ALessononElementary,WorldlyWisdomAsItRelatesToInvestmentManagement&Business

CharlesMunger,USCBusinessSchool,1994

I'mgoingtoplayaminortrickonyoutodaybecausethesubjectofmytalkistheartofstock
pickingasasubdivisionoftheartofworldlywisdom.Thatenablesmetostarttalkingabout
worldlywisdomamuchbroadertopicthatinterestsmebecauseIthinkalltoolittleofitis
deliveredbymoderneducationalsystems,atleastinaneffectiveway.

Andtherefore,thetalkissortofalongthelinesthatsomebehavioristpsychologistscall
Grandma'sruleafterthewisdomofGrandmawhenshesaidthatyouhavetoeatthecarrots
beforeyougetthedessert.

Thecarrotpartofthistalkisaboutthegeneralsubjectofworldlywisdomwhichisapretty
goodwaytostart.Afterall,thetheoryofmoderneducationisthatyouneedageneral
educationbeforeyouspecialize.AndIthinktosomeextent,beforeyou'regoingtobeagreat
stockpicker,youneedsomegeneraleducation.

So,emphasizingwhatIsometimeswaggishlycallremedialworldlywisdom,I'mgoingtostart
bywaltzingyouthroughafewbasicnotions.

Whatiselementary,worldlywisdom?Well,thefirstruleisthatyoucan'treallyknowanything
ifyoujustrememberisolatedfactsandtryandbang'emback.Ifthefactsdon'thangtogether
onalatticeworkoftheory,youdon'thavetheminausableform.

You'vegottohavemodelsinyourhead.Andyou'vegottoarrayyourexperienceboth
vicariousanddirectonthislatticeworkofmodels.Youmayhavenoticedstudentswhojust
trytorememberandpoundbackwhatisremembered.Well,theyfailinschoolandinlife.
You'vegottohangexperienceonalatticeworkofmodelsinyourhead.

Whatarethemodels?Well,thefirstruleisthatyou'vegottohavemultiplemodelsbecauseif
youjusthaveoneortwothatyou'reusing,thenatureofhumanpsychologyissuchthatyou'll
torturerealitysothatitfitsyourmodels,oratleastyou'llthinkitdoes.Youbecomethe
equivalentofachiropractorwho,ofcourse,isthegreatboobinmedicine.

It'sliketheoldsaying,"Tothemanwithonlyahammer,everyproblemlookslikeanail."And
ofcourse,that'sthewaythechiropractorgoesaboutpracticingmedicine.Butthat'saperfectly
disastrouswaytothinkandaperfectlydisastrouswaytooperateintheworld.Soyou'vegotto
havemultiplemodels.

Andthemodelshavetocomefrommultipledisciplinesbecauseallthewisdomoftheworld
isnottobefoundinonelittleacademicdepartment.That'swhypoetryprofessors,byand
large,aresounwiseinaworldlysense.Theydon'thaveenoughmodelsintheirheads.So
you'vegottohavemodelsacrossafairarrayofdisciplines.

Youmaysay,"MyGod,thisisalreadygettingwaytootough."But,fortunately,itisn'tthat
toughbecause80or90importantmodelswillcarryabout90%ofthefreightinmakingyoua
worldly-wiseperson.And,ofthose,onlyamerehandfulreallycarryveryheavyfreight.

Solet'sbrieflyreviewwhatkindofmodelsandtechniquesconstitutethisbasicknowledgethat
everybodyhastohavebeforetheyproceedtobeingreallygoodatanarrowartlikestock
picking.

Firstthere'smathematics.Obviously,you'vegottobeabletohandlenumbersand
quantitiesbasicarithmetic.Andthegreatusefulmodel,aftercompoundinterest,isthe
elementarymathofpermutationsandcombinations.Andthatwastaughtinmydayinthe
sophomoreyearinhighschool.Isupposebynowingreatprivateschools,it'sprobablydown
totheeighthgradeorso.

It'sverysimplealgebra.ItwasallworkedoutinthecourseofaboutoneyearbetweenPascal
andFermat.Theyworkeditoutcasuallyinaseriesofletters.

It'snotthathardtolearn.Whatishardistogetsoyouuseitroutinelyalmosteverydayofyour
life.TheFermat/Pascalsystemisdramaticallyconsonantwiththewaythattheworldworks.
Andit'sfundamentaltruth.Soyousimplyhavetohavethetechnique.

Manyeducationalinstitutionsalthoughnotnearlyenoughhaverealizedthis.AtHarvard
BusinessSchool,thegreatquantitativethingthatbondsthefirst-yearclasstogetheriswhat
theycalldecisiontreetheory.Alltheydoistakehighschoolalgebraandapplyittoreallife
problems.Andthestudentsloveit.They'reamazedtofindthathighschoolalgebraworksin
life....

Byandlarge,asitworksout,peoplecan'tnaturallyandautomaticallydothis.Ifyou
understandelementarypsychology,thereasontheycan'tisreallyquitesimple:Thebasic
neuralnetworkofthebrainistherethroughbroadgeneticandculturalevolution.Andit'snot
Fermat/Pascal.Itusesaverycrude,shortcut-typeofapproximation.It'sgotelementsof
Fermat/Pascalinit.However,it'snotgood.

Soyouhavetolearninaveryusablewaythisveryelementarymathanduseitroutinelyin
lifejustthewayifyouwanttobecomeagolfer,youcan'tusethenaturalswingthatbroad
evolutiongaveyou.Youhavetolearntohaveacertaingripandswinginadifferentwayto
realizeyourfullpotentialasagolfer.

Ifyoudon'tgetthiselementary,butmildlyunnatural,mathematicsofelementaryprobability
intoyourrepertoire,thenyougothroughalonglifelikeaoneleggedmaninanasskicking
contest.You'regivingahugeadvantagetoeverybodyelse.
OneoftheadvantagesofafellowlikeBuffett,whomI'veworkedwithalltheseyears,isthathe
automaticallythinksintermsofdecisiontreesandtheelementarymathofpermutationsand
combinations....

Obviously,youhavetoknowaccounting.It'sthelanguageofpracticalbusinesslife.Itwasa
veryusefulthingtodelivertocivilization.I'vehearditcametocivilizationthroughVenice
whichofcoursewasoncethegreatcommercialpowerintheMediterranean.However,
double-entrybookkeepingwasahellofaninvention.

Andit'snotthathardtounderstand.

Butyouhavetoknowenoughaboutittounderstanditslimitationsbecausealthough
accountingisthestartingplace,it'sonlyacrudeapproximation.Andit'snotveryhardto
understanditslimitations.Forexample,everyonecanseethatyouhavetomoreorlessjust
guessattheusefullifeofajetairplaneoranythinglikethat.Justbecauseyouexpressthe
depreciationrateinneatnumbersdoesn'tmakeitanythingyoureallyknow.

Intermsofthelimitationsofaccounting,oneofmyfavoritestoriesinvolvesaverygreat
businessmannamedCarlBraunwhocreatedtheCFBraunEngineeringCompany.Itdesigned
andbuiltoilrefinerieswhichisveryhardtodo.AndBraunwouldgetthemtocomeinon
timeandnotblowupandhaveefficienciesandsoforth.Thisisamajorart.

AndBraun,beingthethoroughTeutonictypethathewas,hadanumberofquirks.Andoneof
themwasthathetookalookatstandardaccountingandthewayitwasappliedtobuildingoil
refineriesandhesaid,"Thisisasinine."

Sohethrewallofhisaccountantsoutandhetookhisengineersandsaid,"Now,we'lldevise
ourownsystemofaccountingtohandlethisprocess."Andinduetime,accountingadopteda
lotofCarlBraun'snotions.Sohewasaformidablywillfulandtalentedmanwho
demonstratedboththeimportanceofaccountingandtheimportanceofknowingits
limitations.

Hehadanotherrule,frompsychology,which,ifyou'reinterestedinwisdom,oughttobepart
ofyourrepertoireliketheelementarymathematicsofpermutationsandcombinations.

HisruleforalltheBraunCompany'scommunicationswascalledthefiveW'syouhadtotell
whowasgoingtodowhat,where,whenandwhy.Andifyouwrotealetterordirectiveinthe
BraunCompanytellingsomebodytodosomething,andyoudidn'ttellhimwhy,youcouldget
fired.Infact,youwouldgetfiredifyoudidittwice.

Youmightaskwhythatissoimportant?Well,againthat'saruleofpsychology.Justasyou
thinkbetterifyouarrayknowledgeonabunchofmodelsthatarebasicallyanswerstothe
question,why,why,why,ifyoualwaystellpeoplewhy,they'llunderstanditbetter,they'll
consideritmoreimportant,andthey'llbemorelikelytocomply.Eveniftheydon'tunderstand
yourreason,they'llbemorelikelytocomply.
Sothere'sanironrulethatjustasyouwanttostartgettingworldlywisdombyaskingwhy,
why,why,incommunicatingwithotherpeopleabouteverything,youwanttoincludewhy,
why,why.Evenifit'sobvious,it'swisetostickinthewhy.

Whichmodelsarethemostreliable?Well,obviously,themodelsthatcomefromhardscience
andengineeringarethemostreliablemodelsonthisEarth.Andengineeringquality
controlatleastthegutsofitthatmatterstoyouandmeandpeoplewhoarenot
professionalengineersisverymuchbasedontheelementarymathematicsofFermatand
Pascal:

Itcostssomuchandyougetsomuchlesslikelihoodofitbreakingifyouspendthismuch.It's
allelementaryhighschoolmathematics.AndanelaborationofthatiswhatDemingbroughtto
Japanforallofthatqualitycontrolstuff.

Idon'tthinkit'snecessaryformostpeopletobeterriblyfacileinstatistics.Forexample,I'm
notsurethatIcanevenpronouncethePoissondistribution.ButIknowwhataGaussianor
normaldistributionlookslikeandIknowthateventsandhugeaspectsofrealityendup
distributedthatway.SoIcandoaroughcalculation.

ButifyouaskmetoworkoutsomethinginvolvingaGaussiandistributiontotendecimal
points,Ican'tsitdownanddothemath.I'mlikeapokerplayerwho'slearnedtoplaypretty
wellwithoutmasteringPascal.

Andbytheway,thatworkswellenough.Butyouhavetounderstandthatbellshapedcurveat
leastroughlyaswellasIdo.

And,ofcourse,theengineeringideaofabackupsystemisaverypowerfulidea.The
engineeringideaofbreakpointsthat'saverypowerfulmodel,too.Thenotionofacritical
massthatcomesoutofphysicsisaverypowerfulmodel.

Allofthesethingshavegreatutilityinlookingatordinaryreality.Andallofthiscost-benefit
analysishell,that'sallelementaryhighschoolalgebra,too.It'sjustbeendolledupalittlebit
withfancylingo.

Isupposethenextmostreliablemodelsarefrombiology/physiologybecause,afterall,allof
usareprogrammedbyourgeneticmakeuptobemuchthesame.

Andthenwhenyougetintopsychology,ofcourse,itgetsverymuchmorecomplicated.Butit's
anungodlyimportantsubjectifyou'regoingtohaveanyworldlywisdom.

Andyoucandemonstratethatpointquitesimply:There'snotapersoninthisroomviewing
theworkofaveryordinaryprofessionalmagicianwhodoesn'tseealotofthingshappening
thataren'thappeningandnotseealotofthingshappeningthatarehappening.
Andthereasonwhyisthattheperceptualapparatusofmanhasshortcutsinit.Thebrain
cannothaveunlimitedcircuitry.Sosomeonewhoknowshowtotakeadvantageofthose
shortcutsandcausethebraintomiscalculateincertainwayscancauseyoutoseethingsthat
aren'tthere.

Nowyougetintothecognitivefunctionasdistinguishedfromtheperceptualfunction.And
there,youareequallymorethanequallyinfactlikelytobemisled.Again,yourbrainhasa
shortageofcircuitryandsoforthandit'stakingallkindsoflittleautomaticshortcuts.

Sowhencircumstancescombineincertainwaysormorecommonly,yourfellowmanstarts
actinglikethemagicianandmanipulatesyouonpurposebycausingyourcognitive
dysfunctionyou'reapatsy.

Andsojustasamanworkingwithatoolhastoknowitslimitations,amanworkingwithhis
cognitiveapparatushastoknowitslimitations.Andthisknowledge,bytheway,canbeusedto
controlandmotivateotherpeople....

SothemostusefulandpracticalpartofpsychologywhichIpersonallythinkcanbetaughtto
anyintelligentpersoninaweekisungodlyimportant.Andnobodytaughtittomebythe
way.Ihadtolearnitlaterinlife,onepieceatatime.Anditwasfairlylaborious.It'sso
elementarythoughthat,whenitwasallover,Ifeltlikeafool.

Andyeah,I'dbeeneducatedatCalTechandtheHarvardLawSchoolandsoforth.Sovery
eminentplacesmiseducatedpeoplelikeyouandme.

Theelementarypartofpsychologythepsychologyofmisjudgment,asIcallitisaterribly
importantthingtolearn.Thereareabout20littleprinciples.Andtheyinteract,soitgets
slightlycomplicated.Butthegutsofitisunbelievablyimportant.

Terriblysmartpeoplemaketotallybonkersmistakesbyfailingtopayheedtoit.Infact,I've
doneitseveraltimesduringthelasttwoorthreeyearsinaveryimportantway.Youneverget
totallyovermakingsillymistakes.

There'sanothersayingthatcomesfromPascalwhichI'vealwaysconsideredoneofthereally
accurateobservationsinthehistoryofthought.Pascalsaidinessence,"Themindofmanat
oneandthesametimeisboththegloryandtheshameoftheuniverse."

Andthat'sexactlyright.Ithasthisenormouspower.However,italsohasthesestandard
misfunctionsthatoftencauseittoreachwrongconclusions.Italsomakesmanextraordinarily
subjecttomanipulationbyothers.Forexample,roughlyhalfofthearmyofAdolfHitlerwas
composedofbelievingCatholics.Givenenoughcleverpsychologicalmanipulation,what
humanbeingswilldoisquiteinteresting.

Personally,I'vegottensothatInowuseakindoftwo-trackanalysis.First,whatarethefactors
thatreallygoverntheinterestsinvolved,rationallyconsidered?Andsecond,whatarethe
subconsciousinfluenceswherethebrainatasubconsciouslevelisautomaticallydoingthese
thingswhichbyandlargeareuseful,butwhichoftenmisfunction.

Oneapproachisrationalitythewayyou'dworkoutabridgeproblem:byevaluatingthereal
interests,therealprobabilitiesandsoforth.Andtheotheristoevaluatethepsychological
factorsthatcausesubconsciousconclusionsmanyofwhicharewrong.

Nowwecometoanothersomewhatlessreliableformofhumanwisdommicroeconomics.
Andhere,Ifinditquiteusefultothinkofafreemarketeconomyorpartlyfreemarket
economyassortoftheequivalentofanecosystem....

ThisisaveryunfashionablewayofthinkingbecauseearlyinthedaysafterDarwincame
along,peopleliketherobberbaronsassumedthatthedoctrineofthesurvivalofthefittest
authenticatedthemasdeservingpoweryouknow,"I'mtherichest.Therefore,I'mthebest.
God'sinhisheaven,etc."

Andthatreactionoftherobberbaronswassoirritatingtopeoplethatitmadeit
unfashionabletothinkofaneconomyasanecosystem.Butthetruthisthatitisalotlikean
ecosystem.Andyougetmanyofthesameresults.

Justasinanecosystem,peoplewhonarrowlyspecializecangetterriblygoodatoccupying
somelittleniche.Justasanimalsflourishinniches,similarly,peoplewhospecializeinthe
businessworldandgetverygoodbecausetheyspecializefrequentlyfindgoodeconomics
thattheywouldn'tgetanyotherway.

Andoncewegetintomicroeconomics,wegetintotheconceptofadvantagesofscale.Now
we'regettingclosertoinvestmentanalysisbecauseintermsofwhichbusinessessucceed
andwhichbusinessesfail,advantagesofscaleareungodlyimportant.

Forexample,onegreatadvantageofscaletaughtinallofthebusinessschoolsoftheworldis
costreductionsalongtheso-calledexperiencecurve.Justdoingsomethingcomplicatedin
moreandmorevolumeenableshumanbeings,whoaretryingtoimproveandaremotivated
bytheincentivesofcapitalism,todoitmoreandmoreefficiently.

Theverynatureofthingsisthatifyougetawholelotofvolumethroughyourjoint,youget
betteratprocessingthatvolume.That'sanenormousadvantage.Andithasalottodowith
whichbusinessessucceedandfail....

Let'sgothroughalistalbeitanincompleteoneofpossibleadvantagesofscale.Somecome
fromsimplegeometry.Ifyou'rebuildingagreatsphericaltank,obviouslyasyoubuildit
bigger,theamountofsteelyouuseinthesurfacegoesupwiththesquareandthecubic
volumegoesupwiththecube.Soasyouincreasethedimensions,youcanholdalotmore
volumeperunitareaofsteel.

Andthereareallkindsofthingslikethatwherethesimplegeometrythesimple
realitygivesyouanadvantageofscale.
Forexample,youcangetadvantagesofscalefromTVadvertising.WhenTVadvertisingfirst
arrivedwhentalkingcolorpicturesfirstcameintoourlivingroomsitwasanunbelievably
powerfulthing.Andintheearlydays,wehadthreenetworksthathadwhateveritwassay
90%oftheaudience.

Well,ifyouwereProcter&Gamble,youcouldaffordtousethisnewmethodofadvertising.
Youcouldaffordtheveryexpensivecostofnetworktelevisionbecauseyouweresellingso
manycansandbottles.Somelittleguycouldn't.Andtherewasnowayofbuyingitinpart.
Therefore,hecouldn'tuseit.Ineffect,ifyoudidn'thaveabigvolume,youcouldn'tuse
networkTVadvertisingwhichwasthemosteffectivetechnique.

SowhenTVcamein,thebrandedcompaniesthatwerealreadybiggotahugetailwind.
Indeed,theyprosperedandprosperedandprospereduntilsomeofthemgotfatandfoolish,
whichhappenswithprosperityatleasttosomepeople....

Andyouradvantageofscalecanbeaninformationaladvantage.IfIgotosomeremoteplace,
ImayseeWrigleychewinggumalongsideGlotz'schewinggum.Well,IknowthatWrigleyisa
satisfactoryproduct,whereasIdon'tknowanythingaboutGlotz's.Soifoneis40centsandthe
otheris30cents,amIgoingtotakesomethingIdon'tknowandputitinmymouthwhichis
aprettypersonalplace,afterallforalousydime?

So,ineffect,Wrigley,simplybybeingsowellknown,hasadvantagesofscalewhatyoumight
callaninformationaladvantage.

Anotheradvantageofscalecomesfrompsychology.Thepsychologistsusethetermsocial
proof.Weareallinfluencedsubconsciouslyandtosomeextentconsciouslybywhatwesee
othersdoandapprove.Therefore,ifeverybody'sbuyingsomething,wethinkit'sbetter.We
don'tliketobetheoneguywho'soutofstep.

Again,someofthisisatasubconsciouslevelandsomeofitisn't.Sometimes,weconsciously
andrationallythink,"Gee,Idon'tknowmuchaboutthis.TheyknowmorethanIdo.
Therefore,whyshouldn'tIfollowthem?"

Thesocialproofphenomenonwhichcomesrightoutofpsychologygiveshugeadvantagesto
scaleforexample,withverywidedistribution,whichofcourseishardtoget.Oneadvantage
ofCoca-Colaisthatit'savailablealmosteverywhereintheworld.

Well,supposeyouhavealittlesoftdrink.Exactlyhowdoyoumakeitavailablealloverthe
Earth?Theworldwidedistributionsetupwhichisslowlywonbyabigenterprisegetstobea
hugeadvantage....Andifyouthinkaboutit,onceyougetenoughadvantagesofthattype,it
canbecomeveryhardforanybodytodislodgeyou.

There'sanotherkindofadvantagetoscale.Insomebusinesses,theverynatureofthingsisto
sortofcascadetowardtheoverwhelmingdominanceofonefirm.
Themostobviousoneisdailynewspapers.There'spracticallynocityleftintheU.S.,aside
fromafewverybigones,wherethere'smorethanonedailynewspaper.

Andagain,that'sascalething.OnceIgetmostofthecirculation,Igetmostoftheadvertising.
AndonceIgetmostoftheadvertisingandcirculation,whywouldanyonewantthethinner
paperwithlessinformationinit?Soittendstocascadetoawinnertakeallsituation.Andthat's
aseparateformoftheadvantagesofscalephenomenon.

Similarly,allthesehugeadvantagesofscaleallowgreaterspecializationwithinthefirm.
Therefore,eachpersoncanbebetteratwhathedoes.

Andtheseadvantagesofscalearesogreat,forexample,thatwhenJackWelchcameinto
GeneralElectric,hejustsaid,"Tohellwithit.We'reeithergoingtobe#1or#2ineveryfield
we'reinorwe'regoingtobeout.Idon'tcarehowmanypeopleIhavetofireandwhatIhave
tosell.We'regoingtobe#1or#2orout."

Thatwasaverytoughmindedthingtodo,butIthinkitwasaverycorrectdecisionifyou're
thinkingaboutmaximizingshareholderwealth.AndIdon'tthinkit'sabadthingtodofora
civilizationeither,becauseIthinkthatGeneralElectricisstrongerforhavingJackWelchthere.

Andtherearealsodisadvantagesofscale.Forexample,webywhichImeanBerkshire
HathawayarethelargestshareholderinCapitalCities/ABC.Andwehadtradepublications
therethatgotmurderedwhereourcompetitorsbeatus.Andthewaytheybeatuswasby
goingtoanarrowerspecialization.

We'dhaveatravelmagazineforbusinesstravel.Sosomebodywouldcreateonewhichwas
addressedsolelyatcorporatetraveldepartments.Likeanecosystem,you'regettinga
narrowerandnarrowerspecialization.

Well,theygotmuchmoreefficient.Theycouldtellmoretotheguyswhorancorporatetravel
departments.Plus,theydidn'thavetowastetheinkandpapermailingoutstuffthatcorporate
traveldepartmentsweren'tinterestedinreading.Itwasamoreefficientsystem.Andtheybeat
ourbrainsoutaswereliedonourbroadermagazine.

That'swhathappenedtoTheSaturdayEveningPostandallthosethings.They'regone.What
wehavenowisMotocrosswhichisreadbyabunchofnutswholiketoparticipatein
tournamentswheretheyturnsomersaultsontheirmotorcycles.Buttheycareaboutit.For
them,it'stheprincipalpurposeoflife.AmagazinecalledMotocrossisatotalnecessityto
thosepeople.Anditsprofitmarginswouldmakeyousalivate.

Justthinkofhownarrowcastthatkindofpublishingis.Sooccasionally,scalingdownand
intensifyinggivesyouthebigadvantage.Biggerisnotalwaysbetter.
Thegreatdefectofscale,ofcourse,whichmakesthegameinterestingsothatthebigpeople
don'talwayswinisthatasyougetbig,yougetthebureaucracy.Andwiththebureaucracy
comestheterritorialitywhichisagaingroundedinhumannature.

Andtheincentivesareperverse.Forexample,ifyouworkedforAT&Tinmyday,itwasagreat
bureaucracy.Whointhehellwasreallythinkingabouttheshareholderoranythingelse?And
inabureaucracy,youthinktheworkisdonewhenitgoesoutofyourin-basketintosomebody
else'sin-basket.But,ofcourse,itisn't.It'snotdoneuntilAT&Tdeliverswhatit'ssupposedto
deliver.Soyougetbig,fat,dumb,unmotivatedbureaucracies.

Theyalsotendtobecomesomewhatcorrupt.Inotherwords,ifI'vegotadepartmentand
you'vegotadepartmentandwekindofsharepowerrunningthisthing,there'ssortofan
unwrittenrule:"Ifyouwon'tbotherme,Iwon'tbotheryouandwe'rebothhappy."Soyouget
layersofmanagementandassociatedcoststhatnobodyneeds.Then,whilepeopleare
justifyingalltheselayers,ittakesforevertogetanythingdone.They'retooslowtomake
decisionsandnimblerpeopleruncirclesaroundthem.

Theconstantcurseofscaleisthatitleadstobig,dumbbureaucracywhich,ofcourse,
reachesitshighestandworstformingovernmentwheretheincentivesarereallyawful.That
doesn'tmeanwedon'tneedgovernmentsbecausewedo.Butit'saterribleproblemtoget
bigbureaucraciestobehave.

Sopeoplegotostratagems.Theycreatelittledecentralizedunitsandfancymotivationand
trainingprograms.Forexample,forabigcompany,GeneralElectrichasfoughtbureaucracy
withamazingskill.Butthat'sbecausetheyhaveacombinationofageniusandafanatic
runningit.Andtheyputhiminyoungenoughsohegetsalongrun.Ofcourse,that'sJack
Welch.

Butbureaucracyisterrible....Andasthingsgetverypowerfulandverybig,youcangetsome
reallydysfunctionalbehavior.LookatWestinghouse.Theyblewbillionsofdollarsonabunch
ofdumbloanstorealestatedevelopers.Theyputsomeguywho'dcomeupbysomecareer
pathIdon'tknowexactlywhatitwas,butitcouldhavebeenrefrigeratorsor
somethingandallofasudden,he'sloaningmoneytorealestatedevelopersbuildinghotels.
It'saveryunequalcontest.Andinduetime,theylostallthosebillionsofdollars.

CBSprovidesaninterestingexampleofanotherruleofpsychologynamely,Pavlovian
association.Ifpeopletellyouwhatyoureallydon'twanttohearwhat'sunpleasantthere's
analmostautomaticreactionofantipathy.Youhavetotrainyourselfoutofit.Itisn't
foredestinedthatyouhavetobethisway.Butyouwilltendtobethiswayifyoudon'tthink
aboutit.

TelevisionwasdominatedbyonenetworkCBSinitsearlydays.AndPaleywasagod.Buthe
didn'tliketohearwhathedidn'tliketohear.Andpeoplesoonlearnedthat.SotheytoldPaley
onlywhathelikedtohear.Therefore,hewassoonlivinginalittlecocoonofunrealityand
everythingelsewascorruptalthoughitwasagreatbusiness.

Sotheidiocythatcreptintothesystemwascarriedalongbythishugetide.ItwasaMad
Hatter'steapartythelasttenyearsunderBillPaley.

Andthatisnottheonlyexamplebyanymeans.Youcangetseveremisfunctioninthehigh
ranksofbusiness.Andofcourse,ifyou'reinvesting,itcanmakealotofdifference.Ifyoutake
alltheacquisitionsthatCBSmadeunderPaley,aftertheacquisitionofthenetworkitself,with
allhisadvisorshisinvestmentbankers,managementconsultantsandsoforthwhowere
gettingpaidveryhandsomelyitwasabsolutelyterrible.

Forexample,hegavesomethinglike20%ofCBStotheDumontCompanyforatelevisionset
manufacturerwhichwasdestinedtogobroke.Ithinkitlastedalloftwoorthreeyearsor
somethinglikethat.Soverysoonafterhe'dissuedallofthatstock,Dumontwashistory.You
getalotofdysfunctioninabigfat,powerfulplacewherenoonewillbringunwelcomereality
totheboss.

Solifeisaneverlastingbattlebetweenthosetwoforcestogettheseadvantagesofscaleon
onesideandatendencytogetalotliketheU.S.AgricultureDepartmentontheother
sidewheretheyjustsitaroundandsoforth.Idon'tknowexactlywhattheydo.However,I
doknowthattheydoverylittleusefulwork.

Onthesubjectofadvantagesofeconomiesofscale,Ifindchainstoresquiteinteresting.Just
thinkaboutit.Theconceptofachainstorewasafascinatinginvention.Yougetthishuge
purchasingpowerwhichmeansthatyouhavelowermerchandisecosts.Yougetawhole
bunchoflittlelaboratoriesoutthereinwhichyoucanconductexperiments.Andyouget
specialization.

Ifonelittleguyistryingtobuyacross27differentmerchandisecategoriesinfluencedby
travelingsalesmen,he'sgoingtomakealotofpoordecisions.Butifyourbuyingisdonein
headquartersforahugebunchofstores,youcangetverybrightpeoplethatknowalotabout
refrigeratorsandsoforthtodothebuying.

Thereverseisdemonstratedbythelittlestorewhereoneguyisdoingallthebuying.It'slike
theoldstoryaboutthelittlestorewithsaltalloveritswalls.Andastrangercomesinandsays
tothestoreowner,"Youmustsellalotofsalt."Andhereplies,"No,Idon't.Butyoushouldsee
theguywhosellsmesalt."

Sotherearehugepurchasingadvantages.Andthentherearetheslicksystemsofforcing
everyonetodowhatworks.Soachainstorecanbeafantasticenterprise.

It'squiteinterestingtothinkaboutWal-MartstartingfromasinglestoreinBentonville,
ArkansasagainstSears,Roebuckwithitsname,reputationandallofitsbillions.Howdoesa
guyinBentonville,ArkansaswithnomoneyblowrightbySears,Roebuck?Andhedoesitinhis
ownlifetimeinfact,duringhisownlatelifetimebecausehewasalreadyprettyoldbythe
timehestartedoutwithonelittlestore....

Heplayedthechainstoregameharderandbetterthananyoneelse.Waltoninvented
practicallynothing.Buthecopiedeverythinganybodyelseeverdidthatwassmartandhe
diditwithmorefanaticismandbetteremployeemanipulation.Sohejustblewrightbythem
all.

Healsohadaveryinterestingcompetitivestrategyintheearlydays.Hewaslikeaprizefighter
whowantedagreatrecordsohecouldbeinthefinalsandmakeabigTVhit.Sowhatdidhe
do?Hewentoutandfought42palookas.Right?Andtheresultwasknockout,knockout,
knockout42times.

Walton,beingasshrewdashewas,basicallybrokeothersmalltownmerchantsintheearly
days.Withhismoreefficientsystem,hemightnothavebeenabletotacklesometitan
head-onatthetime.Butwithhisbettersystem,hecoulddestroythosesmalltownmerchants.
Andhewentarounddoingittimeaftertimeaftertime.Then,ashegotbigger,hestarted
destroyingthebigboys.

Well,thatwasavery,veryshrewdstrategy.

Youcansay,"Isthisanicewaytobehave?"Well,capitalismisaprettybrutalplace.ButI
personallythinkthattheworldisbetterforhavingWal-Mart.Imeanyoucanidealizesmall
townlife.ButI'vespentafairamountoftimeinsmalltowns.Andletmetellyouyoushouldn't
gettooidealisticaboutallthosebusinesseshedestroyed.

Plus,alotofpeoplewhoworkatWal-Martareveryhighgrade,bouncypeoplewhoareraising
nicechildren.Ihavenofeelingthataninferiorculturedestroyedasuperiorculture.Ithink
thatisnothingmorethannostalgiaanddelusion.But,atanyrate,it'saninterestingmodelof
howthescaleofthingsandfanaticismcombinetobeverypowerful.

Andit'salsoaninterestingmodelontheothersidehowwithallitsgreatadvantages,the
disadvantagesofbureaucracydidsuchterribledamagetoSears,Roebuck.Searshadlayers
andlayersofpeopleitdidn'tneed.Itwasverybureaucratic.Itwasslowtothink.Andthere
wasanestablishedwayofthinking.Ifyoupokedyourheadupwithanewthought,thesystem
kindofturnedagainstyou.Itwaseverythinginthewayofadysfunctionalbigbureaucracy
thatyouwouldexpect.

Inallfairness,therewasalsomuchthatwasgoodaboutit.Butitjustwasn'tasleanandmean
andshrewdandeffectiveasSamWalton.And,induetime,allitsadvantagesofscalewerenot
enoughtopreventSearsfromlosingheavilytoWal-Martandothersimilarretailers.

Here'samodelthatwe'vehadtroublewith.Maybeyou'llbeabletofigureitoutbetter.Many
marketsgetdowntotwoorthreebigcompetitorsorfiveorsix.Andinsomeofthose
markets,nobodymakesanymoneytospeakof.Butinothers,everybodydoesverywell.
Overtheyears,we'vetriedtofigureoutwhythecompetitioninsomemarketsgetssortof
rationalfromtheinvestor'spointofviewsothattheshareholdersdowell,andinother
markets,there'sdestructivecompetitionthatdestroysshareholderwealth.

Ifit'sapurecommoditylikeairlineseats,youcanunderstandwhynoonemakesanymoney.
Aswesithere,justthinkofwhatairlineshavegiventotheworldsafetravel,greater
experience,timewithyourlovedones,younameit.Yet,thenetamountofmoneythat'sbeen
madebytheshareholdersofairlinessinceKittyHawk,isnowanegativefigureasubstantial
negativefigure.Competitionwassointensethat,onceitwasunleashedbyderegulation,it
ravagedshareholderwealthintheairlinebusiness.

Yet,inotherfieldslikecereals,forexamplealmostallthebigboysmakeout.Ifyou'resome
kindofamediumgradecerealmaker,youmightmake15%onyourcapital.Andifyou're
reallygood,youmightmake40%.Butwhyarecerealssoprofitabledespitethefactthatit
lookstomelikethey'recompetinglikecrazywithpromotions,couponsandeverythingelse?I
don'tfullyunderstandit.

Obviously,there'sabrandidentityfactorincerealsthatdoesn'texistinairlines.Thatmustbe
themainfactorthataccountsforit.

Andmaybethecerealmakersbyandlargehavelearnedtobelesscrazyaboutfightingfor
marketsharebecauseifyougetevenonepersonwho'shell-bentongainingmarketshare....
Forexample,ifIwereKelloggandIdecidedthatIhadtohave60%ofthemarket,IthinkI
couldtakemostoftheprofitoutofcereals.I'druinKelloggintheprocess.ButIthinkIcould
doit.

Insomebusinesses,theparticipantsbehavelikeadementedKellogg.Inotherbusinesses,
theydon't.Unfortunately,Idonothaveaperfectmodelforpredictinghowthat'sgoingto
happen.

Forexample,ifyoulookaroundatbottlermarkets,you'llfindmanymarketswherebottlersof
PepsiandCokebothmakealotofmoneyandmanyotherswheretheydestroymostofthe
profitabilityofthetwofranchises.Thatmustgetdowntothepeculiaritiesofindividual
adjustmenttomarketcapitalism.Ithinkyou'dhavetoknowthepeopleinvolvedtofully
understandwhatwashappening.

Inmicroeconomics,ofcourse,you'vegottheconceptofpatents,trademarks,exclusive
franchisesandsoforth.Patentsarequiteinteresting.WhenIwasyoung,Ithinkmoremoney
wentintopatentsthancameout.Judgestendedtothrowthemoutbasedonarguments
aboutwhatwasreallyinventedandwhatreliedonpriorart.Thatisn'taltogetherclear.

Buttheychangedthat.Theydidn'tchangethelaws.Theyjustchangedtheadministrationso
thatitallgoestoonepatentcourt.Andthatcourtisnowverymuchmorepro-patent.SoI
thinkpeoplearenowstartingtomakealotofmoneyoutofowningpatents.
Trademarks,ofcourse,havealwaysmadepeoplealotofmoney.Atrademarksystemisa
wonderfulthingforabigoperationifit'swellknown.

Theexclusivefranchisecanalsobewonderful.Iftherewereonlythreetelevisionchannels
awardedinabigcityandyouownedoneofthem,therewereonlysomanyhoursadaythat
youcouldbeon.Soyouhadanaturalpositioninanoligopolyinthepre-cabledays.

Andifyougetthefranchisefortheonlyfoodstandinanairport,youhaveacaptiveclientele
andyouhaveasmallmonopolyofasort.

Thegreatlessoninmicroeconomicsistodiscriminatebetweenwhentechnologyisgoingto
helpyouandwhenit'sgoingtokillyou.Andmostpeopledonotgetthisstraightintheir
heads.ButafellowlikeBuffettdoes.

Forexample,whenwewereinthetextilebusiness,whichisaterriblecommoditybusiness,we
weremakinglow-endtextileswhicharearealcommodityproduct.Andoneday,thepeople
cametoWarrenandsaid,"They'veinventedanewloomthatwethinkwilldotwiceasmuch
workasouroldones."

AndWarrensaid,"Gee,Ihopethisdoesn'tworkbecauseifitdoes,I'mgoingtoclosethemill."
Andhemeantit.

Whatwashethinking?Hewasthinking,"It'salousybusiness.We'reearningsubstandard
returnsandkeepingitopenjusttobenicetotheelderlyworkers.Butwe'renotgoingtoput
hugeamountsofnewcapitalintoalousybusiness."

Andheknewthatthehugeproductivityincreasesthatwouldcomefromabettermachine
introducedintotheproductionofacommodityproductwouldallgotothebenefitofthe
buyersofthetextiles.Nothingwasgoingtosticktoourribsasowners.

That'ssuchanobviousconceptthatthereareallkindsofwonderfulnewinventionsthatgive
younothingasownersexcepttheopportunitytospendalotmoremoneyinabusinessthat's
stillgoingtobelousy.Themoneystillwon'tcometoyou.Alloftheadvantagesfromgreat
improvementsaregoingtoflowthroughtothecustomers.

Conversely,ifyouowntheonlynewspaperinOshkoshandtheyweretoinventmoreefficient
waysofcomposingthewholenewspaper,thenwhenyougotridoftheoldtechnologyandgot
newfancycomputersandsoforth,allofthesavingswouldcomerightthroughtothebottom
line.

Inallcases,thepeoplewhosellthemachineryand,byandlarge,eventheinternal
bureaucratsurgingyoutobuytheequipmentshowyouprojectionswiththeamountyou'll
saveatcurrentpriceswiththenewtechnology.However,theydon'tdothesecondstepofthe
analysiswhichistodeterminehowmuchisgoingstayhomeandhowmuchisjustgoingto
flowthroughtothecustomer.I'veneverseenasingleprojectionincorporatingthatsecond
stepinmylife.AndIseethemallthetime.Rather,theyalwaysread:"Thiscapitaloutlaywill
saveyousomuchmoneythatitwillpayforitselfinthreeyears."

Soyoukeepbuyingthingsthatwillpayforthemselvesinthreeyears.Andafter20yearsof
doingit,somehowyou'veearnedareturnofonlyabout4%perannum.That'sthetextile
business.

Anditisn'tthatthemachinesweren'tbetter.It'sjustthatthesavingsdidn'tgotoyou.Thecost
reductionscamethroughallright.Butthebenefitofthecostreductionsdidn'tgototheguy
whoboughttheequipment.It'ssuchasimpleidea.It'ssobasic.Andyetit'ssooftenforgotten.

Thenthere'sanothermodelfrommicroeconomicswhichIfindveryinteresting.When
technologymovesasfastasitdoesinacivilizationlikeours,yougetaphenomenonwhichI
callcompetitivedestruction.Youknow,youhavethefinestbuggywhipfactoryandallofa
suddenincomesthislittlehorselesscarriage.Andbeforetoomanyyearsgoby,yourbuggy
whipbusinessisdead.Youeithergetintoadifferentbusinessoryou'redeadyou're
destroyed.Ithappensagainandagainandagain.

Andwhenthesenewbusinessescomein,therearehugeadvantagesfortheearlybirds.And
whenyou'reanearlybird,there'samodelthatIcall"surfing"whenasurfergetsupand
catchesthewaveandjuststaysthere,hecangoalong,longtime.Butifhegetsoffthewave,
hebecomesmiredinshallows....

Butpeoplegetlongrunswhenthey'rerightontheedgeofthewavewhetherit'sMicrosoftor
Intelorallkindsofpeople,includingNationalCashRegisterintheearlydays.

Thecashregisterwasoneofthegreatcontributionstocivilization.It'sawonderfulstory.
Pattersonwasasmallretailmerchantwhodidn'tmakeanymoney.Oneday,somebodysold
himacrudecashregisterwhichheputintohisretailoperation.Anditinstantlychangedfrom
losingmoneytoearningaprofitbecauseitmadeitsomuchharderfortheemployeesto
steal....

ButPatterson,havingthekindofmindthathedid,didn'tthink,"Oh,goodformyretail
business."Hethought,"I'mgoingintothecashregisterbusiness."And,ofcourse,hecreated
NationalCashRegister.

Andhe"surfed".Hegotthebestdistributionsystem,thebiggestcollectionofpatentsandthe
bestofeverything.Hewasafanaticabouteverythingimportantasthetechnologydeveloped.I
haveinmyfilesanearlyNationalCashRegisterCompanyreportinwhichPattersondescribed
hismethodsandobjectives.Andawell-educatedorangutancouldseethatbuyinginto
partnershipwithPattersoninthoseearlydays,givenhisnotionsaboutthecashregister
business,wasatotal100%cinch.
And,ofcourse,that'sexactlywhataninvestorshouldbelookingfor.Inalonglife,youcan
expecttoprofitheavilyfromatleastafewofthoseopportunitiesifyoudevelopthewisdom
andwilltoseizethem.Atanyrate,"surfing"isaverypowerfulmodel.

However,BerkshireHathaway,byandlarge,doesnotinvestinthesepeoplethatare"surfing"
oncomplicatedtechnology.Afterall,we'recrankyandidiosyncraticasyoumayhavenoticed.

AndWarrenandIdon'tfeellikewehaveanygreatadvantageinthehigh-techsector.Infact,
wefeellikewe'reatabigdisadvantageintryingtounderstandthenatureoftechnical
developmentsinsoftware,computerchipsorwhathaveyou.Sowetendtoavoidthatstuff,
basedonourpersonalinadequacies.

Again,thatisavery,verypowerfulidea.Everypersonisgoingtohaveacircleofcompetence.
Andit'sgoingtobeveryhardtoadvancethatcircle.IfIhadtomakemylivingasamusician....
Ican'teventhinkofalevellowenoughtodescribewhereIwouldbesortedouttoifmusic
werethemeasuringstandardofthecivilization.

Soyouhavetofigureoutwhatyourownaptitudesare.Ifyouplaygameswhereotherpeople
havetheaptitudesandyoudon't,you'regoingtolose.Andthat'sasclosetocertainasany
predictionthatyoucanmake.Youhavetofigureoutwhereyou'vegotanedge.Andyou'vegot
toplaywithinyourowncircleofcompetence.

Ifyouwanttobethebesttennisplayerintheworld,youmaystartouttryingandsoonfind
outthatit'shopelessthatotherpeopleblowrightbyyou.However,ifyouwanttobecome
thebestplumbingcontractorinBemidji,thatisprobablydoablebytwo-thirdsofyou.Ittakes
awill.Ittakestheintelligence.Butafterawhile,you'dgraduallyknowallabouttheplumbing
businessinBemidjiandmastertheart.Thatisanattainableobjective,givenenoughdiscipline.
Andpeoplewhocouldneverwinachesstournamentorstandincentercourtinarespectable
tennistournamentcanrisequitehighinlifebyslowlydevelopingacircleof
competencewhichresultspartlyfromwhattheywerebornwithandpartlyfromwhatthey
slowlydevelopthroughwork.

Sosomeedgescanbeacquired.Andthegameoflifetosomeextentformostofusistryingto
besomethinglikeagoodplumbingcontractorinBemidji.Veryfewofusarechosentowinthe
world'schesstournaments.

Someofyoumayfindopportunities"surfing"alonginthenewhigh-techfieldstheIntels,the
Microsoftsandsoon.Thefactthatwedon'tthinkwe'reverygoodatitandhaveprettywell
stayedoutofitdoesn'tmeanthatit'sirrationalforyoutodoit.

Well,somuchforthebasicmicroeconomicsmodels,alittlebitofpsychology,alittlebitof
mathematics,helpingcreatewhatIcallthegeneralsubstructureofworldlywisdom.Now,if
youwanttogoonfromcarrotstodessert,I'llturntostockpickingtryingtodrawonthis
generalworldlywisdomaswego.
Idon'twanttogetintoemergingmarkets,bondarbitrageandsoforth.I'mtalkingabout
nothingbutplainvanillastockpicking.That,believeme,iscomplicatedenough.AndI'm
talkingaboutcommonstockpicking.

Thefirstquestionis,"Whatisthenatureofthestockmarket?"Andthatgetsyoudirectlytothis
efficientmarkettheorythatgottobetherageatotalragelongafterIgraduatedfromlaw
school.

Andit'sratherinterestingbecauseoneofthegreatesteconomistsoftheworldisasubstantial
shareholderinBerkshireHathawayandhasbeenforalongtime.Histextbookalwaystaught
thatthestockmarketwasperfectlyefficientandthatnobodycouldbeatit.Buthisownmoney
wentintoBerkshireandmadehimwealthy.So,likePascalinhisfamouswager,hehedgedhis
bet.

Isthestockmarketsoefficientthatpeoplecan'tbeatit?Well,theefficientmarkettheoryis
obviouslyroughlyrightmeaningthatmarketsarequiteefficientandit'squitehardfor
anybodytobeatthemarketbysignificantmarginsasastockpickerbyjustbeingintelligent
andworkinginadisciplinedway.

Indeed,theaverageresulthastobetheaverageresult.Bydefinition,everybodycan'tbeatthe
market.AsIalwayssay,theironruleoflifeisthatonly20%ofthepeoplecanbeinthetop
fifth.That'sjustthewayitis.Sotheansweristhatit'spartlyefficientandpartlyinefficient.

And,bytheway,Ihaveanameforpeoplewhowenttotheextremeefficientmarket
theorywhichis"bonkers".Itwasanintellectuallyconsistenttheorythatenabledthemtodo
prettymathematics.SoIunderstanditsseductivenesstopeoplewithlargemathematicalgifts.
Itjusthadadifficultyinthatthefundamentalassumptiondidnottieproperlytoreality.

Again,tothemanwithahammer,everyproblemlookslikeanail.Ifyou'regoodat
manipulatinghighermathematicsinaconsistentway,whynotmakeanassumptionwhich
enablesyoutouseyourtool?

ThemodelIliketosortofsimplifythenotionofwhatgoesoninamarketforcommon
stocksisthepari-mutuelsystemattheracetrack.Ifyoustoptothinkaboutit,apari-mutuel
systemisamarket.Everybodygoesthereandbetsandtheoddschangebasedonwhat'sbet.
That'swhathappensinthestockmarket.

Anydamnfoolcanseethatahorsecarryingalightweightwithawonderfulwinrateanda
goodpostpositionetc.,etc.iswaymorelikelytowinthanahorsewithaterriblerecordand
extraweightandsoonandsoon.Butifyoulookattheodds,thebadhorsepays100to1,
whereasthegoodhorsepays3to2.Thenit'snotclearwhichisstatisticallythebestbetusing
themathematicsofFermatandPascal.Thepriceshavechangedinsuchawaythatit'svery
hardtobeatthesystem.
Andthenthetrackistaking17%offthetop.Sonotonlydoyouhavetooutwitalltheother
betters,butyou'vegottooutwitthembysuchabigmarginthatonaverage,youcanaffordto
take17%ofyourgrossbetsoffthetopandgiveittothehousebeforetherestofyourmoney
canbeputtowork.

Giventhosemathematics,isitpossibletobeatthehorsesonlyusingone'sintelligence?
Intelligenceshouldgivesomeedge,becauselotsofpeoplewhodon'tknowanythinggoout
andbetluckynumbersandsoforth.Therefore,somebodywhoreallythinksaboutnothingbut
horseperformanceandisshrewdandmathematicalcouldhaveaveryconsiderableedge,in
theabsenceofthefrictionalcostcausedbythehousetake.

Unfortunately,whatashrewdhorseplayer'sedgedoesinmostcasesistoreducehisaverage
lossoveraseasonofbettingfromthe17%thathewouldloseifhegottheaverageresultto
maybe10%.However,thereareactuallyafewpeoplewhocanbeatthegameafterpayingthe
full17%.

IusedtoplaypokerwhenIwasyoungwithaguywhomadeasubstantiallivingdoingnothing
butbetharnessraces....Now,harnessracingisarelativelyinefficientmarket.Youdon'thave
thedepthofintelligencebettingonharnessracesthatyoudoonregularraces.Whatmypoker
palwoulddowastothinkaboutharnessracesashismainprofession.Andhewouldbetonly
occasionallywhenhesawsomemispricedbetavailable.Andbydoingthat,afterpayingthe
fullhandletothehousewhichIpresumewasaround17%hemadeasubstantialliving.

Youhavetosaythat'srare.However,themarketwasnotperfectlyefficient.Andifitweren't
forthatbig17%handle,lotsofpeoplewouldregularlybebeatinglotsofotherpeopleatthe
horseraces.It'sefficient,yes.Butit'snotperfectlyefficient.Andwithenoughshrewdnessand
fanaticism,somepeoplewillgetbetterresultsthanothers.

Thestockmarketisthesamewayexceptthatthehousehandleissomuchlower.Ifyoutake
transactioncoststhespreadbetweenthebidandtheaskplusthecommissionsandifyou
don'ttradetooactively,you'retalkingaboutfairlylowtransactioncosts.Sothatwithenough
fanaticismandenoughdiscipline,someoftheshrewdpeoplearegoingtogetwaybetter
resultsthanaverageinthenatureofthings.

Itisnotabiteasy.And,ofcourse,50%willendupinthebottomhalfand70%willendupin
thebottom70%.Butsomepeoplewillhaveanadvantage.Andinafairlylowtransactioncost
operation,theywillgetbetterthanaverageresultsinstockpicking.

Howdoyougettobeoneofthosewhoisawinnerinarelativesenseinsteadofaloser?

Hereagain,lookatthepari-mutuelsystem.Ihaddinnerlastnightbyabsoluteaccidentwith
thepresidentofSantaAnita.Hesaysthattherearetwoorthreebetterswhohaveacredit
arrangementwiththem,nowthattheyhaveoff-trackbetting,whoareactuallybeatingthe
house.They'resendingmoneyoutnetafterthefullhandlealotofittoLasVegas,bythe
waytopeoplewhoareactuallywinningslightly,net,afterpayingthefullhandle.They'rethat
shrewdaboutsomethingwithasmuchunpredictabilityashorseracing.

Andtheonethingthatallthosewinningbettersinthewholehistoryofpeoplewho'vebeaten
thepari-mutuelsystemhaveisquitesimple.Theybetveryseldom.

It'snotgiventohumanbeingstohavesuchtalentthattheycanjustknoweverythingabout
everythingallthetime.Butitisgiventohumanbeingswhoworkhardatitwholookandsift
theworldforamispricedbethattheycanoccasionallyfindone.

Andthewiseonesbetheavilywhentheworldoffersthemthatopportunity.Theybetbigwhen
theyhavetheodds.Andtherestofthetime,theydon't.It'sjustthatsimple.

Thatisaverysimpleconcept.Andtomeit'sobviouslyrightbasedonexperiencenotonly
fromthepari-mutuelsystem,buteverywhereelse.

Andyet,ininvestmentmanagement,practicallynobodyoperatesthatway.Weoperatethat
wayI'mtalkingaboutBuffettandMunger.Andwe'renotaloneintheworld.Butahuge
majorityofpeoplehavesomeothercrazyconstructintheirheads.Andinsteadofwaitingfora
nearcinchandloadingup,theyapparentlyascribetothetheorythatiftheyworkalittle
harderorhiremorebusinessschoolstudents,they'llcometoknoweverythingabout
everythingallthetime.

Tome,that'stotallyinsane.Thewaytowinistowork,work,work,workandhopetohavea
fewinsights.

Howmanyinsightsdoyouneed?Well,I'dargue:thatyoudon'tneedmanyinalifetime.Ifyou
lookatBerkshireHathawayandallofitsaccumulatedbillions,thetopteninsightsaccountfor
mostofit.Andthat'swithaverybrilliantmanWarren'salotmoreablethanIamandvery
disciplineddevotinghislifetimetoit.Idon'tmeantosaythathe'sonlyhadteninsights.I'm
justsaying,thatmostofthemoneycamefromteninsights.

Soyoucangetveryremarkableinvestmentresultsifyouthinkmorelikeawinning
pari-mutuelplayer.Justthinkofitasaheavyoddsagainstgamefullofcrazinesswithan
occasionalmispricedsomethingorother.Andyou'reprobablynotgoingtobesmartenough
tofindthousandsinalifetime.Andwhenyougetafew,youreallyloadup.It'sjustthat
simple.

WhenWarrenlecturesatbusinessschools,hesays,"Icouldimproveyourultimatefinancial
welfarebygivingyouaticketwithonly20slotsinitsothatyouhad20punchesrepresenting
alltheinvestmentsthatyougottomakeinalifetime.Andonceyou'dpunchedthroughthe
card,youcouldn'tmakeanymoreinvestmentsatall."

Hesays,"Underthoserules,you'dreallythinkcarefullyaboutwhatyoudidandyou'dbe
forcedtoloaduponwhatyou'dreallythoughtabout.Soyou'ddosomuchbetter."
Again,thisisaconceptthatseemsperfectlyobvioustome.AndtoWarrenitseemsperfectly
obvious.ButthisisoneoftheveryfewbusinessclassesintheU.S.whereanybodywillbe
sayingso.Itjustisn'ttheconventionalwisdom.

Tome,it'sobviousthatthewinnerhastobetveryselectively.It'sbeenobvioustomesince
veryearlyinlife.Idon'tknowwhyit'snotobvioustoverymanyotherpeople.

Ithinkthereasonwhywegotintosuchidiocyininvestmentmanagementisbestillustratedby
astorythatItellabouttheguywhosoldfishingtackle.Iaskedhim,"MyGod,they'repurple
andgreen.Dofishreallytaketheselures?"Andhesaid,"Mister,Idon'tselltofish."

Investmentmanagersareinthepositionofthatfishingtacklesalesman.They'reliketheguy
whowassellingsalttotheguywhoalreadyhadtoomuchsalt.Andaslongastheguywillbuy
salt,whythey'llsellsalt.Butthatisn'twhatordinarilyworksforthebuyerofinvestment
advice.

IfyouinvestedBerkshireHathaway-style,itwouldbehardtogetpaidasaninvestment
manageraswellasthey'recurrentlypaidbecauseyou'dbeholdingablockofWal-Martand
ablockofCoca-Colaandablockofsomethingelse.You'djustsitthere.Andtheclientwould
begettingrich.And,afterawhile,theclientwouldthink,"WhyamIpayingthisguyhalfa
percentayearonmywonderfulpassiveholdings?"

Sowhatmakessensefortheinvestorisdifferentfromwhatmakessenseforthemanager.
And,asusualinhumanaffairs,whatdeterminesthebehaviorareincentivesforthedecision
maker.

Fromallbusiness,myfavoritecaseonincentivesisFederalExpress.Theheartandsoulof
theirsystemwhichcreatestheintegrityoftheproductishavingalltheirairplanescometo
oneplaceinthemiddleofthenightandshiftallthepackagesfromplanetoplane.Ifthereare
delays,thewholeoperationcan'tdeliveraproductfullofintegritytoFederalExpress
customers.

Anditwasalwaysscrewedup.Theycouldnevergetitdoneontime.Theytried
everythingmoralsuasion,threats,younameit.Andnothingworked.

Finally,somebodygottheideatopayallthesepeoplenotsomuchanhour,butsomucha
shiftandwhenit'salldone,theycanallgohome.Well,theirproblemsclearedupovernight.

Sogettingtheincentivesrightisavery,veryimportantlesson.ItwasnotobvioustoFederal
Expresswhatthesolutionwas.Butmaybenow,itwillhereaftermoreoftenbeobvioustoyou.

Allright,we'venowrecognizedthatthemarketisefficientasapari-mutuelsystemisefficient
withthefavoritemorelikelythanthelongshottodowellinracing,butnotnecessarilygive
anybettingadvantagetothosethatbetonthefavorite.
Inthestockmarket,somerailroadthat'sbesetbybettercompetitorsandtoughunionsmay
beavailableatone-thirdofitsbookvalue.Incontrast,IBMinitsheydaymightbesellingat6
timesbookvalue.Soit'sjustlikethepari-mutuelsystem.Anydamnfoolcouldplainlyseethat
IBMhadbetterbusinessprospectsthantherailroad.Butonceyouputthepriceintothe
formula,itwasn'tsoclearanymorewhatwasgoingtoworkbestforabuyerchoosingbetween
thestocks.Soit'salotlikeapari-mutuelsystem.And,therefore,itgetsveryhardtobeat.

Whatstyleshouldtheinvestoruseasapickerofcommonstocksinordertotrytobeatthe
marketinotherwords,togetanaboveaveragelong-termresult?Astandardtechniquethat
appealstoalotofpeopleiscalled"sectorrotation".Yousimplyfigureoutwhenoilsaregoing
tooutperformretailers,etc.,etc.,etc.Youjustkindofflitaroundbeinginthehotsectorofthe
marketmakingbetterchoicesthanotherpeople.Andpresumably,overalongperiodoftime,
yougetahead.

However,Iknowofnoreallyrichsectorrotator.Maybesomepeoplecandoit.I'mnotsaying
theycan't.AllIknowisthatallthepeopleIknowwhogotrichandIknowalotofthemdid
notdoitthatway.

ThesecondbasicapproachistheonethatBenGrahamusedmuchadmiredbyWarrenand
me.Asonefactor,Grahamhadthisconceptofvaluetoaprivateownerwhatthewhole
enterprisewouldsellforifitwereavailable.Andthatwascalculableinmanycases.

Then,ifyoucouldtakethestockpriceandmultiplyitbythenumberofsharesandget
somethingthatwasonethirdorlessofselloutvalue,hewouldsaythatyou'vegotalotof
edgegoingforyou.Evenwithanelderlyalcoholicrunningastodgybusiness,thissignificant
excessofrealvaluepershareworkingforyoumeansthatallkindsofgoodthingscanhappen
toyou.Youhadahugemarginofsafetyasheputitbyhavingthisbigexcessvaluegoing
foryou.

Buthewas,byandlarge,operatingwhentheworldwasinshellshockfromthe1930swhich
wastheworstcontractionintheEnglish-speakingworldinabout600years.Wheatin
Liverpool,Ibelieve,gotdowntosomethinglikea600-yearlow,adjustedforinflation.People
weresoshell-shockedforalongtimethereafterthatBenGrahamcouldrunhisGeigercounter
overthisdetritusfromthecollapseofthe1930sandfindthingssellingbelowtheirworking
capitalpershareandsoon.

Andinthosedays,workingcapitalactuallybelongedtotheshareholders.Iftheemployees
werenolongeruseful,youjustsackedthemall,tooktheworkingcapitalandstuckitinthe
owners'pockets.Thatwasthewaycapitalismthenworked.

Nowadays,ofcourse,theaccountingisnotrealisticbecausetheminutethebusinessstarts
contracting,significantassetsarenotthere.Undersocialnormsandthenewlegalrulesofthe
civilization,somuchisowedtotheemployeesthat,theminutetheenterprisegoesinto
reverse,someoftheassetsonthebalancesheetaren'tthereanymore.
Now,thatmightnotbetrueifyourunalittleautodealershipyourself.Youmaybeabletorun
itinsuchawaythatthere'snohealthplanandthisandthatsothatifthebusinessgetslousy,
youcantakeyourworkingcapitalandgohome.ButIBMcan't,oratleastdidn't.Justlookat
whatdisappearedfromitsbalancesheetwhenitdecidedthatithadtochangesizeboth
becausetheworldhadchangedtechnologicallyandbecauseitsmarketpositionhad
deteriorated.

Andintermsofblowingit,IBMissomeexample.Thosewerebrilliant,disciplinedpeople.But
therewasenoughturmoilintechnologicalchangethatIBMgotbouncedoffthewaveafter
"surfing"successfullyfor60years.Andthatwassomecollapseanobjectlessoninthe
difficultiesoftechnologyandoneofthereasonswhyBuffettandMungerdon'tliketechnology
verymuch.Wedon'tthinkwe'reanygoodatit,andstrangethingscanhappen.

Atanyrate,thetroublewithwhatIcalltheclassicBenGrahamconceptisthatgraduallythe
worldwisedupandthoserealobviousbargainsdisappeared.YoucouldrunyourGeiger
counterovertherubbleanditwouldn'tclick.

Butsuchisthenatureofpeoplewhohaveahammertowhom,asImentioned,every
problemlookslikeanailthattheBenGrahamfollowersrespondedbychangingthecalibration
ontheirGeigercounters.Ineffect,theystarteddefiningabargaininadifferentway.Andthey
keptchangingthedefinitionsothattheycouldkeepdoingwhatthey'dalwaysdone.Anditstill
workedprettywell.SotheBenGrahamintellectualsystemwasaverygoodone.

Ofcourse,thebestpartofitallwashisconceptof"Mr.Market".Insteadofthinkingthe
marketwasefficient,hetreateditasamanic-depressivewhocomesbyeveryday.Andsome
dayshesays,"I'llsellyousomeofmyinterestforwaylessthanyouthinkit'sworth."And
otherdays,"Mr.Market"comesbyandsays,"I'llbuyyourinterestatapricethat'swayhigher
thanyouthinkit'sworth."Andyougettheoptionofdecidingwhetheryouwanttobuymore,
sellpartofwhatyoualreadyhaveordonothingatall.

ToGraham,itwasablessingtobeinbusinesswithamanic-depressivewhogaveyouthis
seriesofoptionsallthetime.Thatwasaverysignificantmentalconstruct.Andit'sbeenvery
usefultoBuffett,forinstance,overhiswholeadultlifetime.

However,ifwe'dstayedwithclassicGrahamthewayBenGrahamdidit,wewouldneverhave
hadtherecordwehave.Andthat'sbecauseGrahamwasn'ttryingtodowhatwedid.

Forexample,Grahamdidn'twanttoevertalktomanagement.Andhisreasonwasthat,like
thebestsortofprofessoraiminghisteachingatamassaudience,hewastryingtoinventa
systemthatanybodycoulduse.Andhedidn'tfeelthatthemaninthestreetcouldrunaround
andtalktomanagementsandlearnthings.Healsohadaconceptthatthemanagementwould
oftencouchtheinformationveryshrewdlytomislead.Therefore,itwasverydifficult.Andthat
isstilltrue,ofcoursehumannaturebeingwhatitis.
AndsohavingstartedoutasGrahamiteswhich,bytheway,workedfinewegraduallygot
whatIwouldcallbetterinsights.Andwerealizedthatsomecompanythatwassellingat2or3
timesbookvaluecouldstillbeahellofabargainbecauseofmomentumsimplicitinits
position,sometimescombinedwithanunusualmanagerialskillplainlypresentinsome
individualorother,orsomesystemorother.

Andoncewe'dgottenoverthehurdleofrecognizingthatathingcouldbeabargainbasedon
quantitativemeasuresthatwouldhavehorrifiedGraham,westartedthinkingaboutbetter
businesses.

And,bytheway,thebulkofthebillionsinBerkshireHathawayhavecomefromthebetter
businesses.Muchofthefirst$200or$300millioncamefromscramblingaroundwithour
Geigercounter.Butthegreatbulkofthemoneyhascomefromthegreatbusinesses.

Andevensomeoftheearlymoneywasmadebybeingtemporarilypresentingreat
businesses.BuffettPartnership,forexample,ownedAmericanExpressandDisneywhenthey
gotpoundeddown.

Mostinvestmentmanagersareinagamewheretheclientsexpectthemtoknowalotabouta
lotofthings.Wedidn'thaveanyclientswhocouldfireusatBerkshireHathaway.Sowedidn't
havetobegovernedbyanysuchconstruct.Andwecametothisnotionoffindingamispriced
betandloadingupwhenwewereveryconfidentthatwewereright.Sowe'rewayless
diversified.AndIthinkoursystemismilesbetter.

However,inallfairness,Idon'tthinkalotofmoneymanagerscouldsuccessfullyselltheir
servicesiftheyusedoursystem.Butifyou'reinvestingfor40yearsinsomepensionfund,
whatdifferencedoesitmakeifthepathfromstarttofinishisalittlemorebumpyoralittle
differentthaneverybodyelse'ssolongasit'sallgoingtoworkoutwellintheend?Sowhatif
there'salittleextravolatility.

Ininvestmentmanagementtoday,everybodywantsnotonlytowin,buttohaveayearly
outcomepaththatneverdivergesverymuchfromastandardpathexceptontheupside.Well,
thatisaveryartificial,crazyconstruct.That'stheequivalentininvestmentmanagementtothe
customofbindingthefeetofChinesewomen.It'stheequivalentofwhatNietzschemeant
whenhecriticizedthemanwhohadalamelegandwasproudofit.

Thatisreallyhobblingyourself.Now,investmentmanagerswouldsay,"Wehavetobethat
way.That'showwe'remeasured."Andtheymayberightintermsofthewaythebusinessis
nowconstructed.Butfromtheviewpointofarationalconsumer,thewholesystem's
"bonkers"anddrawsalotoftalentedpeopleintosociallyuselessactivity.

AndtheBerkshiresystemisnot"bonkers".It'ssodamnedelementarythatevenbrightpeople
aregoingtohavelimited,reallyvaluableinsightsinaverycompetitiveworldwhenthey're
fightingagainstotherverybright,hardworkingpeople.
Anditmakessensetoloadupontheveryfewgoodinsightsyouhaveinsteadofpretendingto
knoweverythingabouteverythingatalltimes.You'remuchmorelikelytodowellifyoustart
outtodosomethingfeasibleinsteadofsomethingthatisn'tfeasible.Isn'tthatperfectly
obvious?

Howmanyofyouhave56brilliantideasinwhichyouhaveequalconfidence?Raiseyour
hands,please.Howmanyofyouhavetwoorthreeinsightsthatyouhavesomeconfidencein?
Irestmycase.

I'dsaythatBerkshireHathaway'ssystemisadaptingtothenatureoftheinvestmentproblem
asitreallyis.

We'vereallymadethemoneyoutofhighqualitybusinesses.Insomecases,weboughtthe
wholebusiness.Andinsomecases,wejustboughtabigblockofstock.Butwhenyouanalyze
whathappened,thebigmoney'sbeenmadeinthehighqualitybusinesses.Andmostofthe
otherpeoplewho'vemadealotofmoneyhavedonesoinhighqualitybusinesses.

Overthelongterm,it'shardforastocktoearnamuchbetterreturnthanthebusinesswhich
underliesitearns.Ifthebusinessearns6%oncapitalover40yearsandyouholditforthat40
years,you'renotgoingtomakemuchdifferentthana6%returnevenifyouoriginallybuyit
atahugediscount.Conversely,ifabusinessearns18%oncapitalover20or30years,evenif
youpayanexpensivelookingprice,you'llendupwithafineresult.

Sothetrickisgettingintobetterbusinesses.Andthatinvolvesalloftheseadvantagesofscale
thatyoucouldconsidermomentumeffects.

Howdoyougetintothesegreatcompanies?OnemethodiswhatI'dcallthemethodoffinding
themsmallget'emwhenthey'relittle.Forexample,buyWal-MartwhenSamWaltonfirstgoes
publicandsoforth.Andalotofpeopletrytodojustthat.Andit'saverybeguilingidea.IfI
wereayoungman,Imightactuallygointoit.

Butitdoesn'tworkforBerkshireHathawayanymorebecausewe'vegottoomuchmoney.We
can'tfindanythingthatfitsoursizeparameterthatway.Besides,we'resetinourways.ButI
regardfindingthemsmallasaperfectlyintelligentapproachforsomebodytotrywith
discipline.It'sjustnotsomethingthatI'vedone.

Finding'embigobviouslyisveryhardbecauseofthecompetition.Sofar,Berkshire'smanaged
todoit.Butcanwecontinuetodoit?What'sthenextCoca-Colainvestmentforus?Well,the
answertothatisIdon'tknow.Ithinkitgetsharderforusallthetime....

Andideallyandwe'vedonealotofthisyougetintoagreatbusinesswhichalsohasagreat
managerbecausemanagementmatters.Forexample,it'smadeagreatdifferencetoGeneral
ElectricthatJackWelchcameininsteadoftheguywhotookoverWestinghouseaverygreat
difference.Somanagementmatters,too.
Andsomeofitispredictable.IdonotthinkittakesageniustounderstandthatJackWelchwas
amoreinsightfulpersonandabettermanagerthanhispeersinothercompanies.NordoI
thinkittooktremendousgeniustounderstandthatDisneyhadbasicmomentumsinplace
whichareverypowerfulandthatEisnerandWellswereveryunusualmanagers.

Soyoudogetanoccasionalopportunitytogetintoawonderfulbusinessthat'sbeingrunbya
wonderfulmanager.And,ofcourse,that'shogheavenday.Ifyoudon'tloadupwhenyouget
thoseopportunities,it'sabigmistake.

Occasionally,you'llfindahumanbeingwho'ssotalentedthathecandothingsthatordinary
skilledmortalscan't.IwouldarguethatSimonMarkswhowassecondgenerationinMarks&
SpencerofEnglandwassuchaman.PattersonwassuchamanatNationalCashRegister.
AndSamWaltonwassuchaman.

Thesepeopledocomealongandinmanycases,they'renotallthathardtoidentify.If
they'vegotareasonablehandwiththefanaticismandintelligenceandsoonthatthese
peoplegenerallybringtothepartythenmanagementcanmattermuch.

However,averagedout,bettingonthequalityofabusinessisbetterthanbettingonthe
qualityofmanagement.Inotherwords,ifyouhavetochooseone,betonthebusiness
momentum,notthebrillianceofthemanager.

But,veryrarely,youfindamanagerwho'ssogoodthatyou'rewisetofollowhimintowhat
lookslikeamediocrebusiness.

AnotherverysimpleeffectIveryseldomseediscussedeitherbyinvestmentmanagersor
anybodyelseistheeffectoftaxes.Ifyou'regoingtobuysomethingwhichcompoundsfor30
yearsat15%perannumandyoupayone35%taxattheveryend,thewaythatworksoutis
thataftertaxes,youkeep13.3%perannum.

Incontrast,ifyouboughtthesameinvestment,buthadtopaytaxeseveryyearof35%outof
the15%thatyouearned,thenyourreturnwouldbe15%minus35%of15%oronly9.75%
peryearcompounded.Sothedifferencethereisover3.5%.Andwhat3.5%doestothe
numbersoverlongholdingperiodslike30yearsistrulyeye-opening.Ifyousitbackforlong,
longstretchesingreatcompanies,youcangetahugeedgefromnothingbutthewaythat
incometaxeswork.

Evenwitha10%perannuminvestment,payinga35%taxattheendgivesyou8.3%after
taxesasanannualcompoundedresultafter30years.Incontrast,ifyoupaythe35%each
yearinsteadofattheend,yourannualresultgoesdownto6.5%.Soyouaddnearly2%of
after-taxreturnperannumifyouonlyachieveanaveragereturnbyhistoricalstandardsfrom
commonstockinvestmentsincompanieswithtinydividendpayoutratios.
ButintermsofbusinessmistakesthatI'veseenoveralonglifetime,Iwouldsaythattryingto
minimizetaxestoomuchisoneofthegreatstandardcausesofreallydumbmistakes.Isee
terriblemistakesfrompeoplebeingoverlymotivatedbytaxconsiderations.

WarrenandIpersonallydon'tdrilloilwells.Wepayourtaxes.Andwe'vedoneprettywell,so
far.Anytimesomebodyoffersyouataxshelterfromhereoninlife,myadvicewouldbedon't
buyit.

Infact,anytimeanybodyoffersyouanythingwithabigcommissionanda200-page
prospectus,don'tbuyit.Occasionally,you'llbewrongifyouadopt"Munger'sRule".However,
overalifetime,you'llbealongwayaheadandyouwillmissalotofunhappyexperiences
thatmightotherwisereduceyourloveforyourfellowman.

Therearehugeadvantagesforanindividualtogetintoapositionwhereyoumakeafewgreat
investmentsandjustsitbackandwait:You'repayinglesstobrokers.You'relisteningtoless
nonsense.Andifitworks,thegovernmentaltaxsystemgivesyouanextra1,2or3percentage
pointsperannumcompounded.

Andyouthinkthatmostofyouaregoingtogetthatmuchadvantagebyhiringinvestment
counselorsandpayingthem1%torunaround,incurringalotoftaxesonyourbehalf'?Lotsof
luck.

Arethereanydangersinthisphilosophy?Yes.Everythinginlifehasdangers.Sinceit'sso
obviousthatinvestingingreatcompaniesworks,itgetshorriblyoverdonefromtimetotime.
Inthe"Nifty-Fifty"days,everybodycouldtellwhichcompanieswerethegreatones.Sothey
gotupto50,60and70timesearnings.AndjustasIBMfelloffthewave,othercompaniesdid,
too.Thus,alargeinvestmentdisasterresultedfromtoohighprices.Andyou'vegottobe
awareofthatdanger....

Sotherearerisks.Nothingisautomaticandeasy.Butifyoucanfindsomefairly-pricedgreat
companyandbuyitandsit,thattendstoworkoutvery,verywellindeedespeciallyforan
individual,

Withinthegrowthstockmodel,there'sasub-position:Thereareactuallybusinesses,thatyou
willfindafewtimesinalifetime,whereanymanagercouldraisethereturnenormouslyjust
byraisingpricesandyettheyhaven'tdoneit.Sotheyhavehugeuntappedpricingpower
thatthey'renotusing.Thatistheultimateno-brainer.

ThatexistedinDisney.It'ssuchauniqueexperiencetotakeyourgrandchildtoDisneyland.
You'renotdoingitthatoften.Andtherearelotsofpeopleinthecountry.AndDisneyfound
thatitcouldraisethosepricesalotandtheattendancestayedrightup.

SoalotofthegreatrecordofEisnerandWellswasutterbrilliancebuttherestcamefromjust
raisingpricesatDisneylandandDisneyworldandthroughvideocassettesalesofclassic
animatedmovies.
AtBerkshireHathaway,WarrenandIraisedthepricesofSee'sCandyalittlefasterthanothers
mighthave.And,ofcourse,weinvestedinCoca-Colawhichhadsomeuntappedpricing
power.Anditalsohadbrilliantmanagement.SoaGoizuetaandKeoughcoulddomuchmore
thanraiseprices.Itwasperfect.

Youwillgetafewopportunitiestoprofitfromfindingunderpricing.Thereareactuallypeople
outtherewhodon'tpriceeverythingashighasthemarketwilleasilystand.Andonceyou
figurethatout,it'slikefindinginthestreetifyouhavethecourageofyourconvictions.

IfyoulookatBerkshire'sinvestmentswherealotofthemoney'sbeenmadeandyoulookfor
themodels,youcanseethatwetwiceboughtintotwonewspapertownswhichhavesince
becomeonenewspapertowns.Sowemadeabettosomeextent....

InoneofthoseTheWashingtonPostweboughtitatabout20%ofthevaluetoaprivate
owner.SoweboughtitonaBenGrahamstylebasisatonefifthofobviousvalueand,in
addition,wefacedasituationwhereyouhadboththetophandinagamethatwasclearly
goingtoendupwithonewinnerandamanagementwithalotofintegrityandintelligence.
Thatonewasarealdream.They'reveryhighclasspeopletheKatharineGrahamfamily.
That'swhyitwasadreamanabsolute,damndream.

Ofcourse,thatcameaboutbackin'73-74.Andthatwasalmostlike1932.Thatwasprobablya
once-in-40-yearstypedenouementinthemarkets.Thatinvestment'supabout50timesover
ourcost.

IfIwereyou,Iwouldn'tcountongettinganyinvestmentinyourlifetimequiteasgoodasThe
WashingtonPostwasin'73and'74.

Butitdoesn'thavetobethatgoodtotakecareofyou.

Letmementionanothermodel.Ofcourse,GilletteandCokemakefairlylowpriceditemsand
haveatremendousmarketingadvantageallovertheworld.AndinGillette'scase,theykeep
surfingalongnewtechnologywhichisfairlysimplebythestandardsofmicrochips.Butit's
hardforcompetitorstodo.

Sothey'vebeenabletostayconstantlyneartheedgeofimprovementsinshaving.Thereare
wholecountrieswhereGillettehasmorethan90%oftheshavingmarket.

GEICOisaveryinterestingmodel.It'sanotheroneofthe100orsomodelsyououghttohave
inyourhead.I'vehadmanyfriendsinthesickbusinessfixupgameoveralonglifetime.And
theypracticallyallusethefollowingformulaIcallitthecancersurgeryformula:

Theylookatthismess.Andtheyfigureoutifthere'sanythingsoundleftthatcanliveonits
owniftheycutawayeverythingelse.Andiftheyfindanythingsound,theyjustcutaway
everythingelse.Ofcourse,ifthatdoesn'twork,theyliquidatethebusiness.Butitfrequently
doeswork.
AndGEICOhadaperfectlymagnificentbusinesssubmergedinamess,butstillworking.
Misledbysuccess,GEICOhaddonesomefoolishthings.Theygottothinkingthat,because
theyweremakingalotofmoney,theykneweverything.Andtheysufferedhugelosses.

Alltheyhadtodowastocutoutallthefollyandgobacktotheperfectlywonderfulbusiness
thatwaslyingthere.Andwhenyouthinkaboutit,that'saverysimplemodel.Andit'srepeated
overandoveragain.

And,inGEICO'scase,thinkaboutallthemoneywepassivelymade....Itwasawonderful
businesscombinedwithabunchoffoolishnessthatcouldeasilybecutout.Andpeoplewere
cominginwhoweretemperamentallyandintellectuallydesignedsotheyweregoingtocutit
out.Thatisamodelyouwanttolookfor.

Andyoumayfindoneortwoorthreeinalonglifetimethatareverygood.Andyoumayfind
20or30thataregoodenoughtobequiteuseful.

Finally,I'dliketoonceagaintalkaboutinvestmentmanagement.Thatisafunnybusiness
becauseonanetbasis,thewholeinvestmentmanagementbusinesstogethergivesnovalue
addedtoallbuyerscombined.That'sthewayithastowork.

Ofcourse,thatisn'ttrueofplumbinganditisn'ttrueofmedicine.Ifyou'regoingtomakeyour
careersintheinvestmentmanagementbusiness,youfaceaverypeculiarsituation.Andmost
investmentmanagershandleitwithpsychologicaldenialjustlikeachiropractor.Thatisthe
standardmethodofhandlingthelimitationsoftheinvestmentmanagementprocess.Butif
youwanttolivethebestsortoflife,Iwouldurgeeachofyounottousethepsychological
denialmode.

Ithinkaselectfewasmallpercentageoftheinvestmentmanagerscandelivervalue
added.ButIdon'tthinkbrilliancealoneisenoughtodoit.Ithinkthatyouhavetohavealittle
ofthisdisciplineofcallingyourshotsandloadingupyouwanttomaximizeyourchancesof
becomingonewhoprovidesaboveaveragerealreturnsforclientsoverthelongpull.

ButI'mjusttalkingaboutinvestmentmanagersengagedincommonstockpicking.Iam
agnosticelsewhere.Ithinktheremaywellbepeoplewhoaresoshrewdaboutcurrenciesand
this,thatandtheotherthingthattheycanachievegoodlongtermrecordsoperatingona
prettybigscaleinthatway.Butthatdoesn'thappentobemymilieu.I'mtalkingaboutstock
pickinginAmericanstocks.

Ithinkit'shardtoprovidealotofvalueaddedtotheinvestmentmanagementclient,butit's
notimpossible.