This legendary investor managed an 18,000-fold return from 1947 until his death in 1994 where he managed to turn $50,000 into $900 million.
Davis says investors should be prepared for any crisis as they are an inevitable part of the market. According to him, history has shown that investors will always encounter crises and uncertainty, yet the market will continue to grow over the long term and its progress does not get derailed.
“History provides a crucial insight regarding market crisis: They are inevitable, painful and ultimately surmountable,” he said in the book
The Davis Dynasty: Fifty Years of Successful Investing on Wall Street written by John Rothchild.
Davis believed investors who keep in mind that the market grows despite crises and uncertainty may be able to cope with the ups and downs better and are less likely to overreact when faced with these events.
He said they are more likely to avoid making major changes to their investment portfolios and are better positioned to benefit from the long-term growth potential of equities.
How Davis attained success despite being a late starter
Davis did not start investing until 1947, when he was 38. He made his fortune by investing heavily in the insurance sector.
Davis felt there were three main reasons to invest in the insurance sector, which were:
- Insurance float is very valuable
- The insurance industry changes slowly
- Good management is a competitive advantage in insurance
Davis believed the real value of an insurer comes from its float, as it is the money collected from premiums that has not been paid out as claims. He was of the view that this money was often shown on the balance sheet as a liability by the companies, but he believed the insurance float was actually an asset.
“The float can be invested in stocks, bonds and other securities. These investments then generate cash for the insurer,” he said.
While investing in the insurance sector, Davis followed a three-point strategy that led to his success.
- Invest in high-quality and undervalued insurers
- Invest with cheap leverage
- Invest for the long-run
1. Invest in high-quality & undervalued insurers
Davis never invested in all insurers and only looked specifically for well-managed insurers with a history of growth. Finding undervalued insurers was an added advantage for him.
Davis was also a big follower of Benjamin Graham style of investing and as a value investor, he looked for insurance companies trading at low price-to-earnings or price-to-book ratios.
He always looked for companies that would increase his wealth by both growing earnings and benefiting from rising price-to-earnings ratios.
Davis’ deep analysis of the insurance industry helped uncover the value in insurers. Many insurers still trade at price-to-earnings ratios lower than many other industries.
2. Invest with cheap leverage
Davis felt many investors are hesitant about using leverage in their investment strategy, but leverage is not intrinsically evil. He believed there were both good and bad types of leverage. He felt good leverage had the following characteristics:
a)It is cheap (the lower interest rate, the better)
b)You cannot be forced to sell securities purchased on leverage
He also felt that even good leverage can be used unwisely and over-leveraging is a very real possibility and should be avoided at all costs.
Davis said the leverage offered by most retail brokerages is bad, as if the stocks decline, they can be forced to sell when using leverage.
Davis used leverage only to boost his returns. He purchased a seat on the New York Stock Exchange, which gave him access to lower margin rates than the typical investors.
He used the maximum allowable amount of margin (slightly over 50%). The interest payments on his margin were tax deductible, which helped him save money on taxes. He used a sensible amount of leverage that did not drastically increase his risk, yet significantly increased his returns.
The combination of high quality insurers, low valuations, and leverage gave Davis very strong returns over a long time period. He generated a 23.2% compound annual growth rate over his investing career.
3. Invest for the long-run
Davis invested in high quality, well-managed insurers that were trading at a discount to fair value. He did not shuffle the stocks of his portfolio very often.
Davis held many of his largest investments through his entire investment career.
“Long-term investing helps investors compound wealth because it minimises frictional costs and lets you reap the maximum amount of reward from your best (highest total return) ideas,” he said.
Davis said when investors constantly trade stocks they must always have ‘new ideas’. He shared some trading principles he often used while trading in the book
The Davis Dynasty, which are still relevant in this day and age.
Let’s look at some of these trading tips from this great investor.
Use your money wisely
Davis believed investors shouldn’t waste money in buying things that are not essential and instead use that money for investment purposes. He was of the view that the future value of investments if invested wisely can be of far more worth than its current value.
Nothing beats time & power of compounding
Davis said investors should believe in the power of compounding as there is nothing that can beat time and the power of compounding returns. “Every dollar you earn has value today, but don’t ignore its future potential. The critical ingredient is time. Luck and stock tips might help win the short-term trading game for a while. Nothing beats time and the power of compounding returns. Wise, winning investing requires years of appreciation,” he said.
Learn from history
Davis said too many investors spend most of their time protecting themselves from the past while ignoring the future. He felt they should learn from market history and act accordingly to the situation. “Even an amateur market historian has the foresight to recognize when investor behavior and current market events mimic the past. The biggest history lesson you can learn is that the market cycles from bust to boom and back again. Investor behavior flows with it. Each time is slightly different but similarities abound and the cycle always rolls on,” he said.
Don’t miss out on opportunities
Davis said short-term fear and pessimism keeps most investors from realizing great returns. He felt not looking beyond the worries causes most investors to miss obvious opportunities.
He said all the possible assets, investors have the biggest love/hate relationship with stocks due to which great performances become a love fest, while terrible ones bring fear and loathing.
“Between these two extremes, and what investors forget, is a great long-term track record at compounding money that no other asset class offers. The few times in history when there is an exception, investors rarely seized the opportunity because they projected their short-term pessimism far into the future,” he said.
See bear market as an opportunity to make money
Davis said bear markets should be considered as the time to buy stocks which can lead to great bull market performances later. He believed bear markets make people a lot of money, they just don’t know it at that time.
“Out of crisis comes opportunity… A down market lets you buy more shares in great companies at favorable prices. If you know what you’re doing, you’ll make most of your money from these periods. You just won’t realize it until much later,” he said.
Be wary of high flyers and hot stocks
Davis said fast growing companies and hot stocks are great to own but they tend to fall the hardest. He felt market history was filled with these stocks that ended badly.
“Buy stocks at any price” never works out in the end. Imagine a store that sold food and clothing “at any price”. When and how often would you buy?” he said.
Use leverage wisely
Davis said investors should only use leverage to boost returns when stocks are at bargain prices and shouldn’t use debt otherwise.
Davis’ always used debt to grow his wealth and didn’t borrow to pay bills or to buy a house. “I don’t recommend you invest on margin (borrow to buy stocks). But borrowing to buy stuff that doesn’t offer any return on that money only forces you to work for that debt in the future. The best investment anyone can make is to pay off credit card balances and high interest loans, especially when stocks don’t offer a comparable return,” he said.
Writing improves learning process
Davis said writing speeds up the learning process by improving retention and helps solidify complex topics into simplified ideas.
Davis himself wrote a weekly bulletin for most of his career although it was only read by a few people.
“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,” he said.
Follow this 3 step investing process.
Davis said investing is a 3 step process which includes:-
1. Learn-The most vital, and ignored phase that lasts for a lifetime.
2. Earn- This phase helps smart investing compound money at the best rate possible over decades.
3. Return- This phase involves giving back to the society by sharing knowledge with the next generation and having a plan for your wealth when you retire.
Davis said learning something like the piano, basketball, or even walking for toddlers are skills that
time to master. Similarly, a childlike determination is needed to learn investing too.
“Once the basic steps are down, the learning accelerates quickly. Anyone who’s watched a child learn to walk for the first time, knows there’s a lot of falling involved but they always get back up,” he said.
It’s not how you start, but how you finish that matters.
Davis felt starting early does help one in their investment careers but it does not assure guaranteed success. He felt one can always make up for the lost time by putting in extra effort. “Start early if you can. Just know that the game isn’t over because you showed up late. You can still win. You’ll need to push yourself harder because sacrifice is needed to make up for lost time,” he said.
(Disclaimer: This article is based on the book “The Davis Dynasty: Fifty Years of Successful Investing on Wall Street” on Shelby Davis written by John Rothchild)
