Friday, May 20, 2016

Charlie Munger, risk, and the too hard pile

From Charlie Munger: The Complete Investor:
The theory behind Munger’s very different approach to dealing with risk is worth examining in detail. As a review, risk is the possibility of suffering a loss (not price volatility). The way Berkshire deals with risk is by buying what they feel is a conservatively valued asset with no risk at a discount price. Their focus is on having protection against mistakes that they may make during that process. What they do not do is increase the interest rate used in the computation to deal with risks inherent in the business. If there are significant risks inherent in the business itself, they put the decision in the too hard pile and move on to other potential opportunities.

This also reminded me of something I mentioned in a previous post where, in an interview with my friend Miguel, Alice Schroeder mentioned this in regards to Warren Buffett’s filtering process:
Typically, and this is not well understood, his way of thinking is that there are disqualifying features to an investment. So he rifles through and as soon as you hit one of those it’s done. Doesn’t like the CEO, forget it. Too much tail risk, forget it. Low-margin business, forget it. Many people would try to see whether a balance of other factors made up for these things. He doesn’t analyze from A to Z; it’s a time-waster.