95-year-old Charlie Munger is a big fan of using checklists in decision making. Pilots use checklists to improve their performance. Surgeon Atul Gawande wrote a book on the importance of lists in the operating room. Munger believes that all investors should use checklists too.
Munger’s investing checklist is not original. Instead, he derives it from investment pioneer Benjamin Graham’s principles of value investing:
1.) Treat a share of stock as a proportional ownership of the business.
The underlying business is the only thing that matters when investing in a stock. Spend no time on top-down factors. Ignore monetary policy, consumer confidence and market sentiment indicators. Always be motivated when you’re buying and selling securities by reference to intrinsic value instead of price momentum.
2.) Buy at a significant discount to intrinsic value to create a margin of safety.
The margin of safety reflects the difference between the intrinsic value and the current market price. This concept rises above all others in the mind of a value investor. The margin of safety will never become obsolete.
3.) Make Mr. Market your servant rather than your master.
Developed by Graham, “Mr. Market” is a metaphor for market behaviour. Graham treats the stock market like a manic-depressive who comes by your office every day. Some days, he’s willing to sell you his interest in a company for way less what than what you think it’s worth. Other days, he’s ready to buy your interest for much more than you think it’s worth. Therefore, consider it a blessing to be in a business with a manic-depressive who gives you this series of options and opportunities all the time.
4.) Be rational, objective and dispassionate.
Rationality is the essential quality of a successful investor. It is the best antidote to psychological and emotional errors. Much like the margin of safety, the idea of being objective and dispassionate will never be obsolete.
Munger believes that the stock market is not totally efficient. It’s this difference between “totally efficient” and “somewhat efficient” that provides opportunity for disciplined investors.
Sven Franssen