Charlie Munger, Warren Buffett Built Berkshire Hathaway to Thrive After They’re Gone

Sarah Hansen, Morningstar Inc markets reporter, discusses why optimism and worry loom over the holiday shopping season. Gregg Warren, strategist for Morningstar Research Services, talks about how Munger’s passing will impact Berkshire and his outlook for the company. He also shares one of his favorite quotes from the sharp-witted investing legend. 

Instacart’s Competition

Lululemon’s Q3 Beats Morningstar’s Expectations

Holiday Shopping Season and Consumer Spending

Retailers’ Mood

Sales Expectations

How the Loss of Charlie Munger Could Impact Berkshire Hathaway

Charlie Munger & Warren Buffett Laid the Groundwork for a Successful Transition

Morningstar’s Outlook on Berkshire Hathaway’s Stock

How Charlie Munger and Warren Buffett Inspired Investors

Favorite Charlie Munger Quote

Read about topics from this episode.

Instacart: Market Dominance at Risk With Heightened Competition

Lululemon Earnings: Strong Momentum Leading Into a Competitive Holiday Period

November Jobs Report Shows Steady Strength In Hiring

Markets Brief: Why Investors Should Pay Extra Attention to Shopping Trends This Holiday

Why Berkshire Hathaway’s Success Will Continue After Charlie Munger ... and Warren Buffett

What to watch from Morningstar.

Why are Active ETFs Everywhere, and Are Investors Abandoning Mutual Funds?

Timing the Market Doesn’t Work — We Did the Math

Make the Most of Your HSA Benefits and Investments in 2024

Headwinds Hold Airlines Back, But Check Out These Travel Stocks for the Holidays

Read what our team is writing:

Sarah Hansen

Greggory Warren

Ivanna Hampton

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Ivanna Hampton: Here’s what’s ahead on this week’s Investing Insights. Charlie Munger’s passing is a “spiritual loss” for Berkshire Hathaway. Morningstar’s Berkshire analyst will explain why what Munger and Warren Buffett built together is expected to thrive for years to come. Plus, we’ll tell you who’s closing in on Instacart and whether the company’s stock is undervalued. And, why this holiday shopping season may hold clues for consumer spending in 2024. This is Investing Insights.

Welcome to Investing Insights. I’m your host, Ivanna Hampton. Let’s get started with a look at the Morningstar headlines.

Instacart’s Rival Competition

Instacart leads online grocery delivery platforms, but rivals are closing the gap. Morningstar has launched coverage of the company. It expects Instacart’s market share to shrink from 70% to 50% by 2027. It's losing ground to DoorDash and Uber. However, Instacart will likely keep the title of market leader. Meanwhile, research company eMarketer predicts Instacart will grow by 13% annually over the next few years. Instacart boasts nearly 8 million users in the U.S., giving them access to most grocery stores. The online grocery delivery service receives a cut of shoppers’ orders. Growth opportunities remain, including expansion beyond the U.S. and Canada and adding new products. Instacart is building a network effect. Its service will become more valuable as more retailers, shoppers, and advertisers use it. Morningstar values Instacart’s shares at $33 and views the stock as undervalued.

Lululemon’s Q3 Beat Morningstar’s Expectations

Lululemon’s third-quarter sales and earnings beat its forecast and Morningstar's expectations. The athletic apparel company reported 19% sales growth. E-commerce and in-store sales improved. The company said the industry rolled out big sales early in the holiday shopping season. It may take the unusual step and spend money on traditional advertising. Lululemon appears on track to finish the year strong, despite concerns about slowing consumer spending. The company recently partnered with connected fitness brand Peloton and exited from another fitness business Mirror. It reported a post-tax impairment of $72 million. Morningstar thinks the financial impact of discontinuing Mirror is minimal since it wasn’t expected to drive in substantial profits. The experience could discourage Lululemon from buying other businesses anytime soon. Instead, it’ll likely use its free cash for share buybacks. Morningstar plans to slightly raise its $267 estimate for what Lululemon's stock is worth. Shares look overvalued.

Holiday Shopping Season and Consumer Spending

The holiday shopping season may hold clues into what’s going on with consumer spending. It has remained strong despite job and wage growth slowing down. Could shoppers finally pull back and buy less stuff? Sarah Hansen has looked into this. She’s a markets reporter for Morningstar Inc.

Thanks for being here, Sarah.

Sarah Hansen: Thanks so much for having me.

Hampton: The forecast has shifted from recession to soft landing among many analysts. Market-watchers are pointing to consumers as the reason. Can you talk about that?

Hansen: Sure. We started 2023 bracing for a recession, and as the year has gone on, it hasn't happened—it just hasn't shaken out that way, and one of the reasons for that is the strength of the consumer. Consumer activity accounts for something like 70% of economic activity in the United States, so it's just a very powerful force. And this year, even as inflation has been relatively high and interest rates have risen, households just kept on spending. And that was good for businesses, it was good for the economy, and it was good for stocks. It helped bolster corporate profits, and it's also helped preserve jobs, since companies that are confident that they'll keep making sales and keep making money are less likely to lay people off.

Hampton: Interest rates are high and credit card debt and delinquencies are up. What's the mood among retailers who depend on a fruitful holiday season?

Hansen: Analysts say that the mood is somewhat cautious. There are lots of reasons to be optimistic right now, but there are also lots of reasons to worry. It really feels like we're at an inflection point for the economy. Interest rates are rising, but it's also true that most consumers are not quite as affected by those high rates as the scary headlines would have you believe. People with mortgages, most of them have locked in their rates before things started ticking up, and most people are not seriously delinquent on things like credit cards or auto loans—and spending, on top of that, was strong over Black Friday and Cyber Monday. But that said, there are also reasons to think that consumers have less wiggle room this year, especially right now, than they have had over the course of the year. That extra cash cushion that people accumulated during the pandemic is being spent down, student loan payments have resumed, and that could also put a dent in household budgets. The labor market right now is strong, but job losses, if they happen, could put a dent in spending, too.

Hampton: So, what are the expectations for sales this year?

Hansen: There's already some evidence that consumers are spending in a more conservative way. We're hearing from retailers that people are opting for, say, smaller DIY projects as opposed to full renovations; people choosing more value-oriented stores compared with higher-end ones. And overall, Morningstar is expecting retail sales to grow this holiday season, but at a slower pace than they did last year.

Hampton: And let's talk about how good or bad shopping numbers could affect Wall Street's outlook. What are market-watchers saying?

Hansen: So, while there is some preliminary data that comes in on holiday spending already about Black Friday and Cyber Monday, we really won't know the full picture of whether or not there was a slowdown until next year. If spending stays strong, when it's especially important for retailers over the holiday season, it could give the economy a pretty big boost. But there also is a pretty interesting catch-22 happening when it comes to people paying attention to markets, which is investors are looking for assurances that the economy is still healthy, but they don't want things to be so robust, too healthy, too hot, so that the Fed feels it needs to raise interest rates or keep them high for too long. Consumer spending that's overly hot could make it harder to get inflation down.

And on the other hand, what investors also want is evidence that the Fed is getting ready to ease policy by cutting rates. That's good for stocks, that's good for the economy, it makes money flow more freely. And a slowdown in consumer spending could be evidence that the Fed is thinking about that. But numbers that are too slow would point to a recession, and that's not what we want either. So, it's a very tricky needle to thread.

Hampton: And what's a takeaway for investors?

Hansen: One good piece of advice I've heard in talking to people is a warning that markets tend to be a little noisier around the end of the year. That's especially true right now. We've had the Fed's last meeting of the year, we don't have any more economic data coming out until 2024, and all that means is that market-watchers and investors will be paying much closer attention to other pieces of information, like consumer spending data, and that could mean more volatility. And it's always a good idea to remember to take a longer-term view when volatility is heightened. It's good to remember that one single positive or negative piece of data won't tip the scales this month, and it's all about keeping an eye on a bigger trend.

Hampton: Well, thank you, Sarah, for your time today.

Hansen: Great. Thanks so much for having me.

Investing legend Charlie Munger served as second-in-command to Warren Buffett at Berkshire Hathaway. Munger passed away at the age of 99 in November. His investing legacy spans 6o-plus years. Gregg Warren has covered Munger, Buffett, and Berkshire for decades. He’s a strategist for Morningstar Research Services. Thanks for being here, Gregg.

Gregg Warren: Thanks for having me.

Hampton: Warren Buffett and Charlie Munger led Berkshire together for decades. What's the impact on the company with the passing of Munger?

Warren: Well, Ivanna, given that Berkshire has historically been run on a decentralized basis with Munger and Buffett doing little to really oversee the day-to-day running of the firm, the impact there is going to be kind of limited.

That said, both men have been really intimately involved in the company's capital allocation decisions, so there will be some impact as Munger has been Buffett's partner investing for the past 60-plus years. One of the main drivers of Berkshire's success over that time has been that Buffett and Munger have been able to find fruitful ways to put the firm's excess capital to work, while also paying close attention to culture and fit when acquiring companies.

That said, Charlie would've been about 100 next month and has not been in the best health the past few years. So, he's not been contributing as much to these efforts as he has in the past, with Buffett actually seeking out more insight from Greg Abel, Ajit Jain, Ted Weschler, Todd Combs, as they will form the bulk of leadership in a post-Buffett and Munger Berkshire.

Hampton: You've written that the investing partners laid the groundwork for a successful transition more than 20 years ago. Talk about that.

Warren: Well, about a decade ago, we really started noting in our research that we felt that Berkshire would survive the eventual departure of both Buffett and Munger. And that there was a groundwork there for a successful transition that they really started around the new millennium. We also acknowledge that the firm's culture and management autonomy, the intrapreneurship feeling that combines everybody that they've ever acquired and worked with, really to a large degree, has become institutionalized within the company.

Now, the key focus here as it relates to the eventual transition is that they started dedicating greater amounts of capital to the acquisition of companies like Berkshire Hathaway Energy, and BNSF, the railway. That could absorb large amounts of excess cash thrown off by Berkshire's operations, either through capital expenditures or both on acquisitions. The expectation here is it would leave less for Buffett and Munger's successors to have to deal with over time.

That's not to say that these successors won't have anything to do, as Berkshire still generates more than $5 billion every quarter in free cash flow. The loss of both Buffett and Munger, in our opinion, would reduce some of the advantages that they've had historically, like being able to extract large amounts of rent from companies for the Buffett seal of approval when making large investments like they did in Bank of America about a decade ago.

On top of that, Berkshire's biggest long-term hurdle in our view is its size, which means it's going to be difficult for them to consistently find deals that not only add value to the firm but are really large enough to be meaningful—something we've really seen up close the past decade. Our take here is that Berkshire is eventually going to evolve from what has been a reinvestment machine into one far more focused on returning capital to shareholders. And this transition, in our view, will only be accelerated by the departure of Buffett and Munger.

Hampton: What's your outlook on Berkshire's stock?

Warren: Right now, based on our fair value estimate, it's $600,000 on the Class As and $400 on the Class Bs. We see the shares as being modestly to moderately undervalued, and the B shares are actually right now trading at a slight discount to the A shares. So, always preferable to step into those when the discount does exist, but it's still not trading at a wide enough margin of safety for us to really tell investors to step in longer term.

We do believe the company, given its diversification and lower overall risk profile, really offers one of the better risk-adjusted return profiles within financial services. And it also is a really good candidate for downside protection during market selloffs. We saw that in 2018, 2020, and last year. Berkshire's ability to generate high-single to double-digit book value growth, which is comfortably above their cost of capital, also has endeared them to investors over time.

We firmly believe it's going to take some time before the company succumbs to the impediments of the size of the business. As we pointed out about a decade ago, we just don't feel that Buffett's departure on top of Munger's passing this year is really going to have as huge of an impact on future operating results as many investors may believe.

That decentralized business model, the business diversification, the high cash-generation capabilities, the unmentioned balance strengths ... Those are all true differentiators for the firm, and in a lot of cases, are competitive advantages overall relative to a lot of their peers. But we still believe the best time to take a stake in Berkshire is when it's trading at a meaningful discount—usually, in the neighborhood of 20% to our fair value estimate.

Hampton: All right. Buffett has credited Munger with reshaping its investment philosophy, and Morningstar credits the duo for influencing its thoughts on investment. What makes Buffett and Munger's investing style an example for others to follow?

Warren: I think for starters, you just look at the results. If we go back to 1965, up until the end of last year, book value per share compounded about 18% annual rate of growth. That compares with 10% return for the S&P 500 annually. And then, the company shares were also about 20% annual on average. So, a fairly good long-term track record.

That said, the last five to 10 years hasn't been as outstanding, but the company has ... Even though book value per share growth trailed the S&P by about 50 to 100 points, the company shares have actually outperformed the market during both those time frames. Still a pretty good result overall. Now, the key to their success really boils down to a few things. They have their own investment criteria as far as what they like to look at when they buy companies.

Key things like simple business models. They're easily understandable. Semblance of an economic moat to keep competitors at bay, large enough deals to be meaningful, consistent earning powers, good returns on equity, good management. These are all things that they really look at, not just when they're doing acquisitions, but when they're actually investing in the shares of companies in the stock market.

And the key to the success that they've had has been staying disciplined and sticking to those criteria whenever they put capital to work. I think Buffett and Munger have also been fond of saying, one way or another over the years, that the key to their success has really been in their ability to avoid making dumb decisions rather than making brilliant ones.

We all know that when Buffett began his investing career, he was looking at cigar butts, something that had one or two good more puffs left in it, but Munger's influence really forced him to focus more on higher-quality companies and being able to pay a higher price point for those companies.

But that said, valuation still matters to both of them. They're looking to buy wonderful companies at fair prices rather than fair companies at wonderful rock-bottom prices. I think that the key there is Munger changed Buffett's mindset to start looking at higher-quality companies and being able to pay a reasonable valuation for what they were getting.

As I look at what they've done and what they've provided for investors over the years, I think the key lessons for me is buy what you know, look for signs of competitive advantage that can sustain those excess returns for longer periods, make sure management is going to be additive to the business, and keep the firm on a path of solid returns. And then, truly focus on price when acquiring or investing in a company.

Hampton: You've served on the analyst panel at the company's shareholder meetings. Can you share an investing lesson or a life lesson you learned from Munger or Buffett?

Warren: Well, I think with Munger, he was always the master of a quick and short retort, which made for very many memorable moments at Berkshire's annual meetings over the years. But actually, one of my favorite Munger quotes relates to not trying to reinvent the wheel. Especially, when it comes to investing.

I'm paraphrasing a bit here, but he basically said that he believes in the discipline of mastering the best that other people have already figured out. Not just sitting down and trying to dream it up all yourself, because nobody's that smart. You get a little bit of snarkiness in there, but you also look at the value of what he's trying to say. I think in a lot of ways, this ties back to their constant refrain about not making dumb decisions rather than making brilliant ones.

Because if you have a good sense of what works, you can really consider what doesn't and avoid going down that path. And I think we've seen that not just within the investment decisions they made, but in some of the other decisions, some of the subseries, like their reinsurance underwriting business, which is a difficult business to operate in and tends to run at a loss. He's given his underwriters the ability to sit on their hands when pricing doesn't make sense.

From that perspective, it's avoiding making that dumb decision of underwriting stuff that you know you're going to lose money on, as opposed to doing the smart thing and just waiting it out and waiting for the price to come back to you. Now, that's not to say that this whole thing is foolproof. Mistakes are always made in investing, and Buffett would be the first to admit that he's made mistakes over the years. But things tend to go better when you're avoiding the obvious mistakes and following paths to success.

Hampton: Well, thanks, Gregg, for sharing your memories and your insights today.

Warren: Thanks for having me.

That wraps up this week’s episode. Thanks for listening. If you enjoy hearing market trends and analyst insights on our podcast, feel free to leave a five-star review on Apple Podcasts. It will help others find us. Thanks to senior video producer, Jake VanKersen, and lead technical producer, Scott Halver. I’m Ivanna Hampton, a senior multimedia editor at Morningstar. Take care.