Thursday, May 17, 2012

Munger's Daily Journal Corp. - Investment Portfolio Now Equals Nearly 90% of Market Capitalization

In a previous post, I noted the following about the Daily Journal Corporation (DJCO):

At the end of December 2011, the Daily Journal's cash and investments in total were worth $ 79.3 million.

There's no debt now so, of course, net cash and investments also equals $ 79.3 million.

Market Capitalization = ~$ 101 million

Enterprise Value (EV = market capitalization minus cash and investments) = ~$ 22 million

The portfolio made up nearly 80% of the company's value at that time. Well, it is now nearly 90%.

Daily Journal had earned a little over $ 7 million on average over the previous five years giving it an enterprise value to earnings multiple that was roughly 3x. So investor's when I wrote the above were only willing to pay roughly 3x what the business itself earned on average over the prior five years.

Naturally, what matters is what it will earn going forward.

Let's look at the it the same way using the most recently reported quarterly results:

At the end of March 2012, the Daily Journal's cash and investments in total were now worth $ 104.1 million.
($ 90 million of it is common stocks, $ 7.7 million bonds, and U.S. Treasury Bills now just $ 500k. The rest is $ 5.9 million of cash and cash equivalents.)

That's a 31% increase in value. In the 10-Q filing they do not note any new purchases (the last purchase they noted was the "common stock of another Fortune 200 company" during the 1st quarter of fiscal 2012. The quarter they just reported is their fiscal 2nd quarter.) so the increase in value most likely comes down to the securities they own have increased in market value substantially since they last reported.

There's still no debt now so, of course, net cash and investments also equals $ 104.1 million.*

Market Capitalization = ~$ 117 million
(Based upon yesterday's $ 84.98/share. The stock has moved up quite a bit this year but considering how well the marketable securities portfolio has performed...not surprising. Of course its not like the short-term "voting machine" has to necessarily make sense.)

Enterprise Value (EV)  = ~$ 13 million

Using the 5 year average earnings that puts the enterprise value to earnings multiple at less than 2x.

Yet, what matters is what they will earn on a normalized basis going forward. In the 1st half of this year they earned $ 3.75 million so it seems they are on pace to be in the ballpark of the five year average. The problem is that the $ 3.75 million is a decline year over year and that's a trend that's likely to continue.

Consider this from the latest 10-Q:

The traditional business segment revenues are very much dependant on the number of California and Arizona foreclosure notices. The number of foreclosure notices published by the Company decreased by 21% during six months ended March 31, 2012 as compared to the prior year period. Because this slowing is expected to continue, we anticipate there will be fewer foreclosure notice advertisements and declining revenues in fiscal 2012. We do not expect to experience an offsetting increase in commercial advertising as a result of this trend because of the continuing challenges in the commercial advertising business.

So, as I mentioned in the other post, it's probably wise to assume earnings in recent years were much stronger than they will be going forward (again, nothing wrong with expecting lower levels and being pleasantly surprised). The investment portfolio performance, effective allocation of future free cash flow, and the sustainability of the traditional business (even if at a lower level of free cash flow) remains the key to value creation at Daily Journal.

I'd feel more comfortable with this if I understood roughly what earnings will look like over the next five to ten years.

Still, when you consider that 1) Charlie Munger and his investing principles inform the capital allocation process*, and 2) much of the market capitalization is supported by the marketable securities alone (securities that are unlikely to be speculative in nature), there certainly seems to be some margin of safety here.

As I mentioned previously, insiders own a bunch of the stock and shares trade in an extremely illiquid fashion. Anyone interested in the shares had better avoid market orders.

Adam

No position in DJCO

* There's a good chance the market value of the marketable securities is down a bit since the end of March. The important thing, of course, is what the intrinsic value of those securities happen to be and how much they increase in value (hopefully) over time. 
** From the 10-Q: The Company's Chairman of the Board, Charles Munger, is also the vice chairman of Berkshire Hathaway Inc., which maintains a substantial investment portfolio. The Company's Board of Directors has utilized his judgment and suggestions, as well as those of J.P. Guerin, the Company's vice chairman, when selecting investments, and both of them will continue to play an important role in monitoring existing investments and selecting any future investments.
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