The transcript from this week’s MiB: Chris Davis, Davis Selected Advisors, is below.
You can stream/download the full conversation, including the podcast extras on Apple iTunes, Overcast, Spotify, Google, Bloomberg, and Stitcher. All of our earlier podcasts on your favorite pod hosts can be found here.
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VOICE-OVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast I have an extra special guest. His name is Chris Davis, and he is Chairman, Chief Investment Officer and one of the longest tenured managers at Davis Advisors. They really are a fascinating company. They run over $20 billion and have been running money for the same families for a long time. And much of the money in those portfolios are their own. They’re not quite a family office, they’ve been on mutual funds, shop for over 50 years, but it’s always nice to talk to people who eat their own cooking.
If you’re at all interested in value investing, but value in a way that doesn’t limit companies like Amazon or Google or Apple, you’re going to find this to be a fascinating conversation. So with no further ado, my discussion with Chris Davis.
VOICE-OVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: My extra special guest today is Chris Davis. He is the chairman and CIO with Davis Advisors, launched in 1969 to manage separately managed accounts, eventually moving into mutual funds and now ETFs. Davis Advisors manages over $22 billion. Chris is also on the Board of Directors of Coca-Cola and is the Co-Vice Chairman of the Museum of Natural History located here in New York City.
Chris Davis, welcome to Bloomberg.
CHRIS DAVIS, CHAIRMAN AND CIO, DAVIS ADVISORS: Thanks so much, Barry. It’s good to be here.
RITHOLTZ: So let’s talk about this industry we’re both in. What was the business like when you joined? Davis Advisors was already an existing company, wasn’t it?
DAVIS: Yeah, I mean, I feel in a way I’ve gone through the full lifecycle of the mutual fund industry. I — I came into it at a time when nobody cared, and then there was a period of time when everybody cared and now we’re back to a period of time when nobody cares. So it’s been a — a long cycle.
RITHOLTZ: When did you start?
DAVIS: I started in the business in 1989 as a accountant at State Street Bank. And then I went to work for a Japanese-American firm, Tanaka Capital Management, and then came into Davis Advisors in 1991.
RITHOLTZ: What was your role in ’91?
DAVIS: Well, it’s funny. I have — working at Tanaka, what I was really passionate about what S&Ls. And — and the reason I was so interested in S&Ls is, if you remember, we were in the midst of the S&L crisis …
RITHOLTZ: Right.
DAVIS: … and I was an analyst, a financial analyst at this buy-side firm. And what struck me is — I don’t know if you remember the movie “It’s a Wonderful Life.”
RITHOLTZ: Sure.
DAVIS: But I kept thinking in all of these headlines about the S&L crisis, there must be a few bailey (ph) building in loans out there, good companies with good loans that are going to come through this time and be value creators. So in all the headlines with Bank of New England failing and all of that, I was passionate about it.
And I think in my old firm there wasn’t quite as much enthusiasm. And when I spoke to my father and talked about coming over to Davis, one of the things we decided is because the firm is called Davis Advisors, there’s a risk that the employer of last resort for people with the same last name.
RITHOLTZ: Right.
DAVIS: And so I said, “If I come in I want my own report card. I’m a banking financials analyst, how about if we start a financial fund?” And so in 1991 we started the Davis Financial Fund.
RITHOLTZ: Was that a distressed asset fund or just a world — a hybrid, a little (inaudible)?
DAVIS: Well, I will say we never intended to be distressed investors, but we became distressed investors from time to time. But no, it was a straight mutual fund but with the idea that we would focus entirely on financial stocks.
And my grandfather had a great phrase, he called “good financial companies, growth stocks in disguise.” He said that they can compound for generations, and yet they’re often valued as if they have no growth.
RITHOLTZ: Right.
DAVIS: And so that was the premise of the fund. They have been running it for 27 or 28 years, but that was the way for me to have my own report card, in a sense, independently of all of the other fears of being employer of last resort.
RITHOLTZ: So for people who might not have been around during the S&L crisis, thousands of — of these S&Ls went belly up, right? A lot of babies were thrown out with a lot of bath water.
DAVIS: Well, you know, one of the great things about starting then is, in a way, the financial crisis was sort of a significantly amplified version but had a similar shape. There were crazy government policies. But the S&L crisis was primarily about commercial real estate.
RITHOLTZ: Right.
DAVIS: We might come back later to the fact that often credit cycles have this diurnal or alternating characteristic. What hurt you last time is usually not what hurts you the next time.
RITHOLTZ: Right.
DAVIS: And as we all know, in the financial crisis, commercial real estate was a sort of a safe place to be. But back in the 80’s, you had looked through office buildings, you had corruptions, you have the Keating Five, you had government hearings and, you know, a lot of reform that came out of that. But you’re absolutely right, the fundamental lesson was the business of banking, the business of making a spread on money, making loans, taking deposit is maybe the — the world’s second oldest profession.
(LAUGHTER)
And that doesn’t go obsolete. And in these cycles, what’s happened is the irrational, irresponsible players get wiped out, the whole industry valuation tanks. But what you realize is, at a fundamental level, the survivors are actually advantaged by the crisis because now there’s less supply, less competition, more rational environment. Often, the regulatory environment has raised modes, cheaper stocks, so that was what this layout was in 1990 or ’91 when I came in and started our financial fund. And in a way, it’s exactly what I see today.
It was just the financial crisis was an amplified version. It’s taking longer for this sector to regain credibility, but I think we’re looking at the same sort of decade ahead that we had in the 90’s where these will really be compounding machines.
RITHOLTZ: And to put a little flesh on those bones, we’re recording this on a morning where J.P. Morgan just reported earnings. They literally reported the best year’s earnings ever in bank history.
DAVIS: Yeah, $8 billion a quarter is real money. You know, and yet what is the perception? You know, the perception is, oh, my god, you know, the — the London Whale. I mean, you know, this is — this whole thing, this could crumble at any site (ph). You know, the London Whale was — was like six weeks’ worth of earnings. You know, it’s amazing.
And — and one of the most interesting things about that, and this is really a lesson. When all banks, all companies, whatever company you own, if you have a long-term time horizon, it’s going to go through a crisis, right?
RITHOLTZ: Right.
DAVIS: It might be new Coke, it might be the salad oil scandal, it might be, you know, Microsoft’s hearings and the — they’re going to go through a — a crisis. And one of the things to really look at is what is the management response.
RITHOLTZ: So let’s get a little more granular on that. We’ve seen fortress Dimon respond to a number of crises, whether it was the purchase of J.P. Morgan or the London Whale or LIBOR or any of those things, and they’ve managed to come out pretty well.
On the other side of the Street, Wells Fargo, they seem to be stuck in a rut one P.R. nightmare after another. They can’t get out ahead of the force-place insurance and — and the phony accounts, and it’s just 11 years after the crisis. They’re still fighting not just the last battle, the last war, how come they can’t seem to get ahead of what is just an endless parade of bad P.R.?
DAVIS: Well, you know, Bill Gates famously said success is a lousy teacher.
(LAUGHTER)
And — and, of course …
RITHOLTZ: True.
DAVIS: … if you look back at Wells Fargo, Wells Fargo was certainly maybe the best positioned and managed the financial crisis better than any other institution. It was partly the nature of their business, but it was partly going all the way back to when we first bought the original Wells Fargo when I started my financial fund back in the early 90’s. You know, it was a company that had an outstanding credit culture, a rational discipline around costs and a lot of common sense in the place.
RITHOLTZ: Right.
DAVIS: And they did the merger with Norwest, which was really the surviving institution. But that culture sort of persisted. And, you know, the old saying is you get more trouble with a good premise than a bad premise.
Well, think about Wells Fargo’s premise. It was very plausible, right? People hate walking into a bank. They love walking into a store. Why? Well, people help them. They help solve their problems, they’re not bureaucratic.
And — and, you know, Norwest — and then ultimately Wells — took this basic idea of viewing their branches at stores with sales people that are there to help you, that are paid commissions. And they recognize that if customers get multiple products with one brank, the customers are happier and the banks are more profitable. The customers are stickier. It’s sort of a win for everybody. So that works for a long time. It carried them through the financial crisis really without a blemish.
Well, of course, over time, they pushed that model too far.
RITHOLTZ: Right.
DAVIS: Right? Eventually, customers have enough products, right? They’ve got three or four accounts. They don’t need a fifth.
Well, rather than simply accept this, the sales force, that was down in the trench levels in some of the businesses, started to cheat. And I would say it would be the equivalent of going into sacks and the commission salesmen there sells you a pair of perish shoes, but he wants to sell you, too, you only want one. So when you leave, he takes your credit card, runs a second pair through, but instantly refunds you. So there’s no cost to you, but what he’s done is so deeply wrong, deeply …
RITHOLTZ: Right.
DAVIS: … unethical, especially for God’s sakes if you’re a bank. So this was happening because of a botched incentive system because it works so well.
But then to quote the wonderful legendary D.A. of our hometown, Bob Morgenthau, it’s not what you do that gets you in trouble, it’s what you do to cover up what you do that gets you in trouble.
(LAUGHTER)
And, of course, what happened is as news of this perked up, Wells buried it. The management didn’t want to know. They underreacted …
RITHOLTZ: Right.
DAVIS: … and that’s put us where we are. But you contrast J.P. Morgan and Wells, and those are two of our largest holdings.
And the reason is, right now, J.P. Morgan can do no wrong. And in a way, it is taking a long time for it to build this credibility. Wells Fargo used to have that credibility. They can do no right. So Wells Fargo is now one of the cheapest of all the banks.
Well, look back 10 or 15 years, who was in the penalty box, right? Well, we know Bank of America, Citi, right? Those two were two of the best performing banks last year.
So companies like people learn from their mistakes. They’ll get it right. They’ve got new management and sooner or later, the cloud will lift and you’ll get ultimately the multiple expansion that comes from people instead of viewing it as a below average bank, it’s viewing it is average. So we’ve been buyers of Wells through this. We think their behavior was terrible, their reactions were terrible, but we also know that they’ll get better.
RITHOLTZ: Quite fascinating. Let’s talk a little bit about your portfolio construction process. A lot of people these days use a lot of computer power to start out with screens, either be they positive or negative. How do you begin the process of creating a portfolio?
DAVIS: You know, I had a — a — a meal with Danny Kahneman quite a while ago at an investor event. And I was sitting next to him and we’re talking about investing. And he said, “Well, as far as I can tell, you’re in the manufacturing business.”
(LAUGHTER)
RITHOLTZ: Right.
DAVIS: And I said, “What — we’re not. You know, what are you, an academic or not in the manufacturing business? You had not won the Nobel Prize at this point.” So — and he said, “Oh, you’re in the manufacturing business.” I said, “Well, what do we make?” And he said, “Decisions.”
(LAUGHTER)
And he said, “If I were you, I would break down the process of making a decision into as many steps and inputs that are measurable as possible and, over time, really look at where the value add, where the value taken away.”
So when we start with thinking about investing, we think about it from the point of view of decisions. We break down the process into these big areas, right? There’s the sourcing of ideas, then there’s exactly what you were asking about, the sort of portfolio construction, the investment decisions. And that includes what you sell, what you buy, opportunity cost, relative weightings and so on. And then there’s, of course, the constant ongoing reevaluation of the portfolio in light of changing prices and changing data, right, because you have new inputs every 12 weeks and sometimes more often than that.
RITHOLTZ: Right.
DAVIS: And so, you know, we start with the view that our number one job is to build generational wealth, right? We — we really think about, you know, the clients that are with us, many of them have been with us for decades. And so we start with the idea that we want to own a business for a long period of time and, therefore, the return on the business is not going to be driven by us trying to predict the future P/E ratio or, you know, what it’ll be in a take-out or a break-up. What we’re really looking at is the earnings that business will generate relative to what we paid for it over time, and those earnings will drive our return.
RITHOLTZ: So you’re not thinking about it in terms of stock or little pieces of paper relative to the company, you’re thinking about the underlying business and what that future cash flow is like?
DAVIS: Yeah, I mean, imagine if you bought an apartment building, let’s say you paid $10 million for an apartment building, and that apartment building was generating $500,000 of cash flow after reinvesting enough to keep the roof, and the furnaces, and the tenants all happy and so on. And if you bought into that, you’d sort of say, well, I guess, I’m starting at sort of a five percent earnings yield.
RITHOLTZ: Right.
DAVIS: Now if, 10 years from now, that apartment building was generating $2 million of value, you don’t need to go out and get the apartment appraised to figure out that you’ve done quite well, right?
RITHOLTZ: Right.
DAVIS: You’re making a lot of money not just because you’re getting a check for $2 million a year or 20 percent of what you paid for it, but also should you decide to sell the building, you know that an asset that generates $2 million a year is way more valuable than one that generates $500,000. People forget because stocks wiggle around and are priced every day that if they viewed them the way they view that apartment building, they would feel a lot calmer when there’s all these gyrations and stock prices going up and down. So we think a lot about earnings yield on cost as sort of the way to build wealth and measure that wealth creation overtime.
And so when we start to portfolio, we’re agnostic about whether we’re buying an apartment building or a pizzeria or a hotel or a office building, we’re buying a whole range of different types of businesses but all with the same mindset. Will the earnings that business produces over time build wealth not over three years or five years, but over 10, 20, 30 years? And that sort of mindset allows us to be open-minded whether we’re looking at United Technologies or Berkshire Hathaway or Wells Fargo, we can look in a sense at cash across all of those businesses and look at that growth over time as the creator of wealth.
RITHOLTZ: And I find it interesting you used an apartment building as a metaphor. I’ve talked about this in the past. If your house where you live in was priced daily, I think people would lose their minds over the day-to-day fluctuations. You can ignore it because it’s not priced daily. It sounds like you approach owning individual equities the same way.
DAVIS: Yeah. I mean, if somebody came up to — with that, you know, apartment building you paid $100 million for and it’s now earning $2 million and they said, “Hey, I’ll give you $5 million for it.” You wouldn’t be depressed, right? You would — you just feel like …
RITHOLTZ: You’d laugh at it.
DAVIS: Well, that seems a little silly, so I’m not interested. And so, in a sense, we start with this mindset of building wealth over the long-term, and in this way, we always say we’re absolute return investors, right? We view it as if we’re buying the entire business. We look for the returns to be driven by the cash the business produces over a long period of time.
And that, in a sense, quiet things down. And the more clients look at their portfolio when they see these companies, even when the prices are gyrating, if they can look through at the underlying business, it creates a much greater sense of equanimity in the face of, as you say, gyrating prices.
RITHOLTZ: So you began as an analyst while covering finance firms, you’re now a portfolio manager. What’s the work flow at your office like between the analysts that work for Davis Funds and you as a portfolio manager?
DAVIS: Well, I mean, I learned from the best because I — I learned from my father. And on my father’s business card it said “analyst” and mine would be the same. I mean, we have a small team. You know, they’re only eight or nine of us. We’ve been together a long time on average.
And what we say is that, you know, the portfolio manager has to be the lead analyst on every company we own. And the reason is I worked at other places, and I worked at places that typically had the — the normal structure. They have junior analysts, senior analysts. They have portfolio managers. They have strategists, economists.
And what I found is the person deciding whether to buy or sell a stock in that structure is often relying on the data provided by the most junior person at the firm, right? The most junior person is doing the legwork. You don’t know if they’re good or not and you’re making an investment decision on that. So we, in a sense, break down that distinction.
Now on our team, I would say we have people that are traditional analysts. To use an unfortunate phrase that goes back to the Cold War, we always say that the portfolio manager has to be a fellow traveler on the research process with the analyst. So we have an analysts that do spectacular leg work and are, you know, in our sourcing process, were looking for ideas. And they will surface those early, and then the portfolio manager along with that analyst work on that idea together. And we run concentrated relatively focused portfolios.
So, you know, we only buy one out of 10 names in the S&P 500, right? And I will say like selectivity sort of like — like a college or like an employer, if you have the ability to only choose one out of 10 of your applicants, you can really look for those sort of extraordinary qualities and you can reject the average of the mediocre or worse. And we think selectivity is a huge advantage in active management, and that’s — that’s something that we really work on.
RITHOLTZ: You mentioned opportunity cost and owning a position. How do you decide when to get rid of a position? And is it an all or nothing? Do you scale out or once something hits a certain target, you sell it and that’s the end of the story?
DAVIS: Well, you know, I — I did my master’s degree in Philosophy, actually philosophy and theology. But there was a one that …
RITHOLTZ: So that means you just pray for the results or …
DAVIS: I — I pray for different things than I used to, but — but there’s still a lot of praying going on. I mean, let’s just say …
(LAUGHTER)
… you know, J.P. Morgan’s earnings, you know, were the answer to my prayers.
But the — but what I’d say is there is a wonderful English philosopher, Elizabeth Anscombe. And she had this wonderful phrase where she said, “The fact of twilight doesn’t mean we can’t tell day from night.”
And so when we look and value a business, we don’t come out with an estimate that, you know, company X is worth $34 a share. There’s just amazing false precision in that. You — you have an enormous amount of uncertainty that you have to price in. So what we tend to come up with are what we call ranges of fair value.
Now we stole this idea from Ben Graham. Ben Graham and his class at Columbia did an exercise on a specific company to determine its value. And — and I’m doing this from memory, but it’s roughly this. He came at the end of the day and he said, “This company is worth between $20 and $120 a share.”
RITHOLTZ: That’s a quite range.
DAVIS: Yeah, all the — all the students are like, oh, my God, that’s worthless, that — you know, that’s useless. He said, “No, no, no, no, it’s very, very, very valuable if the stock is below $20 or above $120.” That’s sort of our mindset. We recognize we look for a range of fair value for the businesses that we study.
All of our portfolio activity happens when companies are below that range or above that range. Within that range, we try not to do so much because turnover has a certain cost …
RITHOLTZ: Sure.
DAVIS: … and an uncertain benefit, so we don’t do a lot of fine-tuning. But as things pushed to the high end of that range, they become sources of cash usually not all at once.
Now, the all at once sale tends to happen because something significant changed. Now what could change is the stock price could go up an enormous amount very suddenly, and that happens once in a while.
I remember a — you probably remember Agilant that was spun out of …
RITHOLTZ: Sure.
DAVIS: … Hewlett-Packard, they announced some new product called the Lambda Router back in 2000 or something like that. And I think the stock went up like 150 percent that day, you know, some ridiculous it went from 30 to 70 or something like that.
RITHOLTZ: That’s a good decade in the day.
DAVIS: Yeah. And it was — so there could be wait times when the stock price moves up a lot where it would become a sell very quickly, but that’s going to be very rare. What often happens is you get new news that causes you to change your projections of future cash flow. You adjust them down. When you discount them to the present, even though the stock is the same or the stock could even have gone down, it may now be above your new range of fair value …
RITHOLTZ: Right.
DAVIS: … so that becomes a sale.
So opportunity cost is a key concept, but — and so you always have to look at each name relative to the others. You just don’t want to imagine that within a tenth of a percent or a nickel a share or even a dollar a share that you really can have that much precision.
RITHOLTZ: Quite interesting. Let’s talk a little bit about the changes that have been going on in the industry. What do you make of the shift from active to passive? How has this changed the landscape?
DAVIS: Well, I think it’s sort of a long-term secular shift. Now, of course, a passive cannot have 100 percent, so the debate will really be at what point is passive sort of at the period where there’s enough excess return for active management to continue price discovery and so on. Well, that’s the theoretical point.
I think the practical point is this. People were charging fees for managing a fund that looked a lot like the index …
RITHOLTZ: Right.
DAVIS: … had higher fees, had high turnover, was run by a portfolio manager with no alignment of interest, none of their own skin on the line. You know, high cost look like the index, high turnover, inexperienced, no alignment, so part of this is a very healthy evolutionary process, right? There was a lot of mediocrity that needed to be pulled out. I …
RITHOLTZ: Quite frankly, it’s amazing how long so much fat was able to stay in the system. Markets are efficient just slowly and eventually efficient.
DAVIS: Well, you know, a lot of it depends on what the return environment is. You know, when — if stocks are compounding at 10, 12 percent, nobody much notices …
RITHOLTZ: Right.
DAVIS: … 100 or 200 basis point fee. If stocks are compounding at six, seven, then it becomes much, much more material. And so I think part of it is about the normal evolution.
You know, if you look in markets like China financial services and markets like that, the fees are still very high. You know, over time, they’ll come down. If you even look at the traditional mutual fund business back in the 50’s, 60’s, 70’s, you know, it’s common to have a six or seven percent load or commission …
RITHOLTZ: It’s amazing.
DAVIS: … you know, and it was just part of the backdrop. So the good thing about capitalism is, over time, things tend to become more efficient, more transparency. And so I think part of what’s happening is very healthy. You’re getting rid of a lot of overpriced mediocrity.
I think part of it is also healthy because one of the biggest determinants of investor return over time is investor behavior. And one of the things that people know is that people’s brains go to mush when it comes to managing money. When prices go up, they get more excited and want more. When prices go down, they do get depressed and want to sell. And so there’s always been a behavior penalty for investing.
But with active management, if you are going to be with a successful active manager, they are going to look different from the index, by and large, will have pretty low cost. They will have an alignment of interest. Those sorts of things tend to really correlate with successful active management.
But one of the important points to know is, over a period of outperformance, even if it’s a decade 10, 20 years, they will go through real periods of underperformance in there. And for some investors, that’s just too much. They can’t handle it. So for them, for those sorts of investors, passive is maybe the right answer because they’re going underperform 100 percent of the time, but just by a tiny little bit.
RITHOLTZ: Right.
DAVIS: And so it may — now, there are other investors. I had lunch with an old friend yesterday, older — older lady, just sort of a wonderful gracious, and we were talking about how her advisor had recommended for her to be in passive index view. She said, “I don’t like that because I want somebody to be in-charge.” And for her, her behavior was greatly improved by knowing there was a portfolio manager. Even if the performance was up or down in any given period, for her it was important to have that alignment.
And so I don’t think there’s a magic answer. It really means looking through at the end client, looking at their own behavior. But what I would say is the more and more goes passive, the better and better it is for those active managers like us that are going to be in the game not just a year from now, but 10 years from now, 20 years from now.
I mean, we run our place like a family office because we’re the largest investor in the funds that we manage. We make a lot more money from 10 percent better performance than 10 percent more assets to manage. And the danger of this active/passive thing is, one, people are confusing price and value, right? Price is what you pay, value is what you get.
You know, if you’re a fiduciary, managing for low cost is definitely part of your duty. But it’s not your only duty, right? You could really imagine a world where a client could say, “Wait a minute, you just automatically bought the most of whatever had gone up the most and whatever was the biggest company.” That was your strategy. And people feeling like, well, that doesn’t feel like I’m necessarily a fiduciary, so costs are part of it. But like risk and volatility, because you can measure cost, you can’t measure fiduciary duty. They equate the two. Well, cost equals fiduciary duty.
In the same way, you can’t measure risk, which is the possibility of something going terribly wrong, but you can measure volatility. So people equate the two, and they aren’t the same. Volatility has something to do with the risk, but it’s not the same as risk.
RITHOLTZ: How do you guys benchmark yourself if you’re running such focused portfolios that aren’t remotely — you mentioned the closet index.
DAVIS: Yeah.
RITHOLTZ: There’s the funds that pretends to be active but have low active share and really look like the index. Your funds don’t look anything like the indexes.
DAVIS: Well, we — we start with a deep truth, which is that if you were to ask the average portfolio manager, would you rather compound at 14 percent a year and have the market compound at 15 or would you rather compound at four and have the market compound at three? The vast majority might take the latter choice …
RITHOLTZ: Really?
DAVIS: … because they would say, well, my firm will be enormous.
We’re the opposite. We — we would use, A, all day.
RITHOLTZ: Right.
DAVIS: Job one is to build wealth. We’re the largest investor in the funds we manage. We would weigh rather compound at 14 than four, and we think every client we have would agree. So that’s job one.
But job two is that we have, over time in all of our strategy since we started them, beaten the benchmarks. Now we haven’t beaten them in all periods and so on, but since we started them until today, we’ve outperformed. And we I think that over time that’s our responsibility. We don’t know what that pattern will look like. We don’t know how long periods of underperformance will be or not. We would optimize for building wealth first, outperforming second, but over time, those are joint goals for us.
And what we would say is we — in a world where indexing continues to gain share, the momentum effects will be large, right? So it can go on a long time.
But, Barry, it’s as simple as this. If I tell you that there is an investment where paying a higher price would increase your future return, you’d say that doesn’t make any sense. The price I pay is a determinant of my return, right? Whatever the return will be the lower the price I pay, the higher my return, right? It makes sense.
Yet momentum ignores that. Momentum says the opposite. The more it’s going up, the more attractive it is.
Our view is we’re going to choose common sense over whatever effects are fashionable and working today because if the wheels come off that effect, it’s going to feel pretty silly to say that, well, I bought it because it broke the 50-day moving average and it’d gone up a lot so it became more attractive to me. So, you know, our view is look, the — the fundamentals overtime wheel out. We have a strategy that we think has added value over the index over time, really all of our strategies. And — and that sort of what we come to work to do, but that is a byproduct of the primary job, which is we want to buy businesses that are compounding machines. We want to build wealth for a generation. And — and that relative performance will essentially wash out from that focus on the primary goal.
RITHOLTZ: I like what that sounds. Let’s talk about the state of the markets today. You’re a value investor. This has been a pretty rough decade for value. It’s been all growth, almost straight through, maybe the fourth quarter of 2018, so value reassert itself. Why is value such a laggard this go-round?
DAVIS: Well, of course, I’m going to take umbrage with the classifications.
RITHOLTZ: It is a really broad classification.
DAVIS: It’s a …
RITHOLTZ: What we describe is value — what some people describe is value is using quite a broad brush to paint with.
DAVIS: Well — and, of course, what counts as value and what counts as growth keeps shifting. Growth is a component of value, right? Companies that grow profitably are more valuable. So when we model the future cash flows of a business, if we have a business that we can buy for, you know, like that apartment building for $10 million, it’s going to produce $1 million coupon in perpetuity. Well, there’s no mystery what our return is. It’s 10 percent, but there’s no growth. That’s OK, return is 10 percent.
Now we buy another business for $10 million, but it only earns $500,000. But that $500,000 is able to be reinvested at 20 percent incremental return on equity. Well, the next year it’s $600,000 then it’s $720,000, then it’s $850,000. That business will end up being a lot more valuable even though you started with a lower earnings yield or to put it in terms of stocks.
A high P/E stock could be a much better value than a low P/E stock depending on what the earnings will do over time. So I think we’re value investors. That category has been a misnomer is some of the greatest value stocks over the last 20 years have been companies like Google.
Google came public at, I think, it was eight or nine times what it earns three years out. So if Google was trading at eight times earnings, you would say it’s a great value stock, right? Well, it was trading at eight times earnings three years out, so it grew into that and then blew by it. So I think one of the problems that value investors have had historically and need to get over — and, by the way, to get over it they should just follow the greatest of all, right? They should follow Warren Buffett, the value investors who say, “I determine value based on a pre-determined set of business characteristics or industries, and I won’t look at technology.”
RITHOLTZ: So you mentioned Google, which is just a money machine, the advertising business just throws off a ridiculous amount of cash. Warren Buffett’s investment in Apple, just Apple continues to not only dominate phones, every time they introduced a new product — I don’t love the Airbuds, but if it was a standalone company, it’d be like a $6 billion or an $8 billion revenue company.
Their services are blowing up. I could see how you can make the argument, Google is a value play, Apple is a value play.
In your top holdings is also Amazon, fast-growing, not a lot of profits. How do you make Amazon a value play?
DAVIS: Well, of course, this is, you know, my — my background, as I said, I — I started as an accountant, and I was not a CPA but I was a fund accountant. But, you know, accounting is the language of business. And GAAP accounting, in particular, can have all sorts of distortions.
And we always say what we’re looking for is not reported earnings, we’re not looking at statutory earnings, we’re looking at owner earnings. In other words, if you owned a business, how much would you say that business was earnings? And what I mean by that is that when a company reports its earnings to the tax authorities, it chooses accounting policies that minimize current reportable income — accelerate depreciation, expends things you could capitalize, you know, deferred revenue, whatever it is. And often when they report their earnings to investors, they do the opposite. They choose accounting policies that maximize current reportable income.
Well, we’re trying to get at owner earnings, which is often between those two. So Amazon may be the best example because if you were to imagine a company that said, “Well, we have a very, very profitable business.” In fact, I’ll use a familiar name, Geico. Now, if Geico says, “Well, insurance policies that have been on our books more than a year or two are very, very profitable, and they stay with us for a long time,” so we’re willing to spend a lot of money to get new policies.
Now, if they could grow their policies 20 percent a year but earn zero in the first year, they would do it. And if they could do it a second year, they’d earn zero in the second year. And in third year, they’d earn zero in the third year. In other words, if they’re investing for growth, but the core business is very profitable, then the accounting can be, in a sense, distorted.
Now I’ll give you real numbers on Amazon. So when we bought Amazon, we were comparing it to Wal-Mart.
Now, Wal-Mart grew sales. This is sort of an amazing thing to think about. Over a 17-year period, they grew sales from about $1 billion to about $70 billion.
RITHOLTZ: This is Wal-Mart.
DAVIS: Wal-Mart over 17 — 17 years.
RITHOLTZ: In the 80’s or 90’s?
DAVIS: This would have been 1980 until like 1997 or somewhere in there, 1985, right around there.
Now, over a 17-year period in its history, Amazon grew sales from a billion to about $100 billion, so roughly the same rate of growth, right? Those would be roughly the same over 17 years.
Now, during the 17 years that Wal-Mart grew from a billion in sales to $70 billion in sales, how much free cash flow do you think they generated? They reported a lot of earnings, so there’s lots of net income. But if you own the business, right, the end of the day, how much cash did you have?
RITHOLTZ: I got to think a few billion dollars, right?
DAVIS: It was negative.
RITHOLTZ: Really?
DAVIS: Negative free cash flow for 17 years cumulatively.
RITHOLTZ: Well, those stores are expensive. You got to buy the land, you got to buy the facilities. So it’s not a zero cost of construction.
DAVIS: Right? But why do they do that? Because they’re going to get a good return on the money …
RITHOLTZ: Right.
DAVIS: … that they spend.
RITHOLTZ: Right.
DAVIS: Now, the accounting treatment for that is that you capitalize it. You call it capital spending and you depreciate it over time. So there’s lots of that income, but if you go to the cash flow statement, there’s no cash. In fact, there was negative. They had to borrow some money …
RITHOLTZ: Right.
DAVIS: … during that period of time …
RITHOLTZ: Makes sense.
DAVIS: … to finance that growth.
Now during the same period of time when Amazon grew sales from a billion to just about $100 billion gross merchandise value, what was their cumulative free cash flow? They reported no earnings.
RITHOLTZ: No profits at all. It’s got to be tens of billions of dollars.
DAVIS: Yeah, the cash, it was about $7 billion, I think, of cumulative. So if you own the business, you have $7 billion in the bank at the end of 17 years, you grew sales from a billion to $100 billion, but you reported no earnings, which is better?
RITHOLTZ: I’ll take the latter for sure.
DAVIS: I’ll take the latter. So our view was …
RITHOLTZ: That’s hindsight though.
DAVIS: (Inaudible).
(LAUGHTER)
But — but what was interesting is then you get to valuation. And when we bought Amazon, it was trading at about one-time sales.
RITHOLTZ: Right.
DAVIS: Wal-Mart, in that period of that 17 years of growth, was trading between one and two times sales that whole period. They both have the same gross margin. They’re both making money selling stuff. It’s just the net margin wasn’t there. So what it required as a value investor to buy Amazon was, one, adjusting the core business and saying if they chose not to grow just like Wal-Mart — when Wal-Mart’s growth slowed, by the way, it just gushed cash.
RITHOLTZ: Right.
DAVIS: Oh, I mean, the cash …
RITHOLTZ: They ran out of places to physically go to stores.
DAVIS: Yeah. And the way the tsunami behind them of all of this cash, of all of those maturing stores just poured in. So cash flow at Wal-Mart went through the roof in the next 15 years.
RITHOLTZ: Right.
DAVIS: So the first thing you have to do is you had to look at that. Second, you had to say, OK, for every dollar that we assume that Amazon could have a five percent margin on sales, without (inaudible) …
RITHOLTZ: Right.
DAVIS: … and we looked at bundles of goods and so on. But what you would say is, well, for every dollar that Amazon is choosing not to report as net income, that they are reinvesting on our behalf, do we have confidence like Wal-Mart that they’re earning a decent return? I think Wal-Mart got about 15 percent or 14 percent or maybe as high as 17 at one point of every dollar they retained and reinvested, that was the return on net income.
So are we confident that Jeff Bezos and Amazon is getting a good return on the money that they are not. And, you know, the answer is look at the data, and this is when we bought it, you know, whether it was pushing into Prime, whether it was pushing in the video, whether it was wonderful creating AWS. They have gotten huge returns, huge returns on the dollar. You have one of the great capital allocators reinvesting. So split the business into those.
Now with AWS, we’d say really there are three components who value AWS as if it was a standalone business, value the retail business, and then estimate what you think would be the return on the incremental capital they’re spending, and ends up Amazon was a terrific value stock. And so we don’t use new math, we don’t use pops, we don’t use iBalls or clicks, we really just look at the cash that that business will produce.
And it’s funny because one of the great things about looking across industries is the more time you spend with Jamie Dimon, the more you see that somebody like Jeff Bezos, they speak the same language. You know, it doesn’t matter that one’s in banking and one’s in finance. It’s interesting they almost work together. I think it’s been reported that Jeff tried to hire Jamie but — when Jamie went to Bank One to be his number two at Amazon.
RITHOLTZ: Oh, really?
DAVIS: Isn’t that amazing?
RITHOLTZ: That’s quite fascinating.
DAVIS: Yeah.
RITHOLTZ: And they did that joint project on healthcare with its Amazon, J.P. Morgan and Berkshire Hathaway that — we still haven’t heard anything about that.
DAVIS: No, right.
RITHOLTZ: And when you look at Amazon, you have to wonder they keep finding these new industries to invest in. What would happen if they push into finance? What would happen if they push into healthcare? Those are two of the biggest industries in the country. I know I don’t want to bet against Jeff Bezos if he rolls something out like that.
DAVIS: Well, there — it’s a hyper rational company that makes decisions for the long-term. You — you know, one thing I would recommend every listener does, if they haven’t done it, they should read Jamie Dimon’s annual reports every year, and they should read Jeff Bezos’ annual reports every year. Both men write their own annual reports, which alone tells you something about the culture …
RITHOLTZ: Right.
DAVIS: … of the place.
RITHOLTZ: For sure.
DAVIS: They are both hyper rational, they’re modest, they’re driven, they have smart people around them. And, you know, in the case of Amazon, you know, Amazon is still smaller in retail of the Wal-Mart. Retail is a $10 trillion business, so there’s enormous, enormous room to go in terms of what they can do. And AWS is probably a bigger business than retail when you look sort of globally how that will unfold.
So I just would say that it is at the higher end of our estimate of fair value, but the determination is for how long they will be able to invest at these high rates of return. And — and so we have sold some over the years and, of course, that’s been a terrible mistake, but we do have a value discipline. So there’s a price we’re our math doesn’t work with Amazon. It is pushed up towards that end. We’ve trimmed some. But honest to God, I just said to my mother — my mother owned Amazon. She bought a little because she liked the story in the very beginning. And I’ve told her it’s a big percentage of your portfolio, I wouldn’t lose a lot of sleep over it.
RITHOLTZ: There you go. Can you stick around a little bit? I have a ton more questions.
DAVIS: Absolutely.
RITHOLTZ: We have been speaking with Chris Davis. He is the Chairman and Chief Investment Officer at Davis Advisors. If you enjoy this conversation, be sure and check out the podcast extras where we keep the tape rolling and continue discussing all things value investing. You can find that at iTunes, Spotify, Google podcast, wherever your finer podcasts are sold.
We love your comments, feedback and suggestions. Write to us at mibpodcast@bloomberg.net. Give us a review on Apple iTunes. You can check out my weekly column on bloomberg.com/opinion. Follow me on Twitter @ritholtz. I’m Barry Ritholtz. You’re listening to Masters in Business on Bloomberg Radio.
(COMMERCIAL BREAK)
RITHOLTZ: Welcome to the podcast. Chris, thank you so much for doing this. I have been chasing you down for a while. We have a — a mutual colleague, Tucker Hughes, who first brought your name up to me, I don’t know, a year ago. And I started doing some research and said, “Hey, this guy is really interesting. Let’s — let’s get him into the studio and have a conversation.” So I’m — I’m glad we finally hunted you down.
You’re — you’re New York-based, right?
DAVIS: New York-born, bred and based.
RITHOLTZ: So — so you’re here, so we’re not taking it too far out of your way. There were a couple of things I mentioned in your intro that we skipped by on the regular questions. I have to ask you, how did you end up on the Board of Directors of Coca-Cola?
DAVIS: Well, that’s a very good question. I — I — I remember I was once asked to be on the board of a wonderful think tank in Santa Fe called the Santa Fe Institute.
RITHOLTZ: Sure, sure.
DAVIS: And, you know, it was founded by Murray Gell-Mann who is a Nobel Prize physicist and wonderful scientist, and incredible innovative work they do there. And Murray asked me to be on the board, and I said, “Well, you know, I’m not going to give you any more money than I give you already …
(LAUGHTER)
… and — and I love the place, but I don’t really think I would contribute much.” He said, “No, we — we’ve studied decision-making in complex situations, and it ends up it’s really important to have diversity.” And I said, “Well, you know, I — I’m — I’m a white male from New York City, I — I don’t know what you mean like what sort.” He said, “Oh, I.Q. diversity.”
(LAUGHTER)
So he said, “We’re all geniuses. We need somebody like you to sort of round it out.” So …
RITHOLTZ: Oh, that’s hilarious.
DAVIS: … I don’t know if that was …
RITHOLTZ: Was he serious or was he joking?
DAVIS: He was actually quite serious.
(LAUGHTER)
RITHOLTZ: We need some dummies.
DAVIS: Yeah, we need somebody else.
RITHOLTZ: Listen, 140 to 160.
DAVIS: That — we looked down on that group. You know, in that group, it was — it was probably not an insult but …
RITHOLTZ: That’s hilarious.
DAVIS: … but, you know, he also, of course, meant, you know, somebody that wasn’t of a science background and so on.
RITHOLTZ: Right.
DAVIS: But — but no, you know, I think that, you know, I would say that Coca-Cola is maybe the preeminent international global company. And so from my point of view, the opportunity to serve sort of that icon to learn to work with, you know, some of the — the terrific directors that are there. And — and at a time that the company may face challenges in terms of, you know, perceptions and — and reinventing the — the model and beverages for life, it’s an exciting time to be involved.
RITHOLTZ: They clearly have, at one point in time, sugared beverages was their whole business. It’s a really much smaller part of what they do. Water and fruit juice and — and all sorts of other stuff has — has really taken over.
DAVIS: Yeah, they really are. You know, in their heart, they’re a beverages company, and sugar was part of that. Historically, it doesn’t need to be and it has not been the same part of it.
RITHOLTZ: Although — although I will tell you whenever I travel to the Caribbean and there’s a local bottle — a Coca -Cola bottling plant, that cane sugar of Coca-Cola is not like anything you get in United States.
DAVIS: Well, and, of course, they sell it in New York at a Mexican Coke.
RITHOLTZ: Yeah.
DAVIS: They call it …
RITHOLTZ: It’s delicious.
DAVIS: … it really — it reminds you of the romance of the brand. And boy, on that …
RITHOLTZ: When you’re a kid anyway.
DAVIS: … hot days sitting on a Caribbean island and somebody brings out that — that ice cold glass bottle of Coke, you’re — you’re absolutely right. It — it really takes you back.
RITHOLTZ: Now, I wouldn’t — I wouldn’t promise that I could identify them in a blind taste test, but everything around that is just so — so unique and special.
The other thing you’re a board member of is the Museum of Natural History, one of my favorite places in the city. How — how did that come about?
DAVIS: Well, you know, I think I’ve always felt a passion about understanding more about science. I mentioned the Santa Fe Institute with that same sort of mindset. You know, it is partly because it’s my — my grandmother who is sort of an icon to me, an amazing woman and she died at 106. She was kayaking at 105, so she really lived a full life. And she had a Ph.D. in International Relations. She was enormously well-read, but she felt very insecure because she never studied science.
And we talked a lot about it late in her life. And she said, “You know, I realized now that the reason was the name science scared me. It took me back to high school biology and feeling overwhelmed and not knowing what was going on.” She said, “I wish they would simply call science how things work and why things happen because then everybody’s interested in it.”
And I would say the Museum of Natural History is maybe the preeminent institution for delighting people with the ideas of science. In other words, it makes them accessible, it makes people curious, it astounds you. And so I felt like, in that sense, thinking of my grandmother who became a supporter of the museum late in her life, that idea of sort of recognizing that scientific literacy, it — it should be a lifelong pursuit because it’s just so fascinating, let alone that it’s good for policy, it’s good for the electorate, it’s good for people to understand the basic fundamentals of the scientific method, and why things happen and how things work.
RITHOLTZ: And — and what New York area school kid does not have a vivid recollection of the first time you see the Tyrannosaurus rex or the blue whale hanging …
DAVIS: Yeah.
RITHOLTZ: … from the ceiling or if you get to go to the planetarium, and every one of those experiences — five, six, seven years old — that stays with you for the rest of your life.
DAVIS: I know. Even that hall of North American mammals, you know, the giant bears standing there and you can almost — those dioramas, you almost feel the twitching, you know, it is — I absolutely agree. And I think for a — like most New York City parents, you know, there are a lot of weekends that you spend just wandering down those halls. And the best thing about the museum is to go with no agenda, to just wander. And, you know, they’re doing a spectacular new addition, the Gilder Center, which is one of the big changes will be how it will affect circulation.
And that — you know, right now when you wander the museum, you get to a lot of dead ends.
RITHOLTZ: Right.
DAVIS: One of the exciting things about the — the new plan is you really will be able to wander sort of almost endlessly, and it’ll be delightful. And it is, you know, it — it is a place that people should just go and revisit and revisit because on every topic, they have a thoughtful, knowledgeable and accessible approach to learning about the world that we live in.
RITHOLTZ: When does that reopen? When does the new addition go live?
DAVIS: I think it’ll be 2021. So coming up quite soon is Jeanne Gang from Studio Gang is the architect. She’s a spectacular architect. The — that entrance will be on Columbus Avenue, so you’ll enter from the other side. That’s just — it’ll be — people forget, I think the museum has something like 26 buildings. You don’t think of that.
RITHOLTZ: It’s giant, it’s enormous.
DAVIS: It is giant and it’s just — I mean, it — it’s a wonderful place. So, you know, I — I like going to an art museum or the opera as much as the next guy, which probably isn’t all that much. But — but going there, it’s always energizing.
And, you know, it’s run — one of the amazing things I’ll just say as an aside about the museum is it’s had the same — you know, when we invest in companies, Barry, we love when you can have a run with an executive like Jeff Bezos or — or Larry Page …
RITHOLTZ: Twenty years.
DAVIS: … or Jamie Dimon, you know, where you can have 20, 30 years of — you know, you gain conviction early and then you have the conviction to ride through the downturns, buy more. And in a way, the Museum of Natural History embodies that because it’s had the same executive director. I don’t want to make up the number, but it’s — it’s …
RITHOLTZ: Decades.
DAVIS: Decade, maybe 30 — 30 or — by the — by the end of her career maybe 40 years almost.
RITHOLTZ: Well …
DAVIS: And she is just a force of nature, Ellen Futter. And so it’s also excited to be part of an institution that has been so shaped by the long-term vision of a leader and to be — in a sense, get to spend time with the team that she’s built. It’s one of the best managed institutions I know.
RITHOLTZ: It’s funny you mentioned the — the ability to wandering at dead ends. My — my wife is now retired, but she taught fashion illustration and design, and so I’ve been dragged to every museum in the world. We just went to the reopened MoMA here in New York, and they did exactly what you described. There — really everything is a loop. There are no more dead ends. You walk into a — a gallery and there’s an exit that takes you to the next gallery. It’s not like the old days where it was a perplexing series of dead ends.
DAVIS: I — I do wonder if it’s almost hard-wired in us to be wanderers. It is amazing and it — it’s something that, I think, you know, New York has lots of problems and I travel all over the country and all over the, world and I can see the pluses and minuses. But one of the wonderful things about New York is that it is a walking city.
RITHOLTZ: Sure.
DAVIS: And you really don’t have that. When I visit Los Angeles and, you know, and — and other cities, small cities — Midwestern, Akron, Toledo, Cleveland, just that — that sense of being able to walk to work, walk through the park, walk around. But I do think there is something, you know, that — that enjoys wandering, and it is wonderful when these institutions reconfigure to allow that.
And — and, of course, intellectually, like investing, one of the great things about investing is it’s wonderful to be able to intellectually wander. You know, one of the things my grandfather was a passionate an investor, he called it the “best game in town.” And he said because everything is relevant. And the moment you get to an end on a thread, you can just move in a different direction, but you — in a sense, it’s not like if you were making chairs for a living. You know, you sort of make the chair, out it goes. You make another chair, out it goes. There’s something about this constant learning, constant improvement, constant wandering process that’s really delightful about it.
RITHOLTZ: I totally agree. I want to get to some questions that we skipped over during the broadcast portion. And really the first thing we have to talk about is Davis Advisors is relatively new to the world of ETFs. This is 2016, 2017, something like that?
DAVIS: Yeah.
RITHOLTZ: You — you guys added a couple of ETFs, which have all accumulated a decent amount of assets under management. Given your 50-year history on mutual funds, what made you say, “Hey, let’s try these newfangled ETFs on for (inaudible)?
DAVIS: It’s such a great question, Barry. You’re going to love the answer because it’s such an interesting story. You know, we didn’t start as a mutual fund company, we started as a institutional advisor, right, that pension adviser. You know, this was the sort of in the early 1960’s, my father started that business. You know, he managed money for people like, you know, AlliedSignal or, you know, foundations and so on, and very reputable.
And one of the consultants that had worked with this firm came to him and said, you know, would you be interested in starting a mutual fund? And my father said, “Well, don’t you need to go to a mutual fund shop? We’re a institutional adviser. Mutual fund is something else.” And happily this adviser said, “Well, I don’t think so because I want you for your money management approach, your money management philosophy. And I have clients for whom a large separate institutional account is not suitable, but a mutual fund would be.”
Well, happily, my father saw that 50 years ago and started the mutual fund. We started managing the mutual funds then.
Well, the same thing happened, Barry, with ETFs. So what happened was we had a long — most of our clients come to us through financial advisors, sort of trusted advisors. They’ve had a long relationship with an adviser that we had done business with for 20 or 30 years came and said, “You know, I’m curious if you could start an ETF” And I, like my father, said, “Well, ETFs, don’t you need to go to an ETF shop? Aren’t they passive? Aren’t they index-based?” He said, “Well, lots of indexes have higher turnover than you have.”
RITHOLTZ: Right.
DAVIS: So, you know, there’s great tax efficiency, there’s ease of transactions. They really are suitable for some clients. So we looked at it, and we launched four actively managed ETFs based on the four strategies that we thought have the most promise in today’s market, where we see the biggest opportunity.
RITHOLTZ: What are those four?
DAVIS: So it’s a concentrated U.S. strategy called DUSA, Davis Select U.S. So that is a — a really sort of focused U.S. strategy.
Davis International, DINT, and that’s non-U.S. international, again very focused so it’s not — you know, the — the international indexes are just a mess. You know, I think we’ve outperformed the international indexes and sort all periods. It’s — and a lot of active managers have. So if you want to invest internationally, being active as usually the way to go, but there weren’t some great active ETFs. So the — global that combines both.
I will say if somebody is coming to us with just — wants one fund, Global is probably the best because it’s the least constrained, DWLD, Davis Worldwide. And then financial, where I started my — we started DFNL because the financial ETFs — you know, the financial ETF, the largest financial ETF, has 50 percent almost, 46 percent in five stocks.
RITHOLTZ: Yeah, that makes sense.
DAVIS: I mean, that’s a little scary, you know. And …
RITHOLTZ: That’s just (aping) the S&P (inaudible).
DAVIS: Yeah, and so they have huge concentration risk in a single subsector. So we — we launched those. They’re actively managed. We run them with the same discipline, the same philosophy, the same team. And I thought, well, this will be the beginning of the wave like everybody will do it now, but it hasn’t happened.
And I think the reason is — is that our — we’re large enough to have credibility to be able to offer it to make the investments and operational excellence to do it, but we’re small enough that we don’t have to worry about liquidity and front running. You know, if we’re buying Google, I don’t have to worry about, you know, somebody trying to jump in in front of us on that.
RITHOLTZ: Sure.
DAVIS: We have a culture of transparency. We’re already low-cost. You know, all of our actively managed funds have below average fees, and so we didn’t have to worry about some fee arbitrage. And — and so we — we sort of said that was fully transparent, you know, through ETFs. We put a lot of our own money in them because there is a lot of tax efficiency in them in this environment.
And — and — and what we found surprisingly, Barry, is there a few traditional ETF advisors that have come to us and said, “Hey, I’m mostly passive, but I’ve looked at the data.” And there are periods of time where even the average active manager outperforms for five years.
RITHOLTZ: Right.
DAVIS: Maybe I should reserve a place in my portfolio for real active management. And so we thought first globally, international but we’re even seeing at the U.S. now.
RITHOLTZ: You — you mentioned the tax efficiency. I know this has been said jokingly, maybe it’s only half-jokingly, but it’s true. If they were introduced as a new product today, mutual funds might have a harder time finding an audience whereas the ETFs, because of the way they’re structured, what happens internally doesn’t generate a tax bill until you sell them. Are we seeing that transition from mutual funds to ETFs or is it still too much of a niche product and mutual funds are going to be around for another century or so?
DAVIS: Well, I mean, we started the ETFs because we saw the advantages. They are not advantaged in every environment, right? A traditional mutual fund with steady inflows has enormous advantages because it can, in a sense, reposition the portfolio without generating any gains and so on.
RITHOLTZ: Right.
DAVIS: And ETF does not have that advantage. An ETF is very much like an SMA, right? It’s a separately managed account in essence. So there are advantages. There are op (ph) environments where you could imagine (inaudible). But, by and large, I would say if I had to predict, I can definitely see the — it would be hard for me to understand why ETFs wouldn’t continue to gain traction because of the relative ease of transactions and so on.
And so, you know, I — I think, in a sense, you know, they have the — the some of the advantages of mutual funds in terms of governance and co-mingled accounts …
RITHOLTZ: Right.
DAVIS: … with the ease of transaction of individual stocks, you could sort of see how that could have a long way to go. And we certainly wanted to put a mark or in the S&P, really the leader in true active management …
RITHOLTZ: Within an ETF.
DAVIS: … within an ETF.
RITHOLTZ: Everybody focuses on low cost and passive, but the tax benefits are just so spectacular. I’m surprised we haven’t seen more mutual funds roll out some form of an ETF-based version of their active funds.
DAVIS: Well, I think that they have a number of barriers that we were comfortable stepping over that stand in their way. Some are too large and they worry about the liquidity effects.
RITHOLTZ: Right.
DAVIS: Some have fees that are too high. So if you’re charging one percent on a mutual fund, it’s hard to offer a low cost ETF and — without creating the opportunity for free arbitrage and so on.
RITHOLTZ: You mentioned that, meaning — I recall when PIMCO first rolled out their ETFs, they had them at a higher price point than their mutual funds.
DAVIS: Right.
RITHOLTZ: Was that the concern, the arbitrage?
DAVIS: Well, yes, I think so. I mean, I think that you — you don’t want to create a situation where somebody could buy the underlying stocks and, in a sense, short the ETF and make a guaranteed return that would be reasonable. So if that guaranteed return is, you know, 30 basis points or 60 basis points, that’s going to be tough to make a lot of money on …
RITHOLTZ: Right.
DAVIS: … because you’re taking single-event risk and things like that. So you’d have to lever it so high. But, you know, if you’re charging one or 1.5 percent, then you — somebody could say, well, I’ll just buy those stocks, short ETF I make an extra 1.5 percent doing that.
RITHOLTZ: Makes sense.
DAVIS: So, you know, it’s a little bit like iTunes. I mean, one of the things that I would say is that, you know, music was free. You could rip it off on the Internet. And I think Apple’s philosophy was if you make it easy for people to do the right thing, they’ll do the right thing.
RITHOLTZ: Sure.
DAVIS: And — and that’s what — and I feel that way about the ETFs. You know, if you make it easy for somebody to do the right thing to invest with you at a reasonable fee, then I think they’ll do it. You know, could — can somebody open a separate account and mimic what you’re doing? You know — you know, of course, they can. People see the conformes, they can see the trades that you’re doing for an account, and they — they can mimic those for other accounts on which they’re not paying you a fee. But I think that if you make it easy for people to do the right thing, they do the right thing.
RITHOLTZ: You know, I’ve — I’ve heard people talk about that, but let’s say someone were to open an SMA and then they would chain a different account to that SMA, that — that seems like it’s far too much work to actually do to save 50 or 75 basis points …
DAVIS: Yeah.
RITHOLTZ: … unless it was hundreds of millions of dollars, in which case it would be really easy to identify who is piggybacking on all your trades.
DAVIS: There was a wonderful story, a real mentor of mine early was a man named Bob Kirby. And he worked at Capital Group, and he was just a legend, a wonderful, wonderful investor and a wonderful human being.
And he tells the story about how he was managing an account for a older lady. And she came in one day and she said, “You know, my husband has died and would you take on managing his account. He always wanted to do it himself, but now that he’s dead I’d like you to take it on.” And Kirby looked at the account and realized that this — this husband had been free-riding on all his trades. And every time Bob bought a stock for the wife, the conforme would be sent home, the husband would take a portion of his paycheck at the end of the month and buy the same stock.
But here’s the punch line, what was amazing is that the husband’s account had meaningfully outperformed. Why? Well, because the husband never sold anything.
RITHOLTZ: Oh, there you go.
DAVIS: And because he was buying it out of income every month whereas as Bob managing this closed account was constantly selling things, and — and so what he was doing what we call “cutting the flowers and watering the weeds,” right, what I’ve done with Amazon for a decade, right? I — I’m constantly trimming it, you know, to add to something that hasn’t gone up. And — and over time, any honest investor and especially any honest value investor will tell you that their biggest mistakes were what they sold, not what they bought.
RITHOLTZ: Quite, quite interesting. I know I only have you here for a finite amount of time, so let me get to my favorite questions that I ask all of my guests. Let — these are usually pretty revealing about who you are and what you’re about.
Let’s start with — you mentioned Amazon Prime, what are you streaming these days? Give us your favorite Netflix, Amazon Prime podcast programs.
DAVIS: Well, this is a very disappointing question because I am — I — I find that I watch things so infrequently. I — I feel there were two decisions I made when I was in my early 20’s as I said, “I’m not going to become a sports fan because it’s three to five hours a week at least.”
RITHOLTZ: At least, right.
DAVIS: At least. And …
RITHOLTZ: I don’t understand who is home every Sunday watching football for 20 weeks a year.
DAVIS: Yeah.
RITHOLTZ: I don’t — I can’t (inaudible).
DAVIS: And — and — you know, and golf is the same way, it’s an enormous commitment of time. And what I felt when Netflix came out and people could binge watch a series, what I said is, well, you know, like Mae West, I — I can resist anything but temptation. So why I get on that trolley? So I simply said, “I’m not going to subscribe because I don’t want to see these.” I don’t want to get addicted to some series.
So I would say, you know, I watch films. I read a lot, but I don’t watch a lot of — you know, I’ve — I’ve seen some of the big ones, the Breaking Bad and so on. But — but I also find if you don’t watch for a long time and then you put it on, you’re so shocked …
RITHOLTZ: Right.
DAVIS: … by the violence and things like that. You’re like, well, this may not be for me. So I’m hopelessly out of sync with pop culture.
RITHOLTZ: I’m — we’ll get to books in a minute, but that’s fascinating. So I was — the next question is tell us the most important thing people don’t know about you, but — but that might be it. Is there — is there something else that is (hiding out)?
DAVIS: Well, I think — I think people that know me assume I’m pretty square, so I — I think that they wouldn’t be surprised by that.
I — I don’t — you know, I would say that in — in many ways that I find very reassuring I’m very conventional, and people may not know I was in the seminary.
RITHOLTZ: Oh, really?
DAVIS: When I — I did a master’s degree in Theology and I went to work for the Episcopal Church, which is really a repository of decency within Christianity. It’s sort of a enormously modest, thoughtful, restrained sect of — of the faith.
And I — I’m fairly agnostic, but I — my — my view was I thought that it — it did a lot of good in the world. But anyway, going to work for the church for a year convinced me that that wasn’t for me. And — and so that might be something people don’t know.
RITHOLTZ: I have a buddy who’s a deacon in the Episcopal Church. And when we’ve discussed not just faith but religion, and he laid out what’s the precepts of that faith is, it was really quite fascinating because it’s such a different premise in terms of perceiving knowledge and responsibility, and it’s very different than what you think of as versus a traditional religious belief.
DAVIS: Well, of course, yeah, religion’s got a bad rap as a result. But — but I will give you something that ties to investing, which is one of my favorite teachers at that time. He was a bishop of Newark, and he — episcopal bishop of Newark. And he once asked me, what’s the opposite of faith? And I said, you know, doubt. And he said, “No, certainty.”
He said, “If you — doubt and faith are required, you — you need doubt to have faith.” In the same way, you need fear to have courage, right? If you don’t have any fear, you don’t have any courage, right? You — you — you may be — you may do things that appear to be courageous, but you don’t have any courage. You need fear in order to be courageous. You need doubt in order to have faith. Certainty is the opposite of faith.
RITHOLTZ: That — that’s so interesting you said that because I have a friend who always ask what’s the opposite of love, and the answer is it’s not hate, it’s indifference.
DAVIS: Indifference.
RITHOLTZ: And it’s the same philosophical …
DAVIS: Yeah. Well, in this political time, it’s a good phrase to bear in mind because, as I said, I — I have time for people whose politics are on either side of this divide provided they think it’s a difficult choice. When somebody thinks it’s obvious and easy, that’s when I get a little nervous.
RITHOLTZ: For sure and it — and it never is. So let’s talk about mentors. Who were some of the mentors that guided your career and helped influence the way you think about investing?
DAVIS: Well, I mean, I — I — I grew up with two at — at the dining room table so …
RITHOLTZ: Right.
DAVIS: … you know, I had, you know, a father that is — my father is a spectacular teacher about investing. It’s just he — very early, it was about the businesses not the pieces of paper. It was visiting companies with him, seeing the people as he would always say people and ideas. He would — we could buy stocks, he would finance them if we wrote a — a report and called the company.
And it was just — he made it — so, you know, I used to say when the train pulled in at night in — he lived out in Tuxedo — and the commuters get off the train and they all looked gray and sort of ashen with their briefcase and, you know, their sack suits. And — and my dad would get off and he was just exuberant. You know, he just love the ideas.
And, of course, he learned from his father who was the same way, the best game in town. And he only invested in financials. That was his specialty, but he just loved it. So those two.
But — but outside of them, it — it would have to be Charlie Munger. I mean, he is — he came into my life at a wonderful stage. I admire him more than almost anybody I know. His intellect, his character, his wisdom, his thoughtfulness, his decency, he’s just one of the great human beings I’ve ever known.
RITHOLTZ: How did Charlie Munger come into your life?
DAVIS: Well, that’s a good question. You know, my grandfather had a long history and my father investing in Berkshire, so we had …
RITHOLTZ: OK.
DAVIS: … gone to annual meetings and — you know, for many years. My board was actually — my father was actually on the board of Geico — I mean, my grandfather was on the board of Geico, so there had been overlaps that way.
But I met Charlie through a mutual friend when I was interested in trying to sell a business that my grandfather had, which was a securities lending business. And I won’t bore you with all of the details of that business, but basically as my grandfather — when my grandfather died, he gave 100 percent of his estate to charity. And — and so he — they asked me to try to wrap up his business while he was still alive so that when he died, people wouldn’t be out on the streets.
And so I was looking for a home for this securities lending operation. And — and I thought Berkshire could be. They had obviously a great balance sheet. They had a big equity portfolio and maybe they would take this operation.
And I arranged this breakfast with Charlie Munger. I pitched it to him between eight and 8:07 in the morning.
RITHOLTZ: Right.
DAVIS: At 8:07 he said, “I have no interest in a business that’s, you know — you know, 10 guys named Tony and — and, you know, were back office business where we don’t” — you know, but he said, “I’m interested in why you picked Berkshire.” And so I talked him about the balance sheet and the security, and he said, “Well, that’s it.”
And then we got to — and we didn’t leave the table until lunch time.
RITHOLTZ: Really?
DAVIS: And it — it was, you know, I would define it as, you know, the — the — the big — most significant change and not just by professional, but really my professional and personal life in terms of the direction of my life. That breakfast was an enormous changer. I’m always been grateful, and I try to see him whenever I can.
And — and if I would I might say, I asked about his 94th birthday what he wanted for his birthday, and he said a paternity suit.
(LAUGHTER)
RITHOLTZ: Yeah, that sounds like him. That’s hilarious.
DAVIS: Yeah.
RITHOLTZ: Let’s talk about books. You mentioned you enjoy reading. I know Munger and Buffett do spend half of their day reading. What are some of your favorite books? What are you reading these days — fiction, nonfiction, whatever?
DAVIS: Well, you know, it’s funny the waves that you go through. I — I find myself in periods of time where I’m reading too much fiction and I need to force back in non-fiction.
RITHOLTZ: Right.
DAVIS: And then the opposite. I’ve been in the opposite phase more recently.
RITHOLTZ: Me, too.
DAVIS: Much more nonfiction. I think it’s part of getting older is that you just become more — you just — you see more wonder in the reality and you’ve lived enough that a lot of the stories in fiction begin to feel, you know, yeah, well, we’ve – we’ve seen that story before.
RITHOLTZ: The — the old joke about fiction versus nonfiction, fiction has to make sense.
DAVIS: Yes, exactly right.
RITHOLTZ: And non-fiction could be completely (inaudible).
DAVIS: It’s perfectly said. So — well, I mean, of course, everybody should read the — what I call the “three scandal books,” you know, of last year, you know, the — the — the Theranos book.
RITHOLTZ: “Bad Blood.”
DAVIS: “Bad Blood,” the unbelievable book on 1MDB on the Malaysian fraud.
RITHOLTZ: Haven’t gotten to that yet.
DAVIS: It’s called the “Billion Dollar Whale.”
RITHOLTZ: Right.
DAVIS: A terrible title, but — but just a spectacular story. And — and then everybody should read Bill Browder, “Red Capital,” you know, that is, you know, just the — the corruption that went on under Putin and Russia. So that was …
RITHOLTZ: That is — that is ongoing
DAVIS: Yeah, it is ongoing. But I would say the best book that I read last year was — I’m going to mispronounce his name, I’m sad to say, it’s Bhu Srivanasan (sic) …
RITHOLTZ: Right.
DAVIS: … B-H-U and then S-R and V and a bunch of consonants. But it was a book called “Americana.” And you have to be careful because when it was first recommended to me, I went and bought a book called “Americana,” which was about a Nigerian refugee, and hairdressing and a few other things. And I thought …
RITHOLTZ: Wong book.
DAVIS: … I was very surprised that my friend recommended this, but it was a good novel, but clearly was the wrong one.
“Americana” is a history of American capitalism, but it’s divided into chapters where each chapter stands on its own as the history of a specific industry in this country …
RITHOLTZ: Oh, that’s — that’s fascinating.
DAVIS: … and not just the people that started it, the ideas, how would caught traction, but importantly how it was financed. You know, who financed the Mayflower? Who financed, you know, the cotton gin? Who financed Ford versus General Motors? Who financed the telegraph or the canals, the — the — the — the microprocessor and transistor?
You know, so you really have this sweeping account beginning with the Mayflower and ending with the Internet of how these industries developed with a real focus on specific companies and people, but also how did the capital flow in, who owned them, how did they raise the money. Wonderful, wonderful book.
RITHOLTZ: That sounds fascinating. I’m going to make a book recommendation to you only because you described that trilogy of fraud books.
DAVIS: Yeah.
RITHOLTZ: If you haven’t read “The Spider Network,” I think it was by David Enrich, it’s about the LIBOR manipulation.
DAVIS: (Inaudible).
RITHOLTZ: If you liked the “Bad Blood” book, this is the same thing. It reads like a thriller …
DAVIS: Yeah.
RITHOLTZ: … straight through, really quite fascinating.
DAVIS: I — I love it. I have to say I think financial journalists don’t get enough credit when they do expose these things. And it’s funny, you know, we all know Theranos, but Theranos was tiny compared to 1MDB. I mean, 1MDB — somehow a young man stole $9 billion and is still at large.
RITHOLTZ: How is that — it’s amazing, isn’t it?
DAVIS: And it’s — it’s almost — you know, whatever you say about Elizabeth and Theranos, you know, she was a believer and went down with the ship.
RITHOLTZ: Right.
DAVIS: I mean, it — it is — so money went in, but billions wasn’t lost. You know, here $9 billion, just poof, it’s a spectacular story. So I — I — if you’re interested in financial markets …
RITHOLTZ: Yes.
DAVIS: … it’s — it’s a good one.
RITHOLTZ: I’m — I’m definitely going to check that out. Tell us about a time you failed and what you learned from the experience.
DAVIS: Well, you know, I said earlier success is a lousy teacher. You know, the culture of our firm is so based on trust between the team of us that work together. And the reason that we feel trust is so important is because admitting and learning from your mistakes is such a critical part of getting better. And so we — actually in our — the center of our research department, we have a wall with the frame stock certificates of our biggest mistakes, and that goes back 20 or 25 years. And it — it keeps growing.
Unfortunately, my son said it’s starting to look like a mural. And — and each certificate has a plaque on the bottom with the transferable lesson learned, and some are mistakes …
RITHOLTZ: I like that.
DAVIS: … of quantification, some are mistakes of qualification, judgment. Some are mistakes of omission, things that we failed to do that we ought to have done, some are mistakes of commission. Some companies are on there twice, and they can be on there twice because you bought them wrong and you sold them wrong.
So, you know, there were — the mistakes of quantification are the easiest to fix because like that manufacturing process earlier when you talked about Danny Kahneman, you know, you constantly feed those back into the process. All right, we have to reconcile the cash flow from operating section with the cash flow from investing section and make sure those tie to the income statement because that’s how Enron or Lucent, most dramatically, was manipulating …
RITHOLTZ: Right.
DAVIS: … their — their cash flow statement — their income statement through their cash flow statement and so on.
Mistakes of quantification, maintenance capital versus depreciation, those are valuable lessons because you put them back in the system. You don’t make him again, the firm gets better.
Judgment is a little tougher because each one looks a little different like Tolstoy’s unhappy families. And you don’t want to learn so broad a lesson that you miss a real — you missed an opportunity the other way.
The mistakes of omission those are enormously valuable. I mentioned Google earlier. Google is on our wall because I did all the work. I met Google five or six times before they came public. You know, we are large shareholders in three newspaper companies, we understood the advertising business and yet we didn’t understand how effective Google ads were for one simple reason. We never called an advertiser.
If we had called Geico or Progressive, who are two of the largest advertisers on Google, before they came public we would have learned that to get a lead through Google was costing them something like $2. Their next nearest customer acquisition vehicle, which I think was late night cable television, was $30.
RITHOLTZ: Wow.
DAVIS: It was so valuable. So anyway, those are mistakes. So I would say, you know, we’ve been guided by failure. And we really have tried to have a culture of embracing it and learning from it, and — and earning a subsequent return on the past mistakes we’ve made.
RITHOLTZ: It’s interesting you guys do that via a wall. All of the — I shouldn’t say all, many of the prominent venture capitalists hold out their — some people call it their anti-portfolio. Either the things they said no to, like Apple or Amazon or some of the more spectacular failures they’ve said yes to, and I don’t want to call it a badge of honor, but it does reflect a certain degree of humility and willingness to learn from mistakes. You don’t see it in many of the companies that manage public funds, so it’s interesting to hear that you guys do something similar to what the VCs do.
DAVIS: Well, I said my — my grandfather said you don’t learn from mistakes if you don’t admit you make him.
RITHOLTZ: Sure.
DAVIS: And — and, you know, we’re in a dynamic business. What — what — what helped us succeed in the 1970’s was different than the 80’s, worked in the 80’s, didn’t work in the 90’s.
RITHOLTZ: Sure.
DAVIS: So this process of evolution — that’s why going back to your very early question about value and growth, it’s why I get so mad when people say I won’t look at something because if you won’t look at biotech because you’re a value investor, you’re going to miss an enormous change in society, in the economy that may or may not unfold. But when it does, it will have real economic consequences, and you might not look at it in order to buy a biotech company, but you might look at it in terms of what it’ll mean for health care costs or what it — which is your — in your insurance portfolio or what it might mean for, you know, life expectancy and so on. So we just — we have a curious mindset, but we also think that the idea of not looking at things is very, very dangerous, one constantly learn.
RITHOLTZ: Right. Why did you invest in the company that cured cancer? Well, they didn’t have any earnings the first two quarters …
DAVIS: Exactly.
RITHOLTZ: … just a crazy, crazy statement.
DAVIS: Well, you know, we’ve made a lot of money investing in cable. And, you know, cable had no earnings for 25 years. And …
RITHOLTZ: Was it that long really, 25 years, wow.
DAVIS: Yeah, I think so. You know, it’s all cash flow. I don’t think they went to earnings until about 15 — 10 or 15 years ago, and cable started in the 70’s. So I would — yeah, I would say it would — it would have been 25 years with no — no reported earnings.
RITHOLTZ: Wow.
DAVIS: But again going back to accounting, lots of cash flow.
RITHOLTZ: So what do you do for fun? What do you do when you’re not in the office or when you’re not reading?
DAVIS: Well, that’s a good question. I mean, I — you know, we — we always say, you know, it’s hard to find the investors that successful investors that had a history of playing team sports. I always say …
RITHOLTZ: That’s interesting.
DAVIS: … it’s sort of the mindset. You tend to end up with runners, swimmers, occasionally golfers, but you don’t get a lot of — in the type of long-term sort of value investing, I think partly it’s because I think investing — successful investing, value investing requires you to think differently than the — the others to set yourself apart. And that mindset tends to lend itself more to quiet pursuits, you know, individual things rather than being part of the team. You had to have lower emotional intelligence, things like that. So I do — you know, I enjoy things like running and swimming.
But — but I would say the one thing I do that’s a little bit unusual is I have — I have had for 20 years or so a very — a very old wooden sailboat and …
RITHOLTZ: I had a feeling you are going to say sailing.
DAVIS: And — and I …
RITHOLTZ: You look like a sailor.
DAVIS: … it was built 52 years ago, 53 years ago. Went on the ramp the same month I did. And it’s not a fancy boat, and it’s a — but it’s a very well-built, sort of hardy boat. And — and I love sailing that wherever I can. And so we’ve been up to Scandinavia or up to Nova Scotia or down to the Caribbean.
And what I love about the metaphor of sailing is that, you know, people say golf is like life. I don’t think golf is like life. I mean, people say you play against yourself and so on. But — but in golf, the small stuff counts the same as the big stuff.
RITHOLTZ: Right.
DAVIS: And I don’t think that’s like life. I don’t think that …
RITHOLTZ: That’s right.
DAVIS: … six-inch pot counts the same as the 100-yard drive in life or, I guess, 200 yards. I don’t know how far people drive a golf ball.
But — but sailing, I think, is very metaphorically powerful especially for investing because you can’t change the direction of the wind, you have to adapt. But if you want to make progress, you can continue to make progress but in an indirect way. And so …
RITHOLTZ: You have to attack against the wind.
DAVIS: Yeah. And when we come back to investing, you know what we say is we know we’re going to go through periods of bad weather and storms. We want to run our portfolio like a ship to survive all different kinds of weather to continue to make progress, but we don’t want to, in a sense, expose our self to the risk that when the storm comes will founder. But we also want to make sure that we’re making progress, so we have to move forward.
So that sort of balance of adaptation, response, thoughtfulness, you know, the inability to predict the short-term, you know, those things all matter.
RITHOLTZ: So two things, first, I’m going to have to send you something. I’m going to make a note to email you something about that exact topic because it’s so fascinating. But second, so I have a small little runabout, little powerboat, but I got into boating through a friend’s sailboat. And to me, there is nothing more relaxing than just being out on the water with no engine noise, just the wind in the sails. There’s something about it that is unique in the world of leisure activities.
DAVIS: Well, we talked about wandering and that may be …
RITHOLTZ: Yes.
DAVIS: … a genetic predisposition to be wanderers, to be explores as having served our species over time. And I agree with you, there’s something about sailing and the — the silence, the harmony, the balance.
I also particularly love navigating. And so, you know, I do a little celestial navigation. I — I have a GPS as — as — as …
RITHOLTZ: Right.
DAVIS: … backup.
RITHOLTZ: Everyone’s got it going right on their dash but …
DAVIS: But, you know, there’s something about being in that moment that I find — and, of course, it’s my favorite way to be with my family …
RITHOLTZ: Right.
DAVIS: … because you’re …
RITHOLTZ: It’s social and absolutely there’s …
DAVIS: …you’re away, there is no TV, there is no cable.
RITHOLTZ: Right.
DAVIS: And, you know, a friend of mine once referred to it as a WASP Winnebago I didn’t love, but — but boy, it is — it is a beautiful way to — to see the world.
RITHOLTZ: So speaking about how we see the world, what are you most optimistic about in the world of investing and what are you most pessimistic about these days?
DAVIS: Well, I’m most optimistic about ingenuity. You know, it just — the, you know, we’re — we’re not, you know, we — we aren’t sort of a mindless optimist, you know, we don’t. But, you know, the fact that — that, on average, the world gets better, the world gets safer, the world gets cleaner, we address problems, in part, because we worry about them so much.
When I look at what’s happening in A.I., in biotech, you know, the innovation what’s happened in China — I was just back from China — I mean, you know, to look at those people, you know, a billion people who, when we were kids …
RITHOLTZ: They were in poverty.
DAVIS: … they were starving.
RITHOLTZ: Yeah.
DAVIS: And, you know, it’s just — the progress of the civilization in the last 30 years is just breathtaking. So I would say I am excited and optimistic because when we talk about black swans, we forget — we assume that black swans are negative, right? A large unexpected event, unpredictable with huge economic consequences, we assume that’s negative.
RITHOLTZ: Right, (inaudible).
DAVIS: No. I mean, you end up with, you know, a pharmaceutical or, you know, a biotech cure for diabetes, Alzheimer’s and ALS and, you know, maybe a couple of others. And you’ll have medical deflation for the next …
RITHOLTZ: Right.
DAVIS: … 50 years.
RITHOLTZ: So just look at the recent data on cancer deaths in United States.
DAVIS: Amazing. So …
RITHOLTZ: Right.
DAVIS: … so I love the innovation. It’s one of the things I love about my job is meeting inventors. I meet with a lot of firms that are still private that are — have great ideas simply because it’s energizing. We don’t invest in a lot because of the risk reward. Tradeoff is too great, but we love living in the future. That part of it is great.
My grandmother was once asked what’s her favorite day. You know, she was 105 when they were — she was asked that. She said tomorrow.
(LAUGHTER)
And so …
RITHOLTZ: It’s a great answer.
DAVIS: … I love that. You know, I think the pessimism is the things that can disrupt that. I mean, obviously, it’s amazing to look at what capitalism has done to — to build wealth in — in China, in India, how well it works.
I lived in — in Europe for five years. I went across the — the Berlin Wall and into Czechoslovakia in the 80’s. I mean, you do not want to go back there. So I get a little bit worried about, you know, I would say the promises that people — politicians can make that can’t be kept without bankrupting the civilization. It’s true of our social security, our healthcare promises.
So, you know, the fact that the policy cycle is longer than the political cycle …
RITHOLTZ: Right.
DAVIS: … is a deep systemic problem. I think we’ll muddle through, but that’s the one that gives me pause.
RITHOLTZ: Quite intriguing. What sort of advice would you give to a recent college graduate who was thinking about a career in finance?
DAVIS: Well, I’d just start with the idea that, you know, I think you better do it because there’s something about it that you find meaningful rather than because you think you’re going to make a lot of money. I mean, one of the great things about what’s happening in the financial services sector generally is that a lot of — you know, a lot of excess pay is being squeezed out, and that’s probably a healthy development.
RITHOLTZ: Right.
DAVIS: You know …
RITHOLTZ: Headcount reduction also.
DAVIS: Yeah, exactly. If people are interested in it because of stewardship, if they’re interested in it because they are excited about the puzzles, you know, one thing I would say to all (isn’t millennials). I have — I have — I have four children, and all of whom I’m very, very proud of right now what they’re doing, but is that don’t imagine that just because something doesn’t sound interesting that it’s not interesting.
I think that there is an enormous amount of pressure on kids when they come out of college to do something that sounds cool, that sounds woke, that sounds connected, that sound — and they cheat themselves out of learning about things that might not sound that interesting that are actually fascinating. So choose your boss. You know, it’s like in college, don’t — don’t study courses that have cool descriptions. Ask your friends what the best teacher they had was, and that — it doesn’t matter if they’re teaching chemistry or they’re teaching politics, it’ll be a great course. And too many people study — you know, are drawn to the description instead of the teacher.
RITHOLTZ: Good, sounds like good advice. And our final question, what do you know about the world of investing today that you wish you knew 30 years ago when you were first getting started?
DAVIS: Well, that’s a good question. I would say I am struck by resilience. I’m struck by how my time horizon continues to lengthen. Yu know, my — my grandfather, you know, there’s a — a story that was true when I was a kid of trying to borrow a dollar from him to buy a hot dog. And he said that if I invested the dollar and earned his returns and lived as long as he would, it would be worth $1,000 by the time I was his age, and he said is a hotdog worth $1,000?
And, you know, the power of compounding the resiliency of the economy and of businesses, you know, if I told you what was going to happen in Italy between 1950 and 2017, you’d have — I don’t know — what 53 governments, you’d have the lira go from, you know, 10 to 3,000. You’d have, you know, the — the euro crisis, you’d have corruption, all — you know, you would have been terrified to have a business in Italy. And yet if you own a Ferrari, you did pretty well.
RITHOLTZ: You did pretty well, sure.
DAVIS: And so the ability for businesses to adapt, to respond, to change, I wish I had really deeply understood that. And God, I wish there were a lot of businesses out along the way that I just held on to, not been — not been so worried about next year’s results, but really focused on the next decade.
RITHOLTZ: Quite fascinating. Chris Davis, thank you so much for being so generous with your time. We have been speaking with Chris Davis, Chairman and Chief Investment Officer at Davis Advisors.
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I’m Barry Ritholtz. You’ve been listening to Masters in Business on Bloomberg Radio.
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