Monday, February 13, 2012

Daily Journal Corp. Expands Investment Portfolio

When it comes to deploying the company's funds, Daily Journal Corporation (DJCO) benefits from having Charlie Munger as its Chairman.

What's the long-term business prospects for Daily Journal?

I think that's far from clear, but the investment results from deploying company funds have been impressive in recent years.

The company's investment portfolio has expanded substantially in size over five years.

At the end of December 2006, the portfolio's value was $ 16.54 million and made up mostly of U.S. Treasury notes and bills. After subtracting debt of $ 4.16 million and, at the time, the company had net cash and investments of just about $ 12.4 million.

According to the 10-Q filing released on Friday, net cash and investment was $ 79.3 million at the end of December 2011 and made up mostly of common stocks.
(A portfolio value of $ 79.3 million with no debt.)

Some of that expansion has come from taking the relatively small original portfolio and very solid free cash flow, then wisely allocating it into marketable securities when prices were low (obviously, the marketable securities didn't go up in value eight-fold, it was the combo of capital appreciation and five years of accumulated free cash flow).

Most of the portfolio has been going into common stocks in recent years.

The Daily Journal is a good example of a solid, if unexciting, core business with difficult to judge (at least for me) longer term prospects.

Yet, because, at least in the near-term (and may be for a long time), the core business continues to require little capital, the excess funds it produces can be allocated to other high return use. It's a good example of why it often makes sense, when in doubt, to own shares of durable businesses that require little capital to remain competitive.

Growth prospects for a business can be uninspiring yet still make a sound investment if it's durable and the excess capital it produces can be allocated productively elsewhere (the worst businesses need every dollar they make and then some to maintain competitiveness).*

The problems begin when those in charge of capital allocation don't make the wisest choices. Certain businesses can put lots of capital to good internal use while some otherwise sound businesses cannot.

See's Candy is an example of a fine business that doesn't need much incremental capital (prior post: Buffett on See's). The profits from See's over the years have been used by Berkshire to make other attractive investments.

The Daily Journal operates as two different businesses. The company describes its "traditional business" (where effectively all the operating profits are produced) as follows in the latest 10-Q filing:

The Daily Journal Corporation (the "Company") publishes newspapers and web sites covering California and Arizona, as well as the California Lawyer magazine, and produces several specialized information services. It also serves as a newspaper representative specializing in public notice advertising.

The other business is a wholly-owned subsidiary (Sustain Technologies, Inc.). It's been mostly an unprofitable software business which supplies case management software systems and related products to courts and other justice agencies.

I'll look more specifically at Daily Journal's portfolio growth, capital allocation, and valuation in a follow up.

Adam

No position in DJCO

* DJCO passes the low capital requirements test but whether the core franchise is durable seems less clear.
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