Charlie Munger: Never Use Formulas And PE Ratios When Investing

Key Concepts

• Continuous Learning: The necessity of constantly updating knowledge and revising prior conclusions.
• Margin of Safety: A key principle from Benjamin Graham’s The Intelligent Investor, emphasizing buying assets significantly below their intrinsic value.
• Business Valuation as Business Analysis: Evaluating stocks as ownership in businesses, focusing on fundamentals rather than speculative trading.
• Scalability: The ability of an investment strategy to effectively handle large amounts of capital.
• Efficient Market Theory (Critique): A questioning of the idea that markets always accurately reflect all available information.
• Value Investing Evolution: The shift from buying strictly undervalued “cigar butt” companies to focusing on better companies at reasonable prices.
• Global Investment Opportunities (China): The potential, and challenges, of investing in emerging markets like China.

The Importance of Lifelong Learning and Adapting Investment Strategies

The discussion centers around the need for continuous learning, particularly in the realm of investing. The speakers emphasize that past knowledge is insufficient and that adapting to changing market conditions is crucial for long-term success. As stated, “If you’re going to live a long time, you have to keep learning. What you formerly knew is never enough.” This is illustrated with the analogy of being “a one-legged man in an ass-kicking contest” – a vivid depiction of being unprepared for the challenges ahead.

Benjamin Graham and the Limitations of Early Value Investing

A significant portion of the conversation revolves around Benjamin Graham, the mentor of Warren Buffett. While acknowledging Graham’s brilliance as an analyst (“the dean of all analysts”), the speakers point out that his investment approach wasn’t scalable. His fund operated with a relatively small capital base – $6 million, with a combined $12 million between the fund and its partnership. Graham’s lack of interest in accumulating vast wealth also contributed to this limitation.

However, the core principles from Graham’s The Intelligent Investor – specifically Chapter 8 (evaluating stocks as businesses) and Chapter 20 (margin of safety) – are lauded as “of enormous value.” The speakers contrast this with the pitfalls of modern corporate finance education, arguing that many taught formulas are “all boulder dash” and serve as a “wonderful operation to teach” for professors, but lack real-world applicability. The warning is clear: “Whenever you hear a theory described as elegant, watch out.”

The Role of Business School and the Shift in Investment Philosophy

While not entirely dismissive of business school, the speakers express concern that the “priesthood” of finance, particularly 30-40 years ago, strayed from the realities of investing, leaning heavily into the Efficient Market Theory. Buffett states he would prioritize a candidate with a strong grasp of Chapter 8 of The Intelligent Investor over a top graduate from a prestigious business school. He emphasizes that successful investing is a “discipline business” that doesn’t require exceptional intelligence, but rather a fundamental understanding of accounting and a consumer-centric mindset.

Buffett even muses on whether formal education was necessary for his own success, suggesting that self-study and mentorship could be equally effective. He highlights the importance of finding “great teachers” who can fundamentally alter one’s perspective, whether in academia or everyday life, and cherishing those relationships. Charlie Munger adds that finding Ben Graham, an unconventional and intelligent thinker, was a pivotal moment.

Evolution of Value Investing and the Challenges of Global Markets

The conversation reveals a shift in Buffett and Munger’s investment strategy over time. Initially, they followed Graham’s approach of buying deeply undervalued, often “lousy” companies. However, they evolved to focus on acquiring better companies at reasonable prices, recognizing that Graham’s original methods were becoming less viable. Buffett notes that Graham himself recognized this shift before his death, acknowledging that the conditions for finding companies selling for a fraction of their working capital were disappearing.

The discussion then turns to the potential of the Chinese market, which Buffett acknowledges American investors are largely missing due to its distance, unfamiliarity, and perceived complexity. Despite some successful investments in China (including a significant position in PetroChina, albeit a small percentage of the overall company due to government ownership), accumulating large positions in foreign markets presents challenges, including reporting requirements and increased scrutiny. Munger consistently encourages further exploration of Chinese investment opportunities. A humorous anecdote is shared about an early Chinese investment that yielded a substantial return on a small initial investment ($200,000 resulting in $2 billion), though not enough to be truly encouraging.

Synthesis/Conclusion

The core takeaway is the importance of continuous learning, adaptation, and a disciplined, fundamental approach to investing. While acknowledging the value of formal education, the speakers emphasize the primacy of practical knowledge, particularly the principles outlined in Benjamin Graham’s The Intelligent Investor. They highlight the evolution of their own investment strategy, recognizing the need to adapt to changing market conditions. Finally, they point to the potential of overlooked global markets, like China, while acknowledging the inherent challenges of investing in unfamiliar territories. The conversation underscores that successful investing isn’t about finding complex formulas, but about understanding businesses, maintaining a margin of safety, and constantly refining one’s understanding of the world.