All-Cap Portfolio Commentary
Mid-Year Update 2018

Market Perspectives

In the year-to-date period the U.S. stock market returned 2.65%, continuing its long advance in an environment of heightened volatility in the capital markets.1 Currently, the U.S. economy remains strong with robust GDP growth, relatively full employment and muted inflation. At the same time, uncertainty exists with respect to interest rates, the durability of the current economic expansion and geopolitical developments, among other considerations. These are all important but unknowable factors.

At Davis, we remain focused on the important and knowable, which requires understanding our portfolio holdings company by company and assessing whether the long-term earnings power of the businesses we own remains intact and able to generate satisfactory rates of return over the next five years. In other words, despite share price volatility, the underlying businesses we own are generating healthy, robust earnings with few exceptions, and are making good financial progress. In the long run and based on our experience dating back almost 50 years as an independent, research-driven investment firm, long-term earnings power matters far more to our ultimate success as investors than relatively minor share price fluctuations during shorter time periods.

Looking ahead, we believe selective stock picking is the best way to navigate the current market environment. As a result, at Davis Advisors we focus on the durability, sustainable growth, competitive moats, and management of every company in the Portfolio and continue to exercise discipline regarding the share price of each company we own.

This report includes candid statements and observations regarding investment strategies, individual securities, and economic and market conditions; however, there is no guarantee that these statements, opinions or forecasts will prove to be correct. Equity markets are volatile and an investor may lose money. Past performance is not a guarantee of future results. 1 U.S. stock market is represented by the S&P 500 Index. Past performance is not a guarantee of future results.

Portfolio Review

The Davis All-Cap Portfolio holds three categories of businesses including in order of proportion:

  • Dominant market leaders
  • Lesser-known, “out-of-the-spotlight” businesses
  • Contrarian investments2

Among the market leaders in the Portfolio are a number of dominant technology companies, some of which have been in existence for decades while others are yesterday’s disruptors that have emerged as some of today’s blue chips.

Texas Instruments, a longstanding market leader in the Portfolio, is the world’s largest manufacturer of analog semiconductor chips.3 The company designs, tests and builds a broad array of analog and embedded processing products—two areas in the semiconductor industry that offer growth, diversity and attractive financial characteristics. Both analog and embedded processing are pervasive technologies used worldwide by more than 100,000 of the company’s customers. Texas Instruments has a strong competitive position in these large and highly fragmented but growing markets that should translate into expanding revenues over the long term. The company invests more than $1 billion annually in R&D to develop new products, exercises greater control over its supply chain by owning its own factories, and has strategically expanded capacity and equipment well ahead of demand. In addition to positioning Texas Instruments for growth, the company’s management team distributes a substantial amount of excess cash to shareholders through dividend increases and share buybacks.

Among the Portfolio’s other market leaders is SAP, a German-based global software provider for enterprise resource planning, business intelligence, and database management founded in 1972 by five former IBM employees. SAP has a global footprint with approximately 388,000 customers in more than 180 countries using the firm’s software products. Companies use enterprise resource planning software solutions for a broad range of applications including human resources, accounting, inventory, and supply chain management. The company is expanding its cloud computing capabilities through a network of more than 40 data centers around the world serving 150 million subscribers. We believe SAP is a top-tier technology company with solid potential for accelerated revenue growth and margin expansion in the years to come.

Amazon is an e-commerce giant that has profoundly reshaped the retail industry over the years. Amazon offers an optional membership-based business model through its Amazon Prime service. In addition to its retail business, Amazon has a state-of-the-art, rapidly growing web services business (Amazon Web Services) that enables companies and other organizations to outsource their computer systems to Amazon’s digital cloud.

Our out-the-spotlight holdings currently include fairly mundane businesses such as Capital One Financial. Capital One is a top 10 U.S. bank based on deposits with branches located primarily in the New York to Washington, D.C. corridor as well as in Texas and Louisiana. This out-of-the-spotlight company may be best known for its competitive credit card offerings and is among the top 10 issuers of Mastercard and Visa cards. In our view, Capital One has a strong balance sheet, solid capital ratios and is well positioned for future growth.

Our contrarian investments include a number of North American shale companies that meet our investment criteria but are underearning relative to their long-term potential in our estimation.

Among recent Portfolio changes, we purchased iQiyi, a Chinese on-line video company, in the second quarter of 2018 and sold our position in FedEx.

Overall, we believe our Portfolio is positioned to provide a diversified balance of durable, well-managed businesses with attractive growth prospects.

Since our firm’s inception nearly 50 years ago, we have adhered to the same, time-tested investment philosophy and rigorous research process of buying durable businesses at attractive prices and holding them for the long term. The more than $2 billion the Davis family and Foundation, Davis Advisors, and our employees have invested side by side with our clients’ savings in similarly managed accounts and strategies remains a true sign of our commitment to and conviction in this enduring philosophy.4

2While we research companies subject to such contingencies, we cannot be correct every time, and a company’s stock may never recover. 3Holdings discussed in this commentary are selected according to objective, non-performance-based criteria. They are chosen each quarter according to a consistent methodology based on their weight in the Davis Advisors All-Cap model portfolio as well as recent purchases and recent sales and are intended only as illustrations of the Davis Investment Discipline. They are not recommendations to buy, sell or hold any security. Individual account holdings may vary. 4As of June 30, 2018.

This material may be shared with existing and potential clients to provide information concerning market conditions and the investment strategies and techniques used by Davis Advisors to manage its client accounts. Please refer to Davis Advisors Form ADV Part 2 for more information regarding investment strategies, risks, fees, and expenses. Clients should also review other relevant material, including a schedule of investments listing securities held in their account.

Davis Advisors is committed to communicating with our investment partners as candidly as possible because we believe our clients benefit from understanding our investment philosophy and approach. Our views and opinions include “forward-looking statements” which may or may not be accurate over the long term. Forward-looking statements can be identified by words like “believe,” “expect,” “anticipate,” or similar expressions. You should not place undue reliance on forward-looking statements, which are current as of the date of this report. We disclaim any obligation to update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise. While we believe we have a reasonable basis for our appraisals and we have confidence in our opinions, actual results may differ materially from those we anticipate.

This report discusses companies in conformance with Rule 206(4)-1 of the Investment Advisers Act of 1940 and guidance published thereunder. The companies we discuss are chosen in the following manner: starting at the beginning of the year, the holdings from a Multi-Cap model portfolio are listed in descending order based on percentage owned. Companies that reflect different weights are then selected. (For the first quarter, holdings numbered 1, 11, 21, and 31 are selected and discussed. For the second quarter, holdings numbered 2, 12, 22, and 32 are selected and discussed. This pattern then repeats itself for the following quarters. No more than two of these holdings can come from the same sector per piece.); one recent purchase and one recent sale are also discussed. A sale is defined as a position that is completely eliminated from the portfolio before the end of the quarter in question. If there were no purchases or sales, the purchases and sales are omitted from the report. If there were multiple purchases and/or sales, the purchase and sale discussed shall be the earliest to occur. If there are multiple purchases and/or sales on the same day, the one that is the largest percentage of assets will be discussed. No holding can be discussed if it was discussed in the previous three quarters.

The information provided in this report does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to buy or sell any particular security. There is no assurance that any of the securities discussed herein will remain in an account at the time this report is received or that securities sold have not been repurchased. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of any account’s portfolio holdings. It should not be assumed that any of the securities discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. It is possible that a security was profitable over the previous five year period of time but was not profitable over the last year. In order to determine if a certain security added value to a specific portfolio, it is important to take into consideration at what time that security was added to that specific portfolio. A complete listing of all securities purchased or sold in an account, including the date and execution prices, is available upon request.

The investment objective of a Davis Multi-Cap Equity account is long-term growth of capital. There can be no assurance that Davis will achieve its objective. Davis Advisors uses the Davis Investment Discipline to invest a client’s portfolio principally in common stocks (including indirect holdings of common stock through depositary receipts). The Multi-Cap Equity strategy may invest in large, medium, or small companies without regard to market capitalization and may invest in issuers in foreign countries, including countries with developed or emerging markets. The principal risks are: common stock risk, depositary receipts risk, emerging markets risk, fees and expenses risk, foreign country risk, foreign currency risk, headline risk, large-capitalization companies risk, manager risk, mid- and small-capitalization companies risk, and stock market risk. See the ADV Part 2 for a description of these principal risks.

Small cap companies have market capitalizations less than $3 billion. Mid cap companies have market capitalizations from $3 billion to $10 billion. Large cap companies have market capitalizations greater than $10 billion. Under normal circumstances, the Multi-Cap Equity Composite invests the majority of its assets in equity securities issued by companies with market capitalizations of less than $20 billion.

The S&P 1500 Index is comprised of the S&P 500, MidCap 400, and SmallCap 600, which together represent approximately 90% of the U.S. equity market. 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 two-thirds of the total market value of all domestic common stocks. Investments cannot be made directly in an index.

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