Charlie Munger (Trades, Portfolio), the recently deceased vice chairman of Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial), has long been a legend in the value investment world. His contributions to the global value investing community and his wisdom have inspired countless investors to pursue value investing. In this disucssion, I will explore what I learned from Munger in my value investing journey.
The importance of business models
Like most value investors, I first learned about value investing from Benjamin Graham and Warren Buffett (Trades, Portfolio). Graham invented the value investing framework centered on three key concepts: intrinsic value, margin of safety and Mr. Market. Buffett added the concept of circle of competence to Graham's value investing framework.
In my opinion, Munger's biggest contribution to the value investing world was pointing out blind spots in Graham's thinking to Buffett. He made Buffett recognize the importance of business models. For me, identifying and comparing business models is the most important lesson that I learned from Munger as well.
Luckily, there are plenty of learning materials from Munger. He commented on different business models almost every year during the Daily Journal Corp.'s (DJCO, Financial) shareholder meetings. For example, at the 2017 meeting, Munger commented on the business model of the oil and gas exploration and development industry as follows:
"The oil and gas business is very peculiar. The people who success in most other businesses are doing way more physical volume than they did in the past. But a place like Exxon (XOM, Financial), the physical volume goes down by two thirds, it's just that the price of oil goes up faster than the physical volume goes down. That is a very peculiar way to make money. And it may well continue, but it's confusing, we're not use to it."
At this year's meeting, he also gave an insightful summary of Taiwan Semiconductor Manufacturing Co. Ltd.'s (TSM, Financial) business model:
"The semiconductor industry is a very peculiar industry. In the semiconductor industry you have to take all the money you've made and with each new generation of chips, you throw in all the money you've previously made. So it's a compulsory investment of everything if you want to stay in the game. Naturally, I hate a business like that. At Berkshire we like a whole lot of surplus money to come in and we can do something else with. And of course, now if you're enough ahead of it, like Taiwan Semiconductor is, that may be a good buy at these prices. It's not at all clear to me that they're not going to succeed mightily. It's a business with enormous promise for the big winner, but it's a difficult business in requiring everybody to keep increasing the bets on and on with all the money. And so it's not perfect that semiconductor business. But remember when Intel owned the world? Intel was once the Taiwan Semiconductor business of the world. They invented the damn business, and they dominated it for decades. And it's not clear to me that Intel's going to have a very decent semiconductor business getting as far behind as they are now. My answer is it's not so damn foolproof as it looked."
Munger's judgment on business models is always sharp and spot on. Because of his influence, when conducting investment research, I will always first try to focus on business models and compare different business models within the value chain.
Multi-disciplinary approach
Another important lesson I learned from Munger is the application of a multi-disciplinary approach in investing. Munger's multi-disciplinary investing approach integrates main theories from history, accounting, business, biology, physics, chemistry, statistics, economics, ecology, psychology and other important disciplines.
In a speech given in 1996, Munger applied theories from biology, chemistry, psychology and business to explain the success of The Coca-Cola Co. (KO, Financial). This is the only time in public that he elaborated on the application of multi-disciplinary mental model with a detailed case study, allowing us to see the power of the approach.
I believe that when investing in BYD (SZSE:002594, Financial), Munger also applied the multi-disciplinary approach. When revisiting the 2010 Wesco Shareholders Meeting notes, I read about his predictions of huge potentials of electric vehicles, photovoltaics and energy storage. He also predicted that BYD will dominate these areas. More than a decade later, these predictions and judgments have proven extremely prescient, which undoubtedly demonstrates the strength and power of Munger's multi-disciplinary approach.
Unfortunately, the guru did not share how he applied the multi-disciplinary approach when researching BYD. But we can still try to understand how he thought about the company from his past speeches. Through these, we can get a glimpse of Munger's multi-disciplinary approach.
Rationality
Last but not least, Munger taught me the the importance of rationality in investing. Before I learned this lesson, I also spent some time studying investment gurus who have decades of experience. What I found out is that most of them equate rationality with empiricism. One of the most typical applications of empiricism in value investing is the historical valuation methodology. If a company's valuation historically oscillates between 10 times and 30 times earnings, then when the company's valuation approaches 10 times earnings, it is a good time to buy. However, the most important assumption of this valuation method is that other conditions remain unchanged, which is not the case most of the time.
After falling into the "value trap" several times, I began to question the reliability and validity of empiricism. Munger's comments on rationality woke me up and made me realize the need to create an environment that can make me more rational and reduce the factors that may make me irrational. For example, in the process of research, it is important to be critical of yourself and always question the important assumptions behind investment decisions. These assumptions should preferably be falsifiable. After establishing the hypothesis, it is important to collect complete and accurate information as much as possible and to promptly address disconfirming evidences that may arise.
Rationality also means avoiding open discussions about positions to avoid falling for the commitment and consistency bias. Although no one can fully achieve rationality in investing, following Munger's teachings has greatly reduced the number of big mistakes in my investment career.
Summing up
In conclusion, Munger taught me the importance of business models, the multi-disciplinary approach and rationality. By applying these lessons in our own investing, we can greatly increase our chances of success.
For that I say, "Thank you, Mr. Munger."
