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Very Attractive Buys in Chris Davis' Portfolio

January 09, 2012 | About:

Davis Advisors is an employee-owned investment management firm created in 1969. It was founded by the Davis Family, and the current leader is Christopher C. Davis, who has over 21 years of experience.

The firm offers a variety of investment vehicles, ranging from real estate funds to the Davis Value Portfolio. Its goal is “to provide investors access to attractive investment opportunities in large-cap, durable, well managed businesses.” Davis always says, “Despite periods of uncertainty, stocks permanently reward patient, long-term investors.”

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?

Davis Advisors constantly seeks businesses with proven leadership, successful operational models, and sustainable competitive advantages. Another issue is 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 these tests, 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,” Davis added.

Davis Advisors utilizes four financial metrics in their analysis:

  1. Owner Earnings, the excess of cash a business generates after reinvesting to maintain capacity but before reinvesting for growth.

  2. Enterprise Value, the price to be paid.

  3. Owner Earnings Yield, once the enterprise value is calculated, owner earnings is divided by enterprise value to yield a calculated return that the firm 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 Advisors generally make the investment if they find there is significant margin of safety.

As regards financial results, 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%.

The firm is in a good shape to face future outcomes. Davis Advisors acknowledges an overall improvement in earnings, cash flow, liquidity, balance sheet strength, and dividend growth.

I found these stock picks as the most attractive to analyze in my FAST graphs valuation tool.

Bank of New York Mellon (NYSE:BK):

Bank of New York is a bank holding company and one of the world's larger financial institutions. They provide comprehensive financial services to individuals, small and mid-sized businesses, multinational corporations, financial institutions, governments and public agencies worldwide.

Its five business lines are: Securities Servicing and Global Payment Services, Private Client Services and Asset Management, Corporate Banking, Global Markets and Retail Banking.

BNY Mellon is financially healthy. As a matter of fact, it is the highest rated US bank and one of the highest rated financial institutions in the world with a AA- rating from S&P. In addition, it has recovered from recent lows; its portfolio valuation has improved as well as its profits.

Its immense size helps it obtain economies of scale in a highly competitive environment. The bank's balance sheet growth is largely driven by deposits placed by custody clients. This provides a cheaper and more stable source of funding than tapping the capital markets.

BK is undervalued when I see its price in relation to its earnings justified valuation and its P/E ratio.

BK has a solid franchise and the stock is very attractive at levels in the 19/21 range.


Google Inc. (NASDAQ:GOOG):

Google manages an Internet search engine that generates revenue when users click or view advertising related to their searches. Google is widely recognized as the “World's Best Search Engine” and is fast, accurate and easy to use. The company also serves corporate clients, including advertisers, content publishers and site managers with cost-effective advertising and a wide range of revenue generating search services.

Google's balance sheet is made up of almost $35 billion in net cash and about $4.2 billion in short-term debt and long-term debt.

Management expects larger increases in online ad spending thanks to a more effective branding advertising.

Google's meteoric rise in smart-phone market share through the Android platform should help to extend its competitive advantages into the mobile world.

Google definitely holds new and significant opportunities for growth.


The Walt Disney Co. (NYSE:DIS):

Walt Disney Company owns 100% of Disney Enterprises Inc. which, together with its subsidiaries, is a diversified worldwide entertainment company with operations in five business segments: Media Networks, Studio Entertainment, Theme Parks and Resorts, Consumer Products and Internet and Direct Marketing.

Walt Disney s fourth-quarter 2011 earnings were of $0.59 per share and jumped 31% from the prior-year quarter triggered by strong performances by the Media Networks and Parks and Resorts divisions.

Furthermore, the company has entered into broadcasting agreements to boost the performance of ESPN, the key driver of the Media Networks division.

Disney's financial health is solid. Debt is a low percentage of total capitalization, and EBITDA is expected to cover interest expense more than 30 times on average during the next five years.

The parks and resorts segment is considered a late-cycle business as vacations are generally planned in advance. This business should post better results as the economic recovery continues. In addition, Pixar is a valuable asset for Disney.

Shares appear NEUTRAL valued in FAST Graphs tool. As we can see, the price line (black) is very close to DIS justified valuation line.


Hewlett-Packard Co.(NYSE:HPQ):

Hewlett-Packard provides a variety of services and products ranging from software to IT consultancy to their clients. HPQ currently trades at $35.30, with a market capitalization of $73.22 billion. In 2011 it grew revenue 1%, non-GAAP EPS 7% and free cash flow 8%. Moreover, it generated $12.6 billion of cash flow from operations. HP's global reach and well-run logistics provide an efficient platform to assimilate and distribute new technologies. HP is effectively targeting technologies to acquire in storage and networking that will help it build an all-in-one portfolio for enterprise data centers. The EDS acquisition instantly positioned HP to be a contender in enterprise services.

HPQ traded very close to its earnings justified valuation line until 2010, when Mr. Market went overly pessimistic about HPQ future prospects.


Intel Corp. (NASDAQ:INTC):

Intel is the largest chipmaker in the world. It develops and manufactures microprocessors and platform solutions for the global personal computer market. Indeed, it was the pioneer of the x86 architecture for microprocessors.

From a financial standpoint, Intel is in good shape. At the end of the third quarter of 2011, the firm had $10.9 billion in cash and short-term investments compared with $7.1 billion in debt.

That is not all. The firm has sustained its position at the forefront of technology by investing heavily in R&D. In addition, it has an immense budget for capital expenditures, allowing it to maintain the most cutting-edge semiconductor manufacturing technologies in the world.

The firm subsidizes marketing efforts by customers when they highlight the Intel brand. As a result, it benefits from powerful brand recognition.

Similar to HPQ but not as dramatic, the market values INTC lower than what its earnings justify.

I find FAST Graphs tool as an excellent way to analyze in a snapshot how the market is valuing each stock.


Rating: 3.1/5 (11 votes)


Tonyg34 - 5 years ago    Report SPAM
If I may start a tangent:

That GOOG FAST graph shows an inherent flaw in the pricing model. Yeah the black line is below the blue and orange lines. That's because the blue line represents a 40 PE multiple. You might be using the longest available moving day averages, but its still charting (technical analysis) without any consideration toward where those future earnings are coming from or how the company may sustain its historic growth rate. Do you really think GOOG "deserves" to trade at 40 times earnings just b/c of its past performance?

By all means it is not only possible but in this instance quite likely that the market is discounting the future earnings of all the companies listed, but the idea of an earnings justified yield implies a level of predictability of earnings that is simply not possible (with a bank that won't see earnings on interest income at historic norms for a long time, or a broken tech stock like HPQ, or tech titan that lost its edge to a new technology, e.g. INTC and ARMH). The reason HPQ traded near earnings justified levels in 2010 and then dropped is b/c its future earnings are impaired. So basically, every stock (relative to its cap size and liquidity) trades at the markets best guess of its "earnings justified yield".

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