Christopher Davis Discusses Smart Value Investing

quite a family office. They've been a mutual fund shop for over fifty years. But it's always nice to talk to people who eat their own cooking. If you are at all interested in value investing, but value in a way that doesn't eliminate companies like Amazon or Google or Apple, you're gonna find this to be a fascinating conversation. So, with no further ado, my discussion with Chris Davis. This is Masters in Business with Barry Ridholts on Bloomberg Radio.

My extra special guest today is Chris Davis. He is the chairman and CEO of Davis Advisors, launched in nineteen sixty nine to manage separately managed accounts, eventually moving into mutual funds and now e T f S. Davis Advisors manages over twenty two billion dollars. 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. Thanks so much, Barry. It's good to be here. 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. Yeah, I mean I feel in a way I've gone through the full life cycle of the mutual fund industry. 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 been

a long cycle. When did you start. I started in the business in nine 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. What was your role? Well, it's funny I have working at Tanaka. What I was really passionate about was sn l's and and the reason I was so interested in san El's is if you remember, we were in the midst of the SNL crisis and I was an analyst, a financial

analyst at this by side firm. And what struck me is, I don't know if you remember the movie It's a Wonderful Life. But I kept thinking, in all of these headlines about the SNL crisis, there must be a few Bailey building and 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 and 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 firms called Davis Advisors, there's a risk that the employer of last resort for people with the same last name. And so I said, if I come in, I want my own report card. I'm a bank in financials analyst. How about if we start a financial fund, and so ine we started the Davis Financial Fund. Was that a distressed

asset fund or just or a hybrid. I would 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.

And so that was the premise of the fund. I've been running it for twenty seven or twenty eight 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 lessons. So for people who might not have been around during the ESML crisis, thousands of of these esnls went belly up, right, A

lot of babies were thrown out with a lot of bathwater. 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 ESNL crisis was primarily about commercial real estate, And we might come back later to the fact that often credit cycles have this diurnal or alternating characteristic, which you hurt you the last time

is usually not what hurts you the next time. And as it we all know, in the financial crisis, commercial real estate was sort of a safe place to be. But back in the eighties you had looked through office buildings, you had corruptions, you had the key to 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 world's second oldest profession, and that doesn't go obsolete. And in these cycles, what happens 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 moats cheaper stocks. So that was what the layout was 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 taken longer for the sector to regain credibility. But I think we're looking at the same sort of decade ahead that we had in the nineties, where these will really be compounding machines to put a little flesh on those bones. We're recording this on a morning where JP Morgan just reported earnings. They literally reported the best use earnings ever in bank history. Eight billion dollars a quarter. Is real money, you know, And yet what is the perception?

You know, the perception is, oh my god. You know the London whale. I mean, you know, this is this whole thing. This could crumble at any site. You know, the London whale was was like six weeks worth of earnings. You know. It's amazing the 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. It might be New Coke, it might be the salad oil scandal, it might be you know, Microsoft's hearings, and they're gonna go through a crisis, and one of the things to really look at is what is the management response. So let's get a little more granuur on that. We've seen Fortress Diamond respond to a number of crises, whether it was the purchase of JP Morgan or the London Whale or Libra or any of those things, and they've managed to come out pretty well.

On the other side of the street, Wells Fargo, they seemed to be stuck in a rut. One PR nightmare after another. They can't get out ahead of the fourth placed insurance and and the phony accounts. And it's just eleven 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 PR. Well, you know, Bill Gates famously

said success as a lousy teacher, and uh. And of course, if you look back at Wells Fargo, Wells Fargo was certainly maybe the best positioned and manage 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 nineties. 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. And they did the merger with Northwest, which was really the surviving institution, but that culture sort of persisted. And you know the old saying is you're get in 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 helped solve their problems. They're not bureaucratic. And and you know Norwest and then ultimately Wells took this basic idea of viewing their branches as stores with salespeople 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 worked for a long time. It's carried them through the financial crisis. Really without a blemish. Well, of course, over time they push that model too far 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 salesforce 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 salesman there sells you a pair of shoes, but he wants to sell you to 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 unethical, especially for God's sakes if you're a bank. So this was happening because of a botched incentive system, because it

had worked so well. But then, to quote the wonderful legendary d A of our hometown, Bob Morgan thaw, 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. And of course what happened is as news of this perked up, well buried it. The management didn't want to know. They underreacted, and that's put us where we have. But you contrast JP Morgan in Wells,

and those are two of our largest holdings. And the reason is right now, JP Morgan can do no wrong, and in a way, it has taken 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 ten or fifteen years. Who was in the penalty box, right, Well, we know Bank America City, 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, as viewing it as average. So we've been buyers of Wells through this. We think their behavior was terrible, the reactions were terrible, but we also know that they'll get better. 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 very positive or negative. How do you begin the process of creating a portfolio? You know, I had a meal with Danny Kahneman UH quite a while ago, uh at an investor event, and now he 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, right, And I said,

we're not. You know, what are you in academic We're not in the manufacturing business. He had not won the Nobel Prize at this point, so uh and uh he said, oh, you're in the manufacturing because I said, well, what do we make? And he said decisions? 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 aways. So when we start with thinking about investing, we think about 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're asking about, the sort of portfolio construction, the investment decisions, and that includes what you sell, what you buy, opportunity cost, relative waitings,

and so on. And then there's of course the constant ongoing revaluation of the portfolio in light of changing prices and changing data, right, because you have new inputs every twelve weeks and sometimes more often than that. 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 will be in

a takeout or a breakup. 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. 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. Yeah, I mean, imagine if you

bought an apartment building. Let's say you paid ten million dollars for an apartment building, and that apartment building was generating five thousand dollars 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 it that you'd sort of say, well, I guess I'm starting

at sort of a five percent earning syield. Now, if ten years from now that apartment building was generating two million dollars of value, you don't need to go out and get the apartment a praise to figure out that

you've done quite well right. You're making a lot of money, not just because you're getting a check for two million dollars a year or twenty percent of what you paid for it, but also should you decide to sell the building, you know that an asset that generates two million dollars a year is way more valuable than one that generates five.

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 over time. And so when we start the portfolio, we're agnostic about whether we're buying an apartment building or a pizzeria, or a hotel or an 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 ten, twenty thirty 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. 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 mind over the day to day fluctuations. You can ignore it because it's not price daily. It sounds like you approach owning individual equities the same way. Yeah, I mean, if somebody came up to with that you know apartment building. You paid ten million four and it now earning two million, and they said, hey, I'll give

you five million dollars for it. You wouldn't be depressed, right you would You just feel like, 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 quiets things down. And the more clients look at their portfolio and they see these companies even when the prices are gyrating, if they can look through at the underlying business, creates a much greater sense of equanimity in the face of, as you say, gyrating prices. So you begin as an analyst covering finance firms, you're now a portfolio manager. What's the workflow at your office? Like between the analysts that work for Davis Funds and you as

a portfolio manager. Well, I mean I learned from the best, because I learned from my father and my father's business card that said analysts 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

typically had the normal structure. They have junior analysts, senior analysts, they have portfolio managers, they have a strategists, economists, And what I found is the person deciding whether to buy a 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 leg work. You don't know if they're good or not, and you're making an investment decision on that. So we,

in a sense breakdown that distinction. Now on our team, I would say we have people that are traditional analysts. Both 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 analysts that do spectacular leg work and are you know, in our sourcing process, we're looking for ideas and they will surface those early and then the portfolio manager along with that analysts work on that idea together and we run concentrated, relatively focused portfolios. So you know, we only buy one out of ten names in the SNP five hundred, right, And I always say like selectivity sort of like like a college or

like an employer. If you have the ability to only choose one out of ten of your applicants, you can really look for those sort of extraordinary qualities and you can reject the average or 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. You mentioned opportunity costs and owning a position. How do you

decide when to get rid of a position? And is it an owl or nothing to scale out or one something hits a certain target, you sell it and that's the end of the story. Well, you know, I did my master's degree in philosophy actually philosophy and theology, but there was a one that means you just pray for the results. 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 Jay Pea Morgan's earnings, you know,

for the answer to my prayers. Uh. But the but what I'd say is there is a wonderful uh English philosopher Elizabeth Anscombe and uh, 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, a company X is worth thirty four dollars a share. That 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, in 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 twenty and a hundred and

twenty dollars a share, and it's quite a range. All the all the students 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 stocks below twenty or above. That sort of is 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 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 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 you probably remember

Agilant that was spun out Hewlett Packard. They announced some new product called the Lambda router back into thousand or something like that, and I think the stock went up like a hundred and fifty percent that day. You know, it was some ridiculous It went from thirty to seventy or something like that. That's a good decade in a day. Yeah, and it was. So there could be times when the stock price moves up a lot where it would become a cell 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, so that becomes the 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 Nicola share or even a dollar or share, that you really can have that much precision. 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? Well, I think it's

sort of a long term secular shift. Now, of course, passive cannot have a 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, 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. Frankly, it's amazing how long so much fat was able to stay in the system. Markets are efficient, just slowly and eventually efficient. Well, you know, a lot

of it depends on what the return environment is. You know, when if stocks are compounding at ten twelve percent, nobody much notices a hundred or two hundred 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, uh 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 fifties, sixties, seventies, you know, it is common to have a six or seven percent load or commission, 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 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, they'll have pretty low costs, 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, ten twenty 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 the're gonna underperform a percent of the time, but just by a tiny little bit, And so it may now there are other investors. At lunch with an old friend yesterday, older older lady just sort of a wonderful, gracious and we were talking about how her adviser 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 ten years from now, twenty 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 ten percent better performance than ten percent more assets to manage. And the danger of this active passive thing is one people are confusing price and value. Right, prices, what you pay,

values what you get. You know, if you're a fiduciary, managing for low costs 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 costs, you can't measure fiduciary duty. They equate the two Oh, 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 risk, but it's not the same

as risk. How do you guys benchmark yourself if you're running such focused portfolios that aren't remotely You mentioned, um, the closet indexers, the funds that pretend to be active, but I've low active share and really look like the index.

Your funds don't look at anything like the indexes. 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 fourteen percent a year and have the market compound at fifteen or would you rather compound at four and have the market compound at three? The vast majority might take the latter choice because they would say, well,

my firm will be enormous. We're the opposite. We we would choose a all day Job one is to build wealth where the largest investor in the funds we manage, we would weigh rather compound at fourteen than four, and we think every client we have would agree. So that's job one. But job too is that we have over time in all of our strategies since we started them

beating the benchmarks. Now we haven't beaten them in all periods and so on, but since we started them to today, we've outperformed, and we 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, out performing 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 bury 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 gone 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 fifty day moving average and had gone up a lot, so it became more attractive to me. So you know, our view is, look,

the fundamentals over time will out. We have a strategy that we think has added value over the index over time, and really all of our strategies, and and that's 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. 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 so value reassert itself. Why is value such a laggard this go round? Well, of course, I'm gonna take umbrage with the classifications. It is a really broad classification. What we describe as value, or what some people describe as value is using quite a broad brush debate with well, and of course, what counts is value,

and what counts is 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 ten million dollars, it's going to produce a million dollar coupon in perpetuity. Well, there's no mystery what our return is. It's ten but

there's no growth. That's okay, returns ten per cent. Now we buy another business for ten million, but it only earns five hundred thousand. But that five hundred thousand is able to be reinvested at incremental return on equity. Well, the next year it's six hundred thousand, then it's seven twenty thousand, then it's eight fifty. That business will end up being a lot more valuable, even though you started

with a lower earnings yielder. To put it in terms of stocks, a high PE stock could be a much better value than a low PE stock depending on what the earnings will do over time. So I think where value investors that category has been a misnomer. Is some of the greatest value stocks of the last twenty years have been companies like Google. Google came public at I think it was eight or nine times what it earned 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 determined value based on a predetermined set of business characteristics or industries, and I won't look at technology. So you mentioned Google, which is just a money machine. The advertising business just throws off a ridiculous amount of cash. One buffets investment in Apple.

Just Apple continues to not only dominate phones, every time they introduce a new product. I don't love the air buds, but if it was a standalone company, it'd be like a six or an eight billion dollar revenue company. Their services are blowing up. I could see how you can make the argument Google is a value play. Apple's value play in your top holdings. Is also Amazon fast growing, not a lot of profits. How do you make Amazon value plan? Well, of course this is you know my

my background. As I said, I started as an accountant and I was not a c p A. But I was a fund accountant. But you know, accounting is the language of business, and gap 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 appreciation, expense, things you could capitalize, you know, defer 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

it owner earnings, which is often between those two. So Amazon maybe 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 twenty percent a year but earned zero in the first year, they would do it. And if they could do it a second year, they'd earned zero in the second year, and a third year, they'd earned 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 Walmart. Now, Walmart grew sales. This is sort of an amazing thing to think about. Over a seventeen year period, they grew sales from about a billion dollars to about seventy billion dollars. This is wal Walmart over seven. This would have been nine eighty to like seven or

somewhere in their right around there. Now, over a seventeen year period in its history, Amazon grew sales from a billion to about a hundred billion, so roughly the same rate of growth, right, those would be roughly the same over seventeen years. Now, during the seventeen years that Walmart grew from a billion in sales to seventy 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 owned the business, right at the end of the day, how much cash did you have? I gotta think a few billion dollars? Right? It was negative, really negative free cash flow for seventeen years cumulatively. Well, those stores are expensive. You gotta buy the land, you gotta buy the facilities, so it's not a zero cost of construction, all right, But why do they do that? Because they're going to get a good return on the

money that they spent. Now, the account and treatment for that is that you capitalize it, you call it capital spending, and you depreciate it over time. So there's lots of net 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 during that period of time to

finance that growth. Now, during the same period of time, when Amazon grew sales from a billion to just about a hundred billion gross merchandise value, what was their cumulative free cash flow? They reported no earnings, no profits at all. It's got to be tens of billions of dollars. The cash it was about seven billion dollars. I think of cumulators. So if you own the business, you had seven billion dollars in the bank at the end of seventeen years.

You grew sales from a billion to a hundred billion, but you reported no earnings, which is better. I'll take the ladder. Take the ladder. So our view was that's but but what was interesting is then you get to valuation, and when we bought Amazon, it was trading at about one time sales. Walmart in that period of that seventeen years growth was trading between one and two time 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 Walmart. When Walmart's growth slowed, by the way, it just gushed cash. Oh, I mean the cash places to physically store 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 Walmart went through the roof in the

next fifteen years. So the first thing you have to do is you had to look at that second, you had to say, okay, for every dollar. Now, we assumed that Amazon could have a five percent margin on sales about Walmart, and we looked at bundles of goods, and 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 Walmart that they're earning a decent return. I think Walmart got about fifteen percent or fourteen percent or maybe as high as seventeen at one point of every dollar they retained and reinvested, that was their return on that increment. 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 answers look at the data and this is when we bought it, you know, whether it was pushing into prime, whether it was pushing

into video, whether it was wonderful creating a WS. 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 a WS, we say, really they're three components. You 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 eyeballs 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 Diamond, 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 ones 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, isn't that amazing, That's quite fascinating. And they did that joint project on healthcare with its Amazon, JP Morgan and uh Berkshire Hathaway that we still haven't heard anything about that. 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 b so Us if he rolls something out like that. Well there, it's a hyper rational

company that makes decisions for the long term. You know, one thing I would recommend every listener does, if they haven't done it, they should read Jamie Diamonds and your reports every year, and they should read Jeff bezos is in your reports every year. Both men write their own annual reports, which alone tells you something about the culture of the place. For sure, they're both hyperrational, 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 retailer than Walmart. Retail is a ten trillion dollar 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 where our math doesn't work with Amazon. It's pushed

up towards that end, and we've trimmed some. But honest to God, if I said to my mother my mother owned Amazon, uh, she bought a little because she liked this 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. There you go, Can you stick around a little bit? I have a ton more questions. Absolutely. 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 finder podcasts are sold. We love your comments, feedback and suggestions right to us at m IB podcast at Bloomberg dot net. Give us a review on Apple iTunes. You can check out my weekly column on Bloomberg dot um slash Opinion. Follow me

on Twitter at ridlts. I'm Barry Hults. You're listening to Masters in Business on Bloomberg Radio. Welcome to the podcast, Chris. Thank you so much for doing this. I have been chasing you down for a while. We have a uh mutual colleague, Tucker Us, who first brought your name up to me, I don't know a year ago, and I started doing some research and said, hey, these guys really interesting. Let's let's get them into the studio and have a conversation.

So I'm I'm glad we finally hunted you down. You're your New York based right, New York born, bread and based, so so you're here, so we're not taking you too far, um out of your way. There were a couple of um 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. Well, that's a very good question. I remember I was once has to be on the board of a wonderful think tank in Santa Fe called the Santa Fe Institute, And uh, you know is founded by Murray Galman, who is a Nobel Prize physicist and wonderful scientists and incredible innovative work they do there, and 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, and and I love

the place, but I don't really think I would contribute much. He said, no, We've 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'm a white male from New York City. I don't know what you mean, like, what sort of he said, Oh, I Q diversity. He said, we're all geniuses, we need somebody like you to sort of round it out. So I don't know if that he's serious. He was actually quite serious. We need some dummies,

we need somebody listen. Six that we looked down on that group, you know, in that group, it was it was probably not an insult, but but he you know, he also of course meant, you know, somebody that wasn't of a science background and so on. But but no, you know, I think that uh, you know, I would say that Coca Cola is maybe the pre eminent international

global company. And so from my point of view, the opportunity uh, to serve sort of that icon, to learn, uh, to work with, you know, some of the terrific directors that are there, and and at a time that the company may face challenges in terms of you know, uh perceptions and and reinventing the model and beverages for life, it's an exciting time to be in. They clearly have. At one point in time, sugar 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. Yeah, they really are, you know, in their heart there 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.

Although although I will tell you, whenever I travel to the Caribbean and there's a local bottle of coca cola bottling plant, that cane sugar coca cola is not like anything you get well, and of course they sell it in New York, Mexican coke they call it, and it really it reminds you of the romance of the brand and boy on your kid. Anyway, a hot day sitting on a Caribbean island and somebody brings out that that ice cold glass bottle of coke, You're you're absolutely right,

and now it takes you back. 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. Um. The other thing you're a board member of is the Museum of Natural History, one of my favorite places in the city. How did how did that come about? Well, you know, I think I've always felt a passion about understanding more about science. I mentioned the same of a

institute with that same sort of mindset. You know, it is partly because it's my my grandmother, who was sort of an icon to me, an amazing woman, and she died at a hundred and six. She was kayaking at a hundred and five. So she really lived a full life, and she had a PhD 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 pre eminent institution for delighting people with the

ideas of science. In other words, it makes them accessible, it makes people curious, It estou 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 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, And what New York area school kid does not have a vivid recollection of the first time you see the Torhinosaurus rex or the blue whale hanging 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 know. Even that Hall of North American Mammals, you know, the giant bears standing there, and you can almost those dioramas, you almost feel them twitching. You know, it is I absolutely agree, and I think for 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 this spectacular new edition the Guilder Center, which is one of the big changes will be how it will affect circulation, and that I you know right now, when you wander the museum, you get to a lot of dead ends. One of the exciting things about the new plan is you really will be able to wander sort

of almost endlessly. It it'll be delightful and it is you know, it is a place that people should just go and revisit and revisit because on every topic they have a thoughtful, knowledgeable, uh and accessible approach to learning about the world that we live in. When does that reopen? When does the new edition go live? I think it will be twenty one, so coming up quite soon. It's uh Gene Gang from Studio Gang is the architects. She's

a spectacular architect. The that entrance will be on Columbus Avenue, so you'll enter from the other side. It's just it'll be fantastic. People forget I think the museum has something like twenty six buildings. Uh, you don't think of it is a giant and it's just I mean it's a wonderful place. So you know, I I like going to an art museum or the operas, but just 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 a side about the museum is it's had the same you know, when we invest in companies Berry. We love when you can have a run with an executive like Jeff Bezos or or Larry Page or Jamie Diamond. You know, where you can have twenty thirty years of you know, you gained conviction early, and then you have the conviction to

ride through the downturns by 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 a decade, maybe thirty thirty or by the end of her career maybe forty years almost, and she is just a force of nature, Ellen futter And 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. It's funny you mentioned the the ability to wander and not hit dead ends. 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 describe there. Really everything is a loop. There are no more dead ends. You walk into uhum 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 end. I do wonder if it's almost hardwired in us to be wanderers. It is amazing, and it's 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. And you really don't have that when I visit Los Angeles, and you know, and and

other cities, small cities Midwestern Akron, Toledo, uh Cleveland. You just that that sense of being able to walk to work, walk through the park, walk around. But I do think there is something in us 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 investor. He called it the best game in town. And he said, because everything is relevant in 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. I totally agree. I want to get to some questions that we skipped over um during the broadcast portion, and really the first thing we have to talk about is Davis Advisors is relatively new to the worlds of ETFs. Uh. This is something like that, you guys added a couple of ETFs which have all accumulated a decent amount of assets under management.

Given your fifty year history and mutual funds, what made you say, hey, let's try these new fangal dtfs on. For some it's such a great question, Barre, and you're gonna love the answer because it's such an interesting story. You know, we didn't start as a mutual fund company. We started as an institutional advisor, that pension advisor. You know, this was the sort of uh in the early nineteen sixties.

My father started that business. You know, he managed money for people like you know, Allied Signal or you know, foundations and so on, and uh, very reputable and uh. One of the consultants that had worked with his firm came to him and said, you know, would you be interested in starting a mutual fund And my father said, well, well, don't you need to go to a mutual fund shop

where an institutional advisor Mutual funds is something else. And happily this advisor 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 fifty years ago and started the mutual funds. We started the managing

the mutual funds. Then, well, the same thing happened Barry with et s. So what happened was we had a long most of our clients come to us through financial advisor sort of trust advisers. They've had a long relationship with an advisor that we had done business with for twenty or thirty years came and said, you know, I'm curious if you could start an E T F and I, like my father, said, well, E T S. Don't you need to go to an E T F shop? Aren't

they passive? Aren't they index based? He said, well, lots of indexes have higher turnover than you have. UM, 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 UH four actively managed ETFs based on the four strategies that we thought had the most promise in today's market where we see the biggest So it's a concentrated U S strategy called d U

S A Davis Select US. So that is a really UH sort of focused U S strategy UH Davis International d I N T and that's non US international again very focused. So it's not you know, the international indexes are just a mess. You know, I think we've outperformed the international indexes and sort of all periods. It's and a lot of active managers have So if you want to invest internationally, being active is usually the way to go, but there weren't some great active ets. So d A

global that combines both. I always say, if somebody's coming does with just wants one fund Global is probably the best because it's the least constraint. D w L D Davis Worldwide and then financial where I started my We started d F n L because the financial e t F s. Do you know the financial e t F the largest financial ETF has almost in five stocks. I mean that's a little scary, you know, aping the s. 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 are 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. And you know, if we're buying Google, I don't have to worry about, you know, somebody trying to jump in front of us or that. Uh. 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 uh. And so we we sort of set out with fully transparent, you know,

true ETFs. We put a lot of our own money in them because there is a lot of tax efficiency uh in them in this environment and and uh and what we found surprisingly very is there a few traditional et F 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. Maybe I should reserve a

place in my portfolio for real active management. And so we saw at first globally international, but we're even seeing in the US. Now 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 e t F s because of the way they're structured. What happens internally doesn't generate a

tax bill until you send sell them. Are we seeing that transition from mutual funds to e T F or is it still too much of a niche product and mutual funds are gonna be around for another century of so well, I mean, we started the e T s 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. An

ETF does not have that advantage. And et F is very much like an s M A right, it's a separately managed to count in essence um. So there are advantages.

There are environments where you could imagine the mean, but by and large, I would say, if I had to predict, I could definitely see the It would be hard for me to understand why et F wouldn't continue to gain traction because of the relative ease of transactions and so on, and so I you know, 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,

but 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 marker in the sand and be really the leader in true active management with any 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 for

the form of an ETF based version of their active funds. Well, I think that they have a number of barriers that we were comfortable, uh stepping over that stand in their way. Some are too large and they worry about the liquidity of effects. 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 e t f uh and without creating the opportunity for fee arbitrage and so on.

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. Was that the concern the arbitrage? 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, uh and in a sense short the E t F and make a guaranteed return that would

be reasonable. Uh So, if that guaranteed return is you know, thirty basis points or sixty basis points, that's gonna be tough to make a lot of money on because you're taking single event risk and things like that, so you'd have deliver it so high. But you know, if you're charging one or one and a half percent, then you somebody could say, well, I'll just buy those stocks short the t F. I make an extra one and a half percent doing that. Um 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. And and that's what and I feel that way about the E t f s. You know, if you make it easy for somebody to do the right thing to invest with you at a reasonable fee, uh, 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 confirms, they can see the trades that you're doing for an account, and 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. You know, I've

I've heard people talk about that. But let's say someone were to open an s m A and then they would shane a different account to that s m A. That that seems like it's far too much work to actually do to save fifty or seventy five basis points, unless it was hundreds of millions of dollars, in which case it would be really easy to identify, um, who

is piggybacking on all your trades. There was a wonderful story but real mentor of mine early was a man named Bob Kirby, and he worked at Capital Group, and he was just a legend wonderful, wonderful investor in a wonderful human being. And uh he tells the story about how he was managing an account for an older lady and uh, 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, uh, this husband had been free riding on all his trades, and every time Bob bought a stock for the wife, the confirm 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 punchline. What was amazing is that the husband's

account had meaningfully outperformed. Why well, because the husband never sold anything, and because he was buying it out of income every month, whereas 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'm constantly trimming it, uh, 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 what they bought. 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 asked all my guests. Lets These are usually pretty revealing about who you are and what you're about. Let's start with, UM, you mentioned

Amazon Prime. What are you streaming these days? Give us your favorite Netflix Amazon Prime podcasts? Uh programs. Well, this is a very disappointing question because I am I. I find that I watched things so infrequently. I I feel there were two decisions I made when I was in my early twenties. As I said, I'm not going to become a sports fan because it's three to five hours a week at least least at least and uh, I don't understand who is home every Sunday watching football for

twenty weeks a year. I don't care. 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, as well, you know, like May West, I I can resist anything but temptation, So why 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 watched films, I read a lot, uh, 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 by violence and things like that, You're like, this may not be for me. So I'm hopelessly out of sync with pop. We'll get two books in a minute.

But that's fascinating. So I was gonna 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 I think. I think people that know me assume I'm pretty square, so I think that they wouldn't be surprised by that. I I don't you know. I would say that it in in many ways that I find very reassuring. I'm very very conventional. Um.

People may not know. I was in seminary, uh when 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 enormously modest, thoughtful, restrained, uh, sect of the faith. And I'm fairly agnostic, uh, but I my my view was I thought that 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 signing people don't know. 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 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. Well, of course, yeah, religion has 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. It 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 doubt And he said no certainty. He said, if you doubt and faith are required of 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 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 that faith. Certainty is the opposite of faith. That's so interesting you said that because I have a friend who always asks what's the opposite of love?

And the answer is, it's not hate, it's different, and it's the same philosophical 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. Well, when somebody thinks that obvious and easy, that's when I get a little nervous for sure, and and it never is. Um. So let's talk about mentors. Who were some of the mentors that guided your career

and helped influence the way you think about uh investing. Well, I mean I I grew up with two at at the dining room table, so you know, I had, you know 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. Uh. He would uh we could buy stocks. He would finance them if we wrote a report and

called the company. Uh and uh. It was just he made it. So, you know, I used to say, when the train pulled in at night, uh in uh. He lived out in Tuxedo. Uh. 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 exuber you know. He just loved 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 them. So those two. But but outside of them, 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, and he's just one of the great human beings I've ever know. How did Charlie Munger come into your life? Well, that's

a good question. Uh. You know, my grandfather had a long history and my father investing in Berkshire, So we had gone to annual meetings. And you know, for many years my board was actually my father was actually on the board of Geico. Uh, 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, uh, when I was interested in trying to sell a business that my grandfather had, which was a curities lending business.

And I won't bore you with all of the details of that business, but uh it basically as my grandfather. When my grandfather died, he gave a hundred percent of his estate to charity and uh, and so he had 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 and maybe they would take this operation. And I arranged this breakfast with Charlie Munger. I pitched it to him

between eight and eight oh seven in the morning. At eight oh seven, he said, I have no interest in the business that's you know, uh, you know ten guys named Tony and you know, back office business where we don't understand, you know. But he said, I'm interested in why you picked Berkshire. And so I talked to him about the balance sheet and the security and he said,

well that's it. And then we got and we didn't leave the table until lunchtime, and it was you know, I would define it as, you know, the big most significant change, uh in not just my professional but really my professional and personal life in terms of the direction of my life. That breakfast was an enormous change. And I've always been grateful to him, and I try to see him whenever I can and and uh uh he

probably wouldn't mind, I say. I. I asked about his birthday what he wanted for his birthday, and he said, a paternity suit. Yeah, that sounds like him. That's hilarious. Um, let's talk about books you mentioned um, uh, you enjoy reading. I know Monger and Buffett do spend half their day reading. What are some of your favorite books? What are you reading these days? Fiction, nonfiction, whatever? Well, you know, it's

funny the waves that you go through. I find I find myself in periods of time where I'm reading too much fiction and I need to force back in nonfiction, and then the opposite. I've been in the opposite phase. More recently, it's 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, you know, well we've we've

seen that story before. The old joke about um fiction versus nonfiction fiction has to make sense, Yes, exact nonfiction could be completely and perfectly said. So well, I mean, of course, everybody should read the what I call the three scandal books, uh, you know of last year. You know, the Paronos book, uh Blood, Bad Blood, the unbelievable book on one MDB on the Malaysian Front. It's called the Billion Dollar Wail. It's a terrible title, but just a

spectacular story. And uh, and then everybody should read Bill Browner read capital you know that is, you know, just the the corruption that went on under Putin in Russia. So that was and is ongoing and is ongoing. Um. But I would say the best book that I read last year, uh was I'm going to mispronounce his name. I'm sad to say it's Boo Trevanissan. I think B h U and then S R and V and a bunch of consonants. Uh. 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 hair dressing and a few other things. And I thought, I was very surprised that my friend recommended this. But it was a good novel, but clearly it 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 and not just the people that started it, the ideas how it 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 microprocessor and resist 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 that sounds fascinating. I'm gonna make a book recommendation to you only because you describe that trilogy of um fraud books. If you haven't read The Spider Network, I think it

was by David Enrich. It's about the library manipulation. If you liked the Bad Blood book, this is the same thing. It reads like a thriller straight through. Really quite fascinating. I love. 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 Sarah Nos but tharahs was tiny compared to one m dB, I

mean one MDB. Somehow a young man stole nine billion dollars and is still at large and it's almost you know, whatever you say about Elizabeth and Paraos, you know, Uh, she was a believer and went down with the ship. I mean it is so money went in, but billions wasn't lost. You know. Here nine billion dollars just poof. Uh. It's a spectacular story. So I if you're interested in financial it's it's it's a good one. I'm definitely gonna check that out. Um, tell us about a time you

failed and what you learned from the experience. Well, you know, I said earlier success as a lousy teacher. Uh. You know, the culture of our firm is so based on trust between the team of us that worked 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 uh that goes back twenty or twenty five years and it keeps growing, unfortunately, my son said, starting to look like a mural and uh. And each certificate has a plaque on the bottom with the transferable lesson learned and

some are mistakes like quantification. Some are mistakes of qualification judgment. Uh. Some are mistakes of omission, things that we failed to do that we ought to have done. Some our mistakes of comission. Some companies are on there twice. Uh. And they can be on there twice because you bought them wrong and you sold them wrong. Uh so uh, you

know there were Uh. The mistakes of quantification are the easiest to fix because like that manufacturing process earlier when we 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 tied to the income statement. Because that's how Enron or Loo sent most dramatically, was manipulating their their cash flow statement, their

income statement through their cash flow statements. On mistakes of quantification. Uh, maintenance, capital versus appreciation, those are valuable lessons because you put them back in the system, you don't make them again. The firm gets better judgments a little tougher because each one looks a little different, like Tolstoy's unhappy families. Um. And you don't want to learn so broad a lesson that you miss a real uh, you miss an opportunity.

The other way, the mistakes of omission, those are enormously valuable. I mentioned Google earlier Google's 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 were 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 two dollars. Their next nearest customer acquisition vehicle, which I think was late night cable television, was thirty dollars. It was so valuable. So anyway, those are mistakes. So I would say, you know, we've been

guided by failure, uh and UM. We really try to have a culture of embracing it and learning from it and and earning a subsequent return on the past mistakes we've made. It's interesting you guys do that via wall all of the I shouldn't say all. Many of the prominent venture capitalists hold out there. 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. Well, it's my my grandfather's You don't learn from mistakes if you don't admit you make them. And and you know,

we're in a dynamic business. What what what helped us succeed in the nineteen seventies was different than the eighties or in the eighties didn't work in the nineties. So this process of evolution. That's why, going back to your very early question about value and growth, that'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 gonna 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 will mean for healthcare costs, or what it which is your in your insurance portfolio, or what it might mean for you know, life expectancy. And so we just we have a curious mindset, but we also think that the idea of not looking at things

is very, very dangerous. Why why didn't you invest in the company that cured cancer? Well, they didn't have any earnings the first two quartersactly, just a crazy You know, we made a lot of money investing in Cable, and you know Cable had no earnings for twenty five years. Isn't that really? I think? So, you know, it's all

cash flow. I don't think they went to earnings until about fifteen ten or fifteen years ago, and Cable started in the seventies, so I would yeah, I would say it would have been twenty five years with no no reported earnings. But again going back to accounting, lots of cash flow. So what do you do for fun? What do you do when you're not in the office or when you're not reading. Well, Uh, that's a good question.

I mean, I you know, we we always say, you know, it's hard to find investors that successful investors that had a history playing team sports. I always say it's sort of the mindset you te to end up with runners, swimmers, case link offers, but you don't get a lot of uh 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 have to have lower emotional intelligence things like that. Um so I do

you know, I enjoy things like running and swimming. Uh. But but I would say the one thing I do that's a little bit unusual is I have I have had for twenty years or so a very very old wooden sail boat feeling and I h it was built fifty two years ago, fifty three years ago, went down the ramp the same month I did. And uh, it's not a fancy boat. And it's uh, but it's a very well built, sort of hearty 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 golfs 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, and I don't think that's like life. I don't think the six inch pot counts the same as the hundred yard drive in life, or I guess

two hundred 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 against the way. 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 ourselves 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 that those things all matter. So two things. First, I'm gonna have to send you something. I'm gonna 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 power boat, but I got into boating through a friends sailboat, and to me, there is nothing more relaxing than just being out on the water with no engine noise, just the wind and the sails. There's something about it that is unique in the world of

um leisure activities. Well, we talked about being wandering and that maybe a genetic predisposition to be wanderers, to be explorers, as having served our species over time, and and I agree that there's something about sailing and the silence, the harmony, the balance. UM. I also particularly love navigating, and so you know, I do a little celestial navigation. I have a GPS as everyone's got to go there. 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 because it's there's no TV, there's no cable and and uh, 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. So, speaking about, um, 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? Well, I'm most optimistic about ingenuity.

You know, it just uh the you know, we're we're not uh you know, we we aren't sort of a mindless optimists, 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. Uh. We address problems in part because we worry about them so much. Um, when I look at what's happening in AI, in biotech, uh, you know, the innovation, what's happened in China was just

back from China. I mean, you know, look at those people, you know, a billion people who when we were kids, uh, they were starving and uh, you know, it's just the progress of the civilization in the last thirty years is just breath taking. 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. No, I mean you end up with a you know, a pharmaceutical or you know, biotech cure for diabetes, Alzheimer's and uh a l S and you know, maybe a couple of others, and you have medical deflation for the next fifty years. Just just look at the recent data on cancer death and it's amazing. So so I love the innovation. It's one of the things I love about my job

is meeting in vendors. 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 five when they were She was asked that, she said tomorrow, And so I love that. Uh, 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 build uh wealth in in China and India, how well it works. Um. I lived in in Europe for five years. I went across the Berlin Wall and into Czechoslovakia and the eighties. 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 is a deep systemic problem. Um. I think we'll muddle through. But that that's the one that gives me pause, quite quite intriguing. Um. What sort of advice would you give to a recent college graduate who was thinking about a

career in finance. Well, I'd 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 gonna 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 uh, you know, a lot of excess pay is being squeezed out uh and that's probably a healthy development that count reduction.

So yeah, exactly if people are interested in it because of stewardship, if they're interested in it because they're excited about the puzzles. You know, one thing I would say to all this is millennials I have I have. I have four children, and all of who 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's 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 sounds 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 uh study, you know, are drawn to the description instead of the teacher. It sounds like good advice. And our final question, what do you know about the world of investing today that you wish you knew thirty years ago when you were first getting started. Well, that's a good question, I would say. Um, I am struck

by resilience. I'm struck by how my time horizon continues to Lengthen, you know, my my grandfather, uh, you know, there's an apoc 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 a thousand dollars by the time I was his age. And he said, it's a hot dog worth a thousand dollars. 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 nineteen fifty and two thousand and seventeen, you'd have, I don't know what fifty three governments, you'd have the Lira ago from you know, tend to three thousand, you'd have, you know, 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 Ferrari, you did pretty well,

did pretty well. And so the ability for businesses to adapt, to respond, uh, to change. I wish I had really deeply understood that. And God, I wish there were a lot of businesses I owned along the way that I had just held on too, uh, not been not been so worried about next year's results, but really focused on the next decade. Quite fascinating. Chris Davis, thank you so much for being so generous with your time. We have been speaking with Chris Davis, Chairman, chief investment officer at

Davis Advisors. If you enjoy this conversation, well be sure and look up and intro down an inch on Apple iTunes and you could see any of the previous three hundred such conversations we've had over the past five and a half years. Uh. We love your comments, feedback and suggestions right to us at m IB podcast that Bloomberg dot net. Give us a review on Apple iTunes podcast section. You can check out my daily read column on ritalts dot com, follow me on Twitter at Ritalts. See my

weekly column on Bloomberg dot com. I would be remiss if I did not thank the crack staff that helps put these conversations together each week. Mark sin Ascuce is my audio engineer. Tracy Walsh is my producer. Michael Batnick is my head of research. I'm Barry Ritolts. You've been listening to Masters in Business on Bloomberg Radio.