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Charlie Munger's Cancer Surgery Formula

June 14, 2015 | About:

In the very end of his talk “Art of Stock Picking” (link), Charlie Munger (Trades, Portfolio) mentioned a very powerful mental model. He calls it the cancer surgery formula:

“Geico is a very interesting model. It’s another one of the 100 or so models you ought to have in your head. I’ve had many friends in the sick business fix up game over a long lifetime. And they practically all use the following formula. I call it the cancer surgery formula.

They look at this mess. And they figure it out if there’s anything sound left that can live on its own if they cut away everything else. And if they find anything sound, they just cut away everything else. Of course, if that doesn’t work, they liquidate the business. But it frequently does work.

And GEICO had a perfectly magnificent business – submerged in a mess, but still working. Misled by success, GEICO had done some foolish things. They got to thinking that, because they were making a lot of money, they knew everything. And they suffered huge losses.

All they had to do was to cut out all the folly and go back to the perfectly wonderful business that was lying there. And when you think about it, that’s a very simple model. And it’s repeated over and over again.

And in GEICO’s case, think about all the money we passively made … it was a wonderful business combined with a bunch of foolishness that would easily be cut out. And people were coming in who were temperamentally and intellectually designed so they were going to cut it out. That is a model you want to look for.

And you may find one or two or three in a long lifetime that are very good. And you may find 20 or 30 that are good enough to be quite successful.”

I’ve read this talk many times but it was not until the last time I read it that I finally get this idea. When combing the cancer surgery formula with another model mentioned in the talk – disadvantage of scale and going narrower specialization, it can be powerful.

We all know that a lot of the spin-offs are pretty good examples of the cancer surgery formula. One current example comes to mind is Masco’s (NYSE:MAS) spin-off of its installation and other services segment, which is a lousy business that has lost a good amount of money in the past, and doesn’t make much money now but requires a lot of assets and capital investment. Masco’s core business is not as good as GEICO of course, but its brands such as Delta and BEHR are very good brands in the niche markets.

Then we’ve also got some big companies practicing de-scaling and to some degree, cutting the folly. P&G (NYSE:PG) for instance, is in the process of cutting 100 out of its 165 brands. This makes perfect sense to me. Just think about the amount of distraction P&G’s executives face when managing 165 brands, many of which are either too small to make an impact or not even closely as good as the top 50. It is perfectly obvious to do that and they should have done that a long time ago. They shouldn’t have gotten to 165 brands in the first place.

Another current example that comes to mind is General Electric (NYSE:GE)’s shredding of the GE Capital business, which has been designated a "systemically important financial institution" by federal regulators. That designation subjects the financing unit to greater financial regulation. It also sold its NBCUniversal entertainment division to Comcast (NASDAQ:CMCSA) in a two-step deal in 2011 and 2013. These steps are taken so that the conglomerate can concentrate on its high value core industrial businesses, which it said should account for 90% of its earnings by 2018.

I have to confess that I haven’t done enough work to come up with a qualified opinion on either of the three situations mentioned above. I listed them because as I was thinking about the application of the cancer surgery formula and de-scaling mental models, I immediately thought of Masco, P&G, and GE as current examples that might be relevant. As Munger pointed out, “you may find one or two or three in a long lifetime that are very good. And you may find 20 or 30 that are good enough to be quite successful.” Whether they are good enough or not, is subject to each investor’s research and judgment.

About the author:

A global value investor constantly seeking to acquire worldly wisdom. My investment philosophy has been inspired by Warren Buffett, Charlie Munger, Howard Marks, Chuck Akre, Li Lu, Zhang Lei and Peter Lynch.

Rating: 5.0/5 (9 votes)



Raj123456789 - 4 years ago    Report SPAM

Should IBM be added to your list for divesting some of its low margin businesses.

Trongska - 4 years ago    Report SPAM

With this cancer surgery formular model, you can look up PNJ:VN company, the largest retail jewelry company in Vietnam. They have cut many non-core investments, including real estate, gas distribution, and eventually bank. So far, their core business margin has been improved dramatically and continues to expand. Great lesson!!!

Vgm - 4 years ago    Report SPAM

Reading your piece, got me wondering if "cancer surgery" is what John Chen has been carrying out on BlackBerry since he took over, cutting back dramatically to some basic healthy elements like security and QNX that are capable of new growth.

Thanks for the stimulation.

Grahamites - 4 years ago    Report SPAM

Softdude - Whether IBM's decision to exit the low margin mainframe server business is out of my circle of competency. I've read a book in which a former IBMer has criticized that decision.

Trongska: Thanks for great example. I look forward to finding more about PNJ:VN.

Vgm - I would not call BlackBerry a cancer sugery based on what I know. QNX is such a small percentage of the business but it is a call option. From the scuttlebutt work I did, BBRY has been losing some businesses to its competitors in enterprise service even with its security advantage. It's probably out of my circle of competency so I don't know whether what's left is great, good, mediocre or bad. Thanks for the comments and stimulation.

Vgm - 4 years ago    Report SPAM

Thanks Grahamites. QNX is small at the moment, but it will underpin BB's foray into the Internet of Things (IoT) which I believe is Chen's major goal for BB in addition to capitalising on unique security for handsets and software. Chen has talked about being able to secure all devices and platform OS's for IoT. According to estimates, there could be 75+ billion IoT devices, including handsets, by 2020. Time will tell.

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