A day learning from Charlie Munger…

I have wanted to do this for a long time, and Bank Holiday Monday finally offered me the time I needed to read through Charlie Munger’s speeches and make notes. Here is what I learnt about the ideas and mental models you need to understand to succeed in business and investing:

The Fundamentals

1. Stay away from ideology — being 100% sure on hard issues makes you a lousy thinker.
2. Figure where you have an edge, then play there and only there. Figure out where your own aptitudes are and play within your own circle of competence. If you find a niche area where you can specialise, then with will, intelligence and discipline you can master the art.
3. Know what you know and what you don’t know. When you don’t know, don’t be afraid to say so. Get rid of people who always confidently answer questions about which they don’t have any real knowledge.
4. Think things through backwards as well as forwards: if you’re looking for a plan to improve sales, what would make sales worse? Eliminate those.
5. What always wins is incentives — make sure the incentives are right for people to help you achieve your goal.
6. Always try to disprove your assumptions. Train yourself away from confirmation bias. Like Darwin, practice diligent, objective curiosity.
7. Braun’s Five W’s: Who, What, Where, When and Why — when telling someone to do something, give all 5 W’s. Especially WHY. If you always tell people why they will understand it better, they will consider it more important and they will be more likely to comply

Economics/Maths

1. Use graphs to express data, humans process them better.
2. Compound Interest
3. Probability Theory
4. Decision Trees
5. Accounting — the basics and its limitations
6. Pareto Principle
7. Understand normal distribution — the bell curve
8. In nature and in business, specialisation is key
9. Advantages of scale are ungodly important
10. Brand power is hard to beat — people trust a recognised brand
11. Things tend towards winner takes all, therefore it pays to be #1, #2 or out
12. Disadvantages of scale: others can specialise to a specific part of your broad customer base and provide better service.
13. Another disadvantage: bureaucracy and territoriality. You get layers of management and associated costs that nobody needs. They are too slow to make decisions and nimbler people run circles around them. They get comfortable and no one brings unwelcome reality to the boss.
14. Scale + fanaticism evolve to be very powerful. Sam Walton invented practically nothing, but he copied everything anybody else did that was smart — and he did it with more fanaticism and better employee manipulation.
15. Anticipating the effects of competition: In some industries eg airlines, the companies will undercut eachother until no one makes any money. In others eg cereal, they won’t. No idea why the difference occurs.
16. Trademarks and exclusivity rights are a great thing — use them.
17. You have to discern when technology will help or hurt. In commodity businesses, the advances go to the customers alone — the capital outlay results in cost reductions but also price reductions.
18. Early birds to new technology have huge advantages — they can surf the wave for a long time

Psychology

1. Develop a checklist of the main models of psychology and tick them off when you’re making decisions eg envy, denial (misery-caused malfunction), incentive-caused bias, social proof, pavlovian association, confirmation bias, loss aversion, appealing to people’s self-interest.
2. The brain is very easy to be psychologically manipulated — rational vs emotional reactions and judgments, conscious vs subconscious.
3. Beware Incentive-caused bias. People will believe that the right thing is the thing that suits them best.
4. Gresham’s Law: Bad behaviour drives out good — Once enough people are cheating the system it’s impossible to stop it .
5. Loss aversion: occurs when a thing you like is taken away from you, or when you almost have something you like and ‘lose’ it (near misses). -5 is much worse than +5.
6. Proctor & Gamble Rule: Incorporate clever marketing plus a good product. Don’t try to do either one alone.
7. Use Pavlovian association: associate your brand with other good things people like: happy times, sex etc. When people get bad news they hate the messenger.
8. Need reinforcing effects to ensure your product is consumed again and again eg caffeine & sweet flavour in beverages
9. Everyone is influenced by what others do and approve — social proof
10. Vivid and humorous examples often aid persuasion

Engineering/Physics

1. Engineering models of back up systems, breakpoints and critical mass.

Chemistry

1. Autocatalysis — once you get something going, events will serve as their own catalysts to keep growing — success breeds more success.

Stock Picking

1. You can outperform the market in stock picking if you bet seldom — bet big when you have the odds, otherwise never.
2. A significant discount = More Upside + a Margin of Safety (Benjamin Graham model)
3. Buffett + Munger pay up for quality businesses.
4. Berkshire has the tremendous advantage of having no clients.
5. It is usually better to bet on the business than the manager
6. Make a few great investments and sit on your assets
7. Better on companies with pricing power is like finding money in the street.
8. Low-priced products with global marketing advantages are great investments eg Gilette
9. Sick business you can fix: a good business run badly that can be recovered — another good investment