Value Investor Chris Davis on Berkshire Hathaway and Stock-Picking | At Barron's

Standard Oil was the most valuable company in the world for 12 decades and maintained this position because John D. Rockefeller built an extraordinary collection of long-lived, durable assets capable of producing reliable cash flow across multiple crises (Great Depression, world wars, inflation), and built a culture that rejected Wall Street, rejected short-termism, and created long-term executive compensation vesting structures (10 years after retirement).

“Standard Oil was the most valuable company in the world for 12 decades uh and how did that happen well John D built a extraordinary collection of assets that had very long lives for producing cash unbelievably durable assets assets uh he built the company to withstand all sorts of turmoil Great Depression world wars uh inflation so on uh uh uh and he built a peculiar culture a culture that rejected Wall Street rejected short-termism the the compensation of the CEO and this came out with Tillerson uh but you could have seen it if you read the proxy statements for years uh the executive compensation for the leadership at Exxon vests 10 years after retirement now that is a culture”

History does not remember specific CEOs; the market may remember Steve Jobs but not subsequent Apple CEOs; similarly, the identity of Standard Oil's CEO after the second CEO is largely unknown, yet the company remained valuable for 12 decades due to the durability of assets and culture, not individual CEO identity.

“when you think about what the fact that we don't know the next CEO the next CEO you know we it and you're you know you're a financial historian and I mean if you don't and you know similarly you know history will history know Tim Cook they'll know Steve Jobs but what Steve Jobs created had a great durability and I would argue what what John D rockfeller created had much more durability”

Charlie Munger was one of the world's great teachers dedicated to the principle that humans have a moral duty to try to get smarter every day, and his greatest value was not just making people better when in his presence but making them wiser when remembering him through his writings and speeches.

“the world lose is one of the Great teachers uh uh uh it is Charlie said that we have a moral duty to try to get smarter every day and at his at his heart Charlie was one of the most profoundly dedicated teachers I've ever known and um when he died I I sent a note out with a quote from um one of the great stoic philosophers who in a senior moment whose name is escaping me I remember the quote but not the the the author uh but the quote was you know great is the man who can make you uh uh uh wiser not just make you better not just when you're in his presence but when he is in your thoughts”

Charlie Munger's role model was Ben Franklin, whose autobiography (about 90 pages, with 80 dedicated to business management, habits, borrowing, and partnerships) contained no discussion of Franklin's revolutionary or constitutional achievements, reflecting Franklin's view that business freedom was a means to pursue and share wisdom.

“his role model of course was Ben Franklin and you think about Ben Franklin who was in many ways one of the greatest businessmen uh of his era Ben Franklin's autobiography is only about 90 pages and I would say 80 of those pages are about how to set up and manage a business uh they're about habits they're about borrowing money they're about uh creating Partnerships um it it's a very useful book there's nothing in there about the Constitutional Convention there's nothing here was the greatest inventor the greatest philanthropist uh one of the greatest authors and he just wrote this very useful book about how to help people succeed and how to improve their own personal habits”

For the first time in recorded history, interest rates approached zero, and this was unprecedented; this near-zero cost of money threw off all the mathematical foundations of value investing because cash flows 10 years in the future became valued the same as near-term cash flows.

“we went through this moment in time where it approached zero and that throws all of the math for what we do you off it means that that cash flow 10 years in the future is worth the same so that was the first big crazy wave that created a world of hurt for Value investors because that discount rate is core tenant a core pillar of what we do”

Interest rates represent the cost of money—the compensation required when lending a productive asset to another party and forgoing its production value—and this cost has existed since before money was even invented, evidenced by historical examples of lending sheep with expectation of return of additional animals.

“if you think about what interest rates are they aren't a a construct they what they represent is that I own a productive asset and if I'm giving that to you for some period of time I'm not getting the the value of that production so you have to pay me something now if I had a flock of sheep and uh or a herd and uh you know you said I'd sure like to have your 10 sheep for a couple of years you know in the before there was even money there are these transactions uh where people would say well that when you give it back to me I expect a few more”

Unlike private equity firms, Davis Advisors holds businesses indefinitely and is not motivated by exit strategies, which makes durability and resilience even more important quality metrics because the business must perform well for decades, not just until a sale.

“we want to own businesses since unlike a private Equity Firm we're not thinking about our exit strategy we Unown businesses that have these quality qualities of durability of resiliency”

Charlie Munger's role model was Ben Franklin, who wrote an autobiography (~90 pages, with ~80 pages on business management) focused on habits, partnerships, borrowing money, and how to help people succeed through improved personal habits—not on his other major accomplishments like the Constitutional Convention or his scientific/philanthropic work.

“his role model of course was Ben Franklin and you think about Ben Franklin who was in many ways one of the greatest businessmen uh of his era Ben Franklin's autobiography is only about 90 pages and I would say 80 of those pages are about how to set up and manage a business uh they're about habits they're about borrowing money they're about uh creating Partnerships um it it's a very useful book there's nothing in there about the Constitutional Convention there's nothing here was the greatest inventor the greatest philanthropist uh one of the greatest authors and he just wrote this very useful book about how to help people succeed”

Using the example of Standard Oil: it was the most valuable company in the world for 12 decades under John D. Rockefeller's leadership, which was possible because he built extraordinary, long-lived durable assets capable of generating cash and withstanding turmoil (Great Depression, world wars, inflation).

“Standard Oil was the most valuable company in the world for 12 decades uh and how did that happen well John D built a extraordinary collection of assets that had very long lives for producing cash unbelievably durable assets assets uh he built the company to withstand all sorts of turmoil Great Depression world wars uh inflation so on”

Davis studied Meta for an extended period before purchasing it, waiting for an opportunity to buy this high-quality business at a discount, much like Davis waited 15 years to study Costco before buying 15 million shares in a single day when the stock dropped from $42 to $26.

“having studied the company from the day it came out this is part of our investment discipline you know we studied Costco for 15 years before we owned a share but one day the stock closed at 42 and it opened at 26 and we bought 15 million shares or something in a single day but we were waiting for an opportunity to buy this beautiful business at a value price that's that's what was served up in meta”

Growth is mathematically a component of value, not a separate category—a company that grows profitably is more valuable than one that doesn't grow, yet the Morningstar style boxes created a false distinction between growth and value that has persisted since the late 1980s.

“these categorizations sort of emerged really in the in the late 80s early 90s with the so called The Morning Star style boxes and and it's been something we've sort of bridled against ever since because it creates this distinction between growth and value and of course the mathematics of it is that growth is a component of value a company that grows profitably is more valuable than one that doesn't grow”

Interest rates are not a construct but a representation of the opportunity cost of productive assets—if you own a productive asset and lend it to someone, you must receive compensation for the production you're forgoing, a principle that applied even before money existed and continues to apply when rates approach zero.

“if you think about what interest rates are they aren't a a construct they what they represent is that I own a productive asset and if I'm giving that to you for some period of time I'm not getting the the value of that production so you have to pay me something now if I had a flock of sheep and uh or a herd and uh you know you said I'd sure like to have your 10 sheep for a couple of years you know in the before there was even money there are these transactions uh where people would say well that when you give it back to me I expect a few more”

Davis Advisors values entire businesses (including all liabilities like debt and unfunded pensions, and unvalued assets like underpriced real estate) rather than just equity, similar to the approach a private equity firm would take, but with a different holding horizon and different exit assumptions.

“we really think about it in the sense of there there's sort of two questions you know what sort of businesses do you want to own and how much do you pay for them because of course we don't think of ourselves as buying stocks right think of ourselves as buying the business and very much like a private Equity Firm well but with important differences which I'll come to but we we we value the entire business now what that means is of course we're buying the equity but we have to think about the liabilities we have to think about the senior calls on Cashflow debt unfunded pensions we also have to think about there might be assets that are under valued they might have real estate at cost”

Davis Advisors seeks to own businesses with qualities of durability, resiliency, sustainable competitive advantage, and decent sustainable returns on equity, and these characteristics become more important in 'disconnected' economic periods where technological and monetary transitions create uncertainty.

“we want to own businesses since unlike a private Equity Firm we're not thinking about our exit strategy we Unown businesses that have these quality qualities of durability of resiliency of sustainable uh competitive advantage of decent Returns on Equity that we think are sustainable over long periods of time we're not so worried about if they're lumpy uh uh we're worried about whether they're durable and so that to us has always been a core part of what we do but it's even more important when you're in this disconnected world that we're in today”

Capital One is Davis Advisors' largest bank holding because it exemplifies a 'growth stock in disguise'—a well-run financial services company that combines the durable traditional business of making spreads on money with innovation and growth, and banking itself is one of the world's oldest professions making it difficult to obsolete despite 50 years of attempted innovation.

“our largest bank holding as Capital One uh which I I think about as the as the original fintech company my grandfather had an expression for a well-run financial as he called it a growth stock in Disguise”

The transition from free money to money having a cost, combined with ongoing technological disruption and the false belief that governments can indefinitely lower taxes while spending more and carrying deficits, represents a dangerous 'magical thinking' that will eventually catch up to the economy.

“there are two sort of themes happening at the same time in the economy and the market and one is this huge transition this transition from free money to money having a cost this technological disruption which is roiling through this transition in the magical thinking that no matter how much money the government prints it doesn't matter you know if you're the if you're the the currency uh standard of the world uh that somehow you can lower taxes and spend more indefinitely carry deficits indefinitely this is all magical thinking right sooner or later it catches up to you”

Wells Fargo and other major banks are currently valued as if they are fragile due to lingering perception from the 2008 financial crisis, but they have demonstrated durability by powering through COVID, interest rate shocks, and now hold twice the capital they had before the crisis.

“they have the characteristic of durability and yet they're valued as if they're fragile because all of us remember the financial crisis and in a funny way that happened after the great crash in the 30s the bank runs you know you got all the way into the 50s and the view of banks changed from their fragile to their boring and once they were viewed as boring they traded at 15 times earnings because they were s you know think of Mr Potter and it's a wonderful life you know he was a villain but if you were an investor he was your friend he was very sensible conservative his three-piece suit uh and so I think there's we're in the front of what could be a long change in perception where Banks go from being perceived as very risky to being perceived as safe but boring like utilities utilities trade at 20 times earnings Banks trade at 10 or 12 banks have twice the capital that they had before the financial crisis we've rolled through covid we've rolled through the interest rate shocks they are beginning to show their durability”

The bond market doesn't distinguish between growth and value because bond prices adjust so that yield to maturity is the same regardless of coupon size, yet stock market investors create this false distinction.

“in the world of bonds There's no distinction if you buy a bond with a low coupon or a bond with a high coupon the idea is that the price adjusts so that your yield to maturity all things being equal is the same nobody says I'm a growth Bond investor or I'm a value Bond investor”

Davis started a financial services mutual fund approximately 30 years ago (around 1990), initially because as a family business employee he wanted his own track record independent of the family brand, and that fund has outperformed the S&P 500 despite the financials sector index underperforming the S&P 500, because within financials there are growth companies in disguise.

“I I started our financial services mutual fund which is a little thing that I started you know 30 years ago uh partly because we're a family business and you know family businesses you can become the employer of Last Resort for people with the same last name and so I sort of thought it was important that I had my own record I was a bank and SNL Insurance analyst so I started this Fund in something like 1990 or roundabouts and you know it's only been in financials for essentially that whole period And yet it's outperformed the S&P 500 and that's not because financials outperform the in fact the financials index underperformed the S&P but it's because within that vast sector there are these growth companies in Disguise”

Berkshire Hathaway board members are unpaid (compensation is $800, 'pretty close' to zero) because the stewardship culture is the essential value system of Berkshire, and the board's primary role is to act as watchdogs, remaining vigilant to promote and nurture that stewardship culture without interfering with it.

“we're paid $800 let's not get carried away here we're not we're not insane pretty close no there the the stewardship culture is is really the essential value system of of Berkshire ha theway and and a big part of the board and is just being Watchdogs Vigilant promoting nurturing doing anything we can not to interfere with that culture and to promote it”

From roughly 2008 to March 2022 (approximately 13-15 years), value investing underperformed because two key mathematical components collapsed: interest rates approached zero for the first time in recorded history, destroying the discount rate pillar of value analysis, and simultaneous techno-optimism reduced perceived risk in distant cash flows of network-effect businesses like Amazon and Google.

“I would say that really since the great financial crisis we went through almost a 15-year period and it was really about 13 years where both of those parts of the equation sort of collapsed most importantly for the first time in all of recorded history the cost of money was free”

Davis Advisors' investment process starts with two fundamental questions: (1) what kind of businesses do you want to own, and (2) how much do you pay for them, treating stock purchases as if buying entire businesses rather than just equity positions.

“well we really think about it in the sense of there there's sort of two questions you know what sort of businesses do you want to own and how much do you pay for them because of course we don't think of ourselves as buying stocks right think of ourselves as buying the business”

Davis Advisors used the same discounted present value framework to value Amazon as it did to value Wells Fargo; the difference was only that the pattern of future cash flows differed between the companies, not the valuation methodology.

“we didn't use a different version of discounted present value for valuing Amazon versus valuing Wells Fargo it's how the it was just the pattern of the cash flows was different”