The stated goal of the Davis Value Portfolio is “to provide investors access to attractive investment opportunities in large-cap, durable, well managed businesses.” The Davis process starts with two primary questions:
1. What kind of businesses do we want to own?
2. How much should we pay for them?
In response to the firm’s first inquiry, they seek businesses with proven leadership, successful operational models, and sustainable competitive advantages. Davis Advisors seek leadership teams that are not only involved in the day to day operations of their respective businesses, but those that seek to maximize shareholder value. The next litmus test lies in whether the firm can generate free cash flow consistently, earn high levels of return on capital, and can produce products not susceptible to becoming obsolescence. The final test of a prospective investment is whether the firm can maintain its dominance in a market due to a combination of brand power, market share, effective supply chain, and numerous qualitative factors. If the investment opportunity passes the aforementioned screenings, further due diligence is conducted to determine the value of the firm.
“Our goal is to purchase durable, well-managed businesses when they are trading at a discount to our estimate of intrinsic value in order to establish a margin of safety, which can enhance prospective returns while reducing investment risk.”
Primarily, Davis Advisors utilizes four financial metrics in their analysis:
1. Owner Earnings – Owner Earnings is the excess cash a business generates after reinvesting enough to maintain current capacity, but before reinvesting for growth. Davis Advisors seeks to normalize this metric due to fluctuating earning potentials during a full cyclical market cycle.
2. Enterprise Value - Enterprise value is the price Davis Advisers would have to pay purchase the business immediately.
3. Owner Earnings Yield – Once the enterprise value is calculated, owner earnings is divided by enterprise value to yield a calculated return that Davis Advisors would earn if they were to purchase the business immediately.
4. Reinvestment Rates – Assumptions are utilized based on future estimated returns on capital.
These metrics will, in culmination, yield an estimated value for a business. Davis Advisers would thus make the investment only if a significant margin of safety can be rendered, and will exit the position once this deviation dissipates. The firm may also exit investments when a significant change in fundamentals or operations hinders their previous findings.
In terms of performance, Davis Advisors returned portfolio returned 31.16% and 12.76% in 2009 and 2010 respectively. Comparatively speaking, the benchmark returned 26.5% and 15.1% for the same period. In 2007 and the 2008, the firm underperformed the benchmark by 8.6% and 10.9%. Since its inception, the value portfolio had an average annual return of 3.14%.
Looking forward, the firm is optimistic with respects to future economic conditions. Davis Advisors acknowledges an overall improvement in earnings, cash flow, liquidity, balance sheet strength, and dividend growth. Furthermore, while Davis acknowledges that the market sentiments is still largely negative, his outlook lies in line with Sir John Templeton’s insightful observation: “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria”. Their final conclusion regarding the market is that while overall prices are down, intrinsic values are higher then ever, and as such, the “market’s pricing will eventually reflect this reality” over the next 10 years.
The following tables and charts demonstrate the sector breakdown of all equities, and the top five holdings held by the firm. Davis Advisers have a majority of their investments in financials and oil & gas holdings. The most notable rebalancing changes were seen with a 1.80% addition to oil holdings, and a .80% reduction in consumer services holdings. In terms of the top five holdings, they comprise 23.38% of all equities held. All five holdings saw reductions in terms of shares held, at an average rate of 2.68% reduced in all sectors. Four of the top five holdings are situated in financials and oil &gas. The firm currently manages $59 billion in approximately 17 equities.
Wells Fargo (NYSE:WFC)
Wells Fargo is a financial services company providing services to their consumers via three primary operating segments: Community banking, Wholesale banking and Brokerage. Their shares trade at $25.21, with a market capitalization of $133.06 billion. Davis acquired each share of WFC at an approximate price of $24.47, yielding a 5.19% potential capital gain. WFC’s position was reduced by .19% quarter to quarter, and is the largest holding of the firm, at 5% of all equities held.
WFC has a P/E ratio of 9.78, a P/B ratio of 1.22, and a P/S ratio of 1.69. Wells Fargo earned $2.58 for the year, with a dividend yield of 1.90%. Revenues totaled $52.8 billion, with a net income of $12.6 billion, yielding a margin of 14.86%. Over the last 10 years, on an annual basis, WFC has grown its revenues and earnings by 10.6% and 4.1% respectively.
Wells Fargo settled a lawsuit with plaintiffs over mortgage securities for $590 million. In other news, WFC is joining Capital One in its bid for HSBC’s credit card unit.
GuruFocus rated WFC with the business predictability rank of 1 star.
Costco is a retailer operating through its membership-only warehouse fronts. COST closed at $76.74 with a market capitalization of $33.60 billion. Costco’s estimated cost of acquisition is $54.08, yielding a capital gain of 41.4% from its current price. Davis reduced his holdings of COST by 6.39% quarter to quarter. Currently, Costco is the 2nd largest holding, at 4.86% of all equities held by the firm.
Costco has a P/E ratio of 23.99, a P/B ratio of 3.09, and a P/S ratio of .43. COST reported a net income of $1.3 billion on sales of $77 billion, yielding a margin of 1.67%. Their earnings for the year were $3.20, with a dividend yield at 1.25%. Costco, on average, has grown its revenues and earnings by 10.3% and 9.2% over the last 10 years.
Costco announced same-store increases of 10%, a key metric for both Costco and retailers in general. In other developments, STELLAservice ranked Costco as number 1 for their online shopping features and shipping speeds.
GuruFocus rated COST with the business predictability rank of 5 stars.
American Express (NYSE:AXP)
American Express is a global charge and credit card merchant operating through four segments: US card services, international card services, global commercial services, and global network & merchant services. American Express currently trades at $47.21, with a market capitalization of $56.32 billion. Davis Advisors acquired AXP at an estimated price of $49.17, yielding a potential capital loss of 4.73%. AXP’s position was reduced by 4.08% quarter to quarter, and is currently the third largest holding at 4.84% of all equities held.
AXP has a P/E ratio of 12.36, a P/B ratio of 3.60, and a P/S ratio of 1.94. Revenues topped $30.2 billion, with a net margin of approximately 13.42%. Earnings were reported at $3.82, with a dividend yield at 1.53%. In terms of long term growth, AXP has grown its revenues and free cash flow by an annual rate of 4.5% and 6.7% respectively, over the last 10 years.
Goldman Sachs reiterated its “Buy” rating on AXP due to AXP’s initiative to drive revenue growth in future quarters. In other developments, American Express is partnering with Verizon to integrate American Express’s Serve, a digital payment capability, into their phones and tablets.
GuruFocus rated AXP with the business predictability rank of 1 star.
Occidental Petroleum (NYSE:OXY)
Occidental Petroleum manufactures and markets oil products and chemical products. Their shares currently trade at $87.34 with a market capitalization of $70.96 billion. OXY’s cost of acquisition in the portfolio is $70.72, yielding a potential capital gain of 23.5%. OXY’s position was reduced by 1% quarter to quarter.
OXY has a P/E ratio of 12.59, a P/B ratio of 2.57, and a P/S ratio of 4.00. Occidental earned $4.3 billion on revenues of $19.1 billion, yielding a 22.78% margin. Earnings for the year totaled $6.94 per share, with a dividend yield at 2.11%. OXY’s has on average, grown its revenues and earnings by 8% and 18.3% over the last 10 years.
Occidental Petroleum announced that they are planning on increasing their oil production by 3 to 4 thousand barrels monthly for the rest of 2011. In other news, Merrill Lynch placed a “buy” rating on OXY, with a price target of $138, a potential capital gain of 58% from its current trading price.
GuruFocus rated OXY with the business predictability rank of 1 star.
EOG Resources (NYSE:EOG)
EOG Resources explores, develops, and markets natural gas and crude oil products. Their shares closed at $95.92 with a market capitalization of $25.75 billion. Davis acquired EOG at an estimated price of $89.82, yielding a capital gain of 6.7%. EOG’s position was reduced by 1.75% quarter to quarter.
EOG has a P/E ratio of 62.17, a P/B ratio of 2.43, and a P/S ratio of 4.31. Earnings were $1.54 per share, with a minor dividend yield of 0.67%. EOG’s net income was reported at $160 million, on revenues of $6.1 billon, yielding a margin of approximately 2.63%. Historically, EOG has grown its revenues and earnings by an average rate of 19.2% and 8.2% over the last 10 years.
According to EOG’S chief execute Mark Pappa, EOG is planning on selling approximately $1.6 billion domestic gas properties to raise cash. In addition, EOG is jointly building an off loading facility for their crude oil with NuStar Logistics.
GuruFocus rated EOG with the business predictability rank of 1 star.
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