Reflections. Charlie Munger: needle in a mountain of hay

When it comes to investing, especially for value investors, the name Charlie Munger brings to mind core tenets not just for investing but to lead life by. A near-centenarian, his life and principles remain invaluable. His advice and wisdom range beyond merely investing, unlike his partner, Warren Buffet. His musings, relating to life, human psychology, and running a business, are extremely important to heed.

He was a man who remained extremely well-read, reading everything from the letters of Cicero and Benjamin Franklin to modern-day scholarly articles on psychology and finance. He was a philanthropist, investor, writer, lawyer, real estate developer, business executive and even a grocery store clerk (he worked in Mr. Buffet’s grandfather’s grocery store as a teenager).

Cigarette-butt investing

Mr. Munger was an excellent investor who Mr. Buffet routinely credits as the leading reason for his shift away from the Benjamin Graham way of investing. Mr. Buffet, a protege of Graham, used to engage in ‘cigarette-butt investing.’

Under the method, an investor looks for companies trading below net working capital and waits for an uptick in its price.

The rationale is the price should eventually climb because the company is trading below what it was worth if liquidated immediately. The investor can then pocket this differential. However, such a method poses multiple drawbacks. The market may not realise such a discrepancy exists for a long time, meaning your capital is tied up with a likely underperforming company. In addition, there is no guarantee the company may not incur losses in the coming quarters, eroding capital value, thus removing room for any price gains. Finally, such opportunities are rare and produce non-scalable returns.

Mr. Munger, on the other hand, suggested Mr. Buffet consider excellent companies at fair prices. Exceptional companies, generally, lead to outsized returns in the long term due to the idea of compounded growth and the reasonable price is compensated by said returns.

However, Mr. Munger’s prowess stretches far beyond investing. His lecture, delivered at Harvard University in 1995, remains one of the most listened to, reproduced, and read lectures on human psychology. The lecture, ‘The Psychology of Human Misjudgment’, covers many broad topics. He famously quipped: “Never, ever, think about something else when you should be thinking about the power of incentives”. The first lesson in a list of many is the power of incentives and disincentives. He says it is vital to understand incentives, especially when you want to run a business or invest. An investor needs a keen sense of what motivates the board, employees, consumers, and other investors.

Moreover, understanding incentives makes discerning macroeconomic outcomes a more straightforward task. Understanding why certain countries raise interest rates, why investors favour one stock over another, and why CEOs prefer to expand or contract can be tied to decoding what incentives they face. Another lesson of his is to understand the practical consequences of what he terms, the “Liking/Loving tendency” which “acts as a conditioning device that makes the liker or lover tend (1) to ignore faults of, and comply with wishes of, the object of his affection, (2) to favour people, products, and actions merely associated with the object of his affection and (3) to distort other facts to facilitate love.”

Such a phenomenon is commonplace among even the most seasoned investors. One notices investors quip, “this promoter never goes wrong”, “this company has always done well for me”, etc. It is crucial for investors to maintain a rational and bird’s eye point of view when it comes to investing. As the English economist John Maynard Keynes stated, “as the facts change my opinions change”. Additionally, Mr. Munger also emphasises the misjudgements that stem from envy/jealousy in this lecture as well as his other famous lecture ‘How to Guarantee a Life of Misery’. Investors get in the way of returns by comparing portfolio returns with their peers. By comparing, one invests in riskier and reckless opportunities, leading to one’s downfall. A detailed inquiry into the lessons one can learn from him would likely consist of a series of long books. His wisdom, however, remains accessible to those who seek it through the lectures, interviews, and written pieces he’s left behind.

To encapsulate the essence of Mr. Munger, one must recognise his profound wisdom extends beyond the world of finance, offering timeless insights into human nature and the discipline of decision-making — a legacy that will continue to guide and inspire generations to come. The authors will miss his sage wisdom.

(Anand Srinivasan is a consultant, Sashwath Swaminathan is a research assistant at Aionion Investment Services)