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Shelby Davis: The Lost Legacy of a Great Investor

Pop1104 views  2012-03-02 00:57   Tagsvalue  investing  shelby  insurance  the  davis  compounding  machines 

In the pantheon of investing greats one of the least talked about, but most successful, is Shelby Davis.   Starting at age 38, he took $50,000, provided by his wife Kathyrn, and amassed it into a $900 million fortune in 47 years.  This amounts to an annual compound rate of return of over 23% during that time span.  While his investing process can be summed up as growth-at-a-reasonable-price, not too much else is know about his investing process; he hardly wrote anything down as to not waste money on paper (he often wrote on the back of envelopes and scraps of paper which were tossed away).  His extreme frugality helped him to save every penny he could to invest in “compounding machines,” as he called them.  When he died he left his money in a charitable trust and left little to nothing for his two children; he was the epitome of a penny-pincher.

Shelby Davis received his bachelor’s in Russian history at Princeton (1930), his master’s degree at Columbia (1931), and his doctorate in political science at the University of Geneva (1934).  Before starting his investment firm, Shelby Cullom Davis & Company in 1947, he worked odd jobs as a European correspondent with CBS in Geneva, as a “statistician” (before “stock analyst” was invented) for his brother-in-law’s Delaware fund, as a speechwriter and economic advisor for Thomas E. Dewey (then Governor of New York), a freelance writer, and author.  He also worked for the War Production Board in Washington in 1942.  A year prior to this he bought a seat on the New York Stock Exchange merely because it was cheap, having no use for it himself.  He paid $33,000 for the seat which had fetched $625,000 in 1929.  By the time Davis died in May of 1994 his seat was worth $830,000.  His last job before he started working on his investment portfolio was as First Deputy Superintendent of Insurance where he worked from 1944 to 1947.

Davis’ work analyzing insurance gave him an upper hand by the time he started his portfolio.  He saw clear advantages in the insurance industry.  Most insurers, he noticed, were selling well below book value.  Dividends were large in this industry and if you bought an insurance company at market price you were basically getting the dividend stream for free.  He also noticed that while life insurance policies were selling like hotcakes, policyholders weren’t dying.  Insurance companies, he realized, were growth companies in disguise.  Having studied Ben Graham’s writings Shelby knew of the power of buying these equities.  Shelby bought out Frank Brokaw & Co., a street away from Wall Street, and turned it into Shelby Cullom Davis & Co.  This is when his seat on the New York Stock Exchange started to show its use and he began to capitalize on that investment using it for his business.

Although he bought insurance stocks his portfolio acted like a modern-day tech portfolio, rising from $100,000 to $234,790 in one year (he always bought on margin).  His biggest holding that year was Crum & Forster.  By the early 1950’s Davis became a millionaire by sticking with insurance stocks.  Insurance companies that had once traded at stodgy multiples (P/E’s of 3-4) and low earnings now traded at P/E’s of 15-20 with high earnings.  Shelby called this the “Davis Double Play,” an initial boost from earnings and another from investors bidding up the multiple.  He largely focused on fundamentals before choosing his investments, looking for a solid balance sheet and making sure the insurer did not hold risky assets like junk bonds.  He then focused on the management quality and made trips to meet with management and drill them.  Diversification was also one of his strategies as he believed you needed to own enough stocks so that the ones you were wrong on were compensated by the ones you were right on.  Although he never gave a “magic number,” in the mid-1950’s he held up to 32 insurance companies.

After a trip to Japan in the mid 1960’s Davis was convinced that investing in Japanese insurance stocks was a winning bet.  There were substantially far less insurers in Japan and many of these were selling at well below book value, sometimes even half of book value.  He quickly snatched up American Insurance Underwriters (later acquired by AIG) and American Family (now AFLAC), both which had big dealings in Japan.  He also added Tokio Marine & Fire, Sumitomo Marine & Fire, Taisho Marine & Fire, and Yasuda Marine & Fire to his holdings.  Davis, after successfully investing in Japanese stocks, began buying stocks in Africa, Europe, the Far East, and Russia.

Like Buffett, Davis snapped up shares of GEICO when it was on the verge of failure.  Davis even snapped up a large enough share to be placed on the board. Davis, enraged by a proposed stock sale plan by Buffett and David Byrne, eventually sold off all his shares and left the board, a decision he would live to regret. Shortly after, he increased his position in AIG but soon began straying from insurance holdings.  Davis got ahold of Value Line during this time and used the analysis to his benefit.  At this point his normal portfolio, usually 30-35 stocks, consisted of hundreds of holdings, often highly rated by Value Line, which he day-traded for small gains and actually profited in a flat market.

Although he deviated somewhat from insurance companies over his lifetime, 11/12 of his most successful investments were still in that industry.  These included AIG, the four Japanese companies above, Berkshire Hathaway, AON, Torchmark, Chubb, Capital Holdings, and Progressive.  The odd man out was Fannie Mae.  He had some other minor successes but the bulk of his portfolio was due to these 12.  If anything can be learned from his investing it’s that holding a few big winners for a long time can go a long way.

Note:  His son, also Shelby Davis, went on to be a successful investor in his own right.  So too did his grandsons Chris and Andrew.

If you’d like to learn more about Shelby C. Davis’ life and investing style I urge you to read The Davis Dynasty by John Rothchild.

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