Munger’s most important work “Poor Charlie’s Almanack”

Poor Charlie's Almanack

Introduction

“Poor Charlie’s Almanack” is a must-read book if you want to understand Munger’s life “thoughts”. The focus is not on investment, but on Munger’s philosophy of life. The content is very rich. I would like to remind everyone that this book is actually very difficult to read and is not suitable for everyone to read. However, if you are willing, you can still understand the contents of the book after reading it several times.

The Chinese version also specially asked Li Lu, who had been a close friend with Munger for decades, to write a good Chinese preface for the Chinese edition of the book. It is recommended that readers should not miss his article.

A quick introduction to Munger

If you really don’t know much about Munger, be sure to read my previous blog article’s complete introduction to him before reading this book, Charlie Munger, a great investor worth remembering”.

Arrangement of this article

The main content of this book is based on several important public speeches in Munger’s career. Therefore, when writing this post, I spent a lot of time to find the online link to the original English transcript of the speeches. You can click on the corresponding link one by one.

My experience in reading this book

If you are honest, very few people will feel that they fully understand the wisdom Munger wants to convey when they first read this book, and very few people will be able to read the entire book in one sitting.

When I was younger, I read this book several times. Frankly speaking, my understanding at that time was very limited, and my reading speed was also very slow, which was not very smooth. I always feel that the content of the book is too difficult, many topics are difficult to understand, the range of topics discussed is too large, and Munger is too smart. I recently took it out and re-read it, and found that my understanding of the content in the book has improved a lot; re-reading this book really feels like finding a treasure.

Munger’s investment philosophy

Multiple mental model

Munger’s investment method does not just conduct a superficial individual assessment of a company’s financial information, but conducts a comprehensive analysis of the company’s internal operating conditions and the overall ecosystem in which the company operates. He calls this set of assessment tools the Multiple mental model.

This is a framework for collecting, processing, and acting on information; this model will borrow and integrate analytical tools, methods, and formulas from all traditional fields. These fields include history, psychology, mathematics, physiology, engineering, biology, physics, chemistry, statistics, economics, etc.

The most important of these tools include engineering’s backup systems, mathematics’ compound interest models, physics and chemistry’s critical point/tilt moment/autocatalysis models, biology’s modern Darwinian synthesis models, and psychology’s cognitive errors. model; he singled out psychology as being particularly important.

This comprehensive analysis method makes it easier for people to understand the various factors related to the investment target, how they affect each other, and how they are related to each other. Sometimes there are ripple effects or spillover effects, and potentially huge Lollapalooza-level effects.

Edison once said, “Scientific theories should be as simple as possible, but not too simple.” Munger said with great feeling: “What I object to most is being overconfident, thinking too confidently: I know that a certain action is more beneficial than anything else.” Disadvantages. You are dealing with a highly complex system where everything interacts with other factors.”

Note: The Lulapalusa effect is a word invented by him, which means the phenomenon in which various factors strengthen each other and maximize each other.

Munger believes that preparation, patience, discipline, and objectivity are the most basic guiding principles. It only takes a few decisions to create a successful investment career. He will make very large bets on the companies he likes and hold them for a long time – he calls it sit on your ass investing.

He believes that the benefits of this investment method are: “You pay less fees to traders, and you hear less nonsense. If the method works, the tax system will give you a return of one, two, or three percent a year.” “So in his opinion, buying stocks of three companies is enough.

Circle of competence

Munger limits investments to “simple and understandable alternatives.” “Concerning investment, we have three options: you can invest, you can’t invest, it’s too difficult to understand.” Only mainstream industries that are easy to understand, have room for development, and can survive in any market environment will be included in his investment list.

Munger has always been skeptical of corporate financial statements and accounting practices. He believes that this is at most the beginning of calculating the value of a company, not the end; because there are so many additional factors that he has to check. These factors include the legal environment, labor, supplier and customer relationships, the potential impact of technological change, competitive strengths and weaknesses, pricing power, environmental issues, and potential risks. It also evaluates the true impact of pension plans, stock options, and health benefits now and in the future. After that, he will adjust the numbers in the company’s financial statements based on his own investigation and understanding.

In addition, he will try to evaluate the company’s competitive advantages and sustainability based on products, markets, trademarks, employees, distribution channels, social trends – that is, the moat. From his experience, “There are very few companies that can last for several generations.”

Finally, he calculates the value of the business, taking into account future dilution, and determines how the value per share compares to market price—that’s the goal of the entire process: a comparison of price and value.

“It is better to buy excellent companies with reasonable stock prices than to buy mediocre companies with cheap stock prices.” Buffett once said that it was Munger who made him more convinced of the wisdom of this method: “Munger understood this truth very early, and I only understood it later. .

After correctly assessing the value of a business, it is also necessary to buy at the right time and conduct a more detailed inspection (i.e. the following checklist) before buying and pulling the trigger. The screening process according to this method requires a lot of self-control, and will result in no targets for action for a long time.

Because of this, he believes: “Diligence is critical to coming up with better investment strategies and executing them.”

Investing Principles Checklist

As for how he did it? Munger recommended the use of checklists. Here are the items worthy of a checklist among his investment principles, including risk, independence, preparation, humility, rigorous analysis, allocation, patience, determination, change, and focus.

“A smart pilot, no matter how talented or experienced he is, will never fail to use a checklist.”

“We tend to put most of our money where we don’t have to make additional decisions.”

Notable speeches and articles

How to Guarantee a Life of Misery

The speech delivered at Harvard-Westlake College in 1986 can now be selected as “How to Guarantee a Life of Misery“. Key points from this famous speech are as follows:

  • Prescriptions that guarantee a miserable life include: drugs to change your heart or feelings, jealousy, resentment.
  • Be capricious and don’t do what you’re doing religiously. As long as you develop such a habit, you can more than offset the effects of all advantages, no matter how big they are.
  • “I just want to know where I’m going to die so I can never go there.”
  • “Thinking in the opposite direction, always thinking in the opposite direction.”

A Lesson on Elementary Worldly Wisdom

“A Lesson on Elementary Worldly Wisdom As It Relates To Investment Management & Business” published in 1995 is all-inclusive, with the following highlights:

Multiple mental model

  • “To the man with only a hammer, every problem looks like a nail.”
  • “If you just remember a few isolated facts and try to piece them together, you’re not going to understand anything. If the facts are not connected in a theoretical framework, it’s useless.” “You have to have a structure in your head. Thinking models rely on the framework of these models to organize indirect and direct experience. “These models must come from various fields, because a small department cannot contain all the wisdom in the world.”

Note: These are the subject areas listed in the multiple mental model mentioned earlier in this article.

  • Most people try to solve all problems with one mental model, and their thinking often only comes from a certain professional discipline; but you must know “important theories of various important disciplines” in order to gain insight into the nature of the problem.

Note: This is also the main theme of the post I wrote before, “Investment knowledge required is breadth, not depth as most people think“

  • Dual-track analysis: “First, look rationally at which factors really control interests? Secondly, when the brain is in a subconscious state, some subconscious factors will cause the brain to automatically form conclusions that seem useful but often fail?”

Note: My personal view is that the dual-track analysis proposed by Munger is actually the theories of System 1 and System 2 proposed by Daniel Kahneman in his masterpiece “Think Fast, Slow”. For details, see my previous post “Investment knowledge requires breadth, not depth as most people think.”

Good companies are rare, concentrated investment

  • “If you find a mispriced bet and you are very sure that it will win, you should bet hard, so our investments are not so diversified.”
  • “It’s much better to seize the few opportunities that come your way than to pretend to know everything.”
  • “The trick is to buy those high-quality companies, because that means you buy the growth momentum of that company and the scale advantage it brings.”
  • How can you do it? One way is to buy few of them. Discover it when it’s time and buy it.”
  • “Find some stock in a great company at a fair price, buy it, and then sit back and wait. This approach can be very, very effective, especially for retail investors.”
  • “It is safer to bet on the growth potential of the company than to bet on the quality or wisdom of the leader.”

Asset management industry

  • “At a net worth level, the entire investment management industry does not create added value for clients, and this is its operating model.”

Note: Later, when Munger answered a student’s question, he said: “As long as people think independently, they can create added value.”

  • “Investors’ considerations are different from those of investment managers. What determines behavior is the incentive mechanism of decision-makers.”

How to evaluate the business you buy?

Buffett and I usually don’t use financial numbers to measure things. We use many of the following objective criteria:

  • Are leaders trustworthy?
  • Will it damage our reputation?
  • What kind of problems might arise?
  • Do we understand this industry?
  • Does this business need additional capital to continue operating?
  • What is the expected cash flow?

We do not expect it to grow in a straight line. As long as the price is moderate, we can also accept cyclical growth.

A Lesson on Elementary, Worldly Wisdom, Revisited

“A Lesson on Elementary, Worldly Wisdom, Revisited” was published in 1997 and 1998. It was the content of Munger’s speech to the students of Professor William Lasher in 1996.

  • “When it comes to cross-disciplinary approaches, I urge you to ignore the boundaries between disciplines. You should master the main theoretical models of each discipline and put them to use when necessary.”
  • “If you can train yourself to be more objective and have knowledge in more fields, then you will be able to think better than someone who only relies on intelligence.”
  • “We don’t have a proven method that can be used to judge all investment decisions. Our methods are all different.”
  • “We just look for opportunities where we know we can make money without using our brains.”
  • “Take Berkshire’s ten most successful investment projects as an example. Even if we don’t invest in other projects, we will be very rich. That money will not be spent in two lifetimes.”
  • “You can make fewer mistakes than others through learning, and you can correct them faster after making mistakes. But it is impossible to live a prosperous life without making a lot of mistakes.”
  • “A common problem among bankrupts is the inability to deal with psychological denial correctly. You put a lot of effort into something, pour your heart and money into it, and the more you invest, the consistency principle will urge you to think: ‘This must succeed. If I put in a little more effort, I will succeed.”
  • “Although some people are more knowledgeable than you, but their cognition is obviously affected by bias caused by the incentive mechanism or similar psychological factors, you must have the confidence to overturn his conclusion.”
  • “In most cases, the most effective way to convince a person is to act in that person’s interests.”
  • “I think you should grasp what others have figured out. I don’t think people can grasp universal wisdom just by sitting down and dreaming. No one is that smart.”

Practical Thoughts on Practical Thinking

In the speech “Practical Thought About Practical Thought“, Munger used examples to explain how to make decisions and solve problems through various thinking models.

He first stated that there are four practical following concepts:

  • The best way to simplify problems is to start by solving the big problems whose answers are obvious.
  • Only mathematics can reveal the true face of science.
  • It’s not enough to think about a problem head-on, you have to think about it from the other side.
  • The best, most practical wisdom comes from basic academic knowledge.

“If you rely entirely on others to think about problems and often pay for expert consultants, you will be in trouble when you go beyond your narrow field of knowledge.”

Note: This passage from Munger is actually the main theme of my previous post, “Thinking cannot be outsourced“

The Need for More Multidisciplin ary Skills from Professionals

This part mainly comes from Munger’s 50th anniversary speech at Harvard Law School: “The Need for More Multidisciplinary Skills from Professionals“

In addition to professionals deliberately causing harm out of selfishness, various intertwined subconscious psychological tendencies also have a continuous and terrible impact on the behavior of professionals. Two of the most common tendencies are:

  • Bias caused by incentives
  • Hammer Man Tendencies

In the elite soft sciences, what are some methods that can accelerate the process of improving subject education:

  • There should be more compulsory courses instead of elective courses.
  • Students need to have more cross-domain knowledge to solve problems, similar to pilot simulation flight, so as to avoid becoming rusty after a long time.
  • Make good use of the best business publications such as The Wall Street Journal, Fortune Magazine, and Forbes Magazine.
  • When recruiting students, universities should avoid those with political ideological tendencies that are too left or too right.
  • Soft science should strengthen the basic academic spirit and methods of imitating hard science.

If the great Harvard can learn more from the training of pilots, it will definitely become even better.

Invest like a Berkshire Hathaway

This chapter is mainly written based on the content of Munger’s speech on “Investment Practices of Leading Charitable Foundations” in 1998.

Munger’s central idea is this: He believes that large foundations should eliminate waste, become role models for society, and avoid making useless blind investments.

Most foundations invest their assets in typically common assets such as stocks and bonds, and they hire and rely on outside investment advisors to manage the foundation’s asset portfolio. Investment advisers invest money in external funds, and these funds then hire their own investment advisers to invest in assets in different fields and conduct a large number of diversified investments based on the so-called beta value and volatility. This will lead to further diversification of an already diversified investment portfolio.

Such an approach would also result in the need to repeatedly pay commissions and advisory fees to each level of investment advisers, analysts or fund managers, and would also increase the buying and selling of stocks and bonds in these “funds of funds”, plus The use of leverage and the frictional costs caused by the accumulation of these things will actually eat up a considerable proportion of the foundation’s fixed costs every year, which can easily exceed 3% of the foundation’s total assets──the key point is that regardless of their performance, The assets of the foundation will shrink by a fixed 3% every year.

Munger proposed the following three options, which he believes can solve the problem encountered by the foundation:

  • Fire investment advisors, reduce the number of transactions, and switch to indexed investments─this is the most reasonable way.
  • Follow the example of Berkshire Hathaway, hold several excellent companies for a long time, do not buy and sell frequently, and reduce the average annual management cost of the foundation’s investment portfolio to less than one thousandth.
  • In addition to non-leveraged investments in the stock market, you can invest in some private equity funds─but Munger does not highly recommend this method, and his own family fund does not use this method. The first major drawback of this approach is that it can easily lead to catastrophic consequences during economic downturns. Secondly, the competition among private equity funds for mergers and acquisitions is very fierce.

“Can you really understand the purpose of derivative financial products? Anyone who says yes is either crazy or lying!”

Wealth effect and febezzle effect

The content of this chapter mainly comes from the speech given to the Pasatena Charitable Foundation in 2000: “Breakfast Meeting of the Philanthropy Roundtable“. The main purpose of Munger’s speech is to help large foundations make fewer mistakes and teach them how to invest effectively and reduce waste.

When traditional economists discuss and conduct statistics, they ignore the item of bezzle – money obtained from corruption that has not yet been exposed.

Munger himself imitated black gold and coined the word febezzle. The 3% shrinking assets that are wasted by the foundation every year are the most typical febezzle. Employee choice is also common in febezzle. All the wealth effects created by febezzle will be even greater under the influence of the Keynes multiplier.

Munger’s friend provided him with data: the annual return of mutual funds is 12.8%, but the annual return received by mutual fund investors is only 7.25%. The huge 5% reward in the middle is actually worthy of the attention of all foundations.

The Great Financial Scandal of 2003

This speech was “The Great Financial Scandal of 2003 – 2000” written by Munger in 2000, which predicted the great financial scandal that occurred in 2003.

At the time of Quant Technology’s death, the company was growing steadily and employees’ compensation consisted mainly of cash, with no stock options. The founder has taken care of the company in an orderly manner. As long as he follows the previous methods, he will definitely be able to expand the scale and income year by year.

However, after the founder passed away, in order to catch up with the rapid rise in market value of contemporary stock market companies and become a more competitive company, the board of directors hired an external management team and determined to thoroughly reform the beautiful system left by the founder to achieve this The goal.

Since the company was already on track under the founder’s management, they had no way to improve it, but the way they found was to use modern metal engineering techniques to beautify the financial reports. Start issuing employee options instead of treating them as salary, which can save the company’s salary costs and significantly reduce the cash bonuses and bonuses that traditional companies should pay to employees. As a result, the company’s costs have been significantly reduced, profits have been significantly increased, and the stock price has of course risen sharply.

Then, the team management team began to falsely report the company’s revenue and net profit, and colluded with external accounting auditors to make the company’s financial report figures present the illusion of perfect growth.

The truth was later revealed, causing shareholder outrage and prompting reform of accounting firms, correction of financial reporting loopholes, and legislation of new regulations.

In fact, this was a fiction created by Munger in 2003, before similar fraud cases broke out in many well-known companies in the US stock market. But two years later, Munger became a prophet because of these accounting fraud cases. The plot used by the company involved in the accounting fraud case is exactly the same as this story.

Nine major flaws in academic economics

This is based on the lecture “Academic Economics: Strengths and Faults after Considering Interdisciplinary Needs” delivered by Munger at the University of California, Santa Barbara. What is written.

Advantages of academic economics:

  • Born at the right time, born in the right place.
  • Attracting the best minds in soft science.

Disadvantages of academic economics:

  • Fatal autism, leading to Hammer Man Syndrome.
  • The basic hard science method of full attribution scholarship was not adopted.
  • The worship of physics──the efficient market hypothesis is a typical representative. For details, see my other post: “Why is the efficient market hypothesis unreasonable?“
  • Too much emphasis on macroeconomics.
  • There is too little integration in economics.
  • Extreme ignorance of psychology and its negative consequences.
  • The consequences of not paying enough attention to the consequences.
  • Not enough emphasis is placed on the concept of febezzle.
  • Don’t pay attention to the effects of virtue and vice.

Munger’s common sense

This is from Munger’s 2007 speech to graduates of the University of Southern California School of Law, “USC Gould School of Law Commencement Address“. It mainly tells you how to achieve success, and Become a rich man. The key points are as follows:

  • The surest way to get what you want is to deserve it and own it.
  • Every night you go to bed a little wiser than you were that morning.
  • Human society can only progress after inventing methods of invention. In the same way, you can only make progress if you learn how to study.
  • When Buffett is awake, he spends half of his time reading and the other half talking to talented people.
  • Avoid extreme ideologies as they can drive people crazy.
  • I don’t deserve to have an opinion unless I can refute my own position better than my counterpart.
  • The value of diligence and frugality.
  • Trust is the best system.

The psychology of human misjudgment

The content of this chapter is based on “The Psychology of Human Misjudgment” by Munger in 2005. This speech was actually composed of three related speeches he had given earlier, which he merged and rewritten.

This article fully demonstrates his original theory in behavioral finance-mainly introducing the 25 causes that Munger himself proposed that lead to human misjudgments. And behavioral finance has now become the hottest new discipline in contemporary economics, finance, and finance.

Closing words

At the end of 2022, the ChatGTP chatbot of the Artificial Intelligence Large Language Model (LLB) launched by OpenAI. In my personal opinion, it is actually the large ideological model of the Munger’s Multiple mental model. Through artificial intelligence and technology, it is It can actually be extended to a small part of people’s real application scenarios to some extent; and I personally think it is still in the early stages.

Poor Charlie's Almanack
credit: Amazon.com

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Author: Andy Lin

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