The death of Charlie Munger this week has seen the world lose a true investing icon. Having been vice-chairman of Berkshire Hathaway since the late 1970s, he worked tirelessly two men worked tirelessly with Warren Buffett to turn the investment firm into the $780bn colossus that it is today.
Senior market analyst Lukman Otunuga of FXTM has described Munger as “a titan in the world of investing“. And he has laid out five core principles of Munger’s that could help investors of all levels build a winning investment strategy.
They are:
1. Understand the company
Otunuga says that Buffett’s right-hand man championed “[investing] in companies whose business models you understand thoroughly. Munger advocated for a ‘circle of competence’ — sticking to industries or sectors you know well“.
This may seem obvious, but many investors make the mistake of putting their capital in firms they don’t fully grasp. This can happen by following the herd or simply not doing quality research.
It’s important to have thorough knowledge of a company and the industry in which it operates before investing. Considering its business model, competitive advantages, balance sheet, and management quality are just a few critical things to consider.
2. Search for value
Another of Munger’s key tips was to “seek out undervalued companies [which] means finding businesses trading for less than their intrinsic value“. Otunuga describes this as “a hallmark of Munger’s value investing strategy“.
Berkshire Hathaway’s favourite way to gauge intrinsic value is by using discounted cash flow (DCF) analysis. This tool calculates what an investment is worth by estimating how much money it will earn in the future.
3. Quality beats quantity
Otunuga notes that Munger also preferred to “focus on a few high-quality investments rather than a diversified portfolio of mediocre stocks. [He] often emphasised the importance of investing in a few companies that you have thoroughly researched and believe in“.
Holding a wide number of stocks helps investors to reduce risk. But owning too many can have significant drawbacks, including inefficient capital allocation and limited knowledge of each stock due to time constraints.
4. Think about risk
Munger banged the drum that investors must “understand the risks involved and avoid investments that you cannot afford to lose. [He] advised against using excessive leverage or investing in complex instruments that are not fully understood“.
Using leverage (or borrowed funds) allows an investor to open a much bigger position than they would otherwise be able to with just their own funds. But while this can amplify returns, it can also cause huge losses when the market moves in the ‘wrong’ direction.
5. Don’t stop learning!
Finally, Otunuga says that “Munger was a proponent of lifelong learning, encouraging investors to read widely and deepen their understanding of the world and markets“.
The economic landscape is constantly evolving and financial markets never stop moving. Keeping a close watch on developments, and honing one’s investment strategy over time, is what separates successful investors from the underachievers.
Charlie Munger built a personal fortune of over $2bn during his lifetime. By following these investing principles, investors of all levels also have a chance to make life-changing wealth over the long term.
