Think biologically when it comes to investing

Nov 30, 2023

This is not a collection of quotes from Charlie Munger. This is a very brief glance at the sharp mind.

Why Bill Gates called Charlie Munger the broadest thinker he has ever encountered.

Charlie Munger posed a puzzle of sorts to an audience during an informal talk in July 1996.

Imagine yourself in Atlanta in 1884. A bunch of you are brought before a rich and eccentric citizen named Glotz. You have to present a business plan to start a business that will turn a $2 million investment to $2 trillion by the year 2034. The new venture must be named Coca-Cola and it must exclusively sell non-alcohol beverages.

You have 15 minutes to make your pitch to Glotz.

What followed was a provoking and startling display of business acumen. Munger laterally presented seemingly non-related issues by delving into a deep repository of knowledge and stunningly brought it all together.

He started off with some basic common sense, which he called "no-brainers".

"We are never going to create something worth $2 trillion by selling some generic beverage. Therefore, we must make your name, “Coca-Cola,” into a strong, legally protected trademark.

We can get to $2 trillion only by starting in Atlanta, then succeeding in the rest of the United States, then rapidly succeeding with our new beverage all over the world. This will require developing a product having universal appeal because it harnesses powerful elemental forces."

He then quoted Aristotle, referred to the biblical Ten Commandments, touched upon Darwinian evolution, and went into some detail regarding Pavlovian effects. By combining math, psychology, sociology, and thinking through the problem in reverse, he conveyed the importance of using multi-disciplinary knowledge to make better decisions.

Munger is voracious reader who does not box himself into believing that learnings from one discipline cannot be implemented in another. In fact, he believes that it makes him a much more rational thinker.

"When I urge a multidisciplinary approach- that you’ve got to have the main models from a broad array of disciplines and you’ve got to use them all – I’m really asking you to ignore jurisdictional boundaries. If you want to be a good thinker, you must develop a mind that can jump these boundaries.

You don’t have to know it all. Just take in the best big ideas from all these disciplines. And it’s not that hard to do."

One of Munger's principal frameworks is to more broadly understand, collect, and organise the factors affecting an investment candidate. This means drawing what he calls "multiple mental models" from a variety of disciplines, including engineering, mathematics, physics, chemistry, and psychology.

Driving this need to understand the various dynamics surrounding an investment--both in its internal and external environment--is Munger's understanding that these various factors can work in concert. Munger termed that dynamic a "Lollapalooza Effect"--when anywhere from two to four forces all are driving the investment in the same direction. And yet, Munger noted in Outstanding Investor Digest in 1997 that the effect isn't "simple addition" but rather more akin to a "nuclear explosion."

One doesn't need to be an academic to tap these different models, including the modern Darwinian synthesis model from biology or cognitive misjudgment models from psychology. Indeed, Munger himself acknowledges that his understanding of these models is entirely self-taught.

Munger's invocation of multiple mental models has given him having a mindset characterised by four guiding principles that any ordinary investor should follow: Preparation, Patience, Discipline, and Objectivity. When practiced correctly, these attributes should result in buying great businesses at good prices and keeping one's portfolio turnover low.

Think biologically when it comes to investing.

The fallout of being an avid reader across disciplines is that one develops a kinetic thought pattern. That was evident when Munger draws parallels between investing and evolutionary biology – destruction is inevitable.

In December 2020, I watched an interview of Charlie Munger by Caltech. I made notes and share his views below (in the first person) and have liberally padded it up with an earlier speech at USC Business School.

Common stock investors can make money by predicting the outcomes of evolution. You can't derive this by fundamental analysis - you must think biologically.

Over the long term, the companies of America behave more like biology than they do anything else. In biology, all the individuals die, so do all the species. It is just a question of time. That pretty much happens in the economy too. All the things that were great when I was young have receded enormously. New things come up and some of them have started to die. That is what the long-term investment climate is.

Look at what has died – department stores, newspapers. If the technology hadn’t changed, newspapers would still be great businesses. U.S. Steel, John D. Rockefeller’s Standard Oil is a pale shadow of its former self. It’s just like biology. They have their time, and then they get clobbered.

When technology moves as fast as it does in a civilization like ours, you get a phenomenon that I call competitive destruction. You have the finest buggy whip factory and all of a sudden in comes this little horseless carriage. And before too many years go by, your buggy whip business is dead. You either get into a different business or you're dead—you're destroyed. It happens again and again and again.

And when these new businesses come in, 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.

Some companies are the cutting edge of change. They destroy others instead of being destroyed themselves. And those are the Googles and the Apples and so forth.

Some get on the cutting edge of change. The way Sequoia does. The most remarkable investment firm in America is probably Sequoia. That venture-capital firm fanatically stays right on the cutting edge of modern technology. They have made more money than anybody and they have the best investment record of anybody. It's perfectly amazing what they have done.

(Sequoia Capital has been an investor in Apple, Google, Airbnb, DoorDash, PayPal, Instagram, WhatsApp, YouTube, Oracle.)

Others, like me, do some of that as well as try to avoid big change.

Berkshire owns the Burlington Northern railroad. You can hardly think of a more old-fashioned business than a railroad business. It’s an excellent asset. Who is going to create another trunk railroad? We made that a success, not by conquering change but by avoiding it. It helps to have a position that almost can’t be taken away by technology. How else will you haul goods across the land, from Los Angeles to Chicago?

Burlington Northern has been adept in harnessing technology. Imagine the good fortune in being able to take an existing railroad, double deck all the trains, raise the heights of the tunnels and create twice the capacity at very low incremental cost. Which is what they have done.

In Gillette's case, they keep surfing along new technology which is fairly simple by the standards of microchips. But it's hard for competitors to do. So they've been able to stay constantly near the edge of improvements in shaving. 

Technology is a killer as well as an opportunity.

The great lesson is to discriminate between when technology is going to help you and when it's going to kill you. And most people do not get this straight in their heads.

When we were in the textile business, we were making low-end textiles - which are a real commodity product. And one day, the people came to Warren and said, "They've invented a new loom that we think will do twice as much work as our old ones."

And Warren said, “Gee, I hope this doesn't work because if it does, I'm going to close the mill.” And he meant it.

He was thinking, “It's a lousy business. We're earning substandard returns and keeping it open just to be nice to the elderly workers. But we're not going to put huge amounts of new capital into a lousy business.”

And he knew that the huge productivity increases that would come from a better machine introduced into the production of a commodity product would all go to the benefit of the buyers of the textiles. Nothing was going to stick to our ribs as owners.

However, technology may increase efficiency without increasing profits.

There are all kinds of wonderful new inventions that give you nothing as owners. The money won't come to you. All of the advantages from great improvements are going to flow through to the customers. It's such a simple idea. It's so basic. And yet it's so often forgotten.

I've never seen a single projection incorporating that. Rather, they always read: “This capital outlay will save you so much money that it will pay for itself in three years.” So you keep buying things that will pay for themselves in three years. And after 20 years of doing it, somehow you've earned a return of only about 4% per annum. That's the textile business. The cost reductions came through all right. But the benefit of the cost reductions didn't go to the guy who bought the equipment.

An increase in efficiency does not mean an increase in profitability. 

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