Here’s a great article at The Telegraph discussing one of our favorite value investors here at The Acquirer’s Multiple, Charlie Munger. The article provides some great insights into Munger’s relationship with Buffett, his investing strategy, and his ten point investing checklist.
Here’s an excerpt from that article:
The world’s most famous investor, Warren Buffett, is renowned for pithy yet wise one-liners. His business partner, Charles Munger, is less well known – but just as skilled as getting to the heart of the matter.
Like Mr Buffett, Mr Munger hails from Omaha, Nebraska, an unfashionable part of America’s Midwest. As vice-chairman of Berkshire Hathaway, Mr Buffett’s phenomenally successful conglomerate, 94-year-old Mr Munger is in effect Mr Buffett’s lieutenant.
Both are disciples of Benjamin Graham, the father of “value” investing.
Unlike many wealthy and successful investors, the two men do not seek to shroud their strategies in mystery. And Berkshire Hathaway makes a point of not promising to outperform the broad stock market in all market conditions. In fact, investors are given a warning that in rising markets the company is likely to underperform.
By contrast with the complex theories used by hedge fund managers, for instance, the pair’s philosophies and approach can be applied by ordinary “DIY” investors. Mr Munger, in particular, is almost obsessed with simplicity and the power of understanding our limitations as investors.
For decades, academics as well as private and professional investors have picked over the words of both men, delivered in open letters and at Berkshire’s annual shareholder meetings.
In an annual report for Wesco, a mutual savings association that Mr Munger led before Berkshire took it over, he wrote: “It’s remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”
Berkshire Hathaway’s rise has been remarkable: its share price rose by more than 4,000pc between 1990 and 2017, compared with a 659pc increase in America’s S&P 500 index over the same period. And that’s not taking dividends into account.
But Mr Munger’s success pre-dates his formal involvement at Berkshire. Between 1962 and 1975 he ran a partnership for a group of investors, producing annual returns of around 20pc against less than 5pc for the Dow Jones Industrial average.
In his 1984 essay The Superinvestors of Graham-and-Doddsville, Mr Buffett described his first meeting with Mr Munger, who was a lawyer at the time, and his investing style.
“I ran into him in 1960 and told him that law was fine as a hobby but he could do better. His portfolio was concentrated in very few securities and therefore his record was volatile but it was based on the discount-from-value approach.”
This “discount-from-value” approach was, like that of Mr Buffett, based on Benjamin Graham’s theories on value investing.
Graham’s system rests on the premise that companies have a true or “intrinsic” value that may be slightly, or greatly, different from their market price. Once an opportunity has been identified, investors should factor in a “margin of safety” – Graham was happy with a 33pc discount.
The whole approach was based on understanding the bipolar personality of “Mr Market”. This embodiment of stock market sentiment sways between overly confident and fearful while the underlying company remains the same.
Graham’s theories were devised in the wake of the Great Depression. After the Wall Street Crash, stock markets were so unloved that it was possible to buy companies at less than the value that their assets would fetch in the event of liquidation.
The strength of markets since then has reduced the number of companies in that category, according to Mr Munger, necessitating an update of Graham’s ideas.
Mr Munger has played down his influence on Mr Buffett but, in a recent talk at Ross University, he explained how he had helped his partner evolve the original principles of value investing to a focus on higher-quality businesses.
“Warren was taught by Ben Graham to buy things for less than they were worth no matter how lousy the business was. [He then bought a firm that] was absolutely certain to go into liquidation.
“The only way forward from there was to wring enough money out of this little business to have more money than he paid to get in and use it to buy something else – that’s a very indirect way to proceed and I would not recommend it.
“We eventually learnt not to buy these ‘cigar butts’ [companies valued at a fraction of their liquidation value] when they were cheap and do these painful liquidations, and stood by better businesses.”
Mr Munger sums up this change of approach in the maxim: “A great business at a fair price is superior to a fair business at a great price.”
Frustratingly for investors, Mr Munger does not set out a precise formula for successfully picking stocks. Instead, he describes the kind of thinking that a successful long-term investor needs and, in a forerunner to modern theories of behavioural economics, identifies some of the most destructive flaws and biases.
One of the most famous of these essential habits of mind is what he has referred to as “worldly wisdom”. This is the continued broadening of the mind, allied with an understanding that people mainly make decisions through a single way of thinking.
“Most people are trained in one model – economics, for example – and try to solve all problems in one way,” Mr Munger said in one of his most famous speeches. “You know the old saying: to the man with a hammer, the world looks like a nail.”
In his book Charlie Munger: The Complete Investor, Tren Griffin summarises Mr Munger’s approach as follows: “In Mr Munger’s view, it is better to be worldly wise than to spend lots of time working with a single model that is precisely wrong.”
He adds: “A multiple-model approach that is only approximately right will produce a far better outcome.”
Mr Munger’s multi-disciplinary approach was born of his own experience. He studied mathematics but the outbreak of the Second World War meant he could not finish his degree. He served as a meteorologist in the US army before studying law.
It was only after this that he began to invest. To become a “worldly wise” investor Mr Munger has advocated using a “lattice of mental models”. He said that “80 or 90 important models” were required to be worldly wise.
Again, he does not make it easy.
Mr Munger has never set down a list of these crucial models. However, his speeches and writings are littered with references to psychological traits and theories.
In a 1995 speech at Harvard University, Mr Munger set out 24 “standard causes of human misjudgement”.
These range from simple concepts such as denial – “The reality is too painful to bear, so you just distort it until it’s bearable” – to the more complex, such as “bias from overinfluence by social proof “. The example that he cites in his speech is when the giant oil companies Exxon and Mobil (before their merger) each began to buy fertiliser companies simply because the other had.
It is hard for amateur investors to grapple with multiple psychological theories at once, and recognising this Mr Munger has also championed the use of “investment checklists” to help overcome some of the flaws and biases that he identifies.
“You need a different checklist and different mental models for different companies,” said Mr Munger.
“I can never make it easy by saying ‘here are three things’. You have to derive it yourself to ingrain it in your head for the rest of your life.”
In Poor Charlie’s Almanack, a collection of Mr Munger’s ideas that was put together by himself and colleagues, a 10-point checklist (see box, below) is provided to guide investors towards better decisions. Note that Mr Munger does not apply the checklist systematically and the list is not presented in order of importance.
CHARLIE MUNGER’S 10-POINT INVESTING CHECKLIST
Risk: All investment evaluations should begin by measuring risk, especially reputational. Apply Benjamin Graham’s “margins of safety” principles, insist on being compensated for the risk you take on, and avoid companies with questionable individuals.
Independence: “Only in fairy tales are emperors told they are naked.” To be objective you must have independent thoughts. Mimicking the herd will lead to no better than average performance.
Preparation: “The only way to win is to work, work, work, work, and hope to have a few insights.” Learn to love learning and never stop asking ‘why?’.
Intellectual humility: Acknowledging what you don’t know is the dawning of wisdom. Stay within your “circle of competence”, the area within which you have superior expertise, and find and reconcile evidence that goes against your thesis.
Analytic rigour: Use of the scientific method and effective checklists minimises errors and omissions. Separate value and price; assess progress, not just activity, and the wealth of a company, as distinct from its size.
Allocation: Proper allocation of capital is an investor’s number one job. Focus on “opportunity cost”, the alternative options for your cash. When a (rare) good opportunity comes along, bet heavily.
Patience: Resist the natural human bias to act. Do not take action for its own sake; this only adds unnecessary costs and interrupts the magic effects of compound interest.
Decisiveness: When proper circumstances present themselves, act with decisiveness and conviction. Best summed up by Mr Buffett’s adage: “Be fearful when others are greedy and greedy when others are fearful.”
Change: Live with change and accept unremovable complexity. Understand that the world moves on and be willing to adapt your “best-loved ideas”.
Focus: Keep things simple and remember what you set out to do. Guard against hubris and boredom. Filter out the minutiae and focus on the obvious.
You can read the full article at The Telegraph here.
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