While reading "The Snowball" by Alice Schroder for the third time, I bumped into a few paragraphs regarding the early investment career of Charlie Munger (Trades, Portfolio). I am fortunate that I did not miss out on these thought-provoking passages as they did not jump out at me the first time I read the book. There are some powerful lessons here and it would be futile for me to put these lessons in better words than Ms. Schroeder. So let’s revisit the story in Schroeder’s own words (I’ve highlighted a few sentences which I think deserve further pondering).
From "The Snowball:"
In 1962, Munger had gone into partnership with his poker buddy Jack Wheeler. Wheeler was a trader on the Pacific Coast Stock Exchange, the Wild West version in miniature of what was going on back east: a floor full of screaming traders, aggressive men looking to make a killing the fastest way they could. He owned an investing partnership, Wheeler, Cruttenden & Company, which included two “specialist posts” on the exchange, where traders took orders from brokers to trade stocks on the floor. They renamed the business Wheeler, Munger & Co., and sold the trading operation.
Munger continued his law practice but bolted from his old firm together with several other lawyers, among them Roy Tolles and Rod Hills. They founded a new firm, Munger, Tolles, Hills & Wood, that suited their ideals of how a law firm should be managed. All along, Munger had naturally resisted following the rules of a law firm run by anyone but himself.
“It’s no coincidence that the year he started his partnership was the same year he started his new law firm. The partners at the old firm found it abhorrent that a young lawyer in their firm would want to be a member of that gambling den, the Pacific Coast Stock Exchange. When Charlie and Roy left the firm, they sat down with the senior partners and said that they wanted these senior partners to understand that the day would come when every first-rate law firm had a member of the Pacific Coast Stock Exchange. This is probably apocryphal, but you can easily picture Charlie delivering that message to them as a parting shot.”
At their new firm, Munger and Hills imposed an elitist, Darwinian ethos designed to attract the brightest and most ambitious. The partners all voted on one another’s pay, which was circulated for everyone to know. Even as the firm launched, however, Munger was already spending a significant amount of time at the Pacific Coast Stock Exchange. Within three years, when he was forty-one, he abandoned the law altogether to work full-time at investing. But he still consulted to the firm and kept an office there, where he remained an important, almost spiritual presence. Tolles, too, shifted most of his attention to investing. Hills, by far the most ambitious and dedicated to law of the three, ran the firm and kept it going.
In his new role as a money manager, Munger had to raise money to manage. Buffett had always hustled for investors in an understated way, often using others as his promoters—people like Bill Angle and Henry Brandt, who found and prepared prospects—so that he could show off his impressive track record with a pleasing modesty. But however gracefully he’d hustled, he’d still done it. Munger felt this was demeaning. “I didn’t really like raising money,” he says. “I always felt that a gentleman should have his money.” Now, however, he managed to parlay his law practice into an investing partnership by raising funds from his powerful Los Angeles business connections. While his partnership was of course much smaller than Buffett’s, the money would be enough.
Jack Wheeler had explained to him that, as a member of the exchange, under its rules he could borrow an additional ninety-five cents for every dollar invested. Thus, if he put up $500, he could borrow another $475 and invest a total of $975. If the investment earned a profit of twenty-five percent, the profit on Munger’s $500 of capital would be nearly double that. While having the potential to nearly double his returns, this borrowing likewise nearly doubled his risk. If he lost twenty-five percent, he would lose nearly half his capital. But Munger, more than Buffett—far more than Buffett—was willing to take on some debt if he was positive the odds were right.
He and Wheeler set themselves up at the exchange in a “crude, cheap” office festooned with radiator pipes and stuck their secretary, Vivian, in the tiny private back office overlooking an alley. Wheeler, a big spender who liked to live large, had just had a hip replacement and soon started showing up for work on the golf course most mornings. Munger fell into a routine, arriving at five a.m., before the market opened on the East Coast, and checking the quotation board. Buffett had connected him with Ed Anderson, the Graham-Newman investor who had worked for the Atomic Energy Commission and seemed so smart; Munger hired him as his assistant.
Most of the traders at the stock exchange had ignored Munger’s arrival on the scene, but one of them, J. Patrick Guerin, took note. Guerin had bought the trading part of Wheeler’s partnership when Wheeler had spun it off and gone into business with Munger. A rough-and-tumble guy who was scrambling like mad to better himself, Guerin had grown up with a “divorced father,” says Munger, “and his mother was a drunk, so he raised himself on the streets. He was high IQ, rebellious, and maladjusted.” After a stint in the Air Force, Guerin had worked as a salesman for IBM, then became a stockbroker at a couple of small firms that peddled third-class stocks because they carried the highest profit, or “spread,” for the firm. This was a part of stockbroking Buffett had detested; Guerin, too, found it a relief to escape life as a “prescriptionist.”
By the time Munger met him, the lean, handsome Guerin had learned to roll his crisp shirt cuff down over his tanned forearm to cover his tattoo. He seemed to have a great number of friends as well as a tinge of Hollywood in his blood; one day he brought his friend, the actor Charlton Heston, down to the exchange for a tour.He did the trading for Wheeler, Munger, and says he immediately recognized that Munger had a money mind and began to cultivate him. He came to the conclusion that he’d been on the wrong side of the Wheeler deal right away, and began to emulate Munger and Buffett, with the goal of forming his own investing partnership.
“With some, the idea of buying dollar bills for forty cents takes, and with some it doesn’t take. It’s like an inoculation. It’s extraordinary to me. If it doesn’t grab them right away, I find that you can talk to them for years and show them records—you can do everything—and it just doesn’t make any difference. I’ve never seen anyone who became a convert over a ten-year period with this approach. It’s always instant recognition or nothing. Whatever it is, I’ve never understood it. But with a fellow like Rick Guerin—no business background in terms of studying it, but he saw it like that, he understood what it’s about, and he was applying it five minutes later. And Rick was smart enough to know that you should get a great teacher, which is what I was lucky enough to do with Ben Graham.”
As the day progressed at the Pacific Coast Stock Exchange, Munger would sit, lost in thought, usually reading. “Charlie! Charlie!” Ed Anderson would shout from the next desk. Munger would say nothing, or grunt something in response. Eventually, Anderson learned to make Munger respond clearly to questions, erasing ambiguity; a simple grunt was not sufficient. But it took time and experience for most people to figure out that Munger’s mind and mouth often went their separate ways.
Guerin did not know this yet. One day he came into the office from his booth on the floor. “Charlie,” he said.“I’ve just been offered fifty thousand shares of XYZ at fifteen dollars. This looks like a good deal.”
“Hmmm, uhm,” said Munger.
“Look, Charlie,” Guerin carried on, “if this interests you, I’m going to buy it.”
“Yeah, yeah,” said Munger.
A little later, Guerin walked back into the office and said, “Charlie, we got them.”
“Got what?” said Munger.
“We bought the fifty thousand shares at fifteen dollars.” Big money.
“What!?” screamed Munger. “What are you talking about! I don’t want ’em! Sell ’em! Get rid of ’em right now!”
Guerin tried to explain. He called on Anderson for backup: “Ed, did you hear this when I said it earlier?”
“Charlie, I was sitting here listening to it, just as Rick said,” Anderson interjected.
“I don’t care! I don’t care! Sell ’em! Sell ’em! Sell ’em!” yelled Munger.
Guerin ran out the door and got rid of the shares. “That was an object lesson,” says Anderson.
Munger bought cigar butts, did arbitrage, even acquired small businesses—much of this in Buffett’s style—but he seemed to be heading in a slightly different direction than Buffett. Periodically, he said to Ed Anderson, “I just like the great businesses.” He told Anderson to write up companies like Allergan, the contact-lens-solution maker. Anderson misunderstood and wrote a Grahamian report emphasizing the company’s balance sheet. Munger dressed him down for it; he wanted to hear about the intangible qualities of Allergan: the strength of its management, the durability of its brand, what it would take for someone else to compete with it.
Munger had invested in a Caterpillar tractor dealership and saw how it gobbled up money, which sat in the yard in the form of slow-selling tractors. To grow, the business had to buy more tractors, gobbling up more money. Munger wanted to own a business that did not require continual investment, and spat out more cash than it consumed. But what were the qualities of such a business? And what gave such a business an enduring competitive advantage? Munger was always asking people, “What’s the best business you’ve ever heard of?” But he was a man of no great patience, and inclined to think that people could read his mind.
His impatience stood out more than any theory that was emerging inside his head. He wanted to get really rich, really fast. He and Roy Tolles made bets on whose portfolio would be up more than one hundred percent in a year. And he was willing to borrow money to make money, whereas Buffett had never borrowed a significant sum in his life. “I need three million dollars,” Munger would say, on one of his frequent visits to the Union Bank of California. “Sign here,” the bank would reply. With these huge sums, Munger did enormous trades like British Columbia Power, which was selling at around $19 and being taken over by the Canadian government at a little more than $22. Munger put not just his whole partnership, but all the money he had, and all that he could borrow into an arbitrage on this single stock—but only because there was almost no chance that this deal would fall apart. When the transaction went through, the deal paid off handsomely.
Yet despite their different approaches, Munger regarded Buffett as the king of investing, and saw himself as merely a friendly pretender to the throne. “Vivian, get me Warren!” he shouted several times a day to whichever secretary had come to occupy Vivian’s desk. He cultivated Buffett like a garden he was tending. Buffett explained his philosophy: “You’ve got to coattail,” he said. But he did not want his friends to coattail him and considered it unethical when they did. Hence, while Munger, cultivating Buffett, was open about his trades—he got Buffett into his British Columbia Power deal, for example—Buffett always kept his trades to himself unless he was working an idea with a partner.