Pro Strategy: How to invest like Charlie Munger

Published Wed, May 18 20165:00 AM EDTUpdated Wed, May 18 201610:22 AM EDT

Editor's note: This is Pro Strategy, a column on how to use the philosophies of the smartest minds on Wall Street to generate quality investment ideas. Billionaire Charlie Munger is one of the most celebrated investors in the world and was an essential partner in Warren Buffett's success. How can we learn from his wisdom and apply his investment philosophy to a current stock? Before becoming the vice chairman of Berkshire Hathaway , Munger had quite the track record himself. From 1962 to 1975 Munger's investment partnership generated 20 percent annual returns versus the S & P 500 's 5 percent. CNBC Pro researched Munger's strategy using previous media interviews, input from a well-known hedge fund manager and transcripts of annual meetings. We then evaluated a current stock's prospects using his framework. "The big money's been made in the high-quality businesses." — Charlie Munger Munger is credited for influencing Buffett to evolve his method, which led to unparalleled investment success. Kase Capital's Whitney Tilson explained Munger's significance in an email to CNBC Pro: "Early in his career, Buffett, as he was taught by Ben Graham, practiced cigar-butt-style investing, buying inferior businesses (like Berkshire Hathaway) that were trading below liquidation value (so-called "net-nets") and quickly selling them after a 50-100% gain. This strategy worked well for many years with a small pool of capital, but as Buffett's assets grew, it wasn't sustainable. Fortunately, Buffett encountered Charlie Munger around this time and Munger helped him appreciate the value of higher quality businesses, in which Buffett could pay a higher multiple than he was accustomed to going in, but then make far more money in the long run thanks to the power of compounding. See's Candies was one of the earliest examples of this." A high quality business was one that had "sustainable competitive advantage" and an ability to generate high returns and profits on capital, according to Munger. Read More Pro Strategy: 'Grand Theft Auto' stock is a steal "You have to figure out where you've got an edge. And you've got to play within your own circle of competence" — Charlie Munger Munger's intimate knowledge of Wells Fargo's bank-lending practices was instrumental in his ability to buy the company's shares at 2009 lows during the heart of the financial crisis. He showed his "circle of competence" of the banking industry and Wells Fargo at the 2016 Daily Journal annual meeting: "We knew that the lending officers at Wells Fargo were not normal bank lending officers. They were grown-ups, and they had a somewhat cynical view, and they were appropriately careful and it was the right way to run a bank. And we knew they were better, and we knew they wouldn't lose at much because they chose better and managed better. So we had an informational advantage." "Move only when you have an advantage. It's very basic. You have to understand the odds and have the discipline to bet only when the odds are in your favor." — Charlie Munger Munger believes successful investing has as much to do with emotional control as analytical ability. He said it requires a "crazy combination of gumption and patience, and then being ready to pounce when the opportunity presents itself, because in this world opportunities just don't last very long" in an interview in 2014. Let's see if we can use Munger's investing philosophy on a stock today. Axalta Coating Systems was roughly a $680 million position in the latest Berkshire Hathaway 13F filing . Buffett has said any holding less than a billion dollars in value is a position of one of his deputy investment managers, Ted Weschler and Todd Combs. It is noteworthy that Munger actually introduced and recommended Combs to Buffett before he was hired. So Axalta Coating Systems may be owned by the "baby Munger" portfolio manager. And it's easy to see why a Munger devotee would find the company attractive. Axalta Coating Systems is the leader in industrial and vehicle coating systems with 25 percent global market share, according to the company. Its products are used in 80,000 auto body shops in 130 countries. The firm's competitive advantages are its global distribution, ability to formulate 4 million colors and more than 900 industry patents. Some customers are so satisfied, 50 percent of their auto products distributors exclusively sell Axalta's solutions. In terms of profitability, the company reported impressive double-digit EBITDA (earnings before interest, tax, depreciation and amortization) of 21 percent in 2015 and management expects EBITDA margin to increase going forward. "Overall we continue to view AXTA as a well-positioned compounder of capital given stability of refinish earnings stream, not tied to OEM cycle (with) pricing power," Nomura's Aleksey Yefremov wrote in a note to clients Apr. 28. The average 12-month price target for Axalta is $32.87 representing 17 percent upside from Tuesday's close, according to FactSet. Read More Pro Strategy: 20 investing rules from hedge fund legend

Charlie Munger, Berkshire Hathaway

Lacy O’ Toole | CNBC

Editor's note: This is Pro Strategy, a column on how to use the philosophies of the smartest minds on Wall Street to generate quality investment ideas.

Billionaire Charlie Munger is one of the most celebrated investors in the world and was an essential partner in Warren Buffett's success. How can we learn from his wisdom and apply his investment philosophy to a current stock?

Before becoming the vice chairman of Berkshire Hathaway, Munger had quite the track record himself. From 1962 to 1975 Munger's investment partnership generated 20 percent annual returns versus the 's 5 percent.

CNBC Pro researched Munger's strategy using previous media interviews, input from a well-known hedge fund manager and transcripts of annual meetings. We then evaluated a current stock's prospects using his framework.