Playing the Chips
During the ten years I've known Chris Davis, I've never heard him sound as bullish about the stock market as he does today.
And that's worth talking about because Davis is one of the nation's premier fund managers. Selected American Shares, which he co-manages with Ken Feinberg, has returned an annualized 5% over the past five years and an annualized 13% over the past ten. Both numbers are more than three percentage points a year ahead of the SP 500.
What are they bullish on? Stocks of large growth companies. Davis doesn't like the term "growth" because he thinks that implies he's gone gaga over tech stocks, which he hasn't, although he does own a few tech stocks.
In contrast to the late 1990s, when the 50 biggest stocks led the market, "huge companies are strangely orphaned" now, he says. "They don't grow fast enough for the growth managers, but at 15 times earnings, they seem to be too high for the value guys. These are companies with above-average growth and below-average prices."
That's not all. Most of these companies pay high dividends, are global franchises, have the power to raise prices and are well-run, financially rock-solid enterprises. "These aren't companies that have collapsed. Earnings are maybe 75% higher than they were in 1998 and the stocks have been flat. The P/E ratios have gone from 30 to 15 or 18."
Says Feinberg: "This is one of the greatest times to be looking for stocks because you have so many quality companies at reasonable valuations with strong balance sheets and great cash flow."
Will these stocks come back into favor? "It's a question of when, not if," Davis says. "We're in a market now where you don't give up anything to buy" quality companies. "You reduce risk, and you pick up liquidity."
Liquidity is something Davis and Feinberg give a lot of thought to now that total assets under management at the firm have swelled to $72 billion. With large caps so cheap, Davis isn't worried about running out of capacity. But if the market changes, and the best values are again mainly in small- and mid-cap stocks "We would close" to new investors, he pledges. Davis and Feinberg are assisted by ten analysts.
One reason assets have surged is that Davis and Feinberg have inherited the management of Clipper fund. Jim Gipson and his co-managers left the fund at the end of last year. In a rare move, the fund's board of directors shocked the fund world by turning down the choice of Clipper's sponsor to run the fund and hiring Davis and Feinberg instead. The pair are now putting their best ideas into Clipper, which will own only about 15 to 25 stocks, compared with 70 for Selected American.
In addition to a great record, Selected American is cheap. If you buy Selected American (SLASX) through an online broker, expenses are 0.92% annually. Directly from the firm, the same fund (SLADX) costs just 0.65%. Clipper (CFIMX) costs 1.12% no matter where you buy it, but costs will decline under Davis and Feinberg's stewardship.
Not only that, but Davis, his family (he's a third-generation money manager) and other insiders have some $2 billion invested in Selected American and Davis New York Venture, its load cousin. Turnover tends to be glacial. The fund typically sells about 7% of its holdings every year. In sum, it's hard to come up with a better large-cap blend fund than Selected American.
Blue chips to grow on
Two years ago, before energy prices spiked, Davis said the energy patch looked attractive. He and Feinberg presciently bought energy stocks, which still make up 12% of the fund. "You're still in a world where oil executives and pundits are all forecasting that the price will be lower than it is today," Davis says. "That usually isn't the end of a cycle."
What else do they like? Health care -- but not the companies you'd expect. With health costs expected to continue rising much faster than GDP, Feinberg says, the winners will be companies "that reduce costs and provide value to customers -- and are protected from the government."
Big drug manufacturers "may have more headwinds than tailwinds," Feinberg cautions. "You have to worry about regulation and price controls."
Nor do Davis and Feinberg like makers of generic drugs -- which, by definition, are commodities. Someone can almost always sell a generic for less, giving companies little pricing power.
The fund has always had a huge stake in financials. They are currently more than half of assets. Davis and Feinberg argue that financials are far more diverse than is typically thought -- and don't move in lockstep with interest rates.
They added to American International Group (AIG) during the scandal, making it a 5% position. The business remained sound, Davis says. "It was a lot of ink." American Express (AXP) is another long-time holding. The firm's credit-card business is far more profitable than those of competitors -- and should stay that way.
They're also bullish on some retail stocks -- specifically Costco (COST) and Wal-Mart (WMT). The buying clout of these huge firms means they can often dictate terms to suppliers, rather than the other way around. "Costco is just getting stronger and stronger," Feinberg says.
Opinions expressed in this column are those of the author.