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Rupert Hargreaves
Rupert Hargreaves
Articles (1239)  | Author's Website |

Charlie Munger's Thoughts on How to Value Wesco Financial From 2009

Munger uses a simple method to arrive at an estimate of intrinsic value for the business

May 28, 2020 | About:

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 (NYSE:BRK.A) (NYSE:BRK.B). 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.

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website

Rating: 5.0/5 (4 votes)



Dirt2624 premium member - 1 month ago

Charlie seems to conclude that for Wesco the intrinsic value was equal to the book value with the deferred tax liability adjusted to 2/3 of the value on the balance sheet which makes sense for a business that is growing. (the portfolio investments within Wesco were recent enough not to be understated on the balance sheet)

With Berkshire, the portfolio investments are now worth substantially more than their balance sheet values so Buffett considers the intrinsic value to be about 140% of book value, but does not reveal if he is adjusting the deferred tax liability. I have sent in that question to the Berkshire AGM for several years but it was never asked of Buffett as far as I know.

Asawhneyy - 1 month ago    Report SPAM

Buffet has clever lines it did not work last decade--world is changed

Cocola-high sugar

Wells Fargo-Fraud

Kraft-Rengineering did not work

New money managerTom/Coombs-average

Only clever lines Buffet/Charlie-Cult is close to end

$137 billions must be given back to shareholders -When ,before nature take over

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