Charlie Munger – Art of Stock Picking

Key Points from Munger’s talk: The Art of Stock Picking

• You have to have models in your head from multiple disciplines:
  • Mathematics: Compound interest
  • Permutations and combinations (probability and decision trees)
  • Accounting and its limitations
  • 5 Ws: Tell who was going to do what, where, when and why
  • Understand statistics: Gaussian curve
  • Engineering idea of a backup system, and breakpoints
  • Physics: Critical mass
  • Psychology of misjudgement
  • Ecosystem: narrow specialisation and niches
  • Microeconomics: advantages of scale
    • eg. cost reductions along the experience curve
    • eg. size of company and use of TV advertising when it first arrived, as the most effective marketing type
    • Social proof
    • Cascade towards overwhelming dominance of one firm (winner takes all): eg. newspapers
  • Disadvantages of scale: competitors move towards a narrower specialisation (scaling down and intensifying)
  • Many markets get down to two or three big competitors or five or six. And in some of those markets, nobody makes any money to speak of (eg. airlines). But in others, everybody does very well (eg. cereals)
  • Microeconomics: Patents, trademarks, exclusive franchises
  • Where do the benefits of cost reductions / efficiencies go? To the guy that buys the new equipment, or to the customer?
  • Competitive destruction: surfing the way of a new business
  • Identify your circle of competence: what are your inadequacies
  • Cancer surgery formula: Look at a business mess and figure out if there’s anything sound left that can live on its own if they cut away everything else. If you can find anything sound, just cut away everything else. Of course, if that doesn’t work, liquidate the business. Can you cut out the folly and go back to the wonderful business?
• Two track analysis
  • Rationality: evaluate the real interests (what are the factors that really govern the interests involved, rationally considered), real probabilities
  • Evaluate the psychological factors that cause subconscious conclusions, many of which are wrong
• Common stocks
  • Like a pari-mutuel system at the racetrack: a pari-mutuel system is a market. Everybody goes there and bets and the
    odds change based on what’s bet
  • Bet only when you have a mispriced bet available, bet very seldom but bet big when you have the odds
  • Understand the concept of “Mr Market”
• Most of the bulk of the billions in BRK have come from the great businesses. Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns.
• Find great businesses when they’re small, run by a wonderful manager (but bet on business momentum, not the brilliance of the manager)
• Watch for the effect of tax deferral on returns but don’t be overly motivated by tax considerations
• There are huge advantages for an individual to get into a position where you make a few great investments and just sit back and wait