Just the facts

Inverting with Charlie

Written by Adam Szypula

February 27, 2023

I’m not sure if it’s the bitter cold or the never-ending grey of this particularly long Toronto winter, but I’ve been in much more of a contemplative mood lately. While not the usual format of “Just the Facts”, I hope you’ll indulge me with this one.

After his passing in December, I made my holiday read Poor Charlie’s Almanack (which you can read for free here). Immediately after finishing, I bought a copy of Poor Richard’s Almanack (Ben Franklin’s collection of aphorisms), found myself revisiting my copy of Nassim Taleb’s Bed of Procrustes and got my hands on a copy of Lessons Learned by Satish Rai, the former Chief Investment Officer at OMERS.

What all these books have in common, in addition to all being wonderful reads I highly recommend, is an incredible ability to summarize complex topics into simple, memorable stories or one-liners. The world is an incredibly complex place, but I’ve always found that an author or speaker’s ability to quickly cut to the core of issues in a way that simultaneously makes sense and sticks with you long after you’ve finished reading is a sure sign of a powerful mind.

In the spirit of the above books, below are a few quotes from Poor Charlie that stood out to me, along with some other things that have been on my mind lately that I feel are worth thinking about. We’ll get back to regularly scheduled programming as the sunshine and warmer weather gradually return.

For some further reading, Warren Buffett included a very touching tribute to the “Architect” of Berkshire in his annual shareholder letter released on Saturday.

 

Charlie spoke a lot about inversion and thinking through problems both backwards and forwards. One of my first encounters with inversion was my exposure to a children's version of The Adventures of Sherlock Holmes when I was a young boy. Through his powers of deduction and logical reasoning, no mystery was too tough for his powerful mind. At the end of each tale I was often initially as bewildered and later impressed as his sidekick Dr. Watson. The below quote sums up the “how” behind Sherlock’s use of inversion to solve crimes that were anything but ordinary.

 

“How often have I said to you that when you have eliminated the impossible, whatever remains, however improbable, must be the truth?” 

– Sherlock Holmes, The Sign of Four (1890)

 

Audience question: How do you incorporate psychology in your investment decisions? I think it would be more than just picking products that will appeal to everybody, like Coke. After all, there are a lot of smart people out there who obviously think just the way you showed us today. So are you looking for failure in the thinking of other investors when you go about picking successful companies?

What makes investment hard, as I said at USC, is that it’s easy to see that some companies have better businesses than others. But the price of the stock goes up so high that all of a sudden, the question of which stock is the best to buy gets quite difficult. We’ve never eliminated the difficulty of that problem. And 98% of the time, our attitude toward the market is that we’re agnostics. We don’t know. Is GM valued properly vis-à-vis Ford? We don’t know.

We’re always looking for something where we think we have an insight that gives us a big statistical advantage. Sometimes it comes from psychology, but often it comes from something else. And we only find a few, maybe one or two a year. We have no system for having automatic good judgment on all investment decisions that can be made. Ours is a totally different system. We just look for no-brainer decisions. As Buffett and I say over and over again, we don’t leap seven-foot fences. Instead, we look for one-foot fences with big rewards on the other side. So we’ve succeeded by making the world easy for ourselves, not by solving hard problems.

Based on statistical analysis and insight?

Well, certainly when we do make a decision, we think that we have an insight advantage. And it’s true that some of the insight is statistical in nature. However, again, we find only a few of those. It doesn’t help us merely for favorable odds to exist. They have to be in a place where we can recognize them. So it takes a mispriced opportunity that we’re smart enough to recognize. And that combination doesn’t occur often. But it doesn’t have to. If you wait for the big opportunity and have the courage and vigor to grasp it firmly when it arrives, how many do you need? For example, take the top 10 business investments Berkshire Hathaway’s ever made. We would be very rich if we’d never done anything else—in two lifetimes.

So, once again, we don’t have any system for giving you perfect investment judgment on all subjects at all times. That would be ridiculous. I’m just trying to give you a method you can use to sift reality to obtain an occasional opportunity for rational reaction. If you take that method into something as competitive as common stock picking, you’re competing with many brilliant people. So even with our method, we only get a few opportunities. Fortunately, that happens to be enough.

– Poor Charlie’s Almanack, Talk 3: A Lesson on Elementary Worldly Wisdom as it Relates to Investment Management and Business (1996)

 

In the spirit of inversion, we can easily understand that a good approach to becoming wealthy is to avoid going broke. This is especially true for younger investors and those just getting started who often begin with a smaller capital base. For them in particular, diversification is a wonderful tool that helps you to reduce the impact of big mistakes that have the potential take you out of the game.

Why you should take your loss aversion tendency seriously:

Drawdown Gain Required
for Breakeven
-10% +11.11%
-15% +17.65%
-20% +25.00%
-25% +33.33%
-30% +42.86%
-40% +66.67%
-50% +100.00%
-60% +150.00%
-70% +233.33%
-80% +400.00%
-90% +900.00%



Everyone wishes they’d bought Amazon at $5 on the first day of 1998, since it’s now up 660x at $3,304. 

  • But who would have continued to hold when the stock hit $85 in 1999 – up 17x in less than two years? 
  • Who among those who held on would have been able to avoid panicking in 2001, as the price fell 93%, to $6? 
  • And who wouldn’t have sold by late 2015 when it hit $600 – up 100x from the 2001 low? Yet anyone who sold at $600 captured only the first 18% of the overall rise from that low.

This reminds me of the time I once visited Malibu with a friend and mentioned that the Rindge family is said to have bought the entire area – all 13,330 acres – in 1892 for $300,000, or $22.50 per acre. (It’s clearly worth many billions today.) My friend said, ‘I’d like to have bought all of Malibu for $300,000.’ My response was simple: ‘you would have sold it when it got to $600,000.’ 

– Howard Marks, Selling Out (2022)

 

“The pari-mutuel system is a system of betting on races in which the winners divide the total amount bet, after deducting management expenses, in proportion to the sums they have wagered individually.

Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position, etc., etc., is way more likely to win than a horse with a terrible record and extra weight and so on and so on. But if you look at the damn odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2. Then it’s not clear which is statistically the best bet using the mathematics of Fermat and Pascal. The prices have changed in such a way that it’s very hard to beat the system. And then the track is taking 17 percent off the top. So not only do you have to outwit all the other bettors but you’ve got to outwit them by such a big margin that, on average, you can afford to take 17 percent of your gross bets off the top and give it to the house before the rest of your money can be put to work. 

Given those mathematics, is it possible to beat the horses using only one’s intelligence? Intelligence should give some edge because lots of people who don’t know anything go out and bet lucky numbers and so forth. Therefore, somebody who really thinks about nothing but horse performance and is shrewd and mathematical could have a very considerable edge, in the absence of the frictional cost caused by the house take.”

– Poor Charlie’s Almanack, Talk Two: A Lesson on Elementary Worldly Wisdom as it Relates to Investment Management and Business (1994)

 

The thoughts of others

Were light and fleeting,

Of lovers' meeting

Or luck or fame.

Mine were of trouble,

And mine were steady;

So I was ready

When trouble came.

– A.E. Houseman, More Poems (1936)

 

“The man who does not read has no advantage over the man who cannot read”

– Mark Twain (1895)

Looking for a good book to read? If the non-fiction books mentioned above don’t suit your fancy, this is a great resource to get some wonderful fiction ideas: TED-Ed Books Series.

Source: 54% of Americans read a book this year - YouGov

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