Charlie Munger is the lessor known half of the partnership team that built Berkshire Hathaway. Prior to that, he was a lawyer, before giving up law to run his own investment partnership.
He started Wheeler, Munger & Company in 1962. The partnership was wound up in 1975. Back-to-back 31% losses in 1973 and 1974 made investors squeamish and in need of capital. Yet, despite the losses, Munger outperformed the market, earning a 19.8% annual return over the 14-year period (compared to 5% for the Dow).
Munger teamed up with Warren Buffett three years later (1978) as vice chairman of Berkshire. In his spare time, he chairs the Daily Journal, designs buildings, and plays the part of a walking, talking encyclopedia. He’s a learning machine who built his own system of mental models to reduce errors in this complex world. His unique view of uncommon sense, as he calls it, can be seen in how he invests.
Extreme concentration and inaction best describe Munger’s approach. He’s comfortable with only three or four wonder businesses in his portfolio. That’s far short of the popular broad diversification strategies recommended today.
Except, extreme concentration is not for everyone. First, finding a handful of wonderful companies worth owning is never as easy as it sounds. Someone not skilled in the art is likely to find awful companies more often than wonderful ones.
Second, it takes a particular mindset to own a handful of stocks and do nothing because the byproduct of concentrated portfolios is higher volatility. Most people are driven to act when the market gets crazy. Munger, however, does nothing and accepts it.
The good news is that you don’t need to invest exactly like Munger to be successful. The best part of investing is the ability to learn how the greats did it. You can learn from their successes and failures, borrow their ideas, and make them your own.
On Traits of a Great Investor
I think great investors to some extent are like great chess players. They’re almost born to be investors… Obviously you have to know a lot. But partly it’s temperament. Partly it’s deferred gratification. You got to be willing to wait. Good investing requires a weird combination of patience and aggression. And not many people have it. It requires a big amount of self-awareness and how much you know and how much you don’t know. You have to know the edge of your own competency.
On His Investment Philosophy
Understanding both the power of compound return and the difficulty getting it is the heart and soul of understanding a lot of things.
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Value investing, the way I conceive it, is always wanting to get more value than you pay for when you buy a stock and that approach will never go out of style… I think all good investing is value investing, and it’s just that some people look for values in strong companies and some look for values in weak companies, but every value investor tries to get more value than he pays for.
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We want to buy something that’s intrinsically a very good business, meaning that an idiot could run it and it would do all right. Then we want that business, which an idiot could run successfully, to have a wonderful person in it running it. If we have a wonderful business with a wonderful person running it, that really turns us on, and it works very well. Now, we do make exceptions, but not many. It’s a pretty simple philosophy.
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I had a friend when I practiced law and he said, “If it won’t stand a little mismanagement, it’s not much of a business.” We like businesses that stand a lot of mismanagement but don’t get it. That’s our formula.
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If you have a pharmaceutical company and you’re trying to guess what new drug is going to be invented, I’ve got no advantage. Other people are better in that than I am. I don’t play in a game where the other people are wise and I am stupid. I look for a place where I’m wise and they’re stupid. And believe me, it works better… That’s my philosophy, and I think you have to know the edge of your own competency. You have to kind of know “This is too tough for me. I’ll never figure this out.” I’m very good at knowing when I can’t handle something.
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A place like Berkshire Hathaway or even the Daily Journal, we’ve done better than average. And now there’s a question. Why has that happen? And the answer is pretty simple. We tried to do less. We never had the illusion we could just hire a bunch of bright young people and they would know more than anybody about canned soup and aerospace and utilities and so on and so on and so on. We never had that dream. We never thought we could get really useful information on all subjects like Jim Cramer pretends to have. And we always realized that if we worked very hard, we can find a few things where we were right. And the few things were enough. And that that was a reasonable expectation. That is a very different way to approach the process.
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There are huge advantages for an individual to get into a position where you make a few great investments and just sit back and wait: You’re paying less to brokers. You’re listening to less nonsense. And if it works, the governmental tax system gives you an extra 1, 2, or 3 percentage points per annum compounded.
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It’s not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it — who look and sift the world for a mispriced bet that they can occasionally find one. And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.
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You’re not talking to a great exiter. My Berkshire, I bought in 1966… I’ve been a good picker. But other people know more about exiting. I’m trying never to have to exit… I think there’s working styles of investments that work well with constant exits. It just hasn’t happened to been my forte. So I’m no good at exits. I don’t like even looking for exits. I’m looking for holds.
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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.
On the Stock Market as a Pari-Mutuel System
The model I like to sort of simplify the notion of what goes on in a market for common stocks is the pari-mutuel system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based on what’s bet. That’s what happens in the stock market.
Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position etc., etc. is way more likely to win than a horse with a terrible record and extra weight and so on and so on. But if you look at the odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2. Then it’s not clear which is statistically the best bet using the mathematics of Fermat and Pascal. The prices have changed in such a way that it’s very hard to beat the system…
In the stock market, some railroad that’s beset by better competitors and tough unions may be available at one-third of its book value. In contrast, IBM in its heyday might be selling at 6 times book value. So it’s just like the pari-mutuel system. Any damn fool could plainly see that IBM had better business prospects than the railroad. But once you put the price into the formula, it wasn’t so clear anymore what was going to work best for a buyer choosing between the stocks. So it’s a lot like a pari-mutuel system. And, therefore, it gets very hard to beat.
On Handling Booms and Busts
I’ve had my Berkshire stock decline by 50% three times. It doesn’t bother me that much. That’s just a natural consequence of adult life, properly lived. If you have my attitude, it doesn’t really matter. I always liked Kipling’s expression in that poem called If. And he said, “Success and failure.” He says, “Treat those two imposters just the same.” You just roll with it.
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You get crazy booms. Remember the Dotcom boom? When every little building in Silicon Valley rented at a huge price and a few months later, about a third of them were vacant. There are these periods in capitalism and I’ve been around for a long time and my policy has always been to just ride them out… What shareholders actually do is a lot of them crowd into buying stocks on frenzy, frequently on credit because they see that they’re going up, and of course that’s a very dangerous way to invest. I think that shareholders should be more sensible and not crowd into stocks and just buy them just because they’re going up and they like to gamble.
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Everything in life has dangers. Since it’s so obvious that investing in great companies works, it gets horribly overdone from time to time. In the “Nifty-Fifty” days, everybody could tell which companies were the great ones. So they got up to 50, 60, and 70 times earnings. And just as IBM fell off the wave, other companies did, too. Thus, a large investment disaster resulted from too high prices. And you’ve got to be aware of that danger.
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I didn’t get rich by buying stocks at a high price earnings multiples in the midst of crazy speculative booms, and I’m not going to change.
On Creative Destruction
The Harvard Business School, when it started out way early, they started out with a history of business and they’d take you through the building of the canals and the building of the railroads and so on and so on and you saw the ebb and flow of industry and the creative destruction of economic changes and so on and so on. It was a background which helped everybody. Of course, what I’m saying is that if I were teaching business, I would start the way Harvard Business School did a long time ago…
If you stop to think about it, business success long-term is a lot like biology and in biology, what happens is the individuals all die and eventually so do all the species and capitalism is almost as brutal as that. Think of what’s died in my lifetime. Just think of the things that were once prosperous that are now in failure or gone. Whoever dreamed when I was young that Kodak and General Motors would go bankrupt? It’s incredible what’s happened in terms of the destruction. Of course, that history is useful to know.
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My first investment with my pitiful savings of a venturesome sort, I invested in a company right in Pasadena. And it was called William Miller Instruments. And I damn near lost all my money. It was hell on earth. We just barely squeaked out with a substantial outcome. But what did us in was the oscillograph that we’d invented, and we were so proud of, and we thought it was going to knock the world flat. Somebody invented magnetic tape without telling me and by the time we got the oscillograph ready to go to market, we sold three. Three total, in the whole country. So technology is a killer as well as an opportunity. And my first experience had damn near killed me…
Over the long-term, big companies of America behave more like biology than they do anything else. In biology, all the individuals die and so do all the species. It’s just a question of time. And that’s pretty well what happens in the economy too. All the things that were really great when I was young have receded enormously. And new things have come up and some of them started to die. And that is what the long-term investment climate is and it does make it very interesting. Look at what’s died — all of the department stores, all the newspapers, U.S. Steel. John D Rockefeller’s Standard Oil is a pale shadow of its former self. It’s just like biology. They have their little time and then they get clobbered…
Some people try to get on the cutting edge of change. So they’re destroying other people instead of being destroyed themselves… Other people, like me, do some of that, joining things like Apple. And in some ways, we just try to avoid big change we think is likely to hurt us.
On Mistakes
I’m constantly making mistakes where I can, in retrospect, realize that I should have decided differently. And I think that that is inevitable because it’s difficult to be a good investor. I’m pretty easy on myself these days. I’m satisfied with the way things have worked out and I’m not gnashing my teeth that other people are doing better. I think that the methods that I’ve used, including the checklist, are the correct methods.
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I have made bad business decisions. You can’t live a successful life without doing some difficult things that go wrong. That’s just the nature of the game. And you wouldn’t be sufficiently courageous if you tried to avoid every single reverse.
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I’m a very blocking and tackling kind of a thinker. I just try and avoid being stupid. And I have a way of handling a lot of problems. I put them on what I call my “too hard pile” and I just leave them there. I’m not trying to succeed in my too hard pile… I sometimes get into things that are too hard, and when that happens, I fail.
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A good bit of the Munger fortune came from liquidating things we originally purchased because we were wrong. Of course, you have to learn to change your mind when you’re wrong. And I actually work at trying to discard beliefs. And most people try and cherish whatever idiotic notion they already have, because they think if it’s their notion, it must be good. And I think, of course you want to be re-examining what you previously thought, particularly when disconfirming evidence comes through. And there’s hardly anything more important than being rational and objective.
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How do you scramble out of your mistakes without them costing too much? And we’ve done some of that too. If you look at Berkshire Hathaway, think of its founding businesses. A doomed department store, a doomed New England textile company, and a doomed trading stamp company. Out of that came Berkshire Hathaway. Now, we handled those losing hands pretty well when we bought into them very cheaply. But of course, the success came from changing our ways and getting into the better businesses. It isn’t that we were so good at doing things that were difficult. We were good at avoiding things that were difficult. Finding things that are easy.
Sources:
A Conversation with Distinguished Alumnus Charles T. Munger
The Not-So-Silent Partner
Redlands Forum Transcript
2021 Daily Journal Annual Meeting
2020 Daily Journal Annual Meeting
2019 Daily Journal Annual Meeting
The Art of Stock Picking
Last Call
- Big Beliefs – M. Housel
- Eight Investing Gems – KCP Group
- How the Drivers of Market Returns Evolved – Investor Amnesia
- Sequence Risk During Retirement – J. Rekenthaler
- The Size Factor – Verdad
- Picking Stocks Like Warren Buffett – Neckar
- When Every Ketchup But One Went Extinct – Atlas Obscura
- How Mammals Won the Dinosaurs’ World – BBC
- Why Do (Some) Humans Love Chili Peppers? – Sapiens
