Chris Davis & BYD

Investment Memo: Owner Accounting, Moats, and Long‑Term Holding – Lessons from Chris Davis

I want to share a quick reflection from a talk yesterday by Chris Davis, who visited my class to discuss his investment philosophy. I found his insights incredibly inspiring, particularly his perspective on ownership mentality for growth companies.

Key Takeaways:

1. Family Investment Philosophy and the Value of Moats
   The Davis family’s approach, spanning three generations, emphasizes investing in businesses with enduring competitive advantages. Their early concepts—later embraced by Buffett—teach us to focus on intrinsic quality and sustainable moats. In practical terms, a moat protects a business from competitors and ensures long‑term profitability. This idea is crucial because, while capital naturally seeks to break down barriers and capture high profits, only companies with a strong moat can fend off the resulting margin compression.

2. Capital Influx, Margin Compression, and the Need for a Sustainable Runway
   As more capital enters an industry, profit margins tend to shrink unless the business has a true competitive barrier. Without a moat, industries risk having their margins eroded to near zero or even negative levels relative to the cost of capital—as seen in certain sectors like photovoltaic manufacturing (See our note on TCL Zhonghuan). Furthermore, sustaining high returns becomes increasingly challenging as a company’s capital base grows. Only by operating in a large or emerging market segment can a company continue to compound earnings over decades.

3. The Virtue of Concentrated, Long‑Term Holding
   A central tenet of the philosophy is to avoid cutting winners too early. Instead of rebalancing out of top performers, the focus should be on building and maintaining heavy positions in high‑conviction investments. The saying goes “Cut the weeds and water the flowers.” This concentration, when combined with deep understanding of the underlying businesses, allows investors to capture the full benefits of compounding over time. In essence, holding onto winners—even through periods of volatility—creates extraordinary returns that short‑term trading rarely achieves.

4. Pursuing Passion Over Following the Crowd
   Young investors are cautioned against simply following prestigious career paths like elite internships in finance without genuine interest. Success in investing requires an authentic passion for the craft. It is vital to choose a path that resonates personally, rather than chasing trends for the sake of reputation or short‑term gain. Real commitment to the art of investing is a key differentiator between those who eventually thrive and those who burn out. It’s my experience interviewing great investors that they will have a natural instinct and get excited when they saw an opportunity, or an edge over market. It’s hard to explain to those who have never felt it before, but I felt like a cougar sizing its prey, waiting to take a whale bite on it. It brings me joy and excitement.

5. Owner Accounting: Looking Beyond Conventional Metrics
   Traditional public accounting may distort a company’s real performance, especially for firms that reinvest heavily to fuel growth. Owner accounting focuses on the true cash flow and long‑term value creation of a business rather than just its current earnings. For example, even if a company like Amazon appears unattractive by standard P/E ratios due to its aggressive reinvestment strategy, a deeper analysis reveals its potential to compound over time.

   Davis said when he evaluated Amazon, he asked himself what if Amazon stopped all the Capex and reduce its R&D to a retailors level? They would be immediately profitable and its trading at a discount to future growth. But investors did not see that and only saw the negative earnings, and they thought it’s going to go bankrupt anytime. This is how he was able to get a good deal buying Amazon at the cheap and holding it over time. It’s something that flows in the Davis family to spot these businesses wrongly penalized by their growth capex investments. Only recently had it come to mainstream as tech investments became more prevalent and people started to focus on future growth, perhaps a little bit too much in some instances.

6. The Legacy of Owner Accounting in Family Investing
   The Davis family’s success is partly rooted in a legacy of using owner accounting to assess investments. Early on, the family recognized that many industries—such as life insurance—might report losses on paper due to high overhead or aggressive capital expenditures, even though they were creating tremendous long‑term value. By applying present value methods, they could identify opportunities where the market mispriced future growth, leading to investments that eventually multiplied many times over.

7. Practical Considerations: Depreciation and Capital Expenditure
   A notable observation is that some companies use aggressive depreciation schedules to improve short‑term earnings. For instance, certain firms may depreciate their assets over two to three years rather than ten. While this accounting technique can boost reported profits in the near term, investors should focus on the underlying cash-generating capability and the business’s ability to reinvest and grow over time.

8. Long‑Term Holding and Confidence in Value Creation & Investing in EM
   Ultimately, the key takeaway is to remain fully invested for the long term. Once an investor understands the true value of a business—by looking beyond public accounting and assessing owner earnings—they should be prepared to hold the position for several years, allowing time for the investment to compound. This conviction-based, concentrated approach is essential for achieving outsized returns and building generational wealth.

   Davis’ grandfather were able to make a fortune and prevent his portfolio from halving during recession by investing in Japanese companies post WWII. We all knew Warren Buffet invested in Japan recently, but that has been a “tradition” for value investors ever since ending of WWII. Allocation to emerging markets when opportunities are favorable is a great hedge against US inflation, and it’s something we seek to implement here.

Investing in BYD:

I started thinking about BYD in a similar light. Davis explained how companies like Amazon invest heavily in expansion and innovation, which GAAP accounting captures as immediate expenses. This approach often results in artificially low or negative net income, masking the company’s potential underlying profitability. If Amazon had ceased these expansionary investments, it would have shown substantial free cash flow and profitability.

Similarly, BYD’s aggressive spending on factory expansions and R&D reflects a forward-looking approach, expensing costs that could otherwise be capitalized. They employ accelerated depreciation and expense almost all of their R&D spending.

BYD has more than 100,000+ staff on R&D. It has 5,000+ engineers working on finetuning the autonomous driving alone. And it’s R&D spending (40B RMB) surpassed Tesla last year (if we account for purchasing power parity of yuan and dollar, the cost for engineering talent in China v. silicon valley US, BYD’s R&D budget would be 2-3x that of Tesla).

BYD CEO Wang Chuanfu said “even in our darkest time, we cannot give up R&D, it’s the only way we can grow long term.” Significant spending on R&D and accelerated depreciation has depressed short term profit for long term growth.

Accelerated depreciation treatment on Capex investments from five years to three years.

Despite these factors, BYD’s 2023 report shows robust performance:
- Revenue rose 42% YoY to CNY 602.3 billion
- Net profit rose 81% YoY to CNY 30 billion, reflecting the underlying strength of its business model as it scales. 

With the company’s gross profit margin projected to reach 21% by 2025 (higher than Tesla and traditional automaker Toyota Motors), I believe it has high earnings potential. By analyzing BYD’s underlying profitability as Davis would, adjusting for its growth-related expenditures, we may find a compelling value investment. From rightsizing the R&D and D&A alone would deliver 3%+ operating margin expansion, BYD should be more profitable than Toyota, given its vertical integration and scale.

To end our Memo, let’s bring up Jeff Bezos Memo. He is a great entrepreneur, and a long term investor.

Wang Chuanfu said, China EV is at a critical stage and now is not the time to count profits, but to takeover more marketshare from traditional ICE manufacturers. Market leadership leads to higher profitability, the economy of scale, which translate to higher marketshare and higher future cashflows.

Based on my observations, Chinese investors are conservative and heavily weigh current earnings more than future earnings potential. The fact that CATL's enterprise value is higher than that of BYD is a great example. There is a revaluation potential after BYD starts to unveil its true earnings potential.