Joe

The University of Berkshire Hathaway

April 23, 2021
, 3:57 pm

In this video you'll learn key takeaways on how to master the investment strategy of Warren Buffett and Charlie Munger.

Key Takeaways

This is how much you would have gained from investing $1,000 in the S&P 500 in 1965. This is how much you would have gained from investing in Berkshire Hathaway.

A return of 12,717%, such as the S&P 500 achieved isn’t too bad. For the price of a 19-inch Zenith TV in 1965, you would be able to buy a brand new (and Swedish) Volvo V60 in 2019.

However, if you invested in Berkshire Hathaway, you could have bought that Volvo at the price of a Barbie doll instead.

In terms of market value, Warren Buffett and Charlie Munger’s Berkshire Hathaway now trails only five companies in the entire world.

Their excellent investing strategies have made Berkshire the largest conglomerate in the world, and they own some of the world’s most famous brands through the company.

Can we learn something about how to invest in stocks from these two gurus? Of course we can. And we shall, because this is: A top five take away summary of: The University of Berkshire Hathaway, written by Daniel Pecaut and Corey Wrenn.

These guys have analyzed every word that Warren Buffett and Charlie Munger have spoken during the annual shareholder meetings of Berkshire Hathaway of the last 30 years.

Let’s see what they have to say about Buffett and Munger’s investing approach.

Buffett and Munger's Investing Approach

1. How to invest during times of inflation

Inflation is an enemy to the investor.

What does it help if your portfolio has increased by say 10% per year during the last 10 years if inflation has been 10% during the same period?

Answer: Nothing at all. You’re just as rich or poor as you were a decade ago.

The aspiring investor must learn how to beat this inflationary enemy.

And this may be extra important to study today, when pretty much every major Western economy have record low interest rates. At least in theory, this should lead to higher inflation.

Let’s start out with what you shouldn’t invest in:

Currencies Well, this one pretty much explains itself. As long as governments around the world keep printing money, the value of currencies will decrease.

Bonds There are some special cases, but with a regular bond, the idea is that you pay a fixed sum now, and in return, you get a fixed future stream of cash flows.

The value of this cash flow is proportional to inflation, which is the reason why investors demand higher bond yields in an inflationary environment.

Gold This may upset some, but according to Warren Buffett and Charlie Munger, gold isn’t a good investment in an inflationary environment either. Actually, it’s not a good investment at all!

Sure, it will keep its value during times of inflation, but so will ANY hard asset. You may as well buy a piece of land or a painting.

The problem is that these investments don’t produce anything. One kilo of gold will remain one kilo of gold even ten years from now.

Therefore, over time, returns from such investments will be mediocre.

To prove a point: In 1987 the Van Gogh painting “Sunflowers” was sold for 40 million dollars, a record at that time for a piece of art.

Someone calculated that, even that record-breaking piece had only had a return of 13% per year since it was created, which Buffett and Munger, with their 20% return, beat by a fair margin.

Okay, so what should you be investing in then?

To cope with inflation, you should invest in assets that produce something.

Like a company in the stock market, for example. Not only that though, you should invest in a business that employs relatively little capital and that has pricing flexibility.

The worst sort of company to invest in during times of inflation is one that requires a lot of capital just to stay in business. Even IF the company can raise its prices, the profits will probably be offset by the investments that were required earlier.

Many industrial companies with a lot of tangible assets on their balance sheets fall into this category.

Companies that sell commodity products often fail the second test of pricing power.

One of Buffett’s favorite examples of a company that fulfills both criteria is See’s Candy. When Berkshire Hathaway purchased it in 1971, it had revenues of $25 million with $9 million in tangible assets.

Forty years later, it had revenues of $300 million, with $40 million of tangible assets.

In other words, See’s Candy needed to invest only $31 million extra to generate $275 million more in revenues.

The very best way to secure your personal finances against inflation is to invest in yourself though. If you increase your earning power, you will be sure to stay ahead of inflation. More on this in the final takeaway.

2. What is investment risk?

In academia, investment risk is defined as the volatility of an investment.

If there are huge swings it must per definition be riskier to invest in, right? WRONG!

Warren Buffett finds this measurement of risk to be silly. How can an investment that alternates between a 20% return and 80% return per year be riskier than a steady 5%?

In Berkshire Hathaway, Warren Buffett and Charlie Munger defines risk as: “The possibility of harm or injury.”

In other words, something that can potentially damage your returns permanently.

With Buffett’s buy-and-hold strategy of stocks, market swings are therefore irrelevant. Instead, he looks at three different types of business risks:

1. Capital structure

The higher the leverage, the riskier the business.

Excess leverage can sometimes cause people to make really dumb decisions, even if they’ve been very successful before.

This goes for individual investors as well, be very careful with leverage.

"Anything times zero is zero"

-Warren Buffet

2. Capital requirements

A company that requires a lot of capital just to stay in business is riskier than one that doesn’t have this characteristic. During times of financial turmoil, this may cause severe liquidity issues.

3. Commodities

A company that is selling a commodity like product without any pricing power always face the risk of a pricing war. During such times, only the low-cost producers survive.

3. Invest using filters

"Few humans have an edge if they follow 40 companies or more"

-Charlie Munger

There simply isn’t enough time to go around for you to investigate EVERY company in the stock market in detail. Therefore, you must use filters so that you don’t waste time on unproductive investing ideas.

Berkshire Hathaway doesn’t have a one size-fits-all system for filtering companies though, as Buffett and Munger think that each industry is different.

So regarding key ratios, such as price to earnings or return on assets, they have nothing generic to share.

However, they have two other types of filters that every investment they make must pass:

1. Great management If the company doesn’t have great executives, who also act in the best interest of shareholders, Buffett and Munger will avoid it.

For more on this investing 101 tip, check out the summary of The Essays of Warren Buffett.

2. Circle of competence If you don’t have a good idea of how the business will perform in the next, say, 5-10 years, you should simply avoid it.

This is one of the key principles to Berkshire Hathaway’s great success. Warren Buffett and Charlie Munger are masters of some industries and some businesses. But more importantly, they know the boundaries of their competence.

For example Berkshire has long stayed away from technology and pharma stocks.
Back in 1999, Buffett actually questioned if anyone could understand technology companies during the peak of the dot-com bubble. He jokingly said that: If he was a business teacher, he would, for the final exam, present an Internet company and ask the students how much it is worth. And anybody who gave him an answer, he would flunk.

Another interesting point regarding filters that Charlie Munger expressed during the year 2017 annual meeting was this: “You must fish where the fish are” China has a lot of fish. In the US market, there are too damn many boats.

4. The share of mind principle

Okay, here comes a quick test. I want you to say out loud the first company that pops up:

Soft drinks
Shaving blades
Smartphones
Ketchup
Kids movies

Were these the companies that you came to think about?

This is the share of mind principle.

The brands of these companies are so strong that they sometimes are mixed up with the products themselves.

It is not a coincidence that Berkshire Hathaway has owned, or currently owns, a substantial number of shares in these companies.

The advantage of these companies, as Buffett explains it, lies in the pricing power that such associations lead to.

For example: If you are thirsty and perhaps also a little bit tired and you need something refreshing, the go-to for many is a Coke.
On the other hand, if you need to free some time while the kids are at home, you put on a Disney movie.

You don’t go for other products, because you’re not certain that they will solve your problems. Therefore, it doesn’t really matter if Coke or Disney costs 20% more than their competitors. The brand’s have great pricing power.

Warren Buffett puts it as simple as this:

"If share of mind exists, the market will follow"

-Warren Buffet

5. Invest in yourself

You are your own greatest asset.

In George Clason’s “The Richest Man in Babylon”, it is suggested that you should always pay yourself first. Always, give yourself 10% of what you earn first. The world can have the rest.

Charlie Munger read this book at an early age and learned about the power of compound interest.

Money, that earns money, that earns money that earns money.

Yeah. However. It was not until later that he also understood the power of mental compound interest.

He decided to always give himself the best hour of the day to improve his mind. Then the world could have the rest.

In takeaway number one, I talked about how you can cope with inflation well if you invest in yourself.

For example, if you are the best surgeon in town, your wage will likely be more than indexed to inflation.
Warren Buffett spent tons of hours in his early days reading every single book he could fetch about investing from the local library Some of them even twice!
He suggests that you should fill your mind about competing ideas and then see what makes sense to you. If only there was a place where you could do that without having to spend tons of hours, and, without having to travel to the local library every day
The earlier you can start, the better.

Not only does money compound but as Buffett and Munger suggest – learning does as well.

Making your first investing mistakes while your account is still small, and to start building up a database of great stocks in your mind, is what they would advise every aspiring investor to do.

All right time to sum up:

The risk associated with an investment is not dependent on the price fluctuations of its stock, but on the underlying characteristics of the business
Use filters to avoid wasting time on unproductive investment ideas
A great branded product is often a good investment. If share of mind exists, the market will follow
Invest in yourself. Use compounding, not only for your bank account, but also for your mind

Joe