Book Review: The Four Filters Invention of Warren Buffett and Charlie Munger (Two Friends Transformed Behavioral Finance)

"I am not a reader, I am a writer." So goes the punchline to an old Russian joke about a reindeer herder who is applying to study philology at the Moscow State University.

I can certainly relate: Reading is difficult for me, writing - a breeze. Given a choice, I substitute the reading of big tomes like Leo Tolstoy's mega drama War and Peace for its Cliffs Notes version.

It's not that I don't want to read Alice Schroeder's The Snowball: Warren Buffett and the Business of Life - I do, but the sheer weight of that book's 976 pages scares the daylights out of me. Why couldn't Alice just spend the time to digest her story into something more palatable to an average Joe, I thought. Bud Labitan must have read my thoughts, because a few days later I received an email from him telling me about his new book on Buffett and Munger.

I had no idea who Bud was, but was so impressed with his mind reading skills that I told him that I would review his book, if he sent it to me. He did, and about a week later the book was in my mailbox. Yesterday, I was stuck at my desk for most of the day and so, finally, got a chance to read it.

To fairly evaluate a book, one must first determine who its target audience is. So my first challenge in reading Labitan's book was trying to figure out who it was written for. Was it intended for a novice or an expert? Is it a guide to a novel investment process, an introduction to value investing in general, or, perhaps, a personal historical overview - a biography of sorts?

On the one hand, many terms used in the book are not first properly defined. On the other, the concepts presented are rather basic and examples pull numbers out of a virtual hat. Some personal stories from Buffett's and Munger's life are retold, but they were not selected for their heartwarming qualities and these retellings are so heavy in quotes that they fail to engage. In fact, the book relies on quotes so much (there are 124 of them, more than pages of content) that it makes you wonder if what you are reading is not, in fact, a report for a business class Bud took at Purdue.

In addition to quotes, the book is also heavy in name dropping. The two names most overused in the book are Benjamin Graham of the "used cigar butt" investing fame and Philip Fisher, a pioneer growth investor, who emphasized quality. Phil Carret, John Burr Williams, Lou Simpson, Jack Byrne and Charles Mizrahi get heavy mention as well. The one name that doesn't get enough mention is Rose Blumkin. Mrs. B. (born Rose Gorelick outside Minsk, Russia in 1893) started Nebraska Furniture Mart in 1937, sold a majority share to Buffett in 1983 and was still involved in day-to-day operations until shortly before her death at the age of 104. She is a legend!

Along with names of important people, the book prominently features names of businesses whose stock Buffett's Berkshire Hathaway owned over the years. Of course, GEICO, Coca Cola, Gillette and Kraft Foods make the requisite list. But in the end, the book simply boils down to rehashing and restating Buffett's investment philosophy of buying "at sensible prices of businesses that have good underlying economics and are run by honest and able people" ad nauseum.

If you savor every written word and are looking for a well written, properly edited and nicely formatted volume, this self-published booklet is not it. If you are interested in a comprehensive biography of Buffett and Munger, look elsewhere. If you are looking for "an amazing Behavioral Finance Formula" advertised on the book's back cover, you will not find it here. But if you, like Bud, think that the main purpose of a glossary is to add pages, even if it is of terms never used in the book - this is the book for you!

Despite all this, I did find some value in the book. Labitan, obviously, spent time studying Buffett and Munger and was able to pull many relevant quotes from Berkshire Hathaway Annual Stockholder Reports as well as from several other sources. The book is no substitute for Cliff Notes on Alice Schroeder's Snowball, but it is short and if skimmed to skip the many repetitions and ignore the few available details that are incomprehensible anyway, can provide a quick introduction to the subject of value investing as practiced by Buffett and Munger.

Now, Alice, can I have a Snowflake?

Comments

[Bud Labitan:]

The Four Filters: U + SCA + ATM + MOS

Jake,

Thanks for a balanced and critical review. The Buffett and Munger innovation was in how they "framed" their investing decision before making it. The liberal use of quotes (which Mr. Buffett approved) was intentional... so that the reader would feel that he was listening to Buffett and not the author Labitan.

I tried to hide my own biases; but a little leaked out in the SOAP process described in chapter 3. The intent there was to show the reader that we can form a general impression of managers using both feelings and facts... using both subjective and objective data.

Here is an old audio clip of Mr. Buffett mentioning the 4 decision filters: [frips.com]

I think the key to appreciating the filters as I do, is to imagine what each of the 4 clusters really represent. 1. Develop an understanding of the economics of the business and its products. 2. SCA is really about Customers. 3. ATM, Able and Trustworthy Managers and 4. Ben Graham's Margin of Safety by buying below Intrinsic Value.

If we give credit to Ben Graham for filter four; then the real advance of the Buffett+Munger collaboration is in "U+SCA+ATM."

Here is an audio that hints at their "growth" in learning towards finding the "wonderful business." [frips.com]

Before we find the "wonderful business," look at the wonderful runner. Imagine a marathon runner and additive factors this way... endurance + strength + determination + experience will probably beat the runner with only endurance + determination.

I hope this explanation helps your readers appreciate the Buffett and Munger innovation of combining 3 qualitative steps with 1 quantitative step... in order to have a higher probability of a better outcome.

Bud

Jun 19 11:22 AM

[Mad Hedge F...:]

they're not infallible. A lot of people like to follow Warren Buffet’s Berkshire Hathaway (BRK/A) as a leading indicator for the market. What better guide than a portfolio of the best of the best, run by the world’s great investor? Recently the news has not been good. If you wonder what a stock looks like when it is rolling over on diminishing volume, this is it. The only question is how big, how fast. As much as I worship the avuncular, chocolate milkshake loving, Sees Candy eating Oracle of Omaha, memorizing his annual letter to investors and hanging on his every spoken word, he hasn’t been doing that well lately. Since March, his main investing vehicle has only managed a 35% gain, compared to a 40% pop for the S&P 500; despite heavy weightings in such best of breed financials like Goldman Sachs (GS). Better keep his ticker on your desk top, because what BRK/A does, the world will follow.

Jun 20 05:33 AM

[Ravi Nagarajan:]

> As much as I worship the avuncular, chocolate milkshake loving,
> Sees Candy eating Oracle of Omaha, memorizing his annual letter to
> investors and hanging on his every spoken word, he hasn’t been doing
> that well lately.

Well, I beg to differ. Market price of Berkshire stock is a poor indicator of how well Buffett and Munger have been doing over the past several months.

Nevertheless, for those with short term mindsets, the Q2 report coming out in August should provide some "momentum" given that the mark to market gains on the derivatives will have reversed Q1's losses and the stock portfolio will be up significantly. The derivative mark to market nonsense is discounted by those who understand Berkshire but I suspect investor interest will be sparked by the improved results. None of this matters for a long term investor but I've observed Berkshire for long enough to come to terms with how misunderstood it is, and the reality that eventually price and intrinsic value will converge.

Jun 20 08:59 AM

[TonyCinTX:]

Well Bud, as a published author (for pay, multiple times) and owner of Berkshire stock (down 25% over last year), I disagree with your philosophy of writing. The point is not to listen to Buffett and Munger, the point and your promise is to elucidate their method, and quotes you can gather is hardly the way to do that. Also, people buy non-fiction books to listen to the authors; not the subjects.

I'd be far more interested in an analysis of Buffett's failed investments (and he admits to many) than in an after-the-fact list of his what-makes-me-great quotes. We read those ad infinitum; "make sure there's a moat", blah blah blah.

You need to add something new; and if you don't have access to WB to do it, it will have to be analysis and your own voice. I've been following Buffett for years. I'm a fan. He's got a big chunk of my investment money. I'm not selling. Nevertheless, I am pretty sure his investing advice can be condensed to a series of six articles, maybe ten, complete with examples. If you don't add something new to that, you don't have a book.

Jun 20 09:10 AM

[grey road:]

BYD company could be huge for them.

Jun 20 10:54 AM

[Sovestor:]

We agree 100% Buffett and Munger are clearly the best investors in the world. However we are 50% unsure that their legacies could be passed to their chosen successors. Buffett and Munger are very rare individually, and extremely rare as a combo. Investors should study their principles and wisdom. We think, the next great highly proven value investors now are John Paulson (Paulson & Co) and Seth Klarman (Baupost). The rest are just trying to emulate Buffett and Munger, or trying to establish themselves as great value investor. If you are 40 to 50 and not year achieving at least $300 million to $1 billion in net-worth nowadays from investing, then you are likely just merely high-performing value investor, not exceptional like Buffett, Munger, Paulson, and Klarman. For those value investors in their 50s who have not even reached $100 million in net-worth due to managing capital....forget about it, you are just ordinary value investor trying to make a very good living by being investment managers promoting the word "value investing"....Any great value investors worth hiring deliver exceptional returns to investors. Hence, John Paulson and Seth Klarman fir the bill as the best value investors today.

Jun 20 11:39 AM

[mkreisel:]

Tracking BRK stock on a monthly basis is just plainly stupid.

There are all kinds episodes during which it underperformed the S&P.

The most notable one was in 1999 when it went down 20+% while the S&P was up 20+%.

Another, even more dramatic underperformance was in 1975 when S&P gained 38% and BRK was down perhaps as much as 40%.

From 2003-2005, BRK again underperformed by as much as 20%.

In all above instances, BRK would come back soaring, utterly crushing the S&P in the following few years. Will this time be different?

Jun 20 02:00 PM

[marru:]

good article.

mgbfinance.blogspot.com/

Jun 21 02:46 AM

[billddrummer:]

Cetin is at it again.

marru, yet another psneudonym.

Jun 21 11:58 PM

[Bud Labitan:]

I think these academic papers help to explain why Buffett and Munger's Four Filters Process outperform the conventional "framing effects" on decision making.

Takemura,K. 1992 Effect of decision time on framing of decision: A case of risky choice behavior. Psychologia, 35,180-185. (In English)

Takemura,K. 1993 The effect of decision frame and decision justification on risky choice. Japanese Psychological Research, 35, 36-40.(In English)

Takemura,K. 1994 Influence of elaboration on the framing of decision. Journal of Psychology, 128, 33-39. (In English)

Takemura,K. 1994 An theoretical explanation of the framing effect: Contingent focus model of decision making under risk. Japanese Psychological Review, 37, 270-291.(In Japanese with English abstract)

Jun 25 08:46 PM