Warren Buffett started out buying businesses at the lowest possible price. One day in 1965, a young man named Charlie Munger told him he was doing it all wrong.
Buffett had just bought Berkshire Hathaway. At that time, Berkshire was a struggling textile mill, not the conglomerate we know today.
Buffett recounts Munger’s advice in his excellent new annual letter, just released this weekend:
“…Charlie, in 1965, promptly advised me: “Warren, forget about ever buying another company like Berkshire. But now that you control Berkshire, add to it wonderful businesses purchased at fair prices and give up buying fair businesses at wonderful prices. In other words, abandon everything you learned from your hero, Ben Graham. It works but only when practiced at small scale.” With much back-sliding I subsequently followed his instructions.”
Munger was teaching Buffett about the power law — that a small number of investments drive almost all returns.
He didn’t use those words exactly. But Munger made sure Buffett understood that being in the best companies is more important than paying the lowest possible price.
The power law rules the world of venture capital, where I spend my days. But the power law is alive and well in public markets too.
Just seven stocks make up around 30% of the value of the S&P 500. One of them is Apple. And sure enough, Berkshire is one of Apple’s largest shareholders.
Buffett started buying Apple shares in 2016. Since then, the shares have risen more than five-fold.
Instead of investing in Apple, Buffett could’ve bought into lots of businesses at super low PE ratios. But would any of them have performed as well as Apple?
I doubt it.
Back in 1965, Buffett had the modesty to listen to Munger and admit he was right. Without that moment, Buffett might have kept buying struggling textile mills like Berkshire. And we probably wouldn’t know his name.
Even as Berkshire grew, Buffett continued to rely on Munger’s counsel:
Many years later, Charlie became my partner in running Berkshire and, repeatedly, jerked me back to sanity when my old habits surfaced. Until his death, he continued in this role and together we, along with those who early on invested with us, ended up far better off than Charlie and I had ever dreamed possible.
Buffett’s humility is a great example for me.
I’ve been angel investing for less than 3 years. A few of my companies are beginning to see success — and the temptation is to think I know everything.
Surely Startup A will win and Startup B won’t work. I know how to pick a winner, right?
Not so fast, Francis.
I’ve learned some, but there’s a lot further to go. And I need to be open to new ideas along the way.
What have you learned from Buffett and Munger? Leave a comment and let us know!
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