Does Charlie Munger Have a Secret Small Cap Stock?

Hey guys, I have a very special treat for you this morning.  New blogger and major-league research hound The Value Major has uncovered a very interesting stock idea with a twist you won’t believe.  I suggest that you do your own homework and keep in mind that this stock has a tiny float before doing anything with it. 

By way of full disclosure, the author plans to buy the stock this morning and I have zero position in the .  Please consider the below an informational post and not a buy recommendation or a solicitation.  Enjoy! – Josh

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Daily Journal Corporation ($DJCO) is a small California-based company that owns and operates 11 small newspapers, several information services for attorneys, and a wholly owned software subsidiary Sustain Technologies, Inc.

My initial reaction to the company was positive because of the financials which I’ll cover shortly. I started to find things I didn’t like almost immediately upon opening the 10k. First off they own an unprofitable software subsidiary, second they had invested most of their significant cash stockpile in stocks and bonds, and third their operation seemed very small to be holding all that cash. They also hadn’t disclosed what they had bought stock and bond wise. The further I read the worse the taste in my mouth got. Here we had a company that had bought—and probably paid too much for—a software company, that while it was in their core business of legal information services wasn’t in print—the area they had been doing business in for a long time. I was also quite concerned that if they made any significant blunders in the stock/bond markets I could see the most attractive thing about the company—its balance sheets—go up in smoke. Add to that the fact that Whitney Tilson had recently bought the company—and I began to wonder if this wasn’t one of those situations where things could go very, very wrong no matter how good it looked on paper.

And then I read the blessed paragraph… the kind I read 10k’s to find. I’m going to quote it verbatim with the important parts bolded.

“Such investments may include additional securities of the companies in which the Company has already invested, securities of other companies, government securities (including U.S. Treasury Notes and Bills) or other instruments.   The decision as to particular investments will be driven by the Company’s belief about the risk/reward profile of the various investment choices at the time, and it may utilize government securities as a default if attractive opportunities for a better return are not available. The Company’s Chairman of the Board, Charles Munger, is also the vice chairman of Berkshire Hathaway Inc. ($BRK-B), which maintains a substantial investment portfolio.  The Company’s Board of Directors utilized his judgment and suggestions, as well as those of J.P. Guerin, the Company’s vice chairman, when selecting the investments that were made last year, and both of them will continue to play an important role in monitoring those investments and selecting any future investments.”

Yes. The guy managing this little cash rich company’s investment portfolio is the Charlie Munger. Yes that one. A guy who I would gladly, in a heartbeat, pay hedge fund rates to manage my own money. This completely eradicated any fears I had about the deployment of the company’s capital in stocks and bonds. Even though Munger is quite old, it’s very clear that there is no premium built into the price of the company… So his existence in relation to the stock is all upside. Could he lose money on the three stocks he suggested they buy? Absolutely. He could also very easily do extraordinarily well and make this company worth significantly more.

This also had the effect of making me feel much better about the software acquisition. There is absolutely no chance that any company that had Munger as a major player in its management would ever get involved in software without it being the most tender, buttery soft, flaky, biscuity deal in the history of computer technology. Munger is man so cheap that, despite being worth 1.7B, he flies first class when he travels. Even Buffett has an airplane. In Warren’s words “I’m good at saying no… Charlie is better.” Charlie didn’t say not to buying Sustain Technologies—and the balance sheet carries no goodwill. These are very good signs. Another good sign is that the software development costs are being expensed directly on the income statement—and the company is still showing a healthy profit.

There is one last tongue in cheek intangible upside to this stock. Bruce Berkowitz bought DJCO in Q1 of 2006 (when he was still lucky) and sold it in Q3 of 2010 (when he was in the process of proving that all he’d been was lucky). Quick note to ReformedBroker—forget a dare, I’m not sure I’d buy that guys portfolio with a gun to my head—you may give Berk some sympathy… But I don’t. I have a hard time finding sympathy for anyone who bought a bank/financial stock thinking it was a ‘value play’ at any point in the last few years. It was terribly obvious that they were lying about everything relevant on their balance sheets after the meltdown—and smart financial people SHORT fraud. Calling it fraud is basically the only thing that does it justice—perhaps their accounting tricks are legal, but in the real world the legal definition of the word ‘fraud’ has far less meaning than the ramifications of intentionally misleading investors.

With no further ado let’s do the beautiful numbers.

Income Statement:

DJCO’s TTM net income is 7.87M. Giving them a horrible 2.5% growth rate mostly to reflect inflation and the potential of their software development and a 10% discount this delivers us 69.21M.

Balance Sheet:

DJCO holds 91.98M in current assets as of the most recent 10Q. It’s stock and bond holdings market value stood at 66.3M as of 6/30/2011. Obviously the value of these has probably declined… But they reached that level as of 6/30 from 50M as of 9/30/2010. It’s pretty safe to say that Charlie knows what he’s doing—and I refuse to discount that 66.3M even a penny as a result. DJCO had 12M in long term assets which in the spirit of fairness I discounted 30% and total liabilities of 32.59M.

Conclusion:

This stock has huge potential upsides. It could make a lot of money because Charlie Munger buys the right stocks or its software company could do very well. Even the software company ceasing to exist would be a positive thing on paper as it would raise net income by reducing expenses. I didn’t really give any of that much credit when I ran the valuation—and that makes me enormously happy. The stock is worth 137M without any of those factors, and it’s trading for 94.26M. That’s a 31% discount. Bon A petit.

Disclosure: I intentionally delayed posting this until I could build a position for myself. As much as I like all of you this stock isn’t large and doesn’t see that much volume– It could have really damaged me to post this as I was attempting to get into it. This is far and away the best opportunity I’ve posted since I started this blog. I’m happily very long.  I am not qualified to dispense professional financial advice. The securities mentioned in this blog are perfectly capable of losing or gaining value.  Past performance is not the same as future performance no matter what your broker and the mutual funds he represents may tell you. I take no responsibility for any results positive or negative you experience should you use any information presented in this blog to make financial decisions.

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Cool story, huh?  The Value Major is a site I expect big things from as the author develops his voice and body of work. 

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The Value Major