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Berkshire Hathaway
The Odds of Investing Success

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By gdefelice
May 16, 2002

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I excerpted the Q&A below from Selena's superb notes. At the end of the Q&A I reposted something I wrote in March.

I thought, in light of some of WEB's meeting comments, my thoughts might make more sense. The post I did was poorly written (grammar included) and thus I doubt it made much sense at the time. But, I was trying to get at the idea that Buffett's expressed so simply at the meeting.

I believe, especially after studying Munger, that everything they do has to do with odds (rather than incredible insight -- though the very insight to think statistically might be the best insight of all...) and getting them as far in your favor as possible and keeping them there -- no single events that can "put you back at GO", as Munger says. They've shown many ways to do it: They've shown how they avoid anything they cannot understand -- this is statistical thinking (once one gets past the "ego" problem of admitting to yourself that you don't really understand something).

Another example is to make your largest single investment in a stock whose business characteristics are fantastic AND whose moat took 60 years to build -- statistics tell you that it is very unlikely that anything that has been around so long will disappear quickly. Or, to limit the number of decisions one makes -- thereby reducing the chance for error and forcing one to focus extremely carefully on each decision. Or, to concentrate your holdings (if an investor isn't sure enough to make big bets, he should be buying an index fund on dollar cost average basis, as Buffett suggests -- Buffett's reasoning is statistically based.

If you don't know what you are doing (and you don't if you're not confident enough to make big bets, I assume he reasons) then when you calculate management fees, trading costs and more frequent tax payments, the average invested dollar is guaranteed to do worse than the market even if the gross returns on that dollar are equal to the markets. Thus, average into an index fund. Since the average dollar's return is the market's average return, his advice -- which by definition is to the masses, the average person -- makes complete statistical sense.

Munger talked at the meetings about thinking -- thinking about the big picture, about why things are happening, about "who the interested parties are, rationally considered" (there are ALWAYS interested parties when there is money around -- even charity money, as 9/11 showed so clearly). Usually when I try to do that, someone will comment (not entirely unfairly) that they have no use for this kind of thinking and they want ideas. No problem, really, just skip the post. But, FOR ME, big thinking is much more interesting if only slightly less profitable. I think a lot of money can be made with a very few decisions (and Munger commented at WESCO meeting that he had a relative who only made eight investing decisions and died rich, and he commented a few years ago at the Berkshire meeting that "we wouldn't be here but for 10 ideas".) I don't think you need so many ideas if you can get a few right.

For example, we're in a housing bubble. It is obvious. Of course it is not entirely national but it exists in my county -- Orange County, CA. The fact the Greenspan specifically stated that we are not is all the proof I need. He's literally telling all of us that no price is too high to pay for real-estate. Who knows when it will pop.

But, I can reason that it is a bubble and I know that all investing bubbles pop, adjusted for time. It's a bubble because housing prices cannot keep rising at 15% a year, as they are where I live, when incomes grow at 3% -- that math doesn't work, especially when the market isn't going up. It will pop when interest rates move up from near 40 year lows and regress towards the mean. Or, it will pop when we enter a real recession or depression, no matter how low rates go.

So, since the value of my house has doubled in the last 4 years and I have a mortgage that becomes adjustable in three years, I'm selling and renting. (Incidentally, if you also have such a mortgage, could you make your payments if rates are 9 or 10% when it starts to "adjust" at the end of the fixed term. I couldn't. I made a mistake, and, when I refinanced at the lowest rates in decades, I didn't fix that rate for the life of the mortgage -- even though I've read Buffett -- DUMB MISTAKE even though I would still be selling if I had. If I "couldn't sell" because I had kids at certain schools or I don't want to rent because I want my kids in a safe environment, etc., I'd be really mad at myself for getting sucked into the adjustable mortgage.

I suspect there are many, many mortgage brokers out there putting people into such loans. As I began to think about [it], I realized just how dangerous these things are. Rates rise, your payments explode and the value of your house declines (as does the present value of everything when rates rise). I'm single with no kids, so renting is not a big deal for me and I would NOT advise this for others -- unless you've recently bought in a hot area or unless you have a mortgage that will float in the future. But, my example is about thinking through the big picture and making a decions based on that. I will not be upset if prices keep rising in the near term. Houses might keep going up but if they do I still expect they'll be below where they are now sometime in the future.

So, after that tortuous introduction, here's the excerpt from the meeting and at the bottom is my link to the Great Wall example.

QUESTION: Regarding whether economic moats, competitive advantages, are usually built slowly or quickly, and how they're built.

BUFFETT: Sometimes you can develop them quickly -- look at Microsoft. But with See's, it couldn't be done sooner than decades. Wal-Mart did a fabulous job in quite a short period. There could be things in new industries -- look at NetJets. We have an advantage there and the industry was born in the mid-1980s.

With Coke, it took decades, and going through lots of competitors. In World War II, Eisenhower wanted Coke for servicemen, so bottling plants were built around the world. That was a powerful [development], but it was 60 years after the company's start.

Disney built a solid moat quickly in animated films.

MUNGER: You can also lose the advantage very fast -- look at Arthur Andersen. It was a very good name not so long ago.

BUFFETT: Snickers has been the top chocolate bar for decades. How do you displace it? It's tough. My guess is that it will still be No. 1 in 10 years. If you were chewing spearmint years ago, you're probably chewing it still.

If a company can gain an advantage quickly, you have to worry about it losing the advantage quickly.
Link to my post from March.

Best,

gdefelice


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