Charlie Munger says "most... people who've made a lot of money have done so in high quality businesses."

If high quality businesses interest you (and they should) then let's look at why Charlie thinks this way, and how you can too in order to make better investments.

High quality businesses tend to generate high returns on invested capital (ROIC). Charlie says over the long-term a businesses returns will mirror its returns on capital. Make it a priority to build a portfolio of high and sustainable ROIC businesses.

"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. "

Quality businesses can scale better than others. If you can find a business with a decades long runway, you can capture a tonne of growth. But try not to make the mistake of assuming that growth will continue if the TAM is shrinking.

"So the trick is getting into better businesses. And that involves all of these advantages of scale that you could consider momentum effects." 

How to find great companies? Starting with companies that are smaller and can grow for many years is a great start. If you’re young, this is exactly how Charlie would invest.

"How do you get into these great companies? One method is what I'd call the method of finding them small get 'em when they're little. For example, buy Wal-Mart when Sam Walton first goes public and so forth. And a lot of people try to do just that. And it's a very beguiling idea. If I were a young man, I might actually go into it."

The method isn’t one that Berkshire uses. Berkshire is too big for this strategy to work.

"But it doesn't work for Berkshire Hathaway anymore because we've got too much money. We can't find anything that fits our size parameter that way. Besides, we're set in our ways. But I regard finding them small as a perfectly intelligent approach for somebody to try with discipline. It's just not something that I've done."

Quality companies with huge market cap are harder to find. When you are constrained by only large caps, your opportunities decrease significantly. So as a retail investor this is a massive edge. 

"Finding 'em big obviously is very hard because of the competition. So far, Berkshire's managed to do it. But can we continue to do it? What's the next Coca-Cola investment for us? Well, the answer to that is I don't know. I think it gets harder for us all the time...."

Great business that are founder led, often have incredible management. But even a great business that is not founder led can attract high quality management. Still, you have make sure a bad manager won’t come in and do stupid things.

"And ideally and we've done a lot of this—you get into a great business which also has a great manager because management matters. For example, it's made a great difference to General Electric that Jack Welch came in instead of the guy who took over Westinghouse—a very great difference. So management matters, too."

Is great management predictable? Do you need something special to find great management?

Charlie gives some insights to those questions.

"And some of it is predictable. I do not think it takes a genius to understand that Jack Welch was a more insightful person and a better manager than his peers in other companies. Nor do I think it took tremendous genius to understand that Disney had basic momentums in place which are very powerful and that Eisner and Wells were very unusual managers." 

Finding an amazing business is great. When you can mix this with a rockstar manager, you've found nirvana. Charlie says you’re making a large error of omission if you do not invest in these opportunities.

"So you do get an occasional opportunity to get into a wonderful business that's being run by a wonderful manager. And, of course, that's hog heaven day. If you don't load up when you get those opportunities, it's a big mistake. 

Talented management can have massive impacts.

“Occasionally, you'll find a human being who's so talented that he can do things that ordinary skilled mortals can't. I would argue that Simon Marks—who was second generation in Marks & Spencer of England—was such a man. Patterson was such a man at National Cash Register. And Sam Walton was such a man." 

What are characteristics of these managers? Charlie like managers that are “intelligent fanatics.” They’re rare, but they do exist.

"These people do come along—and in many cases, they're not all that hard to identify. If they've got a reasonable hand—with the fanaticism and intelligence and so on that these people generally bring to the party—then management can matter much." 

Why should you prefer betting on the quality of a business rather than the quality of management? You want to bet on quality business over quality management.

"However, averaged out, betting on the quality of a business is better than betting on the quality of management. In other words, if you have to choose one, bet on the business momentum, not the brilliance of the manager.”

If you have insights into a superstar management that can drastically improve a business you may find a good opportunity. But they’re very rare and you’d need some great insights to make that call.

“But, very rarely, you find a manager who's so good that you're wise to follow him into what looks like a mediocre business."