Price is What You Pay, Value is What You Get

Wisdom from an Accomplished Value Investor

We make a point of studying the best investors in the world. This week, we came across a Bloomberg Interview with Chris Davis, Chairman and Portfolio Manager of Davis funds. The full interview can be found in the link above, but if you don’t have time to watch, some of the pearls of wisdom are below.

  • There’s a whole category of people that get excited because stocks have already gone up and then they want to jump in… Stocks have this peculiarity that they’re the only asset where somehow the more the price goes up the more people want to buy them.
  • An investor should recognize that the biggest threat to their generating return over time is their own behavior. And so, if somebody has the mindset of when stocks go up I get excited and want to get in and when they go down I want to get out. That behavior penalty will swamp any other choices they make in terms of whether they picked great stocks, whether they hired a great manager, whether they invested in the great fund. So, what I would say is, if you are prone to these very normal behavioral biases having a great financial advisor who can provide that sort of courage, that fortitude and that patience – an advisor who can modify your behavior – is one of the most important investments you can make now. If you’re wired where you don’t have that investor behavior problem, then that simple systematic investment, putting something away every month, every quarter, every year, will matter so much more than whether you selected the hot manager. You can get in at the wrong time but if you stay in, you can earn your way out. What really matters is the behavior.
  • I think all investing is value investing and if it isn’t, it’s either gambling or speculating and if it’s gambling that means you’re putting up money for something that has a negative return expectation, but you feel lucky. All the rest is about investing. You’re putting up money with the expectation of getting more in the future and that expectation is based on an assessment of the cash flows and the probability of that assessment being validated. So that’s sort of the core of what we do. It’s making an assessment about what the value of the business is, generated by the earnings of the business rather than by a prediction about changing psychology or being lucky.
  • Something that really connects to the way we invest here is this idea that you want to buy something that is an attractive value but if that underlying business has durability, high quality, resilient growth it’s so much more valuable because of  the nature of compounding over time. So if you think of buying [Warren Buffett’s] dollar for $0.50, well imagine if that dollar is growing at 15% a year, then it may be worth $0.75 for that dollar because it has the ability to grow. So, in a sense we always say we’re value investors because the valuation discipline is so central to us, but we want to own businesses that we can own for a decade with these qualities of durable, resilient growth.
  • Often people make a distinction between growth investors and value investors. I would say that is a strange distinction because a company that grows profitably is more valuable than one that doesn’t grow. So growth is a component of value. What I would distinguish from is momentum investing and that’s a big characteristic of the market in the last 10 years. The idea that because something is going up it’s likely to continue going up so I’m buying it without regard to the underlying the value of the business, but with an idea that somehow this pattern will continue.
  • I think the way to think about it is that when you get the valuations getting higher and higher and higher, you need to think about what would have to happen for you to earn a 10% return if you bought the whole business. And when you start breaking each one of those businesses down what you find is there’s some of them where they would have to grow, you know, 20% a year for a decade. They would have to maintain margins above 50%. When you look at how many companies have done that in history, I think it’s about a tenth of a percent of companies in the S&P 500 have kept margins above 50% for more than a decade.
  • I’m certain we’re going to have a recession, I’m just not sure when and that’s a big part of our mindset. If we’re buying a business that we’re going to own for a decade we know we’re going to hold it through some sort of shock in the system. What we would say is that we can’t predict, but we can prepare. We have to be prepared both for the sunny days where we’ll make a lot of progress but also to withstand the storms. Trying to predict the timing of those and reposition your portfolio, we think is a dangerous game.
  • You think about the idea of being right more than you’re wrong… well, for a value investor we think along those terms but technically what really matters is not how often you’re right and how often you’re wrong; it’s how much you make when you’re right. So, I don’t mind that patience, that sort of traditional mindset that says I’m willing to let the value of the business appear over time. I don’t need it all at once. I don’t need the big payoff.

A lot of this may not be new, but refreshing the lessons contained here from time to time helps to maintain the proper perspective when the market is rocketing higher, or crashing lower.

Have a great week!

 

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All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

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By: Adam