Munger on the Markets

by JT McGee

I hope everyone had a very Merry Christmas. Mine was pretty awesome. And now we have snow. So sledding it is.

Anyway, I’m taking it easy this week, but I wanted to leave one of my favorite quotes from Charlie Munger:

How do you get to be one of those who is a winner—in a relative sense—instead of a loser?

Here again, look at the pari-mutuel system. I had dinner last night by absolute accident with the president of Santa Anita. He says that there are two or three betters who have a credit arrangement with them, now that they have off-track betting, who are actually beating the house. They’re sending money out net after the full handle—a lot of it to Las Vegas, by the way—to people who are actually winning slightly, net, after paying the full handle. They’re that shrewd about something with as much unpredictability as horse racing.

And the one thing that all those winning betters in the whole history of people who’ve beaten the pari-mutuel system have is quite simple. They bet very seldom.

It’s not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it—who look and sift the world for a mispriced bet—that they can occasionally find one.

Here’s to finding mispriced bets in 2013!

{ 3 comments… read them below or add one }

Value Indexer January 1, 2013 at 18:13

Hey JT, I just rediscovered your site through a trail of links and you seem to have one of the rare approaches that actually stands a chance to beat an index fund. I don’t have time to do a lot of stock analysis at the moment but I’ll be following your site to learn more about it.

One thing I’m wondering about is the accounting standards for very small public companies. As you mentioned the notes in the financial statements can give you a more accurate result than the numbers reported. But even that depends on having realistic numbers to start with. I’m guessing they don’t have the same level of audits that IBM and Coke do, and if they’re like a few non-profits I’ve worked with they may even vote to waive audits. Have you found this to be an obstacle in doing your analysis?


JT McGee January 4, 2013 at 16:38

Hey, thanks for the kind words and comment. I think the strategy can very possibly beat an index, as it is the basis behind virtually all asset managers that beat the market in the long haul. If you haven’t read Warren Buffett’s speech about the Superinvestors of Graham and Doddsville, you definitely should.

As a public company there isn’t much you can hide. All annual reports have to be audited by law. Secondly, there is a tremendous amount of research that can be done just from the internet in identifying the company’s offices, verifying the ownership of major assets, etc. So, no, I don’t really worry about accounting fraud or manipulation of the data.

What one should do is go back in time and make sure that there is no history of aggressiveness. I hate to see inventory write downs, for example, because it tells me that management was too aggressive in the past. Stuff like that throws a flag every time. If you know accounting, you can do most of the checks necessary. Aggressive revenue recognition or aggressive asset valuation can usually be spotted pretty easily if you keep up with every detail of a company’s financial reporting and go back and read historical reports to look for changes.

So, really, it’s all about taking pickiness to a whole new level. There are a lot of companies that would probably fit my quantitative criteria that just don’t fit the qualitative because of aggressive/weird accounting, etc. And this isn’t just limited to small companies; big companies find it so much easier to goof with financial reports that it isn’t even funny. It’s easy to hide accounting trickery in a conglomerate; hard to hide it in a golf product company. Really, I’d put my bottom dollar on audited large companies being looser with their accounting than audited small companies.


Value Indexer January 8, 2013 at 00:03

I just read Buffet’s article a few days ago and found that interesting as well. With all sorts of biases (massive survivorship biases being a big part, but not the only bias) it’s hard to get real evidence that a strategy actually causes outperformance. But your writing, like Buffet’s, is going in an interesting direction 🙂

Good points about the accounting. Most people visibly lack standards no matter how many rules they obey which tells you a lot. I can imagine auditing being more straightforward for small companies but it may not always be pleasant. A friend says she once had to audit the claim that a barn had 120.5 pigs, which did turn out to be true.


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