Tag: Warren Buffett

What makes Warren Buffett a great investor? Intelligence or Discipline?

I thought this excerpt from Warren Buffett’s 2011 interview in India was relevant to not only investing but also decision making. A member of the audience says to Buffett: “As we all know, you are an extremely intelligent person. At the same time, you are very disciplined with your investing approach. What makes Warren Buffett a great investor? Is it the intelligence or the discipline?”

Here is Warren’s response.

Warren: The good news I can tell you is that to be a great investor you don’t have to have a terrific IQ.

If you’ve got 160 IQ, sell 30 points to somebody else because you won’t need it in investing. What you do need is the right temperament. You need to be able to detach yourself from the views of others or the opinions of others.

You need to be able to look at the facts about a business, about an industry, and evaluate a business unaffected by what other people think. That is very difficult for most people.

Most people have, sometimes, a herd mentality which can, under certain circumstances, develop into delusional behavior. You saw that in the Internet craze and so on. I’m sure everybody in this room has the intelligence to do extremely well in investments.

Moderator: They’re all 160 IQs.

Warren: They don’t need it. I’m disappointed they haven’t sold off some already. The 160s won’t beat the 130s at all necessarily. They may, but they do not have a big edge. The ones that have the edge are the ones who really have the temperament to look at a business, look at an industry and not care what the person next to them thinks about it, not care what they read about it in the newspaper, not care what they hear about it on the television, not listen to people who say, “This is going to happen,” or, “That’s going to happen.”

You have to come to your own conclusions, and you have to do it based on facts that are available. If you don’t have enough facts to reach a conclusion, you forget it. You go on to the next one. You have to also have the willingness to walk away from things that other people think are very simple.

A lot of people don’t have that. I don’t know why it is. I’ve been asked a lot of times whether that was something that you’re born with or something you learn. I’m not sure I know the answer. Temperament’s important.

Moderator: That’s very good advice, to be detached from all the noise. You shouldn’t go with the herd.

Warren: If you don’t know the answer yourself don’t expect somebody else to tell you. If you don’t know the answer yourself and somebody else says they know the answer, don’t let that fact push you into coming to a conclusion about something that you don’t know enough to come to a conclusion on.

Stocks go up and down, there is no game where the odds are in your favor. But to win at this game, and most people can’t, you need discipline to form your own opinions and the right temperament, which is more important than IQ.

Pascal said it best: “All men’s miseries derive from not being able to sit in a quiet room alone.”

Warren: If you look at the typical stock on the New York Stock Exchange, its high will be, perhaps, for the last 12 months will be 150 percent of its low so they’re bobbing all over the place. All you have to do is sit there and wait until something is really attractive that you understand.

And you can forget about everything else. That is a wonderful game to play in. There’s almost nothing where the game is stacked in your favor like the stock market.

What happens is people start listening to everybody talk on television or whatever it may be or read the paper, and they take what is a fundamental advantage and turn it into a disadvantage. There’s no easier game than stocks. You have to be sure you don’t play it too often.

You need the discipline to say no.

Ajit: The discipline to say no, if you have that and you’re not willing to let people steamroll you into saying yes. If you have that discipline, that’s more than 50 percent of the battle.

Warren: Don’t do anything in life where, if somebody asks you the reason why you are doing it, the answer is “Everybody else is doing it.” I mean, if you cancel that as a rationale for doing an activity in life, you’ll live a better life whether it’s in the stock market or any place else.

I’ve seen more dumb things, and sometimes even illegal things, justified (rationalized) on the basis of “Everybody else is doing it.” You don’t need to do what everybody else is doing. It’s maddening, during the Internet craze when the bubble was going on.

Here’s your neighbor who’s got an IQ of 50 points below you, and he’s making all this easy money and your wife is telling you “This jerk next door is making money, and you’re smarter than he is. Why aren’t you making money?”

You have to forget about all those things. You have to do what works, what you understand, and if you don’t understand it and somebody else is doing it, don’t get envious or anything of the sort. Just go on and wait until you find something you understand.

From this video, a watermarked transcript of which is available for purchase.

12 Books Every Investor Should Read

philip-fisher-common-stocks-uncommon-profits

If you’re looking for something to read that will improve your ability as an investor, I’d recommend any of the books below. All 12 of them are deeply informative and will leave an impact on you.

1. The Intelligent Investor by Benjamin Graham
Described as “by far the best book on investing ever written” by none other than Warren Buffett. “Chapters 8 and 20 have been the bedrock of my investing activities for more than 60 years,” he says. “I suggest that all investors read those chapters and reread them every time the market has been especially strong or weak.”

2. The Little Book that Beats the Market by Joel Greenblatt
As Buffett says, investing is simple but not easy. This book focuses on the simplicity of investing. Greenblatt, who has average annualized returns of about 40% for over 20 years, explains investing using 6th grade math and plain language. Putting it into practice is another story.

3. Fooled by Randomness by Nassim Taleb
The core of Taleb’s other books — The Black Swan and Antifragile — can be found in this early work. One of the best parts, for me, was the notion of alternative histories. “Mother Nature,” he writes, “does not tell you how many holes there are on the roulette table.” This book teaches you how to look at the world probabilistically. After you start doing that, nothing is ever the same again.

4. The Most Important Thing by Howard Marks
“This is a rarity,” Buffett writes of Howard Marks’ book, “a useful book.” More than teaching you the keys to successful investment, it will teach you about critical thinking.

5. Poor Charlie’s Almanack by Charlie Munger
Charlie Munger is perhaps the smartest man I don’t know. This book is a curated collection of his speeches and talks that can’t help but leave you smarter. Munger’s wit and wisdom come across on every page. This book will improve your thinking and decisions. It will also shine light upon psychological forces that make you a one-legged man in an ass-kicking contest. Read and re-read.

6. Common Stocks and Uncommon Profits by Philip Fisher
Buffett used to say that he was 85% Benjamin Graham and 15% Phil Fisher. That was a long time ago, the Buffett of today resembles more Fisher than Graham. Maybe there is something to buying and holding great companies.

7. The Dao of Capital by Mark Spitznagel
Spitznagel presents the methodology of Austrian Investing, where one looks for positional advantage. Nassim Taleb, commenting on the book wrote: “At last, a real book by a real risk-taking practitioner. You cannot afford not to read this!”

8. Buffett: The Making of an American Capitalist by Roger Lowenstein
This book, perhaps more than any other, has changed the lives of many of my friends and investors because this is how many of them first discovered Warren Buffett and value investing.

9. The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success
An outstanding book detailing eight extraordinary CEOs and the unconventional methods they used for capital allocation. One of them, Henry Singleton, had a unique view on strategic planning.

10. The Misbehavior of Markets: A Fractal View of Financial Turbulence by Benoit Mandelbrot
A critique of modern finance theories, which usually gets built on the underlying assumption that distributions are normal. Nassim Taleb calls this “the most realistic finance book ever published.”

11. Why Stocks Go Up (and Down) by William Pike
This is a basics book on the fundamentals of equity and bond investing – financial statements, cash flows, etc. A good place to start on the nuts and bolts. If you’re looking to learn accounting also check out The Accounting Game: Basic Accounting Fresh from the Lemonade Stand, I’m serious. This is the book I recommended to classmates in business school with no accounting background to get them up to speed quickly.

12. Bull: A History of the Boom and Bust, 1982-2004 by Maggie Mahar
The first and perhaps best book written on the market’s historic run, which started in 1982 and ended in the early 2000s. Mahar reminds readers that euphoria and blindness are a regular part of bull markets – lessons we should have learned from studying history.

Keep in mind that if investing were as easy as buying a book and reading it, we’d all be rich.

The Six Books Bill Gates Thinks You Should Read This Summer

Bill Gates Summer 2014 Reading List

Bill Gates is out with his annual summer reading list and, while shorter than last year’s, it’s nonetheless full of interesting reads.

I ended up ordering two of them, one of which is considered to be “the best business book I’ve ever read” by both Warren Buffett and Gates.

Gates writes “I read them all earlier this year and think each one is terrific. Only one, The Rosie Project, qualifies as a typical beach read. But all six are deeply informative and beautifully written.”

1. Business Adventures, by John Brooks.

Warren Buffett recommended this book to me back in 1991, and it’s still the best business book I’ve ever read. Even though Brooks wrote more than four decades ago, he offers sharp insights into timeless fundamentals of business, like the challenge of building a large organization, hiring people with the right skills, and listening to customers’ feedback. He is also a masterful storyteller, peppering his articles with compelling portraits of everyone from General Electric executives to the founder of Piggly Wiggly groceries. His article on the fate of the Ford Motor Company’s Edsel is a classic. Business Adventures is out of print in hardcover and paperback (not true, after a recommendation from Gates they ran another print, which is due out in Sept.), but you can now buy it in e-book form. And you can download chapter 5, “Xerox Xerox Xerox Xerox,” free. I wish all business writing were half as good.

2. Stress Test, by Timothy F. Geithner.

The central irony of Stress Test is that a guy who was accused of being a lousy communicator as U.S. Treasury Secretary has penned a book that is such a good read. Geithner paints a compelling human portrait of what it was like to be fighting a global financial meltdown while at the same time fighting critics inside and outside the Administration as well as his own severe guilt over his near-total absence from his family. The politics of fighting financial crises will always be ugly. But it helps if the public knows a little more about the subject—what’s at stake, what the options are, what has worked in similar situations—so that the loud talkers resonate a bit less and the knowledgeable ones a bit more. …

3. The Bully Pulpit: Theodore Roosevelt, William Howard Taft, and the Golden Age of Journalism, by Doris Kearns Goodwin.

I read a lot about Teddy Roosevelt last year, around the time Melinda and I took our kids to the Panama Canal. He was instrumental in getting the canal built, and I’d assumed it was the highlight of his career. But it wasn’t. It’s a testament to the breadth and depth of Roosevelt’s accomplishments that the canal warrants only a handful of mentions in this biography. There’s just too much other fascinating material competing for space, from Roosevelt’s relationship with the press and his friendship with William Howard Taft (who was brilliant in his own right) to his efforts to fight corruption and reform the political system.

I’m especially interested in the central question that Goodwin raises: How does social change happen? Can it be driven by a single inspirational leader, or do other factors have to lay the groundwork first? Sometimes a single leader can make a big difference: In the field of global health, Jim Grant almost singlehandedly created a global constituency for children, sparking a movement to double vaccination rates and save millions of lives. But Roosevelt’s case was different. Although he tried to push through a number of political reforms earlier in his career, he wasn’t really successful until journalists at McClure’s and other publications had rallied public support for change.

I loved Goodwin’s Team of Rivals and highly recommend this one too.

4. The Rosie Project: A Novel, by Graeme Simsion.

Melinda picked up this novel earlier this year, and she loved it so much that she kept stopping to read passages to me. I started it myself at 11 p.m. one Saturday and stayed up with it until 3 the next morning. Anyone who occasionally gets overly logical will identify with the hero, a genetics professor with Asperger’s Syndrome who goes looking for a wife. (Melinda thought I would appreciate the parts where he’s a little too obsessed with optimizing his schedule. She was right.) It’s a funny and profound book about being comfortable with who you are and what you’re good at. I’m sending copies to several friends and hope to re-read it later this year. It is one of the most enjoyable novels I’ve read in a long time.

5. The Sixth Extinction: An Unnatural History, by Elizabeth Kolbert.

Climate change is a big problem—one of the biggest we’ll face this century—but it’s not the only environmental concern on the horizon. Humans are putting down massive amounts of pavement, moving species around the planet, over-fishing and acidifying the oceans, changing the chemical composition of rivers, and more. Natural scientists posit that there have been five extinction events in the Earth’s history (think of the asteroid that wiped out the dinosaurs), and Kolbert makes a compelling case that human activity is leading to the sixth. Unlike a lot of people who write about the environment, Kolbert doesn’t resort to hype. She just lays out the facts and wraps them in memorable anecdotes. It’s a sobering but engaging and informative read.

6. Reinventing American Health Care: How the Affordable Care Act Will Improve Our Terribly Complex, Blatantly Unjust, Outrageously Expensive, Grossly Inefficient, Error Prone System, by Ezekiel J. Emanuel.

One of the architects of the Affordable Care Act (a.k.a. Obamacare) makes the case for why the U.S. health care system needed reform and how Obamacare sets out to fix the problems. Although he was deeply involved in its creation, Emanuel is good about making it clear when he’s educating you about the history of health care and when he’s advocating for his ideas. He calls out a few things he disagreed with in Obamacare, like the creation of a separate health-insurance exchange for small businesses. And unlike a lot of experts, he’s willing to make predictions about how health care will change in the coming years. …

And Gates also included a video explaining the reads

Warren Buffett on Scorecards, Investing, Friends, and the Family Motto

Farnam Street

This website is named after a street located in Omaha, Nebraska. An amazing place, Omaha is famous for being the home of Warren Buffett, one of the world’s richest men. The headquarters of Berkshire Hathaway — and his house — just happen to be on “Farnam Street.” The name of this website is an homage to both Buffett and his business partner Charlie Munger.

While Buffett is famous for his investing acumen, he’s also full of sage wisdom on life and living.

In October 2009, while the housing crisis was still in full effect, his authorized biography The Snowball: Warren Buffett and the Business of Life hit the shelves.

Here are some of his lessons on life and investing.

***
Three Early Lessons in Investing

Having bought three shares of Cities Service Preferred at the age of 11, Buffett learned a valuable lesson. After the stock plunged from $38.25 to $27 a share. His sister Doris reminded him daily on the way to school that her stock was going down. Buffett felt “terribly” responsible. When the stock recovered he sold with a slight $5 profit. Almost immediately after, Cities Service quickly soared to $202 a share.

Warren learned three lessons and would call this episode one of the most important of his life. One lesson was not to overly fixate on what he had paid for a stock. The second was not to rush unthinkingly to grab a small profit. He learned these two lessons by brooding over the $ 492 he would have made had he been more patient. It had taken five years of work, since he was six years old, to save the $ 120 to buy this stock. Based on how much he currently made from selling golf balls or peddling popcorn and peanuts at the ballpark, he realized that it could take years to earn back the profit he had “lost.” He would never, never, never forget this mistake. And there was a third lesson, which was about investing other people’s money. If he made a mistake, it might get somebody upset at him. So he didn’t want to have responsibility for anyone else’s money unless he was sure he could succeed.

***
The Scorecard

This is an important one to keep in mind. If we place too much emphasis on what the world thinks, we end up with an outer scorecard.

I feel like I’m on my back, and there’s the Sistine Chapel, and I’m painting away. I like it when people say, ‘Gee, that’s a pretty good-looking painting.’ But it’s my painting, and when somebody says, ‘Why don’t you use more red instead of blue?’ Good-bye. It’s my painting. And I don’t care what they sell it for. The painting itself will never be finished. That’s one of the great things about it.

The big question about how people behave is whether they’ve got an Inner Scorecard or an Outer Scorecard. It helps if you can be satisfied with an Inner Scorecard. I always pose it this way. I say: ‘Lookit. Would you rather be the world’s greatest lover, but have everyone think you’re the world’s worst lover? Or would you rather be the world’s worst lover but have everyone think you’re the world’s greatest lover?’ Now, that’s an interesting question.

This has implications if you’re a parent: What you put emphasis on matters.

If all the emphasis is on what the world’s going to think about you, forgetting about how you really behave, you’ll wind up with an Outer Scorecard.

***
Hang Around People Better Than You

After graduating from Columbia University, Buffett returned to Omaha to live with his parents. He spent part of that first summer fulfilling his obligation to the National Guard. While he wasn’t a natural, it sure beat going off to fight in Korea. Part of his duties in the guard required him to attend training camp in La Crosse, Wisconsin, for a few weeks. That experience taught him an incredible lesson that he’d carry forward for the rest of his life.

“It’s a very democratic organization. I mean, what you do outside doesn’t mean much. To fit in, all you had to do was be willing to read comic books. About an hour after I got there, I was reading comic books. Everybody else was reading comic books, why shouldn’t I? My vocabulary shrank to about four words, and you can guess what they were.

“I learned that it pays to hang around with people better than you are, because you will float upward a little bit. And if you hang around with people that behave worse than you , pretty soon you’ll start sliding down the pole. It just works that way.”

***
The Buffett Family Motto

As simple as it is powerful.

“Spend less than you make” could, in fact, have been the Buffett family motto, if accompanied by its corollary, “Don’t go into debt.”

***
On Why he Wanted Money

Even when he was little he was always fixated on money. He wanted money. Why?

“It could make me independent. Then I could do what I wanted to do with my life. And the biggest thing I wanted to do was work for myself . I didn’t want other people directing me. The idea of doing what I wanted to do every day was important to me.”

***
Principles

In July of 1952, Susie Buffett, having been married only a few months to Warren, went to Chicago with her parents and new in-laws for the Republican convention. The convention was covered on television for the first time in history. Warren, who stayed in Omaha, watched eagerly — “struck by the power of this medium to magnify and influence events.”

The front-runner was Senator Robert Taft, known as “Mr. Integrity.” He wanted three things: (1) small government; (2) pro-business; and (3) eradicate Communism. Taft’s friend and Warren’s father, Howard Buffett, was the head of his presidential campaign. Taft’s main opponent was the moderate and popular war hero General Dwight D. Eisenhower.

While it might have been the first convention covered by television it still lives in the history books as one of the most controversial Republican conventions. Eisenhower backers pushed through a controversial amendment to the rules that handed him the nomination on the first ballot. Taft and his supporters were, of course, outraged.

But Eisenhower soon made peace with them by promising to combat “creeping socialism.” Taft insisted that his followers swallow their outrage and vote for Eisenhower for the sake of regaining the White House. The Republicans united behind him and his running mate, Richard Nixon; “I Like Ike” buttons sprouted everywhere. Everywhere, that is, except on Howard Buffett’s chest. He broke with the party by refusing to endorse Eisenhower.

This was an act of political suicide. His support within the party evaporated overnight. He was left standing on principle— alone. Warren recognized that his father had “painted himself into a corner.” From his earliest childhood, Warren had always tried to avoid broken promises, burned bridges, and confrontation. Now Howard’s struggles branded three principles even deeper into his son: that allies are essential; that commitments are so sacred that by nature they should be rare; and that grandstanding rarely gets anything done.

***
Still Curious?

While reading about Buffett won’t make you as smart as he is, you might learn something in the process. Pick up a copy of The Snowball: Warren Buffett and the Business of Life and give it a shot.

Avoiding Stupidity is Easier than Seeking Brilliance

Avoiding Stupidity is Easier than Seeking Brilliance

Simon Ramo, a scientist and statistician, wrote a fascinating little book that few people have bothered to read: Extraordinary Tennis Ordinary Players.

The book isn’t fascinating because I love tennis. I don’t. The fascinating part is that in the book, Ramo identifies the crucial difference between the Winner’s Game and a Loser’s Game.

Ramo believed that tennis could be subdivided into two games: the professionals and the rest of us.

Players in both games play by the same rules and scoring. They play on the same court. Sometimes they share the same equipment. In short, the basic elements of the game are the same. Sometimes amateurs believe they are professionals but professionals never believe they are amateurs.

But the difference between the game that professionals play and what amateurs play are fundamentally different.

Professionals win points whereas amateurs lose them. Think about professional games. Each player, nearly equal in skill, plays a nearly perfect game rallying back and forth until one player hits the ball just beyond the reach of his opponent. This is about positioning, control, spin. It’s a game of inches and sometimes centimeters.

Avoiding Stupidity is Easier Than Seeking Brilliance

In his 1975 essay, The Loser’s Game, Charles Ellis calls professional tennis a “Winner’s Game.” While there is some degree of skill and luck involved, the game is generally determined by the actions of the winner.

Amateur tennis is an entirely different game. Not in how it is played but in how it’s won. Long and powerful rallies are generally a thing of the past. Mistakes are frequent. Balls are constantly hit into nets or out of bounds. Double faults are nearly as common as faults.

The amateur duffer seldom beats his opponent, but he beats himself all the time. The victor in this game of tennis gets a higher score than the opponent, but he gets that higher score because his opponent is losing even more points.

The Two Games

Ramo found this out because he gave up trying to keep track of conventional scores — “Love,” “Fifteen All,” etc. Instead, he simply looked at points won versus points lost.

In expert tennis, about 80 per cent of the points are won; in amateur tennis, about 80 per cent of the points are lost. In other words, professional tennis is a Winner’s Game – the final outcome is determined by the activities of the winner – and amateur tennis is a Loser’s Game – the final outcome is determined by the activities of the loser. The two games are, in their fundamental characteristic, not at all the same. They are opposites.

After discovering that there are, in effect, two different games and realizing that a generic strategy will not work for both games he devised a clever strategy by which ordinary players can win by losing less and letting the opponent defeat themselves.

… if you choose to win at tennis – as opposed to having a good time – the strategy for winning is to avoid mistakes. The way to avoid mistakes is to be conservative and keep the ball in play, letting the other fellow have plenty of room in which to blunder his way to defeat, because he, being an amateur will play a losing game and not know it.

If you’re an amateur your focus should be on avoiding stupidity.

Investors Bet on Someone Else’s Game

This brings to memory something about Warren Buffett and Ben Graham.

Buffett used to convene a group of people called the “Buffett Group.” At one such meeting Benjamin Graham, Warren Buffett’s mentor and teacher, gave them all a quiz. I spent hours searching for this reference, which comes from Benjamin Graham on Value Investing: Lessons from the Dean of Wall Street.

“He gave us a quiz,” Buffett said, “A true-false quiz. And there were all these guys who were very smart. He told us ahead of time that half were true and half were false. There were 20 questions. Most of us got less than 10 right. If we’d marked every one true or every one false, we would have gotten 10 right.”

Graham made up the deceptively simple historical puzzler himself, Buffett explained. “It was to illustrate a point, that the smart fellow kind of rigs the game. It was 1968, when all this phoney accounting was going on. You’d think you could profit from it by riding along on the coattails, but (the quiz) was to illustrate that if you tried to play the other guy’s game, it was not easy to do.

“Roy Tolles got the highest score, I remember that,” Buffett chuckled. “We had a great time. We decided to keep doing it.”

Avoiding Stupidity

The point is that most of us are amateurs but we refuse to believe it.

This is a problem because we’re often playing the game of the professionals. What we should do in this case, when we’re the amateur, is to invert the problem. Rather than trying to win, we should avoid losing.

This was a point Charlie Munger, the billionaire business partner of Warren Buffett, made a long time ago.

In a letter to Wesco Shareholders, where he was at the time Chairman (and found in the excellent Damn Right!: Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger), Munger writes:

Wesco continues to try more to profit from always remembering the obvious than from grasping the esoteric. … It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent. There must be some wisdom in the folk saying, `It’s the strong swimmers who drown.’

And there is so much wisdom embedded in that quote that I’ve printed it out and attached it to my wall.

Three Underrated Reasons for Berkshire Hathaway’s Enormous Success

Berkshire Hathaway success

Berkshire Hathaway is widely regarded as one of the most successful companies in the world. If you look at Warren Buffett’s 49 year track record with Berkshire, it almost looks easy in hindsight. Make no mistake, however, it wasn’t easy and he certainly didn’t do it alone.

At this year’s annual meeting Buffett and his longtime business partner, Charlie Munger, revealed “the secret” to their success. But it’s not really a secret and, of course, extraordinary success is typically a combination of many things.

Here are three underrated factors that carried the bulk of the weight to creating Berkshire’s success. Oddly, I don’t think you’ll find them on any business school curriculum.

1. Trust

Charlie Munger on Trust

Buffett is famous for his hands-off management style. He lets the CEOs of the companies run their show; he only asks that they send him the money they can’t use.

Good people want to work with him and this is important because most of the people running Berkshire subsidiaries are already wealthy. They don’t have to come to work; they want to come to work. And that is a huge difference. The only time you can get away with a crappy bureaucracy and a culture of distrust is when people have to come to work.

Every now and then something happens at a Berkshire company that calls into question his near abdication of responsibility to a subsidiary. “If only he had been paying attention,” the critics chirp, “this wouldn’t have happened.” Those finger-waving critics are idiots. The alternative approaches are worse, not better.

There are many positives to the approach Buffett takes.

If Buffett closely managed each of his subsidiary CEOs to the point where most bosses manage their subordinates, they’d probably quit. If he sent out memos telling them all to use a new corporate HR system, they’d stop wanting to come to work. In fact Berkshire, a company with over 300,000 employees, has no HR department. If he peppered them with relentless emails from “headquarters” on some new policy, they’d … well how do you feel about all of this stuff?

With Berkshire, Buffett wanted to do things his way. He wanted to paint his own canvas. He didn’t want other people telling him to add a little more blue here and take away a little red there. Most people want to run their own show. And the best part? This system gets more out of people than micromanaging them.

Sure sometimes things go wrong, but for the most part the outcome is positively skewed. Things go wrong in other corporate cultures, they are not immune. When things go wrong in bureaucratic cultures, however, it’s nearly impossible to hold anyone accountable because no one is really responsible for anything. And it’s hard to hold people accountable when they are not responsible. It’s a seductive illusion to think that we can create a system where people can’t mess up. Buffett’s hands off approach makes it clear who is responsible for what. And this approach, not stock options,  creates a real ownership culture.

This system also frees up Buffett’s time. He doesn’t have to chase management details, read power-points, etc. He can sit and read and think — that means he does what he does best. And judging by the results, this has worked out well.

Hiring the right people and trusting them is incredibly underrated and yet nearly impossible to find in large established bureaucratic organizations. Yet as Buffett shows, it’s a much better approach. Trust is incredibly powerful.

2. (Quickly) Scramble Out of Your Mistakes

Warren Buffett on Mistakes

You know the old adage, when you find yourself in a hole the first thing to do is stop digging. That applies to business as well as life.

In the late 1960s Buffett acquired a department store, Hochschild-Kohn, through a company called Diversified Retailing, which later merged with Berkshire.

The people running the company were, in Buffett’s words, “first class.” Retailing, however, is a difficult industry, even with a first class management team. They were, in Buffett’s words, “running in quicksand.” Realizing this quickly after the ink dried on the contract, Berkshire “scrambled” out of it, selling Hochschild-Kohn as quickly as they could — 3 years.

Business schools don’t generally teach this either. What they teach and reinforce, in so many ways, is that you can be the hero. You can be the exception to the base rate.

But in life and business, you don’t need to be the hero. There are no points for difficulty, so as Munger alluded to, smart people will play where competition is weak.

You can have the best management team that money can buy and still fail big in retailing — a recent example being JC Penney.

Buffett learned quickly that, in his words, “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”

3. Remove Ignorance

Warren Buffett on See's Candies

Diversified Retailing also owned shares in a better business: Blue Chip Stamps, which provided supermarkets and other retailing outlets trading stamps to give their customers that could be exchanged for merchandise.

The contrast between running a good business and a poor one stuck with Munger and Buffett and they decided to pay up for a real quality business. On January 3, 1972 Blue Chip Stamps bought See’s Candies, a West Coast Manufacturer and retailer of boxed-chocolates. See’s is an extraordinary business.

As a great business, most people think that See’s main contribution to Berkshire was its overwhelming financial success. It wasn’t. According to Munger, See’s main contribution was “ignorance removal.”

“We were barely smart enough to buy it,“ he said. See’s taught them a powerful lesson, the value of strong brand names.

Without See’s they never would have purchased Coke shares in the 80s. And without Coke, Berkshire would be a lot less prosperous today as that investment has been one of their best.

“If there’s any secret we have, it’s ignorance removal. And the nice thing is we still have a lot of ignorance left to remove,” Munger said at the 2014 Shareholders meeting.

Removing ignorance is about continuously getting smarter. Avoiding stupidity is easier than seeking brilliance.

***

I don’t know why more people don’t copy these three underrated factors to Berkshire’s success.

To sum up:

1. Hire good people and trust them.
2. Quickly admit mistakes and scramble out of them.
3. Remove your ignorance by always learning.

This formula is simple but not easy.