One of the audience questions from the Berkshire meeting earlier this year was from a young man whose family owns a cattle ranch. Below is the dialogue of the Q&A:
Rancher: My family runs some cattle ranches down in Flagstaff, Arizona. And that’s kind of what my question pertains to. I am curious on your thoughts as it relates to the expanding global population and investing in cattle and if you think it is wise. Thank you.
Munger: I think it is one of the worst business I can imagine for somebody like us.
Buffett: There is nothing personal about it.
Munger: Not only is it a bad business, but we have no aptitude for it.
Buffett: Some people have done well in it.
Munger: They have one good year every twenty years or something.
Buffett: I know a few people who have done reasonably well in cattle, but they usually own banks on the side or something.
Munger: Somebody has to occupy the tough niches in the economy. We need you.
We can learn at least four things for Munger’s commentary.
- Munger can be a little rude. He is honest and forthcoming with his thoughts, but has very little patience or tact.
- Munger’s “mental models” and accumulated knowledge allows him to quickly dismiss a business with bad business economics.
- Munger’s does not engage in purchase price or asset value discussion when looking at a bad business. A bad business is a bad business, so move on.
- You do not need a 50-analyst team when you can say no so quickly.
The first is fairly self-evident and only new if this is the first time you have heard Munger speak.
Second, Munger dismisses the cattle ranch as a bad business in under 5 seconds. How can Munger know it is a bad businesses so quickly? He has seen the economics of so many businesses, it becomes fairly easy to dismiss the poor ones. In this case, it is easy to understand that a cattle rancher sells a commodity product. You have never walked into your local Kroger looking for steak from Cattle Ranch X in Flagstaff, Arizona. It is a commodity, pure and simple and the cattle rancher will never have any pricing power. Buffett has often said that the best businesses “buy commodities and sell brands.” Coke is a great example of this, Coke buys sugar and water (basically), puts them together and sells the consumer Coke. See’s Candies is another great example. Hershey’s, Wrigley, Heinz, Budweiser, all of these companies buy commodities and sell brands. Next time your kids are clamoring for Nutella on their breakfast toast, check out the ingredient list: sugar, palm oil and hazelnut, followed by cocoa solids and skimmed milk. This is not rocket science; if you are investor, you want to invest in the company selling Nutella, not the one selling “skimmed milk.” The cattle rancher is always going to be a “price taker” in economic terms. Munger uses his mental models to quickly understand that a cattle rancher is in a commodity business, destined to always be a price taker and immediately dismisses this as a bad business. Thus, he moves on and is able to think more about a better idea…
Third, Munger did not inquire about the potential purchase price or related asset values of the cattle ranch. Howard Marks has often said, “there are no bad assets, only bad prices.” Munger does not agree. If it’s a bad business, he does not want to be involved, no matter how “cheaply” the asset can be purchased. AK Steel and U.S. Steel make great case studies. If you are a cyclical investor or an asset buyer, you could have had multiple opportunities to make doubles or even triples on these two companies over the years. However, since April 1991, these two companies have returned a total of negative 62% and negative 17%, respectively. By contrast, Hershey’s and Coke have returned 808% and 561% over the same period. Investors in Sears have thought for years that the real estate values were good enough despite the bad retail businesses of Sears and K-Mart. I suspect those investors would have preferred to dismiss Sears and K-Mart within 5 seconds as a bad business instead of spending years trying to “unlock” the value of the real estate. The asset value plays remind me of Buffett’s oft-repeated phrase, “time is the enemy of the bad business and the friend of the good business.” Sears and K-Mart are bad businesses and the longer it takes for the real estate value to be realized, the lower those values will be.
Chart Comparing US Steel, AK Steel, Herhsey’s and Coke.
The last lesson involves the investment management area. The two portfolio managers at Berkshire, Todd Combs and Ted Weschler, manage a combined $18 billion in equities. Neither have any full time analysts and Buffett has said only Combs employs a few “part-time channel checkers.” In other words, two people manage $18 billion without the support of an army of analysts. How is this possible? I strongly suspect that Combs and Weschler both employ the same sort of mental model of dismissing bad ideas immediately and choosing to spend much more time focusing on good ideas that could turn out to be great investments. The reality is that this approach is not hard, but few chose to do it. In my opinion, the most plausible reason for why others don’t do it is ego. People have a hard time saying, “I don’t know.” They want to figure out every nook and cranny of the economy and “research” each and every cattle ranch type idea that comes across their desks. At Berkshire, those ideas are off the table within seconds. Berkshire’s success is not some great secret, but it is unconventional, and as Munger and Buffett often say, “People would rather fail conventionally than succeed unconventionally.”