Representative Holdings
New Oriental Education is an example of a company that has seen its stock price decline due to trade concerns but that will not be affected by U.S. tariffs in our view, which is why we added to the position in 2018. New Oriental is the largest provider of private education services in China. The company started in 1993 as a test preparation business, but in recent years has shifted into kindergarten through 12th grade after-school tutoring, which is now its largest and fastest-growing business. We believe this is an industry with several long-term drivers of growth, not the least of which is a different cultural approach to children’s education. As a percentage of income, Chinese parents spend more than four times as much as U.S. parents on their children’s education. This spending is driven by a need to bridge the gap between low public spending on education and extremely competitive university admission rates in China. For example, the admission rate for the top 50 U.S. universities is 23 percent versus an admission rate of only 2 percent for the top 39 Chinese universities. Admission into these top universities depends on a student’s performance on the national Gaokao exam. The Gaokao exam lasts nine hours, spanning two days, and tests students’ knowledge of literature, math, English, and science. In anticipation of the Gaokao exam, students start attending after-school tutoring schools as young as kindergarten age, providing a recurring revenue stream for New Oriental Education, which also benefits from a measurable cost advantage in attracting desirable students as a result of the company’s brand name.
While regulation in the industry is increasing and currently weighing on multiples, we believe fundamentals remain strong and regulation will be a long-term positive for both the industry and New Oriental Education, the industry leader. In our view, the company benefits from both a strong reputation and a strong brand, two key competitive advantages in building its business relative to lower quality, lower cost providers. We expect the Chinese education market and New Oriental Education’s market share to grow over time. New Oriental Education currently trades at 20 times estimated fiscal year 2020 owner earnings with a growth rate in the high 20s.
Berkshire Hathaway, run by Warren Buffett, is an example of a top long-term holding of the Fund that has performed well over time through a combination of owning businesses with durable competitive moats, great capital allocation and an attractive starting valuation. Berkshire is well known for its insurance operations, which include the competitively advantaged auto insurer GEICO and the exemplary reinsurance business managed by the talented Ajit Jain. Given their strong operations and conservative nature, these insurance subsidiaries generate a large amount of excess capital that can be invested in equities. Berkshire’s approximately $200 billion stock portfolio represents approximately 40 percent of its market capitalization. Almost half of this portfolio is invested in U.S. financial institutions (most notably Bank of America, Wells Fargo, American Express, and U.S. Bancorp), and approximately $45 billion is invested in Apple stock.
Berkshire’s portfolio of controlled businesses—the most significant of which are the railroad BNSF, the power utility holding company Berkshire Hathaway Energy, aircraft parts maker Precision Castparts, and the consumer products company Kraft Heinz—now contribute approximately 60 percent of the company’s earnings. More than $20 billion of earnings are distributed annually for Warren Buffett to redeploy, and Berkshire is currently holding an unusually high cash balance of more than $100 billion that is also available for investment in higher yielding investments at an opportune time. Berkshire has both the capital and investing prowess to take advantage of any market dislocations, in our view. Berkshire is trading at 15.5 times look-through earnings and 1.4 times book value and continues to be, in our opinion, highly attractive.
One area where the Fund is finding value now is select international financial companies. A good example of a recent addition to the Portfolio is the Development Bank of Singapore (DBS), the largest bank in Singapore and one of the largest in Asia. With 60 percent of the bank’s deposit base in low cost current accounts and savings accounts, DBS has a significant advantage in the cost of funding. In addition to a retail customer base with strong brand loyalty, DBS has increased its competitive advantage and ability to attract low cost deposits by offering sophisticated cash management services for corporate clients and by making wealth management a strategic focus for the bank. DBS has become one of the top five banks in Asia for wealth management services where it benefits from a few structural advantages including domicile in a AAA-rated rule of law country and having Temasek, Singapore’s Sovereign Wealth Fund, as an anchor investor. Aside from its home market in Singapore, DBS is building its presence in Greater China (China, Hong Kong and Taiwan), India and Indonesia. While this development, apart from its growth in Hong Kong, is currently diluting the company’s overall return profile, we think as business efforts in any of those countries increase in scale they will meaningfully boost DBS’s earnings power. Management also had the foresight to see the threat from nontraditional competitors and has invested to make DBS one of the most technologically advanced banks globally. We think its approach to digital banking will maintain the company’s competitive advantage in terms of efficiency and customer retention for the foreseeable future. DBS trades at just under 10 times estimated 2019 owner earnings, delivering a return on tangible equity in the midteens and a 5 percent cash yield.
Conclusion
We believe a key differentiator and long-term advantage for DWLD is our focus and willingness to look quite different from the Fund’s benchmark index, the MSCI ACWI. While this inevitably leads to periods where we are out of sync with the index over the short term, the fact that Davis Advisors has consistently generated successful long-term results for 50 years gives us great conviction in our fundamental, bottom up, long-term approach to investing. As we apply this tried and true investment approach, we are encouraged by the strong competitive positioning and positive business outlook for the companies the Fund owns. We thank you for your continued trust and interest.
Danton Goei is portfolio manager of Davis Select Worldwide ETF at Davis Funds.