An Introduction to Charlie Munger’s Investment Philosophy

Of the tens of thousands of attendees at every Berkshire Hathaway annual meeting, it is likely that a majority have a working understanding of Warren Buffett’s overall investment philosophy.  Mr. Buffett is not only the public face of Berkshire Hathaway but also has become a celebrity in recent years.  There are probably only a handful of business leaders in America who have similar name recognition.  The same, however, cannot be said about Charlie Munger, Mr. Buffett’s longtime business partner and Vice Chairman of Berkshire Hathaway.  Much less has been written about Mr. Munger over the years and he has a far more modest media profile.  Many shareholders probably assume that Charlie Munger and Warren Buffett have an interchangeable view of investing but the reality is much more nuanced.

Charlie Munger: The Complete InvestorA number of excellent books have covered Charlie Munger’s life and philosophy but, until now, there has not been a relatively brief summary likely to be approachable for a Berkshire shareholder who is simply looking for a quick introduction.  This is why Tren Griffin’s new book, Charlie Munger: The Complete Investor, is likely to be of interest to thousands of Berkshire shareholders as well as others who make it a habit to study the ideas of those who have achieved remarkable success.  Since the book is relatively brief and can be read in one or two sittings, many readers who are already familiar with Charlie Munger may be skeptical regarding whether this book can provide a legitimate overview without being excessively simplistic.  A number of reviews are very skeptical and call the book a mere rehash of previously published material.  In our view, the book has value primarily for individuals who have not been introduced to Charlie Munger’s thinking in the past.

The fact that the book has many direct quotes from Mr. Munger is a source of derision in some of the negative reviews, but it would be almost impossible to write a book purporting to explain the Munger way of thinking about life and investing without extensive use of quotations.   Furthermore, although most of the quotes will be familiar ground for those who have followed Charlie Munger for years, the material will be new and captivating for other readers.  The witty nature of many of the quotations will likely prompt a curious mind to seek additional information elsewhere.

However, the book is not merely a compendium of quotations.  Mr. Griffin does a very good job of presenting the basic concepts of Benjamin Graham’s approach to value investing and this will be useful for readers who are new to the topic.  If all investors simply absorbed the information presented in Chapter 2, Principles of the Graham Value Investing System, much folly would be avoided even if that simply means that a reader resolves to use index funds and avoid the expenses, fees, and underperformance associated with poor active management.

Although most readers already familiar with Charlie Munger will find the chapters on worldly wisdom and psychology to be familiar ground, the book presents this material in a concise and approachable manner that can be read in a very short period of time.  Readers who want to delve deeper will no doubt want to read Poor Charlie’s Almanack which is, by far, the most entertaining and comprehensive coverage of Charlie Munger’s philosophy.  But Mr. Griffin succeeds in presenting the basics to a reader who could very well be intimidated by the time commitment required to read the Almanack.

One of the curious aspects of the book is that Mr. Griffin often repeats the term Graham Value Investing System while discussing Charlie Munger’s specific investment approach.  While it is no doubt true that nearly all value investors have adopted the foundational elements of Mr. Graham’s writings, Charlie Munger has been influenced to a much greater degree by Philip Fisher’s approach to owning higher quality companies.  Mr. Griffin does discuss Mr. Fisher’s influence but seems to more heavily weigh Benjamin Graham when it comes to explaining Charlie Munger’s overarching approach to investing.

Charlie Munger is often described as Warren Buffett’s “sidekick” at Berkshire, a depiction that is both disrespectful and inaccurate.  Although Mr. Munger is modest about his contributions to the success of Berkshire Hathaway, his role in nudging the company toward purchasing higher quality businesses rather than “cigar butts” has added enormous value over time.  Berkshire Hathaway shareholders, as well as other interested investors, would do well to study Charlie Munger’s life and investment philosophy.  Mr. Griffin’s book makes this process approachable with a minimal time investment.  As Warren Buffett has said, value investing is like an “inoculation”:  once presented with the basics, one either “gets it” or does not.  This book makes is far more likely that someone new to value investing will “get it” and seek out additional information on Charlie Munger in particular and value investing in general.

Disclosure:  Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway.


When to Sell a Successful Investment

“If the job has been correctly done when a common stock is purchased, the time to sell it is – almost never.” — Philip Fisher

“Those who believe that the pendulum will move in one direction forever – or reside at an extreme forever – eventually will lose huge sums. Those who understand the pendulum’s behavior can benefit enormously. ” — Howard Marks

There are many approaches used by value investors to identify investment candidates but the obvious common theme is that one makes purchases only when the offered price is significantly below a conservative estimate of intrinsic value.  In times of significant pessimism, there are often far more investment candidates than one would wish to add to a focused portfolio.  This was the case for a number of years following the 2008-09 financial crisis, not only in retrospect but as a function of the opportunities clearly available at the time.  During such times of abundance, the purchase decisions are mainly a function of which opportunities within an investor’s circle of competence offer the greatest prospective returns with acceptable business risk.  Making such bargain purchases, assuming the availability of the necessary cash and the right mindset, is usually an enjoyable experience.

On the other hand, the decision to sell can frequently be agonizing for various reasons.  If a business unexpectedly deteriorates, one must determine whether the relationship between the lower stock price and lower intrinsic value still justifies ownership.  Numerous psychological pitfalls await investors who must decide whether to sell an unsuccessful investment.  Often times, the best approach is to pull the band-aid off quickly and move on.

The more interesting question, and the subject of this article, is when one should sell a successful investment.  This question is almost certainly timely for most readers as markets reach new highs and signs of investor optimism becomes more and more common.  In retrospect, we know that the pendulum referred to by Howard Marks reached its most pessimistic limit in early 2009 bringing with it the greatest opportunities for success.  We cannot know today where the pendulum is exactly located but it seems to be drifting more toward the optimistic end of the spectrum.  This necessitates careful consideration of when a successful investment has run its course.

Motivations for Selling

There are obviously a number of motivations that would lead an investor to sell a successful investment.  Many of the reasons are somewhat beyond the scope of this article.  It is possible that an investor seeks to raise cash for personal reasons such as increased consumption or purchasing a personal residence.  Such needs may be immediate or on the horizon.  Clearly it is not advisable to hold common stocks, regardless of valuation, if the time horizon for the remaining period of ownership is very short.  In such cases, with cash being necessary, one simply sells the investment, pays the required tax, and moves on.

Aside from time horizon constraints, an investor will often consider selling in order to fund the purchase of another investment.  This is the more interesting scenario for purposes of this article.  When does it make sense to sell a successful investment in order to purchase something that is perceived as “better”?

Assess Prospective Returns

Perhaps it goes without saying, but when tempted to sell a successful investment it is necessary to revisit the valuation again in considerable detail.  It is possible that an advancing stock price is in response to an unexpected positive development that was not considered in the original investment thesis.  Investors are subject to both good and bad luck.  When good luck takes the form of an unexpected positive surprise, it wouldn’t make sense to immediately sell and abort the benefits of that good luck.

Assuming the valuation has been revisited and the investment is indeed trading above a conservative estimate of intrinsic value, it is still important to consider the prospective returns of the investment from its current price level.  For example, a month ago, we posted an article on Markel trading above $800 per share for the first time.  Since that time, the stock has advanced an additional 10 percent and currently trades above the $840 intrinsic value estimate provided in the article.  As no obvious new developments have taken place over the past month, the stock appears to be trading about 5 percent above the intrinsic value estimate.

The intrinsic value estimate was based on requiring a 10 percent annualized prospective return over the next five years.  Although the stock recently traded at $875, it still offers the possibility of 9 percent annualized returns over the next five years, holding all other aspects of the valuation constant.

Consider Tax Consequences

Warren Buffett has often discussed the major benefit Berkshire Hathaway realizes by investing policyholder “float” in securities.  Float represents funds that Berkshire holds in anticipation of payment to policyholders, in some cases in the distant future.  However, Berkshire also benefits from another type of “float” represented by deferred taxes on appreciated securities.  Effectively, Berkshire is able to invest deferred taxes that will eventually be payable to the government.

All investors have the same opportunity to benefit from retaining highly appreciated investments with large deferred tax liabilities.  For example, consider an investor who purchased Markel shares at $400 approximately four years ago.  Of the $875 share price, $400 represents the cost basis and $475 represents embedded capital gains.  The current effective top Federal income tax rate on long term capital gains is 23.6 percent.  Assuming residence in a state without income taxes, the investor would have to pay taxes of around $112 per share leaving him with $763 to invest in new opportunities.  In contrast, holding on to the Markel shares will allow the investor to keep all $875 invested.

Continuing this example, if the investor retains Markel shares at $875 and the share price compounds at 9 percent over the next five years, the ending share price would be $1,346.  At that point, taxes of $223 would be owed on the capital gain (assuming no change in tax rate policy) and cash raised on sale would be $1,123.

If the investor instead sells Markel today and reinvests the $763 proceeds, it will be necessary for the new investment to compound at nearly 10.1 percent to match the after tax proceeds realized by holding on to the Markel investment.  At that rate of return, the new investment will be worth $1,234 in five years.  Of this amount, $471 will represent a capital gain and taxes of $111 will be owed to the government  resulting in net proceeds of $1,123.

(As an aside, one must also overcome transaction costs, both explicit in the form of commissions and implicit in the form of bid-ask spreads.  We have ignored transaction costs for purposes of simplicity.)

The Hurdle May Be High

As we can see from the example, the tax friction associated with selling a successful investment and purchasing a new one can be considerable.  In this case, it would be necessary to find an investment offering a return 1.1 percent higher than Markel in order to make the switch pay off.  Furthermore, one would need to be satisfied that the level of business risk is similar or, better yet, lower.  Markel also could have upside above and beyond the intrinsic value estimate if the company succeeds in emulating Berkshire Hathaway’s business model.

It might still make sense to sell Markel and find another investment if it can be done in a tax exempt or tax deferred account.  In such cases, the tax friction disappears, but the other issues remain.  Ultimately, each investor must make an educated decision when it comes to the question of selling appreciated securities.  It goes without saying that frequent activity on a short term basis is almost always ill advised.  The same is often true in the long run, as Philip Fisher pointed out.

Disclosure:  Individuals associated with The Rational Walk LLC own shares of Markel.  Since publication of the article on Markel on June 18, fifteen percent of the Markel shares held on that date were sold in tax exempt and deferred accounts and invested in Berkshire Hathaway with no plans to sell the remaining Markel shares.  See also general disclaimer.

How to Read the Berkshire Hathaway Annual Report

Berkshire Hathaway Mill - New Bedford, MAThe release of Warren Buffett’s annual letter to shareholders is one of the most important events of the year for value investors.  This year, the significance of the letter is accentuated by the fact that fifty years have passed since Mr. Buffett took control of Berkshire Hathaway. Mr. Buffett is effectively the “founder” of Berkshire in its current form as an investment holding company and conglomerate of operating subsidiaries.

Berkshire Hathaway’s annual report, scheduled to be released tomorrow morning, has long followed a format leading off with a table documenting Berkshire’s annual and cumulative performance followed by Mr. Buffett’s letter to investors and Berkshire’s financial results for the past year.  This year, Mr. Buffett’s letter is expected to focus on his view of Berkshire’s potential evolution over the next fifty years.  In addition, Charlie Munger has written a separate letter to shareholders outlining his view of Berkshire’s next fifty years.  According to recent interviews, there has been no collaboration between Mr. Buffett and Mr. Munger when it comes to presenting their thoughts on Berkshire’s future.

Form Your Own Opinion

From the moment the report is posted online at 8 am eastern time tomorrow, social media and news outlets will be flooded with various opinions regarding the annual letter and Berkshire’s results.  Sometimes one has to wonder how it is possible for anyone to form instant opinions but it is a virtual certainty that at 8:01 am, declarative judgments of the contents of the material will already be prevalent online.  To immunize yourself against this intellectual assault, simply print the annual report on actual paper, turn off your computer, and disconnect from all social media and news until after finishing a review of the report.  Failure to do so will inevitably pollute your own judgment regarding the contents of the report and, even worse, may do so in a subliminal manner as the opinions of others act in subtle ways to alter your own thinking.

First Things First

As a general rule, it is best to review the actual results of a business prior to reading management’s assessment of the results.  In most cases, the reason behind doing so is to avoid being unduly influenced by management teams (or more frequently PR consultants) who are trying to spin results in some way.  With Berkshire Hathaway, we do not have to worry about Mr. Buffett trying to mislead shareholders but if we read his letter prior to reading about Berkshire’s results, we will invariably be influenced by his conclusions anyway.  Since it will be very difficult to read the entire financial report before peeking at Mr. Buffett’s letter, at least resolve to conduct a thirty minute review of Berkshire’s important business segments and overall financials before delving into the letter.

What to Look For in the Letter

Mr. Buffett’s letters typically follow a format where he presents his overview of Berkshire’s recent results and follows up with essays on various topics.  Sometimes the topics are directly relevant to Berkshire’s business units but often they also involve much broader topics.  It is likely that the letter will, to some degree, follow the format of prior years but we can perhaps expect a more lengthy review of how Berkshire’s fifty year record came about since this forms the foundation of what Berkshire is today.  Once that foundation is well understood, we can look to the future and we can expect Mr. Buffett’s views on how Berkshire might evolve over the next fifty years.

There are a number of key topical areas that shareholders should look for:

Management Succession

There is no reason to believe that Mr. Buffett has changed his mind regarding continuing to lead Berkshire Hathaway as long as he is fit to do so and recent television interviews provide no reason to suspect any deterioration in his physical or mental condition.  However, as the recent passing of Berkshire Hathaway Director Donald R. Keough at age 88 reminds us, the health of a man in his eighties can often change for the worse very quickly.  Berkshire’s succession plan may not be needed for another ten or twenty years or it could be needed in the near future.

Mr. Buffett is nearly certain to not name the current frontrunner to be Berkshire’s next CEO but he could very well expand upon his thoughts regarding the necessary qualities and characteristics that will be needed.  At this point, there are a number of Berkshire executives who are often named as potential future CEOs but, as time passes, many of these men are getting into their 60s or 70s.  Mr. Buffett might drop clues regarding the desired duration of his successor’s tenure.  He has previously hinted that the next CEO should have a long tenure and, if this is reinforced, one might tend to believe that the top candidate could be in his 50s rather than in his 60s or 70s.

Capital Allocation

Mr. Buffett’s prior letters have often gone into great detail regarding his views on the role of a CEO as capital allocator.  This will be one of the most important roles for the next CEO in addition to maintaining Berkshire’s unique corporate culture.  A key decision that the next CEO will face will involve whether to return capital to shareholders or to continue Mr. Buffett’s practice of retaining all earnings.

Shareholders who might otherwise agitate for a return of capital have long been content to allow Mr. Buffett to retain all earnings since having a large amount of cash on hand provides him with a great deal of optionality when it comes to future deals.  Given Mr. Buffett’s long demonstrated mastery of the art of capital allocation, having long periods of near-zero returns on a pile of cash is viewed as an acceptable trade-off to preserve the optionality of a major deal that would be facilitated by the cash.  No matter how accomplished Mr. Buffett’s successor will be, shareholders are unlikely to have the same patience.  Some words of wisdom regarding how much flexibility Mr. Buffett’s successor should have in this regard might be useful.

It will be virtually impossible for Mr. Buffett to paint a picture of Berkshire in fifty years without at least implicitly rendering a verdict on Berkshire’s ability to continually deploy cash internally at attractive rates of return.  If Berkshire retains all earnings for the next fifty years and is able to reinvest those earnings into attractive new subsidiaries and investments, the market capitalization of the company would be truly mind boggling.  For example, if Berkshire can compound its market capitalization at 5 percent in real terms over the next five decades, its market capitalization would exceed $4 trillion in current dollars.  At some point, Berkshire will clearly have to return capital to shareholders.  Mr. Buffett might provide clues regarding when that day is likely to arrive.

Organizational Structure

Berkshire has a reporting structure where nearly all of the major subsidiary CEOs report directly to Mr. Buffett.  This is partly due to the history behind many acquisitions and Mr. Buffett’s ability to inspire subsidiary managers to the point where they need hardly any “oversight” at all.  Berkshire’s future CEO, regardless of accomplishment, is not going to be Mr. Buffett’s equal in terms of inherent capabilities or in terms of his ability to inspire unquestioned loyalty from his subordinates.  However, it is critically important for Berkshire to retain a decentralized structure that empowers subsidiary managers.  How should this balance be achieved?  While the exact approach may be one that Berkshire’s next CEO will have to formulate, perhaps some clues will be provided in Mr. Buffett’s letter.

“What Would Warren Do?”

At some point, Berkshire’s next CEO is going to face a crisis or some event that leads shareholders and, perhaps even the Board, to start obsessing over “what Warren would do” under the same circumstances.  While it is very important to take lessons from Mr. Buffett’s life and business track record, nothing could be more harmful for Berkshire’s next CEO than to be a slave to the inferred decisions of a past leader.

Apple’s current CEO, Tim Cook, had the seemingly impossible task of taking over for an ailing Steve Jobs in 2011.  Mr. Jobs was adamant that Mr. Cook should not be haunted by constantly asking “what would Steve do?” but should simply do what he thought was right.  Obviously, it would be foolish for Tim Cook to make decisions without considering the lessons he learned from Steve Jobs, but ultimately he has to make his own decisions.  The same will be true for Mr. Buffett’s successor.  Mr. Buffett might choose to paint a picture of how Berkshire shareholders should think about evaluating the next CEO in this light.


The best approach for reading Berkshire’s annual report, or the annual report of any company, is to make your own judgments and avoid being influenced by others until after you have first reached your own preliminary conclusions.  On Saturday morning, the best approach is to print the report on actual paper and to go off-line to avoid even the temptation of considering the views of others prematurely.  Spend the better part of the day reading the report and considering what Mr. Buffett and Mr. Munger have to say about Berkshire’s future and then, if you choose to, engage in discussions with other Berkshire shareholders or review what the professional pundits have to say.

Disclosure:  Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway.