Christopher Davis interview
KAREN GIBBS: It was almost exactly five years ago that the greatest bull market America has ever seen came to sudden and painful end. The tech fueled Nasdaq hit a record high on March 10, 2000 -- then proceeded to fall by more than 78 percent. Investors have been struggling to find their way ever since. One example of that quest for the next big thing can be found in mutual fund data: of the $261 billion that flowed into stock funds during a recent week, more than 90 percent of that money landed in international funds. And no wonder -- General Electric recently told shareholders that most of its growth over the next decade is expected to come from developing countries.
Recognizing when trends like this are just passing fads or fundamental shifts in the market is something Christopher Davis, portfolio manager at Davis funds has excelled at for years.
Well, Chris, the numbers of dollars that are flowing into non-domestic funds, is that a trend or is it a fad?
CHRISTOPHER DAVIS: Well, it shows that people's memories are short. You know, this is the sort of thing that happens every few years, and people forget that investing directly in foreign markets, particularly developing markets, is enormously risky. Different regulatory environments, different accounting standards, different disclosure requirements, and different business models that are generally less stable, less stable currencies. I think you mentioned General Electric, and maybe that's a better way to invest in the developing economies is to own these global multinational leaders that are deploying their capital in those markets to take advantage of it. You've got the growth, but a lot less risk.
GIBBS: Are there some other large multinationals that are poised to take advantage of the explosive growth overseas?
DAVIS: Well, there are many companies that are U.S.-based companies that earn more than 50 or 60, even 70 percent of their money outside the U.S. Of course the well-known ones like Coca-Cola and so on, but a lot of people don't realize that AIG, American International Group, was founded in Shanghai in 1919, so it has very deep roots in Asia and remains the dominant foreign life insurer in Asia.
GIBBS: Well, when you mention AIG, they're under just a little bit of a cloud here. In fact, a lot of the insurance companies are. And individual investors are bombarded constantly with noise, whether it is news of scandals, corporate scandals, whether it's energy prices or Greenspan's interest rate conundrum. What are we supposed to do with all that noise?
DAVIS: Well, it's important to try to filter out the noise and also to recognize how much we react. When times are optimistic and things are going well, people feel more willing to invest. Of course those are the same times that prices are high and therefore returns are going to be the worst. Warren Buffett once said that optimism is the enemy of the rational buyer, and that doesn't mean that you like times that are pessimistic, but you like the prices that pessimism produces. So we like to look at industries that are under a cloud, look at things that seemingly are unpopular or maybe even tainted by a scandal, produces a low price and therefore a better opportunity for future returns.
GIBBS: You mentioned pessimism and how people want to invest when it's optimistic. Your grandfather had a very interesting quote. He said, "You make most of your money in a bear market. You just don't realize it at the time." That sounds like a conundrum in itself.
DAVIS: That's a wonderful quote, and I actually have it framed on a card on my desk when he first mentioned this to me. It's powerful for both sides of it.
First of all, this idea if you make money in a bear market. Well, what he means of course, it's not that your portfolio goes up in value, but that you're buying businesses at bargain prices. Then the value will out over time. In better times you'll realize what a terrific opportunity you had to buy these world class leading companies at bargain prices because there was pessimism. But then he added you don't realize it at the time, because of course at the time it's hard to be immune to the pessimism, to see all of the concerns in the world.
You mentioned earlier the noise. You know, you think about the best year for the S&P 500 in the last 30 years was 1975. The market rose over 37 percent. Nobody thinks of 1975 or in fact the latter part of the '70s as a good time to be invested, and yet the market more than doubled in that five-year period.
GIBBS: It's interesting, because that philosophy that your grandfather, who founded the Davis funds, espouses has gone through the whole family of funds there. Now when you look at companies, it's like everybody wants to buy a high-quality company at value prices and hold for the long term. Easily said, but very difficult to do. How do you proceed with that? What's your philosophy?
DAVIS: Well, investing is a combination of in a sense the mind for analyzing businesses, but ultimately the most important organ for investing is the stomach. You know how difficult it is to buy Tyco when it's under the cloud, it's fallen from $65 a share down to a low of $8. Well, of course the headlines are full of announcements comparing Tyco to Enron, WorldCom, Global Crossing. But what's interesting about that is three of those companies were bankrupt, and Tyco at its dead low had more than $16 billion of equity market capitalization, enormous cash flow.
So what you try to do is find the times when a company is mislabeled or mis-categorized. That is the best opportunity to buy these quality companies at a discount price. So there was Tyco, now perceived to be a good quality, cash-producing company, there thrown into the same garbage pile with these other bankrupted, corrupt enterprises.
GIBBS: Are there other factors that create great buying opportunities other than disasters?
DAVIS: Sometimes there's boredom. My father liked to say boring is beautiful. You know, dull businesses like aggregates, which is a fancy way of saying gravel. You know these businesses have produced generations of millionaires compounding away. Businesses that are packaging companies.
A company we own is Sealed Air, a wonderful packaging company that makes bubble wrap.
Well, these are dull businesses. They don't attract glamorous, high-profile analysts, but yet they're compounding machines. So scandal is one way, what we call being long controversy. Another way is looking at those companies that are out of the spotlight, or companies that are simply dull. Those all can create good opportunities, if you're buying things that you can hold for the long term.
GIBBS: And your long term is what?
DAVIS: Well, our turnover is single digits last year, I believe. So we tend to own things for anywhere between 5 and 10 years. We think that creates, you know, our family, our directors, our employees are the largest shareholders of the funds that we manage.
GIBBS: So you're putting your money where your mouth is.
DAVIS: We eat our own cooking. And we think a lot about after-tax returns and we think about commission costs. And so we think low turnover is a way to win on two counts. It keeps commission costs low. It also improves after-tax returns. So our turnover tends to fluctuate between, you know, 8 and 10 percent up to a high of about 30 percent over the last five or six years. So it's a fairly conservative, long-term approach.
GIBBS: And when do you sell?
DAVIS: Well, of course selling is always a difficult question. The ideal time to sell is when a business that you bought during a time of controversy and you've owned during a wonderful flowering period simply becomes grossly overpriced. I think a great example is what happened to Coca-Cola. When it was purchased by people like Warren Buffett in the late '80s, it was a wonderful bargain investment. By the end of the mid to later part of the '90s, people thought it could never go wrong. It traded as high as 35 times earnings. Well, of course that was a disastrous time, and the stock is still far lower now than it was then. It's been the same company all along, but at periods it was undervalued and at periods it was significantly overvalued. Those overvalued times are the ideal time to be a seller.
GIBBS: How about following the crowd? A lot of people say you can't make money following the crowd and you should be a contrarian. What's your position?
DAVIS: Well, I think that being a contrarian is necessary for success, but not in a knee-jerk way. Sometimes people assume that because something is popular it must be overvalued. That's not necessarily true. In general the market fairly values businesses. That's why the market is fairly efficient. So you've got to look for the anomalies, the times that people think a company walks on water and the times maybe that they can do nothing right. And those are really the times where portfolio activity takes place.
But following the crowd can be a dangerous thing. You know the media, the spotlight tends to fall on companies, even investment managers, that have wonderful three-year records. People pile in based on the last period of good news and are there for the comeuppance at the other side, and that's a disastrous pattern and one we talk to our shareholders a lot about because it's a very human tendency to want to own what's already gone up and to want to sell what's already gone down. That's a very destructive investor pattern.
GIBBS: How about the role of media in touting -- I'm not sure if I should quite use that word, though -- but actually suggesting stocks? Should we be listening to that?
DAVIS: Well, I'm not sure this is the best forum for me to say anything about the media that's not friendly, but it is true that, you know, the media business makes money, not by picking stocks that go up, but by selling magazines or selling advertising, getting viewers. So that's a different business model, so what they have to do is they sort of have to present what people want to hear, what people want to watch. So when stocks have gone up a great deal, people have a great interest in why those stocks have gone up so much and what's the new fad, the new mania. So the business magazine covers are full of recommendations, often corresponding with things that have already happened, the stocks that have already gone up.
So I think talking about individual stocks is a dangerous pattern. You're not there to tell the viewer or the reader when to sell, even if you've told them when to buy. And of course the world changes all the time. So I think talking about individual stocks can be dangerous.
On the other hand, I think FORTUNE in particular does an outstanding job analyzing businesses. Carol Loomis' recent piece on Hewlett-Packard was just masterful and very substantially valuable and better than anything I've read on Wall Street in many years.
GIBBS: So when you are looking to invest your money, what do you look for in a company or in a sector?
DAVIS: Well, we really divide the investment equation into two simple equations, two simple questions, and they're the same questions that you would ask if you were buying an entire business for your own, for yourself.
You would say first, what kind of business do I want to own? What are the characteristics that I'm looking for in that business? Is it run by honorable people? Do they communicate with me honestly? Are they fairly paid? Is it a good business that generates good returns on capital? What are the competitive advantages of that business? Why are those returns sustainable? Do they have brands or patents? Are they low-cost producers or market share leaders? What is it that is the moat around protecting that business?
All of that is the first question, and then the second question is how much do I pay for it? Because a great business can be a terrible investment if you overpay for it, and similarly a bad business can be a good investment if you buy it with enough of a margin of safety in the price. So valuation is the second part of the equation, and there you're trying to get away from just the gap P/E ratios, these book values, simplistic rules of thumb that are thrown around and really trying to look through at what we call the owner earnings of the business. How much, if you owned the entire business, how much cash that business generated at the end of each year after reinvesting enough to protect their competitive position.
So that's the investment process that we go through, and it makes it hard to squeeze us into a style box, are they growth, are they value? You know, growth is an important equation in valuing a company. Growing companies are worth more than companies that don't grow, but it's only one part of the equation. So we try to factor all those into our valuation.
GIBBS: And we are looking, all looking for growth at reasonable prices. What are some of your top holdings?
DAVIS: Well, the top of the portfolio includes companies like American Express, that we purchased after they had lost market share for about 10 years in a row.
They had a new CEO, Harvey Golub coming in, focusing on the core brand, the American Express card, and reinvigorating that brand, and then succeeded by the wonderful Ken Chenault who has just done a first class job. It's one of our largest holdings.
Berkshire Hathaway -- how can you resist investing with one of the greatest business minds in history, Warren Buffett?
And there are wonderful franchises within Berkshire Hathaway, and it's a difficult business to understand. People aren't sure. Oh, it's a very high-priced stock and so on. So we own that.
We own a big position in Tyco, which I mentioned earlier.
We had bought some at high prices and were embarrassed by the mistake of having overpaid and misjudged that management, but we were also able to buy a lot during the crisis, and that's the sort of model that we want to have. So those are the types of companies that we own at the top of the portfolio.
GIBBS: You talked a lot about management. Have you noticed a change in corporate America post-Sarbanes-Oxley?
DAVIS: Well, we think a lot about corporate culture. Now that doesn't mean we don't get fooled. My father once said to me, you know, good judgment comes from experience, but experience comes from bad judgment. So we've had some bad judgment in the last five or six years on managements, but in general we think a lot about culture.
When you think about a company like the mortgage lender Golden West Financial, run by a husband and wife for over 30 years that have just been first class people in how they communicate, their behavior doesn't need to change one bit.
Progressive Insurance Co. in Ohio, wonderfully ably managed, honest with their shareholders, with their customers, with their employees. Their business model, their management tone doesn't need to change. Their business practices don't need to change.
So if you're successful with the type of companies you own -- Costco, run again by Jim Sinegal, a wonderful board of directors, good communication -- if you're successful in picking them in the first place, they don't need to change a thing.
Companies that have very complicated business models that maybe were built around the idea of thinking about earnings guidance and producing results that were very predictable, that's a much more complicated question, because one, businesses all earnings numbers require a certain amount of judgment, the complexity of these businesses, how the auditors deal with them. I think that there have been changes, and I think managements are certainly more conservative and more worried. I think that can be a good thing, but you have to be careful. You don't want to lose the entrepreneur, the Sandy Weill that was able to start with a little consumer finance company and built it up into what eventually is now of course Citigroup. And you want to be careful about stifling that entrepreneurial spirit and that attitude that deals with substance, not necessarily always with the minutia of form, but focuses on substance.
GIBBS: Chris Davis, great having you in the studio. Thanks for joining us.
DAVIS: Wonderful to be here. Thank you.
Bull market for jobs
GEOFF COLVIN: Believe it or not, we've got a bull market in jobs in America -- after the so-called jobless recovery, people are now going to work in big numbers. But the phenomenon is much hotter in some places than others. In fact, certain industries in certain cities are so hot, pay is practically exploding. Like what, like where? Paul Kaihla of Business 2.0 magazine has done the research and publishes the results in the latest issue.
Paul, I was amazed by some of these salary increases. Now in technology, I would have thought that the hottest job market still was someplace in northern California. You say no. Actually Washington, D.C., which you say in fact has the most intense worker shortage in America. How come?
PAUL KAIHLA: Yes, almost in any category, and Washington never really had a recession. And right now in Fairfax County the unemployment rate is 1.8 percent. There's a million people living there, so that's how hot that economy is. But the confluence of IT services growth, defense spending, the homeland security industry, has created this incredible demand for IT workers, especially after you have a security clearance or if you have technical knowledge and project management experience. I mean those salaries are exploding.
COLVIN: Now in another part of the country, you cite the healthcare industry in south Florida, and of course that area has a rapidly-aging population. But we've known that forever, so what gives?
KAIHLA: Well, Florida really led the country out of the recession. Many of those cities in Florida were a year ahead of the national averages in terms of job growth, and places like Gainesville have an unemployment rate of under 2 percent. So they've had this population growth all during the down economy, and that population growth is really weighted to people in retirement age or near retirement age. And so for very select occupations in healthcare, it produces these double-digit wage increases. So pharmacists who were making, you know, in the mid-$60s a year ago are now making more than $80,000, and that's just at hospitals. If you look at retail chains, pharmacists out of school can be making over $90,000 in south Florida.
COLVIN: One more surprise, in Southern California, I would have expected the hottest salary growth to be somewhere in entertainment, in film production or something related to that, and in fact they are very hot. But you found the hottest salary growth was in a completely different industry that really surprised me. What was that?
KAIHLA: It's a subset of the entertainment industry, and that is videogames, which are expected to double in sales from now to 2008, the next three years. So these companies like THQ, Capcom, EA, they've right now got hundreds of job postings, and a lot of these titles are things like senior game producer, senior game designer, artificial intelligence programmer.
COLVIN: Right. You know. Let me ask you about job growth and the job situation in general, because if you hear people talking about it, there's a sort of bad news overlay that seems to influence what's said, and yet the unemployment rate now is 5.4 percent nationally, by any historical standard, a very low number. So what's the explanation?
KAIHLA: I think a lot of it is a hangover from what I like to call the buyer's market for workers. That's where employers could hire the best people for cheap and work them like slaves because they were afraid of losing their jobs. Very different from the bubble economy when employers complained that they had to pay a ton of money to get someone to come in and sit down and do nothing all day, and that person wasn't even that skilled.
We see this buyer's market for workers finally coming to an end, and these spot shortages that we outlined in the story are the very first places where it's coming to an end and very strongly. You can already see it in the BLS data, because in January of last year only 41 cities had unemployment rates under 4 percent. Today that number is 106.
COLVIN: Well, under 4 percent is a very, very tight labor market for sure. But what we've heard so much about, especially leading up to the election, is the phenomenon of offshoring, and it got blamed for a lot of the admittedly slow job growth during the first part of the economic recovery. Is that a phenomenon that's going to hold down job growth now? Or is it not as significant as we were led to believe?
KAIHLA: A phenomenon that's completely misunderstood, and I happen to know from economists who advise Democratic presidential candidates that it was a strategy of the Democrats to try to pave the road to the White House on that offshoring issue, and that's why they very successfully planted that message last year. And of course now with the election over, do you read headlines about offshoring much anymore? No, they're gone.
Really what we went through in this down period for the labor market is what I like to call the productivity recovery. That's really what displaced the demand for new workers. But now that growth rate has really come down. We're at 2 percent in the last quarter, and it could be even lower in 2005.
COLVIN: On the whole, it sounds like your message to people who are either looking for jobs or looking to improve their pay is a hopeful message. Is that fair?
KAIHLA: Yeah, I've pretty well taken a contrarian stance to these doom and gloom stories over the past year and a half, and I've always seen these positive trends emerging in the economy. And another thing that's happening that very few people comment about is the constraint on the growth of the American workforce, which means that we don't need blockbuster GDP growth for the second half of this decade to produce extremely tight labor markets.
COLVIN: Paul Kaihla, thanks for your insights.
KAIHLA: Thanks for having me.
NEXT WEEK: Jeremy Siegel
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