Published on:27 June, 2019
Charlie Munger, as much as Warren Buffett, has lessons for those who invest in Indian stocks. The central tenet of our 12 stock portfolio from a 25 stock investment universe is inspired by Munger’s approach to developing deep knowledge, building mental models and staying within a tight circle of competence.
[Marcellus is recruiting a Compliance Officer and a Quant Analyst. Click here for more details: https://marcellus.in/jobs/
“Carnegie was always proud that he took very little salary. Rockefeller and Vanderbilt were the same. It was a common culture in a different era. All of these people thought of themselves as the founder…If you’re highly conscientious and you hate to disappoint, you will feel the pressure to live up to your incentive fee.” – Charlie Munger (Berkshire AGM, 2003)
The key insights of a giant intellect
A uniquely original and astonishingly capable mind, learned across multiple disciplines without taking a single course in university on business or finance, Charlie Munger’s life provides rich learnings for those who seek wisdom. At the core of Munger’s wisdom is the realisation that thinking does not come naturally to the vast majority of people in the stockmarket i.e. most of us do NOT think most of the time; we parrot/imitate and respond reflexively to what we read, see and hear. Therefore, if we can set up systems & processes and learn tricks which teach us to think, in fact make us think, we will gradually become better than most people around us. This central insight from Munger is extremely relevant for investors in a market like India where herd instinct is even stronger than it is in the developed markets and where accounting/governance inadequacies characterise even prominent companies.
Basis our reading of three superb books – ‘Seeking Wisdom: From Darwin to Munger’ (2003) by Peter Bevelin, ‘Charlie Munger: the Complete Investor’ (2015) by Tren Griffin, and ‘Poor Charlie’s Almanack’ (2005) – we provide our summary of what we are trying to learn from this titan:
There’s another way to think about what Munger is saying. If we gradually build a repository of knowledge and accumulated experience of real world situations, we will gradually become more able to correlate problems we are coming across with the knowledge we have already accumulated. In the words of the psychologist-cum-economist Herbert Simon, “The situation has provided a cue; this cue has given the expert access to information stored in memory, and the information provides the answer. Intuition is nothing more and nothing less than recognition.”
2. Understanding our circle of competence and staying within it: A decade ago, Munger said in a BBC interview, “We have to deal with things that we’re capable of understanding.” At Marcellus have repeatedly been asked why don’t we invest in stocks which don’t have high Return on Capital and strong cashflows. After all, the thinking goes, great investors are all about finding decent companies at bargain prices. However, since we can’t second guess how an ugly frog will become a handsome prince, we have focused on our core competence of investing in great franchises with strong moats & clean management. To quote Munger, “It’s obvious that if a company generates high returns on capital and reinvests at high returns, it will do well. But this wouldn’t sell books, so there’s a lot of twaddle and fuzzy concepts that have been introduced that don’t add much.”
Munger also makes the broader point that “Knowing what you don’t know is more useful than being brilliant” and “Acknowledging what you don’t know is the dawning of wisdom.” Munger’s friend Li Lu has restated this nicely: “The true insights a person can get in life are still very limited, so correct decision making must necessarily be confined to your “circle of competence”. A “competence” that has no defined borders cannot be called a true competence.”
3. Focus on one or two variables: Both in the businesses he invested in and in the way he gradually built a vast body of knowledge, Munger learned to focus on the one or two variables which drive success. In his words “In business we often find that the winning system goes almost ridiculously far in maximizing and or minimizing one or a few variables—like the discount warehouses of Costco.”
As Farnam Street said in a blog honouring Munger, “When everything is a priority, nothing is a priority. Attempting to maximize competing variables is a recipe for disaster. Picking one variable and relentlessly focusing on it, which is an effective strategy, diverges from the norm. It’s hard to compete with businesses that have correctly identified the right variables to maximize or minimize. When you focus on one variable, you’ll increase the odds that you’re quick and nimble — and can respond to changes in the terrain.” (See https://fs.blog/2017/02/charlie-munger-wisdom/
Warren Buffett has articulated this point of view from the perspective of an investor: “You only have to be right on a very, very few things in your lifetime as long as you never make any big mistakes…An investor needs to do very few things right as long as he or she avoids big mistakes.”
4. Focus on outstanding businesses, NOT on cheap stocks: Until he started collaborating with Munger, Buffett was focused on using Ben Graham’s cigar-butt style of ‘value investing’. Munger’s influence played a major role in Buffett gradually abandoning this style through the 1970s and 1980s and moving towards investing in outstanding franchises like Capital Cities/ABC and Coca Cola. Munger deserves enormous credit for first saying:
“Ben Graham had blind spots. He had too low an appreciation of the fact some businesses were worth paying big premiums for.” and then saying:
“Ben Graham had a lot to learn as an investor. His ideas on how to value companies were all shaped by how the Great Crash and Depression almost destroyed him, and he was always a little afraid of what the market can do. It left him with an aftermath of fear for the rest of his life, and all his methods were designed to keep that at bay. I think Ben Graham wasn’t nearly as good an investor as Warren Buffett is or even as good as I am. Buying those cheap, cigar-butt stocks [companies with limited potential growth selling at a fraction of what they would be worth in a takeover or liquidation] was a snare and a delusion…”
Interestingly, this resulted in an investment style for Munger (heavily influenced by the great Phil Fisher) which works nicely for us in India and has given us a portfolio of moated, relatively clean, well run companies like Asian Paints, Marico, HDFC Bank and Page Industries. In Munger’s words, “Once we’d gotten over the hurdle of recognizing that a thing could be a bargain based on quantitative measures that would have horrified Graham, we started thinking about better businesses.”
5. Carefully choose the people you work with: We are fortunate insofar as hundreds of people send us their CVs . However, Munger says one has to be selective because people who do unwise things in one setting usually proceed to do unwise things in other setting as well. In Munger’s words, “…it’s just so useful dealing with people you can trust and getting all the others the hell out of your life. It ought to be taught as a catechism. … [W]ise people want to avoid other people who are just total rat poison, and there are a lot of them.”
Our team’s coverage universe of Indian stocks is only 25. Our Consistent Compounders Portfolio has only 12 stocks in it. We have five analysts in our team and each is required to dissect only 4-5 stocks. Why? Because we don’t think we can realistically ask our analysts to build deep knowledge on more than this number of companies. By ‘deep knowledge’ we mean: (a) familiarity with the last 15 years of annual reports of each of these companies; (b) deep understanding of every single major capital allocation decision made by these companies over the last 15 years; (c) a deeper understanding of the competitive advantages – or the lack thereof – of these companies than anyone else in the Indian stockmarket has; and (d) full understanding of accounting/governance tricks being used to flatter profits & networth. The two variables we obsessively focus on are a company’s sustainable competitive advantages and its accounting quality. All our effort goes in training and teaching ourselves to understand how clever companies build deep moats and how unscrupulous companies steal shareholders’ money. We have described the evolution of our investment philosophy in this film: https://marcellus.in/about-marcellus/
The past decade has taught us that building deep knowledge of high quality Indian firms is unusually rewarding because most analysts/investors operating in India are seldom able to focus long enough on a company to truly understand its moats. For obvious reasons, the management teams of these companies do NOT host conference calls where they spill the beans on the real moat of the company. As a result, if we can understand the same better than others, we should generate superior results over long periods of time. That being said, it is tough, grindingly hard work – not just because of the many hours spent reading but also because of the time & effort involved in tracking down experts who can provide deep, original insights into the workings of these companies. The fact that a legend like Charlie Munger traversed a similar path and came out smiling spurs us on.
To read our other published material, please visit https://marcellus.in/blog/
Saurabh Mukherjea is the author of “The Unusual Billionaires” and “Coffee Can Investing: the Low Risk Route to Stupendous Wealth”.
Note: the above material is neither investment research, nor investment advice. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India as a provider of Portfolio Management Services and as an Investment Advisor.
Copyright © 2019 Marcellus Investment Managers Pvt Ltd, All rights reserved.