Source: Qilehui.

I. The story of the multicolored fish hook.

Years ago, I had a friend who sold fishing gear in Pasadena. He sold fish hooks in all different colors. I had never seen fish hooks with such a variety of colors before, so I asked him: "Do these colored fish hooks make it easier to catch fish?"

He replied, "Charlie, I don't sell fish hooks to fish."

Everyone has this tendency. Deep down, everyone is biased and thinks that when they give someone advice, they are doing so in the other person's best interest, when in fact they are really just looking out for themselves.

Charlie Munger, 'Speech at the 1988 SciClone Financial Shareholders' Meeting'

Because fish hooks are sold to fishermen, whether multicolored fish hooks make it easier to catch fish or not is not the primary concern of the fishing gear store owner. What he cares about is whether fishermen are more willing to buy these kinds of fish hooks.

Salespeople are like this. Their position is to mainly sell the product at hand, not whether the product can bring you high utility value. Division of labor in society brings with it a certain degree of separating interests. This situation is especially applicable to service activities, where investment advisory services are a typical example. Brokerages earn commission from your trades, not income from your profits.

This story can provide us with several inspirations:

Firstly, true empathy is hard to come by. People are often unaware that they are coming from their own standpoint.

Secondly, strictly speaking, no one can make recommendations based on someone else's interests, so we must learn to think independently.

The third inspiration is that when it comes to sales, sometimes what people value about a product is not its actual use, such as when some people buy books not to read them, but to display them; or when people buy clothes not for comfort, but to show off.

II. The skepticism of Solomon Brothers.

At the senior partner level of Solomon Brothers, CEO Gutfreund has always attached importance to credit quality and is skeptical of human nature. As a credit-granting company, this skepticism helps him monitor credit risks.

For large Wall Street investment banks, credit quality is fundamental. If they cannot strictly control the extension of credit, in the event of a risk event in the market environment, they can only clean up the mess themselves. Many brokerages went bankrupt during the stock market crash in October 1987, and an important reason was that they extended credit to many clients with poor credit ratings.

Charlie Munger, 'Speech at the 1988 SciClone Financial Shareholders' Meeting'

Skepticism about human nature is a bit like Xunzi's "theory of evil." Of course, the issue of whether human nature is good or bad is a matter for scholars to debate, not an area we need to address.

But overall, when dealing with people in business, we should trust the laws of human nature rather than the specific individuals. Human weaknesses often have lasting effects and will not disappoint us. And if we naively rely on the other party's integrity, kindness, virtue, etc., we often find ourselves losing some risk prevention abilities and giving others leverage over us.

When analyzing a company, we cannot only look at the integrity of the management. This has specificity and only applies to specific people. We also need to look at the company's system design and corporate culture, which can make dishonest behavior pay a high cost.

There are standards, but no formulas.

In long-term investment practice, we have summarized some standards. It is not to say that we have invented and created some investment formulas. There are standards, but no formulas.

The ideal company creates more money market than net income each year, which can provide a large amount of disposable cash for owners. These funds can be reinvested.

Charlie Munger, 'Speech at the 1988 SciClone Financial Shareholders' Meeting'

There is a big difference between standards and formulas. Standards are a basis for evaluation. As for formulas, in mathematics, we can use a certain formula to directly calculate the answer when solving problems. From the definition, formulas have universality and are applicable to all similar problems.

Obviously, there is no such formula in investment, and the investment environment is constantly changing. What appears to be the same at different times is actually different, so there is no formula that can be continuously applied. In fact, the universal formula itself is a contradictory existence. If it really works all the time and never changes, it will definitely be discovered by more and more people, making it more difficult to make money and no longer universal.

As for the "standards" proposed by Munger, the literal meaning seems simple, but the conditions are actually very harsh, mainly three points:

The first is "every year", and one or two good times cannot explain that this is a good company.

The second is that the created cash should be higher than the net income, which requires the ability of the company's assets to create cash higher than its own cost.

The third is to be able to provide a large amount of disposable cash flow. We need to pay special attention to the words "large amount" and "disposable", which means that it can actually be given to shareholders and does not need to be paid through financing for operational funds.

Obviously, high capital expenditure industries are often unrelated to these three requirements, and a large part of the profits earned need to be used to increase, update and maintain equipment.

Fourth, Wesco's return cannot exceed Berkshire simply because of its small size.

Some shareholders think: Buffett and Munger, who control Wesco, have spent 20 or 30 years to develop and grow Berkshire. Now Berkshire has become a behemoth, but Wesco is still small. Therefore, Wesco's future compound rate of return will far exceed Berkshire's, so Wesco has extremely high investment value.

I can tell you clearly that this idea is wrong.

Charlie Munger, 'Speech at the 1988 SciClone Financial Shareholders' Meeting'

The inspiration of this passage is that even if they are both controlled by Buffett and Munger, for various reasons, Wesco's rate of return may not reach the level of Berkshire's.

For two companies with different controlling shareholders, it is even more wrong to think that the smaller company will have a higher rate of return. This kind of idea does exist among beginners.

In the market, many elephants are still dancing.

Westcom's shareholders bought in because they trusted the management.

In this year's Berkshire Hathaway annual report, Warren wrote that in looking back, he regretted not buying a large amount into some companies that had very good business because he was not bullish on their management.

In contrast, SciClone was not a good business, but our shareholders bought in because they trusted management.

Charlie Munger, 'Speech at the 1988 SciClone Financial Shareholders' Meeting'

Buffett's regret is that he did not buy a 'large amount' into companies that he believed had very good business, meaning he participated but did not hold many shares. This demonstrates how cautious their decision-making process is, with multiple screening requirements including good business and excellent management before a significant holding position is established (actual purchase also needs to consider price).

These two passages from Munger illustrate the importance of good management for investment decisions.

Of course, for most investors, understanding management is often more difficult than understanding business, and in reality, 'trust' in management is not easily established. Therefore, good business is the basis of safety.

Editor/Lambor