BOOK REVIEW: CHARLIE MUNGER – THE COMPLETE INVESTOR

Abstract

Charlie Munger: The Complete Investor is similar to Warren Buffett Speaks in that it’s a collection of quotes and stories from a wise man on how to be a successful investor. The author, Tren Griffen, does a great job of collecting these quotes and words of wisdom into principles and systems.

Value Investing Fundamentals
The author presents the four principles of the Graham value investing philosophy that “will never be obsolete” (p. 7):

1. Treat a share of stock as proportional ownership of the business.
2. Buy at a significant discount to intrinsic value to create a margin of safety.
3. Make a bipolar Mr. Market your servant rather than your master.
4. Be rational, objective and dispassionate.

If you’ve read other posts on www.dhandho.dk/en/, or books on value investing, these principles are not news to you (see for instance What is value investing?).

In short, however, Munger does not regard a stock as simply a piece of paper to be dumped onto someone dumber once you’ve locked in a quick profit. No, stocks are certificates of ownership in underlying businesses. To Munger, it’s empirical that the businesses he buys are characterized by great long-term economics. One can only acquire stocks in such strong businesses at a discount if you’re equipped with a rational mindset that lets you take advantage of Mr. Market’s flaws.

The Genetics of a Value Investor
A large part of the book centers on the necessary mindset and personal skills/traits of the value investor. Such has been expounded on www.dhandho.dk/en/ previously (cf. The Value Investor’s Mindset), but the characteristics are worth repeating.

First, a few words of comfort to some of us: Munger says you don’t need to be particularly smart to become a successful investor. In fact, it might be a handicap: “A lot of people with high IQs are terrible investors because they’ve got terrible temperaments. […] Very-high-IQ people can be completely useless – and many of them are.” (p. 98) Munger believes that the reason many high-IQ people aren’t successful on the financial markets stems from a need to solve hard valuation problems, which they believe they’ll be rewarded for solving. Yet, problems are problematic, which is why Charlie puts them in the ‘too hard’-pile. He simply ignores such opportunities, since “hard problems are hard problems, pregnant with opportunities to make mistakes.” (p. 115)

All right, so if you don’t have to be smart, what is then required? In chapter 5, titled The Right Stuff, the reader is introduced to the 13 traits of the value investor:

1. Patient
2. Disciplined
3. Calm, but courageous and decisive
4. Reasonably intelligent, but not misled by a high IQ
5. Honest
6. Confident and non-ideological
7. Long-term oriented
8. Passionate
9. Studious
10. Collegial
11. Sound Temperament
12. Frugal
13. Risk Averse

Since a lot of these traits are logical and self-explanatory, I won’t go into the details of each. I would rather highlight a couple of quotes that I think capture several of the thirteen points above.

In length of trait 9, Charlie advises: “Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day.” (p. 105) Earlier in the book, being wise was defined as “[having] experience, common sense and good judgment. How one applies these things in life is what makes a person wise.” (p. 53)

To describe the ‘emotional state’ of a successful value investor, the author highlights the following quote in connection with trait 11: “Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior are vital to long-term investment success. The best investors are those who have temperament that is calm and rational” (p. 108)

The Variables of the Graham Value Investing System
We’re now familiar with the four fundamentals of the value investing philosophy, and we have touched upon the personal characteristics that make investors successful. What next? Well, there is yet another list of bullet points that deals with the next step: how to go about managing your portfolio and picking stocks. Under the heading The Variables in the Graham Value Investing System, the below are presented. I believe I’ve dwelled enough on point 1-3 in various other posts, i.e. What is value investing? and the Lessons from 20 investment books post series (part I, II and III). Hence, I’ll comment only on point 4-8.

1. Determining the appropriate intrinsic value of a business
2. Determining the appropriate margin of safety
3. Determining the scope of an investor’s circle of competence
4. Determining how much of each security to buy: Charlie believes in focus investing. He thinks it’s senseless to diversify into an ocean of securities you’re only slightly familiar with. Instead, concentrating in a few seems to be an “obviously good idea”. There is no absolute number of positions that is perfect, but he appears to believe in Graham’s rule about 10-30, which is defined as “adequate though not excessive diversification”.
5. Determining when to sell a security: Warren and Charlie are aligned when it comes to selling securities. For the non-great companies, one should sell the security when it reaches your estimate of intrinsic value. But, it’s much better to buy and forever hold great companies with outstanding economics and expanding values because then “you can sit on your ass [and] that’s a good thing.”
6. Determining how much to bet when you find a mispriced asset: It’s difficult to see the difference between point 4 and this bullet. But again, it’s all about finding mispriced gambles (high upside and low downside), and then “[load] up when we were very confident that we [are] right.”
7. Determining whether the quality of a business should be considered: In the length of point 5, Charlie is always scouting for Phil Fisher type stocks that appreciate in value ‘in perpetuity’. Such a business may be in the market for double-digit P/E and large premiums to book value and still be a bargain. Charlie puts it as such in Damn Right!: “The investment game always involves considering both quality and price, and the trick is to get more quality than you pay for in price.”
8. Determining what businesses to own: To my fellow Buffett & Munger fanatics it can’t come as no surprise that these partners are looking for a business with entry barriers that protect them from competition: moats (or competitive durable advantages). It’s most often strong brands with huge replacement costs that ensure pricing power through i.e. customer loyalty.

Agreed, these points run in circles a bit. Though Charlie and Warren are undoubtedly natural-born stock pickers, and their skill sets can’t be taught through a few principles and personal characteristics, I hope this post has brought you a bit closer to Mungerology. Let me just end this post with a quote from the author about Charlie’s approach to analyzing stocks:

“For a true Graham value investor, there is no substitute for a bottom-up valuation process. […] Effective Graham value investors are like great detectives. They are constantly looking for bottom-up clues about what has happened in the past, and more importantly, what is happening now.  […] What Munger looks for is a business that has a significant track record of generating high, sustained, and consistent financial returns.” (p. 23)

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Jakob Bruhn is part of The Investor’s Podcast writing team, and has his own value investing blog dhando.dk