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Kindle Notes & Highlights
by
Tren Griffin
Started reading
September 16, 2019
Being a Graham value investor requires discipline. It is so much easier emotionally to follow the crowd than to be a contrarian.
if you visit a money management firm that claims to be a Graham value investor and you cannot tell whether the market is open or closed, that is a good sign.
If you’re not willing to react with equanimity to a market price decline of 50 percent two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations. —CHARLIE MUNGER, BBC INTERVIEW, 2010
If you want to get rich, you’ll need a few decent ideas where you really know what you’re doing. Then you’ve got to have the courage to stick with them and take the ups and downs. Not very complicated, and it’s very old-fashioned. —CHARLIE MUNGER, DAILY JOURNAL MEETING, 2013
To profit from courage, you often must have some cash on hand. Having that cash available when the crisis hits also requires courage because it’s hard to sit on cash when markets are rising. The human urge to avoid missing out is a powerful one that can drive investors into the deadly grip of a stock market bubble.
“To buy when others are despondently selling and to sell when others are euphorically buying takes the greatest courage but provides the greatest profit.”3
There’s an old expression on this subject, which is really an expression on moral theory: “How nice it is to have a tyrant’s strength and how wrong it is to use it like a tyrant.” It’s such a simple idea but it’s a correct idea.
We believe there should be a huge area between everything you should do and everything you can do without getting into legal trouble. I don’t think you should come anywhere near that line.
Munger believes honesty is not only the right thing to do morally, but it is the approach that will produce the greatest financial return. When people in business together trust each other because they are honest, the efficiency that results from that trust improves the financial returns of the business.
Finance writer Morgan Housel absolutely nailed it when he wrote, “There’s a strong correlation between knowledge and humility.”
Almost all good businesses engage in “pain today, gain tomorrow” activities.
Munger has recognized that it is hard to think on a long-term basis when you are just getting started or are starting over. For this reason, he said once that accumulating “the first $100,000 is a bitch.”5 That is reason enough to work hard to assemble a basic financial cushion. Not only is it not fun, it is a handicap to live on the edge of financial ruin.
Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things. —CHARLIE MUNGER, POOR CHARLIE’S ALMANACK, 2005
Many things that are not directly financial will compound. Skills, relationships, and other aspects of life can compound and benefit a person who invests time and money wisely to cultivate these things.
One trick related to passion is that you are not likely to be passionate about something you do not understand. Often, the level of passion you will have for a topic will grow over time. The more you know about some topics, the more passionate you will get. Only becoming passionate about things that create that feeling immediately is a big mistake. Some of the best passions in life grow on you in a nonlinear way after a slow start.
In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time—none, zero. You’d be amazed at how much Warren reads, at how much I read. —CHARLIE MUNGER, BERKSHIRE ANNUAL MEETING, 2004
Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day. —CHARLIE MUNGER, POOR CHARLIE’S ALMANACK, 2005
Nothing vicariously exposes you to more mistakes committed by others than reading.
Buffett calls his partner “The Abominable No-Man” because his answer on a given investment is so often “no.”
Buffett noted in his 2013 shareholder letter that he took a massive loss because he did not run a major purchase by Munger.
Warren and I aren’t prodigies. We can’t play chess blindfolded or be concert pianists. But the results are prodigious, because we have a temperamental advantage that more than compensates for a lack of IQ points.
As has been noted previously, it is not possible for everyone to outperform the market. For better or worse, mistakes by other investors are the source of a Graham value investor’s opportunity.
Arguably the best way to sort out whether you have the right temperament for the Graham value investing system is to keep a careful written record of your investment decisions.
Benjamin Franklin wrote: “The way to wealth is as plain as the way to market. It depends chiefly on two words, industry and frugality: that is, waste neither time nor money, but make the best use of both. Without industry and frugality nothing will do, and with them, everything.”9
Using [a stock’s] volatility as a measure of risk is nuts. Risk to us is 1) the risk of permanent loss of capital, or 2) the risk of inadequate return. Some great businesses have very volatile returns—for example, See’s Candies usually loses money in two quarters of each year—and some terrible businesses can have steady results. —CHARLIE MUNGER, BERKSHIRE ANNUAL MEETING, 1997
You can easily see how risk-averse Berkshire is. In the first place, we try and behave in such a way that no rational person is going to worry about our credit. And after we have done that, we also behave in such a way that if the world suddenly didn’t like our credit, we wouldn’t even notice it for months, because we have so much liquidity. That double layering of protection against risk is as natural as breathing around Berkshire. It’s just part of the culture.
For the best essay on the proper definition of risk, it’s a good idea to read Buffett’s 1993 Berkshire shareholder’s letter. Buffett pointed out that risk comes from not knowing what you’re doing.
aspects of a Graham value investor’s style that differ are called variables.
First Variable: Determining the Appropriate Intrinsic Value of a Business
Intrinsic value can be defined simply: It’s the discounted value of the cash that can be taken out of a business during its remaining life.
Because the cash that can flow from a business is not an annuity and instead is based on a number of fundamental factors that are impossible to predict with certainty, determining the value of a business is an art and not a science. Almost every investor will have a slightly different way of determining the intrinsic value of a business, and there is nothing inherently wrong with that fact. For this reason, it is best to think about intrinsic value as falling within a range rather than an exact figure.
We have no system for estimating the correct value of all businesses. We put almost all in the “too hard” pile and sift through a few easy ones. —CHARLIE MUNGER, BERKSHIRE ANNUAL MEETING, 2007
The tendency of many people who are overconfident is just the reverse of Munger’s use of a “too hard” pile. In other words, people with a high IQ often relish the opportunity to solve hard valuation problems, thinking that they will be rewarded for having such ample mental skill with a higher return. The reality is that, in trying to solve hard problems, emotional and psychological problems cause the losses rather than a lack of intelligence. Hard problems are hard problems, pregnant with opportunities to make mistakes.
When Munger and Buffett value a business, they use what they call owner’s earnings as the starting point. Owner’s earnings can be defined as: Net income + Depreciation + Depletion + Amortization – Capital expenditure – Additional working capital.
Owner’s earnings is not a typical valuation metric. Other Graham value investors may use different metrics, like earnings before interest and taxes (EBIT), in calculating value. For example, in The Little Book that Beats the Market, Greenblatt says that he views the depreciation part of EBIT as a proxy for capital expenditures and seems to imply that replacing depreciation with capital expenditure would be a better approach.
Second Variable: Determining the Appropriate Margin of Safety
Making things easier is the fact that Munger and Buffett like the amount of a margin of safety to be so big that they need not do any math other than in their heads.
Being good with numbers doesn’t necessarily correlate with being a good investor. Warren doesn’t outperform other investors because he computes odds better. That’s not it at all. Warren never makes an investment where the difference between doing it and not doing it relies on the second digit of computation. He doesn’t invest—take a swing of the bat—unless the opportunity appears unbelievably good. —BILL GATES, FORTUNE, 1996
Most investors think quality, as opposed to price, is the determinant of whether something’s risky. But high quality assets can be risky, and low quality assets can be safe. It’s just a matter of the price paid for them. … Elevated popular opinion, then, isn’t just the source of low return potential, but also of high risk. —HOWARD MARKS, THE MOST IMPORTANT THING, 2011
When investors violate [this principle] by investing with no margin of safety, they risk the prospect of the permanent impairment of capital. —JAMES MONTIER, THE SEVEN IMMUTABLE LAWS OF INVESTING, 2011
Third Variable: Determining the Scope of an Investor’s Circle of Competence
The idea behind the circle of competence is so simple that it is arguably embarrassing to say it out loud: when you do not know what you’re doing, it is riskier than when you do know what you’re doing. What could be simpler? And yet, humans often do not act in accordance with this idea.
When Charlie thinks about things, he starts by inverting. To understand how to be happy in life Charlie will study how to make life miserable; to examine how a business becomes big and strong, Charlie first studies how businesses decline and die; most people care more about how to succeed in the stock market, Charlie is most concerned about why most have failed in the stock market. —LI LU, CHINA ENTREPRENEUR MAGAZINE, 2010
Fourth Variable: Determining How Much of Each Security to Buy
The idea that it was hard to find good investments, to concentrate in a few, seems to me to be an obviously good idea. But 98 percent of the investment world doesn’t think this way. —CHARLIE MUNGER, BERKSHIRE ANNUAL MEETING, 2004
Seth Klarman pointed out that it is better to know a lot about ten or fifteen companies than to know just a little about many. The number of stocks a person can realistically follow and understand the economics of the specific business better than the market is significantly less than twenty.
There are other Graham value investors who disagree with Munger and instead believe in diversification. Two notable examples were Ben Graham himself and Walter Schloss. Jason Zweig has pointed out that, “Even the great investment analyst Benjamin Graham urged ‘adequate though not excessive diversification,’ which he defined as between 10 and about 30 securities.”6
The Berkshire-style investors tend to be less diversified than other people. The academics have done a terrible disservice to intelligent investors by glorifying the idea of diversification. Because I just think the whole concept is literally almost insane. It emphasizes feeling good about not having your investment results depart very much from average investment results. But why would you get on the bandwagon like that if somebody didn’t make you with a whip and a gun? —CHARLIE MUNGER, KIPLINGER, 2005
Fifth Variable: Determining When to Sell a Security
Selling [something] when it approaches your calculation of its intrinsic value [is] hard. But if you buy a few great companies, then you can sit on your ass. That’s a good thing. —CHARLIE MUNGER, BERKSHIRE ANNUAL MEETING, 2000
