Compare Companies Using Munger’s Head-To-Head Comparisons

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During their latest episode of the VALUE: After Hours Podcast, Huber, Taylor, and Carlisle discuss Compare Companies Using Munger’s Head-To-Head Comparisons. Here’s an excerpt from the episode:

Huber: So, I thought of three ways that you could use this little system. One is you could just use it for head-to-head comparison. If you think about opportunity costs, Charlie Munger had this– My favorite way to explain opportunity cost is to just rephrase what Charlie Munger said about Wells Fargo years ago, and this no longer applies because they sold Wells Fargo. But he used to say, “Our best idea is Wells Fargo. And we would compare every stock that we’re looking at to Wells Fargo. If it’s not better than Wells Fargo, why not just buy more Wells Fargo?”

So, you could use this system to compare it to your best idea. Whatever your best idea is, you could run every prospective investment against that idea. I actually think it’s more practical to compare it against your least favorite idea. So, let’s say you have 10 stocks in your portfolio, if Wells Fargo is your favorite, you’re not going to sell Wells Fargo to buy the new investment. You’re going to sell the number 10 idea to buy the new investment. So, you might want to compare it to– But you can compare one stock against each other. That’s one way.

The other idea that I wrote down that you could use this for is portfolio weighting. You could use it just like the NCAA hockey to rank– again, let’s say you have 10 stocks in your portfolio. You could rank all 10 through this system and determine which one’s one, which one, 1, 2, 3, all the way up to 10. It would be interesting to do because you might find that let’s say you have a 15% position and a 5%, again, O’Reilly and Fastenal to use those two, let’s say you have 15% in Fastenal and only 5% in O’Reilly, and the system tells you the 5% position should be number one and the 15% position should be number seven. It might give you food for thought. It’s like a check and balance.

The interesting thing is it’s not using random inputs. It’s using your own self-selected variables that are important to you as an investor. So, the system is telling you based on the criteria that you’ve deemed to be important, here’s the ranking. And so, it’s just a fun exercise. It doesn’t really work, if you have a lot of stocks. If you have 30 stocks, you’d end up with close to thousand different pairwise comparisons. [crosstalk] Yeah, it would probably be too much work for the trouble. But if you have a concentrated portfolio, it might be interesting to do that.

The third way you could use some sort of a system like this is the way I’ve been using it, which is to prioritize your research efforts in a list of stocks that you’re looking at. So, I’ve designed a little bank-specific pairwise system to rank the stocks that I’m looking at in that industry. It’s bank-specific criteria, like there’s a liquidity test in there, there’s a leverage test, there’s a profitability test. There’s seven or eight different categories. I assign a one through three ranking or one through three-point system. The goal here is, it’s to do nothing more than filter which ones I should dive into deeper. So, those are the three practical applications that you might be able to use this pairwise system for.

Tobias: That’s great, John.

Jake: The guys over at Ensemble Capital, shoutout to Sean and Todd, they do something similar where they do, I think, it’s zero to three. They’ll basically convert a bunch of qualitative assessments into a quantitative assessment, and then be able to compare things against each other. Everyone makes their own assessment and then they talk it out as to arrive at like, “Okay, we’re going to agree that now this is like a two out of three,” when maybe you thought it was three coming into the meeting. But I think that’s actually a very intelligent way to bring some process into the conversation. That way, you’re not talking past each other about these qualitative things that can be all over the map.

John: Yeah, that’s really interesting. Yeah. I think making it simple is the key. The college hockey system is so elegantly simple. There’s like three points. You get one point for each category. You can compare every team against any other team using that system. And again, the goal here is making better decisions. And so, I think having tools– Jake and I talk about Journalytic a lot. I’m a big fan of writing down my ideas. You’re trying to improve your process, increasing the efficiency of your thinking and your analysis and your research efforts and all of that. And so, these are just tools that you can use to help you– [crosstalk]

Jake: I’d be careful though, John. You’re on a slippery slope that leads you to running a quant value ETF.


John: Yeah.

Jake: Something like– [laughs]

John: Yeah, exactly. That’s the thing. I don’t know, what do you think about this, Toby? But for me, this is more, again, it’s to help me increase the efficiency of the research effort, not to make any decisions. Because the way I would look at this is you’ve already put in the work. You’ve already selected the stocks. You’re just trying to determine– Basically, Charlie Munger said, “Is it better than Wells Fargo?” What this is forcing you to do is explicitly explain to yourself why it’s better than Wells Fargo. You might know just intuitively or just through common sense that stock A is better than stock B. But this forces you to itemize, again, based on your own criteria that you’ve created.

Jake: Yeah, show your work.

John: Yeah, show your work. Exactly. Show your work.

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