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Rupert Hargreaves
Rupert Hargreaves
Articles (796)  | Author's Website |

Charlie Munger on Where Benjamin Graham Went Wrong

Buffett's long-term partner does not have the same kind of affection toward Graham as Buffett

May 09, 2019

Warren Buffett (Trades, Portfolio) has built a tremendous fortune by following the investment principles of the dean of value investing, Benjamin Graham. However, Buffett's long-term partner, Charlie Munger (Trades, Portfolio), does not have the same kind of affection toward Graham as Buffett.

Munger on Graham

In an interview with Jason Zweig of The Wall Street Journal back in 2014, A Fireside Chat With Charlie Munger, the great investor explained why he does not have the same kind of love for Graham as his business partner. "I don't love Ben Graham and his ideas the way Warren does," Munger said.

"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 worshipping the master at close range," he added.

Munger went on to say that he believes, "Graham had a lot to learn as an investor," because his investment principles were developed during the Great Depression, and he designed his investment strategy around making sure he never had to lose money again. "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," Munger said. "I think Ben Graham wasn't nearly as good an investor as Warren Buffett (Trades, Portfolio) is or even as good as I am," he adds.

Cigar butt style out of date

Munger's main issue with the way Graham invested was that he stuck to "cigar-butt" style investments, which was undoubtedly a great investment strategy at the time, but the world has changed significantly since then. For Berkshire, with hundreds of billions of dollars in assets under management, it would be impossible to make this strategy work today.

According to Munger, Graham's downfall was "trying to make a strategy that anyone could use." He explained this view in his now well-known speech, "A Lesson on Elementary, Worldly Wisdom as It Relates to Investment Management & Business," at the University of Southern California Business School in 1994:

"Graham didn't want to ever talk to management. And his reason was that, like the best sort of professor aiming his teaching at a mass audience, he was trying to invent a system that anybody could use. He also had a concept that management would often couch the information very shrewdly to mislead."

He went on to add that by combining both robust financial analysis and qualitative analysis of management, Buffett and Munger have been able to build a more profitable investment strategy:

"We realized that some company that was selling at two or three times book value could still be a hell of a bargain because of momentums implicit in its position, sometimes combined with an unusual managerial skill plainly present in some individual or other, or some system or other."

Munger went on to add:

"If a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you'll end up with one hell of a result."

Adapting with the times

I think this is interesting because it offers an insight into how Munger's (and Buffett's) investment strategy has developed over the years. It shows us how important it is not to take any investment strategy for granted.

Graham is considered to be one of the best investment teachers of all time, but if Buffett and Munger had continued to follow his advice blindly, it's possible that they wouldn't have got to where they are today. They realized the strategy was running out of puff, so they decided to tweak how they looked at the market. The rest, as they say, is history. It's a good lesson in never taking any investment strategy for granted and always adapting and planning according to your own experience and circle of competence.

Disclosure: The author owns shares in Berkshire Hathaway.

Read more here: 

Berkshire Hathaway's 1st Quarter Earnings: A Mixed Bag 

Warren Buffett's Amazon Buy: Should You Follow Berkshire? 

Berkshire's Buybacks: Back Up the Truck 

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website


Rating: 4.2/5 (5 votes)

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Comments

Valuator
Valuator - 1 week ago    Report SPAM

Please, everyone, take this to heart.

Thomas Macpherson
Thomas Macpherson premium member - 1 week ago

Thanks for great article Rupert. I've written about by evolution over the years as a value investor. I've certainly moved much closer to the Munger model than the Graham model. But it's an interesting dilemma. I still believe passionately in margin of safety and valuation, but my views on quality (meaning high ROIC, ROE, ROA, no debt, competitive moats, etc.) have moved me to purchase companies that certainly don't meet older Graham-focused value investors such as my friend and former co-worker John Dorfman. Great stuff as always Rupert. Best - Tom

batbeer2
Batbeer2 premium member - 1 week ago

Thanks for sharing your thoughts.

According to Munger, Graham's downfall was "trying to make a strategy that anyone could use."

Well.... Charlie Munger isn't always right. The fact that Graham's framework is of limited use to a billionaire can hardly be qualified as a downfall. You could intelligently argue that Einstein caused the downfall of Newton but you'd be wrong. The truth is that Einstein's work helps us better understand the limits of Newton's brilliant and useful framework. It's the same with Buffett and Graham.

Just some thoughts.

Thomas Macpherson
Thomas Macpherson premium member - 1 week ago

Great points Batbeer.

jtdaniel
Jtdaniel premium member - 1 week ago

Great article and comments. I think it is worth remembering that Graham effectively retired around 1956 when there were still opportunities in net nets and other deep value strategies. He was also flexible enough to really load up on GEICO as a long term compounder. The only time I had much success with deep value investing was near the peak of the 1990s bull market when old economy smoke stacks and home builders were sold hard in favor of dot.com stocks. I have done much better with out of favor growth stocks like Microsoft, Abbott Labs and Starbucks, probably because I hardly ever think of selling them.

Rupert Hargreaves
Rupert Hargreaves - 1 week ago    Report SPAM

Thanks for the comments all, they all add to the debate and I think add to the conclusion that investing is an art, not a science

dirt2624
Dirt2624 premium member - 4 days ago

A man can only deal with the opportunity set he is presented with. Graham had a fantastic record post depression. His partnership/closed end fund traded like a stock on the exchange and traded at the largest premium to NAV that I have ever seen. Annual payouts to shareholders were huge.

Buffett and Munger got to stand on the shoulders of a true giant. And they operated with an opportunity set that required they do things a bit differently. But Buffett says that he could generate returns of 50% per year with a $million - how much of that return would come from the Graham play book - I think the majority.

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