The Davis New York Venture Fund hasn't missed a step since Christopher Davis took over the helm from his legendary father, Shelby, almost five years ago. The large-cap value fund, which carries a five-star Morningstar rating, has outperformed the majority of its peers every year over the past five years.
Long term, it's hard to argue with the New York Venture Fund's track record. It has grown at a 14.97% annual rate since its inception in February 1969. In contrast, the S&P 500 grew at a 12.24% annual rate. Despite a few tough years in the late 1990s, when it failed to keep pace with the tech-crazed S&P 500, the fund has outperformed that index over the past one-year, three-year, five-year and 10-year periods ending in 2000, according to Morningstar.
The secret to the fund's success lies partly in its patience. Look at its top holdings at most junctures in time, and the names aren't that different from many other large-cap funds that trail the New York Venture Fund by noticeable margins. What differentiates the Davises is their ability to spot good companies when they are out of favor, underpriced and still have potential to experience long-term growth.
Most are well-managed companies with strong brand names and market share. "We are buyers of business," says the 35-year-old Davis.
Few rivals question Chris Davis' abilities anymore. Before taking over the family's flagship fund, he ran Davis Financial, which also earned five stars from Morningstar, and worked as an analyst. Today, he benefits from a small research staff for which most fund companies would happily swap their own analysts. "My father is the senior research analyst," he says. "We want to own businesses with long tail winds, not head winds."
New York Venture Fund always has been characterized as a fund that looks for major themes and ferrets out undervalued companies with at least 10 years of growth potential.
In the 1970s, the fund profitted when it identified energy companies at reasonable prices long before energy stocks zoomed in the middle to late 1970s. In the 1980s, Shelby Davis moved into consumer stocks when the baby boomers began spending money and pharmaceutical stocks as the graying of America gained momentum. And in the 1990s, it was financial services and technology stocks that propelled the fund to superior returns.
So far in this decade, Chris Davis has returned to an old but continually evolving theme and bought into undervalued companies capitalizing on the aging population. It's a bigger trend today than it was two decades ago. He's investing in financial services, drug, global investment banking and, on a selective basis, technology stocks.
"The baby boomers are turning from spending to saving and investing," Davis says. "We want to deal with companies with strong brand names who will be helping them meet their financial goals. These are companies like Merrill Lynch and Charles Schwab. American Express has a powerful brand name. Pharmaceuticals' unit growth is driven by the aging population." The fund also owns some reasonably priced technology companies with growing businesses, like Hewlett-Packard.
Davis maintains the real guts of his operation is analyzing companies. The fund owns only 80 stocks, though it follows many more. Davis and his analysts visit companies on its watch list, and they look for opportunities to buy growth at reasonable prices.
The fund doesn't dump stocks for quick profits, opting instead to stick with companies that keep growing-as long as they are in the fund's fair-value ranges. For example, the fund has held and accumulated shares of stocks like AIG, Commercial Credit, Citigroup and Freddie Mac for more than 10 years. It has owned American Express, Wells Fargo and Morgan Stanley for more the five years.
"We want to get to the heart of a business," Davis says. "What would we pay for the company if we wanted to own it? We want to own a business that grows for a long period of time, a low-cost producer that gains market share, a company that has as high earnings as possible."
Davis scrutinizes a company's income and balance statements to determine what to pay for it. He likes to buy companies that may sell below private-market value. Beyond a strong balance sheet, he looks for good cash flow and reserves and considers a firm's GAAP earnings and how they may be inflated.
This approach differs radically from that of many growth managers who have tried to project a company's growth rate far into the future without questioning its fundamentals or price/earnings multiples. Davis believes a stock's price matters. "The fund looks at a company as if it were buying a bond," Davis says. "We look at the future cash flows. We adjust the company's value by the amount of stock options outstanding to account for dilution. We look at the present-value estimate of the company and buy in a range that represents fair value."
Davis may be young, but as part of a family of legendary investors, he had a head start on many of his contemporaries. His grandfather, Shelby Cullom Davis, was a former New York state insurance commissioner who was worth $850 million when he died.
But the grandson couldn't squeeze a buck out of the old man. Davis recalls working summers as a teenager at the elder Davis' insurance brokerage firm. He remembers one particular incident, when the two were coming back from a meeting of the New York Society of Insurance Analysts at lunchtime. Davis had forgotten his wallet and asked his grandfather for a dollar to buy a hot dog from a street vendor. The elder Davis replied, "Do you realize that if you took that dollar and invested it at 15%, when you are my age the dollar wold be worth $1,000?"
"I learned three lessons from that," Davis says. "The power of compounded interest, the importance of not overpaying and not to forget my wallet."
Today, Davis and his family manage $36 billion. Close to $2 billion is the family's money. In late 1995, he became co-manager of the fund with his father. In early 1997, he took over the helm, and Kenneth Feinberg, 43, came on board as a co-manager. The duo run the family's two flagship funds-the $20 billion New York Venture Fund and the $5 no-load billion Selected American Shares Fund. Davis' father is working behind the scenes doing the research. The funds are run nearly identically.
Despite his track record, Davis has big shoes to fill. His father, now 63, founded the firm in 1963. He has the reputation of being one of the few managers who have beaten the market over long periods of time.
So far, Davis has more than held his own. Aided by Feinberg, he has steered the fund to enviable returns. Over the past three years, the New York Venture Fund has grown at a 14.04% annual rate. It has outperformed its peers and the S&P 500, Morningstar reports.
Davis, like his father, prefers to buy and hold. He loves what he calls "fat pitches," companies that get derailed by a short-term disaster and can be picked up cheaply. "We're in the business of headline risk," Davis says. "We like to buy companies selling below fair-market value due to controversy."
For example, last year he saw Tyco International as a fat pitch. In last year's volatile market, stocks were sold off at the first sign of bad news. Tyco's stock got pounded when a questionably researched newsletter called into question Tyco's accounting policies. The report prompted a Securities and Exchange Commission investigation. The stock collapsed on the news. But it gave Davis the opportunity to buy a growing company cheap.
"We did a tremendous amount of work getting comfortable with Tyco's accounting," Davis says. "We pieced together their regulatory documents and looked at all major acquisitions over the past five years. We worked independently with the company to understand their charge-offs and expenses. We talked to the company's competitors and its suppliers. We concluded the accounting was sound."
The move paid off handsomely: Tyco stock has advanced 40% since the middle of last year. Costco Wholesale is another example of how the fund moves in on bad news. Last year, Costco's stock dropped more than 50% from its high because earnings fell below expectations. The stock sold at $60 a share but dropped to $27. Davis bought 17 million shares that day. The reason: The long-term fundamentals looked good. Sales are rising, and the company is opening new stores. It formed a partnership with American Express. American Express customers spend four times as much as other credit card users. Plus, Costco's customers get a rebate on their card purchases that can be used to buy goods at the warehouse. Costco's stock is up about 15% since Davis bought it in the middle of last year.
The fund also did well buying Philip Morris, Tellabs and Providian on bad news last year. Davis sold technology stocks like Oracle and Applied Materials in the first quarter of 2000. He also cut back on his positions in IBM, Hewlett-Packard and Motorola, taking large profits because he felt the long-term earnings of these companies might be impaired.
While the S&P 500 lost 9.1% in 2000-making it the most miserable year for stocks in more than a decade-the fund managed to gain 9.92%. Still, not all of his moves paid off. Despite attractive valuations, stocks like Gannett, Tribune Media and Martin Marietta Materials declined due to the slowing economy. Lexmark, a printing-company stock Davis favored, flopped. He began buying the company when it dropped 20% from its high. But the stock continued to plunge because of deteriorating business conditions and some operating mistakes.
Meanwhile, positions in AT&T, Motorola and Lucent Technologies caused the fund to lose four percentage points in total return last year. "We were slow to recognize AT&T's strategic vulnerability or anticipate the dramatic deterioration in pricing as a result of competition," Davis says. "We were too easily reassured in our conversations with Lucent about the company's loss of $270 million of cash flow from operations."
Going forward, Davis doesn't believe the next 10 years will be as strong as the last decade. Corporate margins are thin, and earnings have deteriorated. But he says there will be plenty of opportunities to profit if the fund "remains sensitive to the relationship between price and valuation of good-quality business."
Davis acknowledges the fund still carries his father's fingerprints. Almost 40% of the fund's $21 billion in assets is invested in its top 10 holdings. The top 40 stocks represent 85% of the portfolio.
The fund's largest holdings include Tyco International, American Express, Household International, Citigroup, American Home Products, Philip Morris, Wells Fargo, Tellabs Inc., Costco Wholesale and Bristol-Myers Squibb.
Christopher Davis, Ken Feinberg and Shelby Davis meet weekly to discuss the portfolio and review their mistakes. The investment themes may be different today than when the elder Davis managed the fund, but the long-term approach to picking stocks is the same.
"My father says he's not going to pick hot winners," Davis says. "He sees his job as avoiding the big losers. With four decades of experience, he sees a lot of scams and hype. He says to take timeless principals and apply them in a way to reflect current market realities."