High Conviction Value Investing with Chris Davis

[00:00:00] Welcome to excess returns where we focus on what works over the long term in the markets.

[00:00:04] Join us as we talk about the strategies and tactics that can help you become a better

[00:00:07] long term investor.

[00:00:08] Justin Carbon, now in Jack Forehand, are principles at the Lydia Capital Management?

[00:00:11] The opinions expressed in this podcast do not necessarily reflect the opinions of the

[00:00:13] ability of capital. No information on this podcast should be construed as investment advice.

[00:00:16] Securities discussed in the podcast may be holdings of clients at the Lydia Capital.

[00:00:19] Hey guys, this is Justin. In this episode of excess returns, Jack and I sit down with Chris Davis,

[00:00:23] chairman and portfolio manager at Davis Advisors, a fun and wide-ranging discussion. We're going to talk about who some of your influences, I think, are, your investment strategy, your experience and views on the market. I think discipline, compounding, and long-term investing, and all the things that I know, you and your team over at Davis Slan strongly believe in.

[00:01:44] I think a good place to start, Wall Street, that means nothing to me. It's so bizarre to me that that's even a term because it covers everything from sales traders and the option derivatives people to investment bankers. And I always felt like what they did

[00:03:01] and what I do is totally different

[00:03:04] that we operate instead of at this frenzied shouting

[00:04:02] and what makes businesses grow over time. That would what I would call the broad framework and the excitement that almost everything

[00:04:07] is relevant, almost everything is relevant in one way or another.

[00:04:12] If I was to think about two technical lessons, maybe the most important one was this idea

[00:04:20] of owner earnings.

[00:04:22] This idea that people look at a series of his investing. And then I think on my, what I really learned from my father was this idea that the market is constantly evolving, constantly changing. It's an ecosystem that's in flux, it's never stable.

[00:05:42] And therefore what works for one decade

[00:05:45] is unlikely to work grandfather's day. You know, the idea was that these life insurance companies that were growing so dramatically after World War II, because the baby boom was underway and the suburbs are being built and family formation is at an all time high.

[00:07:02] You know, the first thing you did when Amazon. You know, you're exactly right. You know, Amazon was willing to lose money acquiring new customers because they knew the present value of each customer was going to be so great. And I'm really just gonna talk about the retail business.

[00:08:20] But because obviously AWS was its own spectacular creation,

[00:08:25] but just thinking of the retail business, Amazon. And what was so interesting is that it took Walmart, oh, I want to get these numbers right. I'm doing this from memory. So I want to say that they went, they crossed a billion in sales. And then 17 years later, they were at, let me see if I get this right.

[00:10:46] So growth cost them and the way they accounted for the growth, the cost of that growth was through capital spending. And it was very intelligent to do because they got like a 17 or 18% return on

[00:10:53] the capital they spent. So you wanted them to do it. But the point was if you owned all of Amazon,

[00:10:59] all of Walmart for that 17 years, you had to is the likelihood or stickiness of actually being able to monetize that customer base? I mean, we can look back now and look at Amazon. Like I think the switching costs

[00:12:20] of the Amazon right now are huge.

[00:12:21] I mean, where do people, I mean,

[00:12:22] they have all your orders,

[00:12:24] they have all the recommendations.

[00:12:25] I mean, that's where everyone goes to order stuff

[00:12:27] for the most part. classes with these high fees, but you could get diversification and higher returns. And you know, he did great for Yale and he was an unsung hero. And in a way, you could argue dramatically underpaid relative to the value he created. But what he did is he basically popularized this view that so well, what endowment should do is buy a lot of high fee

[00:14:45] DE shawd, you know, that's a man that understands return on capital and is hyper rational and driven and brilliant.

[00:14:48] But it opened the door for this idea of lots of companies saying, oh, yeah, we're in the

[00:14:52] customer acquisition business and we'll figure out how to monetize that customer later.

[00:14:58] And of course, then the charlatans line up and come up with business model after business

[00:15:03] model that will never be profitable, but just could raise a lot of capital and spend a lot but specifically Coca-Cola and Berkshire Hathaway. And obviously those boards are made up of great executives and leadership and people with top notch business credentials and characteristics. So what in your mind makes a really great board

[00:16:22] of directors, a solid board of directors? And you know, as you can relate it to the ones that you've

[00:16:25] sat on that you've experienced So, that was the example. I was just trying to timeshift because I owned Amazon once in 2002, that era, when they were only doing two or had to just run that in the background, just to get that sorted. So anyway, now for boards, well, I think boards are by and large. And I'm going to say that if I could single out maybe the most heroic, brave and outstanding board of directors that I've ever seen in my experience as an investor, it would be correct and they had to be willing to take that risk personally. And I think it was, I've been, and of course, Philip Morris has been one of the best performing stocks for the last 30 or 40 years. We owned it

[00:21:40] for some period of time and have not owned it in a long their mindset, their commitment to their shareholders, their sense of duty and honor and integrity. And of course, nobody willingness to be unpopular, resist whatever short-term trends are there, you know, and I like that that Berkshire doesn't pay its directors in any meaningful way because it passed. And I know you had a personal relationship with him and I know you learned a lot from him. So I was wondering if you could talk about that a little bit and like the biggest lessons you learned from Munger. Well, Charlie changed my life. I met him. I was young enough and I was trying to sell him a business that belonged to my grandfather's

[00:25:41] firm as a securities lending business.

[00:25:44] And about five minutes into the conversation, Charlie was something that I had seen in the very beginning when we were talking about companies are people and ideas and capital and so

[00:27:00] on. The people part I always thought about in terms of trying to assess management. But really Held up at at Harvard and and it you can get a reprint of it and it's just fabulous So that really helped but I think Beyond that I would say the the big things he taught me were oh and another sort of technical It was just that notion of inversion how important it is, you know right outside my office I have hung a letter that Warren wrote in

[00:28:24] 1965 I think it might have been a lit might big part. And then I think personally, Charlie, the threehip, and his inculcating that into me, that this is not a game. This is, you're entrusted with people's life savings and that notion of stewardship. It really, coming out of that breakfast and then all of our meetings subsequently,

[00:31:02] that idea, it led to wanting to have a board of directors

[00:31:05] made up of people that I admire In fact, he was one of the warmest and kindest and most loyal people I knew, but he didn't really care if people thought that. He was his own judge and he was a tough grader. I probably pitched him for four and a half minutes. He gave his answer in 30 seconds. But what was wonderful is with that five minutes behind us, we sat there for another

[00:32:23] three hours and that was the three hours that changed everything.

[00:32:27] But you're right. That's a really honorable business. I thought that was a really cool way to flip it and to look at it as what it actually is versus maybe the way the public perception of it is sometimes. Yeah. Well, I owe a lot of that to Charlie, but I also owe a lot you don't lose track of the fact that it's not a game, that it really is a question of whether somebody who's trusted you with their

[00:35:00] savings will be able to live independently, or whether they'll become dependent on somebody We buy businesses and the way you judge a good business is whether or not it makes a profit. A profession is a little different. We're in a profession and in a profession, you don't sell a product to a customer. You provide a service to a client. You could say, well, it's just words, but they're important words because as I say, in a business,

[00:36:21] you sell a product to a customer and you measure your success based on the profits that you

[00:36:27] make from that sale. What is the size of assets under management? What's the profitability of the firm? What's the growth of the firm? We don't think any of those statistics will tell you whether or not you're doing a good job as a professional. So, those sort of nitpicky words to us end up mattering. And so that idea of stewardship is sort of baked in there.

[00:37:43] And as I say, that one well, that's pretty full. So we trimmed some because now it's a bigger position at a higher valuation. All the theory tells you to trim this up. Then it went to 25 times earnings. We said, well, Jesus, if we were selling 20 times earnings now, it's even bigger.

[00:39:02] We got to sell more.

[00:39:04] And we were completely out at about 27 times earnings. And then you're going to get into some mediocre piece of crap and you are failing to correctly assess the risk of doing something stupid with the money that you realize from this wonderful decision that you made. He said it was a decision where you beat me. Like, you know, Berkshire should have bought that block and you bought 17 million shares

[00:40:20] in one day at 27.

[00:40:23] The stock enclosed at 40 the day before we were ready and we just jumped in there and Now, there's some reasons that I will not give myself a haul pass, but I will say that there are few mitigating factors. One is if I ran my own accounts separately from our clients rather than just put my money in the funds, I have a fabulous partner in Danton. And Danton has been, you know, he's everything you want in a partner in that I think we make each other better. I think I have enormous admiration for him. And he is, he, when he first joined me all those years ago,

[00:43:05] you know, my father had had sort of a soft cap coming when they own a stock at 30 and it goes to 60, they want to sell it. Both are stupid because where a stock was has nothing to do with its value, right? It doesn't matter that something was at 30 and now it's at 60 or something was at 120 and now it's at 60. Where it was before thinking, that is a very, very good thing to try to work on fixing. And I got a lot of room to fix that one. That is, so I love what you say. were absolutely comfortable having something run up to 20, 30, 40, 50% of their portfolio without worrying about it. That takes enormous resolve. That's still an area we need to work on.

[00:47:00] As Dan said to me, it is an area we need to work on, but the tail end of a long bull

[00:47:05] market is probably not the right in financials right now. I'm wondering how do you think about that limit? How do you think about how much you'll put of the fund in a specific sector like financials

[00:48:23] when you have high condition that there's a lot of opportunity there?

[00:48:26] Well, that's super concentrated and you're going to get killed. Now, if I had a portfolio that was in three different sectors, at three stock portfolio in the portfolio and think about risk and concentration in those terms. So when you think of financials in particular, there are just so many vastly different models that fall into that classification, right? You think about, you know, Chubb

[00:51:01] is in a wildly different business than Wells Fargo.

[00:51:05] And Wells Fargo is in a wildly different business

[00:51:08] than Bank of New York and Wells Fargo and Julius Bear and the development Bank of Singapore and

[00:52:24] Chub and you know where you'd sort of say well only in this sector. What's interesting about that fund is the financial stock index has underperformed the S&P from then to today. And our financial fund outperformed both the S&P and the financial stock index, and yet it was 100% in financials.

[00:53:41] And so there's just such, a higher probability that these companies can stay more dominant longer given the structure of the firms? Do you think that's not right? And 10 years from now, the top companies in the S&P are going to look very different than

[00:55:02] they do today?

[00:55:03] Well, it's always destruction of the largest ones. Sometimes those are driven by geography or particular bubbles in a sector and so on. But if you were to so something changed in the nature of technology over the last 20 years. And the question is, is that likely to persist? Well, I would go and say something also changed in the nature of consumer companies in the 1950s that made financial services, it's related but a little bit different in retail, it's related but a little different but you got Walmart replacing the regional department stores and so on. I think the same is true in a way of technology that you basically have had a shift where it is a bit of. And in the same way this displaced the PC, which displaced the mini, which displaced the mainframe, you know, there will be another transformation. And that in some ways I've thought makes Apple vulnerable in a way that it's harder for me

[01:00:20] to imagine how you displace, you know, is going to be great, which is if you could teach one lesson to your average investor based on your wisdom in the market, what would that be?

[01:01:43] Well, it would be that he had outperformed the market. But even if he had just simply tracked the market over this long period of time, but he did it with deep conviction because he saw each holding as a business.

[01:03:02] He didn't see it as a stock market.

[01:03:04] He didn't see it as a piece of paper.