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Application of Charlie Munger's Human Psychology Checklist

June 03, 2014 | About:

I've recently wrote a lot about Charlie Munger (Trades, Portfolio)’s multi-disciplinary approach, especially with regard to the subject of human misjudgement. But one thing I haven’t covered is how we can use Munger’s framework to minimize the occurrence of unforced errors caused by failing to use a simple psychological checklist. Fortunately, I found the following great checklist provided by Munger by accident and I immediately applied it to one of the investment ideas pitched to me. In this article, I will share with the readers how I have utilized this checklist to avoid getting myself into a situation I may regret later.

Below is the checklist:

1. Look for disconfirming evidence – killing your own ideas.

2. Emphasize factors that don’t produce lots of easily available numbers.

3. Under-weigh extra vivid experience and overweigh less vivid experience. Same with recent events, i.e cool off.

4. Remember the lesson: An idea or a fact is not worth more merely because it is easily available to you.

5. There’s no logical answer in some cases except to wring the money out and go elsewhere.

The stock in case was Weight Watchers International (WTW), a stock that has attracted quite a few value investors' eys. I got this idea from a friend in Asia. On the surface, there is a lot to like about this business. It has a high profit margin and operating margin. The business is a cash cow. It earns high return on invested capital, has negative working capital need, requires minimum capital spending. The U.S. Preventive Services Task Force endorses Weight Watchers’ multi-component intensive behavioral therapy (MCBT) as the only weight-loss treatment. It recommends that doctors refer patients to community-based programs, which is Weight Watchers’ network of leaders and members it built since the 1960s. It is more effective to participate in Weight Watcher’s meetings and use its products. It’s an established brand with dominating market share in North America. Better yet, the stock is at multi-year low. It’s not a lay-up but certainly a very tempting idea.

You may have guessed the result already. I didn’t buy it. I was tempted to act but Munger’s checklist forced me to step back and be more rational about it. Here is how I utilized the checklist:

1. Look for disconfirming evidence – killing your own ideas

In this case, it was actually not too hard to find disconfirming evidence:

  • Consecutive years of revenue declines.

    Consecutive years of revenue declines.

  • Mobile apps and regional and community weight loss programs have been eroding Weight Watchers’ moat gradually, as evidenced by the decline in both paid meeting weeks and total paid weeks.

    Mobile apps and regional and community weight loss programs have been eroding Weight Watchers’ moat gradually, as evidenced by the decline in both paid meeting weeks and total paid weeks.

  • Consecutive years of decline in net margins.

    Consecutive decline in net margins.

  • High operating leverage, which will magnify the effect of revenue decline on bottom line.

These are all signs of value traps.

2. Emphasize factors that don’t produce lots of easily available numbers

Well, I’m not sure if Munger means numbers that are harder to find or qualitative factors. But by going through Yelp and Glassdor.com, I’ve found some disconcerting reviews from both the customers and the employees. Weight Watchers has a rating of merely over 2 out of 5 on glassdoor.com. There is an abundant number of customers who gave 1 star reviews on Yelp, including some of Weight Watchers' loyal customers, who pointed out the change in quality of meetings.

Another material factor is the big headwind of secular behavioral change: people simply use apps more and go to meetings less. Weight Watchers’ app is not better than its competitors'. I’ve downloaded the app and even paid for it for a few days. I was subject to the tendency to like the app as I was still leaning toward the bull case but after a few days, I found the app extremely disappointing for a company as large as Weight Watchers International.

3. Under-weigh extra vivid experience and over-weigh less vivid experience. Same with recent events, i.e cool off.

To be honest, I struggled with this point. A decent amount of judgment is involved in determining what is extra vivid experience and what is less vivid experience. What makes it more difficult is that I have very limited experience with the product of Weight Watchers International. "Not applicable" seems to be the appropriate answer here in terms of business product.

Regarding recent events, the fact that WTW jumped more than 20% after the company beat earnings and revenue forecasts and raised 2014 guidance is a significant recent event. It certainly boosted the confidence in WTW’s shareholders for a few days and created short-term extra vivid experiences for investors. What’s interesting is that the numbers are actually horrible. For the quarter, Weight Watchers’ revenue, was almost 17% lower than the same quarter last year. There were fewer active subscribers in its North American and UK segments. For the quarter, active subscribers were down 14% from a year earlier. In terms of profitability, for the quarter, Weight Watchers saw its earnings per share dropped 56% compared to the same quarter a year earlier. The numbers did beat analysts’ expectations, which we can argue is an extra vivid experience given that beating or missing analysts’ expectations is what most investors focus on. We can also argue that the deteriorating business fundamentals are less vivid as they didn’t make it to the headlines as beating analysts’ expectations. But as I pointed out in my previous article, we should focus on the fundamentals, not the share price.

4. Remember the lesson: An idea or a fact is not worth more merely because it is easily available to you.

Although this is only a reminder, I think here we have to be mindful of the source and evidence of the idea. If it’s pitched by a friend who provides you with only biased data easily available to you, it is more prudent to force yourself to apply a discount to the idea and force yourself to do your own work. The same applies to an idea borrowed from a guru. Borrowed convictions are the most dangerous ones. With gurus' holdings and activities easily available now, we must be more mindful of this availability tendency.

5. There’s no logical answer in some cases except to wring the money out and go elsewhere.

Again, this is another good reminder. In this case, I agree that the logical answer is to go elsewhere. WTW looks cheap but it also has a few characteristics of a classic value trap. Assigning a probability of whether it will turn around or not is too hard.

Now I have concluded my first experience with Munger’s checklist. You can tell I struggled with this checklist quite a bit and I am not entirely satisfied with my work. The point is, it’s not supposed to be easy but doing it forces me to take a more rational approach. And if I make it a routine, I will get better with using this checklist.

My suggestion to you: Take this checklist seriously and apply it to your next investment decision.

About the author:

A global value investor constantly seeking to acquire worldly wisdom. My investment philosophy has been inspired by Warren Buffett, Charlie Munger, Howard Marks, Chuck Akre, Li Lu, Zhang Lei and Peter Lynch.

Rating: 4.6/5 (14 votes)



Dvitale880 - 5 years ago    Report SPAM

Thank you!

Olanderf premium member - 5 years ago

Am I missing something? It looks like the article has disappeared.

Grahamites - 5 years ago    Report SPAM

Dvitale880- You are very welcome.

Grahamites - 5 years ago    Report SPAM

Olanderf: I'm not sure what the problem is. I can still see the article.

Seattle Ethan
Seattle Ethan - 5 years ago    Report SPAM

#3, I don't have an example for WTW, but I'm reminded of Jason Zweig's comments about inflation. He said most investors worry about sudden downward movement of security prices when it's the LT inflation that's going to kill your purchasing power.

I see the same irrational fear in society too. People are more afraid of terror attacks or other horrific events when a flu or cholestrol is more likely to kill you in the LT. But people worry about the terror attacks bc it's more vivid.

Olanderf premium member - 5 years ago

Thanks, working now. Must have just been an issue with my browser.

Hafenklang premium member - 5 years ago

hi, I can't see the article. Checked it with three different browsers... any ideas what happened? thanks!

Grahamites - 5 years ago    Report SPAM

Hafenklang: I don't know what is the cause of your technical difficulty. You may want to check with gurufocus's support team.

Peterc123 premium member - 5 years ago

When Munger talks about 'extra vivid experiences' he is especially pointing to recent stories that are blinding us. In this case, you could for example think of WTW's bad looking capital structure, which is mainly due to a big longterm loan that it took in 2012 coming from an ill-timed management decission to buy part of Artal's stake at $80 valuation. Additionally, there is the easy to swallow story that 'these are the days' when technology will bring down a company with an older method while besides a big 'buzz' (that definitely confuses the customer) apps have no proven track record. Munger would also point out that, being so successfull in the past, WTW's method would have some clear strenghts and he would use his 25-points checklist of human psychology to find that there are some Lollapalooza effects that make it that successful.

Munger would als never base his assessment of a company on a relative comparison of year-over-year quarter results. He would look at the attractive valuation metrics, the easy generated cashflow, the capacity of the company to fullfil its future obligations, the considerable moat of the company and the improved strategy of the management. He would also point out that the total market will drastically grow in the future including a new B2B segment that WTW is going after and that is fueled by governement considering obesity as a disease.

Following the lessons of Munger, you would conclude that WTW is a great value play with some risk due to its capital structure. However, overall, Munger would argue that the appreciation probability could easily be the double of what the market values the company today. If the market capital of WTW would be 20x higher, he would even consider it today.

I hope this gives you a better idea of the use of his checklist.

Only1emmapeel - 4 years ago    Report SPAM

i've recently wrote? proof-reading your bylines is rather thought-provoking, i'd say.

i won't charge you for this, but just so you know, you NEVER say, "I've recently wrote." it's, "i recently wrote," or "i've recently written." do you need an editor? i am available. thanks!

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