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By Dan Culloton | 06-08-2011 08:25 AM

Feinberg: Quality Franchises Will Be Key for Stock Investors

Owning high-quality companies will be integral to achieving growth in a low-growth environment, says the Davis/Selected American manager.

Dan Culloton: Hi I'm Dan Culloton, associate director of fund analysis with Morningstar. And I am here at the Morningstar Investment Conference with Ken Feinberg, Manager of the Davis Financial Fund and co-manager of Selected American and Davis New York Venture.

Ken, thanks for being here today.

Ken Feinberg: My pleasure, Dan.

Culloton: Well there is lot of interesting speakers on the conference agenda this week, including yourself of course, but we just heard Bill Gross speak, and he had lots of interesting things to say about the market in general.

I know you are not a top-down type of investor, but he did say something which I thought has bearing upon your portfolio and the way you invest at Davis, and that's he pointed out how real interest rates have fallen so far, that they affect not only the prospective returns for fixed income but also for other assets and stocks in particular. In fact he said that because people used the real interest rate to discount stocks, cash flows going forward, that they are so low right now that stocks are on their own, that their prospective returns are capped. Assuming that that's true, if stocks are on their own, what does a stock investor look for going forward to get an adequate return?

Feinberg: It's a very good question, and I'll start with the overall portfolio for second, because I do agree with Bill Gross. He is a brilliant investor, and one of the things or points we've been making for at least a year or so, is if the 10-year Treasury is yielding a little under 3% today, which is what it's yielding, and we look at our portfolio, and I am going to speak of Selected American and New York Venture as examples, and I am sure other fund managers have similar portfolios, the earnings multiple we would call the owner earnings multiple in our stocks is actually around 12 to 13 times. So if we invert that, we would say we're getting somewhere between a 7% and 8.5% yield today on the companies we own versus under 3% for a 10-year Treasury bond, so as a portfolio, we would definitely think with no guarantees that if you look out five or 10 years, a portfolio of companies yielding 7% to 8.5%, give or take, should do better than the 3% Treasury bond.

To get back to the question, in terms of companies, you know when we make an investment, we tend to have very low turnover. So if our turnover averages a little less than 10% a year, we are going to own a company for 10 years. And some companies we own for a lot longer, some for shorter. So one of the first questions we like to ask is, why should this business be able to grow earnings and free cash flow revenues in an intelligent manner for five or 10 years.

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