The Psychology of Charlie Munger: For Investors, Fairness Pays

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If you know Berkshire Hathaway (NYSE: BRK-B  ) , then you probably know its vice chairman, Charlie Munger -- Buffett's right-hand man. Munger's book, Poor Charlie's Almanack, collects his speeches and musings, including his intriguing thoughts on the 25 tendencies that lead us humans to make really bad decisions. For your benefit and mine, this series will review each of those ill-fated impulses, the errors they create, and the antidotes that can help make us better investors.

Today, we're on to tendency No. 7: The Kantian Fairness Tendency.

Metaphysically speaking, of course
This one took me back to my college days; the reference to Kant's categorical imperative caught my eye immediately. I'm not going to get into the weeds on this one, as I spent an entire semester on it and I'm still not sure we ever actually reached any conclusions.

The basic idea as pertains to Munger is that we have and follow certain rules that, when followed by everyone, result in a pretty fair shake for all involved. They key is that everyone needs to follow along, hence the dilemma.

A "real-life" example
Do unto others as you would have done unto you. Sound familiar? It should. It's the Golden Rule, and it relates to this fairness tendency. A perfect example is one in the book relating to traffic. Think about a big traffic jam where one of two lanes going in the same direction is shut down so that the two must merge into one.

Basic fairness dictates that we alternate letting people in. So I let someone merge into my lane in front of me, then the person behind me does the same thing, and so on. It makes perfect sense, and when followed, it makes the best of a given situation. But as we also know, it doesn't always work that way and not everyone plays along.

Why should I care about this? I'm an investor!
Say we have a company that has historically paid a nice little dividend to its shareholders as a way to return value. As time goes on, if the company continues to grow and perform well, shareholders may rightly expect that their dividend should grow, too. But what if it doesn't? What if something changes? What if the company decides to do something else with that cash, like buy back shares?

On the surface, this may seem OK. Management is reducing the number of shares outstanding and creating value that way. Or is it? What if management is buying back shares simply to offset the dilution from options gained through compensation packages? That doesn't seem so fair, does it? Or does it? I mean, we know that most executives receive options in some capacity as compensation, so this happens all the time.

Take Gap (NYSE: GPS  ) , for example. Management has repurchased 67 million shares for $1.4 billion in the first half of this year, which implies a price of about $21 per share. But share count hasn't gone down by quite that much on a sequential basis. At the end of 2010, the company had 588 million shares outstanding. Halfway through 2011, the number was down to 542 million -- a difference of 46 million. So a big chunk -- about a third -- of that $1.4 billion went to offset share-based compensation.

So what does this mean?
When it comes to issues like these, Gap isn't the worst, Gap isn't the best, and life moves on. People are gonna get paid one way or another, that's for sure. And this is nothing way out of order. The key here for any company is "How much?" and "How often?" If it's something that's abused frequently and consistently, well, then we have a problem. Then they start looking like that car that decides it's not going to play along by not letting anyone in. And I hate that car.

Read the other installments so far in this series:

Motley Fool Stock Advisor analyst Jason Moser owns shares of Berkshire Hathaway. The Motley Fool owns shares of Gap and Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 24, 2011, at 12:21 AM, Goodlaw7 wrote:

    With regard to Gap, you appear to have used the wrong share count figure. You should have used 510m shares outstanding at the end of the quarter. Instead you used the AVERAGE during the quarter of 542m to imply lots of share dilution that is factually incorrect. In the process you unjustly dinged a company and provided a worthless example. Please try to be more competent in the future.

  • Report this Comment On September 24, 2011, at 5:47 PM, TMFJMo wrote:

    @Goodlaw7,

    You are correct. In fact the number of shares outstanding at the end of the second quarter was 510,206,631 and that 542M was used in error; my apologies for any confusion.

    The overall subject of the article still holds true...investors need to make sure they are getting a fair shake so I don't consider it totally worthless. But hey, to each his/her own.

    Thanks for the kind words!

    Foolish best,

    Jason

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