"Charlie Munger dismisses the cattle ranch as a bad business in under 5 seconds. How can Munger know it is a bad businesses so quickly? He has seen the economics of so many businesses, it becomes fairly easy to dismiss the poor ones. In this case, it is easy to understand that a cattle rancher sells a commodity product. You have never walked into your local Kroger looking for steak from Cattle Ranch X in Flagstaff, Arizona. It is a commodity, pure and simple and the cattle rancher will never have any pricing power. Buffett has often said that the best businesses “buy commodities and sell brands.” Coke is a great example of this, Coke buys sugar and water (basically), puts them together and sells the consumer Coke. See’s Candies is another great example. Hershey’s, Wrigley, Heinz, Budweiser, all of these companies buy commodities and sell brands. Next time your kids are clamoring for Nutella on their breakfast toast, check out the ingredient list: sugar, palm oil and hazelnut, followed by cocoa solids and skimmed milk. This is not rocket science; if you are investor, you want to invest in the company selling Nutella, not the one selling “skimmed milk.” The cattle rancher is always going to be a “price taker” in economic terms. Munger uses his mental models to quickly understand that a cattle rancher is in a commodity business, destined to always be a price taker and immediately dismisses this as a bad business. Thus, he moves on and is able to think more about a better idea…
Charlie Munger did not inquire about the potential purchase price or related asset values of the cattle ranch. Howard Marks has often said, “there are no bad assets, only bad prices.” Munger does not agree. If it’s a bad business, he does not want to be involved, no matter how “cheaply” the asset can be purchased. AK Steel and U.S. Steel make great case studies. If you are a cyclical investor or an asset buyer, you could have had multiple opportunities to make doubles or even triples on these two companies over the years. However, since April 1991, these two companies have returned a total of negative 62% and negative 17%, respectively. By contrast, Hershey’s and Coke have returned 808% and 561% over the same period. Investors in Sears have thought for years that the real estate values were good enough despite the bad retail businesses of Sears and K-Mart. I suspect those investors would have preferred to dismiss Sears and K-Mart within 5 seconds as a bad business instead of spending years trying to “unlock” the value of the real estate. The asset value plays remind me of Buffett’s oft-repeated phrase, “time is the enemy of the bad business and the friend of the good business.” Sears and K-Mart are bad businesses and the longer it takes for the real estate value to be realized, the lower those values will be.
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