Buffett gets most of the praise, but his sidekick is a great source of investing wisdom, too.
Ask investors who they associate with the company Berkshire Hathaway and the answer you'll invariably get is Warren Buffett. Berkshire and Buffett are synonymous in people's minds but much of the credit for Berkshire's success goes not to Buffett but to Berkshire's Vice-Chairman and Buffett's long-time business partner, Charlie Munger.
My colleague Padraig O'Hannelly has already covered Munger's investment record as part of his series on Great Investors in this article from 2009. So today I'm going to focus upon Munger's other contributions to Berkshire Hathaway and to investing in general.
Outspoken whilst behind the scenes
Buffett is the public face of Berkshire Hathaway and he occasionally appears in commercials for its many subsidiaries, such as this advert for GEICO where he dresses up as Axl Rose, lead singer of the heavy metal band Guns N' Roses.
In contrast Munger keeps a lower profile and thus doesn't attract as much press as Buffett. But on those occasions when he comments on the record he's well worth listening too, particularly because he tends to be more direct and far less diplomatic than Buffett.
For instance, in 2008 when Buffett was asked about investment banks, he remarked that some had become too large and complex to run. Munger's response was "The whole damn industry has lost its moral moorings."
However, that's nothing to the time when a shareholder asked him to compare the benefits that Internet companies gave to society with the rampant speculation in their shares: "When you mix raisins and turds, you've still got turds."
The Abominable No-Man
Buffett uses Munger as a sounding board for his ideas and has given him the nickname "the abominable no-man." As Buffett says: "If we ask Charlie something and he says "no," then we put all of our money in it. If he says, "that's the stupidest thing I've ever heard," then we make a more modest investment."
Whereas Buffett's life centres on Berkshire, Munger has many other interests including being the chairman of Wesco Financial Corporation (80% owned by Berkshire). For some investors, one of the highlights of the investment year is the publication of the Wesco annual report which contains Munger's letter to Wesco shareholders.
Munger gets the lion's share of the credit for suggesting to Buffett that as an alternative to Benjamin Graham-style value investing, where you searched for companies whose share prices were well below their net asset value, that it was sometimes worth paying what appeared to be a high price for a Graham investor for a quality company with strong brands.
This came about in 1972 after Munger was persuaded by Ira Marshall to buy See's Candy, a Californian sweet maker, at a price well above what he would have normally paid. The performance of See's then caused Munger, soon followed by Buffett, to appreciate that it was worth paying up for a business which has a sustainable competitive advantage.
The result was that Berkshire Hathaway started to focus more upon companies with strong brands which possessed what Buffett calls a moat to protect the business against competition.
But things could have turned out very differently, as Munger puts it, "If See's Candy had asked for $100,000 more, Warren and I would have walked -- that's how dumb we were."
Investor psychology and mental models
One of Munger's interests is examining the interactions between psychology and business, in particular how people react strongly to incentives and thus why it is important to ensure that incentives do not give out the wrong signals, such as rewarding destructive behaviour.
Munger's observations are summed up in a lecture given at Harvard Law School in 1995 titled "The Psychology of Human Misjudgement", where he outlined twenty-four different ways in which human psychology causes people to make serious errors of judgment.
You can find the lecture transcript here; you might find it to be a real eye opener (copies can also be found on the Wikipedia page).
Another topic where Munger's theories are especially pertinent is the field of "mental models"; the way in which people use their existing knowledge of facts and processes to interpret new facts and thus solve problems.
Munger notes that many people have effectively been trained to look at the world in just the one way. These people will often they will try and force the facts to fit their model, rather than fitting a model to the facts, which can cause them to make major errors.
For example, if you give the same problem and set of facts to a biologist, a doctor, an engineer, an economist, a lawyer, a physicist, a politician, a rugby player and a soldier, each will probably try and solve it using their particular mental model. As the old adage says, "to the man with a hammer every problem looks like a nail".
Munger argues that to combat this tendency people should acquire several mental models by ensuring that they have an basic understanding of the big ideas in the big disciplines; biology, economics, physics, politics, psychology, etc. and then learn to use them.
Further reading
At the last count there are nearly fifty books about Buffett whilst there are only three about Munger; Damn Right!, From Darwin to Munger and Poor Charlie's Almanack. These come highly recommended although given the price at which copies of Poor Charlie's Almanack usually go for you might prefer to try the other two first!
Let's finish with one of my favourite Munger quotes, "We all are learning, modifying, or destroying ideas all the time. Rapid destruction of your ideas when the time is right is one of the most valuable qualities you can acquire. You must force yourself to consider arguments on the other side."
More from Tony Luckett:
> Tony owns shares in Berkshire Hathaway
