Saturday, November 22, 2014

The American and Foreign Power Company

The American and Foreign Power Company was a publicly-traded utility that became a speculative favorite during the late 1920s. Benjamin Graham wrote about it in Security Analysis, using it as an example of the financial innovation and speculative excess that characterized that period.

AFPC issued a range of securities during the 1920s: bonds, common stock, two kinds of preferred stock, and "stock-option warrants." Stock-option warrants were essentially what we call warrants today: instruments created by the issuer that allowed investors to buy newly-issued stock at a certain price.

Graham wrote that warrants evolved from a niche instrument to a prominent security during the 1920s: they were originally attached to bonds and preferred stock as a way of giving them convertability into common stock. In this form, "the warrants themselves had little significance in relation to the company’s capitalization structure." But by the late '20s they had become widely-issued and widely-traded as discrete securities and were used as a popular way to speculate.

AFPC was at the vanguard of this change. In 1929 its common stock was worth $300 million, which by itself would have qualified the company as a major securities issuer, but its warrants were worth several times more:

The option warrants issued by a single company—American and Foreign Power Company—attained in 1929 an aggregate market value of more than a billion dollars, a figure exceeding our national debt in 1914.

AFPC's market capitalization was impressive not only compared to what preceded it but what followed:

It is an amazing fact that the option warrants created by one company, American and Foreign Power, reached an indicated market value in 1929 of over a billion dollars, a figure that exceeded the market value of all the railroad common stocks of the United States listed on the New York Stock Exchange in July 1932, less than three years later.

APFC itself wasn't immune to the Great Depression. At its nadir, the company "trembled on the brink of receivership, as shown by a price of only 15 1/4 for its 5% bonds."

Outside the Roaring Twenties

Graham used AFPC to illustrate financial trends during a specific period of time. In doing so, he gave only a small cross-section of the company's interesting history. Fortunately an article on, "The Rise and Fall of The American & Foreign Power Company," offers a more detailed description of the company and its experiences.

AFPC began life as part of a holding company called Electric Bond & Share, which itself began life as a subsidiary of Thomson-Houston, one of General Electric's predecessor companies.

Thomson-Houston sold electric equipment to utilities. In the late 1800s, when electrical transmission was still a recent invention, most utilities were small and thinly capitalized. Thomson-Houston provided them with a form of vendor financing, taking the utilities' debt and equity securities as partial payment for its equipment.

In 1905, it organized Electric Bond & Share as a subsidiary for the specific purpose of holding these securities. While EB&S was officially a utility holding company, in practice it was a financial intermediary, aggregating the securities of a number of tiny issuers into a holding company that could finance itself at better rates.

EB&S made its first foreign investment in 1917, buying electrical systems in two Panamanian cities. Investments in Guatemala, Brazil, and Cuba soon followed. In 1924, EB&S created AFPC as a subsidiary for holding these foreign investments. The following year, General Electric spun off EB&S and it became a separate publicly-traded company.

AFPC soon followed as a public company, and it pursued the same business model as EB&S, namely being a financial intermediary that operated as a utility. The United States ran large trade surpluses with the rest of the world during the 1920s, and AFPC, as a major international investor, helped to recycle those surpluses.

AFPC stepped up the pace of its investments as a public company, buying utilities in Argentina, Brazil, Chile, China, Costa Rica, Ecuador, and India. It also bought minority stakes in utilities in Canada, Italy, Japan and elsewhere. In 1929 it acquired Shanghai's municipal utility, making what at the time was the single largest American investment in China.

The Depression ensued, and AFPC nearly went bankrupt. It suspended dividends on its preferred stock in 1932 and didn't begin to pay them again until 1939. The unpaid dividends that accumulated during the interim were significant relative to AFPC's (admittedly diminished) market capitalization.

AFPC's problems during the Depression were political as well as financial. Mexico and Cuba forced it to reduce electricity prices, and many other countries prevented it from repatriating its subsidiaries' profits. It had to write off the Shanghai utility during World War II, and Argentina nationalized several of its utilities.

The company's fortunes seemed to improve during the 1950s, but that was a false dawn. Fidel Castro confiscated AFPC's Cuban properties in 1960, at which time they were its largest holdings. Brazil also expropriated one of its properties, and Mexico forced it to sell its utilities to the Mexican government at a cut-rate price. Exacerbating this theft, the government then refused to let AFPC repatriate the sale's proceeds.

AFPC responded to these misfortunes by gradually liquidating. It sold its foreign utilities throughout the 1960s and early 1970s and merged with Boise Cascade. The last remaining utility, a property in Ecuador, was sold in 1976.

Emerging markets

AFPC illustrates a big-- and in my opinion, under-appreciated-- risk of investing in emerging markets. Namely, that many of these countries have an opportunistic and predatory attitude toward foreign investors. In a period of globalization when foreign direct investment is increasing, they'll respect foreign investors' property rights because they know that doing so is necessary to receive foreign investment and its attendant benefits.

But if a depression or financial crisis shuts off the foreign-investment spigot, these countries will see no further reason to respect foreigners' rights. If their investments aren't confiscated, they'll be subject to actions that drastically limit their return on investment.

As the article notes, "[F]oreign adventures don't always work out as anticipated. In addition to the normal risks of business, including fluctuating exchange rates, there are unforeseen political risks that can seriously affect rates of return on investment."

Wednesday, November 12, 2014

Is industry consolidation overrated?

Recently, an investor I follow on Twitter wrote: "Most overplayed investment theme: bad industries consolidating leading to rational competition and price increases."

My sense is that he's right: industry consolidation is a precursor to oligopolistic pricing, but it's not enough by itself. In industries with minimal barriers to entry, the benefits of consolidation are usually temporary for a variety of reasons:

• If the industry is cyclical and has long lead times between capital investment and returns, it's easy for players to misjudge the cycle and overbuild regardless of how consolidated the industry is.

• Often the consolidation happens during an economic boom and merely amplifies pricing power that already existed. Once the boom ends, pricing discipline breaks down.

• If the industry consolidation is financed with debt, the newly-consolidated players may overproduce in order to generate the cash flow they need to meet their debt obligations.

• Price increases attract new entrants, and these entrants have no institutional memory of the hard times that would restrain them from overproducing.

There are also some circumstances in which consolidation actually worsens industry dynamics. In 2011, the coal-mining industry consolidated when coal prices were near their peak, and as Credit Bubble Stocks writes:

The mergers resulted in a funny kind of adverse selection where the most bullish managements with the worst historical sense and facility at market timing ended up controlling capital allocation for the whole industry.

Sometimes consolidation gives an industry greater financial resources: economies of scale, lower borrowing costs, etc. If it gains these resources but lacks pricing discipline, then consolidation really just gives the industry players more rope with which to hang themselves.

Examples of "bad oligopolies"

Iron ore is the quintessential bad oligopoly. A handful of companies dominate iron-ore mining, but it has minimal pricing and cap-ex discipline, there were a bunch of aggressive new entrants during the boom years, and the major players recently started a price war.

Several prominent hedge funds have invested in Greek bank stocks. Their belief is that the Greek banking system is poised to earn high returns on equity because it's consolidated into four players.  Vienna Capitalist has written an excellent post critiquing this assumption:

In real life it is difficult to count the “true” number of players. You could have a lot of players in one sector, some of which occupy a niche in that market allowing them to still earn high ROEs. Alternatively, you could have only one or two players but competitive prices and average profitability. How? Well, they might be so-called “Contestable Markets” where the threat of another player entering the market keeps prices down. Airline routes are a classic example for the latter. 

According to the Austrian School, a competitive market CANNOT be meaningfully defined by the number of buyers/sellers, as the classic perfect competition model suggests. What MATTERS instead is whether there is free entry/exit into a particular market. As value investors only know too well: without barriers to entry a business is poised to earn mediocre returns, no matter how many players…

The bull case for Greek bank stocks states that all the other European countries with consolidated banking systems have high ROEs. Vienna points out that those countries have all experienced large, secular increases in debt as a percentage of GDP, and this debt tailwind may be the real reason for their high returns. They're consolidated and they earn high ROEs, but the former didn't necessarily cause the latter.

Airlines and HDDs

In the past few years, the hard disk drive industry has consolidated into three players and the American airline industry has consolidated into four major players. Both industries are earning large profits right now, but I wouldn't be surprised to see either of them revert to being a bad oligopoly. (Note: I'm far from being an expert on these industries, so my opinions could be partly or totally wrong.)

My concern with airlines is that while the industry has consolidated and arguably become more rational in the United States, it seems to be much less rational elsewhere. Reuters has an article (hat tip to Jake Freifeld) describing how foreign budget airlines are ordering lots of planes they don't need so they can get into the leasing business. If these would-be lessors misjudge demand and create a glut of aircraft, that could make it cheaper for entrants in the American market to acquire new planes. It could also reduce the value of the assets the American incumbents use to secure loans.

The risk with hard disk drives is well-known: flash memory is taking share. The price difference between flash and HDDs seems to be decreasing both relatively and absolutely. I think absolute difference is the important one: if there's a $350 difference between similar-sized drives, few people will be interested in flash. But if that falls to only $30 or $40, flash may actually be the better deal considering speed and power consumption.

I switched to a flash drive a year ago and noticed a big improvement in speed. Notably, my old hard drive was 500 gigabytes but I was using very little of that, so I only needed to buy a 120-gigabyte flash drive. That narrowed the effective price difference between HDDs and flash.

Over the years I've read various articles about flash memory shortages, so I assume there are supply constraints that prevent flash from displacing HDDs quickly. I don't find that particularly reassuring, though. Aldi and Lidl are relatively small upstarts in the British supermarket industry, yet they seem to have seriously damaged the incumbents' profitability. That's a glib comparison-- there are big differences between supermarkets and HDDs-- nonetheless, disruptive competitors often have an outsized effect on pricing and margins.

Tuesday, November 11, 2014

Kill your investing gurus: Jim Rogers

Jim Rogers is another investing guru who's become famous as much for his personality as his ideas.

Rogers worked for George Soros's hedge fund during its early years, and after leaving Soros in 1980, he took two years-long around-the-world car trips. Each trip spawned a travelogue, Investment Biker for the first and Adventure Capitalist for the second, in which Rogers offers readers a Master of the Universe's view of foreign cultures. According to The New York Times, "One problem is that Mr. Rogers's writing is unexceptional and pedestrian. Another is that he is overimpressed by the depth of his insights."

While the books don't show him developing much curiosity about the places he visited, they do show him developing his public persona: whereas he was once merely a rich investor, today he's Jimmy Rogers, the straight-talking, globetrotting adventurer with a pink bow tie.

An Amazon reviewer for Rogers's more recent book Hot Commodities writes that "Rogers goes for a funny and folksy Warren Buffet style but can't quite pull it off," which is a sharp observation. While Buffett the showman has arguably eclipsed Buffett the investor, the latter remains an accomplished figure. With Rogers, there's no brilliant investor for the showman to eclipse. His public predictions have been very wrong.

It may seem unfair to criticize him for that, since even the best investors often make bad predictions and bad investments. Soros has whiffed his share of predictions over the years, and that hasn't stopped him from being a phenomenon. But the problems with Rogers's investing strategy go beyond a handful of bad calls.

First, Rogers practices what one might call the "stream of anecdotes" style of macro investing. The reasoning behind his investments is mostly ad hoc: in an interview he might say he's bearish on the US because its government is running large deficits, then he'll say he's bullish on Bolivia because he visited the country recently and its cellphone reception was better than he'd expected. (This was his actual rationale for investing in Bolivia in Adventure Capitalist.) While he has strong opinions about everything, those opinions don't amount to a coherent system in which different kinds of information are weighted according to their importance.

Second, two of his most vocal recommendations have been to buy commodities and short Treasuries, and I think his logic is flawed on both counts.


Rogers has been bearish on the US dollar and US government debt for at least the past fifteen years, and probably longer, although the rationale for his bearishness has changed over time. For many years, trade deficits and fiscal irresponsibility were going to generate a financial crisis. More recently, he's claimed that quantitative easing will generate an inflationary crisis.

Here's his opinion from 2003:
The dollar is not just in decline; it’s a mess. If something isn’t done soon, I believe the dollar could lose its status as the world’s reserve currency and medium of exchange, something that would lead to a huge decline in the standard of living for U.S. citizens like nothing we’ve seen in nearly a century.

Here's last year's opinion:
All that money printing has Rogers bearish on U.S. Treasury debt. He said he's shorting government bonds and that if it's indeed the end of the 30-year bond bull market, those shorts will pay off. In particularly he said it's time to short long-dated U.S. government debt.

Notably, Rogers also said it was time to short long-dated U.S. government debt in 2005, when Steven Drobny interviewed him for Inside the House of Money.

Rogers's arguments have an intuitive appeal: everyone knows that large trade deficits and government deficits can't go on forever, and there's widespread skepticism of the Federal Reserve and its actions. These are valid concerns, so I don't mean to dismiss them blithely, but I think the financial crisis that Rogers expects will be neither as immediate nor as inflationary as he suggests.

First, having a reserve currency makes persistent deficits not only possible but likely: in order to accumulate reserves, other countries have to run current-account surpluses with the country that has the reserve currency. Its deficits are a byproduct of reserve currency status, not necessarily a sign that the status is about to end.

And while people tend to think of the United States's deficits as the result of Americans living beyond their means, to a great extent the arrow of causality flies the other way. China and many other countries try to grow by suppressing domestic consumption and subsidizing export-oriented industries, which produces trade surpluses with the US.

Second, quantitative easing isn't synonymous with money printing. (Note: that isn't an endorsement of QE.)

Third, in countries that finance themselves by borrowing in their own currency, there's a tendency for high total debt levels to suppress interest rates. If rates rise, the debt load becomes unmanageable, which pushes the economy into a recession and renews downward pressure on rates. Credit Bubble Stocks has called this idea the self-limiting hypothesis. We've seen this play out in Japan, and I think it will play out in the United States too.


In 2004, Rogers published Hot Commodities, which advocates buying physical commodities as investments. The book endorses the idea of a commodity supercycle, stating that "stocks and commodities have alternated leadership in regular cycles averaging 18 years."

I'm not familiar enough with oil or farm commodities to generalize about their performance, but I've traded metals and mining stocks for a while, and my experiences with them make me very skeptical of the commodity supercycle idea.

There's a subscription site called The Chart Store that offers a wealth of historical charts. For widely-used metals, it has charts going back to late 1800s. Most of these charts show no trend in real prices. The price of aluminum has fallen significantly over the past century, but copper, lead, zinc, and nickel have shown little real change over time. Despite that, they've been quite volatile: metals price cycles tend to be the same length as overall economic cycle, and sometimes they're even shorter.

The mix of volatility and mean reversion means that the typical metal trades in a wide range. For instance, copper has normally traded between $1 and $3.50 in today's prices. On a few occasions, metals have overshot or undershot their range as a group. During the Great Depression, prices plunged far below the low end of their range. The same thing happened in the late 1990s, when many metals approached their Depression-era prices. By contrast, in 2006-07 prices broke above the range's high end.

So commodity prices started the 2000s near record low levels, and less than a decade later they were making record highs. Prima facie this looks like evidence of a supercycle, but that kind of price gain had actually never happened before. It was an unprecedented move rather than a manifestation of a price cycle that commodities repeatedly, inevitably go through. Moreover, there are specific identifiable reasons for both the record lows and record highs, so we don't need to invent the idea of a supercycle to explain the move.

In the 1990s, there was a series of emerging markets debt crises, the most prominent of which were the Tequila Crisis, the Asian Financial Crisis, and Russia's 1998 default and devaluation. The common features of these crises were that they 1) fostered a need for foreign currency, since the crises were generally the result of external debts and 2) crushed the local currency, making commodity production much cheaper. Essentially, the crises provided both a carrot (lower production costs) and a stick (the need for hard currency) for flooding the commodities markets.

During the same period Russia was recovering from the Soviet Union's breakup, and its legal regime was weak and unstable. Most of the people who seized control of newly-privatized companies in 1990s Russia did so through dubious means, and they realized that in the same climate their companies could just as easily be seized from them. This lack of ownership security gave them an incentive to maximize short-term profits. For mining and oil companies, that meant producing as much as they could as quickly as they could. Russia is a major commodity producer, so this dynamic led it to dump large amounts of commodities on the world market throughout the '90s and particularly after 1998.

By 1999, metals were near Great Depression levels. There was a bounce in 2000, but prices fell again in 2001 and 2002 and retested the lows. Yet five years later, many were at record highs.

The obvious cause of this price rise is China's (mal)investment spree and the associated demand for commodities. But financial speculation also played a role, as Frank Veneroso argued in his 2007 World Bank presentation.

Commodities prices surged in the 1970s, and this figures prominently in the commodity supercycle story. But Veneroso points out that the '70s aren't comparable to the more recent commodity price surge because inflation was so much higher in the '70s. To a large extent the commodity price gains during that period merely kept pace with inflation, with the real gains staying within historical norms. Commodities had similar nominal price increases during the 1970s and the 2000s, but the 2000s witnessed much larger real increases.

Veneroso also points out that the rise in commodity prices during the 2000s coincided with explosive growth in both the trading volume and outstanding notional value of commodity derivatives. Some mining executives have also commented on this speculation:

"There's a fair amount of financial money in commodities today," [Phelps Dodge CEO Steven Whisler said in 2006]. "Is that creating some froth? Yes. How much, I don't think anybody knows."

Despite price rises that would normally be associated with shortages, Veneroso claims, companies like the copper fabricator Nexans had no trouble obtaining metals, suggesting that financial demand rather than real demand was fueling the rise.

A few years ago, Howard Schultz from Starbucks made the same claim about speculation in the coffee market. According to a 2010 Reuters article:

"Starbucks Corp Chief Executive Officer Howard Schultz decried the commodity market on Wednesday, saying financial speculators, not product shortages, were to blame for recent price spikes in coffee."

More recently, there are reports of large amounts of copper being hoarded at Chinese port warehouses.

Veneroso devotes much of his presentation to refuting the bull arguments for commodities. He claims that these arguments, while superficially plausible, are really just the kind of new era arguments that are used to justify every bubble.

Whither commodities?

I think the mining industry is heading for a perfect storm in which: 1) Chinese demand will fall as they stop building empty cities, 2) there will be a supply glut as the industry finishes bringing enormous amounts of new capacity online, and 3) financial demand will disappear and metals stocks that have been hoarded will flood the market as prices fall. There will be a huge sell-off that pushes prices below the marginal cost of production and keeps them there for years, and that will put the commodity supercycle theory to rest.

Most commodities have fallen this year as the dollar has rallied, some significantly, and that's already led to a lot of skepticism about the commodity supercycle. So to many readers, the idea that commodities are mean-reverting and have a terrible outlook will be familiar if not obvious. Nonetheless it's worth repeating, because while commodities are down year-to-date, they're at risk of falling much more over the next few years. Ignore short men who tell tall tales about commodities: they are not a sound investment.

Sunday, November 9, 2014

Background on Wesray, the leveraged buyout pioneer

Wesray was a prominent private equity firm during the 1980s. It took its name from its two founders, William E. Simon and Ray Chambers. Prior to founding Wesray, Simon had a long career on Wall Street and in the federal government, culminating in his service as Treasury Secretary for several years under Richard Nixon and Gerald Ford. Chambers was fifteen years younger than Simon and had a more modest career: he was originally a tax accountant but became an early practitioner of the leveraged buyout during the 1970s, buying and selling several small companies.

Simon and Chambers met in 1980 through a mutual acquaintance, and Simon instantly recognized the potential of leveraged buyouts. He and Chambers became ad-hoc partners, teaming up to acquire a small business that supplied oysters to restaurants and another small business that rented musical instruments. A year later they became business partners on a more permanent basis, founding Wesray in September 1981.

Wesray's first major deal was its 1982 acquisition of Gibson Greetings, a greeting card printer, from RCA. The deal had an element of luck: Simon and Chambers had originally intended to buy a mobile communications company that RCA owned called Tactec Systems, and they ended up buying both Tactec and Gibson.

The Gibson acquisition was a phenomenal success. Wesray paid $81 million for the company even though its book value was $87 million, and most of that book value was tangible assets that Wesray could borrow against, which meant that it had to put up only $1mm of the purchase price as equity, with the other $80mm being borrowed money.

The acquisition coincided with the beginning of an enormous bull market, and Wesray was able to take Gibson Greetings public less than 18 months later at a $290mm valuation. Simon and Chambers each contributed a third of the equity investment, which meant that they each made $70mm on a $330k investment.

While Gibson made their reputation, it was far from being their only profitable deal. Wesray purchased Avis Car Rental in 1986 and, as with Gibson, flipped it less than two years later for a huge profit.

Why was Wesray successful?

Simon's fame undeniably contributed to Wesray's success. His reputation as a political and financial leader gave him and Chambers access to deals they probably wouldn't have received otherwise.

Leverage and timing also played a role. Wesray borrowed 99% of the purchase price of Gibson Greetings, and it used similarly high leverage for its other leveraged buyouts. One article estimates that Wesray borrowed 98% of the money it used on its average deal. In the bull market of the 1980s, this gave Simon and Chambers a powerful tailwind.

But it would unfair to claim that their success was merely a result of luck, leverage, and fame. They also had a thoughtful strategy that allowed them to make investments with favorable risk/reward ratios. With Gibson Greetings, and again with many of their later deals, Simon and Chambers invested in companies that had both the potential for growth and valuable assets that they could use to secure loans. Essentially, the asset value allowed them to borrow money at lower rates and with less risk than they would otherwise have to take.

They also demonstrated a sense of perspective. Simon wanted to pull back in the mid-1980s as valuations rose and the competition for leveraged buyouts increased. He recognized, either explicitly or intuitively, that Wesray's investment strategy worked best when companies traded near their asset value and became less viable as prices rose. He also cared about his fiduciary duty and worried about Wesray's other investors losing money. In this regard he was the opposite of Henry Kravis, who was always eager to do more and bigger deals irrespective of valuation.


Pubic information about Wesray is scant, but I was able to dig up a few things. A 1986 article from Fortune describes the firm's history and investment strategy. Another article, from Cincinnati Magazine, profiles Simon. (Gibson Greetings had its headquarters in Cincinnati.) Simon's autobiography, A Time for Reflection, also discusses Wesray, although it emphasizes his conservative political philosophy more than his career as a buyout pioneer.

On Quora, someone asked "Why was the 1981 Gibson Greeting Cards LBO such a home run?" and "Ray Chambers" responded. I can't guarantee that this is really Chambers, but it has the ring of truth:

There were a number of factors that attracted us to purchase Gibson.  We had the opportunity to acquire the company at a discount from book value.  The management of Gibson, led by Tom Cooney and LR Jalenak, were inspired to turn in record performances because for the first time in their careers they had the chance to own a meaningful part of the equity of their company.  Because of the purchase price being a discount from book value, the lenders were willing to look to the liquidating value of the assets more than the historic cash flow as security for their loans.

When the Gibson transaction was completed in January, 1982, the prime lending rate of interest was 21 percent and economists were predicting it would go to 30 percent.  Thankfully, during 1982 it went the other way and Gibson's management performed splendidly.  The net profit for the year 1982 after interest on the significant amount of debt was the same as the previous year when the company had no debt.  In early 1983, the IPO window opened for a short time and Gibson was able to capitalize on that opportunity in the market.

Saturday, November 8, 2014

Kill your investing gurus: Charlie Munger

In Kill your investing gurus, I offered a skeptical opinion of Warren Buffett and his public persona. That post's comments became a discussion of his business partner, Charles Munger, which is appropriate because much of the criticism I directed at Buffett can also be directed at his partner.

I've never taken Munger or his persona seriously, for several reasons:

1. His ideas, while generally correct, aren't novel or profound. Most of his "worldly wisdom" is just common sense. I think people give Munger's ideas more credit than they deserve because of the halo effect: he's a billionaire, and he's associated with an even richer billionaire, so people assume his ideas must be important.

2. I disagree with his philosophy of investing and some of his advice on how to invest successfully. There's a lot of room for debate about the nature of investing, so I won't claim that he's wrong and I'm right, but this post will offer a few counterpoints to his ideas.

3. I find him arrogant, although I'm sure many people will find this article arrogant too. De gustibus.

Munger's ideas

Kill your investing gurus claimed that "many investment gurus are famous less for their ideas than for their personalities. They are famous for being themselves." I wrote that about Buffett, but it's even more true of Munger: he expresses his opinions much more bluntly than almost anyone else, and that appeals to a lot of people.

But when Munger's ideas are separated from his earthy manner and considered on their own merits, they become much less impressive. They're really just rehashes of other people's ideas or rehashes of common sense.

For example, Munger has argued that:

• We're creatures of habit, so having good habits is a prerequisite of success.
• Being articulate and persuasive isn't the same thing as being right.
• Envy and the desire for revenge can lead to irrational decisions with poor outcomes.
• Drugs are bad.

These things are all true, and understanding them could benefit a novice investor or someone who lacks common sense, but they're obvious to experienced investors. The obvious doesn't become profound just because a billionaire says it.

Munger's most famous idea is probably his "latticework of mental models." Poor Charlie's Almanack, which is a collection of his speeches and quotes, describes it as follows:

[Munger] calls the tools he uses [to evaluate investments] 'Multiple Mental Models.' They borrow from and neatly stitch together the analytical tools, methods, and formulas from such traditional disciplines as history, psychology, physiology, mathematics, engineering, biology, physics, chemistry, statistics, economics, and so on...

When properly collected and organized, his Multiple Mental Models (about one hundred in number, he estimates) provide a context or 'latticework' that leads to remarkable insights as to the purpose and nature of life.

The thing is, this is nothing new. "Mental models" are merely ideas or rules of thumb. The necessity of placing them in a "latticework" isn't new either: everyone knows that discretion is important in applying ideas. The power of compound interest and the law of large numbers could both be considered mental models, but they're obviously relevant to different situations.

Like Nicholas Nassim Taleb, Munger coins new terms for old ideas and claims them as original insights. Apart from his mental models, there's his "elementary world wisdom," which is really just common sense, his "availability-misweighing tendency," formerly known as the streetlight effect, and his "liking/loving tendency" formerly known as the halo effect. These ideas were fine in their original forms and didn't need him to re-brand them.

Reading widely is overrated...

The excerpt from Poor Charlie's Almanack about Munger's mental models makes it clear that he thinks that reading widely is important. Elsewhere, Almanack states that:

[Munger's] encyclopedic knowledge allows him to cite references from classical orators to eighteenth- and nineteenth-century European literati to pop culture icons of the moment. Where else would you find Demosthenes and Cicero juxtaposed against Johnny Carson or today's investment managers set against Nietzsche, Galileo, and a "one-legged man in an ass-kicking contest"?

I agree that knowledge is valuable: psychology plays a prominent role in financial markets, and human psychology changes very slowly if it changes it all, so reading about the financial markets of the past can help one understand the present. But reading widely is less important than being able to determine what information is meaningful and what isn't. Professional investors are constantly inundated with ideas and data, and most of those data are irrelevant, misleading, or trivial.

I'm skeptical that reading about "history, psychology, physiology, mathematics, engineering, biology, physics, chemistry, statistics, economics" makes people better investors. Apart from the psychological aspect of finance, I think that Wall Street is a discrete system with relatively few parallels to other fields. For example, famous economists are notoriously bad at making financial predictions even though economics is related to finance. By contrast, many of the most talented investors seem to be idiot savants: e.g. George Soros is a brilliant trader with an intutive understanding of the market, but no one takes his philosophy seriously.

Reading about biology or engineering might be useful in helping investors understand how systems withstand stress and exogenous shocks, but that's just one limited benefit. Reading extensively about art history or the human body or whatever won't make one a better stockpicker. is acting rationally

Munger has talked and written a lot about the importance of acting rationally. I think this is just self-aggrandizement. When people give exhortations to act rationally, it's usually a way for them to say, "I am a superior thinker."

The Wall Street Journal has a Munger quote that demonstrates the absurdity of the "act rationally" rhetoric:

I don’t have the slightest interest in gold. I like understanding what works and what doesn’t in human systems. To me that’s not optional; that’s a moral obligation. If you’re capable of understanding the world, you have a moral obligation to become rational. And I don’t see how you become rational hoarding gold. Even if it works, you’re a jerk.

First, when one has to react to other people's irrationality, the rational response isn't always obvious. Panics, financial crises, and hyperinflations all involve people doing things that are beneficial individually but worsen the overall problem. When other people's irrational panic can damage you financially, it often makes sense to panic first, even if doing so isn't strictly rational. If Munger were really interested in understanding what works and what doesn't in human systems, he would respect this dynamic.

Second, I think it's important to separate morality from investing as much as possible. I don't mean that people should invest in companies that violate their ethical principles, but they should avoid seeing moral issues where they don't exist. Imagine a farsighted investor in Germany after World War One: he sees that crushing reparations payments will lead to hyperinflation, so he invests in gold. That lets him preserve his family's wealth while countless other people lose their life savings, but according to Munger he's a jerk who shirked his moral duty.

Munger's arrogance

Apart from philosophical disagreements, I find Munger's arrogance offputting. That doesn't automatically invalidate his ideas, but it takes a lot of chutzpah to claim, as Munger did, that "Ben Graham had a lot to learn as an investor."

Munger criticized Graham for practicing a very limited strategy of buying only net-nets, but that's a oversimplification of Graham's ideas. As Oddball stocks recently wrote, "Sprinkled throughout Security Analysis are recommendations that investors look for higher quality companies over lower quality companies.  At one point [Graham] even recommended that investors simply buy the best company in each industry when the entire industry hit its low point in the business cycle."

Munger also says that the Great Depression stunted Graham as an investor by making him overly conservative. He implies that Munger-Buffett strategy of buying quality GARP stocks is superior to Graham's strategy of buying cheaper, but lower-quality, companies with a margin of safety.

I think the issue is less clear-cut and that which kind of investment performs better is largely a function of the economic environment. Buying quality businesses with long-term growth prospects has been a phenomenal strategy for Munger and Buffett, but their careers have coincided with the longest bull market in history. Graham's approach may offer fewer rewards in an extended bull market, but it's arguably more robust during bear markets and periods of stagnation. It's a solid all-weather strategy.

Regardless of which is better, it's crazy to say that Graham "had a lot to learn." I've read several books by or about Graham, and the salient feature of his writing is the breadth of knowledge it displays. He wrote thoughtfully on numerous topics: valuation, financial history, competitive advantage, agent-principal conflicts, and many more. To Munger's credit, he acknowledges that Graham was "one of the only intellectuals — probably the only intellectual — in the investing business at the time."

The book I quoted from earlier, Poor Charlie's Almanack, is another example of Munger's hubris. It's primarily a compilation of his quotes and speeches, but it also includes a biography hagiography of Munger along with numerous blurbs from his friends testifying to his brilliance. Essentially it's a vanity project that Munger, to give a false appearance of modesty, couldn't compile himself.

The title is a takeoff of Benjamin Franklin's Poor Richard's Almanack, and the book frequently compares Munger to Franklin. Among other things, Peter Kaufman, the book's editor, calls Munger "this generation's answer to Ben Franklin" with no trace of irony, and the beginning of chapter two superimposes a picture of Munger on Franklin's engraved portrait.

Despite the constant comparisons, I can't imagine Franklin indulging in this kind of self-aggrandizement. As Peter Lynch astutely wrote, "In my experience the next of something almost never is—on Broadway, the best-seller list, the National Basketball Association, or Wall Street." Or the next Ben Franklin.