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|  | SEPTEMBER 2, 2004
 FUND Q&A Seeing Opportunities Others Overlook Selected American Shares' Kenneth Feinberg seeks stocks with good earnings but low valuations. Financials top his big holdings Kenneth Feinberg and Christopher C. Davis, co-managers of Selected American Shares (SLASX ), like to buy companies whose earnings are growing consistently but that are trading at depressed valuations. Outfits may pop up on their radar screen because they're facing bad news, or simply because they're overlooked by the market. Once the managers buy a stock, they like to hold onto it for the long term. Their strategy has allowed them to beat other funds in their category -- large-cap blend -- as well as the broader market. For the 12-month period ended July 30, the $6.7 billion portfolio returned 17.2%, vs. gains of 11.7% for the average large-cap blend fund and 13.2% for the Standard & Poor's 500-stock index. For the three-year period, the fund posted a 2.4% annualized return, compared with 2% losses for the peer group of funds and 1.5% for the S&P 500. What's more, the fund has lower volatility than its peer group, lower expenses, and a significantly lower rate of portfolio-holdings turnover. Based on risk and return characteristics during the last three years, S&P gives the fund its highest overall rank of 5 Stars. Feinberg, who joined the fund in May, 1998, also co-manages the Davis New York Venture Fund (NYVTX ) and Davis Financial Fund (RPFGX ) for Davis Selected Advisers, the investment adviser for the both Selected Funds and the Davis Funds. Palash Ghosh of Standard & Poor's Fund Advisor recently spoke with Feinberg about the fund's investing strategy and its top holdings. Edited excerpts of their conversation follow: Q: What kind of stocks do you look for? A: We invest in mid- or large-cap companies that are trading at modest valuations, but that have long track records of earnings growth and sustainable forward-earnings growth rates. We like to hold onto our stocks for the long term. Q: What else characterizes your investment strategy? A: We put great emphasis on meeting with company managements and making sure they're committed to their shareholders. We want to understand a company's business model, their products, and their competitive environment. We think our investment process ensures stable long-term performance and minimizes risk and volatility. Q: What are your 10 largest holdings? A: As of June 30, 2004: American Express (AXP ), 6.8% [of total assests]; American International Group (AIG ), 5.3%; Altria Group (MO; formerly Philip Morris), 4.8%; Tyco International (TYC ), 4.6%; Berkshire Hathaway (BRK.A ), 4.6%; HSBC Holdings (HBC ), 3.5%; Bank One (since acquired by J.P. Morgan Chase), 3.4%; Citigroup (C ), 3.3%; Progressive Corp. (PGR ), 3.3%; and Wells Fargo (WFC ), 3.2%. The top 10 holdings represented 42.8% of total assets. Typically, our 10 largest stocks account for 42% to 48% of assets. The fund currently has 62 holdings. We prefer to keep a relatively concentrated portfolio. Q: What are your largest industries? A: As of June 30: insurance, 18.9%; financial services, 16.0%; banking and savings and loan, 15.6%; energy, 7.1%; and consumer products, 4.8%. Q: How would you characterize the kinds of companies that populate the portfolio? A: Stocks in our fund typically fall under three categories: The bulk of our assets are invested in the familiar, household names that are strong global leaders. A smaller portion is invested in companies that have strong business fundamentals but that are less well known and perhaps overlooked by the general investing public, and the last portion consists of companies whose stocks are facing pressure due to some controversy or negative headlines. Q: Can you discuss one of each of these types of stocks? A: American Express, which has been in the fund for 10 years, is clearly a blue chip, global leader. It was under various clouds when we bought it, after having been poorly managed by former CEO James Robinson. When Harvey Golub took over the company in 1994, he and Ken Chenault, the current CEO, immediately cut some costs and made the company more entrepreneurial, focusing particularly on their long-neglected credit-card business, which faced very tough competition. They brought it out of the doldrums, and their core card business flourished. Over the past decade they have bought back 20% to 25% of shares outstanding. We initially bought the stock when it traded at a 10 p-e [ratio]. It's now at 19. Progressive, despite being a highly successful automobile insurer, remains largely unknown to the general public. Currently trading at a p-e of only 11.2, it has delivered earnings that have compounded more than 20% annually over the past 20 years. They have done a fantastic job in growing market share and profitability. Altria Group became a big position in the fund in early 2000, right after Philip Morris lost a huge Florida class-action case in which a $145 billion judgment was assessed. However, Philip Morris was able to appeal, and this judgment was overturned, along with several other cases. Although we were closely aware of the ongoing litigation risks, we felt that the stock's 6 p-e gave it a strong risk-reward profile. Philip Morris has lost some market share to discount cigarette manufacturers, but Altria has been well managed under the shareholder-oriented CEO Louis Camilleri, who's seeking to break the company up into three parts, including a spinoff of Kraft Foods, which is struggling. If he can do this, we think the stock should be worth $75.
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