The Art of Stock Picking

Charlie Munger's greatest speech teaches an investor how to beat the market.

Apr 21, 2024

Many desire to become good stock pickers, but few achieve it. Investors aspire to the success stories of Buffett and Munger who have led the way as prime examples of the power of compound interest.

Thankfully, both Buffett and Munger have dedicated significant portions of their lives to reading, learning, and, most importantly, sharing their invaluable insights with the world. Their wealth of knowledge is a treasure trove for the average investor.

In 2008, Charlie Munger gave a speech entitled “The Art of Stock Picking.” It is one of the most fabulous reads for all who are looking to invest in the long term. Today, we are summarising some takeaway points from the late “original-thinker” of Berkshire.

Mental Models

Charlie starts his speech by spending more than half of it on the topic of mental models. More specifically, there are benefits to having multiple models in your mind. He summarises this section by saying, “The basic microeconomics models, a little bit of psychology, a little bit of mathematics, helping create what I call the general substructure of worldly wisdom.”

Munger describes these as the “carrot before the desert” and emphasises their importance in investing. Today, we will focus more on the secondary part of his speech, which is stock picking itself. So, we will leave a link to the full document at the end of the article so you can benefit from his thoughts on mental models.

Average Results

“The average result has to be the average result.” When looking at the US equity benchmark, the S&P 500, you will see an average return from US companies over the years. That, in turn, means that it is impossible for everyone to beat the market. It will only ever be those who can perform at an above-average rate.

That stat doesn’t inspire the masses, but Munger doesn’t leave it there. Stock markets have very small transactional costs, which is different from horse betting, where the house takes 17%. Because the house is not against you, Munger mentions that those who have “enough fanaticism and enough discipline” are able to get better than average results.

Bet Seldom. Bet Heavy

Munger relays a conversation he had with the president of Santa Anita, a Thoroughbred racetrack in Arcadia, California. The president explained that there were a few who regularly “beat the house” when it came to horse betting, but these ones were not active day-to-day. They bet very seldom. But when they did, they bet heavily.

This is one key takeaway from Munger’s speech. There is no need to learn everything about everything, and you will not find a plethora of opportunities in life. You only need a few insights. More specifically, he says that Berkshire has maybe had ten “insights.” But that has been plenty for them to make their billions.

Munger also relays an excellent story from Buffett, who believes that being limited to just 20 investments in a lifetime would make investors much better:

An excerpt from later in the speech: “How many of you have 56 brilliant ideas in which you have equal confidence? Raise your hands, please. How many of you have two or three insights that you have some confidence in? I rest my case.”

Understand Value

Munger acknowledges that it is possible to take a more active approach to investing and move in and out of “hot” sectors. But he knows no one who has been very successful in doing this.

Munger notes later in his speech that finding mispricings in the market is more scarce these days as the world gradually wised up and those real obvious bargains of Graham’s time disappeared.

But investors can still find opportunities today because of Mr. Market.

Small Companies

You can do very well by finding small companies. But this also requires lots of research and analysis.

The only reason that Berkshire cannot invest this way today is because they are too big. They need to find opportunities that much their cash balances, of which there are not many anymore.

“You do get an occasional opportunity to get into a wonderful business that's being run by a wonderful manager. And, of course, that's hog heaven day. If you don't load up when you get those opportunities, it's a big mistake…

However, averaged out, betting on the quality of a business is better than betting on the quality of management. In other words, if you have to choose one, bet on the business momentum, not the brilliance of the manager.”

Play The Long Game

Compound interest and time will be your greatest assets over the long run. Munger explains that the math is simply in your favour if you find a good investment and do nothing, rather than managing the position too much.

“There are huge advantages for an individual to get into a position where you make a few great investments and just sit back and wait: You're paying less to brokers. You're listening to less nonsense. And if it works, the governmental tax system gives you an extra 1, 2 or 3 percentage points per annum compounded.”