All-Cap Portfolio Commentary
Fall Update 2018

Market Perspectives

As of the end of the third quarter, the U.S. stock market’s year-to-date return was 10.6% as measured by the S&P 500 Index and 10.5% as measured by the Portfolio’s benchmark, the S&P 1500 Index.1 Although we have witnessed more volatility in recent periods, U.S. economic fundamentals remain strong with historically low unemployment, robust gross domestic product (GDP) growth and modest inflation. The Federal Reserve continues on its path to normalize interest rates now that the economy has clearly recovered from the last financial crisis, but is doing so in a gradual, measured and manageable fashion thus far. In brief, the U.S. economic backdrop and fundamentals appear favorable overall.

In terms of opportunities and risks, prospective growth rates and current valuations vary greatly by business and by industry at the moment. On average, the forward price-to-earnings ratio of the S&P 500 Index is approximately 18 times, which is neither inexpensive relative to history nor indicative of an overall market bubble. Today we see the greatest number of value opportunities in out-of-favor or out-of-the-spotlight businesses such as leading companies in the financial services industry, reasonably priced industrial companies and attractively priced North American shale companies as well as a focused list of technology companies whose long-term growth rates justify somewhat higher multiples.

At the same time, we are consciously avoiding certain risks with an eye to preserving capital. For example, we are not meaningfully invested at this time in consumer staples, telecommunication stocks or utilities stocks—groups normally associated with the so-called “dividend darlings.” While currently offering above-market dividend yields, these sectors remain fairly expensive especially in light of their rather anemic (and in some cases negative) top-line growth and high payout ratios. Furthermore, they become even more expensive if operating margins, which are at the high end of their historical range, are normalized. In other words, as a truly active manager we will continue to focus on businesses that our analysis indicates are compelling risk/reward opportunities and avoid those that do not meet our standards.

Consistent with our philosophy of buying durable businesses at value prices and holding them for the long term, we are investing selectively in businesses that meet our investment criteria of strong balance sheets, durable competitive moats, and the potential for earnings to expand over time with attractive valuations.

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. 1 Past performance is not a guarantee of future results.

Portfolio Review

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

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

Oracle, a representative market leader in the Portfolio, offers a wide array of enterprise information technology solutions including cloud applications, databases, and engineered systems to 430,000 customers in 175 countries.3 The company provides a wide choice of software, systems and cloud deployment models, including public, on-premises and hybrid clouds to allow businesses to work efficiently and simplify workflows. Oracle is the second largest enterprise software company, the largest database company by revenue and the second largest enterprise application company. Oracle’s large market share, focus on expanding cloud-based solutions and reasonable valuation make the company an attractive addition to our Portfolio.

A representative out-of-the-spotlight business is Quotient Technology (formerly, a leader in digital coupons including online, print, social media, and mobile coupon promotions. The company’s rapidly growing digital transactions, unique customer database and large scale presence in digital coupon disbursement set it apart from the competition, creating a favorable long-term outlook for revenue growth combined with a reasonable valuation.

Aptiv PLC, another out-of-the-spotlight business, is a global manufacturer of auto parts oriented toward green technology, advanced safety and connectivity solutions for the auto market. Under the strong leadership of CEO Kevin Clark, we anticipate Aptiv will continue enjoying growth over the years ahead due to tailwinds in active safety and high voltage demand in the auto industry. In addition, the company plans to expand into adjacent markets with its technology, such as aerospace and commercial vehicles.

Among our more contrarian investments is Wells Fargo, a financial services company that is attractively valued given its strong position across North America in banking, insurance, investments, mortgages, and consumer and commercial finance services. Despite negative headlines facing the company today, Wells Fargo maintains two major competitive advantages: First, the company boasts a sizable, low-cost and stable retail deposit base that has historically enabled Wells Fargo to generate one of the highest net interest margins in the industry. Second, Wells Fargo’s credit and underwriting culture remains among the strongest in the industry as evidenced by historically below-average credit losses. With a current valuation of roughly 11 times earnings, we believe the company remains attractively priced even considering the negative impact of the recent controversies weighing on Wells Fargo’s share price. The new management team that took the helm within the last two years is making good progress in addressing past deficiencies and we believe this augurs well for this investment over the longer term.

Among recent portfolio changes, EQT Midstream Partners was sold during the third quarter of 2018.

Overall, we believe the durable balance sheets and long-term earnings power of the companies that make up the Davis All-Cap Portfolio strongly position us to continue building shareholder wealth over time.

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

2 While we research companies subject to such contingencies, we cannot be correct every time, and a company’s stock may never recover. 3 Holdings 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 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.

Trailing Price/Earnings (P/E) Ratio is the weighted average of the price/earnings ratios of the stocks in a portfolio. The P/E ratio of a stock is calculated by dividing the current price of the stock by its trailing 12 months’ earnings per share. Portfolio totals are computed using an inverse harmonic methodology.

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.

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.

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