The Davis Discipline – A Good Book and An Amazing Life


If you haven’t heard of Shelby M.C. Davis – and relatively few people have because he’s a very private person – you’re missing the story of one of the world’s great investing families, as well as one of the world’s most generous philanthropists. He’s an all-timer.

The Davis Discipline: Fifty Years of Successful Investing On Wall Street by John Rothchild traces the three generations of Davis men, from the original patriarch Shelby Collum Davis, to his son Shelby M.C. Davis, and the grandsons Andrew and Chris Davis.

The book offers timeless lessons in six condicio sine qua non ingredients for building wealth: In particular, the role of

  1. Equity-ownership of one’s own business,
  2. Specialized knowledge
  3. Hard work
  4. Massive leverage
  5. Tightwad behavior, and
  6. Extraordinary luck.

Equity-ownership

The most important wealth-creating decision Davis Sr. ever made – mirrored later by his son Shelby M.C. Davis – was to found his own business.

Davis Sr. trained as a New York insurance regulator, making a respectable but limited salary from the State. At age thirty-eight he quit his job, borrowed $50,000 from his wife’s family, and set himself up in business as a stockbroker, with a seat on the New York Stock Exchange, specializing in insurance stocks.

Shelby M. C. Davis, his son, made an equally fateful decision in 1968 when he left his job as an analyst at the Bank of New York to join a few partners to found the mutual fund company which eventually became Davis Selected Advisors.

Now, founding a own company does not guarantee wealth, because most new businesses fail, and because lots of people end up earning less working for themselves than they did working for others.[1]

On the other hand, equity ownership is the only way to create significant wealth. Every single large personal fortune – on the Forbes 400 list for example – results from business ownership, usually highly risky and undiversified to start. It might not have worked out – and undoubtedly even the Davises felt the risk of failure in the beginning – but owning their own businesses was the key first step.

 

Specialized knowledge

Davis Sr. – sitting in his insurance-regulator seat – gained deep insight into the insurance business at a particularly propitious moment. In the post-World War II era, insurance companies traded at extraordinarily cheap valuations.

Davis also happened to combine two great insights. First, he understood value investing before the world had even heard of Warren Buffett. Davis was the president of value-investor Benjamin Graham’s stock analysts’ organization in 1947. Second, Davis dug deeply into the investment portfolios and business practices of insurance companies.

Shelby Collum Davis
Shelby Collum Davis

The result of Davis combining these two specialized insights closely resembled Warren Buffett’s path to wealth. Davis’ built his $50,000 initial investment stake into a personal fortune worth close to $900 million by the time he passed away in 1994. As the book reports, most of those gains came from purchasing insurance company shares, just as Buffett’s fortune grew from post-World War II insurance company ownership as well.

Shelby M.C. Davis, his son, invested in a wider variety of US and multinational companies, but his methods sprang from his father’s focus on specialized knowledge. Most importantly, Davis developed the art and science of deep dives into the quarterly reports of public companies as well as thorough independent research to discover attractive companies – classic value-investor practice.

 

Borrowing to the gills – leverage

Shelby Davis Sr. began his insurance brokerage with limited funds – $50,000 in 1948 – but took advantage of his ability to borrow money as a broker-dealer. Because of consumer protection laws, individuals who purchase stocks “on margin” through their broker can only borrow 50% of the value of their investment. A broker-dealer on the other hand, is allowed to borrow far more, limited mostly by what others are willing to lend them.

Davis Sr. purchased beaten-down insurance stocks for a living, and that alone might have made him a small fortune over his lifetime. Using borrowed funds as a broker-dealer, however, made him a huge fortune. The difference was that he magnified his returns by borrowing huge sums of money for decades.

Of course leverage can giveth, and leverage can taketh away. Sometimes borrowing huge amounts of money leads to a massive blowup of wealth. In Davis’ case, leverage enhanced rather than destroyed his fortune.

In a sense, all fortunes require leverage. Sometimes this is achieved by borrowing huge sums of money as Davis did, or as many real-estate investors do. Sometimes the leverage is actually ‘operating leverage,’ as in the example of the top equity owner of a law firm who employs many junior attorneys to do the work for him while he reaps the benefits at the top of the pyramid.

More recently, social media firms like Facebook and Twitter achieve a different kind of leverage through massive network-effects. The programming and administration work required to support an online network of 10,000 people, for example, becomes much more interesting as a business proposition when extended to the currently estimated 1.3 billion users of Facebook. That’s another kind of leverage.

In any case, you need leverage to create huge wealth.

The $1,000 hot dog – tightwad behavior

Davis family lore tells of Shelby Davis, Sr. taking a walk with his grandson, Chris Davis, in Manhattan. Chris asked granddad whether he would buy him a $1 hot dog. Davis Sr. pounced on his grandson with an object lesson in thrift and compound interest.

Did grandson Chris realize that $1, invested wisely, would double in value in five years? Furthermore, did he realize that this $1, compounded over 50 years, when Chris would be his grandfather’s age, would become worth over $1,000?[2]

Grandfather Davis asked: “Are you so hungry you need to eat a $1,000 hot dog?”

And that, ladies and gentlemen, is how wealthy people get, and stay, wealthy. It’s also an elegant lesson summarizing the key points of pretty much any book on building long-term wealth.[3]

 

Luck

Let’s face it: Nobody builds a great fortune without a tremendous amount of luck. While it may be true that “the harder I work, the luckier I get,” many hard-working brilliant people who combine business ownership with specialized knowledge and leverage do not achieve the fortunes they seek.

In Davis Sr.’s case, two pieces of luck stand out.

First, he began making leveraged investments in insurance stocks just at the beginning of a period of extraordinary growth. While he had the discipline to never sell, his leveraged investment at the time of a profound equity market downturn could have led to a forced a sale. Luckily for him, his fortune did not suffer that fate.

Second, as author Rothchild describes, Davis Sr. took a pause from investing his fortune between 1968 and 1975, when he served as US ambassador to Switzerland. During that period a bear market in stocks crushed his then-personal fortune of $50 million down to $20 million.

While historical counter-factuals are difficult, Rothchild wonders what would have happened had Davis been more actively involved in investing during those years. His distance from the investing world in precisely those years may have been a piece of extraordinary financial luck.

Later, between 1975, when Davis Sr. returned to managing his money, and his death in 1994, his fortune soared with markets to nearly $900 million.

 

Giving it all away

Interestingly, Davis Sr. set an amazing precedent with his fortune. He was determined that his heirs should not be handed a large fortune to inherit, so he dedicated the vast bulk of his money to political causes he believed in.

Shelby MC Davis
Shelby MC Davis

His son, Shelby, who established his own mutual fund business independently of his father, earned his own fortune. Although Shelby Jr.’s sons have taken over management of that business, he has made it clear to them that they will not inherit his wealth either.

In fact, I met Shelby Davis because he is in the process of giving away his fortune, as fast as he can, to support higher education for students from all over the world.

 

Another reason I’m interested in this book, and the Davis family

Shelby M.C. Davis, the son, happens to be a personal hero of mine.

Around the time he turned 60, Davis deeply embraced his father’s model that children should not inherit money. Children should be taught important lessons about building wealth, but ultimately they need to stand on their own and earn their own way.

The Davis family mantra is “Learn, Earn, Return” – describing the 3 phases of a good life. After studying at Princeton and working for Bank of New York in his first thirty years of Learning, and then building a successful mutual fund company over the next 30 years of Earning, Shelby decided to Return the bulk of his wealth to a cause he believed in, just as his father had.

In the late 1990s he worried that American students were overly parochial in their understanding of the world beyond our borders. The future, he believes, belongs to people who can think and act internationally.

As a result of this belief, and his plan to Return his fortune, he became the leading benefactor of my favorite institution, the target of my own philanthropy.

Davis discovered the United World College of The American West – a two-year International Baccalaureate high school with 220 students from 70+ countries, dedicated to leadership training, fostering an international social conscience, and bettering the human condition.

UWC_Davis_Scholars_at_Brown
UWC Davis Scholars at Brown University

Over time, Davis realized that not just the US students, but also the students arriving from abroad, had the power to transform US higher education for the better by internationalizing US university campuses.

He invested – with little fanfare or even recognition – close to $100 million of his wealth in supporting this institution and its sister schools, the other 13 United World Colleges around the world.

shelby_davis_philanthropy
Shelby, his wife, mother, and UWC Davis Scholars at Wellesley

On top of that extraordinary commitment, Davis currently supports 2,400 United World College graduates at 90 US universities studying for their undergraduate degrees, through the Davis United World Scholars Program. He’s spending tens of millions of dollars per year of his fortune on this program to simultaneously transform individuals’ lives and to internationalize US higher education.

As Davis says, the point is to ‘plant seeds of hope’, by supporting the higher education and leadership training of extraordinary young people from all over the world. Do you want to feel hopeful about the future of the world? Check out these UWC students at Brown University.

I’ve written and done interviews before about the extraordinary commitment it takes to pay for one child’s undergraduate education, but what about taking on financial responsibility for 2,400 undergraduates at the same time?

He funds this commitment year after year, sending tens of millions of dollars out of his future estate, both to help the students and to ‘save his sons’ from the burden of inheritance.

Basically, it’s ridiculous. Shelby Davis is amazing.

I recommend reading The Davis Discipline because it shows how some people accumulate extraordinary wealth.

I recommend studying Shelby M.C. Davis’ life because it shows how personal wealth can be dedicated to a higher purpose.

NB: A version of this book was also published by John Rothchild as The Davis Dynasty: Fifty Years of Successful Investing on Wall Street

 

 

Please see related posts:

Philanthropy Part I – Giving Money Away

Teaching kids Compound Interest

Teaching kids stock investing

On Entrepreneurship, Part I – Fixed Income vs. Equity Ownership

Similar to the $1,000 hot dog: Bach’s Latte Effect from The Automatic Millionaire

 

 

[1] Just ask your friendly Anonymous Banker. And review this tale of woe.

[2] Clever users of the compound interest or discounted cash flow formula will easily calculate that grandfather Davis was assuming an approximate 15% annual compound return. An aggressive assumption for sure, but he managed to earn better than that during his investing career.

[3] Such as, just to offer a few examples, the recently reviewed Automatic Millionaire, The Intelligent Investor, 25 Myths You’ve Go To Avoid If You Want To Manage Your Money Right, The Only Investment Guide You’ll Ever Need, Simple Wealth Inevitable Wealth, and The Millionaire Next Door.

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I Miss The Great Recession Already

End of recessionI’m just going to come out and say it, ok?  I miss the Great Recession already.

I miss it for two reasons: first as an investor and second as a human.

The Investment Side of the Great Recession

As an investor, the Great Recession represented the good times, now past.[1]

Recessions – or at least their financial unfolding via changes in asset prices – cause not only wealth destruction, but also wealth creation.  For investors[2] in particular, a recession is often necessary in order to deploy capital at attractive prices.

Warren Buffett famously gets irritated about the lack of investment opportunities in his annual Berkshire Hathaway letters during boom times, like his 1999 letter[3] and 2007 letter,[4] because prices of public securities outpace intrinsic value.  Conversely, he gets very busy and active buying companies when prices drop and other investors flee.  Recessions for Buffett, as well as for many investors, represent the best time to accumulate wealth.  Which is why he famously says:

“Be fearful when others are greedy, and be greedy when others are fearful.”

 

Another famous value investor, Shelby Collum Davis,[5] said more pointedly:

“You make most of your money in a bear market.  You just don’t know it at the time.”

If you believe Buffett and Davis, as I do, then you too will think wistfully of the Great Recession because, as an investor, the good times are in the past.  Now, with US equity indexes up over 100% from their March 2009 lows, investing consists of purchasing expensive assets and hoping they get more expensive.  Which has a lot more to do with gambling than it does with investing.

The Human Side of the Great Recession

Of course this may sound awfully callous from a human perspective, and I don’t mean to diminish the real human suffering of the Great Recession.  In fact, on the contrary, it’s the humanity that emerged during the Great Recession that I want to call attention to, as the part I’m going to miss the most.

Remember when your 401K lost 5% of its value every month – month after month after month – between August 2008 and March 2009?  Remember that you just stopped regularly checking its value – or any part of your supposed net worth – by about December 2008, because the whole thing just became too painful to contemplate?

At that moment, falling into the Great Recession, we all confronted, in our own way, the painful reality that our human worth had to be something other than our financial net worth.  Because otherwise we just became half of who we were.

Remember when in the space of just a few short months either you – or someone you knew well – lost a job, a house, or a business?

As awful as that was, our collective acknowledgement of suffering changed the way we acted on a daily basis.  For people relatively well off, the new austerity forced a kind of back-to-basics approach to living.  Luxury consumption plummeted, and staycations soared in popularity, if only out of solidarity with those who suffered even more.

I personally lost money in the Great Recession.  But what turns out to be even more painful, as a fiduciary, is losing other people’s money.  I dreaded calling investors on the phone to report a loss, and I dreaded, worse yet, seeing them in person.  To make it more painful for me, my investors, unfortunately, were often my friends and family.  The thought of it kept me awake and tossing in bed in the 1-3am hours.  For a couple of years.  Not good times.

Would you like to know what reduced me tears, however?  It was the investors who told me it was going to be ok, that they still believed in me, and that the lost money didn’t mean they valued me less as a person.  Even as I write this now, it gets a little dusty in the room when I think of that.

There’s a human element that only reveals itself in the bad times.

Laissez Les Bons Temps Rouler

My sense is that sometime between Groundhog Day and Mardi Gras 2013, the Financial Infotainment Industrial Complex will peak out at the nation’s Great Recession shadow, and officially declare the long Winter finally over.

That declaration will signal it’s time for luxury living again and real vacations.  Masters of the Universe will know they can safely begin to channel their inner Patrick Bateman in public again.

In that smooth shift from Recovery to laissez les bons temps rouler I’m certain we’ll go back to checking our net worths in the mirror more often, and possibly our human worths less often.

But I hope we’ll hold on to the memory of what we had, and lost, and recovered, during the Great Recession.

Mardi-Gras-Mask



[1] I acknowledge I’m being colloquial, not academic, about what I mean by a recession generally or the Great Recession in particular.  I don’t mean an economist’s definition of recession, which would refer to changes in GDP.  I also don’t mean to quibble about an US equity ‘bear market,’ as it’s been a few years since that occurred.  What I really mean is a holistic sense that, with unemployment below 8% nationally and the general level of stocks approaching their 2007 highs, the national mood has swung away from Recession and toward Recovery and I’m confident soon enough we’ll be in Boom Times.

[2] By “investor” I mean as distinct from “gambler,” which is what most of us do when we purchase public securities.

[3] Which I’ve helpfully linked to here, and would call your attention in particular to page 16, in which he anticipates the bursting of the tech bubble and the bursting of the equity bull market in general.

[4] Which is linked to here, and I’d call your attention to pages 18-20 in which Buffett tries to lower expectations for equity returns going forward.

[5] Whose son and grandsons run this firm, Davis Advisors.

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