're delighted every tenth of a percent that goes up.
15:53
SPEAKER_01: It's a very odd thing for us to do.
15:55
SPEAKER_01: Obviously, we've got no special insights as to how sticky Apple's business is.
16:01
SPEAKER_01: Apple has a very sticky bunch of customers.
16:05
SPEAKER_01: Will they be able to keep that going?
16:07
SPEAKER_01: And if so, how long?
16:09
SPEAKER_01: I don't know, but I think the chances are pretty good it's gonna be quite sticky, and that's why we bought it.
16:15
SPEAKER_02: But it is an unbelievable company.
16:18
SPEAKER_02: I mean, that it it's an amazing business, and you can put all their products on a dining room table.
16:22
SPEAKER_02: I mean, that is not that's not the way it used to be in this country.
16:26
SPEAKER_02: We we took a large position in Apple, which I do regard as more a consumer goods company in terms of certain economic characteristics, although that it you know it has a huge tech component in terms of what that product can do or what other people might come along to do to leapfrog it in some way.
16:48
SPEAKER_02: But I I uh I think I'll I think I'll end up being with no guarantees, but I think I'll end up being one for two instead of O for two, but we'll find out.
16:58
SPEAKER_00: Many investors still think certain companies like Alphabet or Amazon are not value investing.
17:06
SPEAKER_00: So, how should we think about getting into these faster growing larger companies?
17:12
SPEAKER_00: Let's see what the deo said.
17:14
SPEAKER_02: It's interesting that you the term value investing came up because I can assure you that both managers who he is a value investor.
17:23
SPEAKER_02: Uh the idea that value is somehow connected to book value or low price earnings ratios or anything, uh, as Charlie has said, all investing is value investing.
17:33
SPEAKER_02: I mean, you you're you're putting out some money now to get more later on, and you're making a calculation as to the probabilities of getting that money and when you'll get it and what interest rates will be in between, and all the same calculation goes into it, whether you're buying some bank at 70% of book value or you're buying Amazon at some very high multiple of reported earnings.
17:54
SPEAKER_02: Amazon, the people making the decision on Amazon are absolutely as much value investors as I was when I was looking around for all these things selling below working capital uh years ago.
18:08
SPEAKER_02: So that has not changed.
18:11
SPEAKER_02: The considerations are identical when you buy Amazon versus bank stock that's uh looks cheap statistically against book value or earnings or something of the sort.
18:24
SPEAKER_02: Uh in the end, it all goes back uh to ESOP.
18:30
SPEAKER_00: How do we find businesses that fit your criteria?
18:34
SPEAKER_00: And for this snippet, we're going back to my birth year, 1998, on stock selection.
18:40
SPEAKER_00: Let's listen in.
18:42
SPEAKER_02: We look at it as the criteria for selecting a stock is really the criteria for looking at a business.
18:47
SPEAKER_02: Uh we are looking for a business we can understand.
18:51
SPEAKER_02: That means they sell a product that we think we understand and we understand the nature of their competition, what could go wrong with it over time.
18:58
SPEAKER_02: And then when we find that business, we try to figure out whether the economics of it means the earning power over the next five or ten or fifteen years is likely to be good and getting better or poor and getting worse.
19:12
SPEAKER_02: But but we try to evaluate that future stream, and then we try to decide whether we're getting in with some people that we feel comfortable being in with, and then we uh try to decide what's an appropriate price for what we've seen up to that point.
19:27
SPEAKER_02: And uh as I said last year, what we do is simple but not necessarily easy.
19:34
SPEAKER_02: Uh the uh what the checklist that is going through our mind is not very complicated.
19:42
SPEAKER_02: Um knowing what you don't know is important, and sometimes that's not easy.
19:47
SPEAKER_02: And knowing the future is definitely uh it's impossible in many cases, in our view, and and it's difficult in others, and sometimes it's relatively easy, and we're looking for the ones that are relatively easy.
19:58
SPEAKER_02: And then when you get all through, you have to find it at a price that's that's interesting to you, and that's very difficult for us now, although there have been periods in the past where it's been a total cinch.
20:09
SPEAKER_02: Uh and that's what goes through our minds.
20:11
SPEAKER_02: If you were thinking of buying a service station or a dry cleaning establishment or a convenience store in Omaha to invest your life savings in and run as a business, you think about the same sort of things.
20:23
SPEAKER_02: You think about the competitive position and what it would look like five or ten years from now and how you were going to run it, who was gonna run it for you, and how much you had to pay.
20:31
SPEAKER_02: And that's exactly what we think of as when we look at a stock, because a stock is nothing other than a piece of a business.
20:37
SPEAKER_02: Charlie?
20:38
SPEAKER_01: If finance were when finance is properly taught, uh it should be taught from cases where uh the investment decision is easy.
20:51
SPEAKER_00: So what can we take away from this episode?
20:54
SPEAKER_00: That investing isn't about formulas or forecasts, but about developing the right cast of mind.
21:03
SPEAKER_00: One that's always learning, always questioning, and always striving to understand the world just a little better each day.
21:13
SPEAKER_00: That was part one of our series of super investors.
21:17
SPEAKER_00: Join us next time as we dive into more lessons from Warren Buffett and Charlie Munger.
21:23
SPEAKER_00: As always, stay curious, keep learning, and happy investing.