The Ideas of Charlie Munger

Patrick A. Labbe, CFA

I recently finished Tren Griffin’s book Charlie Munger: The Complete Investor.  Munger, you’ll recall, is Berkshire Hathaway’s long-standing Vice Chairman and a great investor in his own right.  Among the topics in the book are the core ideas behind Munger’s view of investing.  The ideas are simple, but powerful, and I wanted to share a few of them with you along with some of my own thoughts.

Treat stock investing as a proportional ownership in a business.  The reason this is the first principle is because it creates the proper frame of mind for successful investing.  For example, as a Ventas, Inc. shareholder, you own a proportionate interest in more than 1,000 medical-related real estate properties capable of generating about $4.00 per share in cash during a normal, non-recession year.  Most of that cash is paid out to you as an owner, while the rest is used to acquire more properties that should generate more cash.  Like any business owner, you can monitor the progress and future prospects of the company by carefully studying its operating results and employing insightful analysis.  When market prices fluctuate, always remember that a share of stock is backed by a real business.  Speculators focus on what the stock price is likely to do, investors focus on what the business is likely to do.

Seek protection with a margin of safety.  Engineers use a margin of safety when they purposely design systems to be much stronger than needed for normal usage, in anticipation of emergencies, unforeseen use, or degradation.  Investors achieve a margin of safety when they buy a business at a significant discount to their estimate of value.  Investors should avoid the temptation to strive for precision, understanding that the method used to estimate value is less important than the business assumptions used to determine value.  Apply the old adage:  It’s better to be generally right than precisely wrong.  In other words, good investors rely more on thinking and less on calculating.

The market is there to serve investors, not to instruct them.  Market prices tend to fluctuate much more than the intrinsic values of the companies themselves.  This is because even when investors apply some type of rational valuation approach, stock prices often have a speculative component.  The speculative component typically reflects the fact that many market participants are inclined to buy what’s gone up and avoid what’s gone down.  In the short run then, market prices tend to be a bit fickle and often subject to excess, but in the long run prices tend to track the value of the business.  Good investors accept volatility as part of owning stocks.  The best investors have the ability to exploit it.

The key to using these concepts is the ability to apply them rationally, objectively and dispassionately.  That’s really the hard part.  Indeed, when asked to account for his great success, Munger reportedly replied:  “I’m rational; that’s the answer.”