Munger’s Investment Valuation Process

  • View a stock as an ownership of the business and judge the staying quality of the business in terms of its competitive advantage. Look for more value in terms of discounted future cash-flow than you are paying for. Move only when you have an advantage.
  • Circles of competence( I’m no genius, I’m smart in spots and stay around those spots … Thomas Watson)
    • To stay within this circle, screen to limit investment fields to only simple, understandable candidate. Candidates usually fall into 3 baskets
      • Too tough to understand: you have to have a special insight into the business. If you have competence, you know the edge.
      • Yes: Is it an easy to understand, dominant business franchise that can sustain itself and thrive in all market environments.
      • No: Heavily promoted deals and IPOs.
      • Those that survive are run through the mental model.
    • If you cannot respond legitimately to the next question, you lack mastery and are likely you’re outside your circle of competence.
  • Take into account all relevant aspects, both internal and external to the company and its industry, even if they are difficult to identify, measure or reduce to numbers. However recall the ecosystem theme( The maximization/minimization of a single factor can make the single factor disproportionately important.
  • Treat financial reports and their accounting with skepticism. they’re the beginning of a proper calculation of intrinsic valuation, not the end.
  • There’s no thing as risk-less investment. just find those with few risks that are easily understandable.
  • Assess and understand competitive advantage in every respect(products, markets, trademarks, employees, distribution channels etc) and the durability of that advantage. A company’s competitive advantage is its moat. A superior company has a deep moat that is continuously widened.
    • Think in terms of Moats: The ability of a business to keep its width and its impossibility of being crossed is the primary criterion of a good business. The moat should be widened every year. if it is, the business will do well.
    • Also think in terms competitive destruction(forces that over the long term lay siege to a company).
    • This helps when a fanatic sets his sights on your marketplace. A large enough and constantly widening moat is the only way to survive.
    • Identify and buy only those systems that beat these odds
  • Recast financial statement figures(on both sides) to fit your view of reality.
  • Assess a companies management beyond number crunching( to what degree are they able, trustworthy and owner-oriented).
  • Calculate the intrinsic value of the whole business( with allowance for potential dilution) and determine an approximate value per share to compare to market prices.(The comparing value(what you get) to price(what you give) is the fundamental purpose of the whole process)
    • A great business at a fair price is superior to a fair business at a great price.
  • Work with a margin of safety
    • This is dependent on the price paid. It is large at a price, smaller at another and non existent at a higher price.
    • Investing  strategies should have backup systems and extra capacity built in
  • Ignore insignificant detail and distractions.
  • Apply a prior to pulling the trigger checklist( this is based on the principle that proper valuation is a companion of proper timing).
  • Invest Decisively
  • Charlie’s superior performance comes from a constant search for better methods of thought, a willingness to prepay through rigorous preparation and the extraordinary outcomes of his multidisciplinary model
  • According to the munger school of highly-concentrated, focused investing
    • Make investments so you don’t have to make another decision. If you buy something because its undervalued, then you have to think about selling it when it approaches your calculation of its intrinsic value. That’s hard. If you buy a few great companies, you can sit on your ass. That’s a good thing.
  • Books to enlighten on what makes a great business model(A focus on the issue of competitive destruction and how to adapt, survive and even dominate over time
    • Guns germs and steel
    • The selfish gene
    • Ice Age
    • Darwin’s blind spot
TLDR Okay it’s a good company. But is the price low enough, Is the management made up of people you are comfortable with, is it cheap enough to buy, is it cheap for the wrong reason or the right reason, What’s the flip side, What can go wrong that i haven’t yet seen

An Investing principles checklist

  • Risk: All investment evaluations should begin by measuring risk, especially reputational
    • Incorporate an appropriate margin of safety
    • Avoid dealing with people of questionable character
    • Insist upon proper compensation for risk assumed
    • Always beware of inflation and interest rate exposures
    • Avoid big mistakes; shun permanent capital loss
  • Independence
    • Objectivity and rationality require independence of thought
    • Just because other people agree or disagree with you doesn’t make you right or wrong. The only thing that matters is the correctness of your analysis and judgment
    • Mimicking the herd invites merely average performance
  • Preparation: The only way to win is to work , work, work , work and hope to have a few insights.
    • Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day.
    • More important than the will to win is the will to prepare.
    • Develop fluency in mental models from the major academic disciplines
    • If you want to get smart, the question you have to keep asking is “why, why, why”
    • It’s not give to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it – who look and sift the world for a mispriced bet that they can occasionally find one.
  • Intellectual Humility: Acknowledging what you don’t know is the dawning of wisdom
    • Stay within a well-defined circle of competence
    • Identify and reconcile disconfirming evidence
    • Resist the craving for false precision, false certainties, etc
    • Above all, never fool yourself and remember that you’re the easiest person to fool.
  • Analytic vigor: The use of the scientific method and effective checklists minimizes errors and omissions
    • Determine value apart from price, progress apart from activity and wealth apart from size.
    • It is better to remember the obvious than to grasp the esoteric.
    • Be a business analyst, not a market, macroeconomic or security analyst
    • Consider totality of risk and effect, Look always at potential second order and higher level impacts
    • Think forwards a backwards – Invert always invert.
  • Allocation: Proper allocation of capital is an investor’s number one
    • Remember that highest and best use is always measured by the next best use(opportunity cost)
    • Good ideas are rare: when the odds are greatly in your favour, bet(allocate heavily).
    • Don’t “fall in love” with an investment- be situation-dependent and opportunity-driven
  • Patience: Resist the natural human bias to act
    • Compound interest is the eight wonder of the world. Never interrupt it unnecessarily
    • Avoid unnecessary transactional taxes and frictional costs; never take action for tis own sake
    • Be alert of the arrival of luck(Both for it’s positive and negative tendecies).
    • Enjoy the process with the proceeds, because the process is where you live
  • Decisiveness: When proper circumstances present themselves, act with decisiveness and caution
    • Be fearful when others are greedy and greedy when others are fearful
    • Opportunity doesn’t come often, so seize it when it does
    • Opportunity meeting the prepared mind: that’s the game
  • Change: Live with change and accept unremovable complexity
    • Recognize and adapt to the true nature of the world around you: don’t expect it to adapt to you
    • Continually challenge and willingly amend your best loved ideas
    • Recognize reality even when you don’t like it- especially when you don’t like it.
  • Focus: Keep things simple and remember what you set out to do
    • Remember that reputation and integrity are your most valuable assets and can be lost in a heartbeat
    • Guard against the effects of hubris and boredom
    • Don’t overlook the obvious drowning in minutiae
    • Be careful to exclude unneeded information or slop:” a small leak can sink a great ship”
    • Face your big troubles; don’t sweep them under the rug
    • The task of a man is not to see what lies dimply in the distance, but to do what lies clearly at hand.
P. S.
  • On learning: If you’re going to be an investor, you’re going to make some investments where you don’t have all the experience you need. But if you keep trying to be a little better over time, you’ll start to make in events that are virtually certain to have good outcome. If you don’t keep learning, others will pass you by.
  • EBITDA = Bullshit earning
  • To the young: work with small stocks, searching for unusual mis-priced opportunities.
  • The idea of excessive diversification will yield a good result is false. Good investments will almost always involve low diversification.
  • A better business is one where you don’t have to put back all your profit in at the end of the year.
  • If you develop the right judgement skills, you’ll buy shares during price declines. Really good investment opportunities don’t come along too often and don’t last too long, but so be prepare to act. Have a prepared mind.
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