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.
This article is going to be a very simple and straightforward summary list of the merely handful of ideas that carry the very heavy freight taken directly from Charlie Munger (Trades, Portfolio)’s talk “Art of Stock Picking.” I think each serious value investor should read this talk multiple times. No doubt it is one of the greatest speeches ever given in the field of investing. For simplicity purposes, I will only list out the 18 models that I summarized with minimum explanation. Interested readers can then add their own notes and applicability of each model.
- Compound interest.
- Elementary math of permutations and combinations (I would make sure to include Bayer’s Formula).
- Accounting. However, you should understand the limitations.
- Braun Company’s 5 W’s – who was going to do what, where, when and why.
- Normal distribution (bell curve).
- Backup system from engineering.
- Breakpoints from engineering.
- Critical mass from physics.
- Cost-benefit analysis
- How your brain works.
- Psychology of misjudgment.
- The concept of ecosystem.
- Advantage of scale.
- Cost reduction
- Information advantage
- Advantage of scales coming from psychology (social proof especially)
- The idea that in some businesses, the very nature of things is to sort of cascade toward the overwhelming dominance of one firm.
- Disadvantages of scale and going to a narrower specialization.
- Concepts of patents, trademarks, exclusive franchises and so forth.
- Discriminate between when technology is going to help you and when it is going to kill you.
- Surfing – when a surfer gets up and catches the wave and just stays there, he can go a long long time.
- Circle of competence.
Of course it is not enough to merely know the names of the aforementioned models. Like Munger said, “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 our head. And you’ve got to array your experience both vicarious and direct on this latticework of models."
