Warren Buffett (Trades, Portfolio), and most other value investors, now believe quality is more important than price.
The man who taught us this—by example and logical thinking—is Charlie Munger (Trades, Portfolio). He nudged Buffett away from cigar-butt investing and toward investing in quality companies.
Munger is best known for his role as vice chairman of Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial), as Buffett’s right-hand man. We also know him for his folksy, sometimes humorous insights into investing.
But Munger has also been, on his own, a successful investment manager: In an early partnership, at Wesco Financial (where he collaborated with Buffett) and most recently as the chairman of the publicly-traded Daily Journal Corp. (DJCO, Financial), a newspaper and website publisher.
How does an investment manager fit in at a newspaper company? Has he maintained his edge while there?
Who is Munger?
Munger was born in Omaha, Nebraska in 1924. According to Everipedia.com, he worked at a grocery store owned by Buffett's grandfather while in high school.
From there it was off to the University of Michigan, where he studied mathematics. He interrupted his studies in 1943 and joined the U.S. Army Air Corps, where he specialized as a meteorologist. Despite the lack of an undergraduate degree, he entered Harvard Law School and received a Juris Doctor in 1948.
After graduating, Munger and his family moved to Pasadena, California, where he joined a law firm. He founded his own real estate law firm in 1962, but soon switched professions by forming a new partnership: Wheeler, Munger and Company. It was an investment firm that lasted until 1976, after experiencing losses of 32% in 1973 and 31% in 1974. Overall, though, he did very well, as shown in this chart from the book, “Damn Right: Behind the scenes with Berkshire billionaire Charlie Munger” (cited in an article at the A Wealth of Common Sense website):
Munger moved on again, this time to Wesco Financial Corp., which would become a wholly-owned subsidiary of Berkshire Hathaway. Originally a savings and loan association, it evolved into a diversified financial firm with $1.5 billion of holdings in Coca Cola (KO, Financial), Wells Fargo (WFC, Financial) and others. It also was a major insurer and reinsurer, providing floats which needed to be invested. Munger was CEO and chairman of Wesco from 1984 through 2011. Through that, he reconnected with Buffett and went on to become vice chairman of Berkshire Hathaway.
GuruFocus reports Munger was the person who convinced Buffett to give up his cigar-butt investing style and focus instead on high-quality companies that could be held for the long term.
While still vice chairman of Berkshire Hathaway, Munger’s main association for the past few years has been with the Daily Journal Corp., which publishes newspapers and websites in California and Arizona. It also operates a public notice advertising service.
Unless otherwise noted, this bio is based on information at Everipedia.org.
The 93-year old Munger started his career by practicing law, then moved to investing, apparently seamlessly, and succeeded in generating excellent results across several different investment platforms.
What is the Daily Journal Corp?
The company publishes 10 newspapers, primarily in California and Arizona, according to its 10-K for 2016. While not entirely law, justice and courts focused, this area makes up a significant portion of its revenues.
It also has a Journal Technologies subsidiary, which supplies case management software and related services for courts and various justice agencies. This subsidiary accounted for 56% of the company’s total revenue in 2016. Within this business, it operates secure websites through which traffic citation fines can be paid by the public.
It might just another struggling media company were it not for Chairman Munger’s investing skills. In early 2009, in the immediate wake of the 2008 banking crisis, Munger put $20 million of the company’s cash flow into four stocks: Wells Fargo, Bank of America (BAC, Financial), U.S. Bancorp (USB, Financial) and Posco ADR (PKX, Financial), a manufacturer and seller of steel rolled products and plates in South Korea.
The Motley Fool reports that at the end of 2015, Wells Fargo was up 570%, Bank of America was up 431% and U.S. Bancorp was up 374%, while Posco lost 31% (the Posco position has been pruned back as a result). This chart illustrates the dramatic results: Going from practically zero assets in 2008 to $166 million in 2015:
Another chart in the Motley Fool article shows the Daily Journal's income from dividends and interest rose from 1.7% of revenue to 8.7% (2009 to 2015). That meant $3.8 million of non-operating income in 2015.
For the trailing 12 months to Sept. 30, GuruFocus shows net interest income has risen to 9.1% of total revenue (net interest income: $3.60 million, total revenue: $39.49 million).
While almost all other newspaper publishers are bleeding income, The Daily Journal has a load of dividend, interest and potential capital gains income to keep it on solid footing for many years. All thanks to Munger’s ability to allocate capital effectively.
What are Munger’s investing strategies?
Where to start with Munger’s philosophy, strategy and tactics? It is hard to know since he has written and spoken extensively, and been interviewed many times—not to mention being cited so often by Buffett.
For Munger, it all starts on a higher plane, where philosophical, ethical and behavioral thinking come together. He pulled together many of these ideas in his book, "Poor Charlie's Almanack," which was published in 2005. The title is a tribute to Benjamin Franklin's "Poor Richard's Almanack," Munger being a devotee of Franklin. The book is a compilation of his speeches, talks and other thoughts.
Mental models come up frequently in discussions of Munger’s thinking. That is what he calls different ways of thinking about issues, and the more you have of those mental models, the less likely your thinking biases will get you into trouble. An example of a mental model is the Pareto Principle and its 80-20 rule.
According to a site that specializes in mental models, Farnam Street, there are two types. First, there are the models that help us predict the future by simulating time. Second, there are models that help us better understand how we can be led astray by our mental processes.
Munger is also well known for what he calls the "Lollapalooza Effect," which refers to acting irrationally because of a group of mental models going in the same direction at the same time.
Getting more specific, Munger uses checklists--different lists for different companies--to check his own mental models and the whole investment process. Old School Value lists the principles behind the checklists this way; this list provides an overview:
- Always start by measuring risk, which means an appropriate margin of safety and insisting on proper compensation for risk assumed.
- Independence means objectivity, rationality and avoiding "the herd."
- Preparation refers to working hard, reading voraciously and always asking why.
- Intellectual humility involves staying within your circle of competence and, most importantly, never fooling yourself.
- Analytic rigor means using the scientific method and robust checklists, and thinking forward and backward, or as Munger puts it, "Think forwards and backwards--Invert, always invert."
- Allocation: he says an investor’s top job is properly allocating capital. In Munger's universe, the best use is always measured by the next best use, assessments of opportunity costs.
- Patience refers to the propensity of humans to do something rather than wait. He follows Einstein in believing that compounding is the eighth wonder of the world, and should not be unnecessarily interrupted.
- Decisiveness: Opportunity is a rare thing, so grab it when it shows itself.
- Change includes living with change, adapting to the world around you rather than expecting it to adapt to you.
- Focus means keeping things simple and staying focused on your goals. Also, do not get lost in the noise, keep your eye on the prize to which you aspire.
Munger says, “You have to learn all the big ideas in the key disciplines in a way that they’re in a mental latticework in your head and you automatically use them for the rest of your life.”
An original and robust thinker, Munger has used this secular wisdom in his investing career. That mental latticework drives a way of thinking that has made Munger one of the brightest minds in investing.
Holdings
Perhaps the most specialized sectoral profile of any of the gurus:
At the end of the third quarter of 2017, GuruFocus reported Munger's portfolio had just four stocks--the same stocks he bought in 2009 (with the proportion of the portfolio they represent):
- Wells Fargo & Co. (WFC, Financial): 56.9%
- Bank of America Corp. (BAC, Financial): 37.78%
- U.S. Bancorp (USB, Financial): 4.86%
- POSCO (PKX, Financial): 0.44%
This portfolio, worth $154 million, takes high-conviction to new levels. Not only is the portfolio almost entirely financial, but just one stock makes up more than half of it, the currently controversial Wells Fargo.
Performance
As noted above, Munger outperformed while running investments at Wesco Financial. This TipRanks chart shows him currently running close to the S&P 500 over the past five years:
This essentially static portfolio has had its ups and downs over the past five years, and currently has no significant edge over the benchmark index. That is well below his earlier outperformance at Wesco.
Conclusion
While Munger is no longer generating the big returns, he nevertheless has set up the Daily Journal with income for life, so to speak.
His high-conviction portfolio of just four stocks will fluctuate above and below the S&P 500 as market conditions change. However, the income just keeps coming in, $3.60 million in the latest fiscal year. There are also potential capital gains should the Daily Journal find itself in a financial crisis at some time in the future. In any case, Munger stayed true to form, buying quality companies, then giving them time to become significant compounders.
Value investors have much to learn from Munger. Not only by reading or listening, but by adjusting mental models and following what he has done.
Disclosure: I do not own shares in any of the companies listed in this article, and do not expect to buy any in the next 72 hours.
