You can beat a race, but you can’t beat the races

Alex Morris has published a compilation of Buffett and Munger remarks at annual meetings. This allowed me to add to my file of times the two have talked about horse race betting and the lessons to be learned there.

Munger’s quote, in his Worldly Wisdom speech, is the bluntest of all:

How do you get to be one of those who is a winner—in a relative sense—instead of a loser? Here again, look at the pari-mutuel system. I had dinner last night by absolute accident with the president of Santa Anita. He says that there are two or three betters who have a credit arrangement with them, now that they have off-track betting, who are actually beating the house. They’re sending money out net after the full handle—a lot of it to Las Vegas, by the way—to people who are actually winning slightly, net, after paying the full handle. They’re that shrewd about something with as much unpredictability as horse racing. And the one thing that all those winning betters in the whole history of people who’ve beaten the pari-mutuel system have is quite simple. They bet very seldom. It’s not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it—who look and sift the world for a mispriced bet—that they can occasionally find one.  And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.  That is a very simple concept. And to me it’s obviously right—based on experience not only from the pari-mutuel system, but everywhere else.”

I noted professional horseplayer Inside The Pylons saying something related on his Bet With The Best podcast appearance:

Like you have no chance doing stuff like that long term. So you only bet the races where you think are good betting races.

But when you look at nine to nine or 10 races, Santa Anita, I mean, jeez, even if you’re sharp, I mean, if you bet more than three races a day, you’re a sicko I mean, there’s just so many bad races.

This theme recurs in the Morris compilation:

2003 MEETING (02:36:36) *

WB: “The beauty of the investment game, what really makes it great, is that you don’t have to be right on everything. You don’t have to be right on 20%, 10%, or even 5% of the companies in the world. You only have to get one good idea every year or two. I used to be very interested in horse handicapping, and the old story was you could beat a race but you can’t beat the races … If somebody gave me all five hundred stocks in the S&P and I had to make some prediction about how they would behave relative to the market over the next couple years, I don’t know how I would do. But maybe I could find one where I’m 90% sure I’m right. It’s an enormous advantage in stocks: You only have to be right on a very, very few things as long as you never make big mistakes.”

ACTIVE MANAGEMENT AND PROFESSIONAL INVESTORS

1997 MEETING (01:21:40)

WB: “Money managers, in aggregate, have underperformed index funds. It’s the nature of the game. They simply cannot overperform, in aggregate. There are too many of them managing too big a portion of the pool. It’s for the same reason that the crowd could not come out here to Ak-Sar-Ben [racetrack] and make money, in aggregate, because there’s a bite taken out of every dollar that was invested in the pari-mutuel machines. People who invest their dollars elsewhere through money managers in aggregate cannot do as well as they could do by themselves in an index fund. They say you can’t get something for nothing. But the truth is money managers, in aggregate, have gotten something for nothing; they’ve gotten a lot for nothing. And the corollary is investors have paid something for nothing. That doesn’t mean people are evil.

 FROM POOR INVESTMENTS

1995 MEETING (01:01:17)

WB: “A very important principle in investing is that you don’t have to make it back the way you lost it. In fact, it’s usually a mistake to try and make it back the way that you lost it.”

CM: “That’s the reason so many people are ruined by gambling; they get behind and then they feel they have to get it back the way they lost it. It’s a deep part of human nature. It’s very smart just to lick it by will; little phrases like that are very useful.”

WB: “One of the important things in stocks is that the stock does not know you own it. You have all these feelings about it; you remember what you paid and you remember who told you about it, all these little things. And it doesn’t give a damn, it just sits there. If a stock is at $50 when somebody’s paid $100, they feel terrible. Meanwhile, somebody else who paid $10 feels wonderful. It has no impact whatsoever. As Charlie says, gambling is the classic example. Someone goes out and gets into a mathematically disadvantageous game. They start losing it, and they think they’ve got to make it back, not only the way they lost it, but that night. It’s a great mistake.”

Some other words of interest: On ValueLine:

PATIENCE (WATCHING FOR HISTORIC FINANCIAL DATA)

1995 MEETING (03:54:41)

CM: “I think the one set of numbers that are the best quick guide to measuring one business against another are the Value Line numbers. That stuff on the log scale paper going back fifteen years, that is the best one-shot description of a lot of big businesses that exists. I can’t imagine anybody being in the investment business involving common stocks without that on their shelf.”

WB: “And, if you have in your head how all of that looks in different businesses and industries, then you’ve got a backdrop against which to measure. If you’d never watched a baseball game and never seen a statistic on it, you wouldn’t know whether a .3o0 hitter was a good hitter or not. You have to have some kind of a mosaic there that you’re thinking is implanted against, in effect. And the Value Line figures, if you ripple through that, you’ll have a pretty good idea of what’s happened over time in American business.”

CM: “I would like to have that material going all the way back; they cut it off at fifteen years back. I wish I had that in the office, but I don’t.”

WB: “I saved the old ones. We tend to go back. If I’m buying Coca-Cola, I’ll go back and read the Fortune articles from the 193os on it. I like a lot of historical background on things, just to get it in my head how the business has evolved over time, and what’s been permanent and what hasn’t been permanent, and all of that. I probably do that more for fun than for actual decision-making. We’re trying to buy businesses we want to own forever, and if you’re thinking that way you might as well look back a way and see what it’s been like to own them forever.”

The way you learn about businesses is by absorbing information about them, thinking, deciding what counts and what doesn’t count, relating one thing to another. That’s the job. And you can’t get that by looking at a bunch of little numbers on a chart bobbing up and down or reading market commentary and periodicals or anything of the sort. That just won’t do it. You’ve got to understand the businesses. That’s where it begins and ends.”

SCUTTLEBUTT (ON-THE-GROUND RESEARCH)

1998 MEETING (04:27:09)

WB: “One advantage of allocating capital is that an awful lot of what you do is cumulative in nature, so you get continuing benefits out of things you’ve done earlier. By now, I’m fairly familiar with most of the businesses that might qualify for investment at Berkshire. But when I started out, and for a long time, I used to do a lot of what Phil Fisher described, the scuttlebutt method …

“The general premise of why you’re interested in something should be 80% of it.

You don’t want to be chasing down every idea that way; you should have a strong presumption. You should be like a basketball coach who runs into a seven-footer on the street. You’re interested to start with; now you have to find out if you can keep him in school, if he’s coordinated, and all that sort of thing. That’s the scuttlebutt aspect of it. But as you’re acquiring knowledge about industries in general, and companies specifically, there really isn’t anything like first doing some reading about them, and then getting out and talking to competitors, customers, suppliers, ex-employees, current employees, whatever it may be. You will learn a lot. But it should be the last 10% or 20%. You don’t want to get too impressed by that, because you really want to start with a business where you think the economics are good, where they look like seven-footers, and then you want to go out with a scuttlebutt approach to possibly reject your original hypothesis. Or maybe, if you confirm it, do it even more strongly.

“I did that with American Express back in the 1g6os; essentially the scuttlebutt approach so reinforced my feeling about it that I kept buying more and more as I went along. If you talk to a bunch of people in an industry and you ask them

STOCK SELECTION

1998 MEETING (03:02:34)

WB: “The criteria for selecting a stock is really the criteria for looking at a business. We are looking for a business we can understand. They sell a product that we think we understand, or we understand the nature of the competition and what could go wrong with it over time. And then we try to figure out whether the economics, the earnings power, over the next five, ten, or fifteen years is likely to be good and getting better, or poor and getting worse. Then we try to decide whether we’re getting in with people that we feel comfortable being in with. And then we try to decide what’s an appropriate price for what we’ve seen up to that point in the business.

“What we do is simple, but it is not necessarily easy. The checklist that we go through in our minds is not very complicated. Knowing what you don’t know is important; knowing the future is impossible in many cases, and difficult in others. We’re looking for the ones that are relatively easy. Then you have to find it at a price that’s interesting to you, and that’s very difficult for us now (although there have been periods in the past where it’s been a total cinch).

“That’s what goes through our mind. If you were thinking of buying a gas station, dry cleaner, or convenience store to invest your life savings in and to run as a business, you’d think about the competitive position and what it would look like five to ten years from now, and how you were going to run it, or who was going