Charlie Munger: 2 Hour Interview – Opportunity and the Black Death

Becky Quick interviewed Warren Buffett’s partner, Charlie Munger, for two hours at the University of Michigan. Tariq Ali of Street Capitalist has the link.

Warren Buffett is gun scope focused on making money. Charlie Munger, like Benjamin Graham, scans a wider field of vision. Also like Benjamin Graham, Charlie Munger talks a lot about professional ethics. He blames accountants for Enron and says Arthur Andersen got what it deserved.  He talks about how his dad almost lied on a hunting license to save five dollars. Why? Because he was with friends who were lying on theirs. The moral of the story: avoid temptation. And learn psychology. A good place to start is Poor Charlie’s Almanack.

On opportunities, Charlie quotes his great-grandfather, a pioneer and banker who fought in the Black Hawk War:

“When you find one, my dear grandchildren, and you can clearly recognize it, seize it boldly and don’t do it small.”

Seizing opportunities is Charlie’s best advice.  What’s his best quote?

“The Black Death was good for the survivors.”

The Black Death was a 1300s plague that killed 30% to 50% of all Europeans. It cut the ropes of the rigid labor market that tied down Europe’s economy.

I know what you’re thinking. With unemployment at 9.6%, we could use a plague. It’s nature’s own stimulus package.

Like wars, plagues always kill but seldom stimulate. The Roman plague of the 160s killed millions and did nothing for the economy.

Besides, quantitative easing is more sanitary.…

arnes & Noble: CEO Campaigns for Riggio – Bookstore Darwinism

William Lynch, CEO of Barnes & Noble (BKS), sent a letter to shareholders as part of the Riggio party’s campaign for the September 28th board election against Ron Burkle.

The letter’s chewy center is bookstore Darwinism:

a. Fewer bookstore competitors – It’s clear there will be fewer bookstores in this country and as we continue to maintain the best real estate portfolio of locations and best run retail bookstore model, our stores will be the beneficiary of this consolidation…

b. Fewer stores selling books – approximately 50% of the $21 billion U.S. book business is transacted in non-book retail outlets such as mass merchants, as well as drug and mass discounters. As the physical book market contracts over the next four years, from approximately $21 billion to $19 billion, we see many of these non-book retailers de-emphasizing the book category with greatly reduced shelf space and in some cases eliminating it all together. This will provide an opportunity for us.

Evidence of this shake-out already exists as our share gains from our largest physical bookstore competitors have accelerated in the last year. Today, the Company owns approximately 18% of the U.S book market, and we expect that figure to grow to 20-25% over the next three years.

I was just chatting about this with Sivaram of Can Turles Fly?. My expectation: The offline book market will shrivel while Barnes & Noble takes a bigger piece of that shriveled pie.

See: Would Benjamin Graham Buy Barnes & Noble at $15 a share?…

Barnes & Noble: On the Proxy Campaign Trail

A Barnes & Noble (BKS) shareholder wrote this at GuruFocus:

I’ve gotten no less than 5 (maybe more) phone calls trying to influence how I vote my tiny stake of 1,900 shares. Mostly I don’t answer them, but in (one) case where I did, and had a little debate, the caller seemed fairly well informed on the issues. Of course he was following a script but even so…(he was) fairly good at responding to my questions…It must cost a lot to staff up, train, call up every small shareholder, and be ready to answer questions. 

It does cost a lot. And the parties don’t staff up themselves. They hire expert proxy campaigners. That’s what Benjamin Graham did in his 1927 proxy campaign against the Bushnell brothers at Northern Pipeline. And that’s what Ron Burkle is doing in his 2010 proxy campaign against the Riggio brothers.

Ron Burkle hired Mackenzie Partners. This is what Mackenzie does:

…initial tasks…include analyzing the shareholder base and developing voting projections based on our knowledge of the…constituents’ past and…future voting practices…From there, we develop a…communications strategy based on the issues involved and launch a comprehensive campaign. The solicitation…includes a full-scale telephone campaign to retail holders, (and) in-person visits and conference calls with management of the largest institutions…

Sounds like James Carville for corporations.

You can read about Benjamin Graham’s proxy campaign at Northern Pipeline in Chapter 11 of Benjamin Graham: The Memoirs of the Dean of Wall Street.

The Barnes & Noble polls close September 28th.…

Interactive Investor: One of my Favorite Blogs

Richard Beddard writes about stocks Benjamin Graham would buy. Beddard focuses on U.K. stocks. If you use a discount broker who doesn’t let you place orders overseas, you probably think you’re saving money. You’re not. Cheap brokers cost Graham and Dodders money. Lost Benjamin Graham bargains cost more than commissions. My advice: switch brokers and read Beddard.

If Benjamin Graham was alive, he’d be in foreign micro caps. It’s easy to find cheap micros overseas. It’s hard in the U.S. Lots of American investors focus on cheap micros. You need to go where the competition ain’t.

Beddard writes well. There’s more muscle than fat on his prose.

He sticks to Orwell’s rules:

1. Never use a metaphor, simile, or other figure of speech which you are used to seeing in print.
2. Never use a long word where a short one will do.
3. If it is possible to cut a word out, always cut it out.
4. Never use the passive where you can use the active. 
5. Never use a foreign phrase, a scientific word, or a jargon word if you can think of an everyday English equivalent.

I would add another: Never use a pun.

Beddard does. And he does it well (Dart: in for the long haul). You can tell Beddard reads Krugman. Krugman also does puns well (Brother, Can You Paradigm?).

If you’re looking for the best Benjamin Graham bargains in Britain, check out the Interactive Investor blog.…

What are the 4 Most Important Numbers to Know About a Stock?

A lot of investors think they have to be scientists. They have to be rational. They have to be objective. And they have to weigh all the facts equally.

Some of those are good ideas. Others aren’t. Yes – You need to be rational when judging a stock. But I’m not sure you need to be objective. Let’s talk a bit about that.

I’ve said before that if you want to become a better investor, you should think less about stocks and think more about thinking.

Thinking about how you think is not objective. But it is rational.

Being objective means focusing on the stock instead of the investor. Scientists write papers from an objective view. They describe their experiments in a way others can copy. They don’t make science personal.

So why should you make investing personal?

Because it’s safer that way.

There’s a great book called

The Checklist Manifesto: How to Get Things Right

. It talks about how checklists can be used to break complex tasks into simple steps that prevent mistakes. Not just for amateurs. But for professionals. For experts.

People like doctors, pilots, – and yes – even investors make fewer mistakes when they use checklists.

I’ve talked about checklists in the past. In “Investor Questions Podcast #11: Why Does Evergreen Energy’s Stock Always Go Down?”, I said you should focus on stocks with Z-Scores of 3 or more, F-Scores of 3 or more, and 10 straight years of positive free cash flow.

I still think that’s a good idea. Investors who stick to those rules will make fewer mistakes than investors who don’t.

But that checklist isn’t good enough. There are other mistakes you can make. The checklist I gave you in podcast #11 won’t protect you against all of them. The most important rule I left off was price. Investors who don’t add a price rule to their checklist can still lose a lot of money.

I’ll give you a fuller checklist later. For now let’s talk about why you need a checklist in the first place.

I want you to take off your lab coat and put on a fedora. Stop thinking of yourself as a scientist and start thinking of yourself as a detective.

You walk into a hotel room. There’s a dead man in a business suit lying face down on the carpet.

The hotel room is full of clues. Dozens of them. But how do you know what’s a clue? How do you make sense of the data?

There are two ways to tackle this problem. One way is to start in gatherer mode. You walk around the room looking at stuff, taking pictures, and writing things down.

The other way is to start in hunter mode. Instead of starting with the data you start with a theory. Or a question. Or a hunch. You follow that thread as far as it takes you.

Which way is best?

I don’t like either of them. The gatherer mode …

Suggested Link: Charlie Munger Op-Ed

Warren Buffett’s business partner, Charlie Munger, writes an op-ed in the today’s Washington Post.

Read “How We Can Restore Confidence” by Charlie Munger.…

On the President’s Address

President Obama spoke about the economy last night. I am not a political commentator, so I may not be able to correctly score the politics of the fight.

The President began by painting gloomy word pictures of a Depression – without actually using the “D” word:

“…They can’t pay their bills and they’ve stopped spending money. And because they’ve stopped spending money, more businesses have been forced to lay off more workers. Local TV stations have started running public service announcements that tell people where to find food banks, even as the food banks don’t have enough to meet the demand… As we speak, similar scenes are playing out in cities and towns across the country. Last Monday, more than 1,000 men and women stood in line for 35 firefighter jobs in Miami.”

Theory

Although the President said – correctly I think – that most economists agree a stimulus is necessary, agreeing a stimulus is necessary and agreeing it is sufficient are two different things. Economists don’t agree a stimulus is sufficient. Nor did most of them think very highly of a New Deal redux like this one until more proven measures – like monetary stimulus – were already depleted.

What economists do agree on is that the economy is very bad and that the number of tools that have been tried before and not yet tried this time around is very low. In technical terms, they are advocating a kitchen sink approach.

Seventy years of social science have given government a whole new toolbox with which to approach the same problems (of 1929) and despite the change in process the outcome has remained the same.

Eventually, this will make for an interesting case study. The idea that the Great Depression was a unique and unrepeatable event will be challenged. The idea that lessons learned in retrospect can be applied in the future has been seriously compromised. It is not clear that in an ever-changing system like an economy, theory could keep pace with reality. Prescriptive economics may not work. But prescriptions have to be made nonetheless.

Politics

The President made some errors last night. He gave in to partisan temptations and reminded Republicans of their previously profligate ways.

An excellent point – if he was aiming for honesty – but honesty is rarely the best policy. Utility is.

He needs to pass bills – not win elections – and maybe his little reminders helped Democratic chances at the ballot box, but he hurt the country’s chances of getting the bills it needs passed. It was an understandable but idiotic mistake. It wasn’t just partisan politics, it was poor tactics.

The President is a lot weaker than he appears. Constitutionally, his legislative powers are – well – non-existent. A President is not a Prime Minister.

The man himself is popular. His policies are not. His party’s majorities are large, but not large enough to pass bills in the Senate – even without any Democratic defections. And there will be defections. …

On the Geithner Plan

Yesterday, the stock market tanked as Treasury Secretary Geithner outlined his financial stability plan. Blogger Felix Salmon noticed the mirror image:

“I like the symmetry here. On November 21, when Barack Obama announced that he was nominating Tim Geithner to be his Treasury secretary, the Dow rose 494 points and broke through the 8,000 barrier. On February 10, when Geithner gave his first major speech as Treasury secretary, the Dow fell 273 points and broke through the 8,000 barrier.”

I once wrote that “the market is a lot like a fun house mirror”. New data affects prices indirectly. And sometimes the reflection comes out warped. Ben Graham said it best:

“…the influence of…analytical factors over the market price is both partial and indirect – partial, because it frequently competes with purely speculative factors which influence the price in the opposite direction; and indirect, because it acts through the intermediary of people’s sentiments and decisions.”

I’m not sure if the market decline had more to do with the substance of Geithner’s speech or the sentiments of traders. I certainly didn’t think it justified marking American businesses down a couple percentage points.

Personally, I didn’t find the plan especially bad. I thought it would have a lot more detail. I’m glad it didn’t. How could anyone come up with a detailed plan at this point?

Some banks – some very big banks – are going to have to be recapitalized. The only way to start that process is to look at the economic reality under the accounting fictions that are bank balance sheets.

It doesn’t matter if you use mark-to-market or mark-to-model, you’re still going to end up with some very inaccurate balance sheet numbers in times like these.

Markets – be they liquid or illiquid – value assets oddly from time to time. And models are as flawed as their makers.

At least Geithner is talking about a stress test. That sounds like the first step toward recapitalizations.

Unfortunately, he’s also talking about private money coming in to buy toxic assets. Unless there are ironclad government guarantees involved I’m not sure that will fly.

Some of these assets weren’t just overpriced the way houses were – they were inherently flawed.

Toxic Assets

Accountants record. They don’t analyze.

There isn’t a right number and a wrong number. There are just useful numbers and useless numbers.

For example, it makes not one iota of difference to me – as an investor – what dollar value public Company A assigns its 23% stake in public Company B, because public Company B files with the SEC. All I need to know is the number Company A put on its books and where I can read all about Company B. The rest is up to me.

Unfortunately, you can’t do this with “toxic assets”.

In her book Dear Mr. Buffett, Janet Tavakoli quotes an email from Warren Buffett:

“I’ve looked at the prospectuses, and they are not easy to read. If you want to

On Buffett and Derivatives

Review by Geoff Gannon

Janet Tavakoli’s Dear Mr. Buffett is an unusual amalgam of a simple, personal story and a complex, public one.

The personal story begins with an invitation from the Oracle himself:

“Be sure to stop by if you are ever in Omaha and want to talk credit derivatives…”

Buffett had just re-read Tavakoli’s Credit Derivatives & Synthetic Structures and noticed a letter from the author tucked between the book’s pages. With a quick apology and the above invitation, Buffett unknowingly set in motion a process that would give the public a rare glimpse inside his inner sanctum.

Tavakoli took Buffett up on his offer and recorded the ensuing encounter in Chapter 2 of Dear Mr. Buffett.

The promise of this tantalizing morsel will draw buyers in. But readers will find much more than another book on Warren Buffett.

The real story begins in 1998. That’s when Buffett’s Berkshire Hathaway bought General Re. Berkshire was a major insurer with a home-grown reinsurance business. General Re was considered the crème de la crème of reinsurers.

I say “considered”, because unbeknownst to Buffett there was a lot of crap among the crème. That crap came in the form of derivatives.

Meta-Bets

Derivatives are exactly what they sound like. The value of a plain vanilla security like a stock or bond is derived from the underlying business – its assets, earnings, and capacity to meet obligations. These are simple, straight bets.

Derivatives are meta-bets. Like an ironic narrator, they stand a level above the action. Instead of betting on a business, they bet on the betting on that business. Instead of betting on a borrower’s future income and collateral they bet on the bet a banker made on that borrower’s future income and collateral.

If the investment banks that created these derivatives used the same ad agency as BASF, their slogan would be: “We don’t make a lot of the securities you buy; we make a lot of the securities you buy riskier”.

Theory of Everything

Tavakoli has her own Theory of Everything in Finance:

“The value of any financial transaction is based on the timing of cash flows, the frequency of cash flows, the magnitude of cash flows, and the probability of receipt of those cash flows.”

It’s a simple theory. Derivatives are complex. But no amount of complexity can free a security from this iron clad rule.

“In finance, we make up a lot of fancy and difficult to pronounce names and create complicated models to erect a barrier to entry that keeps out lay people. High barriers tend to protect high pay. I’ve written about some of these esoteric products: credit derivatives, CDOs, and more, but before I look at the latest hot label dreamt up, I look at the cash to find out what is really going on.”

So does Warren Buffett.

Buffett Bets

As Tavakoli points out, financial journalists seized on Buffett’s description of derivatives as “financial weapons of mass destruction” while completely ignoring another …

On Buffett’s Big Blunder

Warren Buffett is getting a lot of criticism for a big blunder. He sold put options on four stock indexes – including the S&P; 500.

Buffett described these derivatives in his 2007 letter to shareholders:

“Last year I told you that Berkshire had 62 derivative contracts that I manage (We also have a few left in the General Re runoff book). Today, we have 94 of these…”

Financial Weapons of Mass Destruction

Before criticizing Buffett, we need to take a moment to praise him. After all, the guy had the foresight to clean out the General Re derivatives before the credit crisis hit.

Yes, Berkshire took a loss. And, yes, Buffett clearly overestimated both the rationality and morality of the human capital over at General Re – much as he had at Salomon.

Buffett was never well-liked at Salomon. And I’m sure there are some folks (or ex-folks) at General Re who don’t find him quite as avuncular as he is reputed to be.

I would say they simply don’t understand each other, if I didn’t think the truth was exactly the opposite. Buffett got to know Salomon and General Re better with time – and the better he knew them, the less he liked them.

The General Re derivatives were a disaster averted. Had Berkshire kept the book intact or never acquired General Re, we’d be hearing a lot more about what was in that book.

Is it a mere coincidence that Buffett, the CEO who made the decision to unwind the General Re book, called derivatives “financial weapons of mass destruction”?

No. Buffet saw something in that book. And he did something about it. Most CEOs did not.

Style Drift

Enough praise. Back to the blunder:

“Over the past five years, Buffett frequently called derivatives ‘financial weapons of mass destruction’, comparing derivates to ‘hell…easy to enter and almost impossible to exit.’ Yet, he has, very much out of character, immersed himself in a large and, thus far, unprofitable derivative transaction. His investment successes have not been in speculating in the market (something he has been critical of) but rather by purchasing easily understandable companies with dependable cash flows…”

That’s Doug Kass writing lasting year about Buffett’s style drift. He goes on to write:

“It immediately occurred to me after gazing at Buffett’s style drift (manifested in Berkshire Hathaway’s large first quarter derivate losses) that he might be increasingly viewed as the New Millennium’s Ben Franklin, a man who wrote ‘early to bed and early to rise’ but spent many of his evenings in France, whoring all night…”

Not surprisingly, Kass is negative on Berkshire stock. I won’t argue that point. Berkshire has fallen. And short sellers have made money.

Kass presents Buffett’s derivative transaction as “speculating in the market”.

Insurance

Let me offer an alternate explanation.

Berkshire Hathaway has substantial insurance operations. It is, in fact, a huge insurer of large, often unusual risks. In some cases, Berkshire prefers to keeps such risks to itself instead …