Posts Tagged charliemunger
If you already have a million dollars or more, this blogpost is not for you.
For all others, I’ll cut the bullshit and get to the chase. I am just mighty pissed off.
When you have less than a million dollars –
Please don’t listen to any or all the Gurus who are propagating 16% CAGR, 18% CAGR, 20% CAGR. You know the usual spiel. Say, you have 5 Lakh rupees. Gurus recommend that you should be happy be 18% CAGR or 20% CAGR and over a long period of time (40 years), you would be so rich, that even the rich would be ashamed.
For all those studies, where you read that if you had invested in quality at any price, and just held on to them for a long period of time (40 years), you would have made enough money to be proud of yourself.
You really want to know what they DON’T tell you.
By the time you are rich, you will be OLD. You will be very old. Your kids and grand kids, of course, would really appreciate all your journey, effort and all the good things that you have done for them. You will just die as a rich man without all the good things before it. That’s just a tragedy.
Since the readers of this blog are reasonably well versed with numbers, let me illustrate it with numbers.
Let me get the first and the easiest thing out of the way without the numbers. People keep doing these fancy calculations in excel about how much their salary is growing to grow, how health expenses will increase, plug in a sexy inflation number and try to arrive at a figure which they think will be enough for retirement.
Let me solve that for you. You need a million dollars (ex-Mumbai). Unless you want to live the luxurious life of Vijay Mallya ,(well, if you were Mallya, you wouldn’t do all these calculations), a million dollars would let you live and eventually die peacefully.
Ok, now for the numbers bit.
Let’s say you start investing at the age of 27 (well, how better it would be if you could start investing at the age of 15, but try convincing your teenage son or a fresh graduate not to spend on the latest smartphone and you’ll know what I mean). You start with Rs. 5 lakh (You can plug in any arbitary number).
Let’s say you manage to do 18% CAGR over a long period, say 40 years. Do you know how much money you would have by the time you are 67? 37 cr 51 lakh.
Whoa. That’s a lot of amount you say. Definitely it is.
But what would you do with so much amount at 67? You would be old, frail and not really ready to say travel widely or eat whatever you want or whatever shaukh (sic) you have.
Ok. So, how much money would you have by the time you are 57? 7 cr 16 lakh. Did you observe the difference?
Ok. So, how much money would you have by the time you are still fit, healthy and want to do what you want – say at the age of 47? 1 cr 37 lakh.
Did you see the difference? Did you really observe the beauty of compounding? You would not dream to live a reasonably luxurious life, traveling where you want, doing what you want to do with 1 cr 37 lakh.
And that’s my problem with folks preaching ‘my target is 18% cagr because the Gurus said it’, ‘I am ok with 16-20% cagr, but I don’t yet have a million dollars’.
Nobody, or rather, from whatever I have read spells out clearly on this intricate relationship between CAGR and Age. You can be rich, but you are already old.
I would rather die with 10 cr, in the process doing what I want than die with 37 cr to make my children and grand children happy.
And that brings me to my real point.
You should really not be aiming anything less than 35-40% CAGR if you are not already a millionaire. It just sucks not to aim for it.
Why did I say 35-40% at a minimum? That’s because, you can make 100x your money in 15 years with a 36% CAGR. Your 5 lakh will become 5 cr in 15 years (if you start at 27, by the time you are 42 – you are reasonably rich and an almost millionaire). This is not something that I picked up from the now famous 100-to-1 book. That never spoke of age. In fact, he talks very long time frames.
Is this the bull market in me speaking? Definitely. But why not? Look, unless you are outrageously lucky with a stock or timing the depth of a bear market, your BIG returns are going to come only in a bull market. Again, numbers. If a Rs. 20 has to become Rs. 100, you need a 400% return. That same Rs. 100 to come back to Rs. 20 requires just a 80% drop. So, you absolutely need to make killer returns in the bull market to survive the bear market.
People will try to dissaude you by quoting process will get corrupted, people will indulge in speculative stocks etc. My question is – what’s a corrupt process? Just because there is a wave of high quality, high management integrity bull market this time, everybody is on this bandwagon of the right process etc. It’s almost as if investing was just born in 2009.
And speculation. I don’t think speculation is going to net you 35-40% CAGR for 15 years. I have not met anybody yet doing this.
Is this easy? It’s obviously not meant to be easy. Just because you have some internet forums and whatsapp groups these days doesn’t mean investing is easy. There is a lot of hard work, there is a lot of luck and there is a lot of position sizing science involved before you make that million dollars. As Munger says, ‘It’s not meant to be easy. If you think it is easy, you are stupid’.
And speaking of Munger (which, in these days of the current bull market, seem to encapsulate all other Gurus), here’s what he had to say in Snowball – remember, when he was young –
So, for all those people who keep saying 18-20% CAGR, you are either already a millionaire or you are just bullshitting. Aim higher. Work harder. Enjoy the process of investing. And actually enjoy life at the right age. There is no fun in dying rich. And there is a tragedy in dying really rich without having enjoyed or doing what you really wanted to do.
Go for 35-40% CAGR (atleast). Become a millionaire. Live comfortably.
P.S – Cynical folks may obviously point out that 5 lakh is only a starting capital and people will add as and when they grow in life. You know, if people were so disciplined in investing, we’d have a lot more people active in 10 year and 15 year SIPs.
P.P.S – Other folks might point out CAGR is not important but how much, as a % of your networth, is more important to overall gains. Absolutely agree. Convince your friend in a bear market to put 90% of his networth in equities. % of networth is very important, but even with smaller sums of money (and I do think Rs. 5 lakh is a smaller amount of money these days, with freshers from IIMs earning Rs.20 lakh), CAGR at the right levels covers a lot of ground.
Every Tom, Dick and Harry seems to be posting about Berkshire’s Annual Letter 2011. Most of the blogposts I’ve read seem to be interpreting what Buffett said. However, my endeavor in this blogpost is to cull out the bits that I liked (and thought were important) in the Annual Letter and present them here. No interpretations, no extension of logic etc. Just pure excerpts from the annual letter found here. I am sure each one of us on different points on the investing learning curve will interpret his statements differently and there is no one single interpretation that would do justice.
On Berkshire’s intrinsic value,
Our share of their earnings, however, are far from fully reflected in our earnings; only the dividends we receive from these businesses show up in our financial reports. Over time, though, the undistributed earnings of these companies that are attributable to our ownership are of huge importance to us. That’s because they will be used in a variety of ways to increase future earnings and dividends of the investee. They may also be devoted to stock repurchases, which will increase our share of the company’s future earnings.
On Buffett’s Natural Gas bet,
A few years back, I spent about $2 billion buying several bond issues of Energy Future Holdings, an electric utility operation serving portions of Texas. That was a mistake – a big mistake. In large measure, the company’s prospects were tied to the price of natural gas, which tanked shortly after our purchase and remains depressed. Though we have annually received interest payments of about $102 million since our purchase, the company’s ability to pay will soon be exhausted unless gas prices rise substantially. We wrote down our investment by $1 billion in 2010 and by an additional $390 million last year.
On Berkshire’s performance in bull and bear markets,
We’ve regularly emphasized that our book-value performance is almost certain to outpace the S&P 500 in a bad year for the stock market and just as certainly will fall short in a strong up-year. The test is how we do over time. Last year’s annual report included a table laying out results for the 42 five-year periods since we took over at Berkshire in 1965 (i.e., 1965-69, 1966-70, etc.). All showed our book value beating the S&P, and our string held for 2007-11. It will almost certainly snap, though, if the S&P 500 should put together a five-year winning streak (which it may well be on its way to doing as I write this)
On Stock buyback/repurchases,
Charlie and I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.
The first law of capital allocation – whether the money is slated for acquisitions or share repurchases – is that what is smart at one price is dumb at another. (One CEO who always stresses the price/value factor in repurchase decisions is Jamie Dimon at J.P. Morgan; I recommend that you read his annual letter.)
When Berkshire buys stock in a company that is repurchasing shares, we hope for two events: First, we have the normal hope that earnings of the business will increase at a good clip for a long time to come; and second, we also hope that the stock underperforms in the market for a long time as well.
Let’s do the math. If IBM’s stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%.
The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.
On Insurance businesses,
At bottom, a sound insurance operation needs to adhere to four disciplines. It must (1) understand all exposures that might cause a policy to incur losses; (2) conservatively evaluate the likelihood of any exposure actually causing a loss and the probable cost if it does; (3) set a premium that will deliver a profit, on average, after both prospective loss costs and operating expenses are covered; and (4) be willing to walk away if the appropriate premium can’t be obtained. Many insurers pass the first three tests and flunk the fourth.
On his two new personnel,
Todd Combs built a $1.75 billion portfolio (at cost) last year, and Ted Weschler will soon create one of similar size. Each of them receives 80% of his performance compensation from his own results and 20% from his partner’s. When our quarterly filings report relatively small holdings, these are not likely to be buys I made (though the media often overlook that point) but rather holdings denoting purchases by Todd or Ted.
On Berkshire’s derivative positions,
Though our existing contracts have very minor collateral requirements, the rules have changed for new positions. Consequently, we will not be initiating any major derivatives positions. We shun contracts of any type that could require the instant posting of collateral. The possibility of some sudden and huge posting requirement – arising from an out-of-the-blue event such as a worldwide financial panic or massive terrorist attack – is inconsistent with our primary objectives of redundant liquidity and unquestioned financial strength.
On basic choices for investors (which I highly recommend to be read in full rather than this brief summary),
Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.
From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a non-fluctuating asset can be laden with risk.
Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.
The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century. This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future. The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful).
Our first two categories enjoy maximum popularity at peaks of fear: Terror over economic collapse drives individuals to currency-based assets, most particularly U.S. obligations, and fear of currency collapse fosters movement to sterile assets such as gold. We heard “cash is king” in late 2008, just when cash should have been deployed rather than held. Similarly, we heard “cash is trash” in the early 1980s just when fixed-dollar investments were at their most attractive level in memory. On those occasions, investors who required a supportive crowd paid dearly for that comfort.
My own preference – and you knew this was coming – is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment.
One book recommendation,
I think you’ll also like a short book that Peter Bevelin has put together explaining Berkshire’s investment and operating principles. It sums up what Charlie and I have been saying over the years in annual reports and at annual meetings.
(all emphasis mine)
1) NHAI bonds are all over the internet. For the uninitiated, NHAI is issuing bonds at 8.3% coupon rate (Face value: Rs.1000/-) and the best part of it is that they are tax free. As in, these bonds are not like the infrastructure bonds where only your investment (to the extent of Rs.20000/-) is tax deductible, but the interest received on these bonds is taxed. However, in NHAI’s case, the interest is tax free.
These bonds are rated AAA and technically govt. backed (which indicates that the chances of default are close to zero; although after seeing Europe, nobody would trust govt. anymore)
Compare these bonds with SBI bonds issued in Feb/March 2011. These bonds were offered a 9.75% coupon rate (Face value: Rs. 10000/-). However, the interest arising out of these bonds are taxable (as in added to your income, and will be taxed at your marginal rate). More details here
The point of this post is that there is a logical opportunity to make money by buying NHAI bonds and selling SBI bonds (more fancy language – we need to go long NHAI bonds and short SBI bonds). The reasoning is as follows:
Let’s take the case of the 10 yr bond in both NHAI and SBI case.
If you look over at SBI bonds (series N3, which is the 10 year retail bond issue), it is quoting at a price of Rs. 10,705/-. If I had bought these bonds when they were issued (that is, my buying price would be Rs. 10k), my interest per year would be Rs. 975. Consider if my marginal rate is 30%, the real return on these bonds would be 6.83% ((975*.7)/10k). If I buy these bonds at the current rate, my yield would further drop to 6.38%. (I ignored the call option effect here, but including that, the effect would still be very marginal, maybe about 10-15 basis points).
Compare that with the NHAI issue. If I invest in NHAI bonds right now (i.e., at its face value of Rs.1000/-), I will get Rs.83/- every year, translating to a tax free yield of 8.3% (i.e., the coupon rate).
Why would anyone in their right minds invest in SBI bonds which will return them only 6.83% while NHAI bonds will give them 8.3% (NHAI bonds are govt. backed, mind you. Technically, they are more safe than SBI bonds although in reality both carry almost the same risk-free status).
Therefore, my guess is that the markets would recognize this pretty quickly and correct NHAI and SBI bond prices in such a way that the yield on either of the bonds will be very similar. If we hold the assumption that SBI bonds would not get sold (because of lack of liquidity or some such), then NHAI bonds have to rise to Rs.1200/- to equalize the yields. Alternatively, since NHAI bonds will be oversubscribed and hence may quote at a premium of say 5%-7%, SBI bonds can be sold to such a level that the yield on SBI bond is close to the yield on NHAI bonds, which implies a price of Rs. 850-875 for the SBI bond.
Hence, there is a trade here – going long on NHAI bonds and going short on SBI bonds will generate a return of about 10-15% in a short period of time, if not more.
So, why am I writing this and not executing the trade? Well, going long on NHAI bonds is easy (you can subscribe, today!), but going short on SBI bonds is close to impossible (for one, there is no active bond market in India and two, there is no active CDS market on SBI bonds). Therefore, this is a trade which seems very logical, but close to impossible to execute it (unless you have connections and can find some way to short SBI bonds).
2) If you have not read ‘The Art of Stock Picking’ by Charlier Munger, please drop everything else and read it right now. I came across this by happenstance only a few days ago and was kicking myself to have missed out on this gem of a talk by Munger. Reading this once gave me an insight into how to look for a Page, a Titan, a TTK, a Astral and so on and so forth. Must read, bookmark, print out and all that.
Some of the gems include (must read in full for impact though) –
Well, the first rule is that you’ve got to have multiple models because if you just have one or two that you’re using, the nature of human psychology is such that you’ll torture reality so that it fits your models, or at least you’ll think it does.
First, what are the factors that really govern the interests involved, rationally considered? 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 malfunction.
If people tell you what you really don’t want to hear what’s unpleasant there’s an almost automatic reaction of antipathy. You have to train yourself out of it. It isn’t foredestined that you have to be this way. But you will tend to be this way if you don’t think about it.
If it’s a pure commodity like airline seats, you can understand why no one makes any money. As we sit here, just think of what airlines have given to the world safe travel, greater experience, time with your loved ones, you name it. Yet, the net amount of money that’s been made by the shareholders of airlines since Kitty Hawk, is now a negative figure ‑ a substantial negative figure. Competition was so intense that, once it was unleashed by deregulation, it ravaged shareholder wealth in the airline business.
That’s such an obvious concept ‑ that there are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that’s still going to be lousy. The money still won’t come to you. All of the advantages from great improvements are going to flow through to the customers.
n, there are huge advantages for the early birds.And when you’re an early bird,
there’s a model that I call “surfing” ‑ when a surfer gets up and catches the wave and just stays there, he can go a long, long time. But if he gets off the wave, he becomes mired in shallows….But people get long runs when they’re right on the edge of the wave ‑ whether it’s Microsoft or Intel or all kinds of
people, including National Cash Register in the early days.
So you have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don’t, you’re going to lose. And that’s as close to certain as any prediction that you can make. You have to figure out where you’ve got an edge. And you’ve got to play within your own circle of competence.
And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.
The way to win is to work, work, work, work and hope to have a few insights.
In the stock market, some railroad that’s beset by better competitors and tough unions may be available at one-third of its book value. In contrast, IBM in its heyday might be selling at 6 times book value. So it’s just like the pari-mutuel system. Any damn fool could plainly see that IBM had better business prospects than the railroad. But once you put the price into the formula, it wasn’t so clear anymore what was going to work best for a buyer choosing between the stocks. So it’s a lot like a pari-mutuel system. And, therefore, it gets very hard to beat.
In investment management today, everybody wants not only to win, but to have a yearly outcome path that never diverges very much from a standard path except on the upside. Well, that is a very artificial, crazy construct. That’s the equivalent in investment management to the custom of binding the feet of Chinese women. It’s the equivalent of what Nietzsche meant when he criticized the man who had a lame leg and was proud of it.
It’s so damned elementary that even bright people are going to have limited,
really valuable insights in a very competitive world when they’re fighting against other very bright, hardworking people.
Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.
So the trick is getting into better businesses. And that involves all of these advantages of scale that you could consider momentum effects.
However, averaged out, betting on the quality of a business is better than betting on the quality of management. In other words, if you have to choose one, bet on the business momentum, not the brilliance of the manager.
Within the growth stock model, there’s a sub-position: There are actually businesses, that you will find a few times in a lifetime, where any manager could raise the return enormously just by raising prices and yet they haven’t done it. So they have huge untapped pricing power that they’re not using. That is the ultimate no-brainer.
I think a select few a small percentage of the investment managers can deliver value added. But I don’t think brilliance alone is enough to do it. I think that you have to have a little of this discipline of calling your shots and loading up if you want to maximize your chances of becoming one who provides above average real returns for clients over the long pull.