I explain the 4 investing steps that have helped Charlie Munger and Warren Buffett get rich. If we can follow this same simple formula, we are bound to become wealthy over time!
Charlie Munger’s Simple 4 Step Investing Checklist
- Meaning: We are capable of understanding it
- Moat: Intrinsic characteristics that give it a durable competitive advantage
- Management: with integrity and talent
- Margin of Safety (MOS): Buy at a price that makes sense and gives a MOS
When Charlie says gives a margin of safety considering the natural vicissitudes of life, this means that we want to build in a buffer or enough margin for error given how life is always changing. The margin of safety is a discount to what we believe the intrinsic value of the business is.
Charlie Munger throws shade on the “professional classes” that sometimes make investing harder than it has to be because he said, “it’s all so obvious and so simple, what would they have to do with the rest of the semester?”
For meaning, we make sure to do our homework and thoroughly research a company we believe is within our circle of competence (our ability to understand something).
If we can understand a given business, we can have a certain level of conviction, then we may not have to look at the stock price for many years and we know that the business will do well.
One example is Starbucks, where I believe I understand their business model of selling coffee, tea, food, and the “third place” experience to its customers.
In the aftermath of the Great Recession in 2009, Charlie Munger explained how it’s in the nature of long term shareholding that there will be vicissitudes or volatility in the stock market. The quoted market value of your stock could go down by 50%. If you’re not willing to react with equanimity to a market price decline of 50%, 2 or 3 times a century, then Charlie said “you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get compared to the people who do have the temperament who can be more philosophical about these market fluctuations.”
If you have the right investing temperament and true conviction, you won’t be phased by a 50% drop in the stock price in businesses you’re invested in. And a 50% drop might even give you an awesome margin of safety price at which to buy more of the wonderful business at.
Think of a business moat as the water surrounding the business castle, making it harder for competitors to break through a company’s competitive advantages.
Examples of moats: Coca cola has a brand moat, Apple has a switching moat, Costco is a price moat, utility companies are toll bridge moats, social media is network effects, and pharmas have secrets moats.
Warren Buffett said in 1995 that they are looking for businesses with a wide moat, protecting a terrific economic castle with an honest lord (management) in charge of the castle. “In essence that is what business is all about,” Buffett said.
One example is Tesla that would meet Buffett’s moat criteria as it has a position in consumers’ minds and it has tech advantages.
Charlie added that management should have low agency costs and that the business has advantages of scale of market dominance, such as a retailer that can buy cheaper and enjoy higher sales per square foot. It’s economies of scale.
Charlie said Berkshire’s operations have been constructed that an idiot could run Berkshire, but he would prefer Warren to remain allocating capital.
Similarly, Buffett said in 2008 that you want to “buy into a business that’s doing so well an idiot could run it, because sooner or later, one will.”
Charlie further explained the investing rationale that went into Coca Cola, and when you can figure out the intrinsic value, that is when you invest heavily.
Charlie said that he and Warren have the mindset of the person who’s buying the whole business. He calculates the price of the whole business to see if it’s attractive, even if he’s buying it on a per share basis. So they like to buy shares at a price that’s lower than what a rational person would pay if he could buy the whole business.
The key is to think of yourself as a business owner and buy a wonderful business at a reasonable price. This principle applies to both buying a whole business or buying individual shares of a publicly traded company.
If you’re interested in learning how to take control of your finances and start becoming an investor like Warren Buffett, check out my free PDF guide.
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