There are two types of knowledge. First, we have real knowledge. We see it in people who have committed a large amount of time and effort to understand a topic.
The second type is chauffeur knowledge – knowledge from people who have learned to put on a show. These people just make show that they know everything but they just speak what they have heard from the source. They speak as per the predefined script ready for them.
Any fool can know. The point is to understand. – A. Einstein
Investment – It is difficult to judge who is an expert and who has just a bird view of knowledge.
In 1998 Wesco meeting, Charlie Munger Quoted –
I try to get rid of people who always confidently answer questions about which they don’t have any real knowledge. To me, they are like the bee dancing its incoherent dance. They are just screwing up the hive.
Mr Warren Buffett suggests us to decide what we know and stay with it, what he calls a circle of competence. Mr Munger suggests that the size of the circle is not important but important is, we stay within its limit well. If we do not know anything, we should simply say we don’t know rather act as an expert. I also faced such problems during the initial days of my career. I considered people with Chauffeur knowledge as an expert until I do not meet real experts.
In the stock market, we meet many people who act as an expert but the majority of them not. We have to carefully check their knowledge before trust on them. We have to understand their investment philosophy and process before making a judgement of them. True experts recognize the limits of what they know and what they do not know. If they find themselves outside their circle of competence, they keep quiet or simply say, ‘I don’t know.’ We also have to perform the same for becoming an expert in our field.
Majority of the big winners’ companies have also seen the worst period during their journey. It is not necessary that if the company has delivered a 25%+ CAGR then it will get into the smooth way. There always be a huge up and downs to it. Many storms such companies have experience but as investors, we need to stay during those storms if we have made an investment into the great companies then only we can able to earn good returns from it.
Mr. Munger has established a hedge fund company, Wheeler, Munger & Company in the year 1962 which has a pre-fees return of 37.10% during the year 1962 to 1969. And 14-years of partnership, Mr. Munger has delivered around 19.82% CAGR compared to 5.20% CAGR with the dividend of S&P500.
If we love when stocks moving into the upward direction then we must have to be ready to accept its downward journey also. It is a part of the game and without accepting the losses, we cannot become a seasoned investor. Even Mr. Sachin Tendulkar cannot hit a century into the each of the match, some of the match having a ZERO score also. If he only focuses on the century then it might be possible that he cannot able to play well. Similarly, if we keep focussing on the scoreboard then we may not able to create a good investment fortune.
Mr. Munger has an investment of 61% of his portfolio to the Bluechip stamp and original business of the bluechip stamps has started getting deteriorate from the peak revenue of $12.42 crore in 1982. Bluechip has made an investment into the See’s Candies, the Buffalo Evening News, and Wesco Financial before getting merged into the Berkshire Hathway in the year 1983.
The firm of Mr. Munger has lost 31.90% in the year 1973 and 31.50% in the year 1974 v/s 13.10% and 23.10% decline of Dow Jones respectively. And he bounces back by 73.20% of the gain to the year 1975 but few of the large investors have left him which break him mentally and emotionally. He decided to liquidate the partnership. But after the worst performance during the year 1973-1974, Mr. Munger has delivered a 24.30% CAGR before fees.
We need to be mentally ready for the big losses during our investment journey if we want to earn a decent return for the long term. If we are not mentally and emotionally ready we will not able to survive to the investment journey.
We should not sell stocks just due to a fall in the price of the stocks. If we keep on doing such practices then we will not survive for the long term to the stock market. If we know that stock can fall by 50% after we bought it, then we will make a position which is comfortable for us during the decline.
We need to make a balance between equity and debt as per own comfort. So that we can able to play an investment game in a good manner. Also, get the strength of absorbing such shock.
When we own something, we value it more preciously. If we purchase any stocks than it becomes a value for us. We value more which we are holding, which is known as an endowment bias. Due to the higher value for us, we cannot able sold out or go away from our holding.
Mr. Buffett has always mentioned that not to become too much confidence.
We can see that Mr. Buffett does not get overconfidence on his own holding, but especially he mentioned that he can have poor performance for his investment. And when he felt that he could not able to manage fund then he has discontinued his partnership approach.
Mr. Buffett has made much successful investment such as see’s candy, Coca-Cola, GEICO, Nebraska Furniture Mart, etc. But he has also made a mistake to make an investment to the Salomon Brothers, US Air, and Dexter Shoes, etc.
When Berkshire had purchased Dexter shoes than they have issued shares of Berkshire for acquiring a Dexter. Dexter got bought by Berkshire for the worth of $433 million which turnouts to be a ZERO a few years later. Mr. Buffett has mentioned into his letter to shareholders that one of the biggest mistakes he had made was to acquire Dexter shoes and that is by issuing a share of Berkshire. Berkshire share was quoted at $16765 at the time of Dexter acquisition which is currently quoted at $304057, which has grown by 13% CAGR for the same period and at the same time Dexter becomes zero. Mr. Buffett had bought H.H.Brown and Lowell Shoe in the year 1991 and 1992 respectively before the acquisition of Dexter.
In the year 2000, Mr. Buffett has recognized his mistake and write of remaining accounting goodwill. The overconfidence of Mr. Buffett has hampered a huge value to the Berkshire which teaches us that we should not be overconfident for any of the trade. When we are overconfident, we cannot able to see the negative part of our trade. We have to be neutral with our holding. I always mentioned that there is not a favorite stock of mine when people asked me for my favorite holding. I would like to hold the stock until it remains within my criteria of holding. As and when it goes out of it, I put a sell order into it. If we consider any of our investment as a favorite, then we get attached towards it and we cannot able to sell it when it is going out of our criteria.
One of the concepts which are essential to understanding making an investment and value to the business.
Many of us focus on the story builds for a particular business and make a hope investing rather than focusing on the actual reality. I always quote- “Stories are for kids, not for investors.” We need to focus on the ability of the company for creating access return on invested capital (Access return means higher than the cost of capital) and that should be sustainable for a longer period of time.
Mr.Buffett has always put a huge emphasis on the business which has a moat and earns consistently higher return compared to the cost of capital.
See’s Candy as an example of Great business –
Indian Companies example for Great business
One of the two-wheeler and commercial vehicle manufacturing company
One of the FMCG Company
One of the Assets Management Company
Here, the company does not require to make a huge investment to earn more money. Float itself take care of the major requirement of the invested capital. Many a time float covers working capital as well as fixed assets requirement. Due to such nature, Profit earns from operation majorly gets to the investment and cash so that investment and cash to the company is compound which also provides benefits to the business.
Good Business –
Good business which does not have float available with the business or least float available with business, company has to invest money which they earn from profit, and sometimes little external funding also requires.
Indian Companies example for Good business
One of the company from tableware industry
One of the pharma company
One of the Tea manufacturing company
Gruesome Business –
A gruesome business which does not have float available with the business, company has to invest money which they earn from profit, and also external funding requires to earn little profitability, sustaining the business or further growth. Here, huge capital is required to run a business.
Mr.Buffett has quoted an example of U.S. Air, He acquired a preference share of the company in the year 1989 and sold at the year 1998 with a huge gain. After that company gone for bankruptcy for the twice. The airline business is a cyclical business, huge dependence on the prices of crude oil and during the year 1998-99, crude oil prices were at the bottom (near to the price at the year 1988). So that profitability gets improved for the year 1998-99 and after that crude has never come back to those price level, which has affected to the profitability of the company.
Indian Companies example for gruesome business
One of the telecom company of India
One of the logistics company
One of the steel manufacturing company
We have to use a different valuation matrix for each category of the businesses and cannot provide a similar valuation to each category of businesses. We cannot give the same value to pour water and to dirty water. Yes, it is true that we can make process and pour dirty water but for that, we need to bring more capital and many a times, few qualities of water will be lost during the process of dirty water to pour water.
We have to sell out our position into the cyclical business at the proper time or else we stuck with the business.
Now, for taking an exit from cyclical businesses – When margin approaching towards a previous high margin, we should start to exit from a cyclical business. We need to track the price of the commodities as well as quarterly operating margins.