There are many aspects of intelligence, but one of the most fascinating is the flexibility to change one's mind, especially when confronted with new and challenging facts and evidence.
The late, influential British economist John Maynard Keynes is quoted as having said, "When the facts change, I change my mind. What do you do, sir?"
Let's explore this idea using a few examples from Warren Buffett (Trades, Portfolio) and Charlie Munger's investment record.
Airlines
For many years, Buffett wrote about the bad economics of the airline industry, citing lack of profitability, commoditized service and negative shareholder returns.
In a 1999 speech, he mentioned that over the previous 20 years, 129 airlines had filed for bankruptcy, and Continental Airlines had filed twice. In the same presentation, he quipped that had he been present at Kitty Hawk in 1903 when Orville Wright took off, he would have done a service to the capitalist system by shooting down the aircraft.
However, previously, in 1989, Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) had invested $358 million in US Air Group with 9.25% convertible preferred shares partly because of Buffett's admiration for then-CEO Ed Colodny.
Despite an unsuccessful attempt to unload the position at a 50% loss, eventually the hiring of new management and favorable business conditions caused the common shares to increase sharply in value, and the preferred stock was redeemed at a substantial profit. As my grandmother used to say, "Better lucky than smart."
In spite of his long-term aversion and a fortuitous avoidance of a possible large loss, in 2016 Buffett invested $10 billion in the shares of the four largest carriers in the U.S. airline industry and he even mentioned that he would conceivably purchase an entire airline.
Buffett cited deregulation, consolidation, a record number of travelers and a growing U.S. economy as reasons for his change of heart.
Utilities and railroads
Over many years, Buffett advised against investing in capital-intensive companies that needed frequent infusions of additional cash in order to operate effectively.
However, Berkshire's growing cash balance and Buffett's evolution in thinking compelled him to invest billions of dollars in utilities and renewable energy.
In 1994 he commented that these businesses "may not make you rich, but can help you stay rich." He also acted on the theory that utilities are a vital, recession-proof business, and today Berkshire owns 90% of MidAmerican Energy Company -- which serves much of Iowa as well as parts of Illinois, South Dakota and Nebraska -- along with other large holdings in the same industry.
The same thinking can be detected in Buffett's purchase of an entire railroad. Possibly influenced by his good friend Bill Gates (Trades, Portfolio), a Berkshire director who has a long-standing and substantial investment in Canadian National Railway, in 2007 Berkshire became the largest shareholder in Burlington Northern Santa Fe Corp. Lauding the efficiency of rail over other forms of transportation, he explained that a good railroad is able to haul "one ton of freight 500 miles on one gallon of diesel fuel."
In 2009, in a $44 billion transaction, Buffett bought the remaining balance of BNSF, thus acquiring the entire railroad company and explaining that the purchase was an investment in the economic future of the U.S.
Buffett avoided investing in technology companies for many years, explaining that he did not understand that type of business and that they were not part of his "circle of competence."
However, in 2016 he began to accumulate Apple (AAPL, Financial) stock and by the first quarter of 2018, Berkshire Hathaway owned about 240 million shares or close to 5% of the company, a position worth about $50 billion. Because of Apple's aggressive buyback program, Berkshire's ownership percentage could increase without any additional purchases.
In addition, Buffett was quoted as saying that he would not be averse to owning the entire company, as he said about an airline.
It is not known the degree of influence that Buffett's investment co-lieutenants, Todd Combs and Ted Weschler, might have had on this decision, but apparently he became interested in Apple when he noticed that his grandchildren were glued to their iPhones, not only to communicate with their friends but for the additional functionalities as well. He has also mentioned that he enjoys the convenience of looking up information on his iPad.
During an interview at Berkshire's 2018 Annual Meeting, Buffett told Fortune columnist Jen Wieczner, "I didn't go into Apple because it was a tech stock in the least. I went into Apple because I came to certain conclusions about both the intelligence with the capital they deploy, but more important the value of their ecosystem and how permanent that ecosystem could be."
In any event, the Apple investment represents a change of heart and flexibility in thinking.
Buybacks
Except for the 2012 purchase of about 9,200 class-A shares from the estate of the manager of a Berkshire subsidiary, Buffett and his vice-chairman Charlie Munger shunned buybacks of Berkshire stock.
But, a few years ago they announced that with a cash balance of over $ 100 billion, share repurchases might be prudent if implemented below 120% of book value. With Berkshire consistently selling above that threshold for a long time, buybacks did not take place.
Recently, Buffett announced that purchases would occur at prices that he and Munger deemed to be below intrinsic value. As explained in the Berkshire owner's manual, "Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the cash that that can be taken out of a business during its remaining life."
He went on to explain that while book value is relatively easy to figure out, intrinsic value is not a hard-and-fast calculation because it depends on many variables. In fact, it is a number that may vary depending on the person who is doing the calculating because it is an "estimate rather than a precise figure."
Recently, Berkshire announced that it bought back 225 class-A shares at an average price of $312,806 and 4,139,192 class-B shares at a $207 average price for a total spend of about $927 million.
In any event, a shrinkage of share count is beneficial for existing shareholders and a prudent allocation of capital.
Conclusion
Berkshire Hathaway is headed by two gentlemen who are blessed with sound mental acuity and whose thoughts and aphorisms are widely quoted. In fact, Munger has said that Buffett's investment prowess became even sharper after the age of 75.
In addition, there is an interview with Munger and investor Li Lu conducted at the 2018 Berkshire annual meeting. Li runs a hedge fund in which Munger is an investor, and during the conversation Munger said, "You have to keep learning if you want to be a good investor. As we've kept learning, and as conditions have changed, our investments have changed." He went on to say, "We changed because the world changed. Confucian thought and successful investing."
Any person who is interested in investing should read and re-read all available material about Buffett and Munger. Buffett's letters to Berkshire shareholders going back to 1977 are readily available for free on the Berkshire website. These "portable MBAs" are priceless learning tools thanks to Buffett's intellectual generosity.
Munger's wonderfully insightful speech, "The Psychology of Human Misjudgment," originally delivered at Harvard in 1995, is a must-read. It consists of 25 admonitions about the subtle influences on our minds that lead to irrational behavior and emotional miscalculations. The speech is included, with other valuable information, in the book "Poor Charlie's Almanack" and it is also available on the internet.
Studying the Buffett-Munger approach will instill the important concept of mental agility. Adding the work of Howard Marks (Trades, Portfolio), John Train, Philip Fisher, Benjamin Graham and retired Fortune Magazine columnist Carol Loomis, who also edits Buffett's annual shareholder letters, along with the writing of other fine, influential financial thinkers like John Templeton, Seth Klarman (Trades, Portfolio) and John Bogle, will help to form a base of knowledge and wisdom for anyone interested in the fascinating field of investments.
