Daily Journal (DJCO) is one of those strange, interesting firms. It's a meager $100 million newspaper firm whose readers consist mainly of lawyers and realtors. What everyone probably knows is that Charlie Munger (yes, THAT Charlie Munger) is and has been chairman for more than 35 years. What you may not know is that the CEO Gerald Salzman is also the COO and CFO. And he's done a fine job given the environment by making a profit for the last 10 years. Most newspapers have gone out of business due to the internet. Instead, DJCO's current net income margin is above 20%.
But what really makes this firm fascinating is what it has done with the profits. Over the last decade, they've taken almost all the cash and invested in either cash or US government bonds. Then the 2008 crash happened. As the market declined in 2009, the decision was made to purchase two common stocks and certain corporate bonds. This ended up paying off rather well, as the value of the stocks rose substantially, resulting in a doubling of DJCO's stock price. As of March 31, they hold securities in 6 firms. The value of its securities currently stands at about $98 million at a cost of $46 million, demonstrating capital allocation at its finest.
Assessing this firm's value is easy, yet strange when compared to the market value. The simplest way is to add the value of the newspaper operations and the value of the securities separately. This valuation will use a simple free cash flow divided by discount rate equation. For the newspaper business, it's a fairly conservative assumption to say that the free cash flow essentially equals the net income. Working capital without the securities doesn't change much or decreases. Also, the depreciation basically equals or exceeds capital expenditures. Taking the average net income for the last 5 fiscal years gives about $7 million (rounded down from $7.2 million). As for the discount rate, the implied equity risk premium based on Aswath Damodaran's calculation is about 6.52%, and the risk free rate used is 1.38% (current 10-year bond rate of 1.63% minus an assumed default risk of 0.25%) giving a discount rate of 7.9%. Given the current newspaper environment, we'll assume a negative growth rate of 2%. This makes the final discount rate 9.9%, giving the newspaper business a value of $70.7 million (7/0.099=70.7). Assuming the value of the securities hasn't changed, the value of the stock is 70.7+98.2= $169 million.
When compared to the current market cap of DJCO, about $118 million, there's a very large discrepancy. What's stranger is when the value of the securities and $5 million of the cash is subtracted out of the market cap, you get a P/E ratio of about 2 ((current market cap-securities-cash)/TTM earnings=(118.2-98.2-5)/7.5). Why is that? There are only two reasons I can conjure up. Either the business is highly discounted due to the market believing the net income will become negative within the next year, or the discount rate is high due to the incredibly low daily trading volume. If it is the latter, it brings up an interesting question: When you're valuing a business, who do you value it as? Do you value it as yourself, the individual investor who can easily move $5,000 dollars in and out of this stock, or as the institutional investor, who would be forced to apply a large discount rate due to the lack of liquidity of the stock? The answer to that question can possibly be inferred based on your own premise of efficient or inefficient markets. If markets are efficient, then the current price is the intrinsic value, meaning the latter is the correct answer and vice versa.
Another method of valuing this firm would be to assume the newspaper business is worth zero, leaving only the cash and securities. One could think of it as buying a closed end mutual fund with a 20-30% premium.
To me, DJCO is undervalued (even despite the rise in value over the last few years) and it will be interesting to see where they are in the next 3-5 years.