A particularly astute student of human nature - particularly insofar as it relates to business and investing - Charlie Munger (Trades, Portfolio)'s counsel is highly prized and relied upon by friend and partner Warren Buffett (Trades, Portfolio). His insights are equally valued and sought after by more than a few OID subscribers and contributors (and editors).
Therefore, we were very pleased to be allowed to sit in on Munger's lecture at the University of Southern California last year on "investment expertise as a subdivision of elementary, worldly wisdom" and very gratefully acknowledge his generous permission to share it with you.
As always, we highly recommend a very careful reading (and re-reading) of his comments and
insights and hope that you find them as valuable as we do:
This is Part 2 of the lecture. Read Part 1 here.
THINGS TEND TOWARD WINNER TAKE ALL.
THEREFORE, IT PAYS TO BE #1, #2 OR OUT.
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Things tend to cascade toward winner-take-all.
Munger: There's another kind of advantage to scale. In some businesses, the very nature of things is to sort of cascade toward the overwhelming dominance of one firm. The most obvious one is daily newspapers. There's practically no city left in the U.S., aside from a few very big ones, where there's more than one daily newspaper.
And again, that's a scale thing. Once I get most of the circulation, I get most of the advertising. And once I get most of the advertising and circulation, why would anyone want the thinner paper with less information in it? So it tends to cascade to a winner-take-all situation. And that's a separate form of the advantages of scale phenomenon.
Similarly, all these huge advantages of scale allow greater specialization within the firm.
Therefore, each person can be better at what he does.
It's not irrational to insist on being #1 or #2 or out.
Munger: And these advantages of scale are so great, for example, that when Jack Welch came into General Electric, he just said, "To hell with it. We're either going to be #1 or #2 in every field we're in or we're going to be out. I don't care how many people I have to fire and what I have to sell. We're going to be #1 or #2 or out."
That was a very tough-minded thing to do, but I think it was a very correct decision if you're thinking about maximizing shareholder wealth. And I don't think it's a bad thing to do for a civilization either, because I think that General Electric is stronger for having Jack Welch there.
HOWEVER, BIGGER ISN'T ALWAYS BETTER - THERE ARE ALSO DISADVANTAGES OF SCALE.
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Bigger isn't always better. Sometimes, it's just the reverse....
Munger: And there are also disadvantages of scale. For example, we - by which I mean Berkshire Hathaway - are the largest shareholder in Capital Cities/ABC. And we had trade publications there that got murdered - where our competitors beat us. And the way they beat us was by going to a narrower specialization.
We'd have a travel magazine for business travel. So somebody would create one which was addressed solely at corporate travel departments. Like an ecosystem, you're getting a narrower and narrower specialization.
Well, they got much more efficient. They could tell more to the guys who ran corporate travel departments. Plus, they didn't have to waste the ink and paper mailing out stuff that corporate travel departments weren't interested in reading. It was a more efficient system. And they beat our brains out as we relied on our broader magazine.
That's what happened to The Saturday Evening Post and all those things. They're gone. What we have now is Motorcross - which is read by a bunch of nuts who like to participate in tournaments where they turn somersaults on their motorcycles. But they care about it. For them, it's the principal purpose of life. A magazine called Motorcross is a total necessity to those people. And its profit margins would make you salivate.
Just think of how narrowcast that kind of publishing is. So occasionally, scaling down and intensifying gives you the big advantage. Bigger is not always better.
Another defect of scale - flush, fat, stupid bureaucracy.
Munger: The great defect of scale, of course, which makes the game interesting - so that the big people don't always win - is that as you get big, you get the bureaucracy. And with the bureaucracy comes the territoriality - which is again grounded in human nature.
And the incentives are perverse. For example, if you worked for AT&T in my day, it was a great bureaucracy. Who in the hell was really thinking about the shareholder or anything else? And in a bureaucracy, you think the work is done when it goes out of your in-basket into somebody's else's in -basket. But, of course, it isn't. It's not done until AT&T delivers what it's supposed to deliver. So you get big, fat, dumb, unmotivated bureaucracies.
Bureaucracy's a terrible problem - especially in government.
Munger: They also tend to become somewhat corrupt. In other words, if I've got a department and you've got a department and we kind of share power running this thing, there's sort of an unwritten rule: "If you won't bother me, I won't bother you and we're both happy." So you get layers of management and associated costs that nobody needs. Then, while people are justifying all these layers. it takes forever to get anything done. They're too slow to make decisions and nimbler people run circles around them.
The constant curse of scale is that it leads to big, dumb bureaucracy - which, of course, reaches its highest and worst form in government where the incentives are really awful. That doesn't mean we don't need governments - because we do. But it's a terrible problem to get big bureaucracies to behave.
Some companies deal with bureaucracies well: e.g., GE.
Munger: So people go to stratagems. They create little decentralized units and fancy motivation and training programs. For example, for a big company, General Electric has fought bureaucracy with amazing skill. But that's because they have a combination of a genius and a fanatic running it. And they put him in young enough so he gets a long run. Of course, that's Jack Welch.
Others don't deal with it very well at all....
Munger: But bureaucracy is terrible.... And as things get very powerful and very big, you can get
some really dysfunctional behavior. Look at Westinghouse. They blew billions of dollars on a bunch of dumb loans to real estate developers. They put some guy who'd come up by some career path - I don't know exactly what it was, but it could have been refrigerators or something - and all of a sudden, he's loaning money to real estate developers building hotels. It's a very unequal contest. And in due time, they lost all those billions of dollars.
You get a lot of dysfunction in a big, fat, happy place.
Munger: CBS provides an interesting example of another rule of psychology - namely, Pavlovian association. If people tell you what you really don't want to hear - what's unpleasant - there's an almost automatic reaction of antipathy. You have to train yourself out of it. It isn't foredestined that you have to be this way. But you will tend to be this way if you don't think about it.
Television was dominated by one network - CBS - in its early days. And Paley was a god. But he didn't like to hear what be didn't like to hear, And people soon learned that. So they told Paley only what he liked to hear, Therefore, he was soon living in a little cocoon of unreality and everything else was corrupt - although it was a great business,
So the idiocy that crept into the system was carried along by this huge tide. It was a Mad Hatter's tea party the last ten years under Bill Paley.
And that is not the only example by any means. You can get severe misfunction in the high ranks of business, And of course, if you're investing, it can make a hell of a lot of difference. If you take all the acquisitions that CBS made under Paley, after the acquisition of the network itself, with all his dumb advisors - his investment bankers, management consultants and so forth who were getting paid very handsomely - it was absolutely terrible.
For example, he gave something like 20% of CBS to the Dumont Company for a television set manufacturer which was destined to go broke. I think it lasted all of two or three years or something like that. So very soon after he'd issued all of that stock, Dumont was history. You get
a lot of dysfunction in a big fat, powerful place where no one will bring unwelcome reality to the boss.
An everlasting battle between the pros and cons of size.
Munger: So life is an everlasting battle between those two forces - to get these advantages of scale on one side and a tendency to get a lot like the U.S. Agriculture Department on the other side - where they just sit around and so forth. I don't know exactly what they do. However, I do know that they do very little useful work,
A CASE STUDY IN ECONOMIES VS. DISECONOMICS
WAL-MART VERSUS SEARS, ROEBUCK.
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A chain store can be a fantastic enterprise.
Munger: On the subject of advantages of economies of scale, I find chain stores quite interesting. Just think about it. The concept of a chain store was a fascinating invention. You get this huge purchasing power - which means that you have lower merchandise costs. You get a whole bunch of little laboratories out there in which you can conduct experiments. And you get specialization.
If one little guy is trying to buy across 27 different merchandise categories influenced by traveling salesmen, he's going to make a lot of dumb decisions. But if your buying is done in headquarters for a huge bunch of stores, you can get very bright people that know a lot about refrigerators and so forth to do the buying.
The reverse is demonstrated by the little store where one guy is doing all the buying. It's like the old story about the little store with salt all over its walls. And a stranger comes in and says to the store owner, "You must sell a lot of salt." And he replies, "No, I don't. But you should see the guy who sells me salt."
So there are huge purchasing advantages. And then there are the slick systems of forcing everyone to do what works. So a chain store can be a fantastic enterprise.
Sam Walton played the game harder and better than anyone.
Munger: It's quite interesting to think about Wal-Mart starting from a single store in Bentonville, Arkansas - against Sears Roebuck with its name, reputation and all of its billions. How does a guy in Bentonville, Arkansas with no money blow right by Sears, Roebuck? And he does it in his own lifetime - in fact, during his own late lifetime because he was already pretty old by the time he started out with one little store....
He played the chain store game harder and better than anyone else. Walton invented practically nothing. But he copied everything anybody else ever did that was smart - and he did it with more fanaticism and better employee manipulation. So he just blew right by them all.
And he had a very shrewd strategy....
Munger: He also had a very interesting competitive strategy in the early days. He was like a prize fighter who wanted a great record so he could be in the finals and make a big TV hit. So what did he do? He went out and fought 42 palookas. Right? And the result was knockout, knockout, knockout - 42 times.
Walton, being as shrewd as he was, basically broke other small town merchants in the early days. With his more efficient system, he might not have been able to tackle some titan head-on at the time. But with his better system, he could sure as hell destroy those small town merchants. And he went around doing it time after time after time. Then, as he got bigger, he started destroying the big boys.
Well, that was a very, very shrewd strategy.
I believe that the world is better for having Wal-Mart.
Munger: You can say, "Is this a nice way to behave?" Well, capitalism is a pretty brutal place. But I personally think that the world is better for having Wal-Mart. I mean you can idealize small town life. But I've spent a fair amount of time in small towns. And let me tell you - you shouldn't get too idealistic about all those businesses he destroyed.
Plus, a lot of people who work at Wal-Mart are very high grade, bouncy people who are raising nice children. I have no feeling that an inferior culture destroyed a superior culture. I think that is nothing more than nostalgia and delusion. But, at any rate. it's an interesting model of how the scale of things and fanaticism combine to be very powerful.
Sears was a classic case study in diseconomics.
Munger: And it's also an interesting model on the other side - how with all its great advantages, the disadvantages of bureaucracy did such terrible damage to Sears, Roebuck. Sears had layers and layers of people it didn't need. It was very bureaucratic. It was slow to think. And there was an established way of thinking. If you poked your head up with a new thought, the system kind of turned against you. It was everything in the way of a dysfunctional big bureaucracy that you would expect.
In all fairness, there was also much that was good about it. But it just wasn't as lean and mean and shrewd and effective as Sam Walton. And, in due time, all their advantages of scale were not enough to prevent Sears from losing heavily to Wal-Mart and other similar retailers.
A MODEL WE'VE HAD TROUBLE WITH - ANTICIPATING COMPETITION AND ITS EFFECTS.
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In some markets, no one makes out. In others, everyone does.
Munger: Here's a model that we've had trouble with. Maybe you'll be able to figure it out better. Many markets get down to two or three big competitors - or five or six. And in some of those markets, nobody makes any money to speak of. But in others, everybody does very well.
Over the years, we've tried to figure out why the competition in some markets gets sort of rational from the investor's point of view so that the shareholders do well, and in other markets, there's destructive competition that destroys shareholder wealth.
It's easy to understand why air travel is so unprofitable....
Munger: If it's a pure commodity like airline seats, you can understand why no one makes any money. As we sit here, just think of what airlines have given to the world - safe travel. greater experience, time with your loved ones, you name it. Yet, the net amount of money that's been made by the shareholders of airlines since Kitty Hawk, is now a negative figure - a substantial negative figure. Competition was so intense that, once it was unleashed by deregulation, it ravaged shareholder wealth in the airline business.
But why is the cereal business so profitable?
Munger: Yet, in other fields - like cereals, for example - almost all the big boys make out. If you're some kind of a medium grade cereal maker, you might make 15% on your capital. And if you're really good. you might make 40%. But why are cereals so profitable - despite the fact that it looks to me like they're competing like crazy with promotions, coupons and everything else? I don't fully understand it.
Obviously, there's a brand identity factor in cereals that doesn't exist in airlines. That must be the main factor that accounts for it.
Maybe it boils down to individual psychology....
Munger: And maybe the cereal makers by and large have learned to be less crazy about fighting for market share - because if you get even one person who's hell-bent on gaining market share....
For example, if I were Kellogg and I decided that I had to have 60% of the market, I think I could take most of the profit out of cereals. I'd ruin Kellogg in the process. But I think I could do it.
In some businesses, the participants behave like a demented Kellogg. In other businesses, they don't. Unfortunately, I do not have a perfect model for predicting how that's going to happen.
For example, if you look around at bottler markets, you'll find many markets where bottlers of Pepsi and Coke both make a lot of money and many others where they destroy most of the profitability of the two franchises. That must get down to the peculiarities of individual adjustment to market capitalism. I think you'd have to know the people involved to fully understand what was happening.
A FEW WORDS ON PATENTS,
TRADEMARKS AND FRANCHISES.
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Patents haven't made people much money - until recently.
Munger: In microeconomics, of course, you've got the concept of patents. trademarks, exclusive franchises and so forth. Patents are quite interesting. When I was young, I think more money went into patents than came out. Judges tended to throw them out - based on arguments about what was really invented and what relied on prior art. That isn't altogether clear.
But they changed that. They didn't change the laws. They just changed the administration - so that it all goes to one patent court. And that court is now very much more pro-patent. So I think people are now starting to make a lot of money out of owning patents.
But trademarks and franchises have always been great.
Munger: Trademarks, of course, have always made people a lot of money. A trademark system is a wonderful thing for a big operation if it's well known.
The exclusive franchise can also be wonderful. If there were only three television channels awarded in a big city and you owned one of them, there were only so many hours a day that you could be on. So you had a natural position in an oligopoly in the pre-cable days.
And if you get the franchise for the only food stand in an airport, you have a captive clientele and you have a small monopoly of a sort.
A BASIC LESSON OFTEN FORGOTTEN:
NEW TECHNOLOGY CAN KILL YOU.
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You have to discern when technology will help and hurt.
Munger: The great lesson in microeconomics is to discriminate between when technology is going to help you and when it's going to kill you. And most people do not get this straight in their heads. But a fellow like Buffett does.
For example, when we were in the textile business, which is a terrible commodity business, we were making low-end textiles - which are a real commodity product. And one day, the people came to Warren and said, "They've invented a new loom that we think will do twice as much work as our old ones."
And Warren said, "Gee, I hope this doesn't work - because if it does, I'm going to close the mill." And he meant it.
Advances in commodity businesses go to buyers alone.
Munger: What was he thinking? He was thinking, "It's a lousy business. We're earning substandard returns and keeping it open just to be nice to the elderly workers. But we're not going to put huge amounts of new capital into a lousy business."
And he knew that the huge productivity increases that would come from a better machine introduced into the production of a commodity product would all go to the benefit of the buyers of the textiles. Nothing was going to stick to our ribs as owners.
That's such an obvious concept - that there are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that's still going to be lousy. The money still won't come to you. All of the advantages from great improvements are going to flow through to the customers.
The newspaper business is another matter altogether....
Munger: Conversely, if you own the only newspaper in Oshkosh and they were to invent more efficient ways of composing the whole newspaper, then when you got rid of the old technology and got new fancy computers and so forth, all of the savings would come right through to the bottom line.
A three-year payback often means a 4% per year return.
Munger: In all cases, the people who sell the machinery - and, by and large, even the internal bureaucrats urging you to buy the equipment - show you projections with the amount you'll save at current prices with the new technology. However, they don't do the second step of the analysis which is to determine how much is going to stay home and how much is just going to flow through to the customer. I've never seen a single projection incorporating that second step in my life. And I see them all the time. Rather, they always read: "This capital outlay will save you so much money that it will pay for itself in three years."
So you keep buying things that will pay for themselves in three years. And after 20 years of doing it, somehow you've earned a return of only about 4% per annum. That's the textile business.
And it isn't that the machines weren't better. It's just that the savings didn't go to you. The cost reductions came through all right. But the benefit of the cost reductions didn't go to the guy who bought the equipment. It's such a simple idea. It's so basic. And yet it's so often forgotten.
THE NATIONAL CASH REGISTER MODEL IS EXACTLY WHAT YOU'RE LOOKING FOR.
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Early birds have huge advantages....
Munger: Then there's another model from microeconomics which I find very interesting. When technology moves as fast as it does in a civilization like ours, you get a phenomenon which I call competitive destruction. You know, you have the finest buggy whip factory and all of a sudden in comes this little horseless carriage. And before too many years go by, your buggy whip business is dead. You either get into a different business or you're dead - you're destroyed. It happens again and again and again.
And when these new businesses come in, there are huge advantages for the early birds. And when you're an early bird, there's a model that I call "surfing" - when a surfer gets up and catches the wave and just stays there, he can go a long, long time. But if he gets off the wave, he becomes mired in shallows....
But people get long runs when they're right on the edge of the wave whether it's Microsoft or Intel or all kinds of people, including National Cash Register in the early days.
National Cash Register was a lead pipe cinch....
Munger: The cash register was one of the great contributions to civilization. It's a wonderful story. Patterson was a small retail merchant who didn't make any money. One day, somebody sold him a crude cash register which he put into his retail operation. And it instantly changed from losing money to earning a profit because it made it so much harder for the employees to steal....
But Patterson, having the kind of mind that he did, didn't think, "Oh, good for my retail business." He thought, "I'm going into the cash register business." And, of course, he created National Cash Register.
And he "surfed". He got the best distribution system, the biggest collection of patents and the best of everything. He was a fanatic about everything important as the technology developed. I have in my files an early National Cash Register Company report in which Patterson described his methods and objectives. And a well-educated orangutan could see that buying into partnership with Patterson in those early days, given his notions about the cash register business, was a total 100% cinch.
And, of course, that's exactly what an investor should be looking for. In a long life, you can expect to profit heavily from at least a few of those opportunities if you develop the wisdom and will to seize them. At any rate, "surfing" is a very powerful model.
FIGURE OUT WHERE YOU HAVE AN EDGE THEN, PLAY THERE AND ONLY THERE.
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If we don't believe we have an advantage, we don't play.
Munger: However, Berkshire Hathaway, by and large, does not invest in these people that are "surfing" on complicated technology. After all, we're cranky and idiosyncratic - as you may have noticed.
And Warren and I don't feel like we have any great advantage in the high-tech sector. In fact, we feel like we're at a big disadvantage in trying to understand the nature of technical developments in software, computer chips or what have you. So we tend to avoid that stuff, based on our personal inadequacies.
Figure out where you have an edge - and stay there.
Munger: Again, that is a very, very powerful idea. Every person is going to have a circle of competence. And it's going to be very hard to advance that circle. If I had to make my living as a musician.... I can't even think of a level low enough to describe where I would be sorted out to if music were the measuring standard of the civilization.
So you have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don't, you're going to lose. And that's as close to certain as any prediction that you can make. You have to figure out where you've got an edge. And you've got to play within your own circle of competence.
Life is much like trying to be a good plumbing contractor.
Munger: If you want to be the best tennis player in the world, you may start out trying and soon find out that it's hopeless - that other people blow right by you. However, if you want to become the best plumbing contractor in Bemidji, that is probably doable by two-thirds of you. It takes a will. It takes the intelligence. But after a while, you'd gradually know all about the plumbing business in Bemidji and master the art. That is an attainable objective, given enough discipline. And people who could never win a chess tournament or stand in center court in a respectable tennis tournament can rise quite high in life by slowly developing a circle of competence - which results partly from what they were born with and partly from what they slowly develop through work.
So some edges can be acquired. And the game of life to some extent for most of us is trying to be something like a good plumbing contractor in Bemidji. Very few of us are chosen to win the world's chess tournaments.
[Editor's note: Munger's comments remind your editor of Buffett's comments in John Train's The
Money Masters. Buffett asks Train, "How do you beat Bobby Fisher?" Answer: "Play him in anything but chess."]
One person's garbage is another's treasure.
Munger: Some of you may find opportunities "surfing" along in the new high -tech fields - the Intels, the Microsofts and so on. The fact that we don't think we're very good at it and have pretty well stayed out of it doesn't mean that it's irrational for you to do it.
TO A MAN WITH PROFICIENCY IN MATH, EFFICIENT MARKET THEORY LOOKS LIKE A NAIL.
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On to dessert - the selection of common stocks....
Munger: Well, so much for the basic microeconomic models, a little bit of psychology, a little bit of mathematics, helping create what I call the general substructure of worldly wisdom. Now, if you want to go on from carrots to dessert, I'll turn to stock picking - trying to draw on this general worldly wisdom as we go.
I don't want to get into emerging markets, bond arbitrage and so forth. I'm talking about nothing but plain vanilla stock picking. That, believe me, is complicated enough. And I'm talking about common stock picking.
Do as I do, not as I say....
Munger: The first question is, "What is the nature of the stock market?" And that gets you directly to this efficient market theory that got to be the rage - a total rage - long after I graduated from law school.
And it's rather interesting because one of the greatest economists of the world is a substantial shareholder in Berkshire Hathaway and has been from the very early days after Buffett was in control. His textbook always taught that the stock market was perfectly efficient and that nobody could beat it. But his own money went into Berkshire and made him wealthy. So. like Pascal in his famous wager, he hedged his bet.
The iron rule of life: Only 20% of us can be in the top 5th.
Munger: Is the stock market so efficient that people can't beat it? Well, the efficient market theory is obviously roughly right - meaning that markets are quite efficient and it's quite hard for anybody to beat the market by significant margins as a stock picker by just being intelligent and working in a disciplined way.
Indeed, the average result has to be the average result. By definition, everybody can't beat the market. As I always say, the iron rule of life is that only 20% of the people can be in the top fifth. That's just the way it is. So the answer is that it's partly efficient and partly inefficient.
Efficient market theory is seductive. Only it's not true....
Munger: And, by the way, I have a name for people who went to the extreme efficient market theory - which is "bonkers". It was an intellectually consistent theory that enabled them to do pretty mathematics. So I understand its seductiveness to people with large mathematical gifts. It just had a difficulty in that the fundamental assumption did not tie properly to reality.
Again, to the man with a hammer, every problem looks like a nail. If you're good at manipulating higher mathematics in a consistent way, why not make an assumption which enables you to use your tool?
BETTING ON HORSES AND PICKING STOCKS HAVE MORE THAN A LITTLE IN COMMON.
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Odds on horses and stocks are set by the market.
Munger: The model I like - to sort of simplify the notion of what goes on in a market for common stocks - is the pari-mutuel system at the race track. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based on what's bet. That's what happens in the stock market.
Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position etc., etc. is way more likely to win than a horse with a terrible record and extra weight and so on and so on. But if you look at the damn odds. the bad horse pays 100 to 1, whereas the good horse pays 3 to 2. Then it's not clear which is statistically the best bet using the mathematics of Fermat and Pascal. The prices have changed in such a way that it's very hard to beat the system.
And then the track is taking 17% off the top. So not only do you have to outwit all the other betters, but you've got to outwit them by such a big margin that on average, you can afford to take 17% of your gross bets off the top and give it to the house before the rest of your money can be put to work.
Believe it or not, some people make money betting horses.
Munger: Given those mathematics, is it possible to beat the horses only using one's intelligence? Intelligence should give some edge, because lots of people who don't know anything go out and bet lucky numbers and so forth. Therefore, somebody who really thinks about nothing but horse performance and is shrewd and mathematical could have a very considerable edge, in the absence of the frictional cost caused by the house take.
Unfortunately, what a shrewd horseplayer's edge does in most cases is to reduce his average loss over a season of betting from the 17% that he would lose if he got the average result to maybe 10%. However, there are actually a few people who can beat the game after paying the full 17%.
I used to play poker when I was young with a guy who made a substantial living doing nothing but bet harness races.... Now. harness racing is a relatively inefficient market. You don't have the depth of intelligence betting on harness races that you do on regular races. What my poker pal would do was to think about harness races as his main profession. And he would bet only occasionally when he saw some mispriced bet available. And by doing that, after paying the full handle to the house - which I presume was around 17% - he made a substantial living.
You have to say that's rare. However, the market was not perfectly efficient. And if it weren't for that big 17% handle, lots of people would regularly be beating lots of other people at the horse races. It's efficient, yes. But it's not perfectly efficient. And with enough shrewdness and fanaticism, some people will get better results than others.
It ain't easy, but it's possible, to outperform in stocks, too.
Munger: The stock market is the same way - except that the house handle is so much lower. If you take transaction costs - the spread between the bid and the ask plus the commissions - and if you don't trade too actively, you're talking about fairly low transaction costs. So that with enough fanaticism and enough discipline, some of the shrewd people are going to get way better results than average in the nature of things.
It is not a bit easy. And, of course, 50% will end up in the bottom half and 70% will end up in the bottom 70%. But some people will have an advantage. And in a fairly low transaction cost operation, they will get better than average results in stock picking.
What works betting horses also works for stock picking.
Munger: How do you get to be one of those who is a winner - in a relative sense - instead of a loser?
Here again, look at the pari-mutuel system. I had dinner last night by absolute accident with the president of Santa Anita. He says that there are two or three betters who have a credit arrangement with them, now that they have off-track betting, who are actually beating the house. They're sending money out net after the full handle - a lot of it to Las Vegas, by the way - to people who are actually winning slightly, net, after paying the full handle. They're that shrewd about something with as much unpredictability as horse racing.
And the one thing that all those winning betters in the whole history of people who've beaten the pari-mutuel system have is quite simple. They bet very seldom.
Winners bet big when they have the odds - otherwise, never.
Munger: It's not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it - who look and sift the world for a mispriced bet - that they can occasionally find one.
And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don't. It's just that simple.
Read Part 3 of the lecture here.
