RIP Charlie Munger: The Most Important Lesson He Taught Me

The investment world recently bid farewell to Charlie Munger, Warren Buffett’s trusted business partner at Berkshire Hathaway Inc. (BRK.A, BRK.B) and one of the greatest investors of all time. Munger, who died just a month shy of his 100th birthday, leaves behind a legacy of investment wisdom and a very impressive investing track record to back up his wide-ranging musings.

While he provided a lot of advice over the years for investors to glean and incorporate into their own portfolios, the most important lesson that Munger taught me was the importance of thinking clearly as an investor. In this article, we will delve into this quality and then share how I am implementing it in the current market environment.

Munger’s Mastery of Clear Thinking

Charlie Munger epitomized the virtue of clear thinking in investment decision-making by distilling complex situations into their fundamental elements and avoiding fads and panics while maintaining a laser-like focus on the fundamentals. For him, investing was not about chasing the latest market trends or following popular opinion; it was about understanding the intrinsic value and potential of a business and allocating capital accordingly.

One of the key aspects of Munger’s discipline of clear thinking was his focus on long-term value rather than short-term gains. He understood that true investment success comes from identifying companies with enduring qualities, such as strong business models, durable competitive advantages, and competent management. This led him to eschew sectors and assets prone to hype and speculation, such as Bitcoin (BTC-USD) and meme stocks like AMC Entertainment (AMC), and instead invest in proven long-term compounders like Costco (COST) and Apple (AAPL).

Another manifestation of Munger’s clear thinking was his ability to recognize his own limitations. He espoused the idea that every investor has a “circle of competence” which consists of industries and business models that an investor is able to analyze and understand sufficiently to be able to make an educated long-term investment decision about them. As a result, Munger religiously avoided industries or investment opportunities that fell outside of this circle, thereby giving him a high degree of conviction in the investments that he did make and likely preventing him from making many serious mistakes.

Munger also demonstrated clear thinking through his ability to learn from his mistakes. For example, he recently acknowledged his misjudgment in investing in Alibaba (BABA, BABAF), expressing regret over being captivated by the company’s commanding presence in the Chinese Internet sector and admitting that he overlooked the fundamental aspect of the company being, at its core, a retailer:

“I regard Alibaba as one of the biggest mistakes I ever made. In thinking about Alibaba, I got charmed by their position in the Chinese internet and didn’t stop to realize, ‘they’re still a g**-d***** retailer.’”

Last, but not least, Munger’s clear-eyed approach to investing was characterized by patience. He never felt compelled to act unless a highly compelling opportunity presented itself. This meant that he often sat on substantial cash reserves and even underperformed the S&P 500 (SP500) for periods of time, rather than succumbing to the pressure to be constantly invested.

Incorporating Munger’s Clear Thinking Into My Portfolio

How am I incorporating Munger’s clear-thinking approach to my portfolio in November 2023? While the “Magnificent Seven” (AAPL, Microsoft (MSFT), Nvidia (NVDA), Amazon (AMZN), Tesla (TSLA), Meta (META), and Alphabet (GOOG)) and AI-centered stocks like Palantir Technologies (PLTR) are currently dominating financial headlines and the total returns charts, driving the S&P 500 and Nasdaq (QQQ) indices higher, Munger’s clear-eyed investing philosophy has me avoiding chasing trends and preventing the fear of missing out from causing me to buy richly-valued stocks.

Instead, I am focused on buying quality defensive dividend stocks and funds (SCHD) whose valuations have been beaten down unjustifiably over the past two years due to rising interest rates and the flight of capital toward AI companies. In particular, I am finding value in the REIT (VNQ), MLP (AMLP), and utilities (XLU) sectors, with companies like Crown Castle Inc. (CCI), Enterprise Products Partners (EPD), Enbridge Inc. (ENB), and Algonquin Power & Utilities Corp. (AQN) presenting an attractive combination of value, quality, and defensiveness:

Each of these companies has an investment-grade balance sheet with plenty of liquidity. Each of these companies is trading at a discounted valuation relative to its historical averages. Each of these companies sports an elevated dividend yield that should be sustainable. Each of these companies is quite recession resistant. Each of these companies owns very valuable infrastructure assets.

Given the growing likelihood of falling interest rates and a recession next year, these stocks provide an asymmetrical risk-reward profile for me. While they may not be today’s “hot stocks” and may continue to languish for several months to come, and AI stocks may very well continue to soar higher, keeping the clear-headed long-term, valuation, and fundamentals-focused approach of Charlie Munger at the forefront of my mind should enable me to patiently wait for the market to eventually confirm the investing principle of Ben Graham (the “Father of Value Investing”) that:

In the short run, the stock market is a voting machine. Yet, in the long run, it is a weighing machine.

Investor Takeaway

Charlie Munger’s example of being very disciplined about thinking clearly about his investment decisions has had a bigger impact on me than any of his other many quips and investment views. This practice – deeply rooted in the core tenets of value investing such as understanding intrinsic value, long-term perspective, and recognizing one’s own circle of competence – is something that will never become outdated. Yes, there will always be investing fads and bubbles that will cause many to doubt the virtues of following the tried-and-true value investing approach of Munger and Buffett, but over the long term, buying a basket of quality businesses for meaningfully less than they are worth and having the patience to wait for the market to come to its senses about them will always come out ahead of the broader market.

Given where markets are today, I believe that this aspect of Munger’s investment philosophy is more important than ever. As a result, I am buying high-quality, undervalued businesses within my circle of competence hand-over-fist and patiently waiting for the market to recognize the embedded value in these companies. While I wait, I am collecting a lucrative stream of passive income through the fat dividends that these businesses are paying.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.