![Charlie Munger’s Investment Principles And Checklists [IN-DEPTH] Charlie Munger’s Investment Principles And Checklists [IN-DEPTH]](https://www.valuewalk.com/wp-content/uploads/2015/12/checklists-768x682.jpg)
Charlie Munger’s Investment Principles And Checklists
“You need a different checklist and different mental models for different companies. I can never make it easy by saying, ‘Here are three things.’ You have to derive it yourself to ingrain it in your head for the rest of your life.” – Charlie Munger
- Good checklists are precise, efficient, easy to use even under difficult conditions, do not try to spell out everything, and provide reminders of only the most critical and important steps; the power of checklists is limited
- Bad checklists are vague, imprecise, too long, hard to use, impractical, and try to spell out every single step
- Do-confirm checklist: perform jobs/tasks from memory and experience, but then stop, run the checklist and confirm that everything was done correctly
- Read-do checklist: carry out tasks as they are checked off – more like a recipe
Process
Focus on original source documents, working from in to out
- SEC fillings
- Read 10-Qs, 10-Ks, proxies and other filings in reverse chronological order
- Press releases and earnings calls/transcripts
- Other public information
- Court documents, real estate records, etc.
- Industry publications
- Third-party analysts
- Sell-side research only as a consensus-checking exercise
- Research the company’s competitors with the same process
- Research and speak to competitors, (former) employees, and people in the supply chain
- Estimate valuation before looking at market valuation
- Valuation – What would a rational, long-term, private buyer would pay in cash today for the entire business?
- Asset value
- Earning power
- if EP >NAV, then franchise value
- Growth value
- Valuation – What would a rational, long-term, private buyer would pay in cash today for the entire business?
- Requirements
- Large, well understood margin of safety
- Reinvestment opportunities for capital in the business
- Quality, ownership stake, and shareholder-orientation of management
- Ability to bear pain, both the company’s and my own
- Munger’s “Four Filters”
- Understand the business
- Sustainable competitive advantages (aka, favorable long-term economics)
- Able and trustworthy management
- Price that affords a margin of safety (aka, a sensible purchase price)
Pause Points in the Process
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Always think in terms of Process + Patience
How big is the margin of safety? How reliable is it? Why?
Pause #1
- Are the business and its securities able to be understood and valued?
- Avoid loss by
Pause #2
- Go back through all financial disclosure looking for information and context missed the first time
- Patterns/trends
- Level and quality of disclosure
- Specifics (see next section)
- Patterns/trends
Pause #3 – final checks
- What can go wrong? Do a “pre-mortem”
- How can capital be permanently impaired by this investment?
- What are the probabilities? Are the odds heavily in my favor?
- What is the time horizon?
- How attractive is the opportunity? Namely, how attractive is compared to my best current investment?
Munger’s “two-track analysis”
- First, lay out and deeply understand the rational factors that govern the situation under consideration
- Second, focus attention on psychological missteps – either your own or those of other investors
“The Most Important Things”
- Margin of safety
- Balance sheet
- Capital structure and liquidity
- Asset value
- Cash flow
- Realistic and reliable owner’s earnings (especially a few years from now)
- Can cash be reinvested at attractive compound rates?
- How has management allocated capital?
Initial ideas to consider in the process
- Separate the business from the balance sheet
- How is the business capitalized? Is it sustainable? Is it relatively efficient/optimal?
- What are the assets worth? Liquidation value and reproduction value
- Are there any “hidden” assets or liabilities?
- Excess cash, real estate, LIFO, etc.
- Pension, legal liability, litigation, operational malfeasance, funding/liquidity puts, etc.
- Separate the business from the cash flows
- What are the cash flows saying, regardless of the broader business stereotypes/assumptions?
- How much cash can be taken out of the business every year? Owner’s earning (net income plus DA minus capex) normalized and over time
- Earnings yield (EBIT/TEV) and ROIC (EBIT/(WC+fixed assets))
- What are the capex requirements? With regard to inflation? Depreciation?
- What is the business’s competitive situation? How good is management?
- What could kill the business? What disrupts the underlying fundamentals?
- Competition/moat
- Cost structure
- What are incremental margins? How attractive is the compounding opportunity?
- Is capital being allocated properly? Investing in the business vs. returning capital to shareholders
- Are the company’s end markets stable/shrinking/growing? Susceptible to rapid (technological) change?
- Other considerations
- Market perceptions
- Quality of management and alignment of interests
- Is this opportunity worth a punch on our punch card?
- Psychological factors
- Think in terms of the “psychology of misjudgment” and common biases (see below)
- Where are we in the cycle?
- Where are we in the economic cycle?
- Where are we in the cycle for risk assets?
- Where are we in the industry cycle applicable to this company?
- Portfolio composition
- Target 15-25 individual (i.e., diversified or uncorrelated) investments
- Size constraints
- Portfolio liquidity
- Ability to withstand pain
See full PDF below.