As many people may know, 1909-born Shelby Cullom Davis started his investing career quite late, when he was 38 years old, after he quit a state government job to start investing with $50,000 seed capital. For the record, in his investing life, he turned that $50,000 into $900 million, mostly on insurance stocks.
The book gives quite a few lessons on investing in insurance stocks in particular, and investing approaches in general. Here are some takeaways from the book:
He and the rest of the family were extremely long-term investors — not five years or ten years, but perpetually. “Their financial escapades cover the period from the late 1940s, when most Americans were afraid to own stocks, through the 1940s, when most Americans were afraid not to own stocks. Along the way, they invested through two lengthy bull markets, 25 corrections, two savage bear markets, one crash, seven mild bear markets, and nine recessions; three major wars, one presidential assassination, one resignation, and one impeachment; 34 years of rising interest rates and 18 years of falling interest rates; a lengthy struggle with inflation…”
For insurance stocks, Davis got excited when he found insurance stocks selling cheap. What were the catches for him? He had discovered that the typical insurers were sold for less than its book value. The bonds and mortgages in its fixed-income portfolio were worth far more than the market price. Any buyers would get their money’s worth and then some in a slice of the portfolio. They would get the ongoing insurance business for free as a bonus. In addition, the buyer would get 4% to 5% dividend yield, twice the yield on long-term Treasury bonds.
He often leveraged his portfolio by borrowing on margin. He was comfortable borrowing the maximum that SEC allowed, around 50%. But the safety net was that he figured cut-rate prices for insurance companies. Shelby, his son, said: “My father hated taxes, so margin became his favorite weapon against the IRS. The interest he paid on his loans was tax-deductible, and his deductions wiped out the taxes he’d otherwise have owned on the dividends he got. Also, by raising the stakes on his investing, margin kept him focused.”
He needed to study management well before investing. He and Phillip Fisher were quite similar on the scuttlebutt approach. He traveled a lot, visiting CEOs, having face-to-face meetings. When the CEO announced goals for the future, he challenged them to provide details. He didn’t like it when the management of companies provided predictions about their long-term profit growth but were vague on their plans of how to achieve them. One of his favorite questions was: “If you had one silver bullet to shoot a competitor, which competitor would you shoot?”
Only after seven years of self-employment, he had already become a wealthy man. He was focusing only on insurance stocks. In 1950, insurance companies were sold for four times earnings. Ten years later, they were there for 15-20x earnings, and their earnings had quadrupled for that 10-year period. He called it “Davis Double Play.” “As a company’s earnings advanced, giving the stock an initial boost, investors put a higher price tag on earnings, giving the stock a second boost. Davis got a third boost from his margin loans.”
So what were his procedures to choose insurers to invest in? First he would crunch the numbers to find out whether the company was really making money. After he knew the company was profitable, he would look into the portfolio where the assets compounded. Here he separated reliable assets (government bonds, mortgages, blue-chip stocks) from iffy assets.
He had learned a lesson from being so close to investing in an attractive insurer, but he luckily noticed that its portfolio was full of junk bonds. Later on, several bonds in the portfolio defaulted, and the insurer collapsed. Once the numbers convinced him, he began to talk to management, sales force, executives and claim offices to know about companies’ strategies for fending off competitors and luring new customers.
Last but not least, he stressed the importance of diversification. “Own enough stocks so your unpleasant surprises are outnumbered by your pleasant surprises.” He was good at numbers, but he didn’t pick stocks on numbers alone. He once told his son: “You can always learn accounting on the side, but you’ve got to study history. History gives you a broad perspective and teaches that exceptional people can make a difference.”