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Conviction and Approach to investing | Learning from Buffett and Munger’s Checklist

with 13 comments

How important is conviction in investing?

You didn’t have to have a high IQ or a lot of investment smarts to buy junk bonds in 2002, or certain other things after Long-Term Capital Management blew up. You just had to have the courage of your convictions and the willingness to act when everyone else was terrified and paralyzed. The lesson of following logic rather than emotion is obvious, but some people can follow it and some can’t.
[CM: When we were young, there weren’t very many smart people in the investment world. You should have seen the people in the bank trust departments. Now, there are armies of smart people at private investment funds, etc. If there were a crisis now, there would be a lot more people with a lot of money ready to take advantage.]
But in 2002, there were all these people with lots of money [and the opportunities were still there].
[CM: When you have a huge convulsion, like a fire in this auditorium right now, you do get a lot of weird behavior. If you can be wise [during such times, you’ll profit].]
Three years ago, you could find a number of companies in [South] Korea with strong balance sheets trading at three times earnings.
[CM: But there was a huge convulsion there.] Buffett: But that was 4-5 years ago. It had already passed.
[CM: You couldn’t name 20 more examples like it. [e.g., there are only a few examples in recent times of such weird behavior leading to huge, obvious bargains in entire asset classes.]]
Even if I could, I wouldn’t! [Laughter]

  • Source: BRK Annual Meeting 2006 Tilson Notes
  • Time: 2006

    How do you avoid misjudgement?

    WB said repeatedly that it doesn’t take above a 125 IQ to do this…in fact, IQ over this amount is pretty much wasted. It’s not really about IQ. – Staying within circle of competence is paramount – When you are within the circle, keep these things in mind:

    • Don’t get in a hurry
    • You are better off not talking to others
    • Just keep looking until you find something (don’t give up)
    • Good ideas come in clumps – by time, by sector, by asset class
    • Source: Buffett Vanderbilt Notes
    • Time: Jan 2005

    CM – Charlier Munger  

    WB – Warren Buffett
    Charlie Munger’s checklist from Poor Charlie’s Almanack
    Risk

    – All investment evaluations should begin by measuring risk, especially reputational
     –  Incorporate an appropriate margin of safety
     –  Avoid dealing with people of questionable character
     –  Insist upon proper compensation for risk assumed
     –  Always beware of inflation and interest rate exposures
     –  Avoid big mistakes; shun permanent capital loss
    Independence

    – “Only in fairy tales are emperors told they are naked”
     –  Objectivity and rationality require independence of thought
     –  Remember that just because other people agree or disagree with you doesn’t make you right or wrong – the only thing that matters is the correctness of your analysis and judgment
     –  Mimicking the herd invites regression to the mean (merely average performance)

    Preparation

     – “The only way to win is to work, work, work, work, and hope to have a few insights”
     –  Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day
     –  More important than the will to win is the will to prepare
     –  Develop fluency in mental models from the major academic disciplines
     –  If you want to get smart, the question you have to keep asking is “why, why, why?”

    Intellectual humility

    – Acknowledging what you don’t know is the dawning of wisdom
     –  Stay within a well-defined circle of competence
     –  Identify and reconcile disconfirming evidence
     –  Resist the craving for false precision, false certainties, etc.
     –  Above all, never fool yourself, and remember that you are the easiest person to fool
    “Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things.”

    Analytic rigor

     – Use of the scientific method and effective checklists minimizes errors and omissions
     –  Determine value apart from price; progress apart from activity; wealth apart from size
     –  It is better to remember the obvious than to grasp the esoteric
     –  Be a business analyst, not a market, macroeconomic, or security analyst
     –  Consider totality of risk and effect; look always at potential second order and higher level impacts
     –  Think forwards and backwards – Invert, always invert

    Allocation

     – Proper allocation of capital is an investor’s number one job
     –  Remember that highest and best use is always measured by the next best use (opportunity cost)
     –  Good ideas are rare – when the odds are greatly in your favor, bet (allocate) heavily
     –  Don’t “fall in love” with an investment – be situation-dependent and opportunity-driven

    Patience

     – Resist the natural human bias to act
     –  “Compound interest is the eighth wonder of the world” (Einstein); never interrupt it unnecessarily
     –  Avoid unnecessary transactional taxes and frictional costs; never take action for its own sake
     –  Be alert for the arrival of luck
     –  Enjoy the process along with the proceeds, because the process is where you live

    Decisiveness

     – When proper circumstances present themselves, act with decisiveness and conviction
     –  Be fearful when others are greedy, and greedy when others are fearful
     –  Opportunity doesn’t come often, so seize it when it comes
     –  Opportunity meeting the prepared mind; that’s the game

    Change

     – Live with change and accept unremovable complexity
     –  Recognize and adapt to the true nature of the world around you; don’t expect it to adapt to you
     –  Continually challenge and willingly amend your “best-loved ideas”
     –  Recognize reality even when you don’t like it – especially when you don’t like it

    Focus

     – Keep things simple and remember what you set out to do
     –  Remember that reputation and integrity are your most valuable assets – and can be lost in a heartbeat
     –  Guard against the effects of hubris (arrogance) and boredom
     –  Don’t overlook the obvious by drowning in minutiae (the small details)
     –  Be careful to exclude unneeded information or slop: “A small leak can sink a great ship”
     –  Face your big troubles; don’t sweep them under the rug

    ——————————————————————————————————–
    What I takeaway:
    Think independently
    No substitute for hard work
    Moderate IQ is good enough to be materially richest person in World
    Compare your new stock idea with top 5-7 ideas (opportunity cost). Stay within your top 10 ideas forver. Ensure that upside is three to four times more than downside for next 1-2 years. Can your new stock beat 30% compounding of TTK Prestige over next five years ? If investing for a decade, can you stock beat 20%+ compounding of Asian Paints ?
    Bet hard in no brainers (20% of your portfolio atleast).

    Buffett’s best quote for me is something on lines of, “It makes sense to invest only when a stock screams in undervaluation at you”. It kind of jumps out from the screen and slaps you to wake up from stupor. The moment you have to open excel spreadsheet or calculator, its not a cinch.

    Written by amitdipsite

    November 7, 2010 at 12:38 am

    Posted in Uncategorized

    13 Responses

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    1. Amit – Are you still holding Relaxo ? what's your take on Q2 results and long term story for Relaxo, they are not good? seems to be well priced at 400+.

      rajesh

      November 7, 2010 at 2:42 am

    2. Still holding Relaxo, though not in my personal account. Long term story fully intact, its time to keep accumulating. Should reward you 30% plus compounded for every year held.

      Multibagger

      November 7, 2010 at 4:51 am

    3. @doctorgeeta: I respect all individuals and their views/perspective. However let me tell you somewhere I read “To know what people really think, pay regard to what they do, rather than what they say.”..
      Now you see here, Amit has not only did extensive research to find out a great story, he actually shared with us that can create huge wealth for common man like me and other. How many people you find of this type in world now? How many people share their knowledge? I found so religious type of people, treating human like things. They use human for their goal and then throw them away once it is fulfilled.
      For me if somebody loves Human, shares knowledge unbiased way, live life in his own authentic way is a true Humanaire™. He is the most religious person.

      Rahul Kumar Paliwal

      November 9, 2010 at 4:44 am

    4. @Rahul,

      All the knowledge is borrowed from others and written here, very very small portion if at all could be my own, the whole framework is from other investors by books.

      A wise man said, read one hour, think over it two hours and meditate all the time.

      I am probably in a phase in life where I have gone hyper on stocks/investments and hence lose temper.. a quotation I recall “Hatred is too strong an emotion to be used over someone you don't like”. Clearly we can't change the world, city, all organisations or whole of our neighbourhood, so one has to be selective in making friends so that we have good experiences. Another one by wise man, “Loneliness is the price to be paid for greatness”.

      While I completely enjoy the process of investing, I believe after few years I'll move onto another work on another theme which at present I do not consider myself qualified enough to write on. There is story of a not so well off person, approached by his materially well off neighbour and said, “Why don't you work harder and try to earn more money like me ?” to which this average person replied, “If I keep working like you, where will be the time for me to sing music ?”

      Most people spend all their life in chasing material wealth, when its a part of life and not heart of life.
      A wise man said, “the art of creating wealth (material, societal, relationships etc.) is the second greatest art after the art of knowing God”.

      Most people don't know what is the difference between human body and animal body, why is it special ? It looks physically same, and what is full potential of a human being. What is mind, memory, magic of life, being sentient beings. Something I am not qualified to speak more on yet. I cannot expect everyone to think and aspire for same ideas either which is perfectly fine.

      Regards

      Multibagger

      November 9, 2010 at 11:39 pm

    5. Discussion on Moneycontrol

      pankaj kunwar

      I really love your blog and your indeptth research on photoquip. However I feel that the business in India may not be much scalable because of the limited awareness about photography even in cities . The use may be focussed in big cities only like Delhi and Bombay . Whereas TTK prestige , Hawkins or Titan directly target the essentialities of great Indian middle class . I tried to find out number of photography institute in India . At least that can give us an idea of the no. Of upcoming photographers . I tend to disagree on your estimated ratio of 1 in 5000 for India .

      Price when posted : BSE: Rs 48.50 ( -1.02 % )
      ————————————————-

      Hey Pankaj,

      I have had those same doubts about demand and growth but in India this business has grown 51% last year from 8.7 crores revenues to 13 crore revenues in domestic Indian market. That also surprised me. And on Global level Elinchrom CEO is saying “We have had the biggest backlog of orders last month compared to anytime in our history of 50 years”, it takes out lots of doubts…the traction is because they have introduced gear for intermetial and entry level segment.

      Rotalux is powerful brand for softboxes and is not changeable with technology and as stable as underwear market. Will likely to be around another 50+ years. While the market size may not grow, smart players sieze share from other players.

      Another news for me last week was that softboxes and studio flash/lights are used also for film/video shooting in studios not just still photography !

      Here is some list of institutes

      indicareer(dot)com/Photography/India-Career-Photography.html

      You have to factor this in: More and more people are getting DSLR cameras and want to venture into photography part time too, with more cheap DSLRs someday they may be available for 100$ per camera, so equipment market will rise.

      All in all limited downside but good probabilty of upside.

      Multibagger

      November 10, 2010 at 12:45 am

    6. @Amit,
      Hi Amit,

      I do not know how to start because I felt a complete silence after reading your words of wisdom conversed to me. I was only smiling because of 2 reasons:
      1) I found a true Humanaire™, I am that much excited as you were after finding Photoquip. For me both are rare events.

      2) When I was reading that conversation, I was filling like I am reading myself, I am talking to my soul. This is exact what you know I ….. And yes financial freedom is what is my last desire, so I can start to work upon, EOD what actually matters, as you quoted correctly “When I will sing?”.

      And truly and frankly I was expecting that conversation because a person who knows something from deep of the heart, can only say “what ever little I know”. Because in this world nothing in original, this is what my friend says (http://bit.ly/dlL6Mc). All knowledge comes from origin.

      And yes we are becoming such a materialistic that, that very basic juice of life or that Art, we lost. You quoted beautifully:
      “The art of creating wealth (material, societal, relationships etc.) is the second greatest art after the art of knowing God”.
      The day People will run behind this art, This Earth will blossomed.

      Regards to you as well.
      Rahul

      Rahul Kumar Paliwal

      November 11, 2010 at 8:07 pm

    7. Dear Rahul,

      You are a Humanaire for having invented the term for sure !

      Thats quite right. Nothing is original except from silence of self. Quite paradoxical but true. The more time one spends alone, the wiser one becomes.

      If we compare earth's status in not Milky way galaxy but observable universe (in 1930s scientists thought that there are only 3 – 4 galaxies). We have about 100 billion galaxies, each having 100 billion stars, Sun is an ordinary sized star with 9 big rocks rotating around it. Earth being one of rocks, is insignificant.

      As of today we don't know whethere that are 100 billion parallel Universes too…Physics today believes in only 1 universe and possibility of others. Imagine viewing earth form some other Universe or one of 100 billion galaxies each having 1000s of crores of stars, its insignificant. If size of India is like Milky Way galaxy, then earth is like a small speck of one of thousands floating dust/ pollen grain particle that you see in sunlight.

      All wealth of past and present Fortune/Forbes Billionaires is on that particle. Very much like in Movie “Horton Hears A Who”… all universe is inside a flower. So wealth is only in relative sense because we are so small. A wise man said, “If you get an idea of how much territory you cover, then you will immediately leave everyone and everything”.

      Regards

      Multibagger

      November 11, 2010 at 11:09 pm

    8. Dear Amit,

      ****An Alchemist*******

      Its very rare to find out somebody whose frequency matches to you. The whole description about the reality that how small are we, or let me question if we can be measured by any way, compared to this infinite existence, you put it very well. This is what I used to think from my very childhood. We belongs to a small village and like all other villager we used to rest in night at top of house (No electricity that time, now too only for 4-5 hours). So the moment we laid down to bed, the whole universe used to become a window to unknown. I used to watch stars hours and hours until I went to deep sleep, and that really used to give me thoughtless and timeless experiences. This entire conversation with existence, with stars used to fill me with a deep calm silence. And when we get into sleep with that calmness and peace we wakeup in the morning with that. One become reach by everyday. And thats why one still can see a deep satisfaction and cunning-less smile at poorer villager. They have entire existence with them, leave aside your printed papers. You truly said “Entire wealth on that small dust particle…..”

      Now I really miss that life and want to go back thats why I talked about Financial Freedom. And I want my child to have the same treasure of peace, calmness which, now a days missed from Urban life/culture. However Thats does not mean I will not assist them to get educate them for Modern stuffs.

      I also respect you to give the hint by putting your idea about “Conviction”. You know this word is buzzing to me since last 2-3 months. Many time in life we loose opportunities because of lack of “Conviction”. We used find good opportunity, good business, excellent management, nice ROE/ROCE stuffs, huge potential …everything which we can collect from outside world, but…but it is “Conviction” where we misses the bus and this looses a life turning event.

      I agree with you, and thankful to you for giving a hint about that. First you got an idea, you did research, taken other's perceptive, verified management, checked potential and decided upon what Warren Buffet told about “stock screams in undervaluation at you” and the last thing left is “Conviction”, so then you spoke about that.

      Beautiful!! Amit.!!Beautiful!!
      You know mental models, you know where a retails investor lacks. And most important you invested your time to bring it to us with 2 legends with wisdom, Warren buffer and the great Charlie Munger (seeking wisdom).
      I loved it, Amit. Thanks a billion.

      Warren Buffet said once “With each investment you make, you should have the courage and the conviction to place at least 10 percent of your net worth in that stock.”

      When I talk about getting hints here, if anybody can recall “The Alchemist”, Coelho talks about “signs and omens” and I am also able to read lots of Omens from you and your articles. One is about “Conviction” I talked about, other I can derive from your “About me”:–“I wanted to know about God and about wealth, schools don't equip you with either. Blind are leading the blind. “
      Even I started to speak about the that in my blog, will soon try to put it clearly.

      Thanks again, Amit. Thanks for being An Alchemist for us. And you are “An Alchemist.”.

      Rahul Kumar Paliwal

      November 13, 2010 at 8:26 am

    9. Dear Rahul,

      I am over whelmed. I am at loss of words and not deserving of so much praise. I redirect the credit to those who are actually the original contributors to the knowledge. I have merely summarized their succinctly.

      Simple living, high thinking with all awareness of world in upbringing as you have suggested is key to happiness.

      We all have our strengths and can learn from each other, no person has all qualities. I read your blog once, liked it and will try to read your blog.

      Thanks to you for your love and affection. I am sure we will all become financially independent, or close over the next decade. 30% compounding for 10 years becomes 14 times the principal amount. And if we put in additional money every year then even more.

      I would highly recommend to keep good quality of shares in portfolio, no cement, steel, cyclical commodities at this stage.

      I actually lost quite a bit (all invested in shares) of money in 2007 after some Banks in UK were nationalised and started fresh in 2008 with savings from salary.

      I read and loved Alchemist, good one by Coelho.

      Best regards

      Amit

      Multibagger

      November 13, 2010 at 10:06 am

    10. Dear Amit,

      Sure, will try to keep with your advice on portfolio. May be I would share few details so in leisure time you can put some comment on that.

      It was really sad to hear about “Losses in 2007”. Would like to hear it in details some time to learn from that.

      Yes, Compounding is the 8th miracle of this world.

      Please keep sharing your thoughts and learnings.

      Regards
      Rahul

      Rahul Kumar Paliwal

      November 13, 2010 at 11:49 am

    11. Thank you Amit, for this wonderful post. I keep reading through your blog for some nuggets and i always find some🙂

      sanjay

      October 17, 2012 at 3:31 am


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