Billionaire Charlie Munger of Berkshire Hathaway (BRK.A)(BRK.B) and the Daily Journal (DJCO) is considered by many to be one of the best investors of all time. As a result, when he speaks, investors listen. The Wall Street Journal recently interviewed him and – as usual – his responses were worth listening to. In particular, he shared the following quote which stuck out to me:
I think that the modern investor, to get ahead, almost has to get in a few stocks that are way above average…. They try and have a few Apples or Googles or so on, just to keep up, because they know that a significant percentage of all the gains that come to all the common stockholders combined is going to come from a few of these super competitors.
In this article, I will discuss in greater depth what he means, compare this approach to that of another highly regarded stock picker, and share my approach to stock picking in the current environment as well.
Charlie Munger’s Advice For The Modern Investor
In addition to his comments to the Wall Street Journal, Mr. Munger also recently stated on a podcast interview something similar, but with a bit more elaboration:
Everybody needs some significant participation in the 12 companies that do better than everybody else and you need two or three of them at least, and if you have that mindset, Apple is a logical candidate to be on the list
Based on Mr. Munger’s advice, the modern stock picker who wants to get ahead should build core positions in at least a few of the mega-cap stocks that dominate the top holdings list of the S&P 500 (SPY)(VOO) and Nasdaq (QQQ). Essentially, this boils down to the magnificent seven, plus Berkshire Hathaway (though Berkshire is already somewhat correlated to AAPL given its massive stake in the company).
- Apple (AAPL)
- Microsoft (MSFT)
- Amazon.com (AMZN)
- NVIDIA (NVDA)
- Alphabet (GOOG)(GOOGL)
- Meta Platforms (META)
- Berkshire Hathaway
- Tesla (TSLA)
Essentially, his logic is that these massive companies have such immense market caps and command such prominent positions in the leading index funds, that their long-term gains are going to make up a disproportionate percentage of all long-term stock market gains. As a result, picking the mega caps that are most likely to continue delivering exceptional long-term performance already puts you in a position to participate in the vast majority of long-term stock market gains.
Obviously, Munger and his partner Warren Buffett think that AAPL is going to be one of those companies, given their outsized bet on it. Instead of betting on Elon Musk’s TSLA, they are invested heavily in one of its biggest rivals BYD (OTCPK:BYDDF), and they own a small stake in AMZN. Otherwise, they have largely steered clear of the other mega-cap stocks, though Mr. Munger has personally made significant investments in other very large and highly successful companies like Costco (COST) and also has dabbled – unsuccessfully – in Alibaba (BABA) shares.
Munger’s latest comments and strategy suggestions seem like a natural extension of the mantra that he taught Warren Buffett years ago:
It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
Where Peter Lynch Thinks The Best Bargains Are Right Now
Interestingly, these comments contrast quite sharply with those recently made by another highly successful stock picker Peter Lynch, who believes that the mega-cap stocks have experienced a significant valuation bifurcation with the rest of the market and are quite possibly overvalued right now. Instead, he believes that small-cap stocks (IWM) offer the most compelling value right now.
My Approach To Stock Picking
Mr. Munger’s track record is certainly hard to argue against and his reasoning is somewhat sound. Certainly, the mega-cap stocks have had incredible performance over the past decade and their capacity to harness the rise of artificial intelligence and big data to further cement and expand their competitive advantages makes it hard to foresee any of their downfalls. Sure, there are up-and-coming tech stars like Palantir (PLTR) and many others that may challenge some of these companies in certain ways (just ask TSLA about its Chinese competition for example). However, these companies are all so large, well-diversified, and cash, data, and talent-rich that it is hard to see how they suffer a precipitous decline as increasingly data-driven decision-making prevents management from making any enormous strategic blunders. Therefore, it is very possible that – while many or even all of these companies may fail to deliver the dominant total return CAGRs that they have in the past – they will continue to deliver strong – if not above market average – returns over the long-term.
On the other hand, Mr. Lynch’s track record is also hard to argue against, and I have been implementing an approach much more in line with his latest perspective, as I have focused primarily on off-the-beaten-path, mostly (but not always) smaller-sized companies and made big profits in the process. Some of my past big winners have included NVE Corp. (NVEC), New York Community Bancorp (NYCB), Energy Transfer (ET), Universal Insurance Holdings (UVE), and Unum Group (UNM).
Given where market valuations and macroeconomic fundamentals are right now, I still lean in this direction, as I am finding a plethora of high-yielding, smaller-sized businesses that combine compelling valuations with defensive business models and solid balance sheets, thereby setting them up to outperform in a potential recession.
That being said – while I do not own any of the mega-caps at the moment – I am also investing in some larger, more dominant companies with tremendous track records as well in places where I think value can be found as well. These include Brookfield Asset Management (BAM) (one of the leading global alternative asset managers), Realty Income (O) (the gold standard of triple net lease REITs), and Enterprise Products Partners (EPD) (the gold standard of midstream infrastructure businesses).
Investor Takeaway
Mr. Munger believes that investors are best suited to building a core position or two in the mega-cap stocks and then rounding out their portfolio around that base. Mr. Lynch, meanwhile, believes that mega-caps may actually be disproportionately overvalued and that smaller-sized businesses are where the best bargains are to be found.
Personally, I see merit to Mr. Munger’s reasoning from a long-term perspective, especially for part-time investors who do not have as much time to dig into researching smaller-sized companies. In fact, investing in SPY or QQQ right now is effectively doing just that, as both indexes are heavily overweight mega-cap stocks.
However, given where valuations are, I agree with Mr. Lynch that the risk-reward in many smaller-sized companies is disproportionately attractive right now. In particular, with interest rates likely at or near their peak and a recession still more likely than not in the coming year, it makes a lot of sense to me to buy a diversified portfolio of utilities (XLU) and other defensive dividend-paying stocks on a value basis rather than piling into richly valued wildly popular mega-cap stocks. Perhaps a time will come when the risk-reward in those names will be attractive again, and I do not necessarily think that investors need to completely abandon that part of the market, but as for me and my portfolio, we are following Peter Lynch in looking for value among the smaller-sized companies.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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