Charlie Munger - Troubles with the classic value investing

Key takeaways at the end

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[...] It is true that Warren had a touch of brain block from working under Ben Graham and making it ton of money. It's hard to switch from something that worked so well. [...] The trouble with what I call the classic Ben Graham concept is that gradually the world wised up, and those real obvious bargains disappeared. [...] Ben Graham followers responded by changing the calibration [...]. In effect, they started defining a bargain in a different way. And they kept changing the definition so that they could keep doing what they'd always done. [...] But such is the nature of people who have a hammer - to whom, as I mentioned, every problem looks like a nail.

[...] If we'd stayed with classic Graham the way Ben Graham did it, we would never have had the record we have. And that's because Graham wasn't trying to do what we did. [...] Having started out as Grahamites – which, by the way, worked fine – we gradually got what I would call better insights. And we realized that some company that was selling at two or three times book value could still be a hell of a bargain because of momentums implicit in its position, sometimes combined with an unusual managerial skill plainly present in some individual or other or some system or other.

Poor Charlie's Almanack (2023); Chapter Four; Talk Two

My cigar-butt strategy worked very well while I was managing small sums. Indeed, the many dozens of free puffs I obtained in the 1950s made that decade by far the best of my life for both relative and absolute investment performance. [...] Most of my gains in those early years, though, came from investments in mediocre companies that traded at bargain prices. Ben Graham had taught me that technique, and it worked.

[...] Though marginal businesses purchased at cheap prices may be attractive as short-term investments, they are the wrong foundation on which to build a large and enduring enterprise. Selecting a marriage partner clearly requires more demanding criteria than does dating. [...] It took Charlie Munger to break my cigar-butt habits and set the course for building a business that could combine huge size with satisfactory profits.

2014 Berkshire Hathaway Shareholder Letter

* Bold emphasis added

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Key concepts and takeaways:

• Value investing today: You will see that today, there is no clear definition of value investing. Investors will typically point to Buffett when they are trying to find a mispriced or a bargain purchase. They will use a combination of ratios that they developed themselves or read somewhere. They will calculate these ratios using market data and financial statements to justify what is and what is not a "value" company and to make an investment decision. This approach to investing would not make sense to Charlie or Warren. Remember that Buffett himself said that the very term value investing is redundant. Although markets are not fully efficient, bargains of those sorts have largely disappeared.

• Short-term puff vs. long-term value: In the narrow definition of value investing (what Buffett practised in the 1950s, following his teacher and mentor Ben Graham) the mispriced opportunities that Buffett identified would typically be troubled businesses "with one puff left". Buffett would invest, realise this short-term investment profit, and move on. It took Charlie to convince him that this approach is not sustainable (time, effort, size) if you are investing for the long-term. Buffett concluded that buying Berkshire itself was a mistake. Instead, they pivoted to focus on high quality businesses with an enduring competitive advantage and predictable cash flows. This approach is equally applicable to an individual investor, who also has limited resources. It is far better to focus on a few, high quality companies that will deliver returns over the long-term than to try and repeatedly realise shot-term profits.