One of the greatest lessons I have learned from billionaire investor Charlie Munger (Trades, Portfolio) is the importance of reading widely. Munger once said, "In my whole life, I have known no wise people (over a broad subject matter area) who didn't read all the time — none, zero."
Every investor should have a solid understanding of investment principles and other financial concepts. In the financial world, there are plenty of ways one can slip up, so it's a good idea to have as much understanding as possible before one gets involved with financial products such as stocks, bonds and derivatives.
However, if one is to be a successful investor in the long-term, one should understand more than how a stock works or whether or not a bond offers a positive real yield.
Broad understanding
To give a straightforward example, I think one of the most undervalued securities on the market at the moment is British American Tobacco (BTI, Financial). The UK-listed equity offers a dividend yield of 8% and trades with a price-earnings ratio of 8. These metrics look desirable, and from a financial perspective, the business has many different attractive qualities. It is highly cash generative, rewards shareholders and has a high return on capital. What's more, the cigarette business is itself a lucrative enterprise. Products can be manufactured for a few pennies and sold for dollars.
The stock looks cheap, but it is cheap for a reason. Most people now know smoking is bad for health, and the consumption of cigarettes worldwide is declining on a per capita basis. We know this because it is a publicized fact, but that's not always the case for other industries and sectors.
Despite this fact, readers may not know that cigarette consumption is actually increasing around the world. The number of smokers as a percentage of the global population is declining, but as the population grows, the nominal number of smokers is increasing.
Therefore, the number of cigarettes sold is also increasing. Most people who don't read into the sector don't realize this. Some readers may also be surprised to learn that tobacco companies have actually benefited from not being allowed to advertise. Brand value has become more important, and advertising spending has dropped, leading to improved returns and profit margins.
These are quirks of the tobacco industry that one may only realize by reading material not related to the sector. Health journals provide information on cigarette consumption, and marketing case studies show how the advertising ban has benefited the industry.
Munger's recommendation
This is just one very simple example, but it illustrates just how important Munger's principles of reading widely really are for investors. As such, it should come as no surprise that Munger recommends investors spend time every day trying to become a little wiser:
"Spend each day trying to be a little wiser than you were when you woke up. Day by day, and at the end of the day if you live long enough-like most people, you will get out of life what you deserve."
It doesn't have to be financial material. Any information is relevant and can be used to construct mental models that cover different sectors and industries. History is particularly informative. I find it amazing how many times I come across historical case studies which have similarities with current situations.
By studying history, we can also try and avoid mistakes others have made in the past, especially when it comes to financial mistakes. It's a lot cheaper and easier to buy and read a book than it is to lose one's life savings in a bad investment. Reading and studying can save investors a lot of time and effort and potentially produce profits.
