Lessons from Charlie Munger- IV

Mar 3, 2011

In the previous article, we had discussed how a wrong set of incentives across the entire economic system was responsible for the US financial crisis. Today, please do not panic, for we are going to talk about love.


Liking and loving tendency

Love is one of the most basic of emotions. The very first manifestation of it is between a mother and the new-born child. For a child, this earliest experience has far reaching effects. The child learns to love and to be loved in return. It becomes a kind of a programming device. And it extends not only towards people, but also towards things, ideas and concepts. Of course, the child learns to dislike and hate as well. But we'll limit this piece to our tendency to love and to like.

This tendency to love has its own set of side effects. It acts as a conditioning device and often distorts our perceptions. To make it simple, think of someone you love- your spouse, your kid, your favourite actor or cricketer. You could also think of any idea or belief that is very dear to you. Now ask yourself these questions:

• Do you tend to ignore their faults? Do you readily comply with their wishes?
  
• Do you favour people, products, and actions merely associated with them?
  
• Do you distort any unpleasant facts about them?

Now why are we talking about all this? Has it got anything to do with investments and stocks? Most certainly yes! We are firmly of the belief that being a successful investor requires discipline and a sound emotional make-up.

Have a look at your stock portfolio. There is one very common error that most investors do with stocks that they own. Once they have bought a stock, they automatically start developing a feeling of affection towards it. Don't we often hear people raving about certain blue chips with an admiration that borders around reverence? Any negative comment about them will either be ignored, dismissed or defended. It almost seems like a marriage brimming with loyalty and affection. Take the so-called "hot" sector stocks. Don't they often cause many a feeble hearts to melt? And what happens to all thoughts about business and valuation? Well, well, well... You know best. We dislike challenging and reasoning with things and ideas that we love.

Our bottom line is this. Do fall in love, but not with your stocks. Love your capital and do the best you can to protect it and to help it grow. And what better of doing that than being a disciplined value investor!

https://www.equitymaster.com/detail.asp?date=3/3/2011&story=6&title=Lessons-from-Charlie-Munger--IV

Lessons from Charlie Munger- III

Jan 13, 2011

In the previous article, we had discussed the influence of incentives at the level of individual firms and some antidotes for investors. In this article, we'll discuss the power of incentives in the context of economic systems. 

We all are part of various systems or groups- from a micro-system like a family to a macro-system like an economy. If you rip apart any system and look at its core design, you will find mainly two things: incentives and disincentives. They may be in the form of rules, regulations, norms, customs, traditions, mores or ethics. And you see them everywhere, don't you? Be it religion, politics or economics, every system is made up of these elements. 
We'd like to point out to you how the success or failure of any economic system depends on how incentives and disincentives are designed. Let us explain.


What made the free-market economy work?

The success of the free-market system as an economic system comes from its inherent reward-punishment mechanism. Owners have a strong incentive to prevent all waste in operations. Their businesses will perish in the face of brutal competition if they are not efficient. Replace such owners by salaried government employees and you will normally get a substantial reduction in overall efficiency. 

Communism has failed due to the absence of exactly those incentives that have motivated private enterprises to flourish in democracies. The fall of the Soviet communists is a glaring example of wrong system design. But one may also point the knife at the US- the epitome of free-market economy, for bringing in one of the worst financial crises ever. What really went wrong? Well, there is not just one simple answer to this. But we'll restrict our discussion to the main theme of the article.


The US financial crisis: an outcome of wrong incentives and absence of disincentives 
It is fashionable to bash up the US Fed and the big investment banks for all the menace they created. But blaming them alone would do us more harm than good; because the crisis was a failure of the entire system and not the outcome of a few crooks alone. In one part, the financial crisis was a result of a series of incentives that induced unscrupulous behaviour across the entire system. The other major mishap was a complete dearth of penalties for wrong behaviour. Looking back, the evidence comes out pouring, often overwhelming.

Though it is not widely discussed, the original subprime lenders of the 1990s had already gone bust by turn of the century. A child could point and say, "Don't make loans to people who can't repay them." Simple. But amusingly and frighteningly, the lesson learnt was a bit complicated: "Keep making such loans; just don't keep them on your books." The lenders made the loans, and then sold them off to the fixed income departments of big Wall Street investment banks. These investment banks in turn packaged them into bonds and sold them off to investors. So the originator of loans had little incentive to bother at all about creditworthiness. On the other hand, there was hardly any penalty to curb his recklessness. As Mr. Raghuram Rajan, a leading economist who saw the crisis unfolding as early as 2005 noted, "Incentives were horribly skewed in the financial sector, with the workers reaping rich rewards for making money but being only lightly penalized for losses." 

Also, the problem was not that no one warned about the dangers. It was that those who benefited from an over-heated economy- which included a lot of people- had little incentive to listen. So everyone enjoyed this "passing the parcel (read atom bomb)" game as long as the music played. And we all know what happened after the music stopped.

India 2010: A carnival of scams

We just emphasised the omnipotence of incentives and how a flawed reward-punishment mechanism can bring about the collapse of a giant system. It is quite clear that man responds more often and more easily to incentives than to reason and conscience. Didn't we see this axiom crystallizing before our own eyes with the cracking of a series of scams last year? Again, we will not arrive at an effective solution if the issue is not addressed at the most fundamental level. Firstly, we have to accept that man is fallible and corruptible, if the situation so allows. So the solution does not lie in moralising individuals alone, but more importantly, in creating robust systems that reward fair and ethical behaviour and deter deceitful practices. 

https://www.equitymaster.com/detail.asp?date=1/13/2011&story=5&title=Lessons-from-Charlie-Munger--III

Lessons from Charlie Munger- II

Jan 5, 2011

In the previous introductory article, we briefly discussed Charlie Munger's multidisciplinary approach to investing. Starting with this article, we'll discuss his list of "24 Standard Causes of Human Misjudgment" and understand how they have powerful implication for investors.

Reward and Punishment Super-response Tendency

Why do we do what we do? Why are we tempted to do certain things while refraining from others? Well, all creatures seek their own self-interest. Our innate drive is to maximise pleasure, while at the same time avoiding or reducing pain. In any given circumstance, we assess the risks and the associated rewards and respond in a way that seems to best serve us. With this premise, it is imperative to understand the role of incentives and disincentives in changing cognition and behaviour. 

The power of incentives

There is this interesting case of the logistics services major FedEx Corporation. The integrity of the FedEx system required that all packages be shifted rapidly among airplanes in one central airport each night. And the system had no integrity for the customers if the night work shift couldn't accomplish its assignment fast. And FedEx had a tough time getting the night shift to do the right thing. They tried moral persuasion. They tried everything in the world without luck. Finally, somebody thought it was foolish to pay the night shift by the hour. What the employer wanted was not maximized billable hours of employee service but fault-free, rapid performance of a particular task. So maybe if they paid the employees per shift and let all night shift employees go home when all the planes were loaded, the system would work better. And that solution worked just perfectly. This is a classical case of the power of incentives and how they can be used to produce desirable behavioural changes. 

The abuse of incentives

One of the most important consequences of incentives is what Charlie Munger calls "incentive-caused bias." The following example will explain the same. Early in the history of Xerox, Joseph Wilson, who was then in the government, had to go back to Xerox because he couldn't understand why its new machine was selling so poorly in relation to its older and inferior machine. When he got back to Xerox, he found out that the commission arrangement with the salesmen gave a large and perverse incentive to push the inferior machine on customers. An incentive-caused bias can tempt people into immoral behavior, like the salesmen at Xerox who harmed customers in order to maximize their sales commissions.

The story of mutual funds in India is quite similar to that of the Xerox case. Mutual funds that offer the maximum commission to distributors are the best sold funds. Also, consider your own stockbrokers. There will be seldom one who will not lure you to trade too often. And seldom will a management consultant's report not end with an advice like this one: "This problem needs more management consulting services." Such behavioural biases exist in most places and situations. And human nature, bedeviled by incentive-caused bias, causes a lot of ghastly abuse. 


Some antidotes for investors

For you investors, we believe it is important to understand the motives and incentives of people and organisations you're dealing and investing with. Everyone ranging from the company you're investing in to your stockbroker, your mutual fund agent and your equity advisor (yes, even we) must pass your scrutiny.

Widespread incentive-caused bias requires that one should often distrust, or take with a grain of salt, the advice of one's professional advisor. The general antidotes here are:

1. Especially fear professional advice when it is especially good for the advisor.
2. Learn and use the basic elements of your advisor's trade as you deal with your advisor.
3. Double check, disbelieve, or replace much of what you're told, to the degree that seems appropriate after objective thought.

https://www.equitymaster.com/detail.asp?date=01/05/2011&story=5&title=Lessons-from-Charlie-Munger--II

Lessons from Charlie Munger- I

The Multi-disciplinarian

Both men have as many striking differences as similarities. One may typecast Buffett as purely an investor and philanthropist. And quite rightly so, for the man devotes his time almost exclusively to his business. Munger, on the other hand, is a generalist for whom investment is only one of a broad range of interests. In many ways, his personality has traces of his own hero-Benjamin Franklin, who along with being a great scientist and inventor, was also a leading author, statesman and philanthropist, and played four instruments. On similar lines, Munger hops around science, architecture, psychology and philanthropy with as much passion and curiosity as he does with business and investments.

Thinking errors and misjudgements

Munger very aptly follows this multidisciplinary approach in all kind of situations. He draws influences from fields as diverse as physics and psychology to his investment process. For long, he had been interested in standard thinking errors. Without diving much into academic psychology textbooks, he developed his own system of psychology more or less in the self-help style of Ben Franklin. In a series of articles that will follow, we will pick up insights from a speech that Munger gave on "24 Standard Causes of Human Misjudgment". But before we start discussing these thinking errors, let us tell you why these lessons have very powerful implications for investors. 

Do we behave like ants?

We may take great pride in our evolutionary superiority over other creatures. But we also often behave like ants. Strange? Not really. Munger has pointed out some very intriguing observations about the behaviour of these social insects. Each ant, like each human, is composed of a living physical structure plus behavioural algorithms in its nerve cells. Mostly, the ant merely responds to stimuli with a few simple responses programmed into its nervous system by its genes. For instance, one type of ant, when it smells a pheromone given off by a dead ant's body in the hive, immediately responds by co-operating with other ants in carrying the dead body out of the hive. Harvard's great E.O. Wilson performed one of the best psychology experiments ever. He painted dead-ant pheromone on a live ant. Quite naturally, the other ants dragged this useful live ant out of the hive. This despite the poor creature kicked and protested throughout the entire process. Such is the brain of the ant.

Of course, our brain is far more complex and advanced. Ants don't design and fly airplanes. But under complex circumstances, don't we also find ourselves behaving counterproductively just like ants? And aren't stock markets a perfect playground for this kind of behaviour? We'll discuss this and a lot more in the forthcoming articles. 

https://www.equitymaster.com/detail.asp?date=12/29/2010&story=6&title=Lessons-from-Charlie-Munger--I&utm_source=archive-page&utm_medium=website&utm_campaign=sector-info&utm_content=story

Charlie Munger - Conservative investing with steady savings without expecting miracles is the way to go.

Charlie Munger

Charles Thomas Munger (born January 1, 1924, in Omaha, Nebraska) is an American business magnate, lawyer, investor, and philanthropist. 

He is Vice-Chairman of Berkshire Hathaway Corporation, the diversified investment corporation chaired by Warren Buffett; in that capacity, Buffett describes Munger as "my partner." 

Munger served as chairman of Wesco Financial Corporation from 1984 through 2011 (Wesco was approximately 80%-owned by Berkshire-Hathaway during that time). He is also the chairman of the Daily Journal Corporation, based in Los Angeles, California, and a director of Costco Wholesale Corporation. 

Like Buffett, Munger is a native of Omaha, Nebraska. After studies in mathematics at the University of Michigan, and service in the U.S. Army Air Corps as a meteorologist, trained at Caltech, he entered Harvard Law School, where he was a member of the Harvard Legal Aid Bureau, without an undergraduate degree. - Wikipedia 

"It's in the nature of stock markets to go way down from time to time. There's no system to avoid bad markets. You can't do it unless you try to time the market, which is a seriously dumb thing to do. Conservative investing with steady savings without expecting miracles is the way to go." - Charlie Munger

https://www.equitymaster.com/outlook/charlie-munger/charlie-munger-value-investing.asp

THE 10 BEST INVESTORS IN THE WORLD

Warren Buffett
Charlie Munger
Joel Greenblatt
John Templeton
Benjamin Graham
Philip Fisher
Mohnish Pabrai
Walter Schloss
Peter Lynch
Seth Klarman



Warren Buffett (1930)

"Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down."

Warren Buffett, born on August 30, 1930 in Omaha, Nebraska, is known as the world's best investor of all time. He is among the top three richest people in the world for several years in a row now, thanks to the consistent, mind-boggling returns he managed to earn with his investment vehicle Berkshire Hathaway. The funny thing is that Buffett does not even care that much about money. Investing is simply something he enjoys doing. Buffett still owns the same house he bought back in 1958, hates expensive suits, and still drives his secondhand car.

Investment philosophy:
 Focuses on individual companies, rather than macro-economic factors
 Invests in companies with sustainable competitive advantages
 Prefers becoming an expert on a few companies over major diversification
 Does not believe in technical analysis
 Bases his investment decisions on the operational performance of the underlying businesses
 Holds on to stocks for an extremely long period, some stocks he never sells
 Uses price fluctuations to its advantage by buying when undervalued and selling when overvalued with respect to intrinsic value
 Puts much emphasis on the importance of shareholder friendly, capable management
 Beliefs margin of safety are the three most important words in investing


Charlie Munger (1924)

"All intelligent investing is value investing — acquiring more than you are paying for."

Charlie Munger is vice-chairman of Berkshire Hathaway, Warren Buffett's investment vehicle. Even though Buffett and Munger were born in Omaha, Nebraska, they did not meet until 1959. After graduating from Harvard Law School, Munger started a successful law firm which still exists today. In 1965 he started his own investment partnership, which returned 24.3% annually between 1965 and 1975, while the Dow Jones only returned 6.4% during the same period. In 1975 he joined forces with Warren Buffett, and ever since that moment Charlie Munger has played a massive role in the success of Berkshire Hathaway. While Buffett is extrovert and a pure investor, Munger is more introvert and a generalist with a broad range of interests. The fact that they differ so much from each other is probably why they complement each other so well.

Investment philosophy:
 Convinced Buffett that stocks trading at prices above their book value can still be interesting, as long as they trade below their intrinsic value
 Has a multidisciplinary approach to investing which he also applies to other parts of his life ("Know a little about a lot")
 Reads books continuously about varied topics like math, history, biology, physics, economy, psychology, you name it!
 Focuses on the strength and sustainability of competitive advantages
 Sticks to what he knows, in other words, companies within his "circle of competence"
 Beliefs it is better to hold on to cash than to invest it in mediocre opportunities
 Says it is better to be roughly right than precisely wrong with your predictions


Joel Greenblatt (1957)

“Choosing individual stocks without any idea of what you’re looking for is like running through a dynamite factory with a burning match. You may live, but you’re still an idiot.”

Joel Greenblatt definitely knows how to invest. In 1985 he started his investment fund Gotham Capital, ten years later, in 1995, he had earned an incredible average return of 50% per year for its investors. He decided to pay his investors their money back and continued investing purely with his own capital. Many people know Joel Greenblatt for his investment classic The Little Book That Beats The Market* and his website magicformulainvesting.com. Greenblatt is also an adjunct-professor at the Columbia Business School.

Investment philosophy:
 Buys good stocks when they are on sale
 Prefers highly profitable companies
 Uses the Normalized Earnings Yield to assess whether a company is cheap
 Beliefs thorough research does more to reduce risk than excessive diversification (he often has no more than 8 companies in his portfolio)
 Largely ignores macro-economical developments and short term price movements


John Templeton (1912 -2008) 

"If you want to have a better performance than the crowd, you must do things differently from the crowd."

The late billionaire and legendary investor, John Templeton, was born in 1912 as a member of a poor family in a small village in Tennessee. He was the first of his village to attend University, and he made them proud by finishing economics at Yale and later a law degree at Oxford. Just before WWII, Templeton was working at the predecessor of the now infamous Merrill Lynch investment bank. While everyone was highly pessimistic during these times, Templeton was one of the few who foresaw that the war would give an impulse to the economy, rather than grind it to a halt. He borrowed $10.000 from his boss and invested this money in each of the 104 companies on the US stock market which traded at a price below $1. Four years later he had an average return of 400%! In 1937, in times of the Great Depression, Templeton started his own investment fund and several decennia later he managed the funds of over a million people. In 2000 he shorted 84 technology companies for $200.000, he called it his "easiest profit ever". The beauty is that despite all his wealth, John Templeton had an extremely modest lifestyle and gave much of it away to charitable causes.

Investment philosophy:
 Contrarian, always going against the crowd and buying at the point of maximum pessimism
 Has a global investment approach and looks for interesting stocks in every country, but preferably countries with limited inflation, high economical growth, and a movement toward liberalization and privatization
 Has a long term approach, he holds on to stocks for 6 to 7 years on average
 Focuses on extremely cheap stocks, not necessarily on "good" stocks with a sustainable competitive advantage, like Warren Buffett
 Beliefs in patience, an open-mind, and a skeptical attitude against conventional wisdom
 Warns investors for popular stocks everyone is buying
 Focuses on absolute performance rather than relative performance
 A strong believer in the wealth creating power of the free market economy



Benjamin Graham (1894 - 1976) 

"Price is what you pay, value is what you get."

Columbia Business School professor Benjamin Graham is often called "The Father of Value Investing". He was also Warren Buffett's mentor and wrote the highly influential book The Intelligent Investor, which Buffett once described as the best book on investing ever written. Graham was born in England in 1894, but he and his family moved to the United States just one year later. His official name was Grossbaum, but the family decided to change this German sounding name to Graham during the time of the First World War. Graham was a brilliant student and got offered several teaching jobs on the University, but instead he decided to work for a trading firm and would later start his own investment fund. Due to the use of leverage, his fund lost a whopping 75% of its value between 1929 and 1932, but Graham managed to turn things around and managed to earn a 17% annualized return for the next 30 years. This was way higher than the average stock market return during that same period. In total, Graham taught economics for 28 years on Columbia Business School.

Investment philosophy:
 Focuses more on quantitative, rather than qualitative data
 First step is to look for stocks trading below 2/3rd of net current asset value (NCAV)*
 Prefers companies which pay dividends
 Looks for companies with a consistently profitable history
 Companies should not have too much long term debt
 Earnings should be growing
 Is willing to pay no more than 15 times the average earnings over the past three years
 Diversifies to spread the risk of individual positions
 Emphasizes the importance of a significant Margin of Safety
 Profits from irrational behavior caused by the manic-depressive "Mr. Market"
 Warns that emotions like fear and greed should play no role in your investment decisions

*NCAV = current assets - total liabilities



Philip Fisher (1907 - 2004) 

"I don't want a lot of good investments; I want a few outstanding ones."

Philip Fisher became famous for successfully investing in growth stocks. After studying economics degree at Stanford University, Fisher worked as an investment analyst before starting his own firm, Fisher & Co. This was in 1931, during the times of the Great Depression. Fisher's insights have had a significant influence on both Warren Buffett and Charlie Munger. Philip Fisher is also author of the powerful investment book Common Stocks and Uncommon Profits, which has a quote from Buffett on its cover which reads: "I am an eager reader of whatever Phil has to say, and I recommend him to you."

Investment philosophy:
 Dislikes technical analysis
 Does not belief in "market timing"
 Prefers a concentrated portfolio with around 10 to 12 stocks
 Emphasizes the importance of honest and able management
 Beliefs you should only invest in companies which you can understand
 Warns that you should not follow the masses, but instead have patience and think for yourself
 Companies should have a strong business model, be innovative, highly profitable, and preferably a market leader
 Has a focus on growth potential of both companies and industries
 Buys companies at "reasonable prices" but does not specify what "reasonable" is to him
 A true "buy & hold" investor who often holds on to stocks for decades
 Beliefs great companies purchased at reasonable prices and held for a long time are better investments than reasonable companies bought at great prices
 Has a "scuttlebutt" approach to doing research by asking questions to customers, employees, competitors, analysts, suppliers, and management to find out more about the competitive position of a company and its management
 Only sells when a company starts experiencing issues with its business model, competitive positioning, or management



Mohnish Pabrai (1964)

“Heads, I win; tails, I don’t lose much. “

Mohnish Pabrai has once been heralded as "the new Warren Buffett" by the prestigious American business magazine Forbes. While this seems like big words, you might start to understand why Forbes wrote this when you look at the performance of Pabrai's hedge funds, Pabrai Investment Funds, which have outperformed all of the major indices and 99% of managed funds. At least, that was before his funds suffered significant losses during the recent financial crisis because of their exposure to financial institutions and construction companies. Still, there is much we can learn from his low-risk, high-reward approach to investing, which he describes in his brilliant book The Dhandho Investor: The Low-Risk Value Method to High Returns.

Investment philosophy:
 Points out that there is a big difference between risk and uncertainty
 Looks for low-risk, high-uncertainty opportunities with a significant upside potential
 Only practices minor diversification and usually has around 10 stocks in his portfolio
 Beliefs stock prices are merely "noise"
 Used to buy reasonable companies at great prices, but now wants to focus more on quality companies with a sustainable competitive advantage and shareholder friendly management



Walter Schloss (1916 - 2012) 

"If a stock is cheap, I start buying." While Walter Schloss might not be the most well-known investor of all time, he was definitely one of the best investors of all time. Just like Buffett, Walter Schloss was a student of Benjamin Graham. Schloss is also mentioned as one of the "Super Investors" by Buffett in his must-read essay The Super Investors of Graham-And-Doddsville. An interesting fact about Walter Schloss is that he never went to college. Instead, he took classes taught by Benjamin Graham after which he started working for the Graham-Newton Partnership. In 1955 Schloss started his own value investing fund, which he ran until 2000. During his 45 years managing the fund, Schloss earned an impressive 15.3% return versus a return of 10% for the S&P500 during that same period. Just like Warren Buffett and John Templeton, Walter Schloss was known to be frugal. Schloss died of leukemia in 2012 at age 95.

Investment philosophy:
 Practiced the pure Benjamin Graham style of value investing based on purchasing companies below NCAV
 Generally buys "cigar-butt" companies, or in other words companies in distress which are therefore trading at bargain prices
 Regularly used the Value Line Investment Survey to find attractive stocks
 Minimizes risk by requiring a significant Margin of Safety before investing
 Focuses on cheap stocks, rather than on the performance of the underlying business
 Diversified significantly and has owned around 100 stocks at a time
 Keeps an open mind and even sometimes shorts stocks, like he did with Yahoo and Amazon just before the Dot-Com crash
 Likes stocks which have a high percentage of insider ownership and which pay a dividend
 Is not afraid to hold cash
 Prefers companies which have tangible assets and little or no long-term debt 10



Peter Lynch (1944)

"Everyone has the brain power to make money in stocks. Not everyone has the stomach."

Peter Lynch holds a degree in Finance as well as in Business Administration. After University, Lynch started working for Fidelity Investments as an investment analyst, where he eventually got promoted to director of research. In 1977, Peter Lynch was appointed as manager of the Magellan Fund, where he earned fabled returns until his retirement in 1990. Just before his retirement he published the bestseller One Up On Wall Street: How To Use What You Already Know To Make Money In The Market. Just as many of the other great investors mentioned in this document, Lynch took up philanthropy after he amassed his fortune.

Investment philosophy:
 You need to keep an open mind at all times, be willing to adapt, and learn from mistakes
 Leaves no stone unturned when it comes to doing due diligence and stock research
 Only invests in companies he understands
 Focuses on a company's fundamentals and pays little attention to market noise
 Has a long-term orientation
 Beliefs it is futile to predict interest rates and where the economy is heading
 Warns that you should avoid long shots
 Sees patience as a virtue when it comes to investing
 Emphasizes the importance of first-grade management
 Always formulates exactly why he wants to buy something before he actually buys something



Seth Klarman (1957) 

“Once you adopt a value-investment strategy, any other investment behavior starts to seem like gambling.“

Billionaire investor and founder of the Baupost Group partnership, Seth Klarman, grew up in Baltimore and graduated from both Cornell University (economics) and the Harvard Business School (MBA). In 2014 Forbes mentioned Seth Klarman as one of the 25 Highest-Earning hedge funds managers of 2013, a year in which he generated a whopping $350 million return. Klarman generally keeps a low profile, but in 1991 he wrote the wrote a book Margin of Safety: Risk Averse Investing Strategies for the Thoughtful Investor, which became an instant value investing classic. This book is now out of print, which has pushed the price up to over $1500 for a copy!

Investment philosophy:
 Is extremely risk-averse and focuses primarily on minimizing downside risk
 Does not just look for cheap stocks, but looks for the cheapest stocks of great companies
 Writes that conservative estimates, a significant margin of safety, and minor diversification allow investors to minimize risk despite imperfect information
 Warns that Wall Street, brokers, analysts, advisors, and even investment funds are not necessarily there to make you rich, but first and foremost to make themselves rich
 Often invests in "special situations", like stocks who filed for bankruptcy or risk-arbitrage situations
 Suggests to use several valuation methods simultaneously, since no method is perfect and since it is impossible to precisely calculate the intrinsic value of a company
 Is known for holding a big part of its portfolio in cash when no opportunities exist
 Beliefs investors should focus on absolute performance, rather than relative performance
 Emphasizes that you should find out not only if an asset is undervalued, but also why it is undervalued
 Is not afraid to bet against the crowd and oppose the prevailing investment winds
 Discourages investors to use stop-loss orders, because that way they can't buy more of a great thing when the price declines


Final words 

I hope you enjoyed reading how some the best investors in the world think about investing. You might have noticed some common themes, like buying companies for less than they are worth. And while they all practice this value investing approach, there are also notable differences between the strategies of these masters of investing. Where Warren Buffett runs a concentrated portfolio and focuses on "good" companies with a sustainable competitive advantage, Walter Schloss managed to earn impressive returns by simply buying a diverse set of extremely cheap companies. As Bruce Lee once said: "Adapt what is useful, reject what is useless, and add what is specifically your own.”


https://www.valuespreadsheet.com/best.pdf

Charlie Munger

Exclusive ValueWalk series on Charlie Munger’s life

• Charlie Munger — Part One: The Beginning
• Charlie Munger — Part Two: Quality Over Value
• Charlie Munger – Part Three: Sit On Your A$$
• Charlie Munger — Part Four: Investment Advice
• Charlie Munger — Part Five: Checklist Investing
• Charlie Munger — Part Six: The Daily Journal
• Charlie Munger — Part Seven: Poor Charlie’s Almanack
• Charlie Munger — Part Eight: Berkshire At 50
• Charlie Munger -- Part Nine: Colorful Charlie And The Cinderella Principle
• Charlie Munger — Part Ten: Conclusion

Charlie Munger's full resource page can be found here.

Charlie Munger: I have seen so many idiots getting rich on easy businesses. Don't buy cheap bargains, but look for very good companies.

Don't buy cheap bargains, but look for very good companies.
I have observed what would work and what would not.
I have seen so many idiots getting rich on easy businesses.
Surely, I am interested in the easy businesses.

How worried are you when the stock market goes down 50%? Ask Charlie Munger who reveals the secrets to getting rich.

Published on 13 Jul 2012

http://www.charliemunger.net -- Charlie Munger, the long-time business partner of famed investor Warren Buffett, talks with the BBC. If you know anything about Charlie Munger, he's famous for his quick wit, plain spokeness and absolute genius. He has helped shareholders of Berkshire Hathaway amass untold forunes.

Warren Buffett - 4 Steps to Picking a Stock

1. You have to deal in things that you are capable of understanding.

2. Then once you're over that filter, you need to have a business with some intrinsic characteristics that give it a durable competitive advantage.

3. Then you should vastly prefer management in place with a lot of integrity and talent.

4. Finally, no matter how wonderful it is, it's not worth an infinite price, so you have to have a price that makes sense and gives a margin of safety considering the natural vicissitudes of life.

It's a very simple set of ideas. The reason that these ideas have not spread faster is they're too simple.

Charlie Munger Quotes

Charlie Munger on Investing

Charlie Munger Reveals Secrets to Getting Rich

@ 6 min

The Psychology of Human Misjudgement - Charlie Munger Full Speech

Charlie Munger's 10 Rules for Investment Success

By Morgan Housel 
December 13, 2007 

Those of you lucky enough to attend a Berkshire Hathaway (NYSE: BRK-A  ) (NYSE:BRK-B  ) annual shareholder meeting have undoubtedly heard Charlie Munger say, "I have nothing to add."

In reality, the guy has quite a bit to add. Thankfully for us, Munger is almost as forthcoming with his investment thoughts as his pal Warren Buffett. In his must-read book, Poor Charlie's Almanac, Munger puts forth a 10-step checklist that even the most inexperienced investors could benefit from.

1. Measure riskAll investment evaluations should begin by measuring risk, especially reputational.

It's crucially important to understand that from time to time, your investments won't turn out the way you wanted. To protect your portfolio, don't set yourself up for complete failure in the first place. Giving yourself a large margin of safety, avoiding people of questionable character, and only taking on risk when you can be sure you'll be satisfactorily rewarded are all steps in the right direction. Companies like Chipotle (NYSE: CMG  ) might have perfectly bright futures, but when their shares are priced for perfection, they might nonetheless prove too risky for savvy investors.

2. Be independentOnly in fairy tales are emperors told they're naked.

With stockbrokers often rewarded for activity, not successful investments, it's critically important to make sure you believe that what you're doing is right. Chasing others' opinions may seem logical, but investors like Munger and Buffett often succeed by going against the grain. Big Berkshire investments such as Coca-Cola (NYSE: KO  ) , and more recentlyPetrochina (NYSE: PTR  ) , were largely ignored by the masses when they were first made.

3. Prepare aheadThe only way to win is to work, work, work, and hope to have a few insights.

It shouldn't surprise you that the best investments aren't the ones we typically read about in the paper. The diamonds in the rough are out there, but finding them requires effort. Buffett reads thousands of annual reports to cultivate ideas -- even if he only comes up with a few candidates each year. Munger advocates a constant curiosity for nearly everything in life. If you never stop asking the "whys" in what you do, you won't have trouble staying motivated.

4. Have intellectual humilityAcknowledging what you don't know is the dawning of wisdom.

Perhaps most crucially to Berkshire's success, its leaders never stray away from their comfort zones. In investing, a clear idea of what the business will look like in the future counts most. If you struggle to comprehend what the business does today, you might as well be throwing darts. While companies like Google (Nasdaq: GOOG  ) and Boston Scientific (NYSE: BSX  ) are certainly titans in their own right today, they might look drastically different in five to 10 years.

5. Analyze rigorouslyUse effective checklists to minimize errors and omissions.

The numbers don't lie. When researching investments, Buffett and Munger like to try to estimate the security's worth before they even look at its price. They are businessmen, not stock-market junkies. They focus their brainpower on the value of businesses, not convoluted economic forecasts or intricate market-timing techniques. Munger is incredibly brilliant, but the analytical rigor of his investment decisions is based around simplicity, not complexity.

6. Allocate assets wiselyProper allocation of capital is an investor's No. 1 job.

In the early days of Munger's investment partnership, he held very few securities. When good ideas came, he poured significant capital into them; otherwise, he simply enjoyed the California sun. The amount of money employed in each of your investments should relate directly to its attractiveness. When you find a great investment, don't be afraid to bet big on it.

7. Have patienceResist the natural human bias to act.

Munger said it best himself: "Half of Warren's time is sitting on his ass and reading; the other half is spent talking on the phone or in person to a highly gifted person that he trusts and trust him." While it can be tempting to jump in and out of the market, true fortunes are made from big commitments in quality companies, held indefinitely. When you're done with that, find a hobby. Spending all day watching stock tickers won't do you much good.

8. Be decisiveWhen proper circumstances present themselves, act with decisiveness and conviction.

This also goes back to not following the herd. When others are jubilant, you should be scared, and vice versa. Don't let others' emotions sway you; the market masses should help you find opportunities in their absence, not guide you down their own path to mediocrity.

9. Be ready for changeAccept unremovable complexity.

Investing success requires us to accept inevitable changes. Munger and Buffett hated railroads for decades, but as the times changed, they threw their old thoughts out the door and invested billions. The world around us won't always conform to our preferences and prejudices, and sometimes our best ideas will prove incorrect. If you aren't willing to roll with a changing market, you may find yourself fighting a lost cause.

10. Stay focusedKeep it simple and remember what you set out to do.

In chasing little, unimportant things, we often overlook huge and critical factors. But by keeping it simple, we can fixate on what really matters: buying good companies at a good price, and holding them until they're fully priced.

Charlie Munger often gets overshadowed by his more famous partner, but don't assume that's any reflection of Munger's own genius. He's undoubtedly been a guiding light for Buffett himself, and by any count, he should go down as one of the greatest investors of all time.

For related Munger-esque Foolishness:

• Munger on Human Misjudgements
• The Best of Charlie Munger
• Munger Goes Mental

http://www.fool.com/investing/general/2007/12/13/charlie-mungers-10-rules-for-investment-success.aspx#.UAlFemGono0

Charlie Munger Quotes

A Conversation with Charlie Munger (2 hour)

Charlie Munger - A Short Biography

CHARLIE MUNGER AND WARREN BUFFETT

Charlie T Munger works alongside Warren Buffett, as Vice-Chairman ofBerkshire Hathaway and Warren invariably refers to him as his partner and right hand man, generously giving Charlie credit for much of his success and that of the company.

Charlie Munger was a practising lawyer, having got into Harvard Law School without then having an existing Bachelor degree, not an easy thing to do.Roger Lowenstein recounts that Charlie was somewhat assertive as a student; when challenged by a professor in the Harvard Socratic fashion to analyze a case, Charlie, who had not prepared for the lesson, is reputed to have told the professor to give him the facts of the case and he, Charlie, would give him the law.

Charlie was practising law in Omaha Nebraska when he met Warren Buffett and Buffett eventually persuaded him to give up the law and get into financial investment. Charlie did so, a decision that one suspects neither man has regretted. Certainly, long time shareholders of Berkshire Hathaway would not.

Munger is chief executive officer of Wesco, an associate of Berkshire Hathaway, and like Buffet, his annual letters to shareholders can give good clues as to the investment secrets of this brilliant duo.

Charlie Munger is not only a brilliant investor; he is also a deep thinker with strong views on society, education and the philosophy of life. Go here to read an example of Charlie Munger’s frank discission of investment philosophy.

In 1995, Charlie Munger addressed students at the Harvard Law School on the issue of psychology of human misjudgement.

Charlie Munger is an interesting man and the recent subject of a book on investment philosophy, Investing: The Last Liberal Art

FURTHER RESOURCES

Our review of Investing: The Last Liberal Art, by Robert Hagstrom

EXTERNAL RESOURCES

The philosophy of Charlie Munger

http://www.buffettsecrets.com/charlie-munger.htm

The World According to "Poor Charlie"

The World According to "Poor Charlie"
Charlie Munger, Warren Buffet's number two speaks to Kiplinger's about investing, Berkshire and more.

December 2005

Charlie Munger has been Warren Buffett's partner and alter ego for more than 45 years. The pair has produced one of the best investing records in history. Shares of Berkshire Hathaway, of which Munger is vice chairman, have gained an annualized 24% over the past 40 years. The conglomerate, which the stock market values at $130 billion, owns and operates more than 65 businesses and invests in many others. Buffett's annual reports are studied by money managers. But Munger, 81, has always been media shy. That changed when Peter Kaufman compiled Munger's writing and speeches in a new book, Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger ($49.00, PCA Publications). Here Munger speaks with Kiplinger's Steven Goldberg.

Why has Berkshire done so well?
Just remember that we had a long run and an early start, particularly in Warren's case. It's much easier for me to talk about Warren than myself, so let's talk about Warren. Not only did he have a long run from an early start, but he got very smart very young -- then continuously improved over 50 years.

Buffett was a student of Ben Graham, the father of security analysis. He was buying deep value stocks -- "cigar butts" -- until you got involved.
If I'd never lived, Warren would have morphed into liking the better businesses better and being less interested in deep-value cigar butts. The supply of cigar butts was running out. And the tax code gives you an enormous advantage if you can find some things you can just sit with.

There are a whole lot of reasons, and Warren was a natural for always just getting smarter. The natural drift was going that way without Charlie Munger. But he'd been brainwashed a little by worshiping Ben Graham and making so much money following traditional Graham methods that I may have pushed him along a little faster in the direction that he was already going.

How do you work together?
Well, it's mostly the telephone and as the years have gone on, and I've passed 80 and Warren is 75, there's less contact on the phone. Warren is a lot busier now than he was when he was younger. Warren has an enormous amount of contact with the operating businesses compared to what he had early in his career. And, again, he does almost all of that by phone, although he does fly around some.

What are your work styles like?
We have certain things in common. We both hate to have too many forward commitments in our schedules. We both insist on a lot of time being available almost every day to just sit and think. That is very uncommon in American business. We read and think. So Warren and I do more reading and thinking and less doing than most people in business. We do that because we like that kind of a life. But we've turned that quirk into a positive outcome for ourselves.

How much of your success is from investing and how much from managing businesses?
Understanding how to be a good investor makes you a better business manager and vice versa.

Warren's way of managing businesses does not take a lot of time. I would bet that something like half of our business operations have never had the foot of Warren Buffet in them. It's not a very burdensome type of business management.

The business management record of Warren is pretty damn good, and I think it's frequently underestimated. He is a better business executive for spending no time engaged in micromanagement.

Your book takes a very multi-disciplinary approach. Why?
It's very useful to have a good grasp of all the big ideas in hard and soft science. A, it gives perspective. B, it gives a way for you to organize and file away experience in your head, so to speak.

How important is temperament in investing?
A lot of people with high IQs are terrible investors because they've got terrible temperaments. And that is why we say that having a certain kind of temperament is more important than brains. You need to keep raw irrational emotion under control. You need patience and discipline and an ability to take losses and adversity without going crazy. You need an ability to not be driven crazy by extreme success.

How should most individual investors invest?
Our standard prescription for the know-nothing investor with a long-term time horizon is a no-load index fund. I think that works better than relying on your stock broker. The people who are telling you to do something else are all being paid by commissions or fees. The result is that while index fund investing is becoming more and more popular, by and large it's not the individual investors that are doing it. It's the institutions.

What about people who want to pick stocks?
You're back to basic Ben Graham, with a few modifications. You really have to know a lot about business. You have to know a lot about competitive advantage. You have to know a lot about the maintainability of competitive advantage. You have to have a mind that quantifies things in terms of value. And you have to be able to compare those values with other values available in the stock market. So you're talking about a pretty complex body of knowledge.

What do you think of the efficient market theory, which holds that at any one time all knowledge by everyone about a stock is reflected in the price?
I think it is roughly right that the market is efficient, which makes it very hard to beat merely by being an intelligent investor. But I don't think it's totally efficient at all. And the difference between being totally efficient and somewhat efficient leaves an enormous opportunity for people like us to get these unusual records. It's efficient enough, so it's hard to have a great investment record. But it's by no means impossible. Nor is it something that only a very few people can do. The top three or four percent of the investment management world will do fine.

What would a good investor's portfolio look like? Would it look like the average mutual fund with 2% positions?
Not if they were doing it Munger style. The Berkshire-style investors tend to be less diversified than other people. The academics have done a terrible disservice to intelligent investors by glorifying the idea of diversification. Because I just think the whole concept is literally almost insane. It emphasizes feeling good about not having your investment results depart very much from average investment results. But why would you get on the bandwagon like that if somebody didn't make you with a whip and a gun?

Is finding bargains difficult in today's market?
We wouldn't have $45 billion lying around if you could always find things to do in any volume you wanted. Being rational in the investment world at a time when other people are losing their minds -- usually all it does is keep you out of something that causes a lot of trouble for other people. If you stayed away from the mania in the high-tech stocks at its peak, you were saved from disaster later, but you didn't make any money.

Should people be investing more abroad, particularly in emerging markets?
Different foreign cultures have very different friendliness to the passive shareholder from abroad. Some would be as reliable as the United States to invest in, and others would be way less reliable. Because it's hard to quantify which ones are reliable and why, most people don't think about it at all. That's crazy. It's a very important subject. Assuming China grows like crazy, how much of the proceeds of that growth are going to flow through to the passive foreign owners of Chinese stock? That is a very intelligent question that practically nobody asks.

What do you think of the U.S. trade and budget deficits -- and their impact on the dollar, which Berkshire is still betting against?
It's not at all clear exactly from some objective bunch of economic data just where the dollar ought to trade compared to the Euro. Who in the hell knows? It's clear that you can't run twin deficits on the scale that the U.S. has forever. As [economist] Herb Stein said, "If something can't go on forever, it will eventually stop." But knowing just when it's going to stop is a very difficult matter.

Is there a bubble in the real estate?
When I see people going to some old flea-bitten old condo and the list price is $1.8 million, and they decide to put it on the market for $2.2 million, and five people start bidding for it, and they sell it for $2.7 million, I say that's a bubble. So there are some bubbly places in the economy. I am amazed at the price of real estate in Manhattan.

So there is some bubble in the game. Is it going to go back to really cheap houses in good neighborhoods in good cities? I don't think so. So I think there will be huge collapses in some places, but, on average, I think that good houses in good places are going to be plenty expensive in future years.

Is there a bubble in energy stocks?
When it gets into these spikes, with shortages and uproar and so forth, people go bananas, but that's capitalism. If the price of automobiles were going up 40% a year, you'd have a boom in auto stocks. But if you stop to think about it, of the companies that you could have bought in, say, 1911, to hold for a long time, one of the very best stocks would have been Rockefeller's Standard Oil Trust. It became almost all of today's integrated oil companies.

How do you feel most corporate citizens behave in the U.S.?
Well, I disapprove of the way most executive compensation is arranged in America. I think it goes to gross excess. And I certainly don't like phony accounting that takes part of the real cost of running the business and doesn't run it through the income account as a charge against the reported earnings. I don't like dishonorable, lying accounting.

Do you think the stock market will return its long-term annualized 10% in the next decade?
A good figure for rational expectation would be no higher than 6%. I think it's unreasonable to assume that the world is going to try to arrange itself so that the inactive, asset-owning class is going to get a much higher share of the GDP than it normally gets. When you start thinking that way, you get into these modest figures. The reason the return has been so good in the past is that the price-earnings ratio went way up.

Ibbotson finds 10% average returns back to 1926, and Jeremy Siegel has found roughly the same back to 1802.
Jeremy Siegel's numbers are total balderdash. When you go back that long ago, you've got a different bunch of companies. You've got a bunch of railroads. It's a different world. I think it's like extrapolating human development by looking at the evolution of life from the worm on up. He's a nut case. There wasn't enough common stock investment for the ordinary person in 1880 to put in your eye.

What do you see for bonds?
The bond market has fewer opportunities now. The short-term rates are the same as the long-term rates, and the premium interest rate you get for taking risk is lower than it ought to be, given the risk. By definition, that's a world in which bond investment is much tougher to do with great advantage.

What do you expect in terms of returns for Berkshire Hathaway?
We have solemnly promised our shareholders that our future returns will be considerably below our previous returns.

But annual reports have been saying that year after year after year.
But lately we've been better at doing what we have long predicted.

What happens to Berkshire after the two of you?
Well, the world will go on and, in my opinion, Berkshire will still be a strong, rich place and with a central culture that will be shrewd and risk-averse. But do I think that we will get another person better than Warren to come in and replace Warren? I think the odds are against it.