Table of Contents

Part One
Part Two
Part Three
Part Four
Part Five
Part Six
Part Seven
Part Eight
Part Nine
Part Ten
CHARLIE MUNGER
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Charlie Munger
CHARLIE MUNGER
Part One
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The Beginning
“Table 5 is the record of a friend of mine who is a Harvard Law
Graduate, who set up a major law firm. I ran into him in about 1960
and told him that law was a fine hobby but he could do better…”–
Warren Buffett’s introduc-tion to Charlie Munger in his essay: The
Superinvestors of Graham-and-Doddsville.
While growing up Omaha, Charlie Munger had his first run-in with
the Buffett family, although he didn’t meet Warren until several
years later. During his teen years Charlie worked at Buffett & Son, a
grocery store owned by Warren Buffett’s grandfather.
The next few years of Charlie Munger’s life were filled with hard
work, love and tragedy. Charlie left Omaha to attend the University
of Michigan in 1941, and left school in 1943 to enlist in the Army Air
Corps. During this time he met and married Nancy Huggins. The
couple moved to Boston so Charlie could attend Harvard Law
School, where Charlie graduated magna cum laude despite having
no under-graduate degree.
During 1949, Charlie, Nancy, and their three children moved to
California where Charlie joined the law firm Wright & Garrett. Then
in 1953, the Mungers divorced. Munger made his first foray into the
business world at this time. One of his legal clients owned a troubled
transformer company and Charlie brought part of the business.
Tragedy followed when Charlie Munger’s father passed away during
1959. Chalier moved back to Omaha to help his family, a move which
turned out to be the most important decision of his life.
Charlie Munger meets Warren Buffett
While at home in Omaha, Charlie Munger was introduced, through
mutual friends, to Warren Buffett for the first time and the two
immediately became friends. The two friends began speaking for
hours every week discussing potential investment ideas, and
eventually in 1962, Buffett convinced Munger to quit his law job and
start his own investment partnership.
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Charlie Munger’s investment partnership opened for business
during 1962 and immediately started to outperform. Over its life,
from 1962 to 1975, the partnership returned an average of 24.3%
per annum for partners, compared to the DJIA, which returned 6.4%
over the same period.
Charlie Munger quality over value
Charlie’s investment style differed to that of Warren Buffett and
other value investors. Rather than seek-ing out deep value, Munger
looked for quality and during 1965 he convinced Warren Buffett to
adopt the same style.
Indeed, that year he encouraged Buffett to make one of his more
famous bolt-on acquisitions for Berkshire; See’s Candies.
See’s was a legendary West Coast manufacturer and retailer of
boxed chocolates, then annually earning about $4 million pre-tax
while utilizing only $8 million of net tangible assets. Alongside the
tangible asset balance, See’s had one huge asset that did not appear
on its balance sheet: a broad and durable competitive advantage
that gave it significant pricing power:
“…The family controlling See’s wanted $30 million for the business,
and Charlie rightly said it was worth that much. But I didn’t want to
pay more than $25 million and wasn’t all that enthusiastic even at
that figure. (A price 4
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that was three times net tangible assets made me gulp.) My
misguided caution could have scuttled a terrific purchase. But,
luckily, the sellers decided to take our $25 million bid. To date, See’s
has earned $1.9 billion pre-tax, with its growth having required
added investment of only $40 million. See’s has thus been able to
distribute huge sums that have helped Berkshire buy other
businesses that, in turn, have themselves produced large
distributable profits. (Envi-sion rabbits breeding.) Additionally,
through watching See’s in action, I gained a business education
about the value of powerful brands that opened my eyes to many
other profitable investments.”– Warren Buffett Berkshire 2014
letter.
At first, Buffett was reluctant to pay more than book value because
he was schooled in value investing.
However, Munger was adamant that he do the deal.
As it turns out the deal has been wildly successful, producing more
than $1bn in pretax earnings since, a return of more than 4,000%.
Joining Berkshire
Charlie Munger quit the money management business during 1978
and moved to join forces with Buffett full-time, by becoming
Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B)’s vice
chairman.
On another, rather more interesting note. As it turns out, Charlie
Munger was well aware that the New England textile business —
Berkshire Hathaway and later Waumbec — was doomed to fail in
the long-term. Last year at the annual meeting of the Daily Journal
Corp., a publishing firm where he serves as chairman he commented
that:
“[The] textile business in New England… was totally doomed
because textiles are congealed electricity and the power rates were
way higher in New England than they were down in TVA country in
Georgia. A totally doomed, certain-to-fail business,”
If Buffett and Munger had joined forces earlier in their careers, who
knows what could have happened.
End of part one
That’s the end of part one of this series on Charlie Munger. Stay
tuned for the rest of the series.
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Part Two
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Quality Over Value
“Warren talked me into leaving the law business, and that was a
very significant influence on me. I was already thinking about
becoming a full-time investor, and Warren told me I was far better
suited to that. He was right. I would probably have done it myself,
but he pushed me to it. I have to say, it isn’t an easy thing to work
very hard for many years to build up a significant career, as I had
done, and then to destroy that career on purpose. That would have
been a lot harder to do if not for Warren’s influence on me.
It wasn’t a mistake. It worked out remarkably well for both of us and
for a lot of other people…
” —Charlie Munger The Wall Street Journal September 2014.
When Charlie Munger came to Berkshire in the late 60s, Warren
Buffett was still investing according to the Graham-and-Dodd
handbook. Buffett was taught how to invest by Benjamin Graham,
and had followed his deep value cigar butt style of investing for
years while running the Buffett partnerships.
However, Charlie Munger had no such attachment to Benjamin
Graham, or his cigar butt style of investing, which as it turns out, had
a dramatic effect on Berkshire Hathaway Inc. (NYSE:BRK.A)
(NYSE:BRK.B)’s direction in the last 1960’s/early 1970’s — as
covered in part one of this series.
“I don’t love Ben Graham and his ideas the way Warren does. You
have to understand, to Warren — who discovered him at such a
young age and then went to work for him — Ben Graham’s insights
changed his whole life, and he spent much of his early years
worshiping the master at close range.
But I have to say, Ben Graham had a lot to learn as an investor. His
ideas of how to value companies were all shaped by how the Great
Crash and 7
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the Depression almost destroyed him, and he was always a little
afraid of what the market can do. It left him with an aftermath of
fear for the rest of his life, and all his methods were designed to
keep that at bay.
I think Ben Graham wasn’t nearly as good an investor as Warren
Buffett is or even as good as I am. Buying those cheap, cigar-butt
stocks was a snare and a delusion, and it would never work with the
kinds of sums of money we have. You can’t do it with billions of
dollars or even many millions of dollars. But he was a very good
writer and a very good teacher and a brilliant man, one of the only
intellectuals — probably the only intellectual — in the investing
business at the time.” — Charlie Munger The Wall Street Journal
September 2014.
Strictly speaking, in the early days of the Buffett partnerships,
Warren wasn’t a deep value investor, he bought a controlling share
in companies and then pushed management teams to unlock value
through asset sales and other forms of restructuring.
Intangible qualities
Charlie Munger had no real desire to follow Buffett’s activist style.
Instead, Munger was happy to buy quality, seek out arbitrage
opportunities and look for cigar butts. His style differed greatly from
that of Buffett.
“Munger bought cigar butts, did arbitrage, even acquired small
businesses…he said to Ed Anderson, “I just like the great
businesses.” He told Anderson to write up companies like Allergan,
the contact-lens-solution maker. Anderson misunderstood and
wrote a Grahamian report empha-sizing the company’s balance
sheet. Munger dressed him down for it; he wanted to hear about the
intangible qualities of Allergan: the strength of its management, the
durability of its brand, what it would take for someone else to
compete with it.
Munger had invested in a Caterpillar tractor dealership and saw
how it gobbled up money, which sat in the yard in the form of slow-
selling tractors…Munger wanted to own a business that did not
require continual investment, and spat out more cash than it
consumed…Munger was always asking people, “What’s the best
business you’ve ever heard of?”
He wanted to get really rich, really fast. He and Roy Tolles made bets
on whose portfolio would be up more than one hundred percent in a
year. And he was willing to borrow money to make money, whereas
Buffett had never borrowed a significant sum in his life…
Munger did enormous trades [with borrowed money] like British
Columbia Power, which was selling at around $19 and being taken
over by the Canadian government at a little more than $22. Munger
put not just his whole partnership, but all the money he had, and all
that he could borrow into an arbitrage on this single stock—but only
because there was almost no chance that this deal would fall apart.”
— The Snowball: Warren Buffett and the Business of Life.
Still, it wasn’t until the late 1990’s/early 2000’s that Charlie
Munger’s quality over value slant 7
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started to really shine through in both his and Warren’s writings.
For example, in Charlie’s speech “A Lesson on Elementary, Worldly
Wisdom As It Relates to Investment Management & Business.” given
in 1995 he stated that:
“We’ve really made the money out of high quality businesses. In
some cases, we bought the whole business. And in some cases, we
just bought a big block of stock. But when you analyze what
happened, the big money’s been made in the high quality
businesses. And most of the other people who’ve made a lot of
money have done so in high quality businesses.
Over the long term, it’s hard for a stock to earn a much better return
than the business which underlies it earns. If the business earns 6%
on capital over 40 years and you hold it for that 40 years, you’re not
going to make much different than a 6% return—even if you
originally buy it at a huge discount. Conversely, if a business earns
18% on capital over 20 or 30 years, even if you pay an expensive
looking price, you’ll end up with a fine result.
So the trick is getting into better businesses. And that involves all of
these advantages of scale that you could consider momentum
effects.
How do you get into these great companies? One method is what I’d
call the method of finding them small get ’em when they’re little. For
example, buy Wal-Mart when Sam Walton first goes public and so
forth. And a lot of people try to do just that. And it’s a very beguiling
idea. If I were a young man, I might actually go into it.”
Then during 2003, Warren Buffett made the following statement
regarding Coca-Cola, See’s Candies, and Buffalo News at the 2003
Berkshire Hathaway meeting:
“The ideal business is one that generates very high returns on
capital and can invest that capital back into the business at equally
high rates. Imag-ine a $100 million business that earns 20% in one
year, reinvests the $20
million profit and in the next year earns 20% of $120 million and so
forth.
But there are very very few businesses like this. Coke has high
returns on capital, but incremental capital doesn’t earn anything like
its current returns. We love businesses that can earn high rates on
even more capital than it earns. Most of our businesses generate lots
of money, but can’t generate high returns on incremental capital —
for example, See’s and Buffalo News. We look for them [areas to
wisely reinvest capital], but they don’t exist.
So, what we do is take money and move it around into other
businesses. The newspaper business earned great returns but not
on incremental capital. But the people in the industry only knew
how to reinvest it [so they squandered a lot of capital]. But our
structure allows us to take excess capital and invest it elsewhere,
wherever it makes the most sense. It’s an enormous advantage.”
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CHARLIE MUNGER
This mentality had a dramatic effect on Berkshire Hathaway’s
performance over the years. All you need to do is to look at Buffett’s
acquisition of See’s Candies in the late 1960’s, to realize that without
Charlie Munger’s quality over value influence on Buffett, Berkshire
wouldn’t have become the American corporate giant it is today.
Buffett’s Early Investment Performance Was Driven By
Activism Warren Buffett’s investment strategy has changed over
the years. From a deep-value nets-nets investing methodology to
today’s, quality at a reasonable price philosophy, Buffett’s portfolio
has undergone several changes.
But in the early days of Buffett’s partnerships, the then
undiscovered Oracle of Omaha used an activist strategy to get
results, the use of which allowed him to make big bets with a highly
concentrated portfolio.
Indeed, reading through Buffett’s early partnership letters to
shareholders (mid 50’s to late 60’s), almost all of the investment
examples he gives are activist situations. He often devoted around a
fifth or more of assets under management into each situation.
Buffett’s activism in Dempster Mill
For example, Buffett started acquiring stock in Dempster Mill, a
manufacturer of farm implements and water systems, during 1956
when the stock was selling at $18, while book value stood at $72 per
share
— current assets amounted to $50 per share.
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Dempster had been highly profitable for many years, although when
Buffett entered the picture the company was only breaking even,
hence the low valuation.
Buffett’s Dempster position was acquired over a period of five years,
from 1956 to 1961 and as Buffett sat on the board of directors, he
became increasingly frustrated with the way the business was being
run.
Then during 1961 Buffett used his financial firepower to acquire
70% of Dempster stock, push out the management team, bring in
new managers and instigate change. Eventually during 1963 Buffett
sold Dempster’s assets for around $80 per share.
This kind of activism investing is common with most of Buffett’s
bigger positions all the way up to the late 60s.
The Sanborn Map trade
Take the Sanborn Map trade (this can be considered a trade because
Buffett was not involved for much more than a year). Before taking a
position, Buffett had computed how long he was willing to hold the
company’s stock and what returns he wanted to make within the
time period. He expected to realize value from the deal within a year
and took a huge bet, using 35% of net partnership assets to acquire
stock.

Like Dempster, Sanborn offered value. The company produced maps

of all cities of the United States, but due to falling profitability the
company’s stock price had fallen significantly below its asset value.
(Sanborn was a special situation, the company owned a portfolio of
securities value at $65 per share, while the company’s stock only
traded at $45. The map business was value at 0 and portfolio of
securities value at $0.70 on the dollar.)
Through various means Buffett and other parties, all of which
wanted change, acquired around 50% of Sanborn’s outstanding
stock and put forward a motion to separate the investment portfolio
and maps businesses. The reorganization was eventually pushed
through, unlocking value from the investment portfolio and
revaluing the map business.
Buffett’s acquisition of Berkshire Hathaway
And finally there’s Berkshire Hathaway Inc. (NYSE:BRK.A)
(NYSE:BRK.B), which was acquired for Buffett’s portfolio at a price
of $7.60 per share, while the firm had working capital of $19 per
share. Buffett, by his own admission should have cut and run with
Berkshire but he stayed, took the company over and tried to turn
things around. Buffett calls this his “$200 billion mistake”.
While these are only three examples from Buffett’s early career, the
weight in his portfolio and speed that these situations were
completed, hints at activism. The Oracle of Omaha consistently
refers to, ‘beating the Dow’ within his early letters and he is always
on the lookout for investments where he can drive outperformance
over a set time frame, often appearing unwilling to wait for
situations to play out.
Perhaps then, if you’re looking to replicate Buffett’s earlier success,
it might be better to follow the likes of outperforming activist
investors such as Bill Ackman, who runs a concentrated portfolio
and has returned 1,199% since starting his fund in 2004. Berkshire
stock has only returned 135% over the same period.
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Part Three
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Sit on your ass
Charlie Munger was never attached to the deep value, Graham esque
mentality like many of his value peers. In fact, Munger always
preferred quality over value. A high quality business trading at an
attractive valuation was Charlie Munger’s Holy Grail.
It wasn’t until the turn of the century that Munger was able to give a
name to this style of investing. The name he chose was; sit on your
ass investing.
The concept of sit on your ass investing was introduced at the 2000
Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) Annual
meeting. The essence of this new school of investment theory; find a
few outstanding companies, buy them, and hold them forever.
In many ways this style of investment management can be traced
back to Berkshire Hathaway’s early days. See’s Candies, Coca-Cola
and American Express Company (NYSE:AXP) were all quality
business brought at an attractive price with the intention of holding
them forever. According to Charlie Munger —
a view that’s also affected Warren Buffett’s style — you should only
buy a stock if you are not willing to hold for ten years, and if you are
willing to commit a substantial portion of your money to it.
Up until the late 1980’s, even Warren Buffett didn’t follow this
school of thought. He traded in and out of undervalued stocks,
selling them when they reached full value and positions were rarely
held for more than a year or two.
Buffett’s active style of management didn’t suit Charlie Munger,
anyway, the figures showed that a more passive style of
management would be better over the long-term.
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The power of compounding
The success of sit on your ass investing is driven by a company’s
ability to successfully compound shareholder equity at an attractive
rate over the long-term — if this isn’t possible, the strategy won’t
work and it’s easier to buy low and sell high.
Charlie Munger’s speech, “A Lesson on Elementary, Worldly Wisdom
As It Relates To Investment Management & Business”, breaks it
down nicely:
“Over the long term, it’s hard for a stock to earn a much better
return than the business which underlies it earns. If the business
earns 6% on capital over 40 years and you hold it for that 40 years,
you’re not going to make much different than a 6% return—even if
you originally buy it at a huge discount. Conversely, if a business
earns 18% on capital over 20 or 30 years, even if you pay an
expensive looking price, you’ll end up with a fine result.”
Similarly, here’s what Warren Buffett said about Coca-Cola, See’s
Candies, and Buffalo News at the 2003 Berkshire Hathaway
meeting:
“The ideal business is one that generates very high returns on
capital and can invest that capital back into the business at equally
high rates. Imag-ine a $100 million business that earns 20% in one
year, reinvests the $20
million profit and in the next year earns 20% of $120 million and so
forth.
But there are very very few businesses like this. Coke has high
returns on capital, but incremental capital doesn’t earn anything like
its current returns. We love businesses that can earn high rates on
even more capital than it earns. Most of our businesses generate lots
of money, but can’t generate high returns on incremental capital —
for example, See’s and Buffalo News. We look for them [areas to
wisely reinvest capital], but they don’t exist.
So, what we do is take money and move it around into other
businesses. The newspaper business earned great returns but not
on incremental capital. But the people in the industry only knew
how to reinvest it [so they squandered a lot of capital]. But our
structure allows us to take excess capital and invest it elsewhere,
wherever it makes the most sense. It’s an enormous advantage.”
At the same meeting, Charlie Munger added the following statement:
“There are two kinds of businesses: The first earns 12%, and you
can take it out at the end of the year. The second earns 12%, but all
the excess cash must be reinvested — there’s never any cash. It
reminds me of the guy who looks at all of his equipment and says,
“There’s all of my profit.” We hate that kind of business.”
How do you get into these great companies?
Of course, if good businesses were easy to find, investing would be
easy. Half the battle is finding these 13
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great companies at great prices.
This is a broad topic and not one that I have space to go into here.
Nonetheless, Charlie Munger does have some views on the topic:
“How do you get into these great companies? One method is what I’d
call the method of finding them small get ’em when they’re little. For
example, buy Wal-Mart when Sam Walton first goes public and so
forth. And a lot of people try to do just that. And it’s a very beguiling
idea. If I were a young man, I might actually go into it.
But it doesn’t work for Berkshire Hathaway anymore because we’ve
got too much money. We can’t find anything that fits our size
parameter that way. Besides, we’re set in our ways. But I regard
finding them small as a perfectly intelligent approach for somebody
to try with discipline. It’s just not something that I’ve done.
Finding ’em big obviously is very hard because of the competition.
So far, Berkshire’s managed to do it. But can we continue to do it?
What’s the next Coca-Cola investment for us? Well, the answer to
that is I don’t know. I think it gets harder for us all the time….
And ideally and we’ve done a lot of this—you get into a great
business which also has a great manager because management
matters. For example, it’s made a great difference to General Electric
Company (NYSE:GE) that Jack Welch came in instead of the guy who
took over Westinghouse—
a very great difference. So management matters, too.
Occasionally, you’ll find a human being who’s so talented that he can
do things that ordinary skilled mortals can’t. I would argue that
Simon Marks—who was second generation in Marks & Spencer of
England—was such a man. Patterson was such a man at National
Cash Register. And Sam Walton was such a man.
These people do come along—and in many cases, they’re not all that
hard to identify. If they’ve got a reasonable hand—with the
fanaticism and intelligence and so on that these people generally
bring to the party—then management can matter much.
However, averaged out, betting on the quality of a business is better
than betting on the quality of management. In other words, if you
have to choose one, bet on the business momentum, not the
brilliance of the manager.
But, very rarely, you find a manager who’s so good that you’re wise
to follow him into what looks like a mediocre business.” — Charlie
Munger’s speech, “A Lesson on Elementary, Worldly Wisdom As It
Relates To Investment Management & Business”.
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Part Four
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Investment Advice
Following on from part three of this series, which explored Charlie
Munger’s ‘sit on your ass’ method of investing, in this part I’m going
to take a look at some of the investment advice that Charlie Munger
has dished out over the years.
Charlie Munger’s age and experience means that he has become one
of the most quotable investors of all time. He says what’s on his
mind, without fear of offending anyone, often making statements
others would have trouble making in public.
Unfortunately, it’s not possible to cram all of Munger’s investment
wisdom into one article. So with the limited space available here, I’m
going to try and condense a few of Charlie’s best nuggets of advice
on to this page.
Cash is king
“The way to get rich is to keep $10 million in your checking account
in case a good deal comes along…There are worse situations than
drowning in cash and sitting, sitting, sitting. I remember when I
wasn’t awash in cash —
and I don’t want to go back.”
In part three, I looked at Charlie Munger’s idea that the best way to
build wealth is to buy great businesses at rock bottom prices. You’ll
have trouble following this strategy if you don’t have cash ready to
deploy at a moment’s notice. Cash offers flexibility, and while it may
not be earning interest with rates near zero, cash’s value isn’t its
ability to earn interest. Providing flexibility and options is how it
earns its keep.
When you keep cash on hand, you need to be patient and wait for
the perfect opportunity. Patience is a fundamental element of
Charlie Munger’s sit on your ass strategy:
“I did not succeed in life by intelligence. I succeeded because I have a
long attention span.”
If you’re concerned about what’ll happen in the markets over the
next five months, you are doing it wrong. Look to the long-term. As
covered in part three:
“…if a business earns 18% on capital over 20 or 30 years, even if you
pay an expensive looking price, you’ll end up with a fine result.”
What’s more:
“There are huge advantages for an individual to get into position
where you make a few great investments and just sit back. You’re
paying less to brokers. You’re listening to less nonsense…If it works,
the governmental tax system gives you an extra one, two, or three
percentage points per annum with compound effects.”
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The ever-growing profit of Buffett’s See’s Candy. Credit Hurricane
Capital case study of See’s Candy.
The underlying business
Just like Warren Buffett, Charlie believes that every stock should be
viewed as the ownership rights to a business, not just a piece of
paper, which may, or may not, increase in value over time:
“The number one idea is to view a stock as an ownership of the
business and to judge the staying quality of the business in terms of
its competitive advantage. Look for more value in terms of
discounted future cash-flow than you are paying for. Move only
when you have an advantage.”
Once again, the above piece of advice reiterates the fact that good
businesses should be brought at attractive prices; it pays to wait for
the right price. Additionally, for those investors that are concerned
about short-term volatility, Munger gives the following advice:
“This great emphasis on volatility in corporate finance we regard as
nonsense. Let me put it this way; as long as the odds are in our favor
and we’re not risking the whole company on one throw of the dice
or anything close to it, we don’t mind volatility in results. What we
want are favorable odds.”
This statement has its roots in Benjamin Graham’s teachings. The
definition of risk has changed over the past two or three decades.
Indeed, many investors now view risk as short-term volatility,
rather than its correct definition of long-term capital loss as Warren
Buffett explained in his age-old essay, The Superinvestors of
Graham-and-Doddsville:
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“…to people that think beta measures risk, the cheaper price would
have made it look riskier. This is truly Alice in Wonderland. I have
never been able to figure out why it’s riskier to buy $400 million
worth of properties for $40 million than $80 million. And, as a
matter of fact, if you buy a group of such securities and you know
anything at all about business valuation, there is essentially no risk
in buying $400 million for $80 million…”
The most important advice
Finally, the two most important pieces of advice that Munger has
issued over the years.
These two statements are surprisingly simple but at the same time,
they are both fundamental factors of long-term wealth creation:
“Spend less than you make; always be saving something. Put it into a
tax-deferred account. Over time, it will begin to amount to
something. This is such a no-brainer.”
“Each person has to play the game given his own marginal utility
considerations and in a way that takes into account his own
psychology. If losses are going to make you miserable – and some
losses are inevitable – you might be wise to utilize a very
conservative patterns of investment and saving all your life. So you
have to adapt your strategy to your own nature and your own
talents. I don’t think there’s a one-size-fits-all investment strategy
that I can give you.”
Trying to navigate the financial markets can be a tough sport,
something Charlie Munger, one of the world’s most successful
investors admits. However, if you play to your strengths, invest for
the long-term and buy quality at a reasonable price, you stand a
good chance of outperforming over the long-term.
If you’re looking for more of Charlie’s advice, below is a selection of
links to various interviews.
Investing Advice from Warren Buffett’s Right-Hand Man – Time
Warren Buffett and Charlie Munger’s best advice
Make Money Like Munger
Charlie Munger’s Investing Principles
Some Good Advice from Berkshire Hathaway’s Charlie Munger 19
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Part Five
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Checklist Investing
Following on from parts three and four, in this, part five of a ten part
series on Charlie Munger, I’m looking at Munger’s investment
process and style of investing.
Checklists are an important tool for investors. The use of checklists
to improve processes first started in aviation and medicine. They
have become an important tool for doctors and pilots to help
minimize mistakes. Atul Gawande’s book, Checklist Manifesto covers
the subject in depth, although strictly speaking Checklist Manifesto
isn’t a guide to financial checklists; it’s more of an essential primer
on complexity in medicine. Indeed, doctors often overlook or omit
steps in the multitude of tasks they have to perform every day, and
as Atul Gawande argues, these are situations where a simple to-do
list could help.
A quick example. According to the New York Times, during 2001 a
simple five-point checklist put in place at Johns Hopkins Hospital
virtually eradicated central line infections in intensive care. It’s
estimated that over the period 43 infections and eight deaths over
27 months were prevented.
Charlie Munger – Poor Charlie’s Checklist
Charlie Munger is also an advocate of using checklists and the list
that he has fund most valuable to investing was published within
Peter Kaufman’s book, “Poor Charlie’s Almanack”.
Poor Charlie’s Almanack is a collection of Charlie Munger’s speeches
and ideas, many of which focus on the development of investors’
skills, or as Charlie Munger would put it, worldly wisdom.
Charlie Munger’s philosophy is that to become successful at stock
picking, and life in general, you need to have a broad view of the
world.
“What is elementary, worldly wisdom? Well, the first rule is that you
can’t really know anything if you just remember isolated facts and
try and bang
‘em back. If the facts don’t hang together on a latticework of theory,
you don’t have them in a usable form. You’ve got to have models in
your head.
And you’ve got to array your experience ? both vicarious and direct ?
on this latticework of models. You may have noticed students who
just try to remember and pound back what is remembered… the
wisdom of the world is not to be found in one little academic
department. That’s why poetry professors, by and large, are so
unwise in a worldly sense. They don’t have enough models in their
heads…”
Charlie Munger’s checklist was designed to help investors deploy
their worldly wisdom.
“Checklist routines avoid a lot of errors. You should have all this
elementary [worldly] wisdom and then you should go through a
mental checklist in order to use it. There is no other procedure in
the world that will work as well.” — Charlie Munger speech to the
University of Southern California Law School.
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Charlie Munger
CHARLIE MUNGER
Charlie Munger – Condensed checklist
Charlie Munger’s full checklist, as published within Poor Charlie’s
Almanack, is extensive and difficult to follow. With that in mind,
here is a condensed version as published on Stockopedia. Charlie’s
full checklist is published below.
Measure risk: All investment evaluations should begin by
measuring risk, especially reputational. This is said to involve
incorporating an appropriate margin of safety, avoiding permanent
loss of capital and insisting on proper compensation for risk
assumed.
Be independent: Only in fairy tales are emperors told they’re
naked. Remember that just because other people agree or disagree
with you doesn’t make you right or wrong – the only thing that
matters is the correctness of your analysis.
Prepare ahead: The only way to win is to work, work, work, and
hope to have a few insights. If you want to get smart, the question
you have to keep asking is “why, why, why?”
Have intellectual humility: Acknowledging what you don’t know is
the dawning of wisdom. Stay within a well-defined circle of
competence & identify and reconcile disconfirming evidence.
Analyze rigorously: Use effective checklists to minimize errors and
omissions. Determine value apart from price; progress apart from
activity; wealth apart from size. Think forwards and backwards –
Invert, always invert
Allocate assets wisely: Proper allocation of capital is an investor’s
No. 1 job. You should remember that good ideas are rare – when the
odds are greatly in your favor, bet heavily. At the same time, don’t
“fall in love” with an investment.
Have patience: Resist the natural human bias to act. “Compound
interest is the eighth wonder of the world” (Einstein); never
interrupt it unnecessarily and avoid unnecessary transactional taxes
and frictional costs.
Be decisive: When proper circumstances present themselves, act
with decisiveness and conviction. Be fearful when others are greedy,
and greedy when others are fearful. Opportunity doesn’t come often,
so seize it when it comes.
Be ready for change: Accept unremovable complexity. Continually
challenge and willingly amend your
“best-loved ideas” and recognize reality even when you don’t like it
– especially when you don’t like it Stay focused: Keep it simple and
remember what you set out to do. Remember that reputation and
integrity are your most valuable assets – and can be lost in a
heartbeat. Face your big troubles; don’t sweep them under the rug.
Charlie Munger’s full checklist
Risk — All investment evaluations should begin by measuring risk,
especially reputational Incorporate an appropriate margin of safety
Avoid dealing with people of questionable character Insist upon
proper compensation for risk assumed
Always beware of inflation and interest rate exposures Avoid big
mistakes; shun permanent capital loss –
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CHARLIE MUNGER
Independence — “Only in fairy tales are emperors told they are
naked”
Objectivity and rationality require independence of thought
Remember that just because other people agree or disagree with
you doesn’t make you right or wrong –
the only thing that matters is the correctness of your analysis and
judgment Mimicking the herd invites regression to the mean
(merely average performance) Preparation — “The only way to
win is to work, work, work, work, and hope to have a few insights”
Develop into a lifelong self-learner through voracious reading;
cultivate curiosity and strive to become a little wiser every day
More important than the will to win is the will to prepare Develop
fluency in mental models from the major academic disciplines If you
want to get smart, the question you have to keep asking is “why,
why, why?”
Intellectual humility — Acknowledging what you don’t know is the
dawning of wisdom Stay within a well-defined circle of competence
Identify and reconcile disconfirming evidence
Resist the craving for false precision, false certainties, etc.
Above all, never fool yourself, and remember that you are the
easiest person to fool –
Analytic rigor — Use of the scientific method and effective
checklists minimizes errors and omissions Determine value apart
from price; progress apart from activity; wealth apart from size It is
better to remember the obvious than to grasp the esoteric Be a
business analyst, not a market, macroeconomic, or security analyst
Consider totality of risk and effect; look always at potential second
order and higher level impacts Think forwards and backwards –
Invert, always invert –
Allocation — Proper allocation of capital is an investor’s number
one job Remember that highest and best use is always measured by
the next best use (opportunity cost) Good ideas are rare – when the
odds are greatly in your favor, bet (allocate) heavily Don’t “fall in
love” with an investment – be situation-dependent and opportunity-
driven –
Patience — Resist the natural human bias to act
“Compound interest is the eighth wonder of the world” (Einstein);
never interrupt it unnecessarily Avoid unnecessary transactional
taxes and frictional costs; never take action for its own sake Be alert
for the arrival of luck
Enjoy the process along with the proceeds, because the process is
where you live –
Decisiveness — When proper circumstances present themselves,
act with decisiveness and conviction Be fearful when others are
greedy, and greedy when others are fearful Opportunity doesn’t
come often, so seize it when it comes 23
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Charlie Munger
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Opportunity meeting the prepared mind; that’s the game –
Change — Live with change and accept unremovable complexity
Recognize and adapt to the true nature of the world around you;
don’t expect it to adapt to you Continually challenge and willingly
amend your “best-loved ideas”
Recognize reality even when you don’t like it – especially when you
don’t like it Focus – Keep things simple and remember what you set
out to do Remember that reputation and integrity are your most
valuable assets – and can be lost in a heartbeat Guard against the
effects of hubris (arrogance) and boredom Don’t overlook the
obvious by drowning in minutiae (the small details) Be careful to
exclude unneeded information or slop: “A small leak can sink a great
ship”
Face your big troubles; don’t sweep them under the rug 23
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Part Six
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Charlie Munger
CHARLIE MUNGER
The Daily Journal
Charlie Munger is best known for his career as Vice-Chairman of
Berkshire Hathaway Corporation and for being Warren Buffett’s
right hand man. He is also chairman of the Daily Journal Corporation
and has been instrumental in the Journal’s growth over the past six
years.
The Daily Journal is a publisher specializing in legal text. The Daily
Journal provides news of interest to members of the legal
profession, specializes in public notice advertising, publishing state-
mandated notices of death, fictitious business names, and sells
software used to administer court cases. Charlie Munger started his
working life as a lawyer, so the Daily Journal is a natural fit for him.
The Daily Journal was a strong business up until the financial crisis.
Return on equity averaged 25% to 30% per annum; cash conversion
was 70% per annum on average, and book value doubled between
2005 and 2008. However, since 2010 revenue growth has slowed to
around 2.6% per annum and net income has fallen by 75%. EBITDA
has more than halved.
Luckily, during the first quarter of 2009, Charlie Munger used $15.5
million of the Daily Journal’s cash to purchase a number of securities
for the company. At first, neither Charlie Munger nor the Journal
disclosed these positions, (although with both Munger and Rick
Gurin working at the Journal, these positions we certain to value
orientated and low-risk). This post from The Value Investors Club
blog post, written only a few months after Munger started buying
shows the secrecy surround the transactions:
“During the first quarter of 2009, Charlie Munger, Chairman of Daily
Journal Corp. (DJCO), made a significant redeployment of the
company’s excess cash into an investment in common equities.
Based on circumstantial evidence, we believe (but cannot be 100%
certain since the Company has not disclosed what its invested in)
that Munger purchased shares of Wells Fargo & Co (NYSE:WFC)
and/or possibly U.S. Bancorp (NYSE:USB) at their recent early-
March lows.”
“As such, DJCO now contains a hidden asset that may not be fully
reflected in its current share price.”
“Based on circumstantial evidence, it appears possible that Munger
plunked $15.5mm of DJCO cash to buy WFC (or USB or both). If this
speculation on DJCO’s equity purchase(s) is correct, then that $15.5
million investment which rose to $24.7mm at the end of March
would now be up to $33-42 million at today’s prices for USB/WFC.
Thus in summary, DJCO looks cheap at a market cap of $64.5
million…we believe there is good value in DJCO based on the
strength of Munger’s legendary capital allocation skills.” — Value
Investors Club July 2009.
Time to buy
Charlie Munger started buying securities with the Journal’s cash for
two reasons. Firstly, value: 25
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CHARLIE MUNGER
“We bought Wells Fargo & Co (NYSE:WFC) stock when it was at $8,
and I don’t think we will have another opportunity like that.” —
Charlie Munger Daily Journal 2015 Meeting [FULL NOTES]
Secondly, the Journal’s board believed that jumping into stocks was
the safest move during the financial crisis:
“The board recognized that this decision would be contrary to the
conven-tional (but questionable) notion that the least risky way to
preserve corporate capital for the long-term benefit of stockholders
is to invest it in government bonds at interest rates approximating
zero,” Source.
From a starting point of just under $16 million, the Daily Journal’s
portfolio had grown to $135.3 million as of 31 December last year.
The portfolio’s holding were revealed for the first time during 2014,
and they are typical Buffett/Munger style investments. Four main
companies account for the bulk of the portfolio; Wells Fargo (by far
the largest position around 70% of portfolio), Bank of America, U.S.
Bancorp and Korean steel producer Posco.
“Posco is the most efficient steel company in the world. It had a
pretty close to a local monopoly position in its country for a long
time. It is very hard to avoid being commoditized in the modern
world. In the places like The The Dow Chemical Company
(NYSE:DOW) Company (NYSE:DOW) with complex chemical
process, with 1000 PhDs, it is still hard to not be commoditized.
Posco was able to do so.” — Charlie Munger Daily Journal 2015
Meeting [FULL NOTES]
And Charlie Munger’s investments have put a rocket under the Daily
Journal’s book value growth. Here’s the Journal’s book value per
share from year-end 2008 to year-end 2014.
Data from Morningstar
Running out of space
It’s almost impossible to cover Charlie Munger’s whole career at the
Daily Journal in only one article.
Nevertheless, this brief history of the Journal’s share portfolio, and
how it has changed the company’s fortunes since inception, does
shed a great deal of light on Charlie Munger’s investing style, as well
as what he looks for when buying a stock and how he would run his
own stock portfolio.
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Charlie Munger
CHARLIE MUNGER
As I have run out of space here, I’ve included a selection of articles
below that provide more information on Charlie Munger’s time at
the Journal.
Notes From Charlie Munger’s Daily Journal Meeting 2015
Munger’s Daily Journal Lifts Curtain of Secrecy on Bets Charlie
Munger’s Portfolio At Daily Journal
Warren Buffett sidekick Munger creates a mini-Berkshire at Daily
Journal Daily Journal Corp Annual Meeting Notes (Feb 6, 2013)
What’s Up With Charlie Munger’s Other Company
The SEC Thought Charlie Munger Was Hiding A Hedge Fund A
Fireside Chat With Charlie Munger
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CHARLIE MUNGER
Part Seven
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Part seven: Poor Charlie’s Almanack
Without a doubt, the best resource you can get on Charlie Munger is
the book, Poor Charlie’s Almanack: The Wit and Wisdom of Charles
T. Munger .
Poor Charlie’s Almanack was constructed by Peter D. Kaufman (the
production team also included Travis Gallup, Carl Foote, Scott Rule,
Dwight Tompkins, Michael Broggie, Steve Mull, Pamela Koch, Eric
Hartman-Birge, Paul Hartman, Charles Belser, Ed Wexler, Whitney
Tilson, Marcus Kaufman, Peter Kaufman, Carol Loomis, Debbie
Bosanek, and Doerthe Obert) and groups together a broad selection
of Charlie Munger’s essays, memoirs, interviews, and speeches. The
book is based on Benjamin Franklin’s Poor Richard’s Almanack, a
popular collection of calendars, weather-related and astrological
material that was published from 1733 to 1758.
Poor Charlie’s breakdown
The first chapter of the book includes a biography of Munger, a short
version of which you can find here — the start of this series. Poor
Charlie’s Almanack then goes on to discuss “the Munger approach to
life, learning, decision-making, and investing”. This part of the book
is just as important as any other.
Poor Charlie’s Almanack was one of the first publications to draw
attention to Munger’s ‘multiple mental models’ approach to
evaluating businesses. Key to this approach is Charlie’s investing
checklist, which I covered in part five of this series.
Also introduced alongside Charlie Munger’s metal models, is his
“Lollapalooza Effect“.
The “Lollapalooza Effect” is, in Charlie’s words, the “multiple biases,
tendencies or mental models all acting at the same time in the same
direction to produce extreme outcomes and investor
misjudgement”.
Or in other words, the “Lollapalooza Effect” describes the mentality
of short-term investors, who chase wild market gyrations in an
attempt to profit.
Charlie’s essays
Chapter three of Poor Charlie’s Almanack covers material from
Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) and
WescoFinancial meetings. The rest of the book is devoted to ten
stand-out talks from Munger given over his 20-year career.
Poor Charlie’s Almanack is essential reading for all value investors.
Not only does it provide essential investing advice, but it also guides
on the psychological side of investing and life in general.
Below are just two excerpts from the book. These two short lessons
are taken from Charlie Munger’s lecture to the students of Professor
Guilford Babcock, at the University of Southern California Marshall
School of Business. the lecture was tilted, “A Lesson On Elementary,
Worldly Wisdom As It Relates To Investment Management &
Business.”
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CHARLIE MUNGER
If you’re interested in more of Charlie Munger’s musings, but don’t
have access to Poor Charlie’s Almanack, here’s a PDF compilation of
documents.
YOU’LL FAIL IN BUSINESS AND IN LIFE.
Without a latticework of models, you’ll fail in school and life.
Munger: What is elementary, worldly wisdom? Well, the first rule is
that you can’t really know anything if you just remember isolated
facts and try and bang ’em back. If the facts don’t hang together on a
latticework of theory, you don’t have them in a usable form.
You’ve got to have models in your head. And you’ve got to array
your experience – both vicarious and direct – on this latticework of
models. You may have noticed students who just try to remember
and pound back what is remembered. Well, they fail in school and
fail in life. You’ve got to hang experience on a latticework of models
in your head.
Absent enough models, your brain will torture reality.
Munger: What are the models? Well, the first rule is that you’ve got
to have multiple models – because if you just have one or two that
you’re using, the nature of human psychology is such that you’ll
torture reality so that it fits your models, or at least you’ll think it
does. You become the equivalent of a chiropractor who, of course, is
the great boob in medicine.
It’s like the old saying, “To the man with only a hammer, every
problem looks like a nail.” And of course, that’s the way the
chiropractor goes about practicing medicine. But that’s a perfectly
disastrous way to think and a perfectly disastrous way to operate in
the world. So you’ve got to have multiple models.
And the models have to come from multiple disciplines – because all
the wisdom of the world is not to be found in one little academic
department. That’s why poetry professors, by and large. are so
unwise in a worldly sense. They don’t have enough models in their
heads. So you’ve got to have models across a fair array of disciplines.
Fortunately, it isn’t all that tough….
Munger: You may say, “My God, this is already getting way too
tough.” But, fortunately, it isn’t that tough
– because 80 or 90 important models will carry about 90% of the
freight in making you a worldly-wise person. And, of those, only a
mere handful really carry very heavy freight.
YOU’RE GIVING A HUGE ADVANTAGE TO OTHERS IF YOU DON’T
LEARN THIS SIMPLE TECHNIQUE.
…Obviously, you’ve got to he able to handle numbers and quantities
– basic arithmetic.
And the great useful model, after compound interest, is the
elementary math of permutations and combinations. And that was
taught in my day in the sophomore year in high school. I suppose by
now in great private schools, it’s probably down to the eighth grade
or so.
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CHARLIE MUNGER
It’s very simple algebra. And it was all worked out in the course of
about one year in correspondence between Pascal and Fermat. They
worked it out casually in a series of letters.
Your brain isn’t designed to figure it out spontaneously.
Munger: It’s not that hard to learn. What is hard is to get so you use
it routinely almost everyday of your life. The Fermat/Pascal system
is dramatically consonant with the way that the world works. And
it’s fundamental truth. So you simply have to have the technique.
Many educational institutions – although not nearly enough – have
realized this. At Harvard Business School, the great quantitative
thing that bonds the first-year class together is what they call
decision tree theory. All they do is take high school algebra and
apply it to real life problems. And the students love it.
They’re amazed to find that high school algebra works in life….
By and large. as it works out, people can’t naturally and
automatically do this. If you understand elementary psychology, the
reason they can’t is really quite simple: The basic neural network of
the brain is there through broad genetic and cultural evolution. And
it’s not Fermat/Pascal. It uses a very crude, shortcut-type of
approximation. It’s got elements of Fermat/Pascal in it. However, it’s
not good.
Without it, you’re giving a huge advantage to others….
Munger: So you have to learn in a very usable way this very
elementary math and use it routinely in life
– just the way if you want to become a golfer, you can’t use the
natural swing that broad evolution gave you. You have to learn to
have a certain grip and swing in a different way to realize your full
potential as a golfer.
If you don’t get this elementary, but mildly unnatural, mathematics
of elementary probability into your repertoire, then you go through
a long life like a one-legged man in an ass-kicking contest. You’re
giving a huge advantage to everybody else. O
ne of the advantages of a fellow like Buffett, whom I’ve worked with
all these years, is that he automatically thinks in terms of decision
trees and the elementary math of permutations and combinations….
YOU HAVE TO KNOW ACCOUNTING – ALONG WITH ITS
LIMITATIONS.
Double-entry bookkeeping was a hell of an invention.
Munger: Obviously, you have to know accounting. It’s the language
of practical business life. It was a very useful thing to deliver to
civilization. I’ve heard it came to civilization through Venice which
of course was once the great commercial power in the
Mediterranean. However, double entry bookkeeping was a hell of an
invention.
And it’s not that hard to understand. But you have to know
accounting’s limitations….
Munger: But you have to know enough about it to understand its
limitations – because although accounting is the starting place, it’s
only a crude approximation. And it’s not very hard to understand its
limitations. For example, everyone can
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Part Eight
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CHARLIE MUNGER
Part eight: Berkshire at 50
In part seven of this series, I looked at the book Poor Charlie’s
Almanack, a compilation of Charlie Munger’s speeches,
presentations and letters. One essay that wasn’t included in Poor
Charlie’s Almanack (mainly because it was written almost a decade
after the book was published — it’s still essential reading) is Charlie
Munger’s contribution to the Berkshire Hathaway 50th anniversary
letter.
Across five pages of the Berkshire Letter, Charlie Munger takes a
look at the factors have been key to Berkshire’s success over the
years.
And the commentary from Charlie Munger really does offer an
invaluable insight into how Berkshire operates. However, these
reflections are not just relevant to Berkshire. Charlie’s observations
can also help the average investor improve their investing process.
Unfortunately, there’s not enough space to cover Charlie Munger’s
whole contribution to the Berkshire letter here. So, I’ve picked out a
few key from the text. The full letter can be found at the link above.
Stick with what you know
“In buying a new subsidiary, Berkshire would seek to pay a fair price
for a good business that the Chairman could pretty well understand.
Berkshire would also want a good CEO in place, one expected to
remain for a long time and to manage well without need for help
from headquarters.”
Charlie Munger refers to Warren Buffett as ‘the Chairman’
throughout his writings to Berkshire shareholders. In this case,
Munger highlights that Berkshire only invests in businesses that
Buffett can understand. Invest inside your circle of competence.
“Buffett’s decision to limit his activities to a few kinds and to
maximize his attention to them, and to keep doing so for 50 years,
was a lollapalooza.
Buffett succeeded for the same reason Roger Federer became good
at ten-nis.Buffett was, in effect, using the winning method of the
famous basket-ball coach, John Wooden, who won most regularly
after he had learned to assign virtually all playing time to his seven
best players.”
The key takeaway, stick with what you know. If you really know and
understand the business that you are investing in, you won’t have a
problem going overweight. Isolate your best ideas and don’t spread
yourself too thinly.
Don’t be in a rush
“Why did Berkshire’s acquisition of companies outside the
insurance business work out so well for Berkshire shareholders
when the normal result in such acquisitions is bad for shareholders
of the acquirer? Well, Berkshire, by design, had methodological
advantages to supplement its better opportunities. It never had the
equivalent of a “department of acquisitions” under pressure to buy…
And, finally, even when Berkshire was getting much better
opportunities than most others, Buffett often displayed almost
inhuman patience and seldom bought. For instance, during his first
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of Berkshire, Buffett saw one business (textiles) move close to death
and two new businesses come in, for a net gain of one.”
Patience is the name of the game, a point Charlie has pointed out
many times before. Indeed, when Charlie Munger sat down for a
‘fireside chat’ with Jason Zweig last year, to talk about the secrets of
Buffett’s success, he delivered the following statement: Successful
investing, Mr. Munger told me, requires “this crazy combination of
gumption and patience, and then being ready to pounce when the
opportunity presents itself, because in this world opportunities just
don’t last very long.”
“It’s waiting that helps you as an investor, and a lot of people just
can’t stand to wait,” he said. “If you didn’t get the deferred-
gratification gene, you’ve got to work very hard to overcome that.”
Berkshire was built by investing in new businesses at just the right
time. Buffett is never in a rush. The results speak for themselves.
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Charlie Munger
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Mistakes and a long-term outlook
“What were the big mistakes made by Berkshire under Buffett? Well,
while mistakes of commission were common, almost all huge errors
were in not making a purchase, including not purchasing Wal-Mart
Stores, Inc.
(NYSE:WMT) stock when that was sure to work out enormously
well.”
Buffett himself has admitted that the biggest mistake he ever made
was buying Berkshire in the first place.
Nonetheless, Charlie Munger’s view of mistakes is more optimistic
and doesn’t dwell on losses, only gains that were missed. It’s not
wise to spend too long dwelling on your losers as this can start to
affect your investing process.
“In its early Buffett years, Berkshire had a big task ahead: turning a
tiny stash into a large and useful company. And it solved that
problem by avoiding bureaucracy and relying much on one
thoughtful leader for a long, long time as he kept improving and
brought in more people like himself.
Compare this to a typical big-corporation system with much
bureaucracy at headquarters and a long succession of CEOs who
come in at about age 59…”
Another great point Charlie Munger makes is that Berkshire’s
success has been driven by Buffett’s long-term outlook. A long
succession of new CEO’s, with different ideas and outlooks, can hold
back business growth. Companies managed by CEO’s with a long-
term outlook, a large stake in the businesses success, or family ties
to the business will perform better than short-sighted peers on
average.
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Part Nine
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Colorful Charlie and the Cinderella Principle
Charlie Munger’s age, experience and reputation in the investment
world allows him to make statements that few others could get
away with. And over the years, Charlie has earned a reputation for
saying what’s on his mind, no matter who it offends, although in
many cases he is only saying what others are already thinking.
At the Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) 2013
annual meeting, Charlie really lived up to his reputation. In just one
meeting he labeled bankers “heroin addicts”, accused the Fed of
hurting savers because they were “convenient”, branded high
frequency trading “legalized front-running” and stated that “letting
Greece into the EU was sort of like serving up rat poison for
whipping cream.” Warren Buffett later explained these statements:
On Greece: “…putting 17 countries into a monetary union where
you synchronize the currency but you didn’t synchronize any other
aspects of their economies, I mean the fiscal policies, the culture,
costs of production, was doomed to failure.”
On bankers: “…leverage has enticed people to do crazy things for
time immemorial…And he would say that, probably say that that
heroin, ba-sically, is leverage and the ability to just borrow more
and more money through deposits or whatever, and that that should
be controlled.”
On the Fed: “…it had to hurt somebody. Bernanke had tough choices
to make, but he decided to step on the gas pedal…and that really
does hurt savers. I mean, it has made it extremely difficult for all
kinds of people who live on fixed-income investments. But,
unfortunately, that was a by-product.”
On high frequency trading: “That’s what it is [legalized front
running]. Yeah, that’s what it is. I mean, that’s the whole game. Why
a — let’s say that high-frequency trading produces gross income of
X. That X comes out of somebody. It doesn’t make Berkshire
Hathaway more productive. It doesn’t do anything of the sort. It
comes, one way or another, it comes out of the pocket of investors.
And the social purpose of it is rather hard to discern.”
When asked about short sellers at the Berkshire meeting, Charlie
stated “We don’t like trading agony for money.” As Buffett explains:
“The reason he said that is because a stock, when you short it, can
theo-retically go to infinity. When you buy a stock at 10, you can
only lose 10
points. When you short a stock at 10, it can go to 100 or 200…We
like to sleep well, and you can’t sleep well if you’re short a lot of
stocks.”
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CHARLIE MUNGER
Charlie Munger – The Cinderella Principle
Throughout this series, I’ve discussed Charlie Munger’s investment
style, process and early life but one thing that I have not discussed is
the informal Cinderella Principle.
The Cinderella Principle is a fundamental part of investing and life in
general. Charlie Munger is one of the greatest examples of the
principle in action.
Put simply, the Cinderella Principle is an example of investors’
psychology. Everyone thinks life is one upward, smooth trajectory
— like a The Walt Disney Company (NYSE:DIS) princess in her
castle. But between “Once upon a time” and “Happily ever after”
there’s a lot of work that needs to be done. Nothing comes easy.
Joshua Kennon gives the best example of Munger’s willingness to
overcome unbelievable challenges and tragedies in order to achieve
what he has:
In 1949, Charlie Munger was 25 years old. He was hired at the law
firm of Wright & Garrett for $3,300 per year, or $29,851 in inflation-
adjusted dollars as of 2010. He had $1,500 in savings, equal to
$13,570 now.
A few years later, in 1953, Charlie was 29 years old when he and his
wife divorced. He had been married since he was 21. Charlie lost
every-thing in the divorce, his wife keeping the family home in
South Pasadena.
Munger moved into “dreadful” conditions at the University Club…
Shortly after the divorce, Charlie learned that his son, Teddy, had
leukemia…Rick Guerin, Charlie’s friend, said Munger would go into
the hospital, hold his young son, and then walk the streets of
Pasadena crying.
One year after the diagnosis, in 1955, Teddy Munger died. Charlie
was 31 years old, divorced, broke, and burying his 9 year old son.
Later in life, he faced a horrific operation that left him blind in one
eye with pain so terrible that he eventually had his eye removed.
By the time he was 69 years old, he had become one of the richest
400
people in the world, been married to his second wife for 35+ years,
had eight wonderful children, countless grandchildren, and become
one of the most respected business thinkers in history.
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Part Ten
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CHARLIE MUNGER
Conclusion
In this concluding part of this series, I’m summing up the key points
of Charlie Munger’s investment philosophy.
1. Quality over value
Charlie Munger looks for quality businesses when investing. Unlike
Warren Buffett, Charlie Munger is willing to pay a high price for a
great business.
“The ideal business is one that generates very high returns on
capital and can invest that capital back into the business at equally
high rates. Imag-ine a $100 million business that earns 20% in one
year, reinvests the $20
million profit and in the next year earns 20% of $120 million and so
forth.
But there are very few businesses like this. Coke has high returns on
capital, but incremental capital doesn’t earn anything like its current
returns.
We love businesses that can earn high rates on even more capital
than it earns.”
“…if a business earns 18% on capital over 20 or 30 years, even if you
pay an expensive looking price, you’ll end up with a fine result.”
“…the big money’s been made in the high quality businesses. And
most of the other people who’ve made a lot of money have done so
in high quality businesses.”
2. Be ready
However, you need to wait for the perfect opportunity before you
pounce. It pays to wait. Sometimes the best thing you can do is
nothing.
“The way to get rich is to keep $10 million in your checking account
in case a good deal comes along…There are worse situations than
drowning in cash and sitting, sitting, sitting. I remember when I
wasn’t awash in cash —
and I don’t want to go back.”
“This great emphasis on volatility in corporate finance we regard as
nonsense. Let me put it this way; as long as the odds are in our favor
and we’re not risking the whole company on one throw of the dice
or anything close to it, we don’t mind volatility in results. What we
want are favorable odds.”

“Move only when you have an advantage.”

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When you keep cash on hand, you need to be patient and wait for
the perfect opportunity. Patience is a fundamental element of
Charlie Munger’s sit on your ass strategy:
“I did not succeed in life by intelligence. I succeeded because I have a
long attention span.”
3. Know what you want and be aware
Decide what you want in an investment and build a checklist to
minimize mistakes.
“Checklist routines avoid a lot of errors. You should have all this
elementary [worldly] wisdom and then you should go through a
mental checklist in order to use it. There is no other procedure in
the world that will work as well.” — Charlie Munger speech to the
University of Southern California Law School.
What’s more, investors should keep upto date on developments
around the world, build a “worldly wisdom” and incorporate this
into their investing strategy.
“What is elementary, worldly wisdom? Well, the first rule is that you
can’t really know anything if you just remember isolated facts and
try and bang
‘em back. If the facts don’t hang together on a latticework of theory,
you don’t have them in a usable form. You’ve got to have models in
your head.
And you’ve got to array your experience? Both vicarious and direct?
On this latticework of models. You may have noticed students who
just try to remember and pound back what is remembered… the
wisdom of the world is not to be found in one little academic
department. That’s why poetry professors, by and large, are so
unwise in a worldly sense. They don’t have enough models in their
heads…”
4. The most important lesson of all
The final takeaway from Charlie Munger’s speeches and writings
over the years is this; in order to succeed you must constantly seek
to learn, adapt, figure out what works for you and apply a technique
that helps you understand the complexities of life.
YOU’RE GIVING A HUGE ADVANTAGE TO OTHERS IF YOU DON’T
LEARN THIS SIMPLE TECHNIQUE.
…Obviously, you’ve got to be able to handle numbers and quantities
– basic arithmetic.
And the great useful model, after compound interest, is the
elementary math of permutations and combinations. And that was
taught in my day in the sophomore year in high school…Your brain
isn’t designed to figure it out spontaneously.
Munger: It’s not that hard to learn. What is hard is to get so you use
it routinely almost everyday of your life…So you simply have to have
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technique.
Many educational institutions – although not nearly enough – have
realized this. At Harvard Business School, the great quantitative
thing that bonds the first-year class together is what they call
decision tree theory. All they do is take high school algebra and
apply it to real life problems. And the students love it.
They’re amazed to find that high school algebra works in
life….people can’t naturally and automatically do this…
To stand out from the rest of the crowd Charlie Munger believes that
you need to develop a simple way of understanding complex
problems. Without this method in place, you’re putting yourself at a
huge disadvantage.
“By Rupert Hargreaves, ValueWalk Staff Writer - (C) ValueWalk
2015 - All rights Reserved - All rights reserved. No part of this
manual covered by copyrights hereon may be reproduced or
transmitted in any form or by any means without prior permission
of the copyright holder.”
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