Davis Advisors Streetwide Conference Call: part 2
On 29 September 2015, Davis Advisors hosted a conference call with a group of US-based financial advisers. From Davis Advisors were Chris Davis (CD), Chairman, Portfolio Manager and Research Analyst and Danton Goei (DG) – Portfolio Manager and Research Analyst. This is the second of a three-part series.
The portfolio
CD: The portfolio looks nothing like the index. We think that’s going to matter a lot in the years ahead.
We don’t start with the index and then build our portfolio contrary to it. We build it one company at a time, based on the fundamentals; but when we’re in a world where there’s so much volatility, you know, I talked about seeing risk where other people feel safe.
Of course, we also want to see opportunity where other people feel risk. And so when we look at the portfolio today, we simply ask the questions:
- Where are we seeing opportunity?
- What are we doing, what are we buying?
The first category of companies is ‘quality on sale’.
United Technologies and Monsanto are new additions to the portfolio. They’re companies we’ve known and studied for a long time; they go on sale, we want a chance. Buying those today was no different to buying the defence contractors years ago when everybody was worried about defence cuts. We look for those opportunities when quality goes on sale.
A second category we look for is the concept of the ‘new’ blue chips. Davis Advisors has a history of buying companies that ultimately disrupted an industry.
DG: For example, back in 2000 I was responsible for media stocks. Over time, our research led us to sell the newspapers but look at the opportunity, and eventually invest, in Google. We didn’t get in at the IPO in 2004, but we started investing in 2007 and then subsequently kept adding it on dips going forward. And that’s been a big contributor over the past seven-eight years.
CD: Google has been a huge contributor, and now people aren’t so startled to see Google in the portfolio. They think of it more as a blue chip. I will say, once a company is being investigated by the Monopolies Commission, usually it’s become a fairly entrenched business!
Just in the last year or two we sold Bed Bath and Beyond. It was a wonderful company that we owned for a long time, but we recognised the disruption that was coming through Amazon and we bought Amazon.
It was the third time in our history owning Amazon and I wrote about it in the annual report this year. I focused on how we apply the value discipline to look at companies where GAAP (Generally Accepted Accounting Principles) earnings may not reflect the economic power of a company, like in the old days of cable or broadcast companies.
Switching a traditional retailer like Bed Bath and Beyond into Amazon, again, fits into that category of new blue chips.
The third category of companies is those under attack, under-owned, unloved, and even those that are under-earning.
The first example is financials.
Our financial weighting has varied over time. It is a sector where we have a lot of conviction, a lot of insight, and we’ve added a lot of value over time. We have done that in times when the sector has been unloved and the times when the sector has been loved.
We think the real opportunity now is that financials remain hated at a time when the underlying businesses are so much stronger; the models are non-obsoletable, they’re compounding machines.
Culture is a defining difference. They’re safer than they’ve ever been in my career, as measured by credit quality, by capital ratios, by reserves.
They’re cheaper than they’ve been in my career when I look at the relative valuation compared to the average company.
So they’re safer. They’re cheaper. They’re earning more. And, of course, they’re hated. As a result, we’ve built up our positions in companies like JP Morgan. Wells Fargo remains a core holding.
One of the things we like about these companies is although they’re very profitable now, they are under earning because of the low interest rate environment. We’re getting a lot of earnings per dollar invested, but we’re also not paying for peak margins.
We worry a lot about what could bring down earnings of companies we own, and we love owning companies where the outlook is for earnings to be higher in future years rather than at risk.
Financials are at the centre of that under attack, undervalued, unloved category. In a sector like financials, there’s a lot of danger to just automatically buying the biggest companies. We think that the portfolio has been able to outperform for so long because it doesn’t look like the averages.
Another sector in this category is Energy.
DG: Energy fits the bill of unloved and looks lousy right now. However, we’ve been able to add value with Energy and it has been a big contributor portfolio in the past.
One of the big drivers of that performance was Kent Whitaker, an energy analyst. He left in 2006 but luckily for us, a year and a half ago, we managedto lure him back. The timing is perfect now energy is on sale again.
The first thing we look for in an energy investment is downside protection. We want to own companies that are low-cost producers because the lower your costs, the more protection you have, the greater your opportunity to remain profitable, even when prices are down.
We also want to own producers that can grow their production at those low costs; even when the price stays constant, we will get growing production, which drives growing earnings. That’s the second thing we look for.
Third, we want long life reserves. We want the ability to grow production for a long, long period of time – years, if not decades, of production.
Fourth, we want companies located in a place where we have greater regulatory conviction. In other words, we would value reserves differently in Algeria than we would in North Dakota.
Finally, we think about the infrastructure – not just the existing infrastructure, but the infrastructure in the pipeline to move those reserves out. Our two biggest investments in energy have been two very focused companies, Ultra Petroleum and Encana. They both checked all of those boxes.
We started building these positions at a time that prices have come down, but we are very excited about the fundamental positioning of these companies, and we think they will do fine in a low rate environment, and very, very well if in a higher price environment.
Note: companies referenced herein are holdings in the Pan-Tribal Global Equity Fund, but do not constitute a recommendation to buy, sell or hold such security.