The Most Successful Card Counter in History Passed Away Today: Charlie Munger
What are the three most important lessons we can learn from Munger and Buffett?
When Ed Thorpe invented card counting, the Casino owners laughed. “It’s mathematically impossible to beat us. We welcome Dr. Thorpe to our casinos to try his luck.”
But soon, the casinos were throwing out not just Thorpe but his students (including Joe Lacob, of the Kleiner Perkins and Warriors fame) as well because they kept cleaning the casinos out. The card counters had to resort to wigs and other disguises to keep on playing blackjack.
. . .
Card counting was invented by Thorpe, a professor of mathematics at MIT. He subsequently went on to invent Black-Scholes equation for figuring out the value of stock options. He didn’t publish it, though, and instead used to it to make millions of dollars trading. The Nobel Prize for the equation went to Black and Scholes who independently figured it out later and did publish it.
The way card counting works is this. When you start playing blackjack with a full deck, the odds are (slightly) in the dealer’s favor. So mathematically, in the course of a full game, from beginning to the end of the deck, the odds are in the casino’s favor.
However, as the play progresses and the cards get played, the odds swing back and forth depending on which cards are left in the deck. At certain points, the odds tilt in favor of the player. If you can figure out when that is, and bet heavily during those periods, you can consistently win. By counting cards, you can keep track of which way odds have swung.
This is the same strategy professional horserace bettors use. Wait, wait, wait until there is a bet where the odds are completely wrong, and then bet heavy. Because the odds in horseracing (and sports betting) is set not by the likelihood that a horse will win but rather on the number of people betting on that horse, sometimes the odds will be radically off from actual probability of the horse’s winning.
Charlie Munger and Warren Buffet’s main investment strategy boils down to that. This is why they say that you should buy stock as if you could only buy 4 or 5 stocks in your lifetime. Is this one of the best 4 or 5 investment opportunities that you will see?
This is good advice when you’re competing against a lot of people in a highly efficient market of course. Charlie and Warren’s advice is, you want to go for no brainers, and go big when those opportunities present themselves.
As an example, Warren used to do extensive research (in days when you had to actually read through stacks of paper) and keep his powder dry until and when he would find a stock that was selling for, let’s say $10, and paying $4 dividends every year, that owned $15 per share of real estate (with no debt), and then buy as much as he could. He wouldn’t look for stock that was going up and buy on momentum.
This is the heart of their investment strategy.
There are many other lessons we can learn from the investing duo, but I will cover just 3 of them in this post.
The second most important part of their strategy was to invest rather than speculate. What’s the difference?
Well, let’s say you buy a stock for $20 today. If that stock went to $10 tomorrow, would you be happy and buy more, or would you be upset and think about selling? What if it continued to drop day after day?
If you would be happy, you are an investor. You’re buying for the long term, and lower the price, bigger of a bargain it is. You’re buying because of the profits and earnings the company is generating. You say, “the company is earning $2 per year per share. I bought it at $20 because that was a good deal. Now I can buy at $10 and get twice as much for my money.”
If you’re upset, you’re a speculator. You’re buying so you can sell at a higher price later.
Think of it this way: if you bought a bond that paid 10% and then next day you could buy the same bond and get paid 20% interest, would you buy more? As Buffett says, when stock he likes drops in price, he sees it as being on sale and he will buy more.
The third most important thing we can learn from the dynamic duo is the concept of inversion. Many problems that are very difficult can be solved by inverting, or looking at it from the end rather than the beginning. It comes from the mathematician Carl Jacobi, who realized many problems are easier to solve by inverting.
In Munger’s words:
“Invert, always invert: Turn a situation or problem upside down. Look at it backward. What happens if all our plans go wrong? Where don’t we want to go, and how do you get there? Instead of looking for success, make a list of how to fail instead — through sloth, envy, resentment, self-pity, entitlement, all the mental habits of self-defeat. Avoid these qualities and you will succeed. Tell me where I’m going to die, that is, so I don’t go there.”
Lot of people misunderstand this rule. It doesn’t mean you just look at things differently. And it doesn’t mean you invert everything. There are just some problems that are easier to solve backwards than forwards.
P.S. And as a bonus…
I said 3 top lessons but I can’t resist, so here it is.
Warren’s #1 Rule of Investing is: Don’t Lose Money. This is another lesson people often don’t fully understand. The full reason is illutrated here: player.vimeo.com/video/708841050?h=4f07bff38e
Put in simple terms, because investments grow exponentially, a substantial loss especially early in the span of investment life can have negative effect that compounds over time, making it almost impossible to recover from.
P.P.S. And as a second bonus…
Buffett was opposed to “leverage” but in fact he used substantial leverage. He used float from insurance companies to ~triple his returns. However, this leverage had an important attribute, namely that it could not be called. So unlike traditional leverage that is subject to margin calls, his was very long-term, almost permanent.
