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Stepan Lavrouk
Stepan Lavrouk
Articles (178) 

Charlie Munger: Benjamin Graham Wasn’t Trying to Play Our Game

Berkshire Hathaway’s vice chairman explains how he and Buffett diverged from Graham’s philosophy

May 23, 2019 | About:

Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) are considered to be disciples of Benjamin Graham, but this is not entirely true. Yes, they are both regarded as two of the greatest value investors of all time, and Buffett in particular adhered to Graham’s investing philosophy quite closely at the beginning of his career. But over time, Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) diverged from classic Grahamite thinking, and, while counterfactuals are impossible to properly evaluate, this seems to have paid off. When talking with students at the University of Southern California in 1995, Munger explained how he and Buffett came to develop their own strategy.

A system anybody could use

“Ben Graham wasn't trying to do what we did. For example, 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. And he didn't feel that the man in the street could run around and talk to management and learn things. He also had a concept that the management would often couch the information very shrewdly to mislead. Therefore, it was very difficult. And that is still true, of course - human nature being what it is.”

It is important to remember that Graham came of age at a time when the stock market was in many ways a lot wilder and less regulated than it is now. The Securities and Exchange Commission was created in 1934, at which point Graham had been in the investment game for almost 20 years. There were relatively few laws around financial disclosure, and fraud was much more widespread than it is nowadays.

As a result, Graham was probably a lot more suspicious of statements made by management than we would be today. Indeed, it is for this very reason he considered buying common stock to be speculative more often than not. In "Security Analysis," he and his co-author, David Dodd, treated bonds as the preferred method of investment, in much the same way as we would treat equities today. So it makes sense that Graham would be a bit skeptical of any investment method that relied on meeting executives and making investment decisions based on character assessments, as Buffett and Munger often do.

Paying up for quality

“Our leap was paying up for quality. And so having started out as Grahamites - which, by the way, worked fine - we gradually got what I would call better insights. And we realized that some company that was selling at 2 or 3 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.

And once we'd gotten over the hurdle of recognizing that a thing could be a bargain based on quantitative measures that would have horrified Graham, we started thinking about better businesses. The bulk of Berkshire's billions were brought by better businesses.”

Buffett has often credited Munger with changing his thinking on the issue of "cigar-butt investing" - buying beaten down companies at basement valuations and squeezing the last bit of value out of them. Munger’s insight was to move on from that model and begin acquiring strong businesses at fair value that he felt were well positioned to continue growing for decades. And who knows? If Graham were alive today to see Berkshire’s record, perhaps he would approve.

Disclosure: The author owns no stocks mentioned.

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

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