Charlie Munger (Trades, Portfolio) served as CEO and Chairman of Wesco Financial from 1984 to 2011. During this time, he built the company from a small savings and loan business into a financial giant.
Munger operated Wesco using a similar strategy to Warren Buffett (Trades, Portfolio) at Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial). He used money generated from the group's operations to invest in new activities, such as acquiring shares for its investment portfolio, and new businesses.
On Aug. 26, 2010, Berkshire Hathaway announced its offer to purchase the remaining 19.9% of Wesco Financial that it did not already own for approximately $500 million. Over the 15 years to the date of the deal, Wesco returned 6.8% annualized for investors, compared to 11% for Berkshire.
Lagging Berkshire
Munger knew that Wesco wasn't as good as Berkshire for a long time. Writing in the firm's 2009 annual report, he said:
"Wesco is not an equally-good-but-smaller version of Berkshire Hathaway…each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value's intrinsic merits has, in recent years, continued to widen in favor of Berkshire Hathaway."
Still, we can learn a lot from Munger's regular investor correspondence when he was running the enterprise.
For example, in the company's 1994 annual report, he provided a breakdown of Wesco's intrinsic value:
"As indicated in the accompanying financial statements, Wesco increased its net worth, as accountants compute it under their conventions, to $678.1 million at year-end 1994, or about $95 per Wesco share, from $626.1 million at year-end 1993."
But this valuation, he went on to note, excluded an "interest-free loan from the government equal to its deferred income taxes on unrealized gains, subtracted in determining its net worth."
Munger estimated that the value of this loan was around $27 per Wesco share at the end of 1994. However, investors would get no "perpetual advantage" from this loan, as someday, the assets would have to be sold, he went on to add.
Therefore, Munger calculated that the "actual" value of Wesco's loan was closer to $9 per share at the end of the financial year.
The investor went on to summarize:
"Thus, if the value of the advantage from the interest-free tax-deferral 'loan' present was $9 per Wesco share at year-end 1994, and after-tax liquidation value was then about $95 per share (figures that seem plenty high to the writer), Wesco's intrinsic value per share would become only about $104 per share at year-end 1994, up 4% from intrinsic value as guessed in a similar calculation at the end of 1993.
And finally, this reasonable-to-this-writer, $104-per-share figure for intrinsic value per share value of Wesco stock should be compared with the $115.12 per share price at which Wesco stock was selling on Dec. 31, 1994. This comparison indicates that Wesco stock was selling about 11% above intrinsic value."
While this certainly isn't a road map for all value calculations, it's an excellent guide for investors who are looking for some guidance on how to value conglomerates.
What's noticeable about this text is how simple it is. Munger and Buffett have frequently said that the best investments are the ones that jump out at you, and this seems to be a great example of their investment practice in action.
It's also quite interesting that Munger concluded that Wesco was overvalued at the time. This is a reflection of his no-nonsense attitude toward business and investing. It's very rare to see such an admission in company annual reports. Managers that do display this kind of candidness may be worth following.
Disclosure: The author owns shares of Berkshire Hathaway.
Read more here:
- The Difference Between Warren Buffett and Berkshire Hathaway​
- Warren Buffett: Ignore Asset Allocation, Focus on Value Stocks and Education​
- Value Hedge Funds Dive Into Tech Stocks in 1st Quarter
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
