Seeking Munger's Advice: How to Understand and Address Challenges, and What to Do When Investments Face Declines

Source: Munger Academy
Author: Ranran

The following is the main text.

In a company's 2020 annual report, the management stated that shortly after the Spring Festival following the outbreak of the pandemic, the first question they discussed in a meeting was, "If sales drop to zero, how long can our company survive?" The management noted, "Witnessing many friends around us losing their jobs, businesses, and even their composure, falling into despair, prudence seems to be the most viable attitude."

There is no doubt that the pandemic has been the macro event with the greatest impact on investment in recent years. To make matters worse, several other external factors have almost completely eroded the profitability of certain industries and companies. Many individuals, investors, and listed companies have felt the pressure and encountered difficulties.

From 1958 to 1970, Buffett wrote letters to partners for 13 years, yet in none of those letters did he mention the influence of any macroeconomic trends on investment. Even in the decades of shareholder letters that followed, Buffett never discussed, as many listed companies do in their annual reports, international affairs or domestic issues, GDP growth rates, or industry output. Macroeconomics is too vast and distant; even someone as perceptive as Buffett, leading a company as large as Berkshire Hathaway, would not dare to speculate on macroeconomic conditions. Most listed companies and investors are simply not qualified to discuss macroeconomics.

The shock brought by this pandemic is macro in nature, but this difficulty is no different from previous challenges. Past experience in overcoming difficulties can provide confidence.

This time, the burden on our shoulders still feels heavy, the breathing still feels labored, and occasionally it feels hard to catch one's breath. But all of this feels very familiar. There is no longer the kind of indescribable oppression and tension that came with facing difficulties for the first time.

The difficulties may be greater than before, but with past experience in overcoming them, knowing that this time is no different allows for a more composed response. There is no need for motivational rhetoric, but having persisted for so long, and having faced hardship for such an extended period, it might be worthwhile seeking advice from the wise Charlie Munger on how to view difficulties, especially as an investor, how he views downturns, and what actions he takes during market declines. These insights might offer some inspiration for our current situation.

Why seek Munger’s advice on how to deal with difficulties?

Why seek Munger’s advice on how to deal with difficulties? Why not turn to Graham, Buffett, or Schloss?

Because Munger has experienced far too many hardships in his life.

He once walked and cried on the streets of Pasadena after losing his young son;

He once exhausted himself worrying over the failure of a factory business deal that went sour;

He once endured excruciating pain, retreating to a corner like a caged beast, after a failed eye surgery.

Munger rejects self-pity

Let us take a specific small example. In 1953, after Charlie Munger's first marriage ended, the house went to his ex-wife, and he moved into a student apartment. Every weekend, he would happily take his children out for fun—visiting parks, going to amusement centers, or visiting friends' homes.

At that time, despite still being particular about his attire, Charlie drove an old, battered Pontiac car. Anyone who saw this dilapidated vehicle assumed he was penniless. Charlie’s daughter once asked him, “Dad, this car is so broken! Why are you driving such a wreck?” Charlie replied, “This way, I won’t attract gold-diggers.” In truth, he was genuinely short on funds at the time as he was working as a lawyer, and lawyers back then did not earn much.

Every time I think of this small incident, I always feel heartache. This little story encapsulates one of the many hardships Munger has experienced.

Next, let us seek wisdom from the sage Munger as he explains how to view difficulties and what a qualified investor should think and do in an adverse market. The following content is excerpted from the Q&A section of the Daily Journal Corporation and Wesco Financial Corporation shareholder meetings.

How does Munger understand difficulties?

First, difficulty is normal.

1. Difficulty is a constant state.

(1) Shareholder: May I ask for your opinion on American Express? Has the moat of American Express narrowed?

Munger: It’s a real pity that American Express lost Costco as a major client. This is how intense competition works under capitalism. Other banks offered more favorable terms and took away this business. Even the strongest companies can fall behind if they let their guard down in such fiercely competitive markets. That's the ruthlessness of modern capitalist markets. Without full vigilance, survival is impossible.

… The management of American Express will surely say that competition is fierce and they’ve been working hard. Isn’t it the same for Daily Journal Company? We’ve also been working hard, but our newspaper business is still on an irreversible decline. Gary, would you say we haven’t put in the effort?

Gary Salzman: We have made efforts, but the competition is just too intense.

Munger: Yes, we could only retreat step by step. Such is the difficulty of the adult world. (2015)

(2) Shareholder: Over the course of a lifetime, the world changes greatly. When I reach your age, will there be anything that remains unchanged? What are the common traits between good businesses of the future and those of today?

Munger: The only constant is this word 'difficulty.' You will experience loved ones leaving this world, endure heavy blows, and taste the bitterness of suffering. Life is filled with 81 trials. Only at life’s end do you realize everything was in vain. No matter how hard you strive, life is destined to end in failure. Once you grasp this truth, you understand what is meant by life being like a dream. Kittens and puppies don’t know about fate, but we are different; we can comprehend the destiny of life as a fleeting illusion.

Some say that the law of conservation of energy in thermodynamics does not apply to life. The outcome of life cannot be victory; everyone is destined to fail eventually. This is the ultimate challenge we must confront. (2017)

2. When times are tough, everyone struggles.

Shareholder: If Daily Journal Company suddenly realizes a large profit, what would the management do? How should one invest given the current low interest rates and low inflation environment?

Munger: In the current environment, the stock market is at a high level, and prices in many areas of real estate are also elevated. With idle funds on hand, it is difficult to find suitable investments. We can only do our best. It is not as though encountering difficulties means there is a magic solution that instantly resolves everything. When difficulties arise, I feel partly responsible, which is normal. (2021)

3. Knowing how hard it is, compared to assuming it’s easy, makes success more attainable.

Shareholder: Berkshire Hathaway’s long-term goal is to increase intrinsic value by 15% annually.

Munger: At most, 15%. We hope Berkshire can grow faster, but we believe 15% is the upper limit of what we can achieve. This target is very challenging, and we cannot guarantee that it will be achieved.

Shareholder: Berkshire Hathaway’s net worth is $57 billion. Mr. Buffett has said that Berkshire’s intrinsic value far exceeds its net asset value.

Munger: Yes.

Shareholder: Intrinsic value depends on return on capital and the discount rate. For the sake of discussion, let’s assume Berkshire’s current intrinsic value is between $800 billion and $1 trillion. Based on this, at a 15% growth rate, Berkshire’s intrinsic value will range between $3.2 trillion and $4 trillion in 10 years.

Munger: Your math is good.

Shareholder: Three to four trillion dollars is no small figure.

Munger: You’re absolutely right.

Shareholder: You and Mr. Buffett have repeatedly indicated that the investment environment is fraught with challenges. How can Berkshire achieve substantial growth given such difficulties? I find it somewhat challenging. What is your opinion?

Munger: Of course, it’s difficult. On the other hand, clearly recognizing the difficulties is better than assuming it’s easy. Understanding the challenges makes it more likely to achieve our goals. (1999)

Second, difficulty has its advantages.

Munger: … If we accept our circumstances with equanimity, we can face life with a positive attitude and realize our own value within the limited time we have. This principle should be clear to everyone. Spending a lifetime starting from zero and achieving great success through incremental efforts allows you to use your abilities and wisdom to help others and set a good example. You will feel extremely proud and fulfilled. It is precisely because it is difficult that there is so much joy in overcoming those challenges.

Another advantage of life’s 'difficulty' is this: Earlier today, before the shareholders’ meeting, we held a board meeting where we discussed issues related to software implementation. Implementing complex software programs in a new region always comes with various problems—frequent malfunctions, repeated restarts, and overwhelming stress. I said that over the course of my life, I have discovered a truth: friendships formed through shared hardships and struggles are the most profound. Such bonds cannot be built during times of comfort and abundance.

In adversity, we struggle to cope and endure hardship, but adversity is where willpower is forged, friendships are strengthened, and success is nurtured. Only by striving together in adversity can people form bonds of solidarity through shared suffering, which is invaluable.

I have another perspective on facing difficulties. Life’s challenges come one after another, each being a test for us and an opportunity to demonstrate our character. I suggest everyone adopt this attitude toward difficulties. Especially as you grow older, this mindset becomes particularly useful. In old age, many challenges cannot be overcome without a positive attitude. (2017)

Third, compared to others, we are not afraid of difficulties.

(1) Simpson: In my view, competition in the property insurance industry will intensify over the next five years. Charlie also mentioned earlier that the performance of property insurers is likely to decline.

Munger: Increased industry competition and potential declines in performance do not worry me at all. I am optimistic about GEICO's prospects. Over the next 20 years, while the entire industry may face tough times, we might defy the trend and move upward. When the industry faces difficulties, everyone faces difficulties; it’s about who has greater resilience. (1999)

(2) Whether in our savings and loan business or in the real estate operations in Santa Barbara, we maintain a substantial margin of safety. It is not easy for us to incur significant losses unless the entire society suffers a major disaster where people can no longer survive – only then would we find ourselves in difficulty.

Once, Derek Bok, the president of Harvard University, was posed with a similar question. At that time, Harvard’s endowment fund was the largest, and its academic reputation and social influence were at their peak. Someone asked Professor Bok what impact it would have on Harvard if the government continued to cut education funding for universities. After pondering for a moment, Bok responded: “We won’t be the first university to fall.”

When issuing loans, we proceed with great caution, ensuring a sufficient margin of safety. The proportion of loans we issue relative to the assessed value of assets is low. Our credit standards for issuing loans are set very high. 99.999% of our long-term loans are secure. Many of the loans we hold are secured by properties with high values but low loan amounts. For example, a property valued at $400,000 might have a loan amount of $20,000. (1990)

Fourth, the harder something is to achieve, the more difficult it is for others to take it away once accomplished.

1. Suffering earlier than others allows one to reap rewards later.

Munger: That’s how doing business works. Whoever gets in first, eats the initial hardship first, and achieves success first secures the advantage. Latecomers will not only have to endure all the hardships again but also face the already established leadership of companies like NetJets. We are suffering now so that future competitors will suffer even more.

This is precisely why many companies prefer to endure hardship early on. When Coca-Cola expanded into global markets, every time it entered a new country, it faced challenges head-on. Now, Coca-Cola has reaped the benefits after enduring those hardships. The same principle applies to NetJets’ expansion into Europe. We endure difficulties now to avoid them in the future. (2000)

2. The harder something is to achieve, the more difficult it is for others to take it away once accomplished.

Munger: If Daily Journal Corporation succeeds, not only will shareholders profit, but we will also make contributions to society. The existing systems used by government agencies are inefficient and require extensive automation. We develop software and provide services that involve tedious and labor-intensive work. Because it is dirty and tiring, others are unwilling to do it, which gives us this opportunity. Microsoft doesn’t want to earn this money; Microsoft can easily make money elsewhere, so why go through this trouble?

The harder it is, the more I like it. Because if it's hard, once we truly succeed, others won't be able to take it away easily. (2015)

Five, face difficulties with humor.

(1) Shareholder: Have you ever considered becoming a crosstalk actor? The frequency with which you deliver punchlines is extremely rare. (Laughter)

Munger: You understand me well. Although I am not Jewish, I greatly admire Jewish humor. Jews make up only 2% of the world’s population but create 60% of the world’s humor. Despite enduring so much hardship, they can still laugh at life, which is truly admirable. I deeply respect the Jewish people. I suggest all of you learn from their approach to facing adversity with humor, as I do. (2018)

(2) Shareholder: You have observed many foolish behaviors in humans, yet you are not disappointed by human stupidity. Have you always been this way? Is it right to think like you do?

Munger: Absolutely right. This is a life attitude I learned from the Jews. They have endured so much suffering yet still face life with laughter—I deeply admire them. This attitude of laughing through hardships fits my personality very well. Humor truly is a great remedy for pain. (2019)

What to do when investments encounter a market downturn?

The above reflects wise man Munger’s understanding of difficulties. Next, let us hear Munger explain what to do specifically in investing when encountering a market downturn.

First, long-term investment requires the ability to withstand a 50% decline.

Shareholder: In 1973, when managing your partners’ funds, you suffered a 30% loss. In 1974, you lost another 30%. Within two years, more than half was lost. What happened at that time? What did you learn from it?

Munger: This question is easy to answer. At that time, while managing my partners’ funds, the partnership fund I managed fell 50% in one year, while the market dropped about 40%. A once-in-thirty-years economic recession occurred, and even dominant newspaper companies fell to price-to-earnings ratios of three or four times. When the market bottomed out, I had fallen 50% from the peak.

The situation of a 50% decline has occurred three times just in my holdings of Berkshire stocks. In investing, one needs to have some resilience. Investing is a long-term endeavor. Since you've prepared for long-term investment, when faced with a 50% drop, you must hold firm and not be frightened out of your wits.

Let me tell you based on my personal experience: focus on improving yourself. When there's a 50% drop, you need to remain calm, as if 'a mountain collapses before your eyes but your expression doesn’t change.' (Applause) Don’t try to figure out how to avoid a major downturn. What’s meant to come will come. If it hasn’t come, it only shows that you haven’t worked hard enough. (2017)

Second, understand that pain is part of investing.

Munger: I have indeed tasted the bitterness of volatility. Check the returns of Wheeler, Munger & Co. for 1973 and 1974, and you'll see how miserable I was at that time. In fact, those two years of significant declines were periods of accumulation; without those two years of tempering, there would have been no subsequent breakthrough. During the worst of the declines in 1973 and 1974, I clearly knew that the intrinsic value of the stocks I held was three times their market price.

As long as I can hold on, the market can't do anything to me. The market fell sharply, and I needed to persevere, but I was far from going bankrupt. That period was indeed difficult. I believe young people should have some fighting spirit, endure some hardships, and get some good training. Being afraid to fight and fearing hardship—isn’t that just being a coward? (1995)

Third, over the long journey of investment, there are different periods; sometimes it's a period that requires patience and endurance.

Shareholder: I am a novice shareholder. I haven’t accumulated substantial wealth yet. I also want to live a prosperous life. You mentioned earlier that there aren’t many opportunities now, which scared me a bit. Is there still hope for beginners like us?

Munger: You novices represent a new generation of investors, and throughout your lives, you will encounter opportunities that belong to you. However, if you expect to get rich easily within the next five years, that may not be realistic. Compared to the seasoned investors around you, your investment journey might be more challenging.

It may be harder, but don’t lose heart.

Shareholder: I am still young, and I have 10 or 20 years ahead of me.

Munger: You young people still have a long investment journey ahead. Sometimes you need to sow, sometimes you need to harvest, and sometimes you need to endure the winter and survive. A child once asked his grandfather what he did during the French Revolution. The grandfather replied, 'I survived.'

Sometimes, mere survival is an achievement. Act according to the times, consider all possibilities, and prepare in advance. (1997)

At this point, I have conveyed how the wise Munger views difficulties and market crashes. I don’t feel I have anything worthwhile to add beyond his words, so almost everything above is a direct quote from Munger.

In the current market, some large listed companies are pillars of the nation, with credit ratings equivalent to China’s sovereign credit rating, yet their prices are significantly below net asset value. Some small- and medium-sized listed companies, which operate without issues and even show improving performance, have stock prices at levels that imply bankruptcy valuation, with some trading below their net cash positions.

During the market crash in the 1970s, Munger said, 'The intrinsic value of the stocks I hold is three times their market price.' In today’s market, anything less than that might not be considered cheap. If it were Buffett, would he be ecstatic like a womanizer entering a kingdom of beauties? As for us, is it really that difficult? Regardless, listening to Munger’s advice on handling adversity can offer some inspiration for our present situation.

By the way, the listed company mentioned at the beginning had forward-thinking management concerned about the impact of the pandemic. However, this company achieved record-high revenue and net profits during the pandemic. It found the right business strategy and has excellent management.

The pandemic was tough, but good companies remain good companies. Unfortunately, their share prices were not spared. At the time of writing, its price continues to hit new lows, trading at less than one-third of its previous high. Even after the decline, it seems the price has only reached a reasonable level. Good companies rarely become truly cheap.

Editor/Rocky