TIP799: The Davis Dynasty w/ Kyle Grieve

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24:47Preston Pysh:All right, back to the show. So just to make sure you understand that, let's go over a quick example. Let's say that Davis found a fictitious insurance company named Insurance USA, which earned about a dollar per share. So it was trading at a PE of four times. The shares would then be priced at$4. Davis would then hold the business while its earnings compounded, let's say up to$8 a share. At that point, other investors were very hip to the fact that insurance companies were decent and would bid up the price up to something like, let's say, 18 times. Now the share price was$144 and Davis would have a 36-bagger on his hands.

25:23Preston Pysh:And this doesn't even factor in the dividends that the insurance companies would pay shareholders. A few other advantages that Davis thought insurance companies had over manufacturers included things like they had additional profits from investing their customers' money into the float. They had much lower capex needs as they didn't require factories or labs. They didn't pollute the environment. They were recession resistant as people needed insurance even when times were tougher. And during these lean times, people would drive fewer miles, meaning fewer accidents and fewer claims. And additionally, during these lean times, interest rates tended to fall, increasing the value of bond portfolios that were held by insurance companies.

26:00Preston Pysh:But the problem with insurance companies is that some of them are good and some of them simply aren't. And Davis understood this well from his days working inside of the industry. He came up with his own framework to separate the good from the bad. The first step was pretty easy. He would look at the numbers and see which business is making money and add any adjustments that were needed. When he found businesses that were profitable, he'd then look where the company was investing its insurance flow. Were they investing in high quality assets such as high grade bonds, stocks, or mortgages, or less desirable assets such as junk bonds?

26:34Preston Pysh:Next, he'd look at a company's private market value. If the company's private market value was less than its public market value, he knew that he was probably onto something good that offered a very wide margin of safety. And as you'll see throughout his investing career, many of these small insurance companies were bought out for significant premiums to their public price, which he benefited greatly from. Now, because Davis placed a significant emphasis on value, he also developed an incredibly thick skin. So when the market's mood changed, it was actually ineffective in changing Davis's conviction, which was why he had so much success.

27:06Preston Pysh:Instead of getting depressed about the market's opinions of his stocks, he'd hold firm and buy more, a classic value investor move. Now, after he understood that the company was truly profitable and was trading at a discount, he turned his attention to management. This was a true advantage for Davis. Since he was on the road so much, he got to speak with insurance executives and insiders to better understand these insurance companies, their sales strategies, and their competitive advantages. One detail that I liked in this book was how Davis handled his relationship with Wall Street. So the downfall of many great investors is simply succumbing to Wall Street's will.

27:40Preston Pysh:That might mean things like changing your compensation system to industry standard 220 or over diversifying your portfolio to match an index. But Davis just didn't take part in any of this. While he knew many analysts and would learn more about their opinions, he rarely actually acted on those opinions. He was more of a lone wolf, which is a bonus in investing because it helps you sidestep groupthink. So Davis's reputation in the industry was growing too. He was referred to as the Dean of American insurance, even though he never worked directly for an insurance company. But with all the contacts he had, he was able to build up his reputation, which further improved his edge in gaining knowledge from the insurance industry.

28:20Preston Pysh:Davis's firm also competed in underwriting IPOs of insurance companies. But his firm was small, so it was very difficult for them to really have any funding necessary for larger IPOs. But through all this, what really moved the needle for Davis at this point was simply owning great insurance businesses. In the mid-1950s, his net worth soared to$1.6 million, a 32 times return on his original$50 ,000 investment. And at this time, there was a considerable amount of turnover in his portfolio. So all 32 insurance companies that he owned over these years were no longer in his portfolio. They were replaced with businesses that he felt a little more comfortable owning for more extended periods of time.

29:01Preston Pysh:From this time, he would focus even more on businesses that he thought could continue to increase their value for decades. And by 1959, his net worth was somewhere in the$8 to$10 million range. The late 1950s were an excellent time for Davis because he met a fellow named Dick Murray, who introduced him to the reinsurance industry. Now, for those who are unfamiliar with reinsurance, it's a business that insures insurance companies against their risk. Murray got Davis into some interesting reinsurers, both in the US and even more importantly, abroad in Europe. And this opened Davis's eyes to the powers of investing internationally.

29:35Preston Pysh:Now, I'd like to pause here to just discuss Davis's mindset in a little more detail. He'd already been incredibly successful investing nearly exclusively in insurance businesses and only in the US. And now he was willing to listen to this gentleman about reinsurers that weren't even in the US. I think this really shows that Davis was willing to continue to learn and seek new opportunities elsewhere. Now, the reinsurance business was an opportunity that clearly was in his wheelhouse. It was an adjacent industry where Davis could easily have learned more and gain insights into which insurance companies would probably benefit from reinsurance or which reinsurers would be the preferred suppliers for the US insurance industry.

30:13Preston Pysh:Now, this evolution is very key because nearly every investor with a multi-decade track record must evolve to continue to succeed. Buffett did it when he moved away from cigar butts and towards higher quality businesses. In Davis's case, it was somewhat similar. He moved away from finding these super cheap insurance companies trading far below book value to replacing them with high quality businesses that he felt he could hold for extended periods of time. Now, the book doesn't exactly outline what precipitated that shift, but only that it happened. Now, I can only speculate here, but perhaps even in those 32 companies, there were maybe a few large winners where Shelby felt he could find more of them if he looked for similar attributes.

30:53Preston Pysh:And perhaps one of those attributes was to find businesses that had these long-term advantages that protected them from the cyclicality of the insurance industry. Now, I'd like to transition here to talk about a couple of key lessons that both Davis and his son, Shelby Davis, learned between 1950 and 1970, which was a great time of volatility in the markets. There are a ton of great lessons from both of them that I think all investors should take into account. So Shelby Davis, Davis's son, approached investing a little differently from his father. He had been spared the pain and heartache of living through the Great Depression, so he wasn't nearly as focused on the downside protection that his father was at first.

31:28Preston Pysh:So let's go back here to the 1960s. Shelby and two partners set up the New York Venture Fund with just$2 million of initial capital. Now keep in mind, this was during the go-go years, where many investors were starting to get media attention, such as Jerry Tsai. Now, the reason fund managers were getting attention was due to their investing in some of these kind of high-flying names that had incredibly impressive returns. As a result of these times, these businesses in the nifty-fifty had some incredibly high expectations. So, Shelby was investing in businesses like Memorex, Digital Equipment, American Microsystems, and Mohawk Data.

32:03Preston Pysh:Shelby thought that the earnings of these new era companies were very, very visible into the future. Now, the book suggests that perhaps Shelby adopted this strategy simply to prove himself as he was at the beginning of his investing career. Now, at first, this strategy worked. The venture fund was up 25 % in its first year. Shelby reflecting on that time said, we all thought we were geniuses. The problem here is that when the entire market also shares in your high expectations of a business, there's something behind the scenes that's happening, which is increasing your risk. And that's the risk that expectations will not meet Wall Street's estimates.

32:38Preston Pysh:So the problem for businesses with high expectations that are already priced in is simply imagining scenarios in which the market is no longer in a loving mood towards these businesses. So let's look at Memorex, for example, which specialize in computer hardware and memory storage. So this business had a bad quarter and the stock dropped 20 % in one day. But that unfortunately was just the beginning as Memorex was once$168 then promptly fell just to$3. This is the fundamental problem with high-priced businesses. They simply do not have that margin of safety. If they go through rough patches, then investors who expected high growth will sell and look for other growth names that they can build conviction in.

33:17Preston Pysh:And when they leave, they often do so indiscriminately, causing massive drops in multiples. So this teaches us two things. One, price drives return more than quality in the short term. And two, avoid stocks that are priced to perfection. While there are all sorts of great businesses that go through price fluctuations, I think you have to treat different companies differently. If a business sees its profits rise initially, then drop like a roller coaster coming from its apex, then chances are you're going to lose a lot of money. But quality businesses might see a massive rise in their profits and the rewards of waiting for that to be reflected in the stock price are actually only available to the patient people who can endure some short-term pain.

33:57Preston Pysh:The second lesson on avoiding stocks priced to perfection is a great one. But I think it requires investors to consider just how much perfection is already priced in. Is it one year of perfection, five years, 10 years? I personally can live with a year of perfection priced in if it's a business that I already own that's gone up to that price point and I think can continue to do well for another five to 10 years. But if it's a business where I think it only has maybe one to two years of growth in it, then there's zero chance that I'm going to pay for perfection because then I get no margin of safety once the fundamentals of that business begin deteriorating.

34:30Preston Pysh:So I mentioned earlier that the New York Venture Fund had done so well in its first year that Shelby and his partners were just swelled with overconfidence. Shelby had been working a ton of that time, up to 16 hours per day, and believed that all that hard work was directly tied to the reason that the fund had been performing so well. But the second year just wasn't so good. The New York Venture Fund went from being one of the top performing funds in America one year to being in the lowest decile in the next. Investing is tough. Now, from 1969 to 1971, the fund's shares went from$10.22 to just$10.88.

35:04Preston Pysh:So there just wasn't much value being created at this time. And much of that was due to the overconfidence that Shelby Davis had in his decisions from the first year. Now, overconfidence is very expensive. And I think this is a fascinating notion. So Ian Castle, who has been a guest of TIP multiple times, believes that early success was very instrumental to his own investing career. But when it came to Shelby Davis, I'm not sure that early success was such a good thing. The problem with early success is that it's usually a product of the market's whim. If you have early success, it usually coincides with the market also going up significantly during your early years when you're establishing your track record.

35:42Preston Pysh:But if you're taking excessive risk in a bull market, that also means that you're going to be severely punished in bear markets where most expensive names are often the ones that just get hammered down the most in price. So it's vital to understand that the outcomes in the short term is less predicated on your process and more predicated on short term noise. It's only after a multi-year period that you'll know whether your process is good. Buffett said that you need at least three to five years to understand whether your strategy works. And I think that's a pretty good amount of time. In five years, you're probably going to have gone through a bear market.

36:13Preston Pysh:And if you still have success going through an up and down cycle, you can have some confidence that your process is actually working. Now, when I first bought crypto, I thought I had a good process because I quadrupled my portfolio in only a few months. But then I lost 97 % of it and it became incredibly evident that my process was completely broken. And this was over a very short period of time, much less than three years. But that humbling process was very potent in shaping me into the investor that I am today. Now, the 1973-1974 period was very difficult for investing. Buffett had already closed his investment partnership many years prior, simply because he couldn't find any more decent ideas.

36:51Preston Pysh:The improving market sentiment at that time was a major reason that Warren couldn't find any ideas. There was just too much money coming into the market and not enough ideas. And a big reason for that was the nifty 50 stocks that I briefly mentioned here. So these were stocks that analysts called one decision stocks. You bought them, and then you didn't touch them. The thesis was that the businesses were just so good that you just didn't need to meddle with the stock and the share price would just pay care of itself. Sounds like hogwash, but people believed this at the time. Now, the decline in 1973-1974 was the market's worst since the Great Depression.

37:26Preston Pysh:And there are several reasons for the crash. There was an unpopular war in Vietnam, which drained sentiment. There was Nixon's Watergate scandal. There was geopolitical unrest in the Middle East. There were oil embargoes that were pushing up oil prices. Then there were also currency issues and inflation problems. And as I mentioned previously, stocks were priced to perfection, and the market was not prepared for this change in the economic cycle. Shelby Davis had learned a few lessons from his first few years with the New York Venture Fund, and he figured that the fund should probably have some cash on hand because if there was another massive drawdown similar to the one that they experienced in their second year, the fund just simply might not survive.

38:02Preston Pysh:So they moved about 30 % of their assets into cash, which ultimately saved them from much of the carnage to come. So during that bear market, the Nifty 50's average PE dropped from 43 times to 17 times. The S &P 400's PE dropped from 30 times to 7.5 times. Blue chips that were in the Nifty 50 were definitely not spared. Polaroid dropped 85%, Disney 81%, Xerox 65%, Coca-Cola 64%, and heck, even McDonald's dropped 61%. Now, the story of Nifty 50's epic free fall, I think, leaves several excellent lessons for us. And I think the biggest one is simply that this event showed that even wonderful companies can actually make horrible investments.

38:43Preston Pysh:Nifty 50 businesses included so many names that we still use today. But if you'd invested in them at their peak times in the early 1970s, you would have had to hold them for a very extended period just to recoup your losses. And this shows that quality doesn't offer a margin of safety if you're paying bubble-like prices. Businesses like Eli Lilly, Philip Morris, Texas Instruments, Merck, and Johnson & Johnson are all businesses that still exist today. But they're great examples that even a fantastic company could be a bad investment when you pay too high of a multiple. Johnson & Johnson at its peak traded for 60 times earnings.

39:18Preston Pysh:Now, I was curious here to know just what it's traded at recently. And over the past 10 years, it's averaged around 18 times. Now, I assume if we went back in time, it might have been growing a little faster and therefore deserved maybe a little bit of a higher average premium, but nothing close to 60 times. So it also shows that quality businesses aren't shielded from becoming part of their own bubbles. Today, when we think of bubbles, we might think of companies in the world of AI. But what about a business like Costco? You know, this is a simple blue chip company that trades for 50 times shaling earnings.

39:50Preston Pysh:Could Costco be in its own mini bubble? Only time will tell. Now, based on my experience, I'm actually okay with quality businesses being a little expensive. The key for me is to have conviction in the business's growth. Now, if that conviction starts wavering, there's a very, very good chance that the base rate multiple could be cut and never rebound to historical averages. So a business like Topicus is a good example of that. I think it's been pretty expensive in the past, but when you look at the valuation multiples a few years out, it offers very compelling returns despite the optically high multiples that it pretty much always trades at.

40:24Preston Pysh:Now, the final lesson I took from this is that the market can be used as a tool to help you determine cash positions. If the entire market is having one of its bouts of irrational exuberance, such as the tech bubble, where I think it becomes really obvious that nearly the whole market is in a bubble, then it's probably a great time to establish some sort of cash position. Now, these are pretty rare occurrences, and I wouldn't bother trying to do this other than when it's incredibly, incredibly obvious that the entire market is overpriced. But if all the signals are there, perhaps you should clone Shelby Davis' example here and have some cash ready to take advantage of the inevitable fall in the market.

40:59Preston Pysh:Now, we're going to look at one of Davis' biggest mistakes in his investing career here, and that was Geico. So Davis actually found Geico quite early in the 1960s. He thought it was a great insurer simply because the business model allowed it to pay out its claims from its customers' premiums while leaving its investment portfolio intact. The 1960s were great for GEICO's performance both fundamentally and via total shareholder returns. Davis's position was so significant that he was actually offered a position on their board, which he happily accepted. But the 1970s saw a reversal in GEICO's fundamentals.

41:32Preston Pysh:The US population became much younger, leading to more insurance claims from reckless drivers. GEICO's CEO, Ralph Peck, was also undertaking a strategic shift by selling policies to non-bureaucrats. So Geico's original strategy was to only sell insurance to government workers as they inherently had fewer claims than the average American. And unfortunately, this new customer ran up claims and reduced its reserves. And Peck actually lied to shareholders and the board about the problems that the business was having. Geico, which had been something of a market darling, plunged in value as it announced a massive$126 million loss for 1975.

42:06Preston Pysh:This took the stock all the way from$42 to$5 and 90 % decline. As one of Geico's largest shareholders, Davis helped appoint Jack Byrne as a new CEO. Byrne cut costs by closing 100 Geico offices, but the stock continued to crater down at$2. Byrne was then introduced to Warren Buffett, who had formerly owned Geico and was attracted by the rock bottom prices that the shares were now trading at. Buffett bought a bunch of shares and he suggested that Byrne sell the stock to raise capital. Now, I found this case study very interesting. And the reason being that if Buffett was willing to buy your stock, that's probably the best possible time to be doing buybacks.

42:44Preston Pysh:And while Geico was clearly not in a financial position to do buybacks, why would Buffett have suggested that they issue shares at very depressed prices? And the answer to that question is that Geico was in a very unique situation. If Geico didn't receive the cash infusion that it needed, there was a chance that it would become insolvent. Geico needed to have the right amount of reserves to satisfy regulators. And if they didn't have those healthy reserves, they could simply just be shut down. Now, banks would have been iffy at this time to lend money to Geico, given the fact that it just had this incredibly bad quarter with negative profits.

43:15Preston Pysh:And that meant the only way to raise capital was to issue equity in Geico and find some people willing to put up the capital. Davis did not like the idea of dilution and was completely opposed to any equity issuance. But Buffett, he figured that dilution at$2 a share was probably much better than owning shares that were worth$0. Geico ended up going through the share issuance. And as a result, Davis stormed out of the Geico meeting when he heard about it and went straight to his office and sold all of his Geico shares, a decision that he regretted for the remainder of his life. Now, the stock went from$2 to$8 in very short order.

43:50Preston Pysh:And a few months after the bailout, Byrne announced that Geico would actually do a share buyback, signaling to Davis that the company was in much better financial position. Now, Davis would get one more upper hand on Geico, which still paled into comparison to the opportunity cost of his decision to sell Geico. So he owned a significant stake in a Geico subsidiary called Government Employees Life Insurance Companies, or Jellico. Byrne tried buying all the shares of Jellico, but Davis' asking price was$21 and Byrne would only pay$13. So the deal never happened. And shortly after, a British insurance company bought out Gallico for$32 a share.

44:28Preston Pysh:Now, this story shows that the right CEO and the right advice can truly save a company that looks destined for the dumps. It's an interesting lesson for devalue investors who look for opportunities like this. I think I would need many more IQ points to ever invest in a situation like this. So it's not something that I would pursue, but I can really see Buffett's viewpoints on this since he was intimately familiar with the business by owning it several years earlier. Let's take a quick break and hear from today's sponsors.

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48:11Preston Pysh:All right, back to the show. Now, Shelby had learned from his first years in the fund business that a strategy based on chasing momentum only worked for short periods of time before you put yourself and your investors at just too much financial risk. So he shifted his strategy from looking for businesses with massive upside potential to focusing more on high quality blue chips that could perform well in a variety of different market conditions. So he bought companies like Philip Morris and Cap Cities simply because he believed that people wouldn't stop smoking cigarettes or watching television.

48:41Preston Pysh:He was now looking at businesses that have very predictable earnings. And one strategy he did was to look for blue chips that had a bad quarter where the market was punishing its share price. I think this is a great strategy. Shelby was cautious to avoid the value traps that keep cheap companies cheap. He relied more and more on management talent and a company's balance sheet to keep these businesses running well during tough times. He also stopped buying and selling so much. The fund's turnover was only 15 % and he also decreased the hurdle rate on earnings expectations, which had been a considerable risk for him early in his investing career.

49:15Preston Pysh:Another strategy he took part in alongside of Peter Lynch was to place a larger focus on small caps. When mid and large cap businesses are getting a lot of attention, small caps just tend to underperform. And this still happens to this day. Given the outperformance that large caps had, Shelby was seeing a lot of great opportunities in the small cap arena, which he milked for the next decade or so. And this strategic shift worked well for Shelby Davis, just as Davis's shift had worked well for him. From 1969 to 1978, the New York Venture Fund returned 43%. Now I know what you're thinking, those are pretty pitiful returns, but you have to remember the market conditions during this time were not good.

49:53Preston Pysh:Over that same stretch of time, the S &P 500 was actually down 1.7%, which makes that achievement quite impressive. But this shows that good stock pickers can still win in down markets. Davis continued to evolve his own investing strategy as well. But as he aged, I think he started to do a few things that just gave him an activity to do rather than rely on his winning strategy, which had just been to do as little as humanly possible. For instance, Davis actually started investing outside of his circle of competence, which was insurance. He began buying businesses across all sorts of industries that he hadn't had any previous success in.

50:28Preston Pysh:This coincided with him being named to the Value Line Board where he received many of their reports and tended to act on them. Since Davis's contacts and businesses such as CEOs had nearly all retired, Davis started feeling a little out of touch with the market. So he began dabbling into over diversification as well. So he reportedly only had about 30 to 50 names for most of his early career. But later on, that number ballooned into the hundreds. To give himself even more to do, which coincidentally gave his brokerage house more business, he began day trading. He never committed more than 3 % of his capital to the strategy, but it was your typical kind of get in, get out strategy that loses many investors a lot of money.

51:07Preston Pysh:Luckily for Davis, he had a very firm understanding here of risk control. But when you have a powerful strategy that just works, it can overcome any adjustments that you make, even if they are suboptimal. So in this period, the 1980s, Davis's insurance portfolio added over$500 million to his net worth. And all this added capital was from just simply sitting on his hands and doing nothing. No tinkering, day trading, or leaning on value line was needed to get any of these results. This story is very reminiscent of an unknown Indian investor who recently passed away named Rakesh Junjunvala. He passed away at the young age of 62 and had a net worth of$4 billion.

51:44Preston Pysh:He never managed any outside money similar to Davis. Rakesh had multiple investing strategies, kind of like Davis in his twilight years. He'd invest long-term and he would also day trade. But Rakesh owned a business in India called Titan Industries, which was a major manufacturer of jewelry, watches, and eyewear. And he'd bought that 20 to 25 years ago. When he started buying Titan, it made up only about 3 % of his overall portfolio, and he never sold a share of the business. Of the 4 billion that he had, 2 billion was generated from Titan. That one stock compounded about 30 % per year for the entirety of his holding period.

52:19Preston Pysh:His strategy, just like Davis's early insurance bets, was to just buy, hold, and not tinker. But what about the other 50 % of Rakesh's portfolio? The majority of that was also in one named called Lupin, a pharmaceutical business. So while Rakesh was actively trading, two stocks that he barely touched made up over 75 % of his net worth. And if that's not a signal to take a similar strategy and avoid the noise, I don't really know what else is. The lesson here from Davis is that drifting from your edge can feel exciting at the time, but it's usually just a signal that you're losing discipline. If you do this early in an investing career, chances are that you're going to have a very tough time compounding simply because you're going to fiddle too much with the winners that can really carry you over the next few decades.

53:03Preston Pysh:But Davis had already done the work for decades prior to establish an incredible portfolio of great businesses. Therefore, the additional fiddling that he did really just didn't hurt him as much as it would have if he dedicated a lot of capital to fiddling much earlier in his career. We've also discussed some of Shelby's transformations, but there's another great one that he learned in the 1980s as well. So I mentioned that Shelby had a nice cash position that he built up before the 1970s bear market. And once that bear market came, Shelby got to work buying bank shares on the cheap. Shelby knew interest rates had bottomed, which would be a big time tailwind for banks.

53:38Preston Pysh:So he backed up the truck on banks taking advantage of the Davis double play. Banks were a logical step for Shelby as he had a stint working at the bank in New York. Shelby liked banks because they didn't manufacture anything, require expensive capex, didn't require machinery, research labs, or highly skilled labor. He also liked the simplicity of banks. You just borrow from depositors and loan to borrowers and pocket the profits from the different interest rates for both of those parties. He also figured banks weren't going anywhere. People would always need somewhere to put their money. It was a business that was very hard to disrupt due to its lack of technological dependence.

54:13Preston Pysh:But he didn't exclusively invest in banks. He added insurance companies like Chubb and Lincoln International, tech plays that focus on hardware such as IBM, Motorola, and Intel, and pharmaceuticals like Merck. Intel was actually a pick that Shelby got behind after meeting Intel CEO Andy Grove and being incredibly impressed with him and his great one-liners. There are two kinds of companies, the quick and the dead. He bought Intel at single digit PE multiples and held it for well over a decade. Now the bear market caused by Black Monday in 1987 further tested Shelby. But as a fund had done in previous markets, it was very well protected from the downside risk.

54:50Preston Pysh:The year after the crash had happened, Shelby's venture fund was down 6 % versus negative 15 % for the S &P 500. One of the best picks that Shelby had made during the bear market was in Fannie Mae. Like all investors, I've had to hold to a lot of volatility caused by bear markets. The European VMS serial acquirer has been a volatile name while I've been a shareholder. I've held through drawdowns of 55 % and 36%. And when I have a business in my portfolio that continues to meet my lofty expectations, I actually view large drawdowns as opportunities to add to my position rather than as justification to sell something that is just showing a little bit of weakness in a share price.

55:26Preston Pysh:I want to briefly discuss something here for listeners who might have experience with trusts. So I personally don't, but I know many listeners do. And there are some very outstanding lessons in here about the advantages and disadvantages of trusts, especially in regard to the constraints that they can put on things. So I discussed very, very briefly in this episode, but Davis's wife came from a very wealthy family. And so they managed their own trust. But by the end of Davis's career, his wife's trust would have been in much better hands if it had just been fully managed by Davis. Davis absolutely creamed it performance wise, despite the suggestions of great stocks from both Davis and his son, Shelby.

56:01Preston Pysh:The problem with trusts is that they're often built on the distrust of heirs to abuse the distributions from the trust. So here's what's written about that in the book. The benefactor's lawyer fix it so that the heirs can't get their hands on the principal, but the trust is set up to provide ample income to satisfy the healthy appetite for spending. With that goal in mind, trusts tend to be heavily invested in bonds and dividend-paying stocks. The Wassermans abandoned their all-bond strategy in 1950, but the portfolio was still income-oriented as opposed to growth-oriented. In most cases, an income portfolio can't reward its owners like a stock portfolio, especially when the income is siphoned off to beneficiaries who use it to pay bills and don't reinvest it for further compounding.

56:43Preston Pysh:Between the siphoning and the taxes levied on withdrawals, an income-oriented trust is destined to become a dwindling asset. What pluck, luck, genius, talent, enterprise, and in some cases, con artistry created one generation, dependency, cash drain, and Uncle Sam destroy in the next two. So the lesson here is that the wrong structure simply handicaps compounding. So if your goal is to compound at a rate of, let's say, 10%, then ask yourself why you own things such as government bonds or other income producing assets that are unlikely to meet your hurdle rate. The fact is that if you want to maximize returns, stocks over the long term are the best vehicle to do it, and it's not even close.

57:22Preston Pysh:So we've spoken today about Davis and Shelby Davis, but this episode is about the Davis dynasty, and that means there's actually one more generation to discuss. And that's Davis's grandson, Chris Davis, who just like his grandfather and father was an excellent investor, and still is. Now Chris's brother, Andrew was also an investor, but he tended to stay out of the limelight. So I'm just going to focus mostly on Chris here. Now, Chris was the Davis who most closely resembled Warren Buffett. At age 10, a year younger than Buffett's first investment, Chris bought an insurer named Associated Madison, and he reportedly never sold it, but also lost track of where it went.

57:56Preston Pysh:While contemplating what Shelby taught his kids regarding investing, he said, The most important thing that I taught them about the investment business is just how much I love being in it, even in the lean years of the 1970s. I was convinced picking stocks was something any kid could do. And I tried to make it fun and keep it simple. The math part, accounting and spreadsheets, I figured they could learn later. I got them involved in the detective work, sniffing out clues about a company's prospects. Sometimes I took them along on company visits, just like my father had taken me. Shelby would incentivize them to analyze companies by dangling a hundred bucks in front of them for an analysis report.

58:32Preston Pysh:Now, one day, Chris asked his grandfather, Davis, for a dollar to buy a hot dog. And Davis went into a lengthy story about the powers of compounding. He told young Chris that if the dollar were invested wisely, it would double every five years. And when Chris was Davis's age in 50 years, that$1 would be worth$1 ,024. After hearing that story, Chris decided that he wasn't that hungry. Now, Chris was much closer to Davis than his father was. As a teenager, he spent a lot of time with his grandfather and helped chauffeur him around as he learned to drive. During school, he'd work at Davis's office doing back-end things like stuff envelopes and sending message on the system.

59:09Preston Pysh:They took walks together and they discussed things like politics and Wall Street. Oddly enough, Chris at one point was studying to become a priest, and he was a communist to boot. Despite all this, his grandfather still saw something in him, saying, philosophy and theology give you a perfect background for investing. To succeed in investing, you need a philosophy, then you've got to pray like hell. So when Davis went to Scotland where Chris was in school, he would take Chris with him to see insurance companies. This helped Chris better understand the insurance business and make key contracts in that industry that would help support his investing career.

59:43Preston Pysh:After a short stint on Wall Street, Chris was actually offered a job with his grandfather and he jumped at that chance right away. There are many lessons that I've learned from my own family growing up that have stuck with me. Frugality is one of them. While I'm probably less frugal than both my mom and dad, I also know that I'm much more frugal than many of the other people close to me that I've observed. My dad, who grew up in Myanmar, was relatively poor growing up. So he's a master at making his money go as far as possible. He's always been great at bargaining and finding excellent stuff at a bargain price.

1:00:12Preston Pysh:He also, as far as I know, has never had a problem with debt because he's always lived below his means. This is a great lesson that I've taken from my dad and placed a lot of emphasis on in my adult years. My mom, on the other hand, is frugal, but she also likes nice things. So while I was growing up, there were times when I know she was in debt. and she would actively tell me about it, which really helped me understand a little more about how debt worked and how it's best to just stay out of it as much as possible. There have been a few times in my life when I was in debt and it felt pretty scary.

1:00:40Preston Pysh:So the last time was about 10 years ago. I signed up for a course to improve my business acumen, which was expensive for me at the time. And unfortunately, it just didn't really come close to paying itself off. But I was left with obviously this huge bill because I had to pay for the course, which I'd paid for with my credit card. Unfortunately, this was during a time where I was making enough money that paying that debt off would have taken a lot longer than I would have liked it to. And that meant paying a lot of interest. But as I began thinking more and more deeply about where I could come up with more money, I remember that I actually been saving money each month to pay my taxes.

1:01:12Preston Pysh:So I checked with my financial advisor who'd been managing that for me to see if I had any extra savings that I could dip into intelligently. And that completely saved me. I use my excess savings as kind of my safety fund, which really helped me avoid paying excessive interest on my debt, which I certainly did not want to pay. So my mom and I have spoken about that period of my life, which was painful for me. And I could tell that she could understand the pain that I had gone through because she'd been through it as well. And that was a really good lesson for me because I ended up taking a risk that didn't pay off, but the savings that I'd made over the years helped me avoid getting into too much financial trouble.

1:01:45Preston Pysh:But since then, I've been debt-free and don't intend to change that in the future. So when Davis hired Chris, he eased him into the job. Chris began writing a few paragraphs on insurance for his grandfather. And he noticed that parts of his writing were being published in Davis' insurance bulletin. Chris also improved his analytical skills in the bulletin by using blank space to write up interesting companies that he was finding. But Chris noticed something interesting. Nobody really was reading the weekly insurance bulletin. Curious, he asked his grandfather why he continued writing it when nobody was reading it.

1:02:18Preston Pysh:Wasn't that just a waste of time and energy? And Davis's reply was great. It's not for the readers. It's for us. We write it for ourselves. Putting ideas on paper forces you to think things through. Great advice. Now at this time, Davis was starting to slow down and passing more and more responsibility to Chris. So he was doing things like giving Chris some of the personal accounts that he was managing. One day in 1992, Davis brought a binder full of computer printouts with Davis's investing gains and losses from his entire investing career. Davis asked Chris to look it over and make some recommendations about what to sell and what to keep.

1:02:55Preston Pysh:Chris then bought these trades to his father and they looked them over together. Shelby was amazed to see that many of his top picks were actually purchased by his father. And this came to him as a big surprise as Shelby and Davis had a pretty tepid relationship and Shelby felt that Davis didn't really value his investing opinions that much. But he found picks like Intel, Fannie Mae, and even the New York Venture Fund in his portfolio. Chris said that seeing those names in his father's portfolio were the words of praise that my father had waited all his adult life to hear and my grandfather had never uttered.

1:03:26Preston Pysh:But they learned some fascinating things about Davis's portfolio. Three quarters of Davis's assets were in about 100 worldwide insurance companies. The rest were scattered among 1 ,500 companies. Part of the reason that he owned so much was that he would buy these 1 ,000 share lots just to get his foot in the door. And these lots made up a negligible amount of his portfolio. So I presume that he may have just maybe wanted to have access to their financials or as a reminder to do more research on them in the future. Now, the really juicy information was in just how Davis had made it onto the Forbes list of wealthiest Americans.

1:03:59Preston Pysh:It wasn't in the 1 ,500 stock pick that Davis made. It was from a few names that he'd held for over 30 years. The book intelligently picks the Wyeths, Rochenbergs, and Warhols as an ode to famous American artists. Davis kept these businesses as part of his own art museum, and the longer he held them, the more valuable they got. Now, a few of these picks included AIG, which was worth$72 million, Tokayo Marine & Fire, which he bought at$641 ,000 and was now worth$33 million, and three other Japanese insurance holdings, Mitsui Sumitomo Marine & Fire and Yasuda Marine & Fire, worth a combined$42 million.

1:04:36Preston Pysh:You may recognize Mitsui and Sumitomo as Warren Buffett made a basket bet on five Japanese companies that included both. Now, I mentioned earlier that Davis regretted selling Geico, but since Davis followed Geico so closely, he ended up with a nice stake in Berkshire A shares. He actually owned 3 ,000 shares, which at the time grew to 27 million. Today, 3 ,000 Berkshire A shares are worth$2.2 billion. Other American holdings were Torchmark, Aon, Chubb, Capital Holdings and Progressive, which were worth a combined$72 million. Now, these dozen or so stocks were worth$261 million. And Chris learned a lot from just how Davis created all that wealth.

1:05:15Preston Pysh:It wasn't from his day trading and tiny value line bets. It was from allowing time to work its wonders on a business that compounded. Rothschild writes, all the Davis dozen had been parked in his portfolio since the mid-1970s. Any young, inexperienced investor has a built-in advantage over a mature, sophisticated investor. Time. He would have also observed that 11 of 12 of these picks were all from insurance, Fannie Mae being the outlier. This would have taught the 25-year-old Chris the importance of being heavily exposed to industries that you understand at a very profound level. Another observation was that compounders can easily wipe out significant losses.

1:05:54Preston Pysh:And Davis had those too. His most expensive flop was a business called First Executive, which went from 2.5 million all the way down to zero. But as you can see from his 12 big winners, that minor loss was just an insignificant rounding error. Once they wrapped up their analysis of Davis's assets, they had to figure out what to do with all of it. There were a few things that they did. First, part of Davis's assets would be funneled into Shelby's New York Venture Fund to be managed by Shelby along with some of the other businesses that Shelby liked. And second, Chris would manage some of the newer portfolios and if they perform well, they would expand the Davis operation.

1:06:27Preston Pysh:And from there, really, the rest is history. As of today, Chris runs the Davis Funds, managing nearly$20 billion, which includes the New York Venture Fund that his father had managed. Davis Funds has many different funds. But if you look at the oldest one on the book, it is the New York Venture Fund, Class A, which is compounded at 11.5 % since 1969, outperforming the S &P 500 by 1 % over that entire period. Truly an incredible feat. Now, I'd like to finish off this episode by discussing a checklist of about six items that we can think about in our own investing that three generations of Davises have used to compound money for many, many decades.

1:07:03Preston Pysh:The first lesson is to avoid cheap junk. Value investors love a good deal, but you must be able to differentiate between a good cheap deal and a bad cheap deal. Shelby learned in the 80s that many businesses deserve to be cheap because chances are they would just go nowhere. Shelby didn't like turnarounds because they often took much longer than management would claim, and the capital could be used much better elsewhere. The second lesson is to avoid expensive greatness. While Shelby loved great businesses, he wasn't willing to pay any price for them. While a great growth company can provide a great return, when growth falters, it's often punished excessively as investors who initially assumed a high growth rate sell out once they realize that the high growth rate period is now over.

1:07:46Preston Pysh:Third is to prefer moderately priced, moderately growing companies. Now, the reason for this continues from that last lesson. If you have a business that's growing moderately, chances are the multiples won't be bid up or down too much or below the growth in intrinsic value. So your downside is well protected. And if the business surprises slightly to the upside, you get the added benefit of multiple expansion. The fourth lesson is to wait for the right time to enter positions. If you analyze a lot of companies, you're going to find some outstanding businesses, but you're also going to find some businesses that are priced to perfection.

1:08:20Preston Pysh:But the market is an excellent tool for transferring wealth from the inpatient to the patient. And one way to put yourself on the right side of that equation is to just wait for great prices to come to you rather than pulling the trigger on businesses that you like, regardless of the share price. The fifth lesson is to bet on superior management. Davis made a killing betting on Hank Greenberg at AIG. Shelby did the same thing with Andy Grove at Intel. So if you find some executives that you think are cut above the rest, follow their careers very closely because they may spark massive upside in a business once they take over.

1:08:51Preston Pysh:And the sixth and final lesson here is that stocks are much less risky the longer you hold them. Many listeners of the show have probably seen the chart showing the index's volatility over one year, five year, and 20 year periods. The longer you hold the stocks, the more likely it is that you make money. The shorter you have them, the more likely you are to lose money simply because the market is a voting machine in the short term. So whether you invest in stocks or ETFs, your best bet is to find businesses that will be around for a long time, buy them, and do nothing. Thank you so much for spending time with me today.

1:09:23Preston Pysh:If you'd like to continue the conversation, please follow me on Twitter at IrrationalMRKTS or connect with me on LinkedIn. Just search for Kyle Greve. I'm always open to feedback, so please feel free to share how I can make this podcast even better for you. Thanks for listening and see you next time.

1:09:38Kyle Grieve:Thanks for listening to TIP. Follow We Study Billionaires on your favorite podcast app and visit theinvestorspodcast.com for show notes and educational resources. This podcast is for informational and entertainment purposes only and does not provide financial, investment, tax or legal advice. The content is impersonal and does not consider your objectives, financial situation or needs. Investing involves risk, including possible loss of principle and past performance is not a guarantee of future results. Listeners should do their own research and consult a qualified professional before making any financial decisions.

1:10:10Kyle Grieve:Nothing on this show is a recommendation or solicitation to buy or sell any security or other financial product. Hosts, guests, and the Investors Podcast Network may hold positions in securities discussed and may change those positions at any time without notice. References to any third-party products, services, or advertisers do not constitute endorsements, and the Investors Podcast Network is not responsible for any claims made by them. Copyright by the Investors Podcast Network. All rights reserved.

1:10:37Thank you.