Christopher Davis Discusses Smart Value Investing

Episode Summary

Executive Summary: Barry Ritholtz interviews Chris Davis, chairman and CIO of Davis Advisors, about value investing, portfolio construction, and the shift from active to passive management. Davis discusses the firm's focus on long-term, concentrated portfolios, learning from mistakes, and the importance of owner earnings over reported earnings. He shares insights on specific holdings like JPMorgan, Wells Fargo, Amazon, and Google, and explains Davis Advisors' expansion into ETFs. The conversation also touches on Davis's personal background, mentors like Charlie Munger, and his philosophy on investing and life.

Main Topics: Value Investing Philosophy and Portfolio Construction (Priority: 5/5): Davis Advisors focuses on concentrated, long-term investments in high-quality businesses, measuring returns by earnings yield on cost rather than stock price fluctuations. The firm uses a decision-making process inspired by Danny Kahneman, breaking down sourcing, construction, and revaluation. Selectivity is key—buying only one out of ten S&P 500 names. Active vs. Passive Management and Market Trends (Priority: 5/5): Davis discusses the healthy evolution of the industry as overpriced mediocrity is squeezed out. He argues that active managers with alignment of interest, low costs, and high active share can thrive, especially as passive investing grows. The conversation contrasts price vs. value and criticizes closet indexing. Case Studies: Financials, Amazon, and Google (Priority: 4/5): Deep dives into Davis's investments: JPMorgan's resilience and credibility, Wells Fargo's cultural failures and recovery potential, Amazon's owner earnings (positive free cash flow despite no reported profits), and Google's missed opportunity due to not calling advertisers. Highlights the importance of understanding accounting and reinvestment returns. Learning from Mistakes and Firm Culture (Priority: 4/5): Davis emphasizes embracing mistakes—visible on a 'wall of shame' with stock certificates and transferable lessons. Categories include quantification, judgment, omission (e.g., Google), and commission errors. A culture of trust enables admitting and learning from failures. Expansion into Actively Managed ETFs (Priority: 3/5): Davis Advisors launched four active ETFs (DUSA, DINT, DWLD, DFNL) in 2016-2017, driven by advisor demand, tax efficiency, and operational excellence. Davis explains the advantages over mutual funds and the barriers preventing other firms from following. Personal Reflections and Mentors (Priority: 3/5): Davis shares his journey from accountant to CIO, including his master's in philosophy/theology, work for the Episcopal Church, and mentorship from his grandfather, father, and Charlie Munger. He discusses the metaphor of sailing for investing and the importance of curiosity and humility.

Key Arguments: Value investing is about owner earnings and long-term cash flow, not static price-to-earnings ratios—companies like Google and Amazon can be value stocks when analyzed correctly. Active management's advantage lies in selectivity and alignment (managers eat their own cooking); passive investing cannot reach 100% market share. Resilience of businesses is underestimated—even through crises like the S&L crisis or financial crisis, survivor institutions become stronger with higher moats. Investors must learn from mistakes systematically; failure is a critical teacher, and a firm's culture should embrace and institutionalize those lessons. The shift from mutual funds to ETFs is driven by tax efficiency and transparency, but active managers with low fees are best positioned to offer competitive ETFs.

Data Points: Assets Under Management: $22 billion - Davis Advisors manages over $22 billion as of the podcast recording. Fund Launch Date: 1991 - The Davis Financial Fund was started in 1991. Selectivity Ratio: 1 in 10 - Davis Advisors buys only one out of ten S&P 500 names. Portfolio Manager Tenure: 27-28 years - Chris Davis has run the Davis Financial Fund for 27-28 years as of the recording. JPMorgan Quarterly Earnings: $8 billion - JPMorgan reported $8 billion in quarterly earnings, described as real money. Amazon Free Cash Flow (17-year period): $7 billion cumulative - During 17 years of growing sales from $1B to $100B, Amazon generated $7B cumulative free cash flow despite no reported profits. Walmart Free Cash Flow (17-year period): Negative cumulative free cash flow - Over 17 years growing sales from $1B to $70B, Walmart had negative cumulative free cash flow due to heavy capital spending. Walmart Sales Growth (17-year period): $1B to $70B - Walmart grew sales from $1 billion to $70 billion over roughly 17 years (1980-1997). Amazon Sales Growth (17-year period): $1B to $100B - Amazon grew sales from $1 billion to $100 billion over a similar 17-year period. Google Ad Cost per Lead: $2 vs. $30 - Google's cost per lead was $2 for advertisers like Geico, compared to $30 for late-night cable TV.

Pivotal Quotes: "If you don't have any fear, you don't have any courage, right? You may do things that appear to be courageous, but you don't have any courage. You need fear in order to be courageous. You need doubt in order to have faith. Certainty is the opposite of faith." — Chris Davis: Davis recounts a lesson from the Episcopal Bishop of Newark, tying the concept of doubt and faith to investing and life. "My grandfather had a great phrase. He called good financial companies growth stocks in disguise. He said that they can compound for generations and yet they're often valued as if they have no growth." — Chris Davis: Explaining the premise behind the Davis Financial Fund and how value investors can find growth in seemingly staid sectors. "We start with the view that our number one job is to build generational wealth... we want to own a business for a long period of time. And therefore, the return on the business is not going to be driven by us trying to predict the future PE ratio... What we're really looking at is the earnings that business will generate relative to what we paid for it over time." — Chris Davis: Outlining the core investment philosophy of Davis Advisors—focus on owner earnings and long-term compounding, not short-term price movements.

Implications: Investors should prioritize long-term cash flow and business quality over short-term price movements. Active management with alignment, low fees, and concentrated portfolios can outperform passive strategies. Learning from mistakes systematically improves investment outcomes. The shift to ETFs will continue as tax efficiency and transparency gain importance.