elementary worldly wisdom

4/9/2015 YCombinator:ElementaryWorldlyWisdom

https://old.ycombinator.com/munger.html 1/21

ALessononElementary,WorldlyWisdomAsItRelatesToInvestmentManagement&BusinessCharlesMunger,USCBusinessSchool,1994

I'mgoingtoplayaminortrickonyoutodaybecausethesubjectofmytalkistheartofstockpickingasasubdivisionoftheartofworldlywisdom.ThatenablesmetostarttalkingaboutworldlywisdomamuchbroadertopicthatinterestsmebecauseIthinkalltoolittleofitisdeliveredbymoderneducationalsystems,atleastinaneffectiveway.

Andtherefore,thetalkissortofalongthelinesthatsomebehavioristpsychologistscallGrandma'sruleafterthewisdomofGrandmawhenshesaidthatyouhavetoeatthecarrotsbeforeyougetthedessert.

Thecarrotpartofthistalkisaboutthegeneralsubjectofworldlywisdomwhichisaprettygoodwaytostart.Afterall,thetheoryofmoderneducationisthatyouneedageneraleducationbeforeyouspecialize.AndIthinktosomeextent,beforeyou'regoingtobeagreatstockpicker,youneedsomegeneraleducation.

So,emphasizingwhatIsometimeswaggishlycallremedialworldlywisdom,I'mgoingtostartbywaltzingyouthroughafewbasicnotions.

Whatiselementary,worldlywisdom?Well,thefirstruleisthatyoucan'treallyknowanythingifyoujustrememberisolatedfactsandtryandbang'emback.Ifthefactsdon'thangtogetheronalatticeworkoftheory,youdon'thavetheminausableform.

You'vegottohavemodelsinyourhead.Andyou'vegottoarrayyourexperiencebothvicariousanddirectonthislatticeworkofmodels.Youmayhavenoticedstudentswhojusttrytorememberandpoundbackwhatisremembered.Well,theyfailinschoolandinlife.You'vegottohangexperienceonalatticeworkofmodelsinyourhead.

Whatarethemodels?Well,thefirstruleisthatyou'vegottohavemultiplemodelsbecauseifyoujusthaveoneortwothatyou'reusing,thenatureofhumanpsychologyissuchthatyou'lltorturerealitysothatitfitsyourmodels,oratleastyou'llthinkitdoes.Youbecometheequivalentofachiropractorwho,ofcourse,isthegreatboobinmedicine.

It'sliketheoldsaying,"Tothemanwithonlyahammer,everyproblemlookslikeanail."Andofcourse,that'sthewaythechiropractorgoesaboutpracticingmedicine.Butthat'saperfectlydisastrouswaytothinkandaperfectlydisastrouswaytooperateintheworld.Soyou'vegottohavemultiplemodels.

Andthemodelshavetocomefrommultipledisciplinesbecauseallthewisdomoftheworldisnottobefoundinonelittleacademicdepartment.That'swhypoetryprofessors,byandlarge,aresounwiseinaworldlysense.Theydon'thaveenoughmodelsintheirheads.Soyou'vegottohavemodelsacrossafairarrayofdisciplines.

Youmaysay,"MyGod,thisisalreadygettingwaytootough."But,fortunately,itisn'tthattoughbecause80or90importantmodelswillcarryabout90%ofthefreightin



makingyouaworldlywiseperson.And,ofthose,onlyamerehandfulreallycarryveryheavyfreight.

Solet'sbrieflyreviewwhatkindofmodelsandtechniquesconstitutethisbasicknowledgethateverybodyhastohavebeforetheyproceedtobeingreallygoodatanarrowartlikestockpicking.

Firstthere'smathematics.Obviously,you'vegottobeabletohandlenumbersandquantitiesbasicarithmetic.Andthegreatusefulmodel,aftercompoundinterest,istheelementarymathofpermutationsandcombinations.Andthatwastaughtinmydayinthesophomoreyearinhighschool.Isupposebynowingreatprivateschools,it'sprobablydowntotheeighthgradeorso.

It'sverysimplealgebra.ItwasallworkedoutinthecourseofaboutoneyearbetweenPascalandFermat.Theyworkeditoutcasuallyinaseriesofletters.

It'snotthathardtolearn.Whatishardistogetsoyouuseitroutinelyalmosteverydayofyourlife.TheFermat/Pascalsystemisdramaticallyconsonantwiththewaythattheworldworks.Andit'sfundamentaltruth.Soyousimplyhavetohavethetechnique.

Manyeducationalinstitutionsalthoughnotnearlyenoughhaverealizedthis.AtHarvardBusinessSchool,thegreatquantitativethingthatbondsthefirstyearclasstogetheriswhattheycalldecisiontreetheory.Alltheydoistakehighschoolalgebraandapplyittoreallifeproblems.Andthestudentsloveit.They'reamazedtofindthathighschoolalgebraworksinlife....

Byandlarge,asitworksout,peoplecan'tnaturallyandautomaticallydothis.Ifyouunderstandelementarypsychology,thereasontheycan'tisreallyquitesimple:Thebasicneuralnetworkofthebrainistherethroughbroadgeneticandculturalevolution.Andit'snotFermat/Pascal.Itusesaverycrude,shortcuttypeofapproximation.It'sgotelementsofFermat/Pascalinit.However,it'snotgood.

Soyouhavetolearninaveryusablewaythisveryelementarymathanduseitroutinelyinlifejustthewayifyouwanttobecomeagolfer,youcan'tusethenaturalswingthatbroadevolutiongaveyou.Youhavetolearntohaveacertaingripandswinginadifferentwaytorealizeyourfullpotentialasagolfer.

Ifyoudon'tgetthiselementary,butmildlyunnatural,mathematicsofelementaryprobabilityintoyourrepertoire,thenyougothroughalonglifelikeaoneleggedmaninanasskickingcontest.You'regivingahugeadvantagetoeverybodyelse.

OneoftheadvantagesofafellowlikeBuffett,whomI'veworkedwithalltheseyears,isthatheautomaticallythinksintermsofdecisiontreesandtheelementarymathofpermutationsandcombinations....

Obviously,youhavetoknowaccounting.It'sthelanguageofpracticalbusinesslife.Itwasaveryusefulthingtodelivertocivilization.I'vehearditcametocivilizationthroughVenicewhichofcoursewasoncethegreatcommercialpowerintheMediterranean.However,doubleentrybookkeepingwasahellofaninvention.

Andit'snotthathardtounderstand.

Butyouhavetoknowenoughaboutittounderstanditslimitationsbecausealthoughaccountingisthestartingplace,it'sonlyacrudeapproximation.Andit'snotveryhardtounderstanditslimitations.Forexample,everyonecanseethatyouhavetomoreorlessjustguessattheusefullifeofajetairplaneoranythinglikethat.Justbecauseyouexpressthedepreciationrateinneatnumbersdoesn'tmakeitanythingyoureallyknow.

Intermsofthelimitationsofaccounting,oneofmyfavoritestoriesinvolvesavery



greatbusinessmannamedCarlBraunwhocreatedtheCFBraunEngineeringCompany.Itdesignedandbuiltoilrefinerieswhichisveryhardtodo.AndBraunwouldgetthemtocomeinontimeandnotblowupandhaveefficienciesandsoforth.Thisisamajorart.

AndBraun,beingthethoroughTeutonictypethathewas,hadanumberofquirks.Andoneofthemwasthathetookalookatstandardaccountingandthewayitwasappliedtobuildingoilrefineriesandhesaid,"Thisisasinine."

Sohethrewallofhisaccountantsoutandhetookhisengineersandsaid,"Now,we'lldeviseourownsystemofaccountingtohandlethisprocess."Andinduetime,accountingadoptedalotofCarlBraun'snotions.Sohewasaformidablywillfulandtalentedmanwhodemonstratedboththeimportanceofaccountingandtheimportanceofknowingitslimitations.

Hehadanotherrule,frompsychology,which,ifyou'reinterestedinwisdom,oughttobepartofyourrepertoireliketheelementarymathematicsofpermutationsandcombinations.

HisruleforalltheBraunCompany'scommunicationswascalledthefiveW'syouhadtotellwhowasgoingtodowhat,where,whenandwhy.AndifyouwrotealetterordirectiveintheBraunCompanytellingsomebodytodosomething,andyoudidn'ttellhimwhy,youcouldgetfired.Infact,youwouldgetfiredifyoudidittwice.

Youmightaskwhythatissoimportant?Well,againthat'saruleofpsychology.Justasyouthinkbetterifyouarrayknowledgeonabunchofmodelsthatarebasicallyanswerstothequestion,why,why,why,ifyoualwaystellpeoplewhy,they'llunderstanditbetter,they'llconsideritmoreimportant,andthey'llbemorelikelytocomply.Eveniftheydon'tunderstandyourreason,they'llbemorelikelytocomply.

Sothere'sanironrulethatjustasyouwanttostartgettingworldlywisdombyaskingwhy,why,why,incommunicatingwithotherpeopleabouteverything,youwanttoincludewhy,why,why.Evenifit'sobvious,it'swisetostickinthewhy.

Whichmodelsarethemostreliable?Well,obviously,themodelsthatcomefromhardscienceandengineeringarethemostreliablemodelsonthisEarth.AndengineeringqualitycontrolatleastthegutsofitthatmatterstoyouandmeandpeoplewhoarenotprofessionalengineersisverymuchbasedontheelementarymathematicsofFermatandPascal:

Itcostssomuchandyougetsomuchlesslikelihoodofitbreakingifyouspendthismuch.It'sallelementaryhighschoolmathematics.AndanelaborationofthatiswhatDemingbroughttoJapanforallofthatqualitycontrolstuff.

Idon'tthinkit'snecessaryformostpeopletobeterriblyfacileinstatistics.Forexample,I'mnotsurethatIcanevenpronouncethePoissondistribution.ButIknowwhataGaussianornormaldistributionlookslikeandIknowthateventsandhugeaspectsofrealityendupdistributedthatway.SoIcandoaroughcalculation.

ButifyouaskmetoworkoutsomethinginvolvingaGaussiandistributiontotendecimalpoints,Ican'tsitdownanddothemath.I'mlikeapokerplayerwho'slearnedtoplayprettywellwithoutmasteringPascal.

Andbytheway,thatworkswellenough.ButyouhavetounderstandthatbellshapedcurveatleastroughlyaswellasIdo.

And,ofcourse,theengineeringideaofabackupsystemisaverypowerfulidea.Theengineeringideaofbreakpointsthat'saverypowerfulmodel,too.Thenotionofacriticalmassthatcomesoutofphysicsisaverypowerfulmodel.

Allofthesethingshavegreatutilityinlookingatordinaryreality.Andallofthiscost



benefitanalysishell,that'sallelementaryhighschoolalgebra,too.It'sjustbeendolledupalittlebitwithfancylingo.

Isupposethenextmostreliablemodelsarefrombiology/physiologybecause,afterall,allofusareprogrammedbyourgeneticmakeuptobemuchthesame.

Andthenwhenyougetintopsychology,ofcourse,itgetsverymuchmorecomplicated.Butit'sanungodlyimportantsubjectifyou'regoingtohaveanyworldlywisdom.

Andyoucandemonstratethatpointquitesimply:There'snotapersoninthisroomviewingtheworkofaveryordinaryprofessionalmagicianwhodoesn'tseealotofthingshappeningthataren'thappeningandnotseealotofthingshappeningthatarehappening.

Andthereasonwhyisthattheperceptualapparatusofmanhasshortcutsinit.Thebraincannothaveunlimitedcircuitry.Sosomeonewhoknowshowtotakeadvantageofthoseshortcutsandcausethebraintomiscalculateincertainwayscancauseyoutoseethingsthataren'tthere.

Nowyougetintothecognitivefunctionasdistinguishedfromtheperceptualfunction.Andthere,youareequallymorethanequallyinfactlikelytobemisled.Again,yourbrainhasashortageofcircuitryandsoforthandit'stakingallkindsoflittleautomaticshortcuts.

Sowhencircumstancescombineincertainwaysormorecommonly,yourfellowmanstartsactinglikethemagicianandmanipulatesyouonpurposebycausingyourcognitivedysfunctionyou'reapatsy.

Andsojustasamanworkingwithatoolhastoknowitslimitations,amanworkingwithhiscognitiveapparatushastoknowitslimitations.Andthisknowledge,bytheway,canbeusedtocontrolandmotivateotherpeople....

SothemostusefulandpracticalpartofpsychologywhichIpersonallythinkcanbetaughttoanyintelligentpersoninaweekisungodlyimportant.Andnobodytaughtittomebytheway.Ihadtolearnitlaterinlife,onepieceatatime.Anditwasfairlylaborious.It'ssoelementarythoughthat,whenitwasallover,Ifeltlikeafool.

Andyeah,I'dbeeneducatedatCalTechandtheHarvardLawSchoolandsoforth.Soveryeminentplacesmiseducatedpeoplelikeyouandme.

Theelementarypartofpsychologythepsychologyofmisjudgment,asIcallitisaterriblyimportantthingtolearn.Thereareabout20littleprinciples.Andtheyinteract,soitgetsslightlycomplicated.Butthegutsofitisunbelievablyimportant.

Terriblysmartpeoplemaketotallybonkersmistakesbyfailingtopayheedtoit.Infact,I'vedoneitseveraltimesduringthelasttwoorthreeyearsinaveryimportantway.Younevergettotallyovermakingsillymistakes.

There'sanothersayingthatcomesfromPascalwhichI'vealwaysconsideredoneofthereallyaccurateobservationsinthehistoryofthought.Pascalsaidinessence,"Themindofmanatoneandthesametimeisboththegloryandtheshameoftheuniverse."

Andthat'sexactlyright.Ithasthisenormouspower.However,italsohasthesestandardmisfunctionsthatoftencauseittoreachwrongconclusions.Italsomakesmanextraordinarilysubjecttomanipulationbyothers.Forexample,roughlyhalfofthearmyofAdolfHitlerwascomposedofbelievingCatholics.Givenenoughcleverpsychologicalmanipulation,whathumanbeingswilldoisquiteinteresting.

Personally,I'vegottensothatInowuseakindoftwotrackanalysis.First,whatare



thefactorsthatreallygoverntheinterestsinvolved,rationallyconsidered?Andsecond,whatarethesubconsciousinfluenceswherethebrainatasubconsciouslevelisautomaticallydoingthesethingswhichbyandlargeareuseful,butwhichoftenmisfunction.

Oneapproachisrationalitythewayyou'dworkoutabridgeproblem:byevaluatingtherealinterests,therealprobabilitiesandsoforth.Andtheotheristoevaluatethepsychologicalfactorsthatcausesubconsciousconclusionsmanyofwhicharewrong.

Nowwecometoanothersomewhatlessreliableformofhumanwisdommicroeconomics.Andhere,Ifinditquiteusefultothinkofafreemarketeconomyorpartlyfreemarketeconomyassortoftheequivalentofanecosystem....

ThisisaveryunfashionablewayofthinkingbecauseearlyinthedaysafterDarwincamealong,peopleliketherobberbaronsassumedthatthedoctrineofthesurvivalofthefittestauthenticatedthemasdeservingpoweryouknow,"I'mtherichest.Therefore,I'mthebest.God'sinhisheaven,etc."

Andthatreactionoftherobberbaronswassoirritatingtopeoplethatitmadeitunfashionabletothinkofaneconomyasanecosystem.Butthetruthisthatitisalotlikeanecosystem.Andyougetmanyofthesameresults.

Justasinanecosystem,peoplewhonarrowlyspecializecangetterriblygoodatoccupyingsomelittleniche.Justasanimalsflourishinniches,similarly,peoplewhospecializeinthebusinessworldandgetverygoodbecausetheyspecializefrequentlyfindgoodeconomicsthattheywouldn'tgetanyotherway.

Andoncewegetintomicroeconomics,wegetintotheconceptofadvantagesofscale.Nowwe'regettingclosertoinvestmentanalysisbecauseintermsofwhichbusinessessucceedandwhichbusinessesfail,advantagesofscaleareungodlyimportant.

Forexample,onegreatadvantageofscaletaughtinallofthebusinessschoolsoftheworldiscostreductionsalongthesocalledexperiencecurve.Justdoingsomethingcomplicatedinmoreandmorevolumeenableshumanbeings,whoaretryingtoimproveandaremotivatedbytheincentivesofcapitalism,todoitmoreandmoreefficiently.

Theverynatureofthingsisthatifyougetawholelotofvolumethroughyourjoint,yougetbetteratprocessingthatvolume.That'sanenormousadvantage.Andithasalottodowithwhichbusinessessucceedandfail....

Let'sgothroughalistalbeitanincompleteoneofpossibleadvantagesofscale.Somecomefromsimplegeometry.Ifyou'rebuildingagreatsphericaltank,obviouslyasyoubuilditbigger,theamountofsteelyouuseinthesurfacegoesupwiththesquareandthecubicvolumegoesupwiththecube.Soasyouincreasethedimensions,youcanholdalotmorevolumeperunitareaofsteel.

Andthereareallkindsofthingslikethatwherethesimplegeometrythesimplerealitygivesyouanadvantageofscale.

Forexample,youcangetadvantagesofscalefromTVadvertising.WhenTVadvertisingfirstarrivedwhentalkingcolorpicturesfirstcameintoourlivingroomsitwasanunbelievablypowerfulthing.Andintheearlydays,wehadthreenetworksthathadwhateveritwassay90%oftheaudience.

Well,ifyouwereProcter&Gamble,youcouldaffordtousethisnewmethodofadvertising.Youcouldaffordtheveryexpensivecostofnetworktelevisionbecauseyouweresellingsomanycansandbottles.Somelittleguycouldn't.Andtherewasnowayofbuyingitinpart.Therefore,hecouldn'tuseit.Ineffect,ifyoudidn'thaveabigvolume,youcouldn'tusenetworkTVadvertisingwhichwasthemosteffectivetechnique.



SowhenTVcamein,thebrandedcompaniesthatwerealreadybiggotahugetailwind.Indeed,theyprosperedandprosperedandprospereduntilsomeofthemgotfatandfoolish,whichhappenswithprosperityatleasttosomepeople....

Andyouradvantageofscalecanbeaninformationaladvantage.IfIgotosomeremoteplace,ImayseeWrigleychewinggumalongsideGlotz'schewinggum.Well,IknowthatWrigleyisasatisfactoryproduct,whereasIdon'tknowanythingaboutGlotz's.Soifoneis40centsandtheotheris30cents,amIgoingtotakesomethingIdon'tknowandputitinmymouthwhichisaprettypersonalplace,afterallforalousydime?

So,ineffect,Wrigley,simplybybeingsowellknown,hasadvantagesofscalewhatyoumightcallaninformationaladvantage.

Anotheradvantageofscalecomesfrompsychology.Thepsychologistsusethetermsocialproof.Weareallinfluencedsubconsciouslyandtosomeextentconsciouslybywhatweseeothersdoandapprove.Therefore,ifeverybody'sbuyingsomething,wethinkit'sbetter.Wedon'tliketobetheoneguywho'soutofstep.

Again,someofthisisatasubconsciouslevelandsomeofitisn't.Sometimes,weconsciouslyandrationallythink,"Gee,Idon'tknowmuchaboutthis.TheyknowmorethanIdo.Therefore,whyshouldn'tIfollowthem?"

Thesocialproofphenomenonwhichcomesrightoutofpsychologygiveshugeadvantagestoscaleforexample,withverywidedistribution,whichofcourseishardtoget.OneadvantageofCocaColaisthatit'savailablealmosteverywhereintheworld.

Well,supposeyouhavealittlesoftdrink.ExactlyhowdoyoumakeitavailableallovertheEarth?Theworldwidedistributionsetupwhichisslowlywonbyabigenterprisegetstobeahugeadvantage....Andifyouthinkaboutit,onceyougetenoughadvantagesofthattype,itcanbecomeveryhardforanybodytodislodgeyou.

There'sanotherkindofadvantagetoscale.Insomebusinesses,theverynatureofthingsistosortofcascadetowardtheoverwhelmingdominanceofonefirm.

Themostobviousoneisdailynewspapers.There'spracticallynocityleftintheU.S.,asidefromafewverybigones,wherethere'smorethanonedailynewspaper.

Andagain,that'sascalething.OnceIgetmostofthecirculation,Igetmostoftheadvertising.AndonceIgetmostoftheadvertisingandcirculation,whywouldanyonewantthethinnerpaperwithlessinformationinit?Soittendstocascadetoawinnertakeallsituation.Andthat'saseparateformoftheadvantagesofscalephenomenon.

Similarly,allthesehugeadvantagesofscaleallowgreaterspecializationwithinthefirm.Therefore,eachpersoncanbebetteratwhathedoes.

Andtheseadvantagesofscalearesogreat,forexample,thatwhenJackWelchcameintoGeneralElectric,hejustsaid,"Tohellwithit.We'reeithergoingtobe#1or#2ineveryfieldwe'reinorwe'regoingtobeout.Idon'tcarehowmanypeopleIhavetofireandwhatIhavetosell.We'regoingtobe#1or#2orout."

Thatwasaverytoughmindedthingtodo,butIthinkitwasaverycorrectdecisionifyou'rethinkingaboutmaximizingshareholderwealth.AndIdon'tthinkit'sabadthingtodoforacivilizationeither,becauseIthinkthatGeneralElectricisstrongerforhavingJackWelchthere.

Andtherearealsodisadvantagesofscale.Forexample,webywhichImeanBerkshireHathawayarethelargestshareholderinCapitalCities/ABC.Andwehadtradepublicationstherethatgotmurderedwhereourcompetitorsbeatus.Andthe



waytheybeatuswasbygoingtoanarrowerspecialization.

We'dhaveatravelmagazineforbusinesstravel.Sosomebodywouldcreateonewhichwasaddressedsolelyatcorporatetraveldepartments.Likeanecosystem,you'regettinganarrowerandnarrowerspecialization.

Well,theygotmuchmoreefficient.Theycouldtellmoretotheguyswhorancorporatetraveldepartments.Plus,theydidn'thavetowastetheinkandpapermailingoutstuffthatcorporatetraveldepartmentsweren'tinterestedinreading.Itwasamoreefficientsystem.Andtheybeatourbrainsoutaswereliedonourbroadermagazine.

That'swhathappenedtoTheSaturdayEveningPostandallthosethings.They'regone.WhatwehavenowisMotocrosswhichisreadbyabunchofnutswholiketoparticipateintournamentswheretheyturnsomersaultsontheirmotorcycles.Buttheycareaboutit.Forthem,it'stheprincipalpurposeoflife.AmagazinecalledMotocrossisatotalnecessitytothosepeople.Anditsprofitmarginswouldmakeyousalivate.

Justthinkofhownarrowcastthatkindofpublishingis.Sooccasionally,scalingdownandintensifyinggivesyouthebigadvantage.Biggerisnotalwaysbetter.

Thegreatdefectofscale,ofcourse,whichmakesthegameinterestingsothatthebigpeopledon'talwayswinisthatasyougetbig,yougetthebureaucracy.Andwiththebureaucracycomestheterritorialitywhichisagaingroundedinhumannature.

Andtheincentivesareperverse.Forexample,ifyouworkedforAT&Tinmyday,itwasagreatbureaucracy.Whointhehellwasreallythinkingabouttheshareholderoranythingelse?Andinabureaucracy,youthinktheworkisdonewhenitgoesoutofyourinbasketintosomebodyelse'sinbasket.But,ofcourse,itisn't.It'snotdoneuntilAT&Tdeliverswhatit'ssupposedtodeliver.Soyougetbig,fat,dumb,unmotivatedbureaucracies.

Theyalsotendtobecomesomewhatcorrupt.Inotherwords,ifI'vegotadepartmentandyou'vegotadepartmentandwekindofsharepowerrunningthisthing,there'ssortofanunwrittenrule:"Ifyouwon'tbotherme,Iwon'tbotheryouandwe'rebothhappy."Soyougetlayersofmanagementandassociatedcoststhatnobodyneeds.Then,whilepeoplearejustifyingalltheselayers,ittakesforevertogetanythingdone.They'retooslowtomakedecisionsandnimblerpeopleruncirclesaroundthem.

Theconstantcurseofscaleisthatitleadstobig,dumbbureaucracywhich,ofcourse,reachesitshighestandworstformingovernmentwheretheincentivesarereallyawful.Thatdoesn'tmeanwedon'tneedgovernmentsbecausewedo.Butit'saterribleproblemtogetbigbureaucraciestobehave.

Sopeoplegotostratagems.Theycreatelittledecentralizedunitsandfancymotivationandtrainingprograms.Forexample,forabigcompany,GeneralElectrichasfoughtbureaucracywithamazingskill.Butthat'sbecausetheyhaveacombinationofageniusandafanaticrunningit.Andtheyputhiminyoungenoughsohegetsalongrun.Ofcourse,that'sJackWelch.

Butbureaucracyisterrible....Andasthingsgetverypowerfulandverybig,youcangetsomereallydysfunctionalbehavior.LookatWestinghouse.Theyblewbillionsofdollarsonabunchofdumbloanstorealestatedevelopers.Theyputsomeguywho'dcomeupbysomecareerpathIdon'tknowexactlywhatitwas,butitcouldhavebeenrefrigeratorsorsomethingandallofasudden,he'sloaningmoneytorealestatedevelopersbuildinghotels.It'saveryunequalcontest.Andinduetime,theylostallthosebillionsofdollars.

CBSprovidesaninterestingexampleofanotherruleofpsychologynamely,Pavlovianassociation.Ifpeopletellyouwhatyoureallydon'twanttohearwhat'sunpleasantthere'sanalmostautomaticreactionofantipathy.Youhavetotrainyourselfoutofit.Itisn'tforedestinedthatyouhavetobethisway.Butyouwilltendtobethiswayif



youdon'tthinkaboutit.

TelevisionwasdominatedbyonenetworkCBSinitsearlydays.AndPaleywasagod.Buthedidn'tliketohearwhathedidn'tliketohear.Andpeoplesoonlearnedthat.SotheytoldPaleyonlywhathelikedtohear.Therefore,hewassoonlivinginalittlecocoonofunrealityandeverythingelsewascorruptalthoughitwasagreatbusiness.

Sotheidiocythatcreptintothesystemwascarriedalongbythishugetide.ItwasaMadHatter'steapartythelasttenyearsunderBillPaley.

Andthatisnottheonlyexamplebyanymeans.Youcangetseveremisfunctioninthehighranksofbusiness.Andofcourse,ifyou'reinvesting,itcanmakealotofdifference.IfyoutakealltheacquisitionsthatCBSmadeunderPaley,aftertheacquisitionofthenetworkitself,withallhisadvisorshisinvestmentbankers,managementconsultantsandsoforthwhoweregettingpaidveryhandsomelyitwasabsolutelyterrible.

Forexample,hegavesomethinglike20%ofCBStotheDumontCompanyforatelevisionsetmanufacturerwhichwasdestinedtogobroke.Ithinkitlastedalloftwoorthreeyearsorsomethinglikethat.Soverysoonafterhe'dissuedallofthatstock,Dumontwashistory.Yougetalotofdysfunctioninabigfat,powerfulplacewherenoonewillbringunwelcomerealitytotheboss.

SolifeisaneverlastingbattlebetweenthosetwoforcestogettheseadvantagesofscaleononesideandatendencytogetalotliketheU.S.AgricultureDepartmentontheothersidewheretheyjustsitaroundandsoforth.Idon'tknowexactlywhattheydo.However,Idoknowthattheydoverylittleusefulwork.

Onthesubjectofadvantagesofeconomiesofscale,Ifindchainstoresquiteinteresting.Justthinkaboutit.Theconceptofachainstorewasafascinatinginvention.Yougetthishugepurchasingpowerwhichmeansthatyouhavelowermerchandisecosts.Yougetawholebunchoflittlelaboratoriesoutthereinwhichyoucanconductexperiments.Andyougetspecialization.

Ifonelittleguyistryingtobuyacross27differentmerchandisecategoriesinfluencedbytravelingsalesmen,he'sgoingtomakealotofpoordecisions.Butifyourbuyingisdoneinheadquartersforahugebunchofstores,youcangetverybrightpeoplethatknowalotaboutrefrigeratorsandsoforthtodothebuying.

Thereverseisdemonstratedbythelittlestorewhereoneguyisdoingallthebuying.It'sliketheoldstoryaboutthelittlestorewithsaltalloveritswalls.Andastrangercomesinandsaystothestoreowner,"Youmustsellalotofsalt."Andhereplies,"No,Idon't.Butyoushouldseetheguywhosellsmesalt."

Sotherearehugepurchasingadvantages.Andthentherearetheslicksystemsofforcingeveryonetodowhatworks.Soachainstorecanbeafantasticenterprise.

It'squiteinterestingtothinkaboutWalMartstartingfromasinglestoreinBentonville,ArkansasagainstSears,Roebuckwithitsname,reputationandallofitsbillions.HowdoesaguyinBentonville,ArkansaswithnomoneyblowrightbySears,Roebuck?Andhedoesitinhisownlifetimeinfact,duringhisownlatelifetimebecausehewasalreadyprettyoldbythetimehestartedoutwithonelittlestore....

Heplayedthechainstoregameharderandbetterthananyoneelse.Waltoninventedpracticallynothing.Buthecopiedeverythinganybodyelseeverdidthatwassmartandhediditwithmorefanaticismandbetteremployeemanipulation.Sohejustblewrightbythemall.

Healsohadaveryinterestingcompetitivestrategyintheearlydays.HewaslikeaprizefighterwhowantedagreatrecordsohecouldbeinthefinalsandmakeabigTV



hit.Sowhatdidhedo?Hewentoutandfought42palookas.Right?Andtheresultwasknockout,knockout,knockout42times.

Walton,beingasshrewdashewas,basicallybrokeothersmalltownmerchantsintheearlydays.Withhismoreefficientsystem,hemightnothavebeenabletotacklesometitanheadonatthetime.Butwithhisbettersystem,hecoulddestroythosesmalltownmerchants.Andhewentarounddoingittimeaftertimeaftertime.Then,ashegotbigger,hestarteddestroyingthebigboys.

Well,thatwasavery,veryshrewdstrategy.

Youcansay,"Isthisanicewaytobehave?"Well,capitalismisaprettybrutalplace.ButIpersonallythinkthattheworldisbetterforhavingWalMart.Imeanyoucanidealizesmalltownlife.ButI'vespentafairamountoftimeinsmalltowns.Andletmetellyouyoushouldn'tgettooidealisticaboutallthosebusinesseshedestroyed.

Plus,alotofpeoplewhoworkatWalMartareveryhighgrade,bouncypeoplewhoareraisingnicechildren.Ihavenofeelingthataninferiorculturedestroyedasuperiorculture.Ithinkthatisnothingmorethannostalgiaanddelusion.But,atanyrate,it'saninterestingmodelofhowthescaleofthingsandfanaticismcombinetobeverypowerful.

Andit'salsoaninterestingmodelontheothersidehowwithallitsgreatadvantages,thedisadvantagesofbureaucracydidsuchterribledamagetoSears,Roebuck.Searshadlayersandlayersofpeopleitdidn'tneed.Itwasverybureaucratic.Itwasslowtothink.Andtherewasanestablishedwayofthinking.Ifyoupokedyourheadupwithanewthought,thesystemkindofturnedagainstyou.Itwaseverythinginthewayofadysfunctionalbigbureaucracythatyouwouldexpect.

Inallfairness,therewasalsomuchthatwasgoodaboutit.Butitjustwasn'tasleanandmeanandshrewdandeffectiveasSamWalton.And,induetime,allitsadvantagesofscalewerenotenoughtopreventSearsfromlosingheavilytoWalMartandothersimilarretailers.

Here'samodelthatwe'vehadtroublewith.Maybeyou'llbeabletofigureitoutbetter.Manymarketsgetdowntotwoorthreebigcompetitorsorfiveorsix.Andinsomeofthosemarkets,nobodymakesanymoneytospeakof.Butinothers,everybodydoesverywell.

Overtheyears,we'vetriedtofigureoutwhythecompetitioninsomemarketsgetssortofrationalfromtheinvestor'spointofviewsothattheshareholdersdowell,andinothermarkets,there'sdestructivecompetitionthatdestroysshareholderwealth.

Ifit'sapurecommoditylikeairlineseats,youcanunderstandwhynoonemakesanymoney.Aswesithere,justthinkofwhatairlineshavegiventotheworldsafetravel,greaterexperience,timewithyourlovedones,younameit.Yet,thenetamountofmoneythat'sbeenmadebytheshareholdersofairlinessinceKittyHawk,isnowanegativefigureasubstantialnegativefigure.Competitionwassointensethat,onceitwasunleashedbyderegulation,itravagedshareholderwealthintheairlinebusiness.

Yet,inotherfieldslikecereals,forexamplealmostallthebigboysmakeout.Ifyou'resomekindofamediumgradecerealmaker,youmightmake15%onyourcapital.Andifyou'rereallygood,youmightmake40%.Butwhyarecerealssoprofitabledespitethefactthatitlookstomelikethey'recompetinglikecrazywithpromotions,couponsandeverythingelse?Idon'tfullyunderstandit.

Obviously,there'sabrandidentityfactorincerealsthatdoesn'texistinairlines.Thatmustbethemainfactorthataccountsforit.

Andmaybethecerealmakersbyandlargehavelearnedtobelesscrazyaboutfightingformarketsharebecauseifyougetevenonepersonwho'shellbenton



gainingmarketshare....Forexample,ifIwereKelloggandIdecidedthatIhadtohave60%ofthemarket,IthinkIcouldtakemostoftheprofitoutofcereals.I'druinKelloggintheprocess.ButIthinkIcoulddoit.

Insomebusinesses,theparticipantsbehavelikeadementedKellogg.Inotherbusinesses,theydon't.Unfortunately,Idonothaveaperfectmodelforpredictinghowthat'sgoingtohappen.

Forexample,ifyoulookaroundatbottlermarkets,you'llfindmanymarketswherebottlersofPepsiandCokebothmakealotofmoneyandmanyotherswheretheydestroymostoftheprofitabilityofthetwofranchises.Thatmustgetdowntothepeculiaritiesofindividualadjustmenttomarketcapitalism.Ithinkyou'dhavetoknowthepeopleinvolvedtofullyunderstandwhatwashappening.

Inmicroeconomics,ofcourse,you'vegottheconceptofpatents,trademarks,exclusivefranchisesandsoforth.Patentsarequiteinteresting.WhenIwasyoung,Ithinkmoremoneywentintopatentsthancameout.Judgestendedtothrowthemoutbasedonargumentsaboutwhatwasreallyinventedandwhatreliedonpriorart.Thatisn'taltogetherclear.

Buttheychangedthat.Theydidn'tchangethelaws.Theyjustchangedtheadministrationsothatitallgoestoonepatentcourt.Andthatcourtisnowverymuchmorepropatent.SoIthinkpeoplearenowstartingtomakealotofmoneyoutofowningpatents.

Trademarks,ofcourse,havealwaysmadepeoplealotofmoney.Atrademarksystemisawonderfulthingforabigoperationifit'swellknown.

Theexclusivefranchisecanalsobewonderful.Iftherewereonlythreetelevisionchannelsawardedinabigcityandyouownedoneofthem,therewereonlysomanyhoursadaythatyoucouldbeon.Soyouhadanaturalpositioninanoligopolyintheprecabledays.

Andifyougetthefranchisefortheonlyfoodstandinanairport,youhaveacaptiveclienteleandyouhaveasmallmonopolyofasort.

Thegreatlessoninmicroeconomicsistodiscriminatebetweenwhentechnologyisgoingtohelpyouandwhenit'sgoingtokillyou.Andmostpeopledonotgetthisstraightintheirheads.ButafellowlikeBuffettdoes.

Forexample,whenwewereinthetextilebusiness,whichisaterriblecommoditybusiness,weweremakinglowendtextileswhicharearealcommodityproduct.Andoneday,thepeoplecametoWarrenandsaid,"They'veinventedanewloomthatwethinkwilldotwiceasmuchworkasouroldones."

AndWarrensaid,"Gee,Ihopethisdoesn'tworkbecauseifitdoes,I'mgoingtoclosethemill."Andhemeantit.

Whatwashethinking?Hewasthinking,"It'salousybusiness.We'reearningsubstandardreturnsandkeepingitopenjusttobenicetotheelderlyworkers.Butwe'renotgoingtoputhugeamountsofnewcapitalintoalousybusiness."

Andheknewthatthehugeproductivityincreasesthatwouldcomefromabettermachineintroducedintotheproductionofacommodityproductwouldallgotothebenefitofthebuyersofthetextiles.Nothingwasgoingtosticktoourribsasowners.

That'ssuchanobviousconceptthatthereareallkindsofwonderfulnewinventionsthatgiveyounothingasownersexcepttheopportunitytospendalotmoremoneyinabusinessthat'sstillgoingtobelousy.Themoneystillwon'tcometoyou.Alloftheadvantagesfromgreatimprovementsaregoingtoflowthroughtothecustomers.



Conversely,ifyouowntheonlynewspaperinOshkoshandtheyweretoinventmoreefficientwaysofcomposingthewholenewspaper,thenwhenyougotridoftheoldtechnologyandgotnewfancycomputersandsoforth,allofthesavingswouldcomerightthroughtothebottomline.

Inallcases,thepeoplewhosellthemachineryand,byandlarge,eventheinternalbureaucratsurgingyoutobuytheequipmentshowyouprojectionswiththeamountyou'llsaveatcurrentpriceswiththenewtechnology.However,theydon'tdothesecondstepoftheanalysiswhichistodeterminehowmuchisgoingstayhomeandhowmuchisjustgoingtoflowthroughtothecustomer.I'veneverseenasingleprojectionincorporatingthatsecondstepinmylife.AndIseethemallthetime.Rather,theyalwaysread:"Thiscapitaloutlaywillsaveyousomuchmoneythatitwillpayforitselfinthreeyears."

Soyoukeepbuyingthingsthatwillpayforthemselvesinthreeyears.Andafter20yearsofdoingit,somehowyou'veearnedareturnofonlyabout4%perannum.That'sthetextilebusiness.

Anditisn'tthatthemachinesweren'tbetter.It'sjustthatthesavingsdidn'tgotoyou.Thecostreductionscamethroughallright.Butthebenefitofthecostreductionsdidn'tgototheguywhoboughttheequipment.It'ssuchasimpleidea.It'ssobasic.Andyetit'ssooftenforgotten.

Thenthere'sanothermodelfrommicroeconomicswhichIfindveryinteresting.Whentechnologymovesasfastasitdoesinacivilizationlikeours,yougetaphenomenonwhichIcallcompetitivedestruction.Youknow,youhavethefinestbuggywhipfactoryandallofasuddenincomesthislittlehorselesscarriage.Andbeforetoomanyyearsgoby,yourbuggywhipbusinessisdead.Youeithergetintoadifferentbusinessoryou'redeadyou'redestroyed.Ithappensagainandagainandagain.

Andwhenthesenewbusinessescomein,therearehugeadvantagesfortheearlybirds.Andwhenyou'reanearlybird,there'samodelthatIcall"surfing"whenasurfergetsupandcatchesthewaveandjuststaysthere,hecangoalong,longtime.Butifhegetsoffthewave,hebecomesmiredinshallows....

Butpeoplegetlongrunswhenthey'rerightontheedgeofthewavewhetherit'sMicrosoftorIntelorallkindsofpeople,includingNationalCashRegisterintheearlydays.

Thecashregisterwasoneofthegreatcontributionstocivilization.It'sawonderfulstory.Pattersonwasasmallretailmerchantwhodidn'tmakeanymoney.Oneday,somebodysoldhimacrudecashregisterwhichheputintohisretailoperation.Anditinstantlychangedfromlosingmoneytoearningaprofitbecauseitmadeitsomuchharderfortheemployeestosteal....

ButPatterson,havingthekindofmindthathedid,didn'tthink,"Oh,goodformyretailbusiness."Hethought,"I'mgoingintothecashregisterbusiness."And,ofcourse,hecreatedNationalCashRegister.

Andhe"surfed".Hegotthebestdistributionsystem,thebiggestcollectionofpatentsandthebestofeverything.Hewasafanaticabouteverythingimportantasthetechnologydeveloped.IhaveinmyfilesanearlyNationalCashRegisterCompanyreportinwhichPattersondescribedhismethodsandobjectives.AndawelleducatedorangutancouldseethatbuyingintopartnershipwithPattersoninthoseearlydays,givenhisnotionsaboutthecashregisterbusiness,wasatotal100%cinch.

And,ofcourse,that'sexactlywhataninvestorshouldbelookingfor.Inalonglife,youcanexpecttoprofitheavilyfromatleastafewofthoseopportunitiesifyoudevelopthewisdomandwilltoseizethem.Atanyrate,"surfing"isaverypowerfulmodel.

However,BerkshireHathaway,byandlarge,doesnotinvestinthesepeoplethatare



"surfing"oncomplicatedtechnology.Afterall,we'recrankyandidiosyncraticasyoumayhavenoticed.

AndWarrenandIdon'tfeellikewehaveanygreatadvantageinthehightechsector.Infact,wefeellikewe'reatabigdisadvantageintryingtounderstandthenatureoftechnicaldevelopmentsinsoftware,computerchipsorwhathaveyou.Sowetendtoavoidthatstuff,basedonourpersonalinadequacies.

Again,thatisavery,verypowerfulidea.Everypersonisgoingtohaveacircleofcompetence.Andit'sgoingtobeveryhardtoadvancethatcircle.IfIhadtomakemylivingasamusician....Ican'teventhinkofalevellowenoughtodescribewhereIwouldbesortedouttoifmusicwerethemeasuringstandardofthecivilization.

Soyouhavetofigureoutwhatyourownaptitudesare.Ifyouplaygameswhereotherpeoplehavetheaptitudesandyoudon't,you'regoingtolose.Andthat'sasclosetocertainasanypredictionthatyoucanmake.Youhavetofigureoutwhereyou'vegotanedge.Andyou'vegottoplaywithinyourowncircleofcompetence.

Ifyouwanttobethebesttennisplayerintheworld,youmaystartouttryingandsoonfindoutthatit'shopelessthatotherpeopleblowrightbyyou.However,ifyouwanttobecomethebestplumbingcontractorinBemidji,thatisprobablydoablebytwothirdsofyou.Ittakesawill.Ittakestheintelligence.Butafterawhile,you'dgraduallyknowallabouttheplumbingbusinessinBemidjiandmastertheart.Thatisanattainableobjective,givenenoughdiscipline.Andpeoplewhocouldneverwinachesstournamentorstandincentercourtinarespectabletennistournamentcanrisequitehighinlifebyslowlydevelopingacircleofcompetencewhichresultspartlyfromwhattheywerebornwithandpartlyfromwhattheyslowlydevelopthroughwork.

Sosomeedgescanbeacquired.AndthegameoflifetosomeextentformostofusistryingtobesomethinglikeagoodplumbingcontractorinBemidji.Veryfewofusarechosentowintheworld'schesstournaments.

Someofyoumayfindopportunities"surfing"alonginthenewhightechfieldstheIntels,theMicrosoftsandsoon.Thefactthatwedon'tthinkwe'reverygoodatitandhaveprettywellstayedoutofitdoesn'tmeanthatit'sirrationalforyoutodoit.

Well,somuchforthebasicmicroeconomicsmodels,alittlebitofpsychology,alittlebitofmathematics,helpingcreatewhatIcallthegeneralsubstructureofworldlywisdom.Now,ifyouwanttogoonfromcarrotstodessert,I'llturntostockpickingtryingtodrawonthisgeneralworldlywisdomaswego.

Idon'twanttogetintoemergingmarkets,bondarbitrageandsoforth.I'mtalkingaboutnothingbutplainvanillastockpicking.That,believeme,iscomplicatedenough.AndI'mtalkingaboutcommonstockpicking.

Thefirstquestionis,"Whatisthenatureofthestockmarket?"AndthatgetsyoudirectlytothisefficientmarkettheorythatgottobetherageatotalragelongafterIgraduatedfromlawschool.

Andit'sratherinterestingbecauseoneofthegreatesteconomistsoftheworldisasubstantialshareholderinBerkshireHathawayandhasbeenforalongtime.Histextbookalwaystaughtthatthestockmarketwasperfectlyefficientandthatnobodycouldbeatit.ButhisownmoneywentintoBerkshireandmadehimwealthy.So,likePascalinhisfamouswager,hehedgedhisbet.

Isthestockmarketsoefficientthatpeoplecan'tbeatit?Well,theefficientmarkettheoryisobviouslyroughlyrightmeaningthatmarketsarequiteefficientandit'squitehardforanybodytobeatthemarketbysignificantmarginsasastockpickerbyjustbeingintelligentandworkinginadisciplinedway.

Indeed,theaverageresulthastobetheaverageresult.Bydefinition,everybodycan't



beatthemarket.AsIalwayssay,theironruleoflifeisthatonly20%ofthepeoplecanbeinthetopfifth.That'sjustthewayitis.Sotheansweristhatit'spartlyefficientandpartlyinefficient.

And,bytheway,Ihaveanameforpeoplewhowenttotheextremeefficientmarkettheorywhichis"bonkers".Itwasanintellectuallyconsistenttheorythatenabledthemtodoprettymathematics.SoIunderstanditsseductivenesstopeoplewithlargemathematicalgifts.Itjusthadadifficultyinthatthefundamentalassumptiondidnottieproperlytoreality.

Again,tothemanwithahammer,everyproblemlookslikeanail.Ifyou'regoodatmanipulatinghighermathematicsinaconsistentway,whynotmakeanassumptionwhichenablesyoutouseyourtool?

ThemodelIliketosortofsimplifythenotionofwhatgoesoninamarketforcommonstocksistheparimutuelsystemattheracetrack.Ifyoustoptothinkaboutit,aparimutuelsystemisamarket.Everybodygoesthereandbetsandtheoddschangebasedonwhat'sbet.That'swhathappensinthestockmarket.

Anydamnfoolcanseethatahorsecarryingalightweightwithawonderfulwinrateandagoodpostpositionetc.,etc.iswaymorelikelytowinthanahorsewithaterriblerecordandextraweightandsoonandsoon.Butifyoulookattheodds,thebadhorsepays100to1,whereasthegoodhorsepays3to2.Thenit'snotclearwhichisstatisticallythebestbetusingthemathematicsofFermatandPascal.Thepriceshavechangedinsuchawaythatit'sveryhardtobeatthesystem.

Andthenthetrackistaking17%offthetop.Sonotonlydoyouhavetooutwitalltheotherbetters,butyou'vegottooutwitthembysuchabigmarginthatonaverage,youcanaffordtotake17%ofyourgrossbetsoffthetopandgiveittothehousebeforetherestofyourmoneycanbeputtowork.

Giventhosemathematics,isitpossibletobeatthehorsesonlyusingone'sintelligence?Intelligenceshouldgivesomeedge,becauselotsofpeoplewhodon'tknowanythinggooutandbetluckynumbersandsoforth.Therefore,somebodywhoreallythinksaboutnothingbuthorseperformanceandisshrewdandmathematicalcouldhaveaveryconsiderableedge,intheabsenceofthefrictionalcostcausedbythehousetake.

Unfortunately,whatashrewdhorseplayer'sedgedoesinmostcasesistoreducehisaveragelossoveraseasonofbettingfromthe17%thathewouldloseifhegottheaverageresulttomaybe10%.However,thereareactuallyafewpeoplewhocanbeatthegameafterpayingthefull17%.

IusedtoplaypokerwhenIwasyoungwithaguywhomadeasubstantiallivingdoingnothingbutbetharnessraces....Now,harnessracingisarelativelyinefficientmarket.Youdon'thavethedepthofintelligencebettingonharnessracesthatyoudoonregularraces.Whatmypokerpalwoulddowastothinkaboutharnessracesashismainprofession.Andhewouldbetonlyoccasionallywhenhesawsomemispricedbetavailable.Andbydoingthat,afterpayingthefullhandletothehousewhichIpresumewasaround17%hemadeasubstantialliving.

Youhavetosaythat'srare.However,themarketwasnotperfectlyefficient.Andifitweren'tforthatbig17%handle,lotsofpeoplewouldregularlybebeatinglotsofotherpeopleatthehorseraces.It'sefficient,yes.Butit'snotperfectlyefficient.Andwithenoughshrewdnessandfanaticism,somepeoplewillgetbetterresultsthanothers.

Thestockmarketisthesamewayexceptthatthehousehandleissomuchlower.Ifyoutaketransactioncoststhespreadbetweenthebidandtheaskplusthecommissionsandifyoudon'ttradetooactively,you'retalkingaboutfairlylowtransactioncosts.Sothatwithenoughfanaticismandenoughdiscipline,someoftheshrewdpeoplearegoingtogetwaybetterresultsthanaverageinthenatureofthings.



Itisnotabiteasy.And,ofcourse,50%willendupinthebottomhalfand70%willendupinthebottom70%.Butsomepeoplewillhaveanadvantage.Andinafairlylowtransactioncostoperation,theywillgetbetterthanaverageresultsinstockpicking.

Howdoyougettobeoneofthosewhoisawinnerinarelativesenseinsteadofaloser?

Hereagain,lookattheparimutuelsystem.IhaddinnerlastnightbyabsoluteaccidentwiththepresidentofSantaAnita.Hesaysthattherearetwoorthreebetterswhohaveacreditarrangementwiththem,nowthattheyhaveofftrackbetting,whoareactuallybeatingthehouse.They'resendingmoneyoutnetafterthefullhandlealotofittoLasVegas,bythewaytopeoplewhoareactuallywinningslightly,net,afterpayingthefullhandle.They'rethatshrewdaboutsomethingwithasmuchunpredictabilityashorseracing.

Andtheonethingthatallthosewinningbettersinthewholehistoryofpeoplewho'vebeatentheparimutuelsystemhaveisquitesimple.Theybetveryseldom.

It'snotgiventohumanbeingstohavesuchtalentthattheycanjustknoweverythingabouteverythingallthetime.Butitisgiventohumanbeingswhoworkhardatitwholookandsifttheworldforamispricedbethattheycanoccasionallyfindone.

Andthewiseonesbetheavilywhentheworldoffersthemthatopportunity.Theybetbigwhentheyhavetheodds.Andtherestofthetime,theydon't.It'sjustthatsimple.

Thatisaverysimpleconcept.Andtomeit'sobviouslyrightbasedonexperiencenotonlyfromtheparimutuelsystem,buteverywhereelse.

Andyet,ininvestmentmanagement,practicallynobodyoperatesthatway.WeoperatethatwayI'mtalkingaboutBuffettandMunger.Andwe'renotaloneintheworld.Butahugemajorityofpeoplehavesomeothercrazyconstructintheirheads.Andinsteadofwaitingforanearcinchandloadingup,theyapparentlyascribetothetheorythatiftheyworkalittleharderorhiremorebusinessschoolstudents,they'llcometoknoweverythingabouteverythingallthetime.

Tome,that'stotallyinsane.Thewaytowinistowork,work,work,workandhopetohaveafewinsights.

Howmanyinsightsdoyouneed?Well,I'dargue:thatyoudon'tneedmanyinalifetime.IfyoulookatBerkshireHathawayandallofitsaccumulatedbillions,thetopteninsightsaccountformostofit.Andthat'swithaverybrilliantmanWarren'salotmoreablethanIamandverydisciplineddevotinghislifetimetoit.Idon'tmeantosaythathe'sonlyhadteninsights.I'mjustsaying,thatmostofthemoneycamefromteninsights.

Soyoucangetveryremarkableinvestmentresultsifyouthinkmorelikeawinningparimutuelplayer.Justthinkofitasaheavyoddsagainstgamefullofcrazinesswithanoccasionalmispricedsomethingorother.Andyou'reprobablynotgoingtobesmartenoughtofindthousandsinalifetime.Andwhenyougetafew,youreallyloadup.It'sjustthatsimple.

WhenWarrenlecturesatbusinessschools,hesays,"Icouldimproveyourultimatefinancialwelfarebygivingyouaticketwithonly20slotsinitsothatyouhad20punchesrepresentingalltheinvestmentsthatyougottomakeinalifetime.Andonceyou'dpunchedthroughthecard,youcouldn'tmakeanymoreinvestmentsatall."

Hesays,"Underthoserules,you'dreallythinkcarefullyaboutwhatyoudidandyou'dbeforcedtoloaduponwhatyou'dreallythoughtabout.Soyou'ddosomuchbetter."

Again,thisisaconceptthatseemsperfectlyobvioustome.AndtoWarrenitseemsperfectlyobvious.ButthisisoneoftheveryfewbusinessclassesintheU.S.where



anybodywillbesayingso.Itjustisn'ttheconventionalwisdom.

Tome,it'sobviousthatthewinnerhastobetveryselectively.It'sbeenobvioustomesinceveryearlyinlife.Idon'tknowwhyit'snotobvioustoverymanyotherpeople.

IthinkthereasonwhywegotintosuchidiocyininvestmentmanagementisbestillustratedbyastorythatItellabouttheguywhosoldfishingtackle.Iaskedhim,"MyGod,they'repurpleandgreen.Dofishreallytaketheselures?"Andhesaid,"Mister,Idon'tselltofish."

Investmentmanagersareinthepositionofthatfishingtacklesalesman.They'reliketheguywhowassellingsalttotheguywhoalreadyhadtoomuchsalt.Andaslongastheguywillbuysalt,whythey'llsellsalt.Butthatisn'twhatordinarilyworksforthebuyerofinvestmentadvice.

IfyouinvestedBerkshireHathawaystyle,itwouldbehardtogetpaidasaninvestmentmanageraswellasthey'recurrentlypaidbecauseyou'dbeholdingablockofWalMartandablockofCocaColaandablockofsomethingelse.You'djustsitthere.Andtheclientwouldbegettingrich.And,afterawhile,theclientwouldthink,"WhyamIpayingthisguyhalfapercentayearonmywonderfulpassiveholdings?"

Sowhatmakessensefortheinvestorisdifferentfromwhatmakessenseforthemanager.And,asusualinhumanaffairs,whatdeterminesthebehaviorareincentivesforthedecisionmaker.

Fromallbusiness,myfavoritecaseonincentivesisFederalExpress.Theheartandsouloftheirsystemwhichcreatestheintegrityoftheproductishavingalltheirairplanescometooneplaceinthemiddleofthenightandshiftallthepackagesfromplanetoplane.Iftherearedelays,thewholeoperationcan'tdeliveraproductfullofintegritytoFederalExpresscustomers.

Anditwasalwaysscrewedup.Theycouldnevergetitdoneontime.Theytriedeverythingmoralsuasion,threats,younameit.Andnothingworked.

Finally,somebodygottheideatopayallthesepeoplenotsomuchanhour,butsomuchashiftandwhenit'salldone,theycanallgohome.Well,theirproblemsclearedupovernight.

Sogettingtheincentivesrightisavery,veryimportantlesson.ItwasnotobvioustoFederalExpresswhatthesolutionwas.Butmaybenow,itwillhereaftermoreoftenbeobvioustoyou.

Allright,we'venowrecognizedthatthemarketisefficientasaparimutuelsystemisefficientwiththefavoritemorelikelythanthelongshottodowellinracing,butnotnecessarilygiveanybettingadvantagetothosethatbetonthefavorite.

Inthestockmarket,somerailroadthat'sbesetbybettercompetitorsandtoughunionsmaybeavailableatonethirdofitsbookvalue.Incontrast,IBMinitsheydaymightbesellingat6timesbookvalue.Soit'sjustliketheparimutuelsystem.AnydamnfoolcouldplainlyseethatIBMhadbetterbusinessprospectsthantherailroad.Butonceyouputthepriceintotheformula,itwasn'tsoclearanymorewhatwasgoingtoworkbestforabuyerchoosingbetweenthestocks.Soit'salotlikeaparimutuelsystem.And,therefore,itgetsveryhardtobeat.

Whatstyleshouldtheinvestoruseasapickerofcommonstocksinordertotrytobeatthemarketinotherwords,togetanaboveaveragelongtermresult?Astandardtechniquethatappealstoalotofpeopleiscalled"sectorrotation".Yousimplyfigureoutwhenoilsaregoingtooutperformretailers,etc.,etc.,etc.Youjustkindofflitaroundbeinginthehotsectorofthemarketmakingbetterchoicesthanotherpeople.Andpresumably,overalongperiodoftime,yougetahead.



However,Iknowofnoreallyrichsectorrotator.Maybesomepeoplecandoit.I'mnotsayingtheycan't.AllIknowisthatallthepeopleIknowwhogotrichandIknowalotofthemdidnotdoitthatway.

ThesecondbasicapproachistheonethatBenGrahamusedmuchadmiredbyWarrenandme.Asonefactor,Grahamhadthisconceptofvaluetoaprivateownerwhatthewholeenterprisewouldsellforifitwereavailable.Andthatwascalculableinmanycases.

Then,ifyoucouldtakethestockpriceandmultiplyitbythenumberofsharesandgetsomethingthatwasonethirdorlessofselloutvalue,hewouldsaythatyou'vegotalotofedgegoingforyou.Evenwithanelderlyalcoholicrunningastodgybusiness,thissignificantexcessofrealvaluepershareworkingforyoumeansthatallkindsofgoodthingscanhappentoyou.Youhadahugemarginofsafetyasheputitbyhavingthisbigexcessvaluegoingforyou.

Buthewas,byandlarge,operatingwhentheworldwasinshellshockfromthe1930swhichwastheworstcontractionintheEnglishspeakingworldinabout600years.WheatinLiverpool,Ibelieve,gotdowntosomethinglikea600yearlow,adjustedforinflation.PeopleweresoshellshockedforalongtimethereafterthatBenGrahamcouldrunhisGeigercounteroverthisdetritusfromthecollapseofthe1930sandfindthingssellingbelowtheirworkingcapitalpershareandsoon.

Andinthosedays,workingcapitalactuallybelongedtotheshareholders.Iftheemployeeswerenolongeruseful,youjustsackedthemall,tooktheworkingcapitalandstuckitintheowners'pockets.Thatwasthewaycapitalismthenworked.

Nowadays,ofcourse,theaccountingisnotrealisticbecausetheminutethebusinessstartscontracting,significantassetsarenotthere.Undersocialnormsandthenewlegalrulesofthecivilization,somuchisowedtotheemployeesthat,theminutetheenterprisegoesintoreverse,someoftheassetsonthebalancesheetaren'tthereanymore.

Now,thatmightnotbetrueifyourunalittleautodealershipyourself.Youmaybeabletorunitinsuchawaythatthere'snohealthplanandthisandthatsothatifthebusinessgetslousy,youcantakeyourworkingcapitalandgohome.ButIBMcan't,oratleastdidn't.Justlookatwhatdisappearedfromitsbalancesheetwhenitdecidedthatithadtochangesizebothbecausetheworldhadchangedtechnologicallyandbecauseitsmarketpositionhaddeteriorated.

Andintermsofblowingit,IBMissomeexample.Thosewerebrilliant,disciplinedpeople.ButtherewasenoughturmoilintechnologicalchangethatIBMgotbouncedoffthewaveafter"surfing"successfullyfor60years.AndthatwassomecollapseanobjectlessoninthedifficultiesoftechnologyandoneofthereasonswhyBuffettandMungerdon'tliketechnologyverymuch.Wedon'tthinkwe'reanygoodatit,andstrangethingscanhappen.

Atanyrate,thetroublewithwhatIcalltheclassicBenGrahamconceptisthatgraduallytheworldwisedupandthoserealobviousbargainsdisappeared.YoucouldrunyourGeigercounterovertherubbleanditwouldn'tclick.

Butsuchisthenatureofpeoplewhohaveahammertowhom,asImentioned,everyproblemlookslikeanailthattheBenGrahamfollowersrespondedbychangingthecalibrationontheirGeigercounters.Ineffect,theystarteddefiningabargaininadifferentway.Andtheykeptchangingthedefinitionsothattheycouldkeepdoingwhatthey'dalwaysdone.Anditstillworkedprettywell.SotheBenGrahamintellectualsystemwasaverygoodone.

Ofcourse,thebestpartofitallwashisconceptof"Mr.Market".Insteadofthinkingthemarketwasefficient,hetreateditasamanicdepressivewhocomesbyeveryday.Andsomedayshesays,"I'llsellyousomeofmyinterestforwaylessthanyou



thinkit'sworth."Andotherdays,"Mr.Market"comesbyandsays,"I'llbuyyourinterestatapricethat'swayhigherthanyouthinkit'sworth."Andyougettheoptionofdecidingwhetheryouwanttobuymore,sellpartofwhatyoualreadyhaveordonothingatall.

ToGraham,itwasablessingtobeinbusinesswithamanicdepressivewhogaveyouthisseriesofoptionsallthetime.Thatwasaverysignificantmentalconstruct.Andit'sbeenveryusefultoBuffett,forinstance,overhiswholeadultlifetime.

However,ifwe'dstayedwithclassicGrahamthewayBenGrahamdidit,wewouldneverhavehadtherecordwehave.Andthat'sbecauseGrahamwasn'ttryingtodowhatwedid.

Forexample,Grahamdidn'twanttoevertalktomanagement.Andhisreasonwasthat,likethebestsortofprofessoraiminghisteachingatamassaudience,hewastryingtoinventasystemthatanybodycoulduse.Andhedidn'tfeelthatthemaninthestreetcouldrunaroundandtalktomanagementsandlearnthings.Healsohadaconceptthatthemanagementwouldoftencouchtheinformationveryshrewdlytomislead.Therefore,itwasverydifficult.Andthatisstilltrue,ofcoursehumannaturebeingwhatitis.

AndsohavingstartedoutasGrahamiteswhich,bytheway,workedfinewegraduallygotwhatIwouldcallbetterinsights.Andwerealizedthatsomecompanythatwassellingat2or3timesbookvaluecouldstillbeahellofabargainbecauseofmomentumsimplicitinitsposition,sometimescombinedwithanunusualmanagerialskillplainlypresentinsomeindividualorother,orsomesystemorother.

Andoncewe'dgottenoverthehurdleofrecognizingthatathingcouldbeabargainbasedonquantitativemeasuresthatwouldhavehorrifiedGraham,westartedthinkingaboutbetterbusinesses.

And,bytheway,thebulkofthebillionsinBerkshireHathawayhavecomefromthebetterbusinesses.Muchofthefirst$200or$300millioncamefromscramblingaroundwithourGeigercounter.Butthegreatbulkofthemoneyhascomefromthegreatbusinesses.

Andevensomeoftheearlymoneywasmadebybeingtemporarilypresentingreatbusinesses.BuffettPartnership,forexample,ownedAmericanExpressandDisneywhentheygotpoundeddown.

Mostinvestmentmanagersareinagamewheretheclientsexpectthemtoknowalotaboutalotofthings.Wedidn'thaveanyclientswhocouldfireusatBerkshireHathaway.Sowedidn'thavetobegovernedbyanysuchconstruct.Andwecametothisnotionoffindingamispricedbetandloadingupwhenwewereveryconfidentthatwewereright.Sowe'rewaylessdiversified.AndIthinkoursystemismilesbetter.

However,inallfairness,Idon'tthinkalotofmoneymanagerscouldsuccessfullyselltheirservicesiftheyusedoursystem.Butifyou'reinvestingfor40yearsinsomepensionfund,whatdifferencedoesitmakeifthepathfromstarttofinishisalittlemorebumpyoralittledifferentthaneverybodyelse'ssolongasit'sallgoingtoworkoutwellintheend?Sowhatifthere'salittleextravolatility.

Ininvestmentmanagementtoday,everybodywantsnotonlytowin,buttohaveayearlyoutcomepaththatneverdivergesverymuchfromastandardpathexceptontheupside.Well,thatisaveryartificial,crazyconstruct.That'stheequivalentininvestmentmanagementtothecustomofbindingthefeetofChinesewomen.It'stheequivalentofwhatNietzschemeantwhenhecriticizedthemanwhohadalamelegandwasproudofit.

Thatisreallyhobblingyourself.Now,investmentmanagerswouldsay,"Wehavetobethatway.That'showwe'remeasured."Andtheymayberightintermsofthewaythe



businessisnowconstructed.Butfromtheviewpointofarationalconsumer,thewholesystem's"bonkers"anddrawsalotoftalentedpeopleintosociallyuselessactivity.

AndtheBerkshiresystemisnot"bonkers".It'ssodamnedelementarythatevenbrightpeoplearegoingtohavelimited,reallyvaluableinsightsinaverycompetitiveworldwhenthey'refightingagainstotherverybright,hardworkingpeople.

Anditmakessensetoloadupontheveryfewgoodinsightsyouhaveinsteadofpretendingtoknoweverythingabouteverythingatalltimes.You'remuchmorelikelytodowellifyoustartouttodosomethingfeasibleinsteadofsomethingthatisn'tfeasible.Isn'tthatperfectlyobvious?

Howmanyofyouhave56brilliantideasinwhichyouhaveequalconfidence?Raiseyourhands,please.Howmanyofyouhavetwoorthreeinsightsthatyouhavesomeconfidencein?Irestmycase.

I'dsaythatBerkshireHathaway'ssystemisadaptingtothenatureoftheinvestmentproblemasitreallyis.

We'vereallymadethemoneyoutofhighqualitybusinesses.Insomecases,weboughtthewholebusiness.Andinsomecases,wejustboughtabigblockofstock.Butwhenyouanalyzewhathappened,thebigmoney'sbeenmadeinthehighqualitybusinesses.Andmostoftheotherpeoplewho'vemadealotofmoneyhavedonesoinhighqualitybusinesses.

Overthelongterm,it'shardforastocktoearnamuchbetterreturnthanthebusinesswhichunderliesitearns.Ifthebusinessearns6%oncapitalover40yearsandyouholditforthat40years,you'renotgoingtomakemuchdifferentthana6%returnevenifyouoriginallybuyitatahugediscount.Conversely,ifabusinessearns18%oncapitalover20or30years,evenifyoupayanexpensivelookingprice,you'llendupwithafineresult.

Sothetrickisgettingintobetterbusinesses.Andthatinvolvesalloftheseadvantagesofscalethatyoucouldconsidermomentumeffects.

Howdoyougetintothesegreatcompanies?OnemethodiswhatI'dcallthemethodoffindingthemsmallget'emwhenthey'relittle.Forexample,buyWalMartwhenSamWaltonfirstgoespublicandsoforth.Andalotofpeopletrytodojustthat.Andit'saverybeguilingidea.IfIwereayoungman,Imightactuallygointoit.

Butitdoesn'tworkforBerkshireHathawayanymorebecausewe'vegottoomuchmoney.Wecan'tfindanythingthatfitsoursizeparameterthatway.Besides,we'resetinourways.ButIregardfindingthemsmallasaperfectlyintelligentapproachforsomebodytotrywithdiscipline.It'sjustnotsomethingthatI'vedone.

Finding'embigobviouslyisveryhardbecauseofthecompetition.Sofar,Berkshire'smanagedtodoit.Butcanwecontinuetodoit?What'sthenextCocaColainvestmentforus?Well,theanswertothatisIdon'tknow.Ithinkitgetsharderforusallthetime....

Andideallyandwe'vedonealotofthisyougetintoagreatbusinesswhichalsohasagreatmanagerbecausemanagementmatters.Forexample,it'smadeagreatdifferencetoGeneralElectricthatJackWelchcameininsteadoftheguywhotookoverWestinghouseaverygreatdifference.Somanagementmatters,too.

Andsomeofitispredictable.IdonotthinkittakesageniustounderstandthatJackWelchwasamoreinsightfulpersonandabettermanagerthanhispeersinothercompanies.NordoIthinkittooktremendousgeniustounderstandthatDisneyhadbasicmomentumsinplacewhichareverypowerfulandthatEisnerandWellswereveryunusualmanagers.



Soyoudogetanoccasionalopportunitytogetintoawonderfulbusinessthat'sbeingrunbyawonderfulmanager.And,ofcourse,that'shogheavenday.Ifyoudon'tloadupwhenyougetthoseopportunities,it'sabigmistake.

Occasionally,you'llfindahumanbeingwho'ssotalentedthathecandothingsthatordinaryskilledmortalscan't.IwouldarguethatSimonMarkswhowassecondgenerationinMarks&SpencerofEnglandwassuchaman.PattersonwassuchamanatNationalCashRegister.AndSamWaltonwassuchaman.

Thesepeopledocomealongandinmanycases,they'renotallthathardtoidentify.Ifthey'vegotareasonablehandwiththefanaticismandintelligenceandsoonthatthesepeoplegenerallybringtothepartythenmanagementcanmattermuch.

However,averagedout,bettingonthequalityofabusinessisbetterthanbettingonthequalityofmanagement.Inotherwords,ifyouhavetochooseone,betonthebusinessmomentum,notthebrillianceofthemanager.

But,veryrarely,youfindamanagerwho'ssogoodthatyou'rewisetofollowhimintowhatlookslikeamediocrebusiness.

AnotherverysimpleeffectIveryseldomseediscussedeitherbyinvestmentmanagersoranybodyelseistheeffectoftaxes.Ifyou'regoingtobuysomethingwhichcompoundsfor30yearsat15%perannumandyoupayone35%taxattheveryend,thewaythatworksoutisthataftertaxes,youkeep13.3%perannum.

Incontrast,ifyouboughtthesameinvestment,buthadtopaytaxeseveryyearof35%outofthe15%thatyouearned,thenyourreturnwouldbe15%minus35%of15%oronly9.75%peryearcompounded.Sothedifferencethereisover3.5%.Andwhat3.5%doestothenumbersoverlongholdingperiodslike30yearsistrulyeyeopening.Ifyousitbackforlong,longstretchesingreatcompanies,youcangetahugeedgefromnothingbutthewaythatincometaxeswork.

Evenwitha10%perannuminvestment,payinga35%taxattheendgivesyou8.3%aftertaxesasanannualcompoundedresultafter30years.Incontrast,ifyoupaythe35%eachyearinsteadofattheend,yourannualresultgoesdownto6.5%.Soyouaddnearly2%ofaftertaxreturnperannumifyouonlyachieveanaveragereturnbyhistoricalstandardsfromcommonstockinvestmentsincompanieswithtinydividendpayoutratios.

ButintermsofbusinessmistakesthatI'veseenoveralonglifetime,Iwouldsaythattryingtominimizetaxestoomuchisoneofthegreatstandardcausesofreallydumbmistakes.Iseeterriblemistakesfrompeoplebeingoverlymotivatedbytaxconsiderations.

WarrenandIpersonallydon'tdrilloilwells.Wepayourtaxes.Andwe'vedoneprettywell,sofar.Anytimesomebodyoffersyouataxshelterfromhereoninlife,myadvicewouldbedon'tbuyit.

Infact,anytimeanybodyoffersyouanythingwithabigcommissionanda200pageprospectus,don'tbuyit.Occasionally,you'llbewrongifyouadopt"Munger'sRule".However,overalifetime,you'llbealongwayaheadandyouwillmissalotofunhappyexperiencesthatmightotherwisereduceyourloveforyourfellowman.

Therearehugeadvantagesforanindividualtogetintoapositionwhereyoumakeafewgreatinvestmentsandjustsitbackandwait:You'repayinglesstobrokers.You'relisteningtolessnonsense.Andifitworks,thegovernmentaltaxsystemgivesyouanextra1,2or3percentagepointsperannumcompounded.

Andyouthinkthatmostofyouaregoingtogetthatmuchadvantagebyhiringinvestmentcounselorsandpayingthem1%torunaround,incurringalotoftaxesonyourbehalf'?Lotsofluck.



Arethereanydangersinthisphilosophy?Yes.Everythinginlifehasdangers.Sinceit'ssoobviousthatinvestingingreatcompaniesworks,itgetshorriblyoverdonefromtimetotime.Inthe"NiftyFifty"days,everybodycouldtellwhichcompanieswerethegreatones.Sotheygotupto50,60and70timesearnings.AndjustasIBMfelloffthewave,othercompaniesdid,too.Thus,alargeinvestmentdisasterresultedfromtoohighprices.Andyou'vegottobeawareofthatdanger....

Sotherearerisks.Nothingisautomaticandeasy.Butifyoucanfindsomefairlypricedgreatcompanyandbuyitandsit,thattendstoworkoutvery,verywellindeedespeciallyforanindividual,

Withinthegrowthstockmodel,there'sasubposition:Thereareactuallybusinesses,thatyouwillfindafewtimesinalifetime,whereanymanagercouldraisethereturnenormouslyjustbyraisingpricesandyettheyhaven'tdoneit.Sotheyhavehugeuntappedpricingpowerthatthey'renotusing.Thatistheultimatenobrainer.

ThatexistedinDisney.It'ssuchauniqueexperiencetotakeyourgrandchildtoDisneyland.You'renotdoingitthatoften.Andtherearelotsofpeopleinthecountry.AndDisneyfoundthatitcouldraisethosepricesalotandtheattendancestayedrightup.

SoalotofthegreatrecordofEisnerandWellswasutterbrilliancebuttherestcamefromjustraisingpricesatDisneylandandDisneyworldandthroughvideocassettesalesofclassicanimatedmovies.

AtBerkshireHathaway,WarrenandIraisedthepricesofSee'sCandyalittlefasterthanothersmighthave.And,ofcourse,weinvestedinCocaColawhichhadsomeuntappedpricingpower.Anditalsohadbrilliantmanagement.SoaGoizuetaandKeoughcoulddomuchmorethanraiseprices.Itwasperfect.

Youwillgetafewopportunitiestoprofitfromfindingunderpricing.Thereareactuallypeopleouttherewhodon'tpriceeverythingashighasthemarketwilleasilystand.Andonceyoufigurethatout,it'slikefindinginthestreetifyouhavethecourageofyourconvictions.

IfyoulookatBerkshire'sinvestmentswherealotofthemoney'sbeenmadeandyoulookforthemodels,youcanseethatwetwiceboughtintotwonewspapertownswhichhavesincebecomeonenewspapertowns.Sowemadeabettosomeextent....

InoneofthoseTheWashingtonPostweboughtitatabout20%ofthevaluetoaprivateowner.SoweboughtitonaBenGrahamstylebasisatonefifthofobviousvalueand,inaddition,wefacedasituationwhereyouhadboththetophandinagamethatwasclearlygoingtoendupwithonewinnerandamanagementwithalotofintegrityandintelligence.Thatonewasarealdream.They'reveryhighclasspeopletheKatharineGrahamfamily.That'swhyitwasadreamanabsolute,damndream.

Ofcourse,thatcameaboutbackin'7374.Andthatwasalmostlike1932.Thatwasprobablyaoncein40yearstypedenouementinthemarkets.Thatinvestment'supabout50timesoverourcost.

IfIwereyou,Iwouldn'tcountongettinganyinvestmentinyourlifetimequiteasgoodasTheWashingtonPostwasin'73and'74.

Butitdoesn'thavetobethatgoodtotakecareofyou.

Letmementionanothermodel.Ofcourse,GilletteandCokemakefairlylowpriceditemsandhaveatremendousmarketingadvantageallovertheworld.AndinGillette'scase,theykeepsurfingalongnewtechnologywhichisfairlysimplebythestandardsofmicrochips.Butit'shardforcompetitorstodo.

Sothey'vebeenabletostayconstantlyneartheedgeofimprovementsinshaving.



TherearewholecountrieswhereGillettehasmorethan90%oftheshavingmarket.

GEICOisaveryinterestingmodel.It'sanotheroneofthe100orsomodelsyououghttohaveinyourhead.I'vehadmanyfriendsinthesickbusinessfixupgameoveralonglifetime.AndtheypracticallyallusethefollowingformulaIcallitthecancersurgeryformula:

Theylookatthismess.Andtheyfigureoutifthere'sanythingsoundleftthatcanliveonitsowniftheycutawayeverythingelse.Andiftheyfindanythingsound,theyjustcutawayeverythingelse.Ofcourse,ifthatdoesn'twork,theyliquidatethebusiness.Butitfrequentlydoeswork.

AndGEICOhadaperfectlymagnificentbusinesssubmergedinamess,butstillworking.Misledbysuccess,GEICOhaddonesomefoolishthings.Theygottothinkingthat,becausetheyweremakingalotofmoney,theykneweverything.Andtheysufferedhugelosses.

Alltheyhadtodowastocutoutallthefollyandgobacktotheperfectlywonderfulbusinessthatwaslyingthere.Andwhenyouthinkaboutit,that'saverysimplemodel.Andit'srepeatedoverandoveragain.

And,inGEICO'scase,thinkaboutallthemoneywepassivelymade....Itwasawonderfulbusinesscombinedwithabunchoffoolishnessthatcouldeasilybecutout.Andpeoplewerecominginwhoweretemperamentallyandintellectuallydesignedsotheyweregoingtocutitout.Thatisamodelyouwanttolookfor.

Andyoumayfindoneortwoorthreeinalonglifetimethatareverygood.Andyoumayfind20or30thataregoodenoughtobequiteuseful.

Finally,I'dliketoonceagaintalkaboutinvestmentmanagement.Thatisafunnybusinessbecauseonanetbasis,thewholeinvestmentmanagementbusinesstogethergivesnovalueaddedtoallbuyerscombined.That'sthewayithastowork.

Ofcourse,thatisn'ttrueofplumbinganditisn'ttrueofmedicine.Ifyou'regoingtomakeyourcareersintheinvestmentmanagementbusiness,youfaceaverypeculiarsituation.Andmostinvestmentmanagershandleitwithpsychologicaldenialjustlikeachiropractor.Thatisthestandardmethodofhandlingthelimitationsoftheinvestmentmanagementprocess.Butifyouwanttolivethebestsortoflife,Iwouldurgeeachofyounottousethepsychologicaldenialmode.

Ithinkaselectfewasmallpercentageoftheinvestmentmanagerscandelivervalueadded.ButIdon'tthinkbrilliancealoneisenoughtodoit.Ithinkthatyouhavetohavealittleofthisdisciplineofcallingyourshotsandloadingupyouwanttomaximizeyourchancesofbecomingonewhoprovidesaboveaveragerealreturnsforclientsoverthelongpull.

ButI'mjusttalkingaboutinvestmentmanagersengagedincommonstockpicking.Iamagnosticelsewhere.Ithinktheremaywellbepeoplewhoaresoshrewdaboutcurrenciesandthis,thatandtheotherthingthattheycanachievegoodlongtermrecordsoperatingonaprettybigscaleinthatway.Butthatdoesn'thappentobemymilieu.I'mtalkingaboutstockpickinginAmericanstocks.

Ithinkit'shardtoprovidealotofvalueaddedtotheinvestmentmanagementclient,butit'snotimpossible.

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