Gustavo Ballvé on June 27th, 2014
Food for thought, Mental models

Morningstar has just held its huge 2014 Conference and it has tons of videos in its website. Chris Davis of Davis Selected Advisers reacts to ages-old questions (for instance, of separating “growth” and “value”) in elegant yet decisively “let’s cut through the common notion” way. Beware of “boxes”, “filters” in general, but especially of those that are too narrow or inadequate. Video and my highlights inside, but the above link has a transcript as well.

The video:



Growth vs Value

(When asked if he was “changing styles” because the fund was hovering in Morningstar’s growth “box” for a while): “I feel unequivocally that Morningstar is a force of good in the world, but this is one place where to me, it can be misleading because I think often to investors, they think that growth and value are something different. And of course, a company that grows profitably is more valuable than one that doesn’t grow. My father used to say, he never bought a company that he thought was going to be earning less money five years from now than when he bought it. So, growth is a component of value, and in that sense, I’d say well, we are growth investors because we think about growth as a component of value.

On the other hand, we are value investors for two critical reasons. One is that we think that growth is hard. We think one of the mistakes people make is projecting rosy estimates way into the future. And growth is hard because the economy shifts, the competitive environment shifts, technology shifts, or whatever it is. And the second reason is because the valuation discipline is central to what we do.

We always say we need to adapt to changing times and hold to unchanging principles, and how we assess growth as a component of value is one of those unchanging principles.”

On holding a large stake in “Financials”

(When asked whether the fund’s stake in “Financials” changed since 2008): “Financials often get lumped into this sort of single category, and it’s funny, because I used to say to people, if we had a three-stock portfolio and it had three financials in it, and we had a separate portfolio and it had a capital goods company, one financial, and one retailer, you would say automatically, oh, that second portfolio is more diversified. But if the second portfolio had Home Depot, Toll Brothers homebuilders and Countrywide finance, you would realize it’s not diversified at all. They are all tied to housing, and very closely.

If we look back at that first portfolio of financial stocks and if one of them is Progressive automobile insurance, one of them is American Express, and one of them is Bank Julius Baer in Switzerland, you’d say, well, there are three very different businesses and they are going to be affected by different macroeconomic events.

One will be based, of course, on consumer spending; one will be about auto accidents, frequency and severity with some weather components and the competitive environment with GEICO and so on. And the third will be about private banking regulations, asset management returns, and so on in Europe. So, it would be a very diversified portfolio.”

On stocks vs other asset classes (in developed countries and as of that time)

(When asked if he still felt that stocks were a good choice): “Dan, absolutely. I mean, that’s the thing that drives me crazy. I look at high-grade commercial real estate. And what are the cap rates on these things? 3.5%, 4%, 3.2%. You know, those are pretax cash flow yields from owning a portfolio of high-grade commercial real estate, and yet I can own a company like American Express with a 7.5% or 8% aftertax free cash flow yield. So the whole market, even if it’s, you pick the number, 15 to 17 times earnings, let’s say. So I invert that. Think of the earnings yield as the invert of that.

So, you are starting at a 6% or 7% earnings yield, and then think of the resiliency of the businesses. Because I think one of the things–my grandfather got in the business in 1948, and everybody clinged to bonds, right, because they remembered the Depression, they remembered the crash. And even though the market had come back, right, it was back to sort of a little higher than it was in ’29, people said, never again. I am not going back. I am going to cling to the safety of bonds. They then lost money for 30 years. Year after year after year they lost money in bonds because they didn’t recognize that starting with those low yields created risk.

So, here are bonds at a 33 times pretax earnings multiple. Here is real estate at a 25 times pretax multiple and here are equities at a 15 to 17 times aftertax multiple. And they have that ability to adapt to be global, to innovate, to reinvent that resiliency, which is what I think ought to draw investors to equities.”

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