Clipper Fund‘s annual letter to shareholders for the period ended December 31, 2014.

H/T Dataroma

Clipper Fund’s results for 2014 continued the trend of recent years in which the value of each dollar entrusted to our management increased at a satisfactory rate but this rate lagged the even stronger returns of the S&P 500® Index. Specifically, shareholder wealth in Clipper Fund increased a cumulative 8%, 62% and 91% over the last one, three and five years respectively.1 But as shown below, these good absolute returns trailed the market averages.

Clipper Fund

The performance presented represents past performance and is not a guarantee of future results. Total return assumes reinvestment of dividends and capital gain distributions. Investment return and principal value will vary so that, when redeemed, an investor’s shares may be worth more or less than their original cost. The total annual operating expense ratio as of the most recent prospectus was 0.75%. The total annual operating expense ratio may vary in future years. Current performance may be higher or lower than the performance quoted. For most recent month-end performance, visit clipperfund.com or call 800-432-2504. The Fund received favorable class action settlements from companies that it no longer owns. These settlements had a material impact on the investment performance of the Fund in 2009. These were onetime events that are unlikely to be repeated. Clipper Fund was managed from inception, February 29, 1984, until December 31, 2005 by another Adviser. Davis Selected Advisers, L.P. took over management of the Fund on January 1, 2006.

Clipper Fund: Investment objectives

As Clipper Fund’s managers, we have two objectives: to earn a satisfactory absolute investment return and to generate relative results in excess of the S&P 500® Index. For most of the periods reflected in the chart above, we have fired on only one cylinder. Although we consider absolute returns paramount, we do not consider the results shown here satisfactory and have ground to make up. However, the fact each dollar entrusted to us since we began managing Clipper near the highs of the last bull market is now worth 52% more despite the real estate bubble, the financial crisis, the great recession, the euro crisis, and the collapse of many well-regarded financial institutions means at least shareholder wealth has grown through these unprecedented times.

Our focus on growing the absolute value of the funds entrusted to our care is driven in part by our significant co-investment. With more than $100 million of our families’ and colleagues’ money invested alongside our shareholders, we always remember the wisdom of the old saying, “You can’t eat relative returns.”3 Our focus on absolute growth is also driven by our stewardship responsibility to Clipper Fund’s shareholders. Whether saving for retirement, a child’s education or some other purpose, shareholders are entrusting their savings to us with the hope we will help them achieve their financial goals by growing the value of their savings over the long term.

To achieve the goal of growing shareholder wealth over the long term, we invest exclusively in equities, using our timetested research approach to seek out durable, well-managed businesses that can be purchased at attractive valuations. Although at times the rate of growth we achieve may be faster or slower, our steadfast focus on equities combined with an investment discipline centered on research, careful stock selection and a long-term perspective has helped us increase the value of our clients’ savings.

However, we have not and will not retreat from our secondary goal of achieving returns that exceed the S&P 500® Index. As active managers, we know we will go through periods when our results trail the market, particularly when indexing and other momentum-based strategies are galloping ahead. We have been through such times before and have always emerged in a strong position. For example, in the late 1990s the S&P 500® Index surged ahead and disciplined, value investors like us were considered dinosaurs. But when the bubble burst in 2000, many of these dinosaurs posted the best relative results of their careers. For example, under the management of our predecessor, Clipper Fund outperformed the Index by a stunning 46% in 2000 and went on to outperform for the next one, three, five, and 10 year stretches.4 Although not directly comparable to Clipper, Davis New York Venture Fund, a more diversified fund we managed at the time outperformed by 19% after the bubble burst and similarly went on to outperform for the next one, three, five and 10 year periods.5 While we do not know when the current cycle will end, we remain confident the investment discipline that has served us well for more than 45 years will continue to do so.

Clipper Fund’s performance

Clipper Fund

The performance presented represents past performance and is not a guarantee of future results. Total return assumes reinvestment of dividends and capital gain distributions. Investment return and principal value will vary so that, when redeemed, an investor’s shares may be worth more or less than their original cost. The total annual operating  expense ratio for Class A shares as of the most recent prospectus was 0.86%. The total annual operating expense ratio may vary in future years. Returns and expenses for other classes of shares will vary. Current performance may be higher or lower than the performance quoted. For most recent month-end performance, visit davisfunds.com or call 800-279-0279.

This history combined with a long record of satisfactory absolute returns convinces us our research-driven, stock-specific approach should continue to add value over time. However, before looking ahead, delving a bit more deeply into what has worked and not worked in the recent periods when our absolute returns have been good but our relative results have lagged is worthwhile. In the plus column, the strong performance of a number of our core holdings such as American Express, Wells Fargo, Berkshire Hathaway, Costco, and Google have made them significant contributors to our returns over the last several years.6 Moreover, during this period, we believe the competitive advantages of these first-class businesses have only increased, giving us confidence in their future prospects as well. In the negative column, our relative results have been hurt most by our decision to avoid a number of companies and sectors that have done especially well. In other words, for the most part, we have been more hurt by the strong performance of stocks we chose not to own than by the weak performance of those we own. For example, although companies with high current dividend yields are currently in fashion, we have avoided or sold most of these stocks because of their below-average growth rates and above-average valuations. Similarly, we have generally steered clear of companies with high leverage ratios that benefit from current low interest rates but risk significant problems if the environment changes. We have also chosen to underweight some of the largest companies in the S&P 500® Index despite the fact these companies currently benefit from the flow of funds into exchange-traded funds and S&P 500® Index funds because their already enormous size may make future growth more difficult. Finally, and not surprisingly, because we question their long-term durability and competitive advantages, we do not own a number of companies that are current investor darlings.

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