VALUE ADDED


Buy in Times of Pessimism

Steven Goldberg

Christopher Davis, co-manager of my favorite fund, Selected American Shares, says there's money to be made buying shares of high-quality companies at reasonable prices.



I won't mince words: If I could buy just one mutual fund, it would be Selected American Shares (symbol SLADX). Chris Davis, one of Selected's co-stewards, is one of the wisest stock pickers in the fund business, and his words are worth heeding. And right now, Davis says, is a good time to buy stocks.

With the market down sharply and pessimism rampant, "we're coming through one of the worst decades for stocks of the past 100 years," and many are selling at attractive valuations, says Davis. "Generally, the best times to invest are after periods when stocks have done very badly. I don't know if we have another bad year ahead of us, but we are far nearer the bottom than the top."

I interviewed Davis before the market collapse September 29. But the selloff didn't shake his confidence. "It is probably more true today than last week in that lower prices today can only increase future returns," he said after the 777-point plunge in the Dow Jones industrial average.

In making investing decisions, Davis says, it's crucial to "try to take your gut out of it. A lot of investing is about emotional control. You want to buy in times of pessimism."

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He focuses on the long term. "Is Johnson & Johnson (JNJ) going to have higher sales five years from now? Of course. I have no concern about that." That makes what happens over the next several quarters much less important in the overall scheme of things. "So much money moves on what people think will happen in the next 12 months. Our thinking about businesses is all based on where we think a company will be in five years."

Few managers truly analyze stocks this way. That gives those who do, I believe, a huge advantage.

With foreign bourses down far more than the U.S. market, Davis is still comfortable investing nearly 20% of Selected's assets abroad. "About 95% of the world's population is outside the U.S.," he says, and many of those people live in countries that are growing faster than the U.S.

In today's troubled market, Davis says, it's crucial to focus on quality companies: "There's plenty of money to be made buying high-quality businesses at reasonable prices in this market. There's no reason to look at dodgier businesses." To Davis, that means investing in companies that carry relatively little debt, operate durable businesses and hold strong competitive positions. Among top Selected holdings that fit that description are Costco (COST), ConocoPhillips (COP), American Express (AXP), Comcast (CMCSK) and Microsoft (MSFT).

Davis says Warren Buffett's Berkshire Hathaway (BRK.B), another big holding, will deploy more of its cash hoard during the current turmoil. Berkshire recently announced its intention to invest $5 billion in Goldman Sachs. Says Davis: "The Goldman Sachs deal is a reminder that this market was made for Berkshire. I think Buffett will deploy a heck of a lot of capital in this environment in a lot of different ways."

It could've been far worse.

At the start of 2008, Selected had about one-third of its assets in financial stocks, including some that would turn into the year's biggest dogs: Merrill Lynch and American International Group (AIG). "We were absolutely wrong" on AIG, Davis says. That the fund is down only 16% year-to-date through September 26 -- about even with Standard & Poor's 500-stock index -- is little short of a miracle.

I've always liked Selected American a lot, but the performance this year deepens my respect even further for Davis and his partner, Kenneth Feinberg. Together with 11 analysts, the pair handle about $75 billion in Selected, similarly managed mutual funds and other investment vehicles.

Long-term performance has been terrific. Over the past ten years through September 26, Selected returned an annualized 8%. That's an average of three percentage points per year better than the S&P 500 and puts Selected among the top 13% of large-company funds that invest in a blend of value and growth stocks.

The fund's Class D shares boast super-low annual expenses of just 0.57%, so you should buy that class if you can. The Class S shares -- the only ones you can buy at some brokers -- charge 0.90% a year.

Davis is the third generation of his family to manage money, and the clan has hundreds of millions of dollars invested in this fund and its near clone, broker-sold Davis New York Venture. Selected holds stocks for the long haul -- the fund rarely trades more than 10% of its holdings each year.

Why has Selected been able to keep its losses in check despite the heavy weighting in financials? Davis says part of the reason is that not all financials are subject to the same pressures that, say, Lehman Brothers and Washington Mutual were under. For instance, Berkshire Hathaway and another Selected holding, auto insurer Progressive Corp. (PGR), have fallen far less than the market.

What's more, Davis and Feinberg have trimmed financials, from a high of about 55% four or five years ago to 27% at midyear. A healthy slug of energy stocks-21% of Selected's assets as of June 30-also helped performance (at least until the energy sector began to weaken last summer).

The bottom line is clear: No one can tell for sure whether the market has hit its low point or whether it will fall much further. But now seems like one of the best opportunities in decades to invest in high-quality companies. As Davis puts it, "Five years from now, the real estate crisis will be a memory."

Steven T. Goldberg (bio) is an investment adviser and freelance writer.




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