"You're looking for a mispriced gamble. That's what investing is. And you have to know enough to know whether the gamble is mispriced. That's value investing." -- Charlie Munger (Trades, Portfolio)
Trying to pick out just one piece of advice from Charlie Munger (Trades, Portfolio) that has more meaning than anything else is impossible.
Over the years, he has issued tons of good advice through lectures, speeches and interviews.
If I had to pick just one with regards to value investing, however, and indeed investing in general, I think the quote above would have to be one of my favorites.
There is much more to this quote than first meets the eye. Munger defines investing as a "mispriced gamble," but it is unlikely that he means investing is gambling directly. Instead, it appears that he is referring to the probabilities every investor has to weigh up before taking a position in any business.
Understanding the probabilities
Being a successful gambler requires an understanding of the probabilities of success and holding on until the right opportunity appears. When the opportunity does arise, it is best to act quickly and with conviction to take advantage of the situation.
The most important part of this process is understanding when the right opportunity appears.
This is why you have to "know enough to know whether the gamble is mispriced." For example, a professional poker player will know precisely when the odds are stacked in their favor based on an analysis of the other players, their own cards and the cards on the table.
The amateur player, on the other hand, might know the basic rules for the game, but won't understand the probabilities and skill involved.
The same is true of investing. An amateur investor might be able to spot a stock that looks undervalued, but understanding why this stock is undervalued and the potential catalysts that could unlock value requires much more experience.
Just buying stocks because they look cheap is the same as playing a hand in poker just because you think you have a good hand. You might win, but the chances of success are unknown. How do you know if it is worth taking a gamble if you do not understand the odds of success?
I believe this is the main takeaway from Munger's comment. He seems to be suggesting that every investor needs to devote the majority of their time to understanding companies, industries and sectors.
Learning how businesses work, how the market works and what to look for in successful companies is essential if you want to understand whether or not a potential investment is undervalued.
Only then can you make an informed decision about whether or not a gamble is mispriced.
Take your time
This is not something you can learn overnight. It takes years of research and practice.
The great thing about investing, however, is that you never have to take a position. You can sit for days, months or years before you have to make a trade. It pays to wait for the right opportunity to come around. Just like a professional poker player, the best investors know when to stay out of the market and when to go all in. As Munger once said:
"If you took our top 15 decisions out, we'd have a pretty average record. It wasn't hyperactivity, but a hell of a lot of patience. You stuck to your principles and when opportunities came along, you pounced on them with vigor."
So, if there is one piece of advice from Munger that I believe is more informative than anything else, this is it. The quote teaches you how to be a good investor without making the subject too overwhelming.
Read more here:
- Passive vs. Active Investing: Do You Have the Time?
- What We Can Learn From Warren Buffett's Kraft Heinz Investment
- John Malone Splashes Out on Discovery Stock
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