Take a simple idea and take it seriously

During the latest Berkshire Hathaway meeting, Warren Buffett referred to Charlie Munger as the architect of Berkshire Hathaway. My appreciation for Munger has existed for years; I've long ceased to consider him merely as Buffett's right hand. Not that Buffett hadn't already pointed that out to us even before I was born.

A book I often revisit to reread a few pages is "Poor Charlie's Almanack." This year, I purchased the new version in Omaha, now the old - the large version - is finally getting some rest and a place of honour on the bookshelf. I can now wear out this new version. It seems as though "Poor Charlie's Almanack" is designed in a way that it always provides an answer you can apply when you flip through its pages.

Invert always invert

One of the powerful statements in the book is a quote he borrowed from the mathematician Carl Jacobi: "Invert, always invert," or in Jacobi's own words: "Man muss immer umkehren."

Always reverse your problem statement. Munger articulated this as: "All I want to know is where I'm going to die so I'll never go there." A statement that caught up with him at the age of 99.9.

As investors, we can also apply this principle. When we try to assess how strong a company is, or how robust the coveted "moat" is, we simply need to ask ourselves what the company could do to ruin itself quickly. And also, what a competitor could do to push this company into the abyss. Sometimes it's not possible to pinpoint exactly what that moat is, but through this exercise, we can conclude whether it exists.

This principle can also be applied to the valuation of a company. Instead of trying to determine what a company is worth, we can also reverse the process and consider what return the company can generate for us at the current stock price, an exercise that seems to be increasingly overlooked.

When I assign a value to a company, I do it differently than before. Previously, I tried to calculate the value as accurately as possible. But as I mentioned in earlier articles, valuation is always an estimation of future growth, cash flows, etc., and therefore never precisely correct. If you can never be precisely correct anyway, wouldn't it be better to calculate what you are willing to pay instead of trying to determine the most accurate value possible and then adding a margin of safety to it?

Minimum required return

In other words, you need to determine at what price you expect to achieve the minimum required return. You can do this by conducting a reverse DCF, for example, with a discount rate of 12%. Of course, this may not always be achievable for every company or every year. Sometimes you make mistakes or the overall market sentiment is against you. But in the long run and with a diversified portfolio, you can set a goal with this approach.

This brings me to the last statement by Munger that I wanted to discuss: "Take a simple idea (that works) and take it seriously."

An example Munger provides is about the return you can expect from your companies. He says that the Return on Capital (ROC) determines how much return the company will generate for you in the long run.

If your time horizon is long enough, you can even overpay for a company. Over 30 or 40 years, your return will eventually converge to this ROC.

What he says is certainly true; you can see it when you look at really long-term histories. But it's not always easy to execute. First of all, you have to be sure that you won't need the money for 30 or 40 years. There have been multiple periods in the past when even top companies took more than ten years to return to their highest price.

Ten years without stock price gain

Take the Nifty-Fifty in the 1970s, for example. Buying these 50 blue-chip stocks with strong earnings growth was thought to be foolproof. They were bought at very high prices. When the crash came in 1973-1974, these stocks also declined, and it took ten years or more for them to return to their highest price. Among these companies were top performers like Coca-Cola, Walmart, Disney, Procter & Gamble, McDonald's, Merck, Johnson & Johnson, IBM, Gillette, Kodak, Black & Decker, etc.

We also saw this phenomenon during the dot-com bubble. Top companies like Microsoft, Amazon, Google, took more than ten years to surpass their highest prices. Cisco still hasn't succeeded after more than 20 years.

And then we're talking about the real top performers; some companies disappeared. In other words, you also need to be able to identify those companies that can maintain their returns over all those years, something that is given to only a select few companies. It will not surprise you then that Munger opted for very high-quality companies.

Since I don't know if I can invest with a horizon of 30 years, the price remains important to me. This leads me to smaller companies to find stocks that, in my opinion, are reasonably priced relative to their quality.

Do you need to be a professional investor?

Finally, I would like to revisit a statement by Bruce Greenwald. Greenwald was a professor of value investing, following in Graham's footsteps, at Columbia University. He also wrote the book "Value Investing: From Graham to Buffett and Beyond".

In an interview, he mentioned that you have to be a professional investor to outperform the market. I disagree with this, but he does make some strong points. For example, a private investor has less time to spend than a professional, which can lead to less knowledge.

The entire market consists of all investors together, and it is natural that they together achieve the average return. The big question then is: how can you ensure that you are above that average in the long run? After all, you are competing with a whole army of professional investors with more time for research and better tools.

Why I disagree that you have to be a professional investor to outperform the index is because as a private investor, you don't have time pressure. A professional investor has to perform because their clients expect it. If they don't perform for several quarters, money will flow out of the fund, and they will earn less.

That's why it's important that if you choose to invest in a fund, the manager has invested a large portion of their capital in the fund. This way, the pain of losing their money will weigh heavier than a lower salary. That's why I also love family-run holdings; there, the interests are truly aligned.

As a private investor, in charge of your own money, you don't have that kind of pressure. It's okay if others achieve higher returns this quarter or this year; you shouldn't want to compare yourself to investors in même stocks or crypto who make hundreds of percentage gains in the short term. Prizes are awarded at the finish line, and I'd like to see how many of them make it to the finish line.