Charlie Munger — Part Four: Investment Advice

This is part four of a ten-part series on the life and career of Charlie Munger, value investor, lawyer, philanthropist, Vice-Chairman of Berkshire Hathaway Corporationand Warren Buffett’s right hand man. He is also chairman of the Daily Journal Corporation and a director of Costco Wholesale Corporation. Parts one, two and three of this series can be found at the links below.

  1. Charlie Munger — Part One: The Beginning
  2. Charlie Munger — Part Two: Quality Over Value
  3. Charlie Munger – Part Three: Sit On Your A$$

To ensure you do not miss the rest of the series sign up for our free newsletter.

Charlie Munger — Part four: Investment advice

Following on from part three of this series, which explored Charlie Munger’s ‘sit on your ass’ method of investing, in this part I’m going to take a look at some of the investment advice that Charlie Munger has dished out over the years.

Charlie Munger’s age and experience means that he has become one of the most quotable investors of all time. He says what’s on his mind, without fear of offending anyone, often making statements others would have trouble making in public.

Unfortunately, it’s not possible to cram all of Munger’s investment wisdom into one article. So with the limited space available here, I’m going to try and condense a few of Charlie’s best nuggets of advice on to this page.

The full article can be found at

Illiquid Stocks Consistently Outperform The Market

The search for value often draws investors into illiquid markets, and to some, this can be a daunting prospect. However, research suggests that illiquid stocks outperform their liquid counterparts over the long-term.


In what has been called an illiquidity-anomaly, several studies published over the past few decades have shown that the market rewards illiquid stocks, although it’s unclear exactly why. One of the earliest studies on the topic was conducted by researchers Amihud and Mendelson who used bid–ask spreads to explain stock returns between 1961 and 1980. Published in 1986, ‘Asset Pricing And The Bid-Ask Spread’ raised some interesting points.

The data showed that average portfolio risk-adjusted returns increased with wider bid-ask spreads. Moreover, the data lead to a conclusion that the spread was by no means an anomaly or an indication of market inefficiency; rather, it represented a rational response by an efficient market to the existence of the spread.

It was found that due to the existence of a wide spread, investors held the illiquid stocks for a longer period and the wider spreads actually attracted investors who were willing to invest with a longer time horizon.

In other words, wide spreads encourage responsible long-term investing, not short-term speculation. Unfortunately, while a wider spread may lead to outperformance, a company’s cost of equity capital will be higher due to the wider spread. Clearly this is not desirable from a company’s point of view.

In the latter part of the 1990’s, two more studies were published that looked at the above average returns of low turnover stocks. These studies, conducted by Haugen and Baker (1996) and Datar, Naik, and Radcliffe (1998)demonstrated that low-turnover stocks, on average, earn higher future returns than do high-turnover stocks.

Illiquidity as a strategy

During 2013, Roger G. Ibbotson, Zhiwu Chen, Daniel Y.-J. Kim, and Wendy Y. Hu released a study that went so far as to say that illiquidity should be a style of investing, like growth and value. The study, entitled Liquidity as an Investment Style argued that:

“Liquidity should be given equal standing with size, value/growth, and momentum as an investment style. As measured by stock turnover, liquidity is an economically significant indicator of long-run returns. The returns of liquidity are sufficiently different from those of the other styles that it is not merely a substitute. Finally, a stock’s liquidity is relatively stable over time, with changes in liquidity associated with changes in valuation.”

Data from the study is shown below.


For his work on the topic of liquidity, Roger Ibbotson and his co-authors received the 2013 Graham & Dodd Prize for the best article in the Financial Analysts Journal.

Ibbotson’s study focused on daily stock turnover as a measure of stock liquidity. He looked at 3,500 U.S. stocks, ranked them by their turnover and then divided them into four quartiles. The least liquid quartile showed an average return of 16.38% per annum over the study period, 1972 to 2011. The most liquid quartile showed an average annual return of 11.04%.

Unsurprisingly, many of the stocks in the most illiquid quartile were cheap, value style stocks, which goes some way to explaining their outperformance — value tends to outperform over the long-term. But Ibbotson and his team also performed the same exercise for all other recognized styles. They found that while the performance of illiquid stocks could be explained by stocks’ cheapness, there was a significant statistical outperformance by illiquid stocks across all strategies that could not be explained. Over the full 1972-2011 period, illiquid stocks fared better than small stocks and high-momentum stocks.

Further evidence

Only a year before the above study was published, Roger Ibbotson published a smaller  liquidity study in the Financial Analysts Journal, which dissected mutual funds.

This study looked at the holdings of U.S. equity mutual funds, offered for sale to U.S. residents, from February, 1995, to December, 2009. Each fund was classified according to its orientation on the value-growth spectrum and the liquidity of holdings. Liquidity was calculated by taking a stock’s average volume over the last year divided by its shares outstanding. In this study, value stocks outperformed growth by 0.80% per annum. Small-caps beat large caps by 1.89% per annum and small-cap value funds outperformed by 3.23% per annum.

The difference in performance between illiquid and liquid stocks was even wider. Value funds that held the least liquid 20% of stocks, outperformed value funds with the most liquid stocks by an average of 2.28% per annum. Illiquid growth funds also outperformed liquid growth funds by 2.25% per annum.

Funds holding the least-liquid small value stocks beat those with the most-liquid large growth stocks by 4.99% on average each year.


So, there is a certain amount of evidence that points to the fact that illiquid stocks outperform the market over the long-term.  There’s also evidence to suggest that illiquid stocks are less likely to suffer dramatic drawdowns during periods of heavy selling, as the FT explores:

“As illiquid stocks should be harder and more expensive to trade, it becomes harder for share prices to readjust smoothly, creating volatility. But in practice, the experience of the 2008 crisis was exactly the opposite. Daniel Kim, one of the co-authors and research director for Zebra Capital Management in Connecticut, reports that illiquid stocks suffered far lower drawdowns during the most dramatic days of heavy selling. That was because, in an emergency, people sold whatever they could, so liquid stocks were sold first.”

Joel Greenblatt’s Original Magic Formula

Most investors are familiar with Joel Greenblatt’s Magic Formula, made famous in his book, “The Little Book That Beats the Market”.

The key drivers of the Magic Formula we know today are Earnings Yield (EBIT / Enterprise Value) and Return on Capital (EBIT / (Net Fixed Assets + Working Capital)). Companies are ranked according to these two metrics — highest earnings yield and highest return on capital — then the 20 to 30 companies with the highest ranks are purchased at a rate of two to three positions per month over a 12-month period.

However, before Greenblatt came up with this quality-and-value screen, he built a strategy around Benjamin Graham’s net-nets strategy, which relatively unheard of and has since become known as Greenblatt’s Original Magic Formula.

Greenblatt’s original Magic Formula

Greenblatt developed his Original Magic Formula with Richard Pzena, who currently manages Pzena Investment Management LLC, a value oriented global investment management firm with $28 billion in assets under management, and Bruce L. Newberg. The three money managers published their findings within the The Journal of Portfolio Management Summer issue 1981, Vol. 7, No.4, in an article entitled, “How the Small Investor Can Beat the Market: By Buying Stocks That Are Selling Below Their Liquidation Value

Greenblatt and his co-authors argued within the article that only way the small investor can beat the market, is by looking for undervalued stocks. To do this successfully, the investor has to look outside the realm of Wall Street’s analyst coverage:

“We should recall, however, that Wall Street research houses limit their coverage to fewer than 500 actively traded issues…Meanwhile the NYSE trades 2000 stocks, Amex trades 1000 companies, and the OTC market trades another 7000 issues…Under these circumstances, the individual may in fact be able to locate unrecognised values in the nearly 9000-stock second tier not closely followed by the “experts”.

The figures are different today, but the underlying argument remains the same. Greenblatt built up his deep value strategy from there:

“In an effort to discover whether inefficiently priced, undervalued securities do exist, we turned to the acknowledged father of security analysis, the late Benjamin Graham…decided to update Graham’s studies to see if his simple fundamental approach still provided the returns that could not be explained by an efficient market.”

To start, Greenblatt used Graham’s traditional net-nets formula to screen for bargains:

Current Assets – Current Liabilities – Long Term Liabilities – Preferred Stock / Number of Shares Outstanding = NCAV Per Share

After using this formula to build a rough list of qualifying NCAV stocks, Greenblatt went further, in an attempt to remove any ‘junk’ firms from the list — something that’s been a thorn in the side of the deep value investors ever since the strategy was first conceived. To try and remove the wheat from the chaff as it were, Greenblatt enlisted the help of the P/E ratio.

Separating out the chaff

Benjamin Graham’s last will was a set of ten rules used for stock selection based on Graham/s five decades of stock market experience. The list of ten points, published around the time of Graham’s death, will be familiar to most value investors:

  1. An earnings-to-price yield at least twice the AAA bond rate
  2. P/E ratio less than 40% of the highest P/E ratio the stock had over the past 5 years
  3. Dividend yield of at least 2/3 the AAA bond yield
  4. Stock price below 2/3 of tangible book value per share
  5. Stock price below 2/3 of Net Current Asset Value
  6. Total debt less than book value
  7. Current ratio greater than 2
  8. Total debt less than 2 times Net Current Asset Value
  9. Earnings growth of prior 10 years at least at a 7% annual compound rate
  10. Stability of growth of earnings in that no more than 2 declines of 5% or more in year-end earnings in the prior ten years are permissible.

There’s no denying that this list of rules is extremely onerous and in most markets the number of stocks that meet all ten criteria is likely to be minimal. (Société Générale publishes a monthly stock screen based on the Graham criteria — the April update can be found here — the bank’s analysts note that in the past two decades, only three companies have passed all ten criteria out of a universe of FTSE World Developed, FTSE 350 stocks and FTSE World Emerging stocks.)

When Joel Greenblatt set out to create his new NCAV strategy he clearly wanted it to be less restrictive than Graham’s criteria. However, Greenblatt also wanted his new deep value strategy to outperform, with less risk than the wider market.

To accomplish these goals, Graham’s list and put together and added the P/E ratio to his NCAV screening criteria. Greenblatt tested four different four portfolios, each with a different P/E screening criteria.

Portfolio one

  • Price below NCAV
  • P/E floating with corporate bond yields
  • No dividends required

Portfolio two

  • Price below 85% of NCAV
  • P/E floating with corporate bond yields
  • No dividends required

Portfolio three

  • Price below NCAV
  • P/E of less than 5
  • No dividends require

Portfolio four

  • Price below 85% of NCAV
  • P/E of less than 5
  • No dividends required

Stocks with a market cap of less than $3 million were discarded from the study. Stocks were sold after a 100% gain or two years had passed, whichever resulted first. The portfolios themselves were equally weighted, so the actual yearly returns of each portfolio were just the average returns of the stocks within each portfolio. The returns of the four portfolios were compared to the Value Line’s own value index.

Greenblatt orignal

The results show that portfolios three and four, which demanded qualifying stocks trade at a P/E of less than five, racked up the best performances of the group.

The average performance of portfolio three was 32.2% p.a. per annum excluding tax and commissions — the high portfolio turnover meant that returns were impacted significantly when including commissions (12.1% p.a. after including taxes and commissions).

Portfolio four returned 42.2% p.a., although this dropped to 29.2% p.a. after excluding taxes and commissions. Interestingly, these two portfolios performed better than Greenblatt’s second Magic Formula, which boasts of 30% p.a. returns.

Finding Value With The Piotroski F-Score Part 4

Unfortunately, over the past month the F-Score portfolio performance has only deteriorated.

A dividend of $0.375 per Noble Corp share was paid to investors on February 6. The dividend totaled $18. There have been no other dividends paid since. Including this contribution, the portfolio’s year to date decline has now increased to 26.67%, from -21.6% as reported at the beginning of February. Month-on-month the portfolio has declined 6.40%. The S&P 500 lost 1.74% over the same period. The F-Score portfolio has underperformed the S&P 500 by 26.23% year to date.

Vantage Drilling and Nuverra Environmental continued to push the overall portfolio lower, declining by around 600bps and 700bps respectively during the period. Willis Lease Finance lost 1231bps during the period, which was by far the worst performance. Speedway Motorsports, OM Group and Ducommun led the pack for the fourth month in a row as a lack of exposure to the oil industry allowed the three companies to benefit from wider equity market strength.

Leading the pack, Ducommun Inc gained 312bps during the period continuing its positive performance for the year.

I’m tempted here to provide some commentary on how the companies have performed and why they have performed as such but that’s not the point. The Piotroski F-Score is designed to be used with financials only and no fundamental analysis…

Read the rest of the article here at

Is It Wise To Go Hunting For Value In South Africa?

In the past decade, the world has changed dramatically for value investors. The rise of the online discount broker and availability of information online has revolutionized the investment landscape for every type of investor. It’s now just as easy to put money to work in Australia as it is in the United States.

So, in this series I’m looking at several different developed, emerging and frontier markets, highlighting their potential risks and rewards for value investors. You can find part one of the series, Is It Wise To Go Hunting For Value In Brazil? Here.

Value investing in South Africa

Africa is often touted as the world’s next high-growth region, following in the footsteps of Asia and South America. And there’s no denying that the region has potential. The continent is home to a third of the planet’s mineral reserves, a tenth of the oil, and it produces two-thirds of the diamonds.

While the continent has been held back by corruption and protectionist economic policies, over the past decade Africa has clocked up an average annual economic growth rate of 5%. Government policies to reform markets and overseas investment have been key growth drivers, but many of the region’s markets remain inaccessible to international investors.

For example, there are 29 stock exchanges in Africa, representing 38 nations. Of these, only 24 exchanges are represented by The African Securities Exchanges Association and only 16 of these exchanges have more than ten securities listed. The region’s three biggest markets are South Africa, Nigeria, and Egypt. Of these three, South Africa is the only market which offers exposure to the whole of Africa, while offering the kind of top ranked audit and accounting standards, a sound banking system, and well-regulated stock exchange that developed market investors have come to expect.

Read the rest of the article here…

FFP S.A. One Of Europe’s Remaining Bargains?

FFP: Diversified portfolio

FFP is not a one trick pony. As well as Peugeot FFP owns E1.4bn in other publicly traded and non-public entities. Additionally, the group owns an interest in private equity funds, amounting to E207m and E52m of real estate. A snapshot of the group’s holdings as of year-end 2014 can be seen below.


At the time of writing, FFP was trading at E68.50 per share, and as shown in the table above, is trading at a discount to its net asset value of around 28%. However, an up to date sum of the parts calculation implies that FFP’s NAV has jumped by more than 20% over the past three months.

For example, Peugeot’s market value alone has risen by 51% year to date. FFP’s second largest holding, Zodiac Aerospace has seen its value jump by 11.7% year to date. The table below shows the gains for the publicly traded securities held within FFP’s portfolio.

Holding YTD Change
Peugeot 51.5%
Lisi 23.3%
IDI SCA 12.2%
Zodiac Aerospace 11.7%
Orpea 15.7%
LT Participations 7.1%
DKSH 4.7%
Immobiliere Dassault 26.9%

*Lt Participations SA is a holding company operating through its subsidiary Ipsos SA

*Compagnie Industrielle de Delle (CID) is the main shareholder of the Lisi Group

Other assets owned by the group include the sole asset of SCI FFP-Les Grésillons, a building in Charenton-le-Pont, which was worth €17m at 31/12/2010. FFP also owns Château Guiraud a Sauternes wine estate that covers some 128 acres, almost 103 of which are vineyard. The average yearly output is 150,000 bottles of Sauternes. FFP owned 11,790,221 call options on the same number of Peugeot SA shares until 20 February this year.

FFP: Simple is best

The best investment thesis’ are simple, and it doesn’t take long to realize that FFP is an undervalued asset, especially consider the equity market gains in Europe over the past three months. FFP’s shares have themselves jumped 37% year to date but based on NAV figures; this still undervalues the equity.

ffp updated nav

NAV per share figures based on 25.1m shares in issue.

I should make it clear that this is only a back-of-the-envelope calculation and should not be used as investment advice. It is only intended to illustrate how undervalued the equity of FFP really is, based on the current value of listed holdings.

View the full article at

Societe Generale Developed And Emerging Market Deep Value Screen

Société Générale publishes a monthly update on the performance of several value orientated fundamental trading strategies across both developed and emerging markets. For deep value investors, one of the most interesting screens is the Graham & Rea deep value screen.

The screen is a strategy developed by Benjamin Graham and James Rea. It uses a set of ten basic investment criteria used to identify deep-value opportunities. These criteria are also known as Graham’s last will, and the Benjamin Graham deep value checklist.

Deep value in developed markets

For developed market equities, Société Générale’s deep value screen covers the universe of FTSE World Developed and FTSE 350 stocks. The screen shows companies that score 2.5 or better on Graham & Rea value and risk criteria. Financial stocks are excluded.

And the screen’s returns are highly impressive. Since 2002, the stocks qualifying for the screen have returned 17% per annum, outperforming the wider universe of FTSE World Developed and FTSE 350 stocks by 6.1%.

Performance is shown on US$ gross total return basis and assumes monthly rebalancing. Here’s the list of developed market stocks that currently meet the Graham & Rea screening criteria.

SG G&R DM Societe Generale Deep Value Screen


View the full article at