The Hidden Insight In Charlie Munger’s Criticism Of Benjamin Graham

Did you see Charlie Munger’s quote on Benjamin Graham during his recent fireside with the Wall Street Journal?

I don’t love Ben Graham and his ideas the way Warren does. You have to understand, to Warren — who discovered him at such a young age and then went to work for him — Ben Graham’s insights changed his whole life, and he spent much of his early years worshiping the master at close range.  But I have to say, Ben Graham had a lot to learn as an investor.  His ideas of how to value companies were all shaped by how the Great Crash and the Depression almost destroyed him, and he was always a little afraid of what the market can do. It left him with an aftermath of fear for the rest of his life, and all his methods were designed to keep that at bay.

I think Ben Graham wasn’t nearly as good an investor as Warren is or even as good as I am.  Buying those cheap, cigar-butt stocks [companies with limited potential growth selling at a fraction of what they would be worth in a takeover or liquidation] was a snare and a delusion, and it would never work with the kinds of sums of money we have. You can’t do it with billions of dollars or even many millions of dollars.  But he was a very good writer and a very good teacher and a brilliant man, one of the only intellectuals – probably the only intellectual — in the investing business at the time.

One of the things about Benjamin Graham’s writings—particularly his mid-career writings about maximizing returns—is that an individual  investment gets treated as a very ephemeral act; you buy your stock for $20 that you think is worth $35, and you sell when it approaches $35. That’s as far as that idea gets you. As a matter of personal preference, I want my good ideas to last a long time, and I want to reap as much benefit from a single decision as possible.

The early style of investing advocated by Graham is hard to pull because it requires a series of successful decisions: (1) you have to find the right company to purchase, at the right price, then (2) you have to make another decision about the right time to sell, and once you do that, you’re (3) back to Step #1 again as you have to take the cash and find something new that’s on sale. To succeed at that style of investing, you need to have constantly new and correct insights.

But it’s more than just convenience—if the Graham approach was more difficult but led to the best results, it might be worth getting over any psychological hang-ups and sucking it up because modifying our behavior would lead to greater rewards. But the hidden insight that was in Munger’s comment was this: if you spend your time searching for a company growing profits per share at 11%, 13%, 15%, or whatever the is the best you can find with high conviction, you only have to get one decision right—the buy at an appropriate price part, and your job is complete.

This conversation topic often gets distorted in investment discussions with questions like, “Is buy-and-hold investing a good strategy?” The question is incomplete until you start discussing what company it is that you are buying and holding. What is nice to know is that, if you decent amount of money to invest, you only have to get one company right in your entire life to have it made (see Munger’s classic comment ‘The bad news is that the first $100,000 is a bitch; the good news is that you only have to get rich once”).

Imagine if you did your homework and saw that Becton Dickinson was growing at rate north of 10% over just about every five-year rolling period dating back to the 1960s. If you study this stuff intensely, they’re one of the few companies that can be heralded as a “baby Johnson & Johnson.” Heck, Becton Dickinson has been raising its dividend every year since 1965, and if you focus on companies with lengthy dividend streaks as the basis for making investments, Becton Dickinson would have turned up on your radar screen at some point in the past decades, as it has been raising its dividend payout since 1965. From 2004 through 2014, its earnings continued to grow at a rate of 11.5%. Every $1 invested in Becton Dickinson on its 25th anniversary of consecutive dividend increases in 1990 would have seen each dollar grow into $18.29 today, and that is the result of you took the dividends as cash each year and spent them however you saw fit.

And if you didn’t do your homework, but had a keen eye for a business with an unassailable moat and chose to purchase Disney stock in the 1980s (say you had bad timing and bought in 1987 before the Black Monday crash), you still would have seen each $1 invested grow into over $26 in the next quarter of a century. Even in the past decade, since becoming a mega-sized corporation, Disney has still grown profits annually at a rate of 15%.

Are there difficult periods, even with a company of Disney’s caliber? Sure. The dividend sat still at $0.35 from 2008 through 2010. During the Recession, its profits declined from $2.26 to $1.82. The price fell from $35 to $15. If you had initiated your position in Disney in 2007, you saw a $10,000 investment become worth less than $5,000 as a result of your timing. It’s an acquired skill to deal with that situation intelligently, and realize that scrounging additional funds to buy Disney selling at the unbelievably low price of 11x earnings is a sign of an opportunity, rather than a burden, emerging.

That’s why I write so extensively about Visa on this site because it is the best stock I have ever found at growing fast internally, with revenues increasing at 18% annually and earnings increasing at 18.5% annually over the past five years. It carries no doubt, and its profit growth is one of the most impressive things I’ve studied. In 2006, Visa made $455 million in net profit. By the end of 2014, it’s expected to be $5.5 billion. That’s because its net profit margins are 43%. It collects fees based on how much money people spend, and that is an automatic, inherent inflation hedge. Its emerging markets operations are growing at 30% annually, while U.S. operations are growing at 8.5%.

Stylistically, the appeal of Munger’s approach is that you make one decision, and the benefits are ongoing. If you stuff your portfolio with the likes of Becton Dickinson, Disney, and Visa, you put yourself in the position to reap long-term returns at a rate north of 10%, and the ongoing effort is minimal, especially compared to the buy-a-discounted-stock-sell-at-fair-value-then-repeat approach that Graham advised in his early life writings.

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4 thoughts on “The Hidden Insight In Charlie Munger’s Criticism Of Benjamin Graham

  1. scchan_2009 says:

    Excellent article – Graham indeed has a lot of weakness in his thinking especially in his views of growth (as you stated; Graham was also a fan of the efficient market hypothesis which is rubbish as well), but there are still some good things you can learn from him. Perhaps the most important Graham lesson is his rejection of market timing, in which a lot of people still claim it can be done – Graham rejected it, Buffett rejected it, Lynch rejected it, and many other people did.
    Overall, I do think “The Intelligent Investor” (I read the whole book) is a great introduction to investing – speculation vs investing, basic ideas of financial analysis, a broad introduction of different type of securities that are available for us to buy (it even talked about derivatives – laugh), and a whole chapter talking about why market timing does not work. Overall, it is still a highly recommended book despite its many flaws.

  2. serenitystocks says:

    Warren Buffett himself says he is 85% Benjamin Graham.

    Buffett even named his son after Graham, and describes Graham’s book The Intelligent Investor as “by far the best book about investing ever written”.

    Given below is part of the conclusion from the study “The Evolution of the Idea of Value Investing: From Benjamin Graham to Warren Buffett” by Robert F. Bierig, Duke University:

    “A [casual] observer of Buffett today would find it difficult to see the Ben Graham influence in many of his activities. However, that influence remains at the core of Buffett’s investment model. Buffett continues to think about stocks as fractional ownership interests in underlying businesses, he continues to operate under the assumption that there is a distinction between price and value, and he continues to search for the largest discrepancy between those two items. In other words, he continues to be a value investor.”

    Cigar butt stocks only refer to the simplistic NCAV or Net-Net stocks. 
    Graham’s more important stock recommendations are often ignored.

    NCAV stocks, or Net-Net stocks, are simply the most well-known of Graham’s strategies, and the source of the general misconception that Graham only recommended cheap stocks. But Graham actually recommended Index, Defensive and Enterprising stocks before NCAV stocks and all were allowed higher Quantitative valuations and required greater Qualitative checks.

    Graham did advocate paying more for Quality. His only prerequisite was that there be the Margin of Safety between price and value, whether the value be Qualitative or Quantitative.

    But most of what Graham actually taught has been forgotten today, and things he warned against are often attributed to him instead. 

    Warren Buffett once wrote an article explaining how Benjamin Graham’s principles are everlasting, their results irrefutable, and his followers consistently exceptional. It’s called “The Superinvestors of Graham-and-Doddsville”.

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