George Davis, Hotchkis & Wiley - We’re In Unchartered Territory Right Now | #339

Episode Summary

Executive Summary: George Davis of Hotchkiss and Wiley discusses a disciplined, long-term value-investing process centered on intrinsic value, normal earnings, and mean reversion. He argues that today’s market offers opportunities in cyclicals like financials and energy, while many growth stocks and defensive sectors look expensive. The conversation also covers lessons from market crises, the importance of team-based research, and the challenges of building a durable active-management business.

Main Topics: Hotchkiss and Wiley’s value-investing philosophy (Priority: 5/5): Davis explains that the firm is rooted in classic value investing: focus on what a business is worth, pay attention to price versus fundamentals, and think long term rather than reacting to market noise. Valuation method and normal earnings framework (Priority: 5/5): The firm builds DCF-style models anchored on estimated 'normal earnings' in year five, then discounts cash flows to estimate intrinsic value. Analysts study sustainable profitability, competition, and peer review assumptions before portfolio construction. Market conditions in summer 2021 (Priority: 4/5): Davis sees a supportive economic and earnings backdrop, but warns that prices across many asset classes are elevated. He highlights unusual trading behavior, meme stocks, and algorithmic momentum as sources of volatility and opportunity. Where value exists now (Priority: 5/5): He says the strongest opportunities are in cyclical sectors, especially financials and energy, while utilities, consumer staples, and high-growth names often look too expensive to justify. Behavioral discipline and long-term compounding (Priority: 4/5): The discussion emphasizes coffee-can investing, avoiding overtrading, and staying patient. Davis argues that compounding over decades is one of the most powerful forces in investing and spending decisions. Lessons from crises and team structure (Priority: 5/5): Davis reflects on three difficult periods—late 1990s, financial crisis, and pandemic—and how they improved the firm’s risk process, research organization, and decision-making through smaller sector teams and peer review. Business of asset management and talent building (Priority: 4/5): He describes the pressures on active managers from fee compression and passive investing, but argues that a strong culture, passion for research, teamwork, and continuous improvement can sustain a successful firm.

Key Arguments: Markets often extrapolate current success or distress too far into the future; value investors should instead estimate long-term sustainable earnings. Mean reversion takes time, so a multi-year holding period is essential for value to work. High earnings and high returns attract competition, making them hard to sustain indefinitely. The best opportunities today are in cyclical businesses where expectations are low and balance sheets have survived severe stress. Many growth and defensive stocks are priced at levels that make future returns unattractive even if the businesses themselves are high quality. Risk should be assessed not just by price volatility but by business quality, balance sheet strength, and governance. A firm with deep sector expertise and peer review can better evaluate complex businesses than a lone analyst. Investor behavior is often the biggest obstacle; overtrading and chasing what is hot destroys long-term compounding. Active management can still win if it is differentiated, high conviction, and clearly communicated to clients. Building a durable investment business requires talent that likes research, competition, teamwork, and learning from mistakes.

Data Points: Firm age: 41 years - Hotchkiss and Wiley was founded in 1980 by John Hotchkiss and George Wiley. George Davis tenure: 33 years - Davis says he joined the firm 33 years ago. Investment team size: 24 investment professionals - Core investment staff involved in research and portfolio management. Research associates: 6 - Additional research associates supporting the investment team. Total firm employees: 64 - Overall headcount at Hotchkiss and Wiley. Average tenure of investment professionals: 16 years - Indicates depth and stability of the research team. Large-cap turnover: 30%-35% - Used as a proxy for a roughly three-year average holding period. Average annual compounded return: 13% - Davis cites the firm’s 40-year average compounded annual rate of return. Large-cap value benchmark return: 11.8% - Comparative benchmark mentioned by Davis. S&P 500 return: 12.1% - Comparative benchmark mentioned by Davis. 10-year Treasury yield peak discussed: 1.7% - Davis notes the yield had been around this level roughly a month to five weeks earlier. 10-year Treasury yield at recording time: 1.25% - He cites the yield as surprisingly lower despite inflation and stimulus concerns.

Pivotal Quotes: "What do you get for the price that you pay in terms of earnings, cash flow, dividends." — George Davis: Summarizing the firm’s core value-investing lens. "We anchor on normal earnings in year five." — George Davis: Explaining the valuation framework used in financial models. "You need to approach things with a bit of humility and not fall in love with your winners and not necessarily shirk away from your losers." — George Davis: On the traits and discipline required of successful investors.

Implications: Listeners should expect value investing to reward patience, discipline, and rigorous analysis rather than frequent trading. The episode suggests active managers can still add value when they focus on price, quality, and long-term fundamentals in a market crowded by momentum and passive flows.