Charlie Munger (Trades, Portfolio) is an investor and the business partner of the world’s most famous investor, Warren Buffett (Trades, Portfolio), but he is also among the rarified group that cleaned up during the financial crisis. The fountain of wit, wisdom and ice-cold discipline got into the market at its most despairing and quietly made a small fortune, primarily on banks, which he still owns nearly a decade later. With the rally in financials in recent months, Munger has three that continue to thrive.
Munger’s move into stocks began in 2009 after keeping most of the investment funds of his company, Daily Journal (DJCO, Financial), in cash and U.S. Treasurys. Initially, he sold most of the Treasurys earning nominal interest to buy $15.5 million in stocks of two Fortune 200 companies, saying he “took advantage of near-panic selling in the stock market.” By September 2010, the unnamed stocks had provided a $9.30 million gain.
By 2010, the stocks were worth $43.05 million. In 2011, Munger deployed $11.15 million to buy more common stocks, and his cost basis of $20.96 million had grown to a value of $52.46 million. In 2012, Munger sold more U.S. Treasury Bills to drop $18.11 million on common stocks, revealing in his annual report that they were again of two Fortune 200 companies, as well as of two foreign manufacturing companies. At the end of the fiscal year, Munger’s $44.76 million investment in common stocks was worth $94.06 million.
2013 brought several new developments. Munger’s $43.04 million in common stock investments ballooned to $143.28 in market value – a 232.9% gain. In its annual report, the Daily Journal said decisions to buy or sells stocks would be based on the attractiveness of other options, meaning Munger probably still believes the securities have relatively good prospects.
“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., 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.“
Further, having a portfolio that passed the $100 million mark meant Munger had to begin disclosing its contents to the SEC. It showed the names of his stocks for the first time: Wells Fargo & Co. (WFC, Financial), Bank of America Corp. (BAC, Financial), US Bancorp (USB, Financial) and POSCO (PKX, Financial).
Per the most recently available information of Dec. 31, Munger’s company had $58.45 million in stocks, with a fair value of $188.73 million, an increase from $158.45 million the previous quarter.
Wells Fargo & Co. (WFC, Financial)
Wells Fargo is Charlie Munger (Trades, Portfolio)’s favorite bank and possibly favorite stock. He has 60% of Daily Journal’s common stock portfolio in the bank and a 623.5% gain since his first purchase deep in the pit of 2009. He discussed how the buy intersected with his investing posture at the 2016 Daily Journal shareholder meeting.
“You make your money by the waiting, not until next depression, but a fair amount of patience is required followed by pretty aggressive discipline when the time comes. Imagine putting all the foreclosure boom money to work in one day on the bottom tick of the market. Sure it was luck, but it wasn’t luck that we had the money ready to deploy and were willing to do so when others were fearful,” he said.
He also remarked on some of the qualities that differentiated it from other financial institutions that Munger has historically panned.
“When Berkshire bought Wells Fargo, the world was unglued in real estate lending-driven banking panic. We knew their bank lending officers weren’t ordinary. They grew up in the garment district as cynics and were careful and better [than others]. This was an information advantage that we had that Wells Fargo had this special capacity. When DJCO bought into Wells Fargo at $8, we knew the bankers were more rational than ordinary bankers. No one should buy a bank without a feeling for how shrewd management is. It is easy to delude yourself into thinking things, as it is very easy to hide the real numbers. Don’t invest in banks without real knowledge.”
Munger has also said he was not optimistic about the banking system as a whole long term, particularly because of the combining of derivative books with insured deposits. “The more bankers want to look like investment bankers, the more I don’t like it,” he said.
He has also said that “It’s not the investment banking that draws you to Wells Fargo” and in 2009, around the time of his first investment, he said it had a “very good” culture compared to some other banks” that were involved in the financial crisis. “There’s a reason why we consider it a much better bank than most of the other big banks,” he said.
On its financial side, Wells has a price-earnings ratio of 14.5, price-book ratio of 1.69 and has grown revenue at a 2.1% annual rate over five years, reaching $88.3 billion for 2016. Return on equity, however, declined for the third year in 2016, to 10.38% from 12.75% in 2013. Its dividend, once cut to 5 cents in the first quarter of 2009, has been restored to 38 cents in the first quarter of 2016, surpassing its pre-crisis peak of 34 cents in the fourth quarter of 2008. Year to date, Wells’ stock price has risen 5% to $57.88 per share at close Tuesday.
Bank of America (BAC, Financial)
As Daily Journal’s second-biggest holding, Bank of America makes up 34.75% of the portfolio, encompassing 2.3 million shares. From the first quarter of 2009, Munger has seen an approximate 224.7% gain on the stock.
Buffett purchased Bank of America in 2011, several years after Munger, but had been following the bank for 50 years. He did not buy the stock based on ratios, however, but based on what it would look like in five years and the difference between that price and the present value. “We do not know how to buy a stock based on ratios,” Charlie said at a 2013 Berkshire annual meeting. “We need to know how a company actually functions.”
With a $247.4 billion market cap, Bank of America has seen its revenue decline at a 2.8% annual rate in the past five years, while it increased its book value at a 3.6% annual rate. Its return on equity increased for the second consecutive year to 6.2% for 2016. Its net interest margins rose to 2.72%, their highest 2010 and a fourth consecutive year of growth.
In the fourth quarter, Bank of America’s loans increased by $20.1 billion and deposits grew $55 billion. Higher interest rates and loans and deposit growth boosted net interest income by 6% from the fourth quarter last year. Its CEO, Brian Moynihan, forecast further growth in 2017 partially due to a potential rise in interest rates.
Munger’s Daily Journal holds 140,000 shares of US Bancorp, composing 4.92% of the portfolio. In a 2013 annual meeting on stage with Munger, Buffett said he “felt good about” the bank, among several others. “They should be a decent investment. But returns on tangible equity will not be as high as 7 – 8 years ago.”
In 2009, Munger answered a question about the troubles banks had gotten into to spark the crisis and shed further light on his banks’ appeal.
“No one can stay away from trouble 100%. However, companies like US Bancorp and Wells Fargo are better at avoiding the common stupidities of banking than most,” he said. Berkshire Hathaway doesn’t get to have perfect managers either. There is always a compromise involved—like what my wife did when she married me. We all have to deal with what is available. I have a friend who will not own any financials because he thinks all the banks will eventually go crazy. And that’s not an irrational statement. But I like banks that acknowledge their problems. The bankers at Wells Fargo admit that they had their heads up their a**when they made most of their second mortgage loans.”
Upon affirming US Bancorp as having an outlook of stable and being among its highest rated banks on Feb. 28, 2017, Moody’s included its financial crisis performance as part of its analysis.
“Moody's noted that USB has an excellent track record in asset quality with low problem loans and net charge-offs. During the recession its annual net charge-offs peaked at 2.17% in 2010, which was well below US peers. For 2016, USB's net charge-offs were a low 0.47%,” the ratings agency said.
Since 2009, US Bancorp’s stock has appreciated 249.4% to $55 per share at close on Tuesday, with a $93.5 billion market cap. Over the past five years, the bank increased its revenue at a 4.8% annual rate and book value at an 8.4% rate. It has also grown its earnings per share every consecutive year since 2007, to a record $3.24 per share for 2016.
US Bancorp’s return on equity, however, has been in annual decline since 2011, to 11.96% in 2016, while returns on equity declined for the third straight year in 2016.
“This is illustrated in that its fourth quarter 2016 net interest margin of 2.98% is average compared to other large US banks, while its return on assets of 1.32% is above the median,” Moody’s said.
The U.S. financial sector has rallied 43.29% over the past year, as Munger’s Wells Fargo rose 20.41%, US Bancorp 39.92% and Bank of America 94.32%. Year to date, the sector rose 5.14% and as Wells Fargo gained 5.03%, US Bancorp 7.03% and Bank of America 11.67%.
See the Daily Journal’s portfolio here.
