The Successful Investor

Transcription

1 Selecting Quality Companies for the Long Term The Successful Investor Mastering Investor Behavior That Builds Long-Term Wealth

2 TABLE OF CONTENTS The Successful Investor Page 1 Uncertainty is the Rule, Not the Exception Page 2 Focus on What is Knowable and Important Page 3 Be Patient Page 4 Expect Periods of Disappointment Page 5 Engage in Healthy Investor Behavior Page 6 Have an Investment Strategy Page 7 Set Realistic Return Expectations Page 8 The Seven Timeless Strategies For the Successful Investor Page 9

3 The Successful Investor The Davis family is one of the most successful investment stories in American history, having accumulated a fortune of more than $2 billion* through buy and hold investing for over 50 years and three generations of portfolio management. Starting in 1947, Shelby Cullom Davis, a former insurance commissioner, invested $100,000 in durable, well-managed businesses at value prices and compounded his fortune into over $800 million by the early 1990s. With the aim of offering his father s investment discipline to a greater diversity of investors, son Shelby M.C. Davis founded Davis Advisors in 1969 and created one of the most distinguished track records of any manager on Wall Street. Today, the Davis family investment fortune is managed by Portfolio Managers Christopher C. Davis, Kenneth Charles Feinberg and Andrew A. Davis. Shelby M.C. Davis serves as an Advisor. Shelby Cullom Davis While many would attribute the Davis family s extraordinary success to investment selection, this tells only part of the story. The other major contributor to the family s ability to build wealth has been its adherence to a set of basic investment principles and strategies that any individual can learn and practice. Specifically, the Davises have always advocated setting realistic return expectations for equities, focusing on what s knowable and important, engaging in healthy investor behavior, being patient, and understanding that periods of disappointment are inevitable. In the following pages, we introduce some of the time-tested principles that have guided the Davis family through both good and bad periods of market history. While not an exhaustive list, these basic lessons constitute keys to the family s success learned over half a century, and we hope they will serve as a useful guide in helping you achieve your ultimate financial goals. Lessons from Over 50 Years of Success on Wall Street *As of December 31, Past performance is not a guarantee of future results. Shelby Cullom Davis borrowed $100,000 in 1947 and turned it into an $800 million fortune by the year While Shelby Cullom Davis success forms the basis of the Davis investment discipline, this was an extraordinary achievement and other investors may not enjoy the same success. 1

4 Uncertainty is the Rule, Not the Exception Long-term investors in equities are always faced with uncertainty. In the 1970s, investors had to weather the bear market, geopolitical turmoil culminating in the Iranian hostage crisis, rampant inflation and skyrocketing energy prices. In the 1980s, investors were faced with Black Monday, the Iran-Contra scandal, an assassination attempt on Ronald Reagan, and the S&L crisis. In the 1990s, investors experienced a euphoric bull market, the repercussions from the collapse of Long-Term Capital and the impeachment of Bill Clinton. Thus far through the 2000s, investors have dealt with the bursting of the tech bubble, an economic recession, geopolitical turmoil in the Middle East, myriad natural disasters, corporate scandals, and rising energy prices. Clearly, the past 30 years have dealt long-term equity investors their share of uncertainty. But through it all, the long-term upward progress of the stock market has not been derailed, as illustrated by the chart below. In fact, since 1970, the S&P 500 Index has increased over 5,000%, which would have compounded a $10,000 initial investment into over $500,000, a fifty-fold increase. 1 As Christopher C. Davis, Davis Advisors Portfolio Manager, once remarked, Building long-term wealth is like driving an automobile. If you narrowly focus on the stretch of road a few feet in front of your car, you risk making unnecessary adjustments and oversteering. Only when you lift your eyes to focus further down the highway will you successfully reach your destination. Despite Decades of Uncertainty, the Historical Trend of the Stock Market Has Been Positive. 1,600 1,500 1,400 1,300 1,200 1,100 1, SPX Daily The 1970s The 1980s Black Monday, Iran-Contra, Reagan Shot, S&L Crisis The 2000s 2/27/ Bear Market, Economic Uncertainty, Geopolitical Turmoil, OPEC Geopolitical Turmoil, Natural Disasters, Corporate Scandals, Rising Energy Prices The 1990s 100 LTC, Asia, Russia, Geopolitical Turmoil, Clinton Impeached This hypothetical investment assumes an investment on 1/1/70 through 12/31/06. Past performance is not a guarantee of future results. The end amount does not take into account any fees or expenses.

5 Focus on What is Knowable and Important Shelby Davis, Founder of Davis Advisors, once stated, If we accept that investing through uncertain times is the rule, not the exception, then the question to ask in my opinion is not whether or when to invest, but how to invest... At Davis Advisors, in order to build long-term wealth for clients, our investment process focuses on what is knowable and important. Instead of focusing our research efforts on issues such as the direction of the stock market, interest rates, oil prices, and earnings, which in our opinion are all important but, unfortunately, unknowable over the short term, our research attempts to uncover such knowable and important issues as the quality of a business management team, the financial condition of a business, a business competitive moats, and the quality of its earnings. By relentlessly focusing on what is both knowable and important, Selected American Shares has delivered attractive results in different market, geopolitical and economic environments. In fact, as illustrated by the chart below, Selected American Shares outperformed the S&P 500 Index in eight out of 10 rolling five year time periods since Davis Advisors began managing the Fund. As Mark Twain said, It ain t what you don t know that gets you into trouble. It s what you know for sure that just ain t so. Focusing on the Knowable and Important Can Help Investors Build Wealth Over Many Different Market, Economic and Political Environments Selected American Shares vs. S&P 500 Index Rolling Five Year Performance The 1990s The 2000s * Selected American Shares (Class S) Periods Ending 12/31 S&P 500 Index Selected American Shares Class S 1 Year 5 Years 10 Years Annualized Returns as of 12/31/ % 9.00% 11.12% The performance presented represents past performance and is not a guarantee of future results. Total return assumes reinvestment of dividends and capital gain distributions. Investment return and principal value will vary so that, when redeemed, an investor s shares may be worth more or less than their original cost. The total annual operating expense ratio for Selected American Shares Class S shares as of December 31, 2006 was 0.90%. The total annual operating expense ratio may vary in future years. Returns and expenses for other classes of shares will vary. Current performance may be higher or lower than the performance quoted. For most recent month-end returns visit selectedfunds.com or call *Returns calculated from 5/1/93 through 12/31/97. Davis Advisors began managing the Fund 5/1/93. See the endnotes for a description of this chart and a definition of the S&P 500 Index. 3

6 Be Patient Christopher C. Davis, Portfolio Manager with Davis Advisors, once remarked that Investors repeatedly abandon a sensible wealth-building strategy just because it is not generating short-term results, and almost without fail, give up on it at precisely the wrong time. In other words, investors who impatiently switch in and out of investments, hoping to catch the next hot trend, stock, asset class, or geographic area, may be doing themselves more harm than good. In fact, history has shown that timing the market is difficult at best, foolhardy at worst. The benefit of a patient, long-term approach to building wealth is illustrated in the chart below, which groups 574 mutual funds into four categories based on their turnover ratio. Turnover ratio is a measure of a fund s trading activity. A turnover ratio of % or more may indicate that a fund is selling (or turning over) most of their holdings every year, while a turnover rate of 20 30% might indicate a more patient, buy and hold investment approach. Though past performance is no guarantee of future results, for these 574 mutual funds, as turnover ratio decreased, 10 year performance increased. While this particular study uses mutual funds, we believe its findings apply generally to all investments. At Davis Advisors, it is our belief that investors who utilize a patient, buy and hold investment approach are well positioned to build long-term wealth by taking advantage of the power of compounding. To quote Warren Buffett, For investors as a whole, returns decrease as motion increases. Portfolio Managers Utilizing a Patient, Low-Turnover Investment Approach Have Rewarded Investors (as of 12/31/06). Turnover Ratio 10 Year Return Growth of $10,000 >99% 7.6% $20,803 63% 99% 7.9% $21,390 35% 63% 8.5% $22,610 0% 35% 8.9% $23,457 Selected American Shares Class S Shares 9% 11.1% $28,693 4 Source: Morningstar as of 12/31/ domestic equity funds Class A shares (excluding index funds) with at least a 10 year track record were included in this study and grouped by reported portfolio turnover. Past performance is not a guarantee of future results. There is no guarantee that in future periods low turnover funds will have higher returns than those funds with higher turnover. Returns do not take into account any sales charge. Reported figures would be lower if a sales charge were included.

7 Expect Periods of Disappointment When constructing a long-term financial strategy, it is important to recognize and acknowledge that even though stocks have historically rewarded patient, long-term investors, even the best investment managers will suffer periods of disappointment. Consider the cases of Charles Munger and Walter Schloss, two of the industry s most successful money managers. Charles Munger, Warren Buffett s partner at Berkshire Hathaway, delivered a 14 year cumulative gain of 1,156% versus only 103.3% for the S&P 500 Index. However, he underperformed the S&P 500 Index in approximately five years of his 14 year tenure. Walter Schloss studied under Benjamin Graham and recorded a 28 year cumulative investment gain of 23,104% versus only 887% for the S&P 500 Index. However, he underperformed the S&P 500 Index in approximately eight years of his 28 year tenure. Clearly, these two legendary investors experienced periods of disappointment on the way to building stellar investment records. The chart below illustrates the percent of top performing large cap investment managers from January 1, 1997 to December 31, 2006 who suffered through a three year period of underperformance, falling into the bottom half, quartile or decile of their group. As illustrated below, 92% of top quartile performing large cap money managers spent at least one three year period in the bottom half of the group; 58% spent at least one three year period in the bottom quartile and 24% spent at least one three year period in the bottom decile. Though each of the managers in the study delivered excellent long-term returns, they almost all suffered through a difficult period. It is important to recognize that while painful and difficult, periods of disappointment are not only possible, but most likely inevitable. Investors who recognize this fact and are prepared for it may be less likely to abandon their investment strategy during such periods. Percentage of Top Quartile Large Cap Equity Managers Whose Performance Fell Into the Bottom Half, Quartile or Decile for at Least One Three Year Period. 100% (1/1/97 12/31/06) 80% 92% 60% 58% 40% 20% 24% 0% Bottom Half Bottom Quartile Bottom Decile Past performance is not a guarantee of future results. Source: Davis Advisors. 114 managers from evestment Alliance s large cap universe whose 10 year average annualized performance ranked in the top quartile from January 1, 1997 December 31,

8 Engage in Healthy Investor Behavior Maintaining a long-term investment strategy is far easier said than done, especially in the face of disappointing short-term results previously mentioned. When faced with such situations, most investors tend to engage in unhealthy investor behavior and may abandon their long-term investment strategies, chase the hot performing categories or try to time the market in some fashion. The impact of engaging in such unhealthy investor behavior is illustrated quite strikingly in the study results below. The study shows that while the average stock fund delivered an average annual return of 11.3% per year from 1986 to 2005, the average stock fund investor received an average annualized return of only 3.9% per year. While this particular study uses mutual funds and mutual fund investors as the basis for its conclusions, we believe Dalbar s findings in this instance apply more generally to the behavior of other investors as well, including institutions. At Davis, we believe one way to encourage healthy investor behavior is to seek out those managers 1) Who have demonstrated an ability to deliver attractive results over the long term during many different market, economic and political environments, 2) Who have acted as stewards of clients capital and 3) Who have communicated with clients openly and honestly. Such managers will instill the conviction necessary to engage in healthy investor behavior. Furthermore, financial professionals can help investors through the process of searching for the right managers and staying invested during the inevitable periods of underperformance. In our view, the cost of financial advice seems relatively modest when compared to the cost of self-inflicted underperformance that results from unhealthy investor behavior. Average Stock Fund Investor Return vs. Average Stock Fund Return ( ) 15% Average Annual Return $100,000 Hypothetical Return of a $10,000 Investment 10% 11.3% $80,000 $60,000 $85,095 5% $40, % $20,000 $21,494 0% Average Stock Fund Investor Average Stock Fund Return $0 Average Stock Fund Investor Average Stock Fund Return Source: Quantitative Analysis of Investor Behavior, published in 2006 by Dalbar, Inc. Dalbar computed the average stock fund investor return by using industry cash flow reports from the Investment Company Institute. The average stock fund return figure represents the average return for all funds listed in Lipper s U.S. Diversified Equity fund classification model. Dalbar also computed the return for a systematic investor making an equal investment amount each month over the 20 year period. The S&P 500 Index was used as the assumed return rate. The systematic investor type would have realized a 6.00% return over the 20 year period. Past performance is not a guarantee of future results. 6

9 Have an Investment Strategy The unhealthy investor behavior previously mentioned is largely due to the fact that investing is an emotional experience. We feel less confident when prices are low and more confident when prices are high. Such an emotional response can lead to unhealthy investor behavior as we may invest more capital in areas of the market that have recently performed well (buying high) and remove capital from areas of the market that have experienced short-term underperformance (selling low). Ideally, the goal of most long-term investors should be the exact opposite of the scenario mentioned above investors should seek to buy low and sell high as we do when we purchase a house or buy groceries for our family. One way to develop a counter-emotional approach towards investing is to have an investment strategy. Most successful long-term investors who have reached their financial goals indicated that they initially developed a roadmap to help them stay focused, consisting of the following components: 1. A Written Investment Policy 2. An Asset Allocation Strategy 3. Rigorous Investment Manager Selection and Evaluation 4. Ongoing Account Monitoring and Rebalancing Institutional investors seem to utilize similar four step strategies more often than traditional individual investors. Such a disciplined approach to investing may be one of the reasons why the average institutional investor outperformed the average individual investor as highlighted in the chart below. 10 Year Average Annual Returns ( ) 12% 10% 10.8% 8% 6% 6.2% 4% 2% 0% Institutional Investor Return Individual Investor Return Source: Mercer Investment Consulting for the Institutional Investor Return and Dalbar for the Individual Investor Return. Returns as of 12/31/04. Institutional Investor represents an average of the return for foundations, endowments, public pension plans and corporate pension plans over the past 10 years. The data originally appeared in the February 21, 2006 issue of Investment News in an article entitled Annual Portfolio Reviews are Required Maintenance. Past performance is not a guarantee of future results. This was a one-time study that has not been updated. 7

10 Set Realistic Return Expectations C onsider this fact: In 40% of all rolling 10 year periods since 1928, the market1 has returned less than 10%. Put another way, almost half of the time equities have returned less than 10% over 10 years. Furthermore, investors have now had 23 out of 24 consecutive rolling 10 year periods of market returns approximately 10% or above. However, from 2001 to 2006, the average annual return of the stock market was 4.67%. To achieve the 10% return stated above for the 10 year period ending 2010, stocks would need to deliver an average annual return from 2007 to 2010 of 18.5%.2 At Davis, we are neither pessimists nor optimists but realists. So it is our belief that for the decade ending 2010, an average annual rate of return for equities approaching the 10% historic rate of return is not realistic, given the challenges investors faced from 2001 to It is important for investors to prepare themselves for such an outcome in order to properly align their expectations with their goals. With that in mind, what is a reasonable return for equities over the long term? Given the tremendous resilience the U.S. economy and American businesses have shown throughout history, we at Davis believe that by owning durable businesses and buying them at a discount, investors have the possibility of achieving above average stock returns over the long term. When considering the myriad outcomes for the long-term rate for equities, it helps to bear in mind Shelby Davis quote below. Put another way, the 7% rate of return he mentions would result in $10,000 compounding to over $76,100 in 30 years. With the Dow around 12,000, rather than worry about the direction of the next 1,000 points, my advice is to stay focused on this reality: If the Index compounds at just 7% on average over the next 30 years, the Dow would increase eight-fold to over 90,000. Shelby M.C. Davis Advisor and Founder, Davis Advisors 1 The market performance discussed is for the Dow Jones Industrial Average. The performance was obtained from a combination of reputable sources, including, but not limited to, Thompson Financial, Lipper, and index websites. Past performance is not a guarantee of future results. 2The hypothetical discussion is not meant to predict any specific investment results. Equity markets are volatile and an investor may lose money. 8

11 The Seven Timeless Strategies For the Successful Investor 1. Accept That Uncertainty is the Rule, Not the Exception When building long-term wealth, periods of uncertainty are the rule, not the exception. But, despite such uncertainty, it is important to bear in mind that the long-term progress of the stock market has been upward. 2. Focus on What is Knowable and Important Since uncertainty is the rule not the exception, it is crucial to focus on what is knowable and important versus unknowable and important. Such an investment approach can help uncover investment opportunities during many different market, economic and political environments. 3. Be Patient At Davis, we believe a patient, buy and hold investment approach is the best way to build long-term wealth. Such an approach allows investors to filter out the noise, maintain their investment strategy and allow the power of compounding to help build wealth. 4. Expect Periods of Disappointment It is crucial to understand that even top performing investment managers will go through periods of disappointment. By recognizing this fact, you may be less likely to engage in unhealthy investor behavior and make unnecessary modifications to your long-term investment strategy. 5. Engage in Healthy Investor Behavior Having conviction in the investment managers you entrust your capital to and working with a financial professional can help investors engage in healthy investor behavior. 6. Have an Investment Strategy Investing is an emotional experience, so develop a roadmap to maintain your focus and discipline necessary to build long-term wealth. 7. Set Realistic Return Expectations Stocks have historically been the best performing asset class for growth of capital over the long term. When planning long-term financial goals, it is important to be a realist, and not an optimist or a pessimist. Past performance is not a guarantee of future results. There is no guarantee that an investor following these strategies will in fact build wealth. 9

12 This material is authorized for use by existing shareholders. A current prospectus must accompany or precede this piece if it is distributed to prospective shareholders. You should carefully consider the Fund s investment objectives, risks, fees, and expenses before investing. Read the prospectus carefully before you invest or send money. There can be no guarantee that Selected American Shares will continue to deliver consistent investment performance. The performance presented includes periods of bear markets when performance was negative. Share price and return vary, so investors may have a gain or loss when they sell their shares. The market prices of common stocks are volatile. Selected American Shares investment objective is capital growth and income. In the current market environment, we expect that income will be low. There can be no assurance that the Fund will achieve its objective. Selected American Shares invests primarily in common stock of U.S. companies with market capitalizations of at least $10 billion. The most important risks of an investment in Selected American Shares are: market risk: the market value of shares of common stock can change rapidly and unpredictably; company risk: the market value of a common stock varies with the success or failure of the company issuing the stock; financial services risk: investing a significant portion of assets in the financial services sector may cause a fund to be more volatile, securities within the financial services sector are more prone to regulatory action in the financial services industry, more sensitive to interest rate fluctuations, and are the target of increased competition; and foreign country risk: companies operating, incorporated or principally traded in foreign countries may have more fluctuation as foreign economies may not be as strong or diversified, foreign political systems may not be as stable and foreign financial reporting standards may not be as rigorous as they are in the United States. As of December 31, 2006, Selected American Shares had 10.4% of assets invested in foreign companies. See the prospectus for a complete listing of the principal risks. Selected Funds investment professionals make candid statements and observations regarding economic conditions and current and historical market conditions. However, there is no guarantee that these statements, opinions or forecasts will prove to be correct. All investments involve some degree of risk, and there can be no assurance that Selected Funds investment strategies will be successful. The value of equity investments will vary so that, when sold, an investment could be worth more or less than original cost. Selected American Shares average annual total returns for Class S shares were compared against the returns earned by the S&P 500 Index as of December 31 of each year for all rolling time periods indicated from May 1, 1993 through The Fund s returns assume an investment in Class S shares on January 1 of each year with all dividends and capital gain distributions reinvested for the time period indicated. Investment return and principal value will vary so that, when redeemed, an investor s shares may be worth more or less than when purchased. Fund performance changes over time, and current performance may be higher or lower than stated. Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue chip stocks. The Dow Jones is calculated by adding the closing prices of the component stocks and using a divisor that is adjusted for splits and stock dividends equal to 10% or more of the market value of an issue as well as substitutions and mergers. The average is quoted in points, not in dollars. The S&P 500 Index is an unmanaged index of 500 selected common stocks, most of which are listed on the New York Stock Exchange. The Index is adjusted for dividends, weighted towards stocks with large market capitalizations, and represents approximately twothirds of the total market value of all domestic common stocks. Investments generally cannot be made directly in an index. Dalbar, a Boston-based financial research firm that is independent from the Selected Funds, researched the negative effects of actively trading mutual funds. The fact that buy and hold has been a successful strategy in the past does not guarantee that it will continue to be successful in the future. Dalbar s figures have been updated through December 31, After April 30, 2007, this material must be accompanied by a supplement containing performance information as of the most recent quarter end. Shares of the Selected Funds are not deposits or obligations of any bank, are not guaranteed by any bank, are not insured by the FDIC or any other agency and involve investment risks, including possible loss of the principal amount invested. Item # /06 Davis Distributors, LLC, 2949 East Elvira Road, Suite 101, Tucson, AZ 85706, , selectedfunds.com