Charlie Munger Investment Analysis Framework

This page documents the complete methodology used for systematic investment analysis, based on Charlie Munger’s time-tested principles.

Core Philosophy

“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”

— Charlie Munger

Five Pillars

Circle of Competence - Only invest in businesses you truly understand
Mental Models - Use multidisciplinary thinking from psychology, economics, physics, biology
Margin of Safety - Buy quality businesses at significant discounts to intrinsic value
Long-term Thinking - Hold great businesses for decades, not quarters
Quality over Quantity - Concentrate on excellent opportunities rather than diversifying into mediocrity

Analysis Process

Phase 1: Initial Screening (2-4 hours)

Quick Financial Health Check (30 minutes)

- Revenue growth trend (5+ years) - Profitability consistency - Debt-to-equity ratio - Free cash flow generation

Business Model Understanding (1 hour)

- How does the company make money? - What are the key value drivers? - Who are the customers and why do they buy? - What could disrupt this business?

Competitive Position Assessment (1 hour)

- Market share trends - Competitive advantages identification - Switching costs analysis - Barrier to entry evaluation

Management Quality Review (30-60 minutes)

- CEO track record and compensation - Capital allocation history - Shareholder communication quality - Insider ownership levels

Phase 2: Deep Dive Analysis (8-12 hours)

Comprehensive Financial Analysis (3-4 hours)

- 10-year financial statement analysis - ROIC calculation and trends - Working capital management - Cash conversion cycle - Segment profitability analysis

Inversion Analysis (2 hours)

- Systematic failure mode identification - Probability assessment of each risk - Potential impact quantification - Mitigation factor analysis

Mental Models Application (2-3 hours)

- Apply 5+ mental models from different disciplines - Cross-check conclusions for consistency - Identify potential blind spots - Stress test assumptions

Valuation Analysis (2-3 hours)

- DCF model construction - Multiple-based valuation - Sum-of-the-parts analysis (if applicable) - Scenario analysis (bear/base/bull cases)

Phase 3: Decision Making (1-2 hours)

Temperament Check (30 minutes)

- Emotional state assessment - Bias recognition exercise - Long-term holding capability - Conviction level measurement

Final Investment Decision (30-60 minutes)

- Buy/sell/hold determination - Position sizing calculation - Entry strategy planning - Monitoring plan establishment

Mental Models Library

Psychology Models

Model	Application
Incentive-Caused Bias	How do management incentives align with shareholders?
Confirmation Bias	Actively seek disconfirming evidence
Social Proof	Don’t follow the crowd; think independently
Authority Bias	Question expert opinions and analyst recommendations
Availability Bias	Don’t overweight recent events or vivid examples
Anchoring	Avoid fixating on irrelevant reference points

Economics Models

Model	Application
Supply and Demand	Industry dynamics and capacity utilization
Scale Economics	Cost advantages from size
Network Effects	Value increases with more users
Switching Costs	Customer lock-in through high change costs
Two-Sided Markets	Platform businesses benefiting multiple user groups

Mathematics Models

Model	Application
Compound Interest	The eighth wonder of the world
Probability	Think in terms of expected values and distributions
Base Rates	Consider historical frequencies before making predictions
Expected Value	Probability-weighted outcomes across scenarios

Decision Framework

When to Buy

Excellent business trading below intrinsic value
Strong competitive position in growing market
Competent management with skin in the game
Multiple mental models confirm the opportunity
Fits within circle of competence
Temperament Check: Can you hold for 10+ years through volatility?
Inversion Passed: Failure scenarios are low probability or manageable

When to Sell

Price significantly exceeds intrinsic value
Business fundamentals permanently deteriorate
Better opportunity emerges (opportunity cost)
Thesis was wrong (admit mistakes quickly)
Temperament Check: Selling from analysis, not emotional reaction

When to Hold

Business continues to compound value
Management executing well
Competitive position intact
Price below fair value
Temperament Discipline: Ignoring short-term noise and volatility

Portfolio Construction

Position Sizing Framework

Tier 1: Core Holdings (40-60% of portfolio)

Position Size: 8-15% each (3-5 positions)
Criteria: Highest conviction, lowest risk, best businesses
Characteristics: Dominant market positions with strong moats

Tier 2: High Conviction (25-35% of portfolio)

Position Size: 5-8% each (2-4 positions)
Criteria: Strong businesses, higher growth potential
Characteristics: Good competitive positions with growth opportunities

Tier 3: Opportunistic (5-15% of portfolio)

Position Size: 2-3% each (1-3 positions)
Criteria: Special situations, turnarounds, deep value
Characteristics: Significant upside potential if thesis works

Cash Position (5-20% of portfolio)

Maintain liquidity for exceptional opportunities
Increase during expensive markets (15-20%)
Deploy during market dislocations (reduce to 5%)

Quality Standards

Research Requirements

✅ Primary sources (10-K, earnings calls, industry reports)
✅ Disconfirming evidence actively sought
✅ Multiple scenarios analyzed (bear/base/bull)
✅ Margin of safety calculated
✅ Opportunity cost vs alternatives

Analysis Rigor

No recommendation without proper research
Sources cited for all key claims
Assumptions explicitly stated
Limitations clearly noted

Tools & Commands

Available Commands

/explain_business [TICKER] - Comprehensive business analysis
/research [TOPIC] - Industry and competitive research
Standard analysis workflow following this framework

File Organization

/analysis/               # Current stock analyses
/analysis/archive/       # Historical analysis files  
/data/financials/        # Financial statements and metrics
/data/market/           # Market data and price history
/portfolio/positions/   # Current investment positions
/portfolio/watchlist/   # Stocks under consideration

This framework has been tested across multiple market cycles and continues to evolve based on new learnings while maintaining core Munger principles.