On Warren Buffett + Charlie Munger And Investing

5 minute read

Last year when I was at home for Christmas, I spent about a week and a half really digging into Warren Buffett’s Letters to Shareholders and Poor Charlie’s Almanac - a collection of Charlie Munger’s public speeches. At the same time, I was applying what I learned as I looked for a way to get my investing kickstarted after a few years of very low returns. In a combination of sheer luck and maybe just maybe a small amount of skill, my portfolio ballooned 62% in 2017, almost 3x the S&P’s 21%. Now, like I said a lot of that can be attributed to sheer luck. The one area which may actually have indicated some level of skill was my investment in MIXT - MiX Telematics Limited. I purchased a small stake in MIXT on April 4 at $6.33/share, then made a much larger purchase on April 10 at $6.10/share. The purchase of this stock was guided by my learnings from studying Buffett and Munger, and at year’s end it was up over 100% at $12.73/share.

So, how did I find this company and what led me to invest in it? Over the next few weeks I am going to attempt to pinpoint another company that I hope will have a similar level of success in 2018. You can follow along as I document what I’ve learned from Buffett and Munger and what I look for in a company. We’ll start below as I rehash some notes I took last year while studying.

Lessons from Charlie Munger

Quotes

“Faced with the choice between changing one’s mind and proving there is no need to do so, almost everyone gets busy on the proof.” - John Kenneth Galbraith

“When a better tool (idea or approach) comes along, what could be better than to swap it for your old, less useful tool?”

“A great business at a fair price is superior to a fair business at a great price.” - Charlie Munger

“Use of the scientific method and effective checklists minimizes errors and omissions.”

“Resist the natural human bias to act.”

“A stock option is both an expense and a dilution.” - Charlie Munger

“If you always tell people why, they’ll understand it better, they’ll consider it more important, and they’ll be more likely to comply.” - Charlie Munger

Especially Important Mental Models:

  • Backup/Redundancy system model of engineering
  • Compound interest model from math
  • Breakpoint / Tipping-moment / Autocatalysis models from physics and chemistry
  • Modern Darwinian synthesis model from biology
  • Cognitive misjudgment models from psychology

Things to Consider When Investing:

  • Current and prospective regulatory climate
  • State of labor, supplier, and customer relations
  • Potential impact of changes in technology
  • Competitive strengths and vulnerabilities
  • Pricing power
  • Scalability
  • Environmental issues
  • Presence of hidden exposures

With Regard to Recent Financial Statement Figures:

  • Free or “owners” cash being produced
  • Inventory or other working capital assets
  • Fixed assets
  • “Frequently overstated” intangible assets like goodwill
  • Cost of stock options, pension plans, and retiree medical benefits
  • Liabilities like insurance floats
  • Management

Competitive Advantages:

  • Products
  • Markets
  • Trademarks
  • Employees
  • Distribution Channels
  • Societal Trends

Checklist:

  • Risk
    1. Incorporate an appropriate margin of safety
    2. Avoid dealing with people of questionable character
    3. Insist upon proper compensation for risk involved
    4. Always beware of inflation and interest rate exposures
    5. Avoid big mistakes, shun permanent capital less
  • Independence
    1. Objectivity and rationality require independence of thought
    2. Just because others agree / disagree with you doesn’t make you right / wrong. All that matters is the correctness of your analysis and judgement
    3. Mimicking the herd invites regression to the mean
  • Preparation
    1. Develop into a lifelong learner through reading, strive to become a little wiser each day
    2. More important than the will to win is the will to prepare
    3. Develop fluency in the mental models from the major academic disciplines
    4. Keep asking “why, why, why?”
  • Intellectual Humility
    1. Stay within a well-defined area of competence
    2. Identify and reconcile disconfirming evidence
    3. Resist the craving for false precision, false certainties, etc.
    4. Never fool yourself and remember you are the easiest person to fool
  • Analytic Rigor
    1. Determine value apart from price, progress apart from activity, wealth apart from size
    2. It is better to remember the obvious than grasp the esoteric
    3. Be a business analyst - not a market, macroeconomic, or security analyst
    4. Consider totality of risk and effect, look always at potential second order and high level impacts
    5. Think forwards and backwards. Invert, always invert
  • Allocation
    1. Remember that highest and best use case is always measured by the next best use (opportunity cost)
    2. Good ideas are rare. When the odds are in your favor, bet heavily
    3. Don’t “fall in love” with an investment - be situation dependent and opportunity-driven
  • Patience
    1. “Compound interest is the eight wonder of the world.” - Einstein. Never interrupt it unnecessarily
    2. Avoid unnecessary transactional taxes and frictional costs, never take action for its own sake
    3. Be alert for the arrival of luck
    4. Enjoy the process along with the proceeds because the process is where you live
  • Decisiveness
    1. Be fearful when others are greedy and greedy when others are fearful
    2. Opportunity doesn’t come often, so seize it when it does
    3. Opportunity meeting the prepared mind. That’s the game
  • Change
    1. Recognize and adapt to the true nature of the world around you - don’t expect it to adapt to you
    2. Continually challenge and willingly amend your “best-loved ideas”
    3. Recognize reality, even when you don’t like it. Especially when you don’t like it
  • Focus
    1. Remember that reputation and integrity are your most valuable assets and can be lost in a heartbeat
    2. Guard against the effects of hubris and boredom
    3. Don’t overlook the obvious by drowning in minutiae
    4. Be careful to exclude unneeded information
    5. Face your big troubles, don’t sweep them under the rug

Five General Notions:

  • It’s usually best to simplify problems by deciding big “no-brainer” questions first
  • Scientific reality is often revealed only by math as if math was the language of God. Also works in practical life
  • Invert. Think problems through forwards and backwards
  • The best and most practical wisdom is elementary academic wisdom, but you must think in a multidisciplinary manner
  • Lollapalooza effects will only come from a combination of factors

Other Notes:

Think in terms of a business and its moat. Managers should strive to widen the moat every year. That may not necessarily mean more $$, but in the long run it will make a better business.

Wesco Financial Statements -> Outstanding Investor Digest

Areas to Study: * Accounting * Fermat and Pascal * Engineering Quality Control * Engineering Backup System * Engineering Breakpoints * Physics Critical Mass * Psychology of Misjudgement

(Poor Charlie’s Almanac) p. 182 -> CBS Executive Paley and living in a bubble

Analyze where benefits of technology go -> Business or customer?

Imagine investing as though you could only make 20 investments in your lifetime… what would you pick?


Disclosure: I hold a long position in MIXT.

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