March 25, 2005

Charlie Munger's Biography - 3

I have been reading the biography and found the following thoughts from charlie worth noting

- Adopt a multidisciplinary approach to investing. One should know the major ideas across varied disciplines such as physics, economics, mathematics etc.
- One should read with a purpose in mind and should array the fact with the major models from various disciplines. One should not just gather facts , but these facts should be used to prove or disprove the various mental models
- To be successful in investing and to constantly improve , one should always ask 'why' why' why'
- one should adopt the approach of analyzing a problem for its most fundamental cause ( derived from physics ) which many times is the most simplest reason for the problem. As applied to investing this would mean that one should be able to zero down to the key factors in analyzing a business and focus on them

There is a good anecdote of charlie's discussion with a professor on the dividend policy for companies. It is a fairly long one, but essentially it demonstrates the depth of his thinking and a commonsensical approach to complex issues. Charlie munger's approach to dividend policy is that a company should retain earnings only if it can create more than a dollar of value for every dollar retained. In the discussion charlie also notes that cost of capital should not be a mathematical construct only...rather it should be looked at from opportunity cost point of view.

This is a very simple but powerful idea. for example if i am a very risk averse investor and my opportunity cost is say 6 % ( Bank FD ? ) , then i should discount a stock say by 6 % and to be safe ask for a high margin of safety.
compare this with an investor whose opportunity cost is 15 % ( current return on his portfolio maybe ). Then the investor should discount the stock with 15 % because if this stock cannot cross the 15 % hurdle , then the investor should not invest in the stock

This book contains a lot of gem of ideas

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