Wednesday, August 18, 2004

Doing Graduate Degrees in Philosophy & Theology Proud

Fund chief champions stocks with longevity

Christopher Davis grew up learning about the stock market from his father and grandfather, both money managers. He began writing company research reports for his father in high school, getting $50 a report. Davis joined his family's advisory firm in 1989 and has served as portfolio manager of the Davis New York Venture fund (NYVTX) for a decade.

Christopher Davis of Davis New York Venture fund.
By Robert Deutsch, USA TODAY

At a time when many mutual fund firms have been accused of ethical lapses and trading irregularities, Davis Advisors stresses its corporate culture of stewardship and integrity. Over the years it also has stuck to a tradition of value investing. The results: The Davis New York Venture fund has outperformed the S&P 500 in every 10-year period since 1969.

USA TODAY's Christine Dugas spoke to Davis about his investing strategy.

Q: Your fund is dominated by financial stocks. Why do you favor them?

A: Financial stocks in general deal with a product that's non-obsoletable. Second, it's a vast business. Everybody in the country is a customer of at least one or two or three financial institutions.

Top 10 holdings of Davis
New York Venture fund
Top 10 holdings of Davis New York Venture fund
% of fund
American Express 7.5%
American International Group 5.3%
Altria Group 5.2%
Tyco International 4.8%
Berkshire Hathaway class A 4.0%
Wells Fargo 3.8%
Citigroup 3.7%
Progressive 3.5%
HSBC Holdings 3.5%
Golden West Financial 3.3%
Source: Davis Funds

About Christopher Davis

Chairman and CEO of Davis Advisors and portfolio manager of the Davis New York Venture fund

Age: 39
Education: Master's degree in philosophy and theology from the University of St. Andrews in Scotland
Family: Wife Sharon, daughter Katie, 4, and sons Willoughby, 16, and Ian, 15
Hobby: Sailing
Recent book read:Wellington: The Years of the Sword by Elizabeth Longford
A favorite charity: The Fresh Air Fund
Boards: A member of the board of trustees of The Santa Fe Institute, an interdisciplinary research institute; the Hudson Highlands Land Trust and the Scenic Hudson Land Trust

Third, it's still a very fragmented business, whether it's property and casualty insurance or banking or investments management or brokerage.

Fourth, they are businesses where management makes a huge difference. And their assets, unlike factories, tend to be income-producing assets like bonds or loans, and so they produce cash earnings.

For every period in history, financial stocks in aggregate sell at a big discount to other types of businesses. People say it's because they're commodity businesses that are leveraged. That's the other side of some of the strengths that I mentioned. But painting them all with the same brush doesn't make any sense.

Q: Do rising interest rates change your outlook for banks and other lenders?

A: If rates go higher because the economy is booming, unemployment is plummeting and the Fed wants to cool things down a little, that's a wonderful environment for many lenders. There's a surge in demand for their products; credit losses go way down.

Now, you can paint a completely different scenario: The government needs to raise money to finance the budget deficit. There is uncertainty in the world. Foreign investors don't want to hold as many U.S.-denominated assets. The dollar is weakening. They need to raise rates to attract investors. Well, that's a terrible environment for lending institutions because there's pressure on credit. And, ultimately, credit is the key for banks and lending institutions.

Q: Financial firms are more diversified today, so why do the stocks get hit when rates go up?

A: If people believe that interest rates are bad for financial stocks, when interest rates move up, financial stocks move down for some period of time. But if the earnings of the business stay robust and the credit losses stay low over time, it's just a matter of waiting through that cycle.

Q: Many banks have been adding branches. Do you think they're going overboard?

A: I don't know any financial services institution that has automatically gotten better because it got bigger. More than anything, financial services is a business of execution. There is no secret formula. Anything you develop in financial services, somebody down the road can duplicate the next day.

The history of financial services in the last decade has been that specialists win, not generalists. So there is no inherent value to size.

Q: You've said that you look for businesses with an owner-oriented management. What do you mean?

A: If you inherited some money and it came with a condition that you had to invest it in one business and you could never sell, then think about the conditions that you would look for in that business. You'd want it to be a good business that you understood. You'd want it to be preferably a non-obsoletable business because you're going to own it for a long time.

When you think about the characteristics you would look for in your partner running that business, you want them to think like an owner. And the best way is for them to be an owner. When companies generate earnings, they invest those earnings on your behalf as the owner. They can pay a dividend, build a new factory, do an acquisition or issue stock or debt. So how they think about their role and their relationship to you as their partner is going to be critical in your success.

Q: Do you believe the corporate reforms in response to accounting scandals are too harsh?

A: There are some wonderful outcomes. The most important is the expensing of stock options. I think that closes one of the really shameful loopholes. I don't think stock options are such a terrible thing, but the idea that they aren't an expense is nonsense.

Q: How do you research companies?

A: The entire research process boils down to two questions: What kind of business do you want to own? And how much do you pay for it? We need to have a strong and independent view of what each business is worth so that when the price is above or below what we think it's worth, we can take advantage of it. We studied Costco for many years. It was always outside our range of fair value. It was trading at $45. And one day they announced they missed earnings, and the stock opened at $27. We bought 17 million shares in one day because we were ready. We had a high conviction of what we felt it was worth.

Q: What part of your job do you enjoy most?

A: I love evaluating business positions and the people running businesses. I love thinking about reinvestment rates on our earnings. How successful are companies at reinvesting our earnings? I love that part of it. I feel like I get to study success. And that's a nice way to go through life.

Q: I've read that your family has $2.5 billion invested in your funds.

A: Our family, employees and our directors are invested. I think there's $2 billion of insider money invested in the funds, and a lot of that's family money.

Q: Does your degree in theology come in handy?

A: I still pray a lot. I think that I used to say almost as a matter of course that investing money is not a high calling. But, lately, as we've gone through these crises in the industry, a shareholder wrote me and reminded me that stewardship is a fairly old calling and is a fairly biblical concept. We have a tremendous research team in terms of their ability and intellect and the diversity of their backgrounds. But, above all, what I'm most proud of is their character.
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