How to Invest Like Charlie Munger

12/1/2023

This week, we said goodbye to Charlie Munger, Vice Chairman of Berkshire Hathaway and the long-time partner of Warren Buffett. His one-line witty comments gave us thought-provoking laughs, and his speeches taught us to think independently and intelligently.

To celebrate him, I want to summarize how Charlie Munger used to invest and break down his mental tricks and approach to picking long-term investments. That's the first part of today's post.

The second part of this post is for those of us who want to get practical and put our learnings into practice. I'll use Charlie's investment approach to screen for stocks that meet his criteria.

Let's talk about that!

I'm Hoda Mehr, founder, and CEO of Stock Card, and on this blog and its accompanying YouTube channel and Podcast show, I share detailed fundamental analyses and interesting investment stories.

This post is part of our educational series to help you hone your fundamental investing skills. Catch up with the other post on How to Invest Like Buffett? or how to Find the Highest-Returning Stocks?

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All Good Investing Is Value Investing

On many occasions, Charlie has made it very clear that to him, the only intelligent way of investing is to pay for something less than what it's worth. This doesn't mean he would go after beaten-down stocks or actively search for the dip. However, it means Charlie wouldn't invest in the best companies in the world if he could not invest in them at a reasonably fair price.

A good example is Berkshire's investment in Apple (AAPL) when it was able to buy the stock during the first quarter of 2016 at around $30 per share, and the stock price now hovers around 200 per share, representing 400%+ return on initial investment, excluding all the dividends it has paid Berkshire. This was about when the broader market started comparing Apple to IBM as the iPhone sales growth slowed.

Charlie and Warren invested in Apple at around 11 times the price-to-earnings ratio and 2.5 times the price-to-sales ratio, which turned out to be an extremely reasonable price for a dividend-paying company that went on to become the largest public market holdings of Berkshire's portfolio in 2023.

Charlie's most important stock-picking trick is to focus on valuation rather than paying too high a price for even the best stocks.

Avoiding Portfolio Ruin by Inverting

Charlie followed another fascinating and unique mental model that helped him avoid the most common investing mistakes. He calls it the inversion approach.

He tells a fascinating story about his time in the Air Force. He was a weather forecaster to help pilots avoid bad weather. To solve the problem of how to save the pilots from bad weather, he used to ask himself the easiest way he could kill those pilots because of bad weather conditions. The answer was freezing conditions and fog. And he focused all his efforts on avoiding fog and freeze.

He used the same "inverting" methodology in his investing. He asked himself how he could ruin his portfolio in the stock market. And the answer was to invest in companies that can easily go wrong or lose companies. Some good examples are companies that make no money or free cash flow or need the stars to be aligned to become a home run.

Charlie would religiously avoid losing companies, even if he had to sit on his hands and do nothing.

Understanding the Market's Natural Rhythm

Berkshire Hathaway's stock has dropped by over 50% at least three times during Charlie's life, and those drops never worried him a bit. If you want to generate outsized returns in the stock market, you better be able to handle a 50% drop with grace, and it should not impact your investment decisions. According to Charlie's teachings, there are two groups of good investors in the world:

Those who invest in broad market indices and know investing in a market index such as the S&P 500 index ETF is a steady and sure way of generating wealth over decades, and it is an effortless and emotionally safe way of investing.
The second group is investors willing to do the research and are pursuing a much higher return than the market's average return and understand the market's nature. These investors know high return requires a lot of work and comes with lots of volatility.

If you want to follow Charlie's steps, you need to figure out which camp of the good investors you belong to. Those who know they can't tolerate a 50% drop and accept the slow-steady return of the overall market. Or those who understand and are not phased out by a possible 50% drop.

Charlie Munger Stock Screener

In the first part of this post, we talked about how Charlie Munger invests. Now, in this second part, I want to get practical and look for stocks using Charlie's investment methodology.

I'll use Stock Card's stock screener tool under the tools section of the website. You can use Stock Card or any other screener.

The first criteria we discussed was to invest in companies with reasonable value. There are, of course, many valuation methodologies. Here, I'm using the standard valuation metrics such as price-to-sales and price-to-earing ratio. We calculate those common metrics on Stock Card and compare each company's valuation with its peers. The stock is undervalued if the valuation is lower than peers by at least 10%. So, let's pick undervalued stocks.
The second part of Charlie's approach was to avoid companies with a high likelihood of ruin. This can include companies with no free cash flow or declining sales. I exclude stocks with declining revenue and no free cash flow using the filters on the screener.
Lastly, Charlie discussed tolerating significant stock price drops to generate substantial returns. To replicate this approach, I go to the theme box on the top of the screener page and add stocks hitting a 52-week low. This theme filter would result in stocks with drastically fallen prices in the last 52 weeks.

When combined with the other criteria, we should get a list of high-quality companies that are undervalued and are experiencing a temporarily undervalued stock price.

At first glance, 28 companies meet the criteria now. I return to the screener to add a few more filters, exclude companies not listed on the Nasdaq or NYSE stock exchanges, and remove all those tiny public companies with a market cap lower than $50M. I'll save the screen as "Charlie Munger Stock Screener" if you want to get the list now or continue your research.

If you liked this post and the screener we built together, I recently recorded an ETF screener demo video that you may also find interesting and helpful as the next post to read.

Otherwise, I'll leave a link to post where I talked about the 6-step process Warren Buffett uses to research stocks. That's also a good next post to read to continue your education.

I'll see you next time!

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