Munger on the Big Three, Franklin, and Smart Energy

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Anytime you get a chance to listen to Charlie Munger talk, you'd better listen up. At the recent Wesco Financial meeting -- the 50th annual -- he called the attendees "cultists." For those cultists who couldn't make it to Pasadena, I've summed up the three most important thoughts I took away from the meeting.

Auto companies
In the future, Charlie Munger envisions that Toyota (NYSE: TM  ) could be in real trouble. If Toyota has a problem, Detroit is really in trouble.

Corporate arrogance, overpay, strategic missteps, inefficiencies, and poor capital allocation have permeated Detroit's Big Three for decades now. Mr. Munger would combine the Big Three into a single company and forgive their liabilities. He would let them pick the brightest and best employees to remain working at the combined company.

Even with that aggressive action, he believes they would still have only about a 40% chance of success. In his opinion, the administration's current plan has a 0% chance. This is a true test for our new president. It's awfully tempting to want to save jobs. In General Motors' (NYSE: GM  ) case, the cost of saving a single job has been estimated in the neighborhood of a million dollars per person, based on approximately $160 billion in liabilities.

Mr. Munger pointed to Rochester, New York, as a valuable lesson. Rochester was the birthplace of Xerox (NYSE: XRX  ) and Eastman Kodak (NYSE: EK  ) . Those companies have faded, yet Rochester has survived. Residents have good health care, and houses are cheap. It's the way of the world that some places will decline while others will prosper, Munger opined.

And so it is with capitalism. The inevitable cycle of innovation, prosperity, bloat, decline, and rebirth continues. Government has a difficult balancing act to perform -- something we haven't demonstrated much success at. They must resist the temptation to save every company from going bankrupt in addition to stepping in and saving some of the worst culprits that left our financial system on the brink of collapse.

We've gotten ourselves into a big mess, and it's going to require discipline and leadership to get us out without generating large amounts of inflation in the years ahead. The right thing to do is often not the most popular course, especially among those who are most impacted by the difficult decisions.

I attended three shareholder meetings (Sears, Wesco, and Markel … you can read about my experience at Sears here) in the span of two weeks, and the importance of culture stood out in each one. Wesco built an ownership culture where the operators and the board members are also significant shareholders, and their interests are aligned.

Investors should assess the quality of the management team and the board of directors of public companies. Surprisingly, when it comes to corporate managers, you don't get what you pay for.

Take most investment banks. Their management teams continually place their own interests (and compensation) ahead of the interests of shareholders. When researching potential investments, investors should take the time to see how well management is compensated, understand what goals they are incentivized to achieve, measure how much they have diluted their fellow shareholders, and see who received the bulk of those restricted stock or stock option awards (management or the rank-and-file).

On Wall Street, it's typical that most investment banks will pay out 50% to 55% of their revenues as compensation! It's not just Wall Street that has turned its back on shareholders.

Even the venerable General Electric (NYSE: GE  ) and its bosses lost their way. Former GE CEO Jack Welch socked shareholders with some extravagant retirement perks for life. Later, he passed along this philosophy to understudies like Gary Wendt (Conseco) and Bob Nardelli (Chrysler). Not surprisingly, their careers, post-GE, were very lucrative for themselves but not so the common shareholders for whom they worked. If you like investing in companies that generate copious amounts of cash flow, your first order of business is to understand what management is going to do with that capital.

When attending an annual meeting, consider the loyalty effect, made popular by Fred Reichheld. What is the average tenure of a board member? What about the average shareholder? What about the management team? How many shareholders and employee owners bother to attend the annual meeting? I love employees, managers, and board members who buy their shares on the open market and are invested right alongside the common shareholders. What a novel idea.

Mr. Munger said Ben Franklin suggested that government officials shouldn't be paid. They should serve because they want to serve and can afford to do it. Berkshire Hathaway (NYSE: BRK-A  ) takes this approach with its board of directors. Serving on a board of directors is an honor and a great learning opportunity.

Why should anyone require that they be paid? "Franklin didn't get anywhere with it, and neither have I. If you like the idea, why don't you carry the torch?" Good idea, Mr. Munger. When you can get a Berkshire board member for peanuts, why would you invest in Goldman Sachs?

A smart energy grid
Mr. Munger talked quite a bit about the importance of a new power grid to enable the transfer of wind and solar power across the United States. He believes that solar provides vast amounts of untapped energy that represents our future for clean energy. Two points struck me while listening to his comments:

While stimulus spending can certainly be inflationary, it isn't always inflationary. It's critically important that our leaders focus stimulus spending on areas that increase our productivity! As Mr. Munger said, Japan spent lots of stimulus money on filling potholes. That kind of spending just doesn't work. Our leaders need to work in a bipartisan way to make sure this money is spent wisely. When pondering stimulus initiatives, each official should be asking themselves, Will this project make the United States more competitive and productive?

I thought back to Ralph Wanger, the legendary manager of the Acorn fund who embraced the idea of investing downstream of technology. When you think about government spending in the 1950s, you think about the public highway system and how it spawned the growth of hotels and fast-food restaurants. In the 1960s our race to put a man on the moon resulted in the invention of the micro-chip and led to the ubiquity of the Internet and personal computers.

If you were investing downstream of those government initiatives, you would have been investing in McDonald's (NYSE: MCD  ) and any computer company you could think of. If (or when) we build this new smart power grid, investors should be thinking about investment ideas that sit downstream.

While the investment ideas might not be obvious today, you will likely see them first if you're looking in the right place. What opportunities will this new grid make commercially viable?

More Munger insight:

Buck Hartzell owns shares of Berkshire Hathaway, Sears, and Markel, which are Motley Fool Inside Value recommendations. Berkshire is also a Stock Advisor selection. The Motley Fool owns shares of Berkshire Hathaway and Markel and has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (18)

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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 May 22, 2009, at 12:48 PM, wuff3t wrote:

    "Mr. Munger said Ben Franklin suggested that government officials shouldn't be paid. They should serve because they want to serve and can afford to do it..."

    For a smart man that's a really stupid remark. Does anyone really want a government that consists solely of people who are so wealthy they don't actually need to work? How on earth would people like that be able to represent the views of the majority? How could they possibly understand how the majority live and what their concerns and needs are?

  • Report this Comment On May 22, 2009, at 1:09 PM, PricePro12 wrote:

    What Ben Franklin means by his statement is that people should solely work for the government because they care, not just for a paycheck.

  • Report this Comment On May 22, 2009, at 2:08 PM, none0such wrote:

    The current prime minister of Italy and the current speaker of the US House of Representatives (the former is a media tycoon while the latter is married to a business tycoon) as well as numerous others fit Franklin's description while still receiving a salary. Even the British Royal family is paid to reign. However, these people also exhibit distinctive characteristics that repulse or endear the public while their political leadership (servitude) is biased by their constituents amplification or excuse of their poor decisions. Governments will function better without guaranteeing a cult of personality follows an individual into office. (witness Mr. Munger's own that guarantees he has an audience. Just because you are smart doesn't mean you are right or honest or fit to lead or serve.)

  • Report this Comment On May 22, 2009, at 11:39 PM, Bult wrote:

    The statement that our race to put a man on the moon resulted in the invention of the micro-chip and led to the ubiquity of the Internet and personal computers is simply wrong. Our race to the moon had nothing to do with the rise of either. Micro-chips arose out of pure fundamental R&D at Bell Labs and Texas Instruments. The internet, as a matter of fact, was born out of pure fundamental research at a particle physics laboratory called CERN in Geneva, Switzerland. The impact of the internet as we see it today was a "black swan", that is, something nobody could have ever predicted. Blindly thinking about a new grid, wind and solar power is foolish. How this may evolve is rather unpredictable, because there are some serious issues with many aspects and, with all due respect, Mr. Munger is not a power engineer. That said, to be open to new technologies with a critical view is very important while at the same time being a true investor rather than a speculator.

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