In his talk to Cal Tech students, Charlie Munger (Trades, Portfolio) mentioned that one of his hobbies was to “collect inanities.”
It is fun to collect inanities because there’s never a shortage, and there are plenty of low-hanging fruits. This really applies to investing as well. But to me, collecting inanities is not fun enough; in order to get the most use out of those inanities, I’ve also collected the lessons from those inanities and added them to my checklist.
Let me share with you a few examples to show how helpful this exercise could be. In order to be respectful, I will not disclose the specific names of these companies or the gurus involved in them. Also I’m shameless and proud to say that one or more of the following inanities came from myself.
Example 1 is a media company, whose shares collapsed during this past year. The company’s stock didn’t appear expensive last year around this time and was growing earnings a little bit with strong cash flows. Due to both industrywide concerns and company specific issues, the share price has declined dramatically. I’ve added five items to my checklist based on my analysis of the investment, two of which are:
- Have you checked what industry concerns are overhanging and how severe they are? Are they secular or temporary?
- Is the business less diversified than other players in the industry and therefore, more vulnerable to the industry-wide concerns?
Had an investor answered the above two questions, he would have predicted the more severe decline in this company’s stock compared to its peers and required a larger margin of safety.
Another example is a leading industrial company run by a proven management team. The business has a nice track record of compounding but is subject to end market weaknesses and has a lot of emerging market exposure. The stock also plummeted this year. In the long term, this company is still very likely to compound shareholder values at a decent rate, but investors who paid a premium may have to wait a bit longer for the compound to work. Of the checklist items that I added based on the analysis of this company, one of them is:
- Is the end market in which the company sells its products or service in cyclical? If so, have the end markets started to show weaknesses and what companies in the ecosystem can you follow to gauge the industry activity level?
The last example is a mortgage servicing company. The company was blessed with an oligopoly position after the financial crisis and enjoyed high market share and nice growth. It looked like a no-brainer until the regulator got involved and almost beat the company to death. From doing scuttlebutt work, it was clear that the competitors were saying they were worried about the company’s operating model, and the employee morale was low. Lo and behold, the company’s stock skydived in a short period of time. The checklist items I added, which also apply to the for-profit educational companies, are:
- If the customers suffer, can some political figure target the company to make a name for himself/herself?
- Can the regulators put some serious constraints on the business if the political pressures dictate?
I remember last year during the Pabrai annual meeting, Mohnish Pabrai (Trades, Portfolio) said that he hasn’t made a major mistake in few years due to the application of the checklist. He even hired an intern to study the inanities of some of the best investors in the world. This is a sensible thing to do. For those of us who can’t afford to hire a Harvard intern to do the work, we can take upon the task ourselves.
I am not writing this to look smart given the benefit of hindsight. Sometimes you may have to experience horrible mistakes in order to learn something, and sometimes you can piggyback on others’ mistakes. But either way, collecting inanities and adding the lessons derived thereof is a very powerful tool to make us better investors.
