VALUE ADDED


The Best Fund You Can Buy

Steven Goldberg

Selected American Shares' focus on high-quality stocks is ideal for this market -- and for the long haul.



Christopher Davis used to be jealous of his father and grandfather. Sure, they had gone through some of the most bruising bear markets ever recorded. But the upside of those painful experiences was that they were able to pick up high-quality stocks at unfathomably low prices. "They could make fortunes by buying companies like Coca-Cola at 12 times earnings and high-quality financials at five times earnings," Davis says. "They just had to buy the great ones and hold them for ten or 15 years."

Now price-earnings ratios on many stocks are nearly as low as they were in the late 1940s and the mid 1970s. "We finally have the same chance they did," says Davis. "And it feels like hell."

Despite the pain, Davis and Kenneth Feinberg, co-managers of Selected American Shares (symbol SLASX), understand the importance of sticking to their discipline. "Lower prices today will create higher returns in the future," Davis says.

But the ride is gut-wrenching. Selected, a member of the Kiplinger 25 plunged 39% last year -- two percentage points more than Standard & Poor's 500-stock index. Year-to-date through February 6, the fund dropped 6.4%, lagging the S&P 500 by nearly three points. Over the past five years, the fund has lost 4.1% annualized, lagging the index by an average of 0.6 percentage point per year.

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Over the past decade, the fund is flat. That, however, beats the index by 2.7 points per year and is good enough to put Selected in the top 17% of large-company blend funds (those that invest in stocks that have both value and growth attributes), according to Morningstar.

Clipper fund (CFIMX), a concentrated version of Selected that Davis and Feinberg took over at the start of 2006, has also been performing miserably. It's roughly even with Selected so far this year, but it tumbled 50% in 2008. In theory, Clipper should do better than Selected over time, but because Clipper holds fewer stocks (24 at last report, versus 103 for Selected), it should be more volatile. Unfortunately, most of the volatility has been on the downside so far.

Despite the wretched recent results, I think Selected is the best large-company, no-load fund you can buy today (Davis New York Venture is a nearly identical load version of Selected). Davis, Feinberg and their team of analysts do a terrific job of identifying great companies selling at cheap prices. And when they find those kinds of companies, Davis and Feinberg hold them for lengthy periods. Selected's turnover last year was just 8%, implying that the managers hold stocks for more than 12 years, on average.

Expenses are 0.88% for the version of Selected that you buy at many online brokers, but just 0.57% for the share class (under the symbol SLADX) that you buy directly from Selected (800-243-1575) and from certain brokers (the initial minimum for the cheaper class is $10,000). Moreover, the Davis family has billions of dollars invested in Selected and other funds run by Davis and Feinberg.

Selected's biggest loser last year, and the one Davis can't forgive himself for, is American International Group (AIG). The federal government had to rescue the insurance giant to prevent its collapse, and its share price plunged from nearly $60 to nearly nothing. AIG cost Selected six percentage points in performance. "AIG was the biggest mistake we've made in years," Davis laments. Merrill Lynch, which was taken over by Bank of America in a deal that required government assistance, was another big loser.

Lots of fine managers have lagged the S&P during this brutal downdraft, and Davis points out that the same thing happened during the 1973-74 bear market, when stocks declined almost 50%. Notable losers from the 1970s mega-bear market included Charlie Munger (Warren Buffett's vice-chairman and alter ego), Sequoia fund and New York Venture fund (then managed by Davis's father, Shelby Davis.)

Davis's current holdings reflect several themes. First, he's buying global leaders with strong balance sheets that have the ability to pass through price increases as inflation picks up. They include Hewlett-Packard (HPQ), Johnson & Johnson (JNJ), Microsoft (MSFT), Procter & Gamble (PG) and Schering-Plough (SGP).

Davis calls these companies camels. "You can ride through the desert on them," he says. "They don't need water." While these are defensive stocks, Davis thinks they'll produce decent returns. "I think of them as a lot better than cash."

Davis also likes opportunistic companies rich with cash. "Berkshire Hathaway (BRK.B) is the archetype." But he says there are plenty of technology and health-care companies that have the wherewithal to make big share repurchases and acquire rivals.

Davis is staying true to his roots. Financial companies are what worked for his grandfather, Shelby Cullom Davis, and his father, so he's keeping 30% of Selected in that sector. Borrowing and lending money, Davis says, "is probably the second-oldest profession. There has never been less competition in the banking industry, nor more universal disdain for the financial industry." Among his favorites are American Express (AXP), Goldman Sachs (GS) and Wells Fargo (WFC).

Davis is a stalwart Buffett disciple. In an October 17 op-ed piece for the New York Times, Buffett wrote that he was investing all his personal money in U.S. stocks. Buffett's bullish stance was premature. But a bearish attitude about stocks in general and the Internet in particular in an article Buffett penned for Fortune magazine in November 1999 proved remarkably prescient-the bear market of 2000-02 began just a few months later.

Like Buffett, Davis is finding better values at home than abroad nowadays. Only 12% of the fund is currently in foreign stocks. But Davis does like companies, such as ConocoPhillips (COP), Philip Morris International (PM) and Occidental Petroleum (OXY), that can capitalize on rapid growth in emerging markets.

When will the bear market end? "You don't reach the bottom of a bear market until you doubt everything," Davis says. "You doubt yourself, you doubt your approach, you lose confidence in all the things you thought were certainties because every day the market is telling you you're wrong and clients are saying, 'How could this happen?' "

By those standards, stocks should have already reached bottom. It's not clear, though, that they have.

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




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