With Berkshire Hathaway's (BRK.A) annual meeting—the Woodstock of Capitalism—set for Saturday, May 4, many investors are preparing to flock to Omaha once again to hear pearls of wisdom both from Berkshire's chairman Warren Buffett and vice chairman Charlie Munger.
It's virtually impossible to overstate the influence that Munger, who recently turned 89 years old, has had on Buffett and on Buffett's investing discipline. Buffett regularly labels Munger as his "partner" at Berkshire, and fills the firm's annual shareholder letters with phrases like, "Charlie and I believe..." In fact, in Berkshire's 2012 letter, Buffett makes reference to their long and fruitful working relationship, noting that "more than 50 years ago, Charlie told me that it was far better to buy a wonderful business at a fair price than to buy a fair business at a wonderful price." That insight has guided Buffett over the years and helped him become more comfortable with paying up for outstanding businesses with economic moats, or sustainable competitive advantages.
Given Munger's age, no one can say how much longer investors can expect to see him sitting at Buffett's side each May, delighting audiences with his wisdom and also chiming in with his favourite line, "I have nothing to add," immediately after Buffett expounds on a topic.
As Berkshire's annual meeting nears, now is an appropriate time to pay tribute to Munger and to some of the core investment principles that he has espoused. Most of these can be found in the excellent 2005 book "Poor Charlie's Almanack," a collection of Munger's best talks, quotations and thoughts. Modelled after "Poor Richard's Almanack" by Munger's hero, Ben Franklin, "Poor Charlie's Almanack" lays out Munger's world view, including his "multidisciplinary" approach to clear, elegant thinking.
It's obviously not just investors in Berkshire Hathaway who can benefit from the collective investing wisdom of Buffett and Munger. Investors in other companies, and, indeed in funds, can tap investment themes the duo have espoused.
The World According to Charlie
One of Munger's principal frameworks is to more broadly understand, collect and organise the factors affecting an investment candidate. This means drawing what he calls "multiple mental models" from a variety of disciplines, including engineering, mathematics, physics, chemistry and psychology. Driving this need to understand the various dynamics surrounding an investment—both in its internal and external environment—is Munger's understanding that these various factors can work in concert. Munger termed that dynamic a "Lollapalooza Effect"—when anywhere from two to four forces all are driving the investment in the same direction. And yet, Munger noted in Outstanding Investor Digest in 1997 that the effect isn't "simple addition" but rather more akin to a "nuclear explosion."
One doesn't need to be an academic to tap these different models, including the modern Darwinian synthesis model from biology or cognitive mis-judgment models from psychology. Indeed, Munger himself acknowledges that his understanding of these models is entirely self-taught.
Munger's invocation of multiple mental models has given him having a mind-set characterised by four guiding principles that any ordinary investor should follow: preparation, patience, discipline and objectivity. When practiced correctly, these attributes should result in buying great businesses at good prices and keeping one's portfolio turnover low. As Munger himself once said, "You're paying less to brokers, you're listening to less nonsense, and if it works, the tax system gives you an extra 1, 2, or 3 percentage points per annum."
Can anyone else follow Munger's mindset? "Poor Charlie's Almanack" describes his world view, perhaps tongue-in-cheek, as "Quickly Eliminate the Big Universe of What Not to Do, Follow Up with a Fluent, Multidisciplinary Attack on What Remains, Then Act Decisively When, and Only When, the Right Circumstances Appear." But as Munger and Buffett have proven, it works. Munger once said, "It's kind of fun to sit there and outthink people who are way smarter than you are because you've trained yourself to be more objective and more multidisciplinary. Furthermore, there is a lot of money in it, as I can testify from my own personal experience."
How Munger Picks Investments
In addition to favouring a narrow, concentrated portfolio, Munger holds the view that he should stick to his knitting when evaluating investment candidates. "Yes" candidates are easy-to-understand businesses with distinct and sustainable competitive advantages with a dominant franchise. He immediately dismisses other possibilities, especially in health care and technology, into what he calls the "too tough to understand" pile and others—deals pushed by brokers, including IPOs—into the "no" pile.
Munger considers every aspect of a business when considering a candidate for investment, evaluating management’s character and capital allocation decision-making. He also analyses a business' competitive advantages, mindful that few businesses endure for multiple generations. Thus, understanding a business' sustainable competitive advantages is critical. Munger pays close attention to the company's operating and regulatory environment, the impact on it from changes in technology, hidden exposures, and the current and future impacts of stock options, pension plans, and retiree medical benefits. Finally, Munger carefully attempts to compute the business' underlying value. To avoid anchoring, he tries to calculate a business' value independently of the price at which a company trades.
