Charlie Munger on Why Great Businesses Beat Bargain Businesses

In 1994, celebrated investor and Berkshire Hathaway Vice Chairman Charlie Munger delivered his famous speech The Art of Stock Picking as a Subdivision of the Art of Worldly Wisdom at the University of Southern California's Marshall School of Business. This commencement address is widely remembered for its lessons on mental models, psychology, probability, and rational decision-making.

The speech also contains valuable insights around business economics and how to identify good businesses worth investing in. Last week, we looked at the benefits and disadvantages of scale. Here we discuss Munger’s approach to value investing and why it makes sense to choose quality businesses over ones that come at a bargain.

The foundation: Benjamin Graham

Like many investors of his generation, Munger began his career following the teachings of Benjamin Graham, known as the father of value investing. Graham's philosophy revolved around investing in companies trading below their intrinsic value and creating a margin of safety. The strategy worked well in an era when markets weren’t as sophisticated and there were several neglected bargains. Munger himself started out as a devoted Graham disciple, hunting for statistically “cheap” companies.

The limitations of investing in a business at a bargain

Over time, though, he realised the pitfalls: a business with weak fundamentals and economics remained a weak business, however cheaply it may have been purchased.  Over the long run, a stock's returns tend to mirror the returns generated by the underlying business. Buying a mediocre company at a bargain price might offer a temporary gain, but it rarely produces long-term wealth.

Great businesses and the power of compounding

So Munger shifted his focus from hunting for value buys to investing in exceptional companies that were capable of compounding value over decades. These businesses shared common traits: durable competitive advantages, strong brands, pricing power, high returns on capital, and limited capital requirements. They managed to generate profits that could compound year after year.

Time is the true test — a company earning high returns on capital for decades can create enormous shareholder wealth. So the secret sauce is not in finding a one-time bargain, but in owning a business whose economics allow it to keep compounding long after the initial investment. This shift in thinking transformed Berkshire Hathaway. While its early success came from Graham-style "cigar butt" investing, much of its later wealth was built through investments in outstanding businesses such as See's Candies and Coca-Cola.

The enduring lesson…

Munger didn’t reject Graham’s idea of value investing outright, rather, he improved upon it and expanded it to fit modern markets. He believed that great businesses create wealth not because they are bought at a bargain price point, but because they continue to earn great returns for years, creating long-term wealth.