Charlie Munger on Capital Allocation Discipline

At the 2019 Berkshire annual meeting, Munger was asked about share repurchases. The question probed the precision of Buffett's buyback threshold and whether Berkshire would be more liberal in repurchasing its own stock. Munger's answer was deliberately imprecise. He told the audience that he was a little more liberal in repurchasing shares than Buffett, and that the question of un-precision in railroading was a related problem - at some point, in a complicated operation, you accepted that you were operating with judgment rather than measurement. The point Munger was making was that capital allocation at Berkshire scale was not a marks-to-the-penny exercise. Repurchasing shares below intrinsic value was a clear duty when the price was clearly below the estimate; the difficulty was that intrinsic value itself was an estimate, not a quote. He told the room that pretending to more precision than the business actually allowed was itself a form of misjudgment. The honest framing was that Buffett and Munger had a range for intrinsic value, and they repurchased aggressively when the market price fell well below the low end of that range. The corollary was a critique of the modern buyback fashion. Munger noted that, historically, companies had refused to buy back their stock when it was a very good idea and were buying it back aggressively when the stock was so high that doing so was frequently a bad idea. He welcomed the audience to adult life - this is the way it is. The observation was that corporate buyback behavior was pro-cyclical, driven by the same incentive biases that drove every other form of capital allocation. The disciplined operator did the opposite: he bought back stock when the price was low and refrained when the price was high, regardless of what the Street was telling him about the optics.

At the 2013 Daily Journal annual meeting, I told the audience that the discipline of inversion, applied to the question of how to allocate capital, produced a different portfolio from the discipline of pursuing the highest expected return directly. The inverter asks the opposite question: what would guarantee the destruction of capital, and how can I avoid that? The capital-allocation-discipline point I tried to convey was that the investor who enumerates the failure modes, and who refuses to do the things that would produce them, has a long-run advantage over the investor who chases the highest expected return without considering the failure modes. The discipline required is to slow down, to write down the failure modes, and to refuse to act until the failure modes have been enumerated and the actions that would produce them have been refused, even at the cost of looking indecisive during the boom. The mistakes-and-learning element was the one I had most wanted to convey. I had made my own share of mistakes by pursuing the highest expected return without enumerating the failure modes, and the cost of those mistakes had, in dollar terms, been very large. The lesson I drew was that the disciplined investor must assume that the failure modes are present in every decision, and he must build the discipline of inversion into his process before the decision is made. The 2013 meeting was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act until the failure modes had been enumerated and the actions that would produce them had been refused. The investor who builds the discipline of inversion will outperform the investor who chases the highest expected return directly. The capital-allocation-discipline lesson I tried to convey was that the investor who avoids the destruction of capital, and who allows the desired outcome to emerge from the avoidance, has a long-run advantage over the investor who chases the highest expected return directly, because the things that produce the destruction of capital are well known and easy to avoid, and the things that produce the highest expected return are difficult to obtain and easy to lose. The 2013 meeting was, in some ways, the most useful I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to do the things that would produce the destruction of capital, and to allow the desired outcome to emerge from the avoidance. The investor who builds the discipline of inversion will outperform the investor with the higher IQ who chases the highest expected return directly.

At the 2002 Berkshire annual meeting, I told the audience that the previous year, with its revelations about Enron and the gradual unwinding of the technology bubble, had confirmed what I had long believed about the discipline of reading accounting footnotes and refusing to invest in businesses whose accounting I could not understand. The market-psychology point I tried to convey was that the crowd, in its broad patterns, repeats the same mistakes in every cycle, because the incentives facing the participants are the same in every cycle, and the biases facing the participants are the same in every cycle. The investor who recognises the patterns, and who refuses to participate in the new version of the old mistake, has a long-run advantage over the investor who assumes that the new version is different. The discipline required is to read the footnotes, to recognise the patterns, and to refuse to participate, even at the cost of looking unfashionable during the boom. The mistakes-and-learning element was the one I had most wanted to convey. I had made my own share of mistakes in the previous two years, by being too cautious during the recovery from the technology crash, and the cost of the caution had, in opportunity terms, been very large. The lesson I drew was that the disciplined investor must be willing to act during a recovery, even when the outlook is unclear, and even when the prices may go lower before they go higher. The 2002 meeting was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to wait for clarity, and to act when the prices were attractive, even at the cost of being early. The investor who builds the discipline of acting during the recovery will outperform the investor who waits for clarity. The capital-allocation-discipline lesson I tried to convey was that the investor who reads the footnotes, and who refuses to invest in businesses whose accounting he cannot understand, has a long-run advantage over the investor who chases the prices on the assumption that the accounting is honest. The 2002 meeting was, in some ways, the most candid I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to read the footnotes, to refuse to invest in businesses whose accounting I could not understand, and to act when the prices were attractive, even at the cost of being early and unfashionable. The investor who builds the discipline of refusal will outperform the investor with the higher IQ who chases the prices on the assumption that the accounting is honest.