Twenty Years of Owning Berkshire Hathaway

“Most people overestimate what they can do in one year and underestimate what they can do in ten years.”

— Bill Gates

Berkshire Textile Mill – 1960s

Every person will have a different definition of what counts as “the long run”, but it is probably fair to say that a decade is thought of as a long time by almost everyone. That is enough time to bring about major changes in life, whether positive or negative. And twenty years seems like half a lifetime ago for anyone under fifty. The daily and weekly vicissitudes of life come and go, good luck and bad luck influences months and years, but over a sufficiently long period of time, most of us reap what we sow. This seems broadly applicable in life but especially true in the world of investing. Over two decades, your results in business are not likely to deviate too far from what your results deserve to be.

When it comes to selecting securities for investment, few people think of the decision as equivalent to entering into a business partnership, as one might when purchasing an apartment building, farm, or gas station with partners. The reason is that securities seem abstract and remote. Investors no longer even receive physical share certificates. Securities might seem like nothing more than numbers on a brokerage statement or flashing across a computer screen. Prices also change on a daily basis adding to the casino-like nature of the experience. The constant onslaught of prices makes people regard securities as transitory experiences. You would never wake up one morning, read about the Federal Reserve’s latest interest rate decision, the latest status of China trade talks, or the progression of the coronavirus epidemic and suddenly decide to sell an apartment building that you own that afternoon. But you might very well log into your brokerage account and sell some stocks.

Of course, share ownership represents equity in a real business, albeit one that the investor is usually not personally involved with or in a position to influence. The fact that a business is publicly traded merely makes it easier to take an ownership interest. It does not change the underlying nature of what you are doing: You are buying a business.

Exactly twenty years ago, I made a decision to purchase my first shares of Berkshire Hathaway. I still hold those shares today along with many subsequent purchases over the years. Since 2009, I have written about the company frequently on this website. But the story of how my first purchase came about started several years before my decision in February 2000.

In the summer of 1995, I was a new college graduate with a degree in finance and, like many young people attracted to investing, I had excessive self-confidence brought about by thinking that mastery of academic finance would automatically translate into investing success. When I read Roger Lowenstein’s new biography of Warren Buffett, The Making of an American Capitalist, I was instantly captivated by the story of how Buffett built his empire. Buffett only appeared one time in my senior year finance textbook yet it seemed obvious that his philosophy deserved far more attention. I quickly read through Buffett’s letters to shareholders and remember thinking that they provided more value than my college degree.

Of course, I looked up Berkshire stock but at around $25,000 per share, one share of stock exceeded my accumulated net worth at the time which was saved up from childhood paper routes and part time jobs in high school and college. Berkshire was not investable for me at that time. Roughly a year later, Berkshire issued Class B shares in response to promoters of “unit trusts” that sought to own Berkshire shares and sell small fractions to individuals, for a hefty fee, of course.

When Buffett announced the recapitalization plans for Berkshire in the 1995 annual letter, released in early 1996, he stated that he and Charlie Munger did not believe that Berkshire, trading at around $36,000 at the time, was undervalued. I took him at his word at the time and did not buy any shares.

Over the next several years, I continued to watch Berkshire shares which more than doubled by mid-1998 before the company went out of favor toward the tail end of the dot-com technology mania that characterized the period around the turn of the century. Warren Buffett was getting close to seventy and repeatedly stated that he did not understand technology and was sitting out the tech stock craze. Berkshire also was having trouble with General Re, a recent acquisition, which was posting losses. Investors were abandoning the stock which, by early 2000, was back at levels not seen since 1997.

My initial purchases proved to be well-timed and this was no doubt due to luck. My initial class B shares were purchased on February 15, 2000 at $1,530 ($30.60 split-adjusted) and then I somehow came close to nailing the bottom on March 9, 2000 at $1,390 ($27.80 split-adjusted). The stock quickly ascended as the dot com boom imploded and Buffett signaled that Berkshire might be cheap enough to consider repurchasing shares. Value stocks began a multi-year ascendency.

The overall story of Berkshire is well known and has been discussed on this website many times, so I will not provide a recap of what has happened over the past two decades other than to say that Buffett defied all skeptics and somehow continued to run the company into his late 80s, found ways to compound intrinsic value through internal reinvestment, acquisitions, and securities purchases, and was able to avoid distributing any capital to shareholders. This internal compounding machine has chugged along for two decades despite widespread belief that Buffett would have to return capital or would soon retire.

My personal story is that I continued buying Berkshire shares over the next several years as I saved a large part of my income. Although I have purchased (and sold) shares of Berkshire over the past decade, I still hold all of the shares I purchased from 2000 to 2005. The purchases were made at various times, some well-timed while others less so, but in aggregate all have performed strongly. In aggregate, each dollar that I invested in Berkshire over the timespan from early 2000 to late 2005 has become nearly five dollars today, all while deferring all taxes until the shares are eventually sold.

The table below shows the dates of my purchases between 2000 and 2005, all of which I still hold today, along with the split-adjusted purchase price, the total return, and annualized return. What’s particularly interesting is that the annualized rates of return are all fairly close together despite some very different initial valuations at the time of my purchase. The price-to-book value, based on last reported book value, ranged from 1.1x book for my March 9, 2000 purchase to a very high 1.8x book for my August 14, 2001 purchase. In the very long run, returns are correlated to business performance rather than the transitory advantage or disadvantage arising from valuation at the time of purchase.

Returns based on closing price of $227.33 on 2/11/2020

Warren Buffett and Charlie Munger purposely created, over a period of many decades, a culture in which shareholders are regarded as business partners rather than merely faceless providers of capital. This attitude has attracted long-term shareholders, some of whom have owned Berkshire for far longer than two decades. In the very long run, associating with talented individuals of high integrity and good business sense will generate satisfactory results.

As Charlie Munger likes to say, Berkshire shareholders sometimes resemble “cult members”, but if you are going to be a member of a cult, you could easily choose a worse one to belong to. The fact is that Berkshire has attracted a shareholder base with an unusually long-term oriented mindset and this culture is likely to outlast Buffett and Munger’s involvement in the business. It has definitely been both a profitable partnership and an excellent education.

Disclosure: Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway.

In Praise of Irrationality

“The trouble with market research is that people don’t think what they feel, they don’t say what they think, and they don’t do what they say.”

— David Ogilvy

Beautiful equations are seductive. Mathematics brings logic and structure to a complicated world and allows us to make sense of things that once seemed inexplicable. In hard sciences such as physics, mathematics represents verifiable truths in the physical world such as the rules of planetary motion. But we need to know the limits of mathematics to avoid being seduced into false precision and delusional conclusions in areas where equations fail to model reality.

Given the success of mathematics as a tool to model many aspects of the physical world, it is not surprising that academics in other fields would attempt to bring mathematical rigor and credibility to their areas of expertise. However, when it comes to social sciences such as economics, we enter into the realm of human behavior which has yet to be reduced to a set of beautiful equations. Human decision making is amazingly complicated, messy, unpredictable, and often seems highly irrational. It is simply not possible to represent human decision making as precisely as we can represent planetary motion or nuclear reactions, but that has not stopped economists from trying.

Rory Sutherland’s book, Alchemy, is a highly entertaining look at the pitfalls that await those who seek to reduce human behavior to a set of equations. Sutherland’s background as Vice Chairman of Ogilvy has put him in a great position to observe the seemingly irrational aspects of consumer behavior. However, his observations extend well beyond tips for marketers and touches on important aspects of human psychology and decision making. As Nassim Nicholas Taleb has pointed out, any book worth reading cannot be “summarized”, and that holds true in the case of Alchemy. The book reads like a series of short essays arranged into various themes, but all center on Sutherland’s opening quip that “the human mind does not run on logic any more than a horse runs on petrol.” However, it would be a mistake to think that this means there is no rhyme or reason behind human behavior. We need to focus on what people are really trying to accomplish which often is very different from what they appear to be trying to accomplish.

Before discussing a few of Sutherland’s ideas in more detail, it is worth taking a brief look at his “rules of alchemy” presented at the start of the book:

Rory’s Rules of Alchemy
  1. The opposite of a good idea can also be a good idea.
  2. Don’t design for average.
  3. It doesn’t pay to be logical if everyone else is being logical.
  4. The nature of our attention affects the nature of our experience.
  5. A flower is simply a weed with an advertising budget.
  6. The problem with logic is that it kills off magic.
  7. A good guess which stands up to observation is still science. So is a lucky accident.
  8. Test counterintuitive things only because no one else will.
  9. Solving problems using rationality is like playing golf with only one club.
  10. Dare to be trivial.
  11. If there were a logical answer, we would have found it.

Reading through these rules provides a flavor of Sutherland’s overall philosophy of human decision making which he refers to as psycho-logic. Far from appearing “rational” or “logical”, Sutherland’s notion of psycho-logical decision making has evolved over time to be useful rather than optimal. Psycho-logical decision making is roughly equivalent to the concept of using heuristics, or coming up with problem-solving approaches that are “good enough” for our purposes, even if they do not always yield the best results. As Sutherland points out, “there are two separate forms of scientific inquiry: the discovery of what works and the explanation and understanding of why it works.” The use of aspirin to reduce pain was known for decades before scientists found out how it actually works. We should be open to utilizing things that we know work even if the rationale behind it remains a bit murky.

Don’t Listen to Your Customers

Sutherland makes a great point early in the book regarding free markets: In contrast to planned economies, free markets are able to generate innovative things even when their popularity does not make any rational sense at the time. By defying conventional wisdom and perceived logic, free markets can accomplish advances that central planning cannot.

Sutherland takes this a step further:

“For a business to be truly customer-focused, it needs to ignore what people say. Instead it needs to concentrate on what people feel.”

Alchemy, p. 45

I am sure that when many people read this quote they will immediately think about Steve Jobs, the legendary founder of Apple. Jobs was famous for not seeking input from customers regarding product design. Jobs observed that “people don’t know what they want until you show it to them.” Readers of Walter Isaacson’s biography of Jobs know that Jobs constantly strove to understand the psychology of customers and had a unique talent allowing him to combine aesthetics with functionality in a way that met needs that customers never knew they had.

In a planned economy (or, indeed, at companies like Nokia or Research In Motion), a market researcher in charge of consumer technology in 2005 might have interviewed users of cell phones to find out what features they would like to see in the future. Most people would have wanted to “do email” on their phones. So the central planner might have responded by making physical keyboards more capable. Jobs was able to envision what consumers really wanted which was a device capable of an unlimited number of functions, one of which was email. By introducing a virtual keyboard for the first iPhone, Jobs created a product capable of morphing itself into a device with capabilities limited only by human imagination.

The point here is not that customer feedback is never important and should be ignored in all cases. Clearly, there are cases where a business would want such feedback in order to make incremental changes to a product or service. However, major breakthroughs are unlikely to be made by seeking responses to obvious questions. Thinking about the underlying reasons for human decision making, which are very often subconscious, is a necessity for those who aspire to achieve real advances.

Perception is Reality

What would create a greater increase in customer satisfaction: Reducing the average speed of a subway ride between suburban Virginia and downtown Washington D.C. by ten minutes or installing electronic signs at each station showing commuters when the next train will arrive?

It is likely that a ten minute reduction in a thirty minute train ride would increase satisfaction to some degree, but the “new normal” would soon set in and familiar gripes would resurface. The problem is that implementing a ten minute reduction would be incredibly expensive. The Washington metro rail system is near capacity already and the two-track system cannot facilitate express trains. For years, long range planners have considered adding an additional tunnel under the Potomac River to alleviate congestion. Clearly, this type of improvement is not possible for the foreseeable future.

On the other hand, installing electronic signs at all stations is a more modest capital outlay and was implemented for the Washington metro rail system around the turn of the century. These signs increased the satisfaction of commuters but saved them no time at all. What the signs did was reduce the sense of uncertainty regarding when the next train would arrive.

Sutherland points to similar innovations that have massively improved the perception of customers without actually improving the service itself. The Uber app could have been designed to simply allow users to summon a car and let them know when the car arrives. However, the inclusion of a map showing where the car is located dramatically improves the perception of the service because customers are able to monitor how far away the car is while waiting. Your car will not arrive a second faster, but you will be much less frustrated with the overall experience.

Sutherland refers to these types of improvements as “psychological moonshots”. An actual moonshot is a very ambitious innovation that is typically not only expensive but risky. Psychological moonshots are a way to “achieve massive improvements in perception at a fraction of the cost of equivalent improvements in reality.” This might sound nefarious — are we trying to trick people? Sutherland would likely respond by asking what difference it makes if we are? If you can achieve an increase in human happiness with psycho-logic, why not pick the low hanging fruit?

Signaling Must Be Expensive

Sutherland’s observations regarding signaling behavior closely tie into the necessity of trust in a well-functioning society. Building a reputation requires years of efforts and can be lost very quickly which implies an asymmetry well captured by Sutherland’s reference to a Caribbean proverb: “Trust grows at the speed of a coconut tree and falls at the speed of a coconut.”

The need to signal seriousness and intent explains a number of actions that are taken by marketers that, on a surface level, makes little sense. Let’s say that you have some information to communicate to clients or potential clients. To an accountant, the rational method of communication would be one that minimizes cost such as using bulk email. However, a bulk email lacks the gravitas associated with a letter on quality paper stock delivered by Fed Ex.

Sutherland recounts his experience working on a marketing campaign where the key to success involved sending a solicitation to try a product via Fed Ex rather than email. He also points out that there is a reason wedding invitations are not sent out via email but on heavy paper or card stock.

Branding Facilitates Satisficing

At a surface level, the willingness to pay a premium price for branded goods strikes many economists as irrational consumer behavior but this attitude stems from not fully understanding what consumers are trying to do:

“Economists tend to dislike the idea of branding and are inclined to see it as an inefficiency, but then they might view a flower as an inefficient form of weed. The reason they might not understand the flower’s extravagance in squandering its resources on producing scent and color is that they don’t fully understand what it is trying to do or the decision-making and information-transfer context in which it is trying to do it. It is not any more irrational for human consumers to pay a premium for heavily advertised products than it is for bees to prefer to visit heavily ‘advertised’ flowers.”

Alchemy, p. 193

Sutherland’s thesis on advertising is that companies are investing heavily in signaling behavior which adds credibility that the product will at least not be bad. After all, heavily advertising a bad product would be self-defeating since it would only spread the word more quickly especially at a time when online reviews can make or break a product.

There are many scenarios where it makes rational sense to seek the product or service that is “good enough” because the risk of picking something unknown and bad is far too high. This is why one might see American tourists flocking to a Starbucks or McDonalds location while traveling abroad. They know exactly what they are going to receive and are probably under no illusions regarding the idea that they are choosing the best possible option. But they know it will be good enough. Those of us who have taken long distance road trips can relate to this as well. Choosing to eat breakfast at IHOP rather than at a no-name diner is likely to be satisfactory whereas the unknown greasy spoon might result in digestive problems on the road.

The power of branding appears to have diminished to some degree in recent years for a number of reasons. Store brands have gained market share as retail establishments themselves become the “brand”. Consumers have come to trust that store brands such as the Whole Foods “365” line and Trader Joe’s branded products have quality very similar to their branded equivalents. Online reviews available on smartphone apps make it relatively easy to pick local restaurants while avoiding the chains. Nevertheless, Sutherland’s views on branding and “satisficing” will continue to justify advertising spending.

Square Pegs and Round Holes

Sutherland urges readers to “never call a behavior irrational until you really know what the person is trying to do.” This is excellent advice given the fact that human behavior simply cannot be studied in the same way as the physical properties of the natural world. Despite great advances in psychology in recent years, we do not fully understand how our minds work. But even if we do not fully understand the decisions people make, we need to recognize that the seemingly irrational could make perfect sense in light of the fact that people are using heuristics to make “good enough” choices under conditions of uncertainty.

Stephon Alexander, a professor of physics, saxophonist, and author of The Jazz of Physics makes the following observations regarding the rational beauty of mathematics:

“An elegant equation is refined, slimmed down to the bare essentials, simple and concise. An elegant equation is tastefully written in the mathematical language of numbers, letters, and symbols. An elegant equation is superior in its ability to house within it other equations that can be derived from it. An elegant equation is a beautiful thing.”

The Jazz of Physics, p. 55

Social scientists, especially in the field of economics, have longed for the ability to reduce human behavior to the types of beautiful equations that help us describe the cosmos, but by insisting on applying pseudo-scientific “rigor” inappropriately, they risk muddying the waters rather than bringing about enlightenment.

If you are looking for hard-and-fast rules governing human behavior, you will not find any in Alchemy or anywhere else, but of course that is precisely Sutherland’s point. Human behavior is often shrouded in mystery and we benefit from being open to considering counterintuitive and seemingly illogical ideas that, for some reason, appear to actually work.

Staying Informed Amid the Noise

Warren Buffett has been a newshound all his life. He is known to read five newspapers a day including the Wall Street Journal, The New York Times, USA Today, The Financial Times, and the Omaha World-Herald. His affinity for handling newsprint started early in life when, at age 13, he took on a job as a newspaper carrier in Washington D.C.1 Those of us who delivered newspapers as teenagers can relate to the rhythmical pattern of the news business represented by the daily package of information that we would accept in bulk and prepare for delivery to our customers. We were small cogs in the massive enterprise of disseminating information and, in our modest way, did our part to keep the population informed while learning invaluable lessons about work ethic and business in the process.

The twentieth century model of news dissemination and consumption was forever altered when the internet went mainstream in the mid 1990s. From its origins in government and academia, the internet had already been revolutionizing communications in narrow contexts for a couple of decades but ordinary individuals still consumed information either in print, by watching television, or by listening to the radio. Each of those twentieth century modes of communication were characterized by their mostly one-way nature in which sources claiming authority disseminated information to the masses. In addition, from the perspective of the individual, consuming the news had a defined end-point. When you reached the end of the newspaper, you were done reading the news of the day. When Walter Cronkite or Dan Rather signed off for the evening, you were done listening to the news of the day. Once you were done with the news, you went on with the rest of your day.

Of course, print newspapers and television broadcasts have continued to coexist with the internet, but they are increasingly anachronisms at a time when news delivery has shifted in at least four important ways.

  • News delivery resembles a water faucet that is never turned off. In the twenty-first century, there is no start or end point to the delivery of information. It never ceases to flow and there is never any sense of being “done” with the process, as one would be when reaching the last section of a print newspaper.
  • The number of sources of information has exploded. We are long past the days when people subscribed to the city’s only newspaper and tuned in to one of the three major networks. The internet has enabled anyone with an internet connection and ideas to become a publisher.
  • The news is now a two way conversation. Through social media or article comments, the response to news is instant and often critical. If you participate in this two way conversation, welcome to the world of social media dysfunction as you eagerly await responses to your comments in a never ending feedback loop.
  • The veracity of information that is published online is often questionable. The mainstream media has made much of the phenomenon of “fake news”, and there is no doubt that misinformation can spread like wildfire on social media. However, along with the liars, manipulators, and cranks distributing twaddle, the democratization of the internet has given a voice to many individuals with worthwhile things to say.

One approach to dealing with these massive changes is to opt out and simply stop consuming daily news. The advantages of doing so can be substantial in terms of freeing up time for more meaningful pursuits. Constant consumption of news militates against achieving a state of flow required to accomplish anything meaningful.

If you are an investor, almost nothing that is happening right now has a material impact on the companies you own. As a citizen, almost nothing that is happening right now has much relevance either. Other than emergency situations, simply opting out of the daily news flow can be a viable strategy. However, many of us find the allure of the news too strong to resist and, if that is the case, we need to find a system that will allow us to benefit from what is out there while not being consumed by it.

Browse, Curate, and Consume

The never-ending nature of the internet is probably the most serious impediment when it comes to consuming information. We are served up with content in an endless stream and most of us make a decision regarding whether to read or view the content right when we encounter it. This is a very unproductive and distracting way to consume information. We are making a decision at that very moment regarding whether to devote precious time to something that just popped into our consciousness. How are we supposed to know if that specific content is worth our time and that the next piece of content we encounter might not be more valuable?

The solution to many problems can be approached by breaking it down into distinct steps:

Browse. Rather than making the decision regarding whether to consume content when it is encountered, simply decide whether the content is potentially interesting to you and, if so, save it using one of the many tools that are specifically designed to do so. I have been using Instapaper for many years to queue content. Pocket and Evernote are other popular options. Certain news applications, including the Wall Street Journal’s iPad app allow for saving articles as well, but using a generic tool like Instapaper is more flexible since it works for all sources. This type of browsing can occur at any time – you are not making a commitment to read anything, only to consider reading it later.

Curate. The next step in the process, which I usually do immediately before consuming content, is to curate the accumulated list of articles that I have saved in Instapaper. I usually set aside anywhere from thirty to sixty minutes per day to consume news. The first five minutes involves curation. I go through the list of articles and often delete many of them immediately, especially if I do not recall why I saved them. Instapaper has a useful time estimate for each piece of content, so if I have a sixty minute “budget” for reading, I will continue curating content by deleting everything that will not fit into that time budget.

Consume. The remaining content is then read in any order that I choose to and when I am done with that queue of material, I am done with my consumption of news for the day and I move on to the next thing I had planned to do. This provides the same sense of completion as one would get from reaching the end of a physical newspaper. What if I encounter some other interesting article a few minutes later? I don’t read it immediately, but simply add it to my Instapaper queue again for consideration the next time I budget time for the news.

Through this cycle of browsing, curating, and consuming, it is possible to benefit from the vast array of information available today without being overwhelmed by it and going down into a rabbit hole of news consumption that you only emerge from hours later, eating into valuable time that you had planned to spend elsewhere.

Participation — A Double Edged Sword

Think twice before you switch from being a consumer of news to a participant in discussion of the news. These two very distinct activities seem to blend together in the minds of many people and greatly increases the time spent on the process. The news has never been a completely one-way process. Many of the most vociferous debates of the early period of American history involved dueling editorials and letters published in the young country’s many flourishing newspapers. However, never before has the two-way process been more democratic and immediate than it is today. By participating, we are harnessing multiple psychological forces that can quickly drag us into a never-ending vortex.

The psychological aspects of the internet have been understood for some time and internet addiction is nothing new. However, the mass adoption of smartphones over the past decade has made the situation far worse. Scientists have found that the use of smartphones can activate the same dopamine pathways that are triggered by chemical addictions. Why is this the case? Humans crave novelty and attention. Phones are set up, by default, to provide a non-stop stream of notifications and other stimuli designed to satisfy our urge to receive feedback of all sorts. We are assaulted by this on a daily basis just from email and text message alerts. When we start participating in discussions of the news, especially on any controversial topic, the intensity of these many mental interrupts increases, sometimes exponentially when things “go viral” on social media.

Anyone who has participated on Twitter or Facebook can immediately relate to the dopamine pathway theory. Don’t try to deny it … when you post a clever tweet, you have an urge to check back to see how many people have responded, liked, or retweeted the content. The same is true for Facebook, Instagram, and now for TikTok, the latest social media craze that has taken off despite sinister links to China. Hours can go by after you start participating in dissemination of the news and get sucked into the vortex of “discussion”.

At a very fundamental level, what people are doing on social media while consuming the news is an activity totally distinct from actual consumption of the news. Even for those who enjoy interacting on social media, clearly separating time devoted to discussion from time devoted to news consumption can improve productivity and your general state of mind.

Silent Interludes

Last summer, I went on a one week vacation that made it impossible to remain connected to civilization. This silent interlude was by design, of course, but one need not be physically unable to access the internet to benefit from occasional breaks.

As I type these words, it is Monday morning and my interaction with electronics since Saturday afternoon has been limited to writing this post and answering a few texts. My iPhone no longer displays any alerts whatsoever other than phone calls and text messages from those I have designated as VIPs. During this time, I have read a hundred pages of Ron Chernow’s The House of Morgan, fifty pages of Stephon Alexander’s The Jazz of Physics, an assortment of other printed content, spent time with family, and watched Super Bowl LIV, all without the distraction of the news or the dopamine rushes associated with social media.

Balance is difficult to strike in a world where information flows like a firehose and is discussed in real-time on multiple social media platforms. However, by browsing and curating content in a deliberate manner prior to consuming the content, we can benefit from the richness of information in the twenty-first century while retaining a sense of focus and purpose.

  1. Buffett: The Making of an American Capitalist, p. 21 []

My $2 Million Apple Mistake

It was Thanksgiving weekend twenty years ago. I had been watching the stock for a couple of months. It was pummeled on soft results in September and seemed cheap to me. On Sunday night, I looked at the Value Line report and on Monday I reviewed the latest financial statements. On Tuesday morning, I pulled the trigger. I was now the proud owner of 500 shares of Apple purchased at $18.1

Hindsight bias is pernicious. By perceiving past events as more predictable than they actually were at the time, we mentally torture ourselves regarding outcomes that could not have been foreseen. Even worse, when we believe that we had foresight in the past that we did not really have, we are more prone to be overconfident regarding current events. This can lead to underestimating the vicissitudes in life that could upend the future.

This article is a true story of a trade nearly two decades ago that seemed smart at the time but, in hindsight, carried a severe opportunity cost. Was the decision a good one based on the information then at my disposal? Or was it a foreseeable debacle that should have been avoided?

Flashback to 2000

Let’s take a journey back two decades to the fall of 2000. By the end of September, the Nasdaq composite index was well into bear market territory, having fallen nearly 30 percent from its high in early March, but the worst was yet to come. Back then, Apple was a struggling computer maker that had suffered greatly in recent years and found itself on the verge of bankruptcy before its iconic founder, Steve Jobs, returned to engineer a turnaround.

When you read about the turnaround today or look at a 20 year chart of the stock, the turmoil of late September 2000 will hardly be noticeable. But the company was having problems that fall and did not sell as many computers during the key back-to-school season as analysts had expected. When the company warned that sales were soft ahead of the end of the fiscal year, the stock was pummeled, falling over 50 percent on September 29.

I started watching the stock.

I cannot reconstruct the story exactly. I did not keep any type of journal in 2000. I was not very experienced when it came to investing nor did I have much capital to invest. But for some reason, Apple’s sharp drop in September caught my attention and I began to follow the company. It is likely that I pulled up the Value Line report on Apple and I’m sure that I also read its latest 10-K and quarterly report, but I doubt I did much more than that. However, by November, I was ready to act.

The Trade

Following its earnings warning at the end of September, Apple continued to fall for the next couple of months. By the end of November it was trading around $18 which must have seemed attractive to me based on the numbers published in the company’s latest 10-K. The company seemed to be on the right track and was trading under ten times trailing earnings:

In addition to being cheap on an earnings multiple basis, the company had book value of over $12 per share and had over $4 billion in cash and short term investments on the balance sheet. The market capitalization was around $6 billion. The market reaction must have seemed overdone to me and the cheapness of the stock suggested a margin of safety. It would be nice to believe that I developed an investment thesis more complete than what I just described but I doubt that was the case.

On Tuesday, November 28, 2000, I purchased 500 shares of Apple at 18 1/16 for a total cost of $9,051.25, including a $20 commission. On March 5, 2001, I sold the 500 shares for $20.25 for proceeds of $10,105 after another $20 commission. My short term capital gain was $1,053.75.

The chart below shows the price action for Apple stock from July 1, 2000 to June 30, 2001 along with my trades:

Source: Yahoo! Finance

This capital gain of slightly over a thousand dollars represented a 11.6 percent gain in just over three months, or an annualized gain of over 50 percent. But it wasn’t smooth sailing during those three months. The stock bottomed at $14 in December and I was substantially underwater before realizing the gain in March.

What was my rationale for selling?

I can only guess.

I suspect that I was attracted by the round number of the $1,000 capital gain. A thousand dollars remains a lot of money in absolute terms, in my view, and certainly back then it was very meaningful. I had made this money in a short period of time and probably wanted to take it off the table.

What did I do with the proceeds?

On this question, I can reconstruct the events with more certainty. The first purchase I made after selling Apple on March 5 was a purchase of 5 shares of Berkshire Hathaway Class B on March 16 at $2,145 per share.2 It so happens that I still own those shares of Berkshire today.

The Aftermath

We all know the story of Apple since I sold in 2001. In the fall of that year, Steve Jobs unveiled the first iPod music player followed by the first iPhone six years later. Today, Apple is a behemoth – the largest company in the United States with a market capitalization in excess of $1.4 trillion.

If you calculate what I left on the table by taking the current stock price of around $317, subtracting $20.25 and multiplying by 500, you would get a figure slightly under $150,000. That’s a lot of money to leave on the table!

But it is worse than that.

Much, much worse!

Apple shares split 2-for-1 in 2005 and split again 7-for-1 in 2014. This means that the 500 shares I sold in early 2001 would be the equivalent of 7,000 shares today. If you take $317 and subtract $1.446 ($20.25 divided by 14) and multiply by 7,000, you get a horrifying $2,209,000!

But wait, there’s more!

Apple started paying a dividend in 2012 and has paid a total of $16.87 per share of dividends over the past seven years. Take $16.87 and multiply by 7,000 to arrive at an additional $118,000 opportunity cost!

But let’s look on the bright side. I still own the shares of Berkshire purchased with the proceeds of my Apple sale. Those five shares of Berkshire Class B have become 250 shares due to Berkshire’s 2010 stock split and are now valued at about $57,000. This represents a compounded annual return of 9.3 percent over the past nineteen years. Not too bad, right?

Evaluating Decisions

Was my decision to trade Apple a mistake? Should I have held those shares purchased in November 2000? Based on what we know today, the answer is self-evident. With benefit of today’s information, it was insane to sell those shares in March 2001!

The problem is that there was no crystal ball in March 2001 that could have predicted the company’s meteoric rise. I could not have predicted it and neither could anyone else. Apple had not even released the first iPod at that point. There was no iOS ecosystem to lock in consumers. It was a struggling personal computer maker in the early years of a turnaround engineered by a visionary but highly erratic leader. It was extremely cheap, however, and had a margin of safety.

Arguably, the stock continued to have a margin of safety when I sold it and there is little doubt that I had a “trading mindset” at that time, at least when it came to Apple. My profits reached a round number and I cashed in my chips and used the proceeds to invest in something I understood well for the long run. Buying Berkshire, in contrast to Apple, was intended to be a multi-year commitment and it turned into a multi-decade commitment — one that I understood well.

Psychological Perils

No matter how much we learn about human psychology, we must never, for a second, pretend that we are studying the mentality and behavior of others. We are, in fact, studying ourselves because we are just as subject to all of the pitfalls as anyone else. Understanding human psychology helps us to understand ourselves better but never immunizes against second guessing and regret. Until recently, I never calculated the opportunity cost of selling those shares. I obviously knew that I had owned Apple years ago and sometimes it occurred to me that those shares would be worth a fortune if I had held. But I avoided the calculation until recently when I posted the results on Twitter:

It turns out that personal humiliation will result in many retweets and likes, but in reality, is there much of a reason to feel humiliated? Not really. After all, little known Apple co-founder Ronald Wayne sold his 10 percent stake in Apple way back in 1977 for a mere $800. Today, this stake would be worth about $140 billion. Mr. Wayne is 85 years old today. Maybe he dwells on the idea that he could be the richest American alive today, but hopefully not. There is no way anyone could have predicted the rise of Apple over the past 43 years.

The endowment effect is just as pernicious as hindsight bias when it comes to investing. If I had just considered trading Apple back then but never actually owned shares, I would not give my “mistake” even a passing thought today. It is the fact that I did own those shares and then decided to sell them that makes it an issue. For some reason, it is not similarly problematic to know that I missed out on other meteoric success stories such as Amazon or Netflix. I never understood either and certainly never owned shares.

Even if I had held those Apple shares beyond March 2001, I know that I would never have continued to hold them until today. For better or worse, I have long been a skeptic regarding Apple knowing that the past is littered with examples of consumer electronics firms that have fallen out of favor. I would have doubtlessly taken money off the table during the early years of Apple’s ascent to reduce risk exposure. The only way I would have held those shares without interruption would be if I had fallen into a coma.

In contrast, I have held shares of Berkshire for multiple decades and I have other investments that I have held for very long periods of time as well. In all of these cases, I had a firm understanding of the businesses involved and a sense of their futures. That was never the case with Apple.

The Headline Was Click-Bait …

So, was this a $2 million “mistake”? I don’t think so. The $2 million in “lost profits” represent a fictional illusion, no more real than if I had won a lottery. But hopefully this story sheds some light on the nature of decision making and the importance of not falling victim to hindsight bias when evaluating past decisions.

Disclosure: Individuals associated with the Rational Walk LLC own shares of Berkshire Hathaway which has an equity ownership interest in Apple.

  1. My purchase was 500 shares at 18 1/16. Stocks were still traded in fractions back then. This is the equivalent of 7000 shares of Apple at $1.29 per share after accounting for a 2:1 stock split on 2/28/2005 and a 7:1 stock split on 6/9/2014. []
  2. This is the equivalent of 250 shares at $42.90 based on Berkshire’s 50:1 stock split on 1/21/2010. []

Farnam Street’s Great Mental Models

“So whatever you wish that men would do to you, do so to them; for this is the law and the prophets.”

The Golden Rule as expressed in Matthew 7:12

Hanlon’s Razor advises us to give others the benefit of the doubt when we interpret the intent of their actions. This is such a simple concept. Taking this approach makes life much more pleasant than it would be if one constantly assumes the worst in others. Most people are busy living their day to day lives and it is not uncommon to be on the receiving end of actions that are negative, whether it involves being cut off on the road or receiving a terse text message from a colleague. When we witness actions that seem unjust or wrong, we have a choice regarding how to respond. We can adopt the mindset of Hanlon’s Razor and attribute the action to stupidity or inadvertent neglect, or we can choose to assume malign intentions.

There are many more people in the world who are inconsiderate or lazy than people who are intentionally evil. Assuming malign intent is not really the best way to bet if we are affected by an action that we do not like. However, we also want to avoid being fools, and in cases where the stakes are particularly high, is giving the benefit of the doubt the intelligent way to behave? And how would we want others to behave in response to our actions if the situation was reversed?

Hanlon’s Razor is an example of a mental model that can help us make better decisions in life but, taken in isolation, a single mental model can be ineffective or even dangerous. We need what Charlie Munger has called a “latticework of models” in our brains that we can call upon when making decisions. Shane Parrish founded Farnam Street to help people “master the best of what other people have already figured out.” Parrish, who worked for many years as a cybersecurity expert at Canada’s top intelligence agency, was heavily influenced by Charlie Munger and spent several years covering various mental models on his website. His new book, The Great Mental Models: General Thinking Concepts, is the first volume in a series that seeks to distill and expand on the content already published on Farnam Street.

The Latticework

Farnam Street’s take on mental models has been heavily influenced by Charlie Munger’s “latticework” approach which has been described in vivid detail by Peter Kaufman in Poor Charlie’s Almanack. Munger realized early in life that the conventional way of making decisions suffers from massive flaws, most seriously the tendency of people to look inward to their own field of expertise and fail to borrow concepts from other disciplines:

“You must know the big ideas in the big disciplines and use them routinely — all of them, not just a few. Most people are trained in one model — economics, for example — and try to solve all problems in one way. You know the old saying: ‘To the man with a hammer, the world looks like a nail.’ This is a dumb way of handling problems.”

Charlie Munger, Poor Charlie’s Almanack, p. 55

Those who fail to adopt a multi-disciplinary approach and compete with those who do so will resemble “one legged men in an ass kicking competition.” Yet, the majority of people go through life either without any notion of mental models at all, being reactive to what the world throws at them, or overemphasizing the few mental models that they are familiar with. What is the solution? As Munger says, you need to grasp multiple models and then use them. You cannot just memorize facts and figures and expect to be able to use them without having a latticework of models that you refer to automatically. Parrish expands on this concept:

“A latticework is an excellent way to conceptualize mental models, because it demonstrates the reality and value of interconnecting knowledge. The world does not isolate itself into discrete disciplines. We only break it down that way because it makes it easier to study it. But once we learn something, we need to put it back into the complex system in which it occurs. We need to see where it connects to other bits of knowledge, to build our understanding of the whole. This is the value of putting the knowledge contained in mental models into a latticework.”

The Great Mental Models, p. 35

This sounds complicated, but Munger believes that eighty to ninety important models carry most of the burden and that mastery of the most important of these models can greatly improve decision making. And while this may sound like a great deal of work, Munger counsels us to go about it in a systematic way to benefit from the compounding effects of the knowledge over time. It turns out that gaining an understanding of mental models can be a great deal of fun if we learn and apply the models to our day to day decisions which will begin to resemble puzzles for us to solve using our growing toolkit.

General Thinking Concepts

Parrish has undertaken a very ambitious task and the first volume of his Great Mental Models series introduces what he refers to as general thinking concepts. The nine concepts covered in the book are not from any specific academic discipline but instead take a step back and provide guidance on how one should approach thinking in general. The general concepts include:

  • The Map is not the Territory
  • Circle of Competence
  • First Principles Thinking
  • Thought Experiment
  • Second-Order Thinking
  • Probabilistic Thinking
  • Inversion
  • Occam’s Razor
  • Hanlon’s Razor

Before taking a look at a few of the concepts in more detail, it is worth noting that the Farnam Street website covers many of these topics, if not all of them, in quite a bit of detail, and this information is freely available to anyone with internet access. Given that this is the case, is it worth reading the book? Obviously, everyone can decide for themselves and there are some negative Amazon reviews that suggest the website is more useful. However, the physical book is aesthetically pleasing and very well presented and can serve as a useful reference volume. There is something to be said for the combination of aesthetics and knowledge found in a well-made physical volume. These are timeless concepts and they seem best presented in a timeless printed format.

Model Blindness

In various disciplines, especially in social sciences, academics tend to develop elegant models purporting to describe human behavior and sometimes even give these models a quasi-mathematical justification. What many people forget, however, is that a model is inherently a simplification of the real world.

The idea that the map is not the territory is a recognition of the fact that maps are reductions of what they purport to represent. As Parrish states, “if a map were to represent the territory with perfect fidelity, it would no longer be a reduction and thus would no longer be useful to us.” If we allow our knowledge to become restricted to the map rather than the territory, we inevitably run into major problems. The world is too complicated to navigate without making use of abstractions, but we cannot treat abstractions as gospel.

Not only can maps (or models, more generally) not show everything about the real world but they are made from a certain perspective and only represent the world at a specific point in time which is subject to change. Parrish cleverly presents a world map created in 1450 and asks “Would you be able to use this map to get to Egypt?” Were it not for accidentally spotting the boot of Italy presented upside down, the map would have been totally indecipherable to me. But when the page is flipped upside down, suddenly it becomes clear and I probably could use it to get to Egypt. The map was made from a different perspective than we are accustomed to today.

The Great Mental Models, p. 46

We must make use of maps and models to navigate anything complicated, but we should do so bearing in mind that reality always trumps models. It is imperative to update models based on what we experience and observe, understanding that the territory does change over time.

And Then What?

Howard Marks, Chairman of Oaktree Capital Management, often emphasizes the need to ask a simple question: “And then what”? In his widely read memos to clients and in his latest book, Mastering the Market Cycle, Marks advises investors to look beyond the surface, or gut level, reaction to events and consider the second and third order consequences that others may be neglecting. Parrish describes second order thinking as follows:

“Second-order thinking is thinking farther ahead and thinking holistically. It requires us to not only consider our actions and their immediate consequences, but the subsequent effects of those actions as well. Failing to consider the second – and third – order effects can unleash disaster.”

The Great Mental Models, p. 109

Pretty obvious, isn’t it? Well, not so much based on several high profile disasters that have happened over time due to people ignoring important second-order effects usually powered by strong incentives. Parrish describes how the British colonial rulers in India attempted to reduce the number of venomous snakes in New Delhi by offering rewards to Indian citizens who brought in dead snakes. Did this reduce the number of snakes in New Delhi? No, it did not because the Indians responded to incentives by breeding more snakes in order to be able to kill them and claim rewards!

Charlie Munger again helps us out when it comes to second-level thinking. His admonition to “never, ever, think about something else when you should be thinking about the power of incentives” can help us to detect second order effects in many cases. Had the British colonial rulers of India considered incentives, they would never have put in place a policy that was sure to make the problem worse!

Parrish notes that we need to avoid allowing the prospect of second and third order effects lead to decision making paralysis. We cannot operate effectively in life if we worry about every conceivable effect of the effects of our actions. We have to use the mental models we have accumulated to make rational decisions.

Pick Your Razor

We opened this article with a brief discussion of Hanlon’s Razor which counsels us to not attribute an action to malice when it can be more easily explained by stupidity or neglect. The book covers this model along with Occam’s Razor which is more widely known. Occam’s Razor encapsulates a very straight forward concept: We should default to explanations that are simple rather than complicated when the simple explanation adequately describes a situation.

There is always a risk of oversimplifying a complex situation but that is not what Occam’s Razor advocates. The explanation must be sufficient to explain the scenario in order to qualify. If one has several explanations, all of which seem to be plausible, the one with the fewest complications is more likely to be true because it has fewer moving parts and assumptions. Furthermore, a simple explanation is easier to falsify, or prove incorrect. Used properly, Occam’s Razor can allow us to make better decisions more rapidly and avoid chasing down dead ends and wasting resources.

There is an interesting tension between Occam’s Razor and Hanlon’s Razor that is worthy of some thought. There are many events in life where one encounters a negative situation caused by another person and, often, the simplest explanation is that this person intended to do us harm, and perhaps this explanation is what we should adopt according to Occam’s Razor. However, human beings are fallible and there are more good people than evil people in the world. Hanlon’s Razor counsels temperance and the benefit of the doubt. How are we to choose?

The answer clearly depends on context, common sense, and the consequences of being wrong. If you are in an auto accident in broad daylight in a busy intersection where the other car made an illegal left turn and slammed into your car, it would seem best to adopt Hanlon’s Razor and assume negligence or stupidity rather than malice and be kind to the other driver.

But if you are waiting at a red light at 2 am and the car in front of you backs into your car without warning, the simplest explanation is that this individual has malign intent. It is possible that they shifted into reverse by accident, but that is not the likely explanation, and the consequences of being wrong are high. It would be best to not get out of your car and instead drive away to a safe location where you can summon help.

No Shortcuts

The fact is that building a latticework of mental models that you know well enough to draw upon takes years of hard work and continual effort. Charlie Munger’s quest for worldly wisdom has taken decades and, at age 96, he hasn’t stopped learning yet. It is unrealistic to think that one can pick up a book like The Great Mental Models or Poor Charlie’s Almanack and suddenly emerge worldly and wise. But while you may not become as wise as Munger or Parrish overnight, reading books like this are required to have a chance to improve over time.

The good news is that the process of learning mental models is not boring, when approached with the right mindset, and can actually be a great deal of fun when approached as a series of puzzles to solve. Knowledge compounds over long periods of time and the progress is not linear. Sometimes the combination of multiple mental models leads to breakthroughs or insights that result in “aha!” moments. You cannot predict when or if such moments will come, but you can add some positive optionality to your life by being prepared.


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