March 18, 2012

Warren Buffett's co-worker Charles Munger on why cereals are better than airlines

Charles Munger has been Warren Buffett's closest co-worker for many years. Here are some points from a speech he gave in 1994:
  • You need some general education before you can be a great stock-picker. You should educate yourself in different areas. You can't solve every problem with one model from one area.
  • You need basic math and learn about things like compounded interest. You also need to use the math routinely in life and practice it.
  • You have to know accounting since it is the language of practical business life. You also need to know the limits in account - how do you really know how long a machine can be profitable?
  • The models that are most reliable come from sciences such as engineering.
  • The psychology of misjudgment is important to learn. For example, The principle of social proof: We are all influenced by what we see others do. If everybody is buying something, we think it is better. We do not like to be the one who is not following the group.
  • The advantages of scale. 
    • If you are big, it is easier to remain big. You would probably buy a Coca Cola for $1 - and not the smaller competitor to Coca Cola for $0.8. You know the taste of coke, and you don't want to gamble with just $0.2 - and maybe buy something cheaper, but less tasty.
    • But big is not always a good thing. Big organizations are sometimes less flexible and somewhat corrupt. The constant curse of scale is that it leads to big, dumb bureaucracy.   
  • Cereals are more profitable than airlines - but Charles Munger doesn't know why and he suggests someone should find out. Almost every cereal manufacturer makes money, and almost every airline loses money. 
  • The efficient market theory is roughly right - markets are quite efficient and it is quite hard for anybody to beat the market as a stock picker. The average result has to be the average result - everybody can't beat the market.
  • But when the market is not efficient, you have to bet big when you are buying a stock.