The Oakmark Fund gained 20% in the quarter, comparing favorably to the S&P 500’s 16% gain. For our fiscal year, the Fund gained 3% while the S&P 500 lost 7%. Though we are pleased to make a profit when others lose money, we aren’t high-fiving each other over a 3% gain. Over extended periods we expect stocks to produce a much better return than they achieved last year, and when that happens, we also expect to achieve higher positive returns.
In a year that was marked by extreme stock market volatility, our portfolio holdings achieved extremely diverse returns. Two holdings—State Street and Apple—more than doubled after our purchases. State Street’s mark-to-market losses, which had spooked investors, turned into gains as most of their maturing investments paid in full. Apple also proved skeptical investors wrong, as fears that cash-strapped consumers |
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Average Annual Total Returns (9/30/09)
10–year 4.16%
5–year 1.98%
1–year 3.38%
Expense Ratio as of 9/30/08 was 1.10%
The performance data quoted represents past performance. The above performance information for the Fund does not reflect the imposition of a 2% redemption fee on shares redeemed within 90 days. If reflected, the fee would reduce the performance quoted. Past performance does not guarantee future results. The investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. Average annual total return measures annualized change, while total return measures aggregate change. To obtain most recent month-end performance data, view it here.
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would trade down from Apple’s premium products never materialized. Two other holdings, Schering-Plough and Liberty Entertainment, agreed to be acquired. Their gains weren’t quite as large, but heavier weightings made their portfolio impact just as big.
Leading the year’s biggest loser list were two banks that suffered from large mortgage losses — Citigroup and Bank of America. We sold our position in Citi near the financial stock bottom because we believed investors were underestimating the dilution from their newly raised capital. We used that money to add to other financials we believed were safer, yet more undervalued. We still own Bank of America because we believe its high market share in consumer banking will lead to good profitability when loan losses subside.
During this past quarter, the general rule seemed to be that whichever stocks fell the most, recovered the most. Liberty Interactive and Capital One were two of our worst performers early in the year, but were our two best in the quarter. Neither reported stellar results, but neither got close to the Armageddon scenarios that were implied by their lowest prices. Our worst performers were generally high-quality companies that didn’t fall as much in the decline, but didn’t move higher during the quarter. That list included Oracle, McDonald’s and Wal-Mart, where we made significant additions to our holdings. Our new purchases, ADP and Johnson & Johnson, fit that same profile. Our thoughts on those two stocks are included below. The only elimination last quarter was Morgan Stanley, but we also reduced Capital One. Their strong rebounds allowed us to fund new purchases, which we viewed as more undervalued and less risky.
Automatic Data Processing (ADP — $39)
ADP is the global leader in payroll processing and related employer services. ADP is generally viewed as one of the safest and most consistent growth companies. We concur with that view, and we believe that its cash-rich balance sheet and lack of debt add to its high quality. Because of that, investors have usually rewarded ADP with a premium valuation. Its price-to-earnings ratio has averaged in the mid-20s over the past 20 years, and it hit nearly 30 times earnings in 2007 when the stock reached $52. Like many extremely high-quality companies, ADP stock largely missed the post-March 9th rally, increasing by 22% while the S&P 500 increased by 58%. With the stock selling at only 16 times trailing earnings and yielding 3.4% (which is more than a 10 year government bond) we believe that this attractive company is now also an attractive stock.
Johnson & Johnson (JNJ — $61)
JNJ is the world’s largest healthcare company. Their products are highly diversified across pharmaceuticals, devices, diagnostics and consumer products. JNJ has been a highly admired company for a long time. Their expanding portfolio of innovative products that solve health problems for a growing and aging population has allowed them to increase both earnings and dividends at double-digit rates for several decades. That translated to a high price-earnings ratio and made JNJ one of many companies we admired, but couldn’t justify purchasing. In 2001, when JNJ first sold for more than $60, the company earned $1.91 per share, for a price-earnings ratio of over 30 times. Today, with expected earnings approaching $5 per share, the price-earnings ratio of just over 12 times is lower than JNJ’s average price-earnings ratio in any of the past twenty years. And its yield of over 3% is also near historic highs. We aren’t oblivious to the change that is coming in healthcare, but we believe that newly insured consumers will increase usage which will be an important offset to new pricing pressures. As often happens, a negative news environment has caused investors to worry about doomsday scenarios. This leads to a much lower stock price that we deem to be a bargain.
William C. Nygren, CFA
Portfolio Manager
oakmx@oakmark.com
Kevin G. Grant, CFA
Portfolio Manager
oakmx@oakmark.com
As of 9/30/09, State Street Corp. represented 1.8% of The Oakmark Fund's total net assets, Apple, Inc. 1.6%, Schering-Plough Corp. 2.2%, Liberty Media Corp. - Entertainment 3.1%, Citigroup Inc. 0%, Bank of America Corp. 1.3%, Liberty Media Holding Corp. - Interactive, Class A 1.4%, Capital One Financial Corp. 1.9%, Oracle Corp. 1.3%, McDonald's Corp. 1.6%, Wal-Mart Stores, Inc. 1.9%, ADP 1.3%, Johnson & Johnson 1.1%, and Morgan Stanley 0%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
The S&P 500 Index is a broad market-weighted average of U.S. blue-chip companies. This index is unmanaged and investors cannot actually make investments in this index.
Investing in value stocks presents the risk that value stocks may fall out of favor with investors and underperform growth stocks during given periods.
The discussion of the Funds’ investments and investment strategy (including current investment themes, the portfolio managers' research and investment process, and portfolio characteristics) represents the Funds’ investments and the views of the portfolio managers and Harris Associates L.P., the Funds' investment adviser, at the time of this letter, and are subject to change without notice.
