Davis Funds 2017 Annual Investor Letter


•  In 2016, Davis New York Venture Fund returned 12.25% versus 11.96% for the S&P 500 Index.¹

•  Over the most recent one, three and five year periods, a $10,000 investment grew to $11,225, $12,316 and $18,681, respectively.¹

•  $1.97 million versus $932,077 is the value of a $10,000 investment in the Fund since inception versus the value of a $10,000 investment in the S&P 500 Index.1

•  Opportunities in today’s market include global leaders selling at bargain prices, dominant lesser-known businesses in necessary economic niches, blue chips of tomorrow and beneficiaries of short-term misperceptions.

•  Risks in today’s market include overvalued dividend darlings and companies with near peak profit margins.

Results of Our Investment Discipline

Davis New York Venture Fund returned 12.25% versus 11.96% for the S&P 500 Index in 2016.2

Davis New York Venture Fund continued its long record of building shareholder wealth. As shown in the chart below, the value of an initial $10,000 investment has increased in all periods shown.

On a relative basis, our results beat the market in 2016 as they have over the long term. Compounded over the long run, our advantage over the index has created enormous value for shareholders.

Just consider that an initial $10,000 invested in Davis New York Venture Fund at our inception would now be worth more than $1.9 million, more than twice as much as an equivalent investment in the S&P 500 Index.

While our disciplined investment approach has not always been rewarded by the market over shorter periods, this active management approach has created wealth for our shareholders in the long run. By standing apart from the crowd, keeping expenses low, investing alongside our shareholders, and ignoring short-term fads, we have built wealth for shareholders and beaten the index since 1969. •

Investment Outlook

Equities should outperform bonds for the next decade.3 Avoid overpriced dividend darlings. Focus on the important and knowable.

The last five years have been filled with the unexpected. Time and again professional forecasters and pundits have been proven wrong: from the rise of ISIS to the collapse in energy prices; from Facebook’s poorly received initial public offering to the bankruptcy of Detroit; from Brexit to the election of Donald Trump. Yet through it all, Davis New York Venture Fund has grown the value of a dollar invested in that time period by more than 80%, showing that while short-term predictions may be worthless, long-term preparation is invaluable.4

The essence of our preparation is a relentless focus on what is both knowable and important. For example, while the short-term outlook for bond markets may not be predictable, we know today’s historically low interest rates leave bondholders with less upside potential and more downside potential than at any other time in modern history. With the yield on long- term government bonds now comparable to the dividend yield on stocks, we expect stocks to outperform bonds handily in the decades ahead.

Another fact that is both knowable and important is market dips are inevitable. For example, since 1928 the market has experienced a 10% dip about every eight months and a 20% dip every two and a half years on average. Yet, when we experience such a dip, the media act as if the world is coming to an end. As a result, many investors panic and sell at low prices creating a buying opportunity for those who can keep their heads. Since stocks are one of the best ways to build long-term wealth, the years ahead are likely to reward those investors who have a long-term perspective, flexibility and steady nerves and to penalize those investors who are frozen by indecision, committed to passive investment strategies or likely to panic during market downturns.

A final important and knowable fact is investors often feel safest when risks are greatest. From internet mania to the housing boom, what looked like a sure thing in the rear view mirror ended up a speculative bubble. Two sectors where investors feel safe today have risen to levels that appear risky to us. First, many popular dividend-paying stocks, often referred to as dividend darlings, have been bid up to premium valuations that could spell trouble for investors who assume dividends are guaranteed. Second, with regulatory encouragement, roughly a trillion dollars has been switched from actively managed funds into passive index funds since 2007. Such huge fund flows create momentum, as more money is automatically invested in those stocks whose prices have already gone up. Unfortunately, momentum-based strategies lead to bubbles and bubbles eventually burst. Moreover, while passive investing may have beaten the average manager, a select few active managers, including Davis Advisors, have beaten the market over the long term. In fact, in addition to Davis New York Venture Fund, all five of the equity strategies managed by our firm, including Davis Global Fund, Davis Opportunity Fund, Davis International Fund, and Davis Financial Fund, have outperformed their peers since their inception.5 Happily, as more money flows into passive index strategies that employ no securities analysis, more investment opportunities are available for investors like us who do. After all, finding undervalued companies is far easier when fewer investors are looking. •

The Portfolio

Global leaders trading at bargain prices. Dominant lesser-known businesses. Blue chips of tomorrow. Beneficiaries of short-term misperceptions.6

Four portfolio themes have allowed us to create a powerful combination of growth and value in Davis New York Venture Fund:

Global Leaders Trading at Bargain Prices—Some of the strongest and best-known companies in the world make up the largest portion of the Portfolio. This fact is nothing new. What is unusual though is short-term economic concerns over the past year have reduced the share prices of a handful of global leaders such as Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B), United Technologies (NYSE:UTI), American Express (NYSE:AXP), and Monsanto (NYSE:MON) to bargain levels at a time of high valuations for the average company.7 Buying top tier businesses at bargain prices is a value investor’s dream.

Dominant Lesser-Known Businesses— Davis New York Venture Fund also invests in a group of lesser-known businesses that dominate dull but necessary niches in the global economy. Whether they participate in unglamorous industries or are headquartered in different countries, these businesses are not household names to U.S. investors. As a result, their shares often trade at a discount to better-known companies despite having the same qualities of market dominance and durability as the global leaders described above. Such companies include Johnson Control’s leadership in fire and security, building controls, and car batteries; Liberty Global’s strength in European cable TV and broadband; LafargeHolcim’s dominance of the world cement industry, and Safran’s leadership in jet engines (the company has been an equal but less well-known partner of General Electric for more than 30 years). These companies combine the relevance and resilience of blue chip companies with below-average valuations.

Blue Chips of Tomorrow—Another theme is fast-moving companies that use innovation to disrupt the economics of larger but less agile competitors. Similar to evolution, capitalism is a process of constant change that rewards businesses that can adapt. Over the decades, we have seen many examples of today’s disrupters emerging as tomorrow’s blue chips. Several of Davis New York Venture Fund’s core holdings reflect this dynamic. Amazon (NASDAQ:AMZN) has not only revolutionized the retail business, but also the information and technology industry through Amazon Web Services (AWS). Alphabet (NASDAQ:GOOGL) (the parent company of Google) began by making the world’s information accessible through the internet and emerged as the largest and most profitable advertising firm in the world, the brains behind the vast majority of all smart phones, a leader in internet video, and the emerging leader in artificial intelligence and self-driving cars.

CarMax (CMX) is another example of an innovator that has been just as disruptive in the auto sector, bringing trust, choice and quality to the murky but enormous used car industry. Investors in disruptive leaders stand to benefit not just from the growth in these companies’ underlying businesses, but also from their gradual inclusion in the ranks of blue chip stocks.

Beneficiaries of Short-Term Misperceptions— Short-sighted investors avoid companies that face short-term misperceptions, creating an opportunity for long-term investors willing to look beyond today’s headlines. In banking, for example, memories of the financial crisis of 2008–2009 combined with subsequent anti-banking rhetoric and media coverage have blinded investors to the fact carefully selected banks are both cheap and safe, in our opinion. Contrary to perception, many top tier banks are not only reporting record earnings but are also far better capitalized than at any time in the last 50 years. While unloved now, we believe the leading financial companies we own will be big contributors to Davis New York Venture Fund’s future returns as the reality of their strong economic fundamentals and rising dividends eclipses current investor perceptions.

Similarly, over the past year, investors fled the energy sector in response to the dramatic (and unsustainable) collapse in oil prices. While oil prices are unknowable in the short term, they must exceed the cost of replacing reserves over time. This simple fact will eventually lead to higher energy prices and should drive future returns for the well-positioned, low-cost producers the Fund holds. As a result, we repositioned the energy portion of the Portfolio, adding to existing holdings and initiating new investments. We own a select group of innovative and well-positioned energy companies with the capital allocation discipline, management experience and low-cost, long-lived reserves that will allow them to increase production for decades to come. Our holdings include Occidental Petroleum, Apache, Cabot Oil & Gas, and Encana.

All in all, the carefully selected companies that make up Davis New York Venture Fund combine above-average resiliency and growth with below-average prices. •


Today, as always, when confronted with background noise, investors benefit from tuning out the static of short-term market predictions and company forecasts and focusing instead on the long-term opportunities and risks. Today, we see significant opportunity in areas of the markets that are over­ looked and risk in popular areas of the market where investors feel safest. This combination creates opportunity for those who can be flexible and independent. At a time when pundits and commentators are making the case that experience and judgment do not matter and that the best investors can hope for is an average result, we strongly disagree. We believe a carefully selected Portfolio of durable, well-managed businesses with competitive advantages, selling at a discount to true value and overseen by a seasoned team with proven results will lead to a better-than-average outcome. In investing, as in any other profession, skill matters. For more than 47 years, we have demonstrated the value of that skill by building wealth for our shareholders and generating results that have exceeded the market averages. With the vast majority of our net worth invested alongside our shareholders, we have every incentive and intention to build on this record in the years and decades ahead.