Despite the fact Charlie Munger (Trades, Portfolio) is generally thought of as one of the figureheads of value investing today, it is relatively unknown that he actually eschewed deep value when he first started to invest money for clients.
Even though he was convinced to go into the money management business by Warren Buffett (Trades, Portfolio), who had been trained by the "father of value investing," Benjamin Graham, Munger set out with his own style and developed his business around that approach, which proved to be possibly the most important decision in investment history. This change not only had an impact on Munger's investment style, but also eventually that of Buffett and the thousands of other investment managers that have since copied this style.
Here's what Munger said about his decision not to follow deep value in a Wall Street Journal interview in 2014:
"I don’t love Ben Graham and his ideas the way Warren does. You have to understand, to Warren -- who discovered him at such a young age and then went to work for him -- Ben Graham’s insights changed his whole life, and he spent much of his early years worshiping the master at close range. But I have to say, Ben Graham had a lot to learn as an investor. His ideas of how to value companies were all shaped by how the Great Crash and the Depression almost destroyed him, and he was always a little afraid of what the market can do. It left him with an aftermath of fear for the rest of his life, and all his methods were designed to keep that at bay.
I think Ben Graham wasn’t nearly as good an investor as Warren Buffett is or even as good as I am. Buying those cheap, cigar-butt stocks was a snare and a delusion, and it would never work with the kinds of sums of money we have. You can’t do it with billions of dollars or even many millions of dollars. But he was a very good writer and a very good teacher and a brilliant man, one of the only intellectuals -- probably the only intellectual -- in the investing business at the time."
Personally, I believe this opinion has far more meaning today than it did when Munger first started investing. Graham, and later Buffett, made a fortune buying stocks trading below net-net asset value because it was easy at the time. Graham was swamped with opportunities after the 1929 crash and, in the post-World War II years, Buffett had the same opportunity. As time has progressed, however, the number of opportunities has declined and it has become harder and harder to find high-quality stocks trading at deep discounts. It is interesting that Munger also believes deep value is " a snare and a delusion."
Instead of deep value, Munger liked quality. It is this love of quality that led him to convince Buffett to fork out the cash for See's Candies. It was his first real non-value investment, but one that, as noted in the 2014 letter to shareholder, paid off handsomely over time:
“…The family controlling See’s wanted $30 million for the business, and Charlie rightly said it was worth that much. But I didn’t want to pay more than $25 million and wasn’t all that enthusiastic even at that figure. (A price that was three times net tangible assets made me gulp.) My misguided caution could have scuttled a terrific purchase. But, luckily, the sellers decided to take our $25 million bid. To date, See’s has earned $1.9 billion pre-tax, with its growth having required added investment of only $40 million. See’s has thus been able to distribute huge sums that have helped Berkshire (BRK.A, Financial)(BRK.B, Financial) buy other businesses that, in turn, have themselves produced large distributable profits. (Envision rabbits breeding.) Additionally, through watching See’s in action, I gained a business education about the value of powerful brands that opened my eyes to many other profitable investments.”
The returns from See's highlight an interesting point and thought-provoking question. See's has been a hands-off business, the product virtually sells itself and every year all Buffett has to do is oversee a price increase. This "sit on your ass" investment has produced a return of 7,500% (based on pre-tax numbers).
Could Buffett have produced the same returns by value investing? It's possible, but it is impossible he would have been able to do so with as little effort as has been required with See's. In other words, when you have an opportunity that's as lucrative, it is easy to see why deep-value investing may appear to be a waste of time.
Disclosure: The author owns no stocks mentioned.
