An Analysis Of Journal Communications (JRN)

Journal Communications (JRN) is comprised of seven essentially separate businesses: The Milwaukee Sentinel, Community Newspapers, Television Stations, Radio Stations, Telecommunications, Printing Services, and Direct Marketing. The company's five reportable segments do not exactly match these seven businesses; however, I believe an investor should analyze JRN on the basis of these seven businesses and their constituent properties, rather than as a single going concern with five reportable business segments. Additional reasons for this belief will be outlined below. For now, it is sufficient to say that if Journal Communications were to divide into seven separate public companies, the combined market value of those companies would be substantially greater than JRN's current enterprise value. Simply put, the sum of the parts would be valued more highly than the whole.

Journal Communications has an enterprise value of just under $1 billion. Pre-tax owner's earnings are probably around $125 million. So, JRN trades at eight times pre-tax owner's earnings. That's cheap.

Journal's effective tax rate is 40%. That is an unusually high rate. Journal's media properties would likely generate more after-tax income under different ownership. The difference would be material; but, for anyone other than a highly leveraged buyer, tax savings would not be a primary consideration. When evaluating Journal as a going concern, it is perfectly appropriate to treat the full 40% tax burden as a reality. These taxes reduce owner's earnings by $50 million.

With after-tax owner's earnings of $75 million and an enterprise value of $1 billion, Journal's owner's earnings yield is 7.5%. Remember, this is the after-tax yield. The pre-tax yield is 12.5%. When evaluating a company, it's best to use the pre-tax yield for purposes of comparison. Last I checked, the 30 - year Treasury bond was yielding 4.63%. So, looking at JRN's current earnings alone, the stock appears to offer a large margin of safety.

This is especially true if you consider the fact that earnings yields offer more protection against inflation than bond yields. They don't offer perfect protection. But, with stocks, there is at least the possibility that nominal cash flows will increase along with inflation. The cash flows generated by bonds are fixed in nominal terms, and therefore offer no protection against inflation.

When evaluating a long-term investment, such as a stock, I do not use a discount rate of less than 8%. This reduces JRN's margin of safety considerably. Instead of being the difference between 12.5% and 4.63%, Journal's margin of safety is the difference between 12.5% and 8%. Is such a margin of safety sufficient? Maybe.

When evaluating a prospective investment, I first look at the risk of a catastrophic loss. What is the magnitude? And what is the probability? For my purposes, a catastrophic loss is defined as any permanent loss of principal. The risk that I've overvalued a business is always greater than my risk of catastrophic loss, because I insist upon a margin of safety. A catastrophic loss is one that wipes out the entire margin of safety.

I can make a bad investment without suffering a catastrophic loss. For instance, most mutual funds are bad investments, because they underperform alternatives. However, mutual funds do not usually carry a high risk of catastrophic loss. In fact, they generally have a low risk of catastrophic loss, because they are highly correlated to the overall market.

It's easiest to understand this concept if you think of valuing companies as being a lot like writing insurance. Even if reality exceeds your expectations in nine out of every ten cases, a terrible misjudgment in the tenth case can cause you great harm. It isn't just how many mistake you make. It's also how big they are.

Some stocks, like Google (GOOG), trade at prices that allow for catastrophic losses of considerable magnitude. Other stocks, like Journal Communications, trade at prices that only allow for very small losses to principal. However, there is also the matter of probability. How likely is it that a Google shareholder will suffer a catastrophic loss? I don't know. I'm not even willing to hazard a guess.

In the case of Journal Communications, I am willing to stick my neck out.

I believe an investment in JRN carries a very low risk to principal - considerably less than, say, an investment in the S