For the past 10 years, the portfolio Charlie Munger (Trades, Portfolio) manages at the Daily Journal (DJCO, Financial) has not changed at all. The company only owns four stocks, which it bought in the depth of the financial crisis at bargain basement prices. They are Wells Fargo (WFC, Financial) (54% of the portfolio), Bank of America (BAC, Financial) (41%), U.S. Bancorp (USB, Financial) (5%) and Posco (PKX, Financial) (0.4%).
In the years leading up to 2008, Munger sat on his hands. At that time, the Daily Journal was a highly cash-generative business, generating an average return on equity of 25% to 30% per annum with a 70% cash conversion rate. Rather than investing the building funds into acquisitions or stocks, Munger decided to invest the money in treasuries, preferring to receive a relatively low return from a risk-free asset.
In 2009, he was offered the opportunity he had been waiting for. In the years after, it was revealed he deployed $15.5 million of the Daily Journal's capital right at the peak of the financial crisis.
Several years later, when asked why he decided to dive into the market at a time when everyone else thought the financial system was teetering on the brink, he responded:
"We bought Wells Fargo & Co. stock when it was at $8, and I don’t think we will have another opportunity like that."
This is probably the most excellent example there is of waiting for the perfect opportunity and acting with conviction when it presented itself. As Munger explained in his 1995 lecture to the students of Professor Guilford Babcock at the University of Southern California Marshall School of Business, "If you don't load up on great opportunities, then you are making a big mistake."
But how do you know when you've got a great opportunity in front of you? In his lecture, Munger said it is best to focus on high-quality businesses:
"We've really made the money out of high quality businesses. In some cases, we boughtthe whole business. And in some cases, we just bought a big block of stock. But when youanalyze what happened, the big money's been made in the high quality businesses. And most of the other people who've made a lot of money have done so in high quality businesses."
He went on to say that if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive price, "you'll end up with one hell of a result."
These businesses are difficult to find, but not impossible. There are two methods for finding companies that fall into this bucket: the "finding 'em small method," which involves buying companies before they get big, and betting on the managers to succeed. This approach is not easy, so Munger recommends the second method for most investors:
"These people do come along - and in many cases, they're not all that hard to identify. If they've got a reasonable hand - with the fanaticism and intelligence and so on that these people generally bring to the party - then management can matter much.
However, averaged out, betting on the quality of a business is better than betting on the quality of management. In other words, if you have to choose one, bet on the business momentum, not the brilliance of the manager."
Of course, if you find a business that has both of these qualities, a skilled management team and high return on capital, then it pays to back the truck up when the opportunity presents itself:
"So you do get an occasional opportunity to get into a wonderful business that's being run by a wonderful manager. And, of course, that's hog heaven day. If you don't load up when you get those opportunities, it's a big mistake."
Disclosure: The author owns no stocks mentioned.Ă‚
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