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1 key investment lesson from Charlie Munger

Everyone knows about Warren Buffett’s extraordinary investment return record. He has an amazing temperament for investing and has dealt with every economic crisis that came Berkshire Hathaway’s way.

A lot of Buffett’s skill is attributed to his learnings from Benjamin Graham, a value investor. However, it is Munger who may have had the biggest influence on Buffett.

Warren Buffett once said to Carol Loomis for a Forbes article ”I have been shaped tremendously by Charlie. Boy, if I had listened only to Ben, would I ever be a lot poorer.”

Indeed Howard Buffett, Warren’s eldest son, said to Janet Lowe that his father is the second smartest man he knows. He says Charles Munger is the first.

Ben Rundle from NAOS Asset Management, which operates Naos Emerging Opportunities Company Ltd (ASX: NCC) and other listed investment companies (LICs), recently quoted in a Livewire article one of the sagest pieces of advice Mr Munger has given the world.

Charlie supposedly said in an article “Over the long-term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.”

Foolish takeaway

I think it’s a fantastic point. If a business is re-investing into itself and earning 10% on that money then it’s unlikely to grow faster than 10% over the long run. That’s why it’s better to own businesses with high returns on equity or assets.

That’s why many of the top performing shares over time such as REA Group Limited (ASX: REA) are the ones with high returns on equity– they are able to re-invest money back into the business at attractive rates of return.

These top growth shares are also earning impressive returns on equity year after year.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia has recommended REA Group Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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