In a 1995 edition of The Outstanding Investor Digest, Charlie Munger recounted the types of business models that he and Warren Buffett like to invest in. Most noteworthy is what he calls the ‘cancer surgery formula’ model saying:
“I’ve had many friends in the sick-business-fix-up-game over a long lifetime. And they practically all use the following formula — I call it the cancer surgery formula. They look at this mess and they figure out if there’s anything sound left that can live on its own if they cut away everything else. And if they find anything sound, they just cut away everything else. Of course, if that doesn’t work, they liquidate the business. But it frequently does work.”
Here’s an excerpt from the article:
It you look at Berkshire’s investments where a lot of the money’s been made and you look for the models, you can see that we twice bought into two-newspaper towns which have since become one-newspaper towns. So we made a bet to some extent…
In one of those – The Washington Post – we bought it at about 20% of the value to a private owner. So we bought it on a Ben Graham-style basis – at one-fifth of obvious value — and, in addition, we faced a situation where you had both the top hand in a game that was clearly going to end up with one winner and a management with a lot of integrity and intelligence. That one was a real dream. They’re very high-class people — the Katharine Graham family. That’s why it was a dream — an absolute, damn dream.
Of course, that came about back in ’73-’74 And that was almost like 1932. That was probably a once-in-40-year-type denouement in the markets. That investment’s up about 50 times over our cost. If l were you I wouldn’t count on getting any investment in your lifetime quite as good as The Washington Post was in ’73 and ’74. But it doesn’t have to be that good to take care of you.
Let me mention another model. Of course. Gillette and Coke make fairly low-priced items and have a tremendous marketing advantage all over the world. And in Gillette’s case, they keep surfing along new technology which is fairly simple by the standards of microchips. But it’s hard for competitors to do.
So they’ve been able to stay constantly near the edge of improvements in shaving. There are whole countries where Gillette has more than 90% of the shaving market.
GEICO is a very interesting model. It’s another one of the 100 or so models you ought to have in your head. I’ve had many friends in the sick-business-fix-up-game over a long lifetime. And they practically all use the following formula — I call it the cancer surgery formula:
They look at this mess and they figure out if there’s anything sound left that can live on its own if they cut away everything else. And if they find anything sound, they just cut away everything else. Of course, if that doesn’t work, they liquidate the business. But It frequently does work.
And GEICO had a perfectly magnificent business—submersed in a mess, but still working. Misled by success, GEICO had done some foolish things. They got to thinking that, because they were making a lot of money, they knew everything. And they suffered huge losses.
All they had to do was cut out the folly and go back to the perfectly wonderful business that was lying there. And when you think about it, that’s a very simple model. And it’s repeated over and over again.
And, in GEICO’s case, think about all the money we passively made…. It was a wonderful business combined with a bunch of foolishness that could easily be cut out. And people were coming in who were temperamentally and intellectually designed so they were going to cut it out. That is a model you want to look for.
And you may find one or two or three in a long lifetime that are very good. And you may find 20 or 30 that are good enough to be quite useful.
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