Friday, 24 February 2012

Stock Picking Philosophy from Charles Munger - Part 5

The following came from a 1994 article by Charles Munger, best known as one of the lead Berkshire Hathaway investors with Warren Buffett.

As a warning, its very long and talks about a lot of topics from role of math and psychology, business management, stock picking, etc but its very informative.

I've picked out a few more juicy paragraphs from it but if you have time, make sure to read it.  I've broken it up into several smaller chunks that I found interesting and will post them out over a few days.

Source: (Courtesy: The Big Picture)
Charles Munger, USC Business School, 1994
A Lesson on Elementary, Worldly Wisdom As It Relates To Investment Management & Business

See Part 1 - Value Investing
See Part 2 - Fewer But Bigger Bets
See Part 3 - Efficient Market Hypothesis & Race Tracking Betting Model
See Part 4 - Advantages & Disadvantages of Scale
See Part 5 - Bureaucracy & Yes Men
See Part 6 - Efficiencies & Profitability Differences from Competition
See Part 7 - Negative Effects of Technology on Business Profits
See Part 8 - Focusing on Your Competitive Edge & Follies of Investment Management
See Part 9 - Sector Rotation & Yearly tax avoidance

  • Bureaucracy
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 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.

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.
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.

  • The Dangers of Yes Men
Television was dominated by one network—CBS in its early days. And Paley was a god. But he didn’t like to hear what he 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 lot of difference. If you take all the acquisitions that CBS made under Paley, after the acquisition of the network itself, with all his 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.

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