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Robert Stephens, CFA
Robert Stephens, CFA
Articles (358) 

Charlie Munger on Identifying the Best Buying Opportunities

A simple approach could strengthen your stock-picking abilities

May 20, 2020 | About:

The challenging economic outlook may be making it more difficult than usual for value investors to identify the most attractive buying opportunities. Many sectors face reduced demand for their products, while a period of lockdown could cause a shift in consumer habits that persists over the long run.

One investor who has a strong track record of picking the best stocks for the long term is Berkshire Hathaway's (NYSE:BRK.A) (NYSE:BRK.B) vice-chairman Charlie Munger (Trades, Portfolio). His simple approach promotes flexibility and a contrarian stance, which may be a key reason why he and Warren Buffett (Trades, Portfolio) have been able to deliver market-beating returns for Berkshire Hathaway’s investors over the long term.

Investing within your sphere of knowledge

It is tempting for any investor to try to become an expert on every industry. However, it is near impossible to have sufficient knowledge to make investments in every sector within the stock market. This task is made even more difficult by the uncertain economic outlook at the moment. 

A better idea is to only invest in those industries and business that you understand. As Munger once said, “We [Berkshire Hathaway] have three baskets for investing: yes, no, and too tough to understand.”

An overreliance on company data

Company data has become more freely available in recent years due to advances in technology. For example, investors can easily access company 10-Ks for free over the internet.

However, an overreliance on data can be problematic when seeking to unearth the best stocks that are available, as it can cause investors to dedicate insufficient time to considering a company’s business model. This may mean that they do not build an accurate picture of how its performance could change in future and how its stock price may react. As Munger once said, “People calculate too much and think too little.”

Adopting a contrarian approach

The current economic slowdown is likely to cause the financial prospects for a wide range of companies to deteriorate in the short run. Investor sentiment towards them may decline as their sales and profitability fall, which could lead to buying opportunities for long-term value investors.

Therefore, adopting a contrarian approach and buying stocks that are unpopular among your peers could be a means of achieving outperformance of the stock market.

This approach requires self-discipline and may not yield high returns in the short run, but it has been an effective strategy used by Munger in the long-term. “Mimicking the herd invites regression to the mean," Munger once said.

Maintaining a flexible strategy

Every company faces unique challenges as a result of a changing economic outlook. For example, some businesses may have taken on too much debt in recent years that requires them to find additional debt sources in the near term. Others, in contrast, may have large cash positions that enable them to make acquisitions while asset prices are low.

Therefore, investors should view each company on a standalone basis. Trying to rigidly apply a set of criteria across all businesses and sectors may mean that the most attractive investment opportunities prove elusive. As Munger once said, “You need a different checklist and different mental models for different companies.”

Disclosure: The author has no position in any stocks mentioned.

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