A Few Principles From Charlie Munger for Investing Wisely

Warren Buffett (Trades, Portfolio)’s partner, Charlie Munger (Trades, Portfolio), is widely viewed as one of the most successful and outspoken value investors of all time. Munger and Buffett, both disciples of Benjamin Graham, the father of value investing, share many of the same insights into what attributes are necessary for disciplined, successful long-term investing. Munger has a few principles or personal characteristics that underlie his investment philosophy for long-term success.

Munger is somewhat unique in the sense that he is a Renaissance man in terms of this fluency in multiple disciplines, in addition to securities analysis and a keen understanding of corporate financial fundamentals. Munger was a successful attorney prior to switching full-time to the investment world. He is also a voracious reader, not only on topics related to the business operations of potential investments, but also on wide-ranging topics such as history, law, psychology and biology.

Munger makes no secret of the fact his knowledge from these multifarious intellectual disciplines clearly informs his investment judgment. In "Buffett& Munger - A Study in Simplicity and Uncommon, Common Sense," author Peter Bevelin distills many of the teachings Buffett and Munger revealed in annual reports, interviews and shareholder letters. He presents a few of the pitfalls Munger urges investors to avoid.

Munger doesn’t view himself as a “specialist” in the sense of possessing superior mathematical or financial analysis acumen or expertise in one business sector or investment discipline. He believes that such specialization, on many occasions, can be a handicap, which obscures from an investor insights that might have been apparent had the analyst shed their myopic or mathematical approach to investment analysis. Indeed, Munger has a certain aversion to computer simulations or pure mathematical analysis as a basis for investment management:

“You don’t need higher math in business and if you learn it you feel tempted to use it – to your detriment. You really have to understand the company and its competitive positions; that’s not disclosed by the math. There is something to be said for ‘keeping it simple.’"

Munger’s incorporation of a KISS component that underlies his securities analysis has additional benefits compared to those systems or methodologies that rely entirely on complex present value computations or projections that look far into the future. The guru has a rather unique way of putting a twist on the old Graham-Dodd adage that trying to ascertain earnings growth far into the future is a fool’s errand:

“I don’t think we’ve reached a new order of things where the laws of mathematics have been repealed. A wise economist once said, ‘If a thing can’t go on forever, it will eventually stop’ ...and it might even get a lot worse. All man’s desired geometric progressions, if a high rate of growth is chosen, at least come to grief on a finite earth.”

Munger does not rely on rigid financial modeling or present value methodologies to determine intrinsic value because the investor becomes vested in believing their own projections or prognosis for the future:

"Some of the worst business decisions I’ve seen are those that are done with a lot of formal projections and discounts back. And the trouble with that approach is that you get to believing the figures. And it seems that higher mathematics with more false precision should help you, but it doesn’t."

Despite the futility of trying to predict the future earnings capacity of an enterprise with any type of accuracy or rigor, investors and analysts continue to issue and rely upon authoritative prognostications, based the mistaken belief that it is indispensable factor in successful investing. Munger attributes the ease with which many investors adopt, without the slightest skepticism, the predictions of others is rooted in human nature. Munger, yet again, describes this phenomenon without any blandishments:

"People have always had this craving to have someone tell them the future. Long ago, kings would hire people to read sheep guts. There’s always been a market for people who pretend to know the future. Listening to today’s forecasters is just as crazy as when the king hired the guy to look at the sheep guts. It happens over and over and over."

Lastly, Munger reminds value investors, or anyone seeking to obtain a company that is selling below its intrinsic value, to view themselves not as those who hold an equity or stock position, but rather as owners of a business. Here, he is restating one of the most distinctive principles of value investing enunciated by Graham in the "Intelligent Investor": namely, the difference between viewing a stock purchase as an ownership interest in a business, versus a certificate of shares traded on an exchange, whose price, due to the vagaries of the market, can fluctuate at any given point in time.

Munger discusses this overall principle in terms of the habit of some individuals predominately basing their investment decisions on where the economy will be at any given point in time, rather than thinking about the operations of an individual business, any competitive advantages it may enjoy and the fundamental financial health of the enterprise relative to other comparable businesses in the sector. He said, “If you’re agnostic about macro factors and, therefore, devote all of your time to thinking about individual businesses and the individual opportunities, it’s a way more efficient way to behave.”

Because of the infinite complexity of econometric modeling, Munger believes it is much better to simply admit one is ignorant:

"Macroeconomics people are often wrong because of extreme complexity in the system they wish to understand. The trouble with making all these macroeconomic predictions is that people start to think they know something. It’s much better to just say you’re ignorant."

In other words, Graham, Buffett and Munger all believed unequivocally that humility can go a long way to improving one’s fundamental long-term investment success.

Even in an investment environment that is awash in information and of seeming infinite complexity, people all too often forget that “Common sense is an enormously powerful tool.” Munger is on firm ground when he says, “People calculate too much and think too little.”

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