Returns

Morningstar founder Joe Mansueto on investing, money, and the company-building life.

Joe Mansueto is founder, CEO, and majority stockholder of Morningstar Inc., a Chicago-based financial-research company best known for its "star" rating system for mutual funds. For the past few years, Morningstar has also offered stock-analysis services.

Mansueto launched Morningstar in 1984 with an investment of $250,000 and a single product -- a quarterly fund-analysis publication. The company has grown to more than $90 million in annual revenues and 800 employees worldwide. It is still private and in a 1999 private-equity sale was valued at $450 million. Mansueto holds an estimated 70% of the stock, worth about $315 million on paper at the time of that deal.

Inc contributor Michael Warshaw spoke with Mansueto about how he thinks about money and investing after 17 years of the company-building life.

Inc: Should entrepreneurs sink everything into the companies they start?

Mansueto: I know I certainly did. When I started Morningstar, I had already worked for a few years in a company of my own and in the mutual-fund industry. I put in all the capital I had, which was $250,000. I started with one publication, Mutual Fund Sourcebook. When I wanted to launch another publication several years later, I borrowed $250,000 from my family.

I didn't enjoy borrowing the money, and it was a good feeling to pay it back. It's funny -- the total start-up capital of $500,000 seemed like a lot at the time, but it's really pretty small compared with what we invest in new products today.

All the capital I put in -- except for $1,000 -- was structured as a loan from me to the company. I think a lot of entrepreneurs use that type of capital structure. If your start-up capital is classified as equity, you get hit with capital-gains taxes when you take money out. The company has since paid me back, and I've paid my family back.

Inc: So do you advise founders today to put everything into their businesses?

Mansueto: I think it completely depends on your risk tolerance.

Inc: What exactly is the downside of sinking it all into the company?

Mansueto: You end up with a really disproportionate part of your wealth in one illiquid asset. You're like a farmer who's land-rich and cash-poor. It's staggering in terms of the lack of diversity. On the other hand, you do have more control over how well the asset does when it's your own company. So that provides some comfort.

To diversify your holdings, you have two choices. You can reduce the size of that large illiquid investment by selling pieces of it to other investors over time, or you can build up your assets outside the company.

Inc: How did you do it?

Mansueto: I built up the assets that I had outside Morningstar. It took a while before I took any money out of the company. I never took a salary until probably the early 1990s, and even then it was modest. I always thought my main remuneration from Morningstar was my ownership, and it still represents over 90% of my wealth.

I do have other investments. I love to invest, and I've built a stock portfolio that is my biggest asset outside of Morningstar.

Even in the early years I wanted to have some liquidity, since Morningstar was so illiquid. I started an IRA back in the early 1980s that has grown into a significant asset. I have a small 401(k) portfolio as well, and a portfolio outside of that.

I'm a big fan of Warren Buffett and, like him, a value-oriented investor. Building a stock portfolio is slow going at first. But over time, if you compound your assets at a high rate, the curve is exponential. So now my outside investments have become a significant asset for me.

Inc: But the way you describe it, leaving so much of your worth embedded in your company is still risky.

Mansueto: Oh, I have a very lopsided portfolio, but I feel good about Morningstar and the prospects for it. I also feel I've built up enough assets outside the company to give me security. Even in my worst-case scenario, my family has more than we would ever need.

One reason for that is that I don't have huge capital needs. I'm not a big spender, nor is my wife. Spending beyond your means is where it gets risky.

I've always lived within my means. I lived in a one-bedroom apartment until three years ago, when I got married. Not that I've taken an oath of poverty -- it was a nice apartment -- but I never owned any real estate. Then, when we got married, I bought a condominium in Chicago. I bought my first new car. And we recently bought a vacation home, a condominium down in Florida. So as I've gotten older and built up more assets, my spending has gone up.

You also need to keep your investment in your company secure. You do that by not going crazy allocating capital to silly projects or using crazy amounts of debt. Morningstar has $45 million in the bank and no debt. That gives me security with my biggest asset.

Inc: Do you recommend your approach for other company founders?

Mansueto: I think it's a very individual decision. My views are fairly extreme. Take, for example, my decision not to sell any of my company shares. A more mainstream view would be to diversify by taking a little money off the table. Sell some shares, either to an outside investor or to employees through an employee stock ownership plan. I could diversify more if I wanted to. I have a pretty unbalanced portfolio.

Look at Bill Gates. He sells 1% of his Microsoft holdings every quarter -- just a little bit to achieve over time a more diversified portfolio. That, I think, is more typical than my approach.

Inc: Is it smarter?

Mansueto: There's a logic to it. From a financial perspective, diversification doesn't lessen your return too much but dramatically lowers your risk. There are tax disadvantages to periodic sales, but probably the overall after-tax return doesn't change significantly. The main thing is that you reduce the risk.

And yet I do something a little different. For me, I think it all boils down to a company more than a financial asset. These are not just shares of IBM I hold and view dispassionately. You have relationships with the people who work here. You've put a lot of time and passion into it. You're proud of the products and what we do for investors. So I don't view my Morningstar shares as strictly a financial asset. I feel like it's a throwback to an earlier time when entrepreneurs built and held businesses instead of the rapid buying and selling that often occurs today.

Inc: What are your investing habits?

Mansueto: I'm an investment junkie. I go online every morning, on Morningstar .com. I walk in the rain to buy Barron's on Saturday. I read annual reports on vacation. You get the picture. I love investing -- it's intellectually challenging trying to understand how a business works and how the various forces in the world affect it.

Inc: How much churn is there in your portfolio?

Mansueto: I try to hold stocks for a long period of time. I'm definitely not a churner. I like to hold things for at least three years. I have one stock in my portfolio I've held for over 10 years, the publisher John Wiley. (See "Joe's Top 10," below.) It's hard to be patient with so much information and news constantly coming to you. But you need to resist the urge that tells you trading activity is a good thing.

Typically, I try to find companies I like and that I want to be a part owner of. Knowing when to sell is the hard thing for most investors. It's much easier to know when to buy. I think most of the sell decisions I've made have been bad ones because the stocks continued to do well after I sold. Sometimes the valuation gets too rich for me. A valuation into the stratosphere will eventually get me to sell.

Inc: Did you get hurt when the dot-com boom went bust?

Mansueto: Like most [value] investors, the last few years have been good ones for me. I've never been attracted to technology stocks, because of their unpredictability and often rapid product obsolescence. So the dot-com phenomenon was a nonevent for my portfolio.

Morningstar is my high-growth, semitechnology investment. What I keep in my stock portfolio is the opposite -- more basic companies like Smucker's, Mercury General Insurance, newspapers, and TV stations.

I like to find good businesses, businesses that have some kind of franchise, some protection from competition. I try to buy them at good valuations and hold on to them. A TV station is something that it's difficult to compete against since you need a license from the FCC.

I've held my Morningstar stock for 17 years. I think any decision I would have made to sell along the way would have been a bad decision -- even if I could have gotten a premium for its true value at the time.

Try to view your public holdings as you do your private holdings. Private-company owners rarely sell their equity, and when they do, they know the value of what they're selling. If you think of a stock as if it were just a piece of paper, the only person who'll grow rich on it is your stockbroker.

Inc: What about right now, as we talk at the end of September, after the terrorist attacks of the 11th and the stock-market volatility that's followed. Has that affected your investing views?

Mansueto: Investing seems pretty trivial compared to the human suffering of the attacks. The answer is no. But overall the damage the attacks caused can't be significant in the long run to an economy as large and powerful as that of the United States. Stocks are worth the discounted value of their future cash flows. The recent attacks haven't changed those estimated cash flows all that much.

I read a quote from Warren Buffett that said whatever you felt about stocks before this all happened is what you should still feel. That's a pretty wise statement. There may be a one-year impact for stocks in some industries, such as insurance and travel, but the overall values haven't changed much. I had losses after the attacks, like everyone else, but because my portfolio has a conservative tilt, it didn't sink as much as the whole. In fact, I think the recent volatility has created a good opportunity for long-term investors. Still, the attacks were such sad events that it's no fun managing your portfolio in their aftermath.


Joe's Top 10

We asked Joe Mansueto to tell us his 10 favorite stocks. He offered the following list and comments. He currently owns shares in each of the companies:

John Wiley (JWb): A $600-million professional publishing company full of "must-have" information for scientific, technical, and medical markets. I've owned Wiley shares for over 10 years. Wiley has dominant positions in many niches that insulate it from competition and allow it to generate lots of free cash flow.

Mercury General (MCY): A low-cost auto insurer that does most of its business in California. It is one of a few insurers that regularly show an underwriting profit. Add to that the earnings from its $1.8-billion investment portfolio and you have a company with solid earning power.

Walt Disney (DIS): My most recent purchase. In September the terrorist attacks and a large sale of Disney shares by the Bass Brothers sent the shares down to $16. The way I like to calculate it (operating income plus goodwill amortization minus interest expense divided by its $32-billion market capitalization at the time), DIS had an 11% earnings yield at that price. A great long-term value.

Cedar Fair (FUN): Owns and operates amusement parks, principally Cedar Point, in Ohio, and Knott's Berry Farm, in California. These are wonderful mini-monopolies that throw off buckets of cash. It's structured as a limited partnership, so there's no corporate tax, and all the income comes right to you. (The current yield is 8%.)

Media General (MEG): Owns newspapers and television stations across the southeastern United States. It's one of the cheaper media stocks and a potential acquisition candidate.

Standex International (SXI): A very cheap industrial conglomerate. I like SXI because its management is very shareholder-oriented. It uses most of its earnings to buy back stock and pay out a hefty dividend. SXI has bought back over half its stock since the mid 1980s.

GATX Corp. (GMT): Leases railroad tank cars and finances large capital assets and equipment. It raised more than $1 billion after-tax by selling off marginal business and is now a focused leasing company. Warren Buffett's Berkshire Hathaway owns 15%.

Great Lakes REIT (GL): A midwestern real estate investment trust that buys small, underperforming commercial properties and turns them around. It doesn't make big bets (its properties are 50,000 to 400,000 square feet), so it offers a conservative way to own real estate.

Peet's Coffee & Tea (PEET): A well-known coffee brand that's very cheap -- market capitalization is $60 million. It's a small company -- with sales of $90 million -- but can grow strongly in the years ahead by selling coffee through many distribution channels.

Mattel (MAT): Barbie and Fisher-Price are great brands that are turning around under MAT's new leadership. A terrible acquisition of the Learning Co. created a nice buying opportunity in MAT several years ago.


Copyright © 2001 Michael Warshaw.


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