The Oakmark Select Fund
Report from Bill Nygren, Portfolio Manager
The Oakmark Select FundReport from Bill Nygren, Portfolio Manager |
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THE VALUE OF A $10,000
INVESTMENT IN THE OAKMARK |
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12/31/98 NAV $19.54 |
Total Return |
Average Annual |
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The Oakmark Select Fund |
21.5% |
39.5% |
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Standard & Poor's 500 Stock Index w/inc** |
21.3% |
31.4% |
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Standard & Poor's MidCap 400 Index w/inc** |
28.2% |
26.6% |
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Value Line Composite Index** |
14.1% |
9.8% |
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*Total return includes change in share prices and in each case includes reinvestment of any dividends and capital gain distributions. **Each of the three indexes or averages is an unmanaged group of stocks whose composition is different from the Fund. The S&P 500 is a broad market-weighted average dominated by blue-chip stocks. The S&P 400 consists of 400 domestic stocks chosen for market size, liquidity, and industry group representation. The Value Line Index is an unweighted average of more than 1,000 stocks. Past performance is no guarantee of future results. |
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I'M GLAD 1999 IS HERE!!
We had a number of things to be proud of in 1998. The Oakmark Select Fund's increase last quarter of 21.5% as well as the 16.2% for all of calendar year 1998 was far above long-term average stock market returns. We also did well relative to our competitors: our increase for 1998 exceeded the average mutual fund by several percentage points and we outperformed 97% of Morningstar's midcap value funds. Here's a special thanks to our Research Department for making those achievements possible. But it's hard to get too excited about our performance when the market indices did so much better. Powered by Internet provider America OnLine, the S&P 400 Midcap gained 28.2% in the quarter and 19.1% for the year, somewhat above your Fund. (AOL alone was responsible for more than one-third of the index's full year increase.) Further, the S&P 500, with high exposure to both technology and giant growth companies by far outperformed the Midcap index, increasing 28.6% in 1998. It was a very frustrating year with the market increase led by stocks we judged to be the most overvalued. Being out-of-sync just isn't any fun.
The start of a new year provides a good opportunity to look forward, and I believe our portfolio is very well positioned. The S&P 500 ended 1998 near its all-time high and sells at 28 times projected 1999 earnings. In contrast, your portfolio has an average P/E multiple just under 14 times projected 1999 earnings (excluding cable tv stocks, which aren't valued using P/E's). As you rebalance your equity portfolios for 1999, I'd encourage you to consider maximizing the weighting you give to small and midcap value funds. Their underperformance in 1998 means that on a relative basis, you are now getting a lot more for your money!
WWW.OVERVALUED.COM
During the quarter, I received a letter from a shareholder asking if I was aware of how much money was going into Internet stocks and suggesting that I consider investing in them to "enhance performance." I am aware.
Internet stocks had an amazing year. AOL, Yahoo! and Amazon.com share prices increased by over 500%. The nine best performing IPO's in 1998 were all Internet stocks, each up over 300%. The resultant sky-high valuations required some fancy footwork from analysts who wanted to recommend purchase of these stocks. A typical buy recommendation from one of our analysts at Harris Associates goes something like this: "My best guess of XYZ's full business value is $60 per share. I recommend purchase below $36 with a sell target of $54." That simple logic didn't work for Internet stocks so analysts got more creative. One report for an Internet company selling at $188 read "we reiterate our buy rating and $175 target." A target price below the current price yet a buy rating! Another tried to justify a target price modestly above the current price by making the most optimistic five-year earnings forecast they could imagine, then applied a 100 times P/E to that estimate. I think every stock in The Oakmark Select Fund would go up at least ten-fold with those assumptions. But my favorite was the firm stating "our price targets...don't appear to make sense relative to current stock prices." So, do they suggest selling the stocks? No. "As such, we are removing the price targets from our weekly table." When all else fails, abandon the discipline. And so far, they've been right.
Would we consider buying Internet stocks to "enhance performance?" In a word, No! Our investment approach identifies stocks at substantial discounts to current business value, where we are confident business values grow with time, and where we believe managements will get rich only if the outside shareholders do. The Internet names fail on all measures. Current prices for Internet stocks are ridiculously high relative to any rational estimates of business value. Over time, the total underlying value of Internet companies will certainly increase as Internet commerce grows. But will today's e-retailers be category killers like Wal-Mart and Home Depot? A report on the Internet written by a well-known brokerage firm in 1995 identified nine "notable websites" for shopping. Today only one would be listed in the Top 10 e-retail sites! It is also interesting to see how quickly price competition has hit Internet retailing. Last Christmas, it was fun to buy books 30% cheaper at Amazon.com than at Borders. This Christmas, a competing website ran an ad in The Wall Street Journal with bestseller pricing 25% below Amazon! Lastly, consider management focus. Top managers of most Internet companies have net worths in the hundreds of millions, if not billions of dollars, all in stock they fear is grossly overvalued. Not only has there been heavy insider selling, but the lineup for secondary offerings is getting long. The way they get rich is not by growing long-term business value, but by selling their stock.
Another fact investors may be overlooking is how significant the Internet activities are for many traditional companies. In your portfolio, Peoples' Bank is a leader in on-line banking, EDS and First Data are strong players in settlement of on-line transactions, Dun & Bradstreet has made its reports available via the Internet, Amgen has used the Internet for direct marketing to potential users of its drugs, Cablevision is rapidly hooking up subscribers to amazingly quick Internet access through existing cable wires, and Liberty Media has interests in popular websites CNN, Discovery, FoxSports, and QVC. All of these companies will benefit as Internet usage grows, yet none are priced like the pure-play Internet stocks that are sure to be deflated when (not if) the Internet bubble bursts. And just in case you're still tempted to goose your performance by owning Internet stocks for a few weeks, look at the December 14 BusinessWeek cover "Amazon.com The Wild World of E-Commerce." Buyer beware, they don't ring the bell any louder.
Thank you for your continuing support and best wishes for a happy and prosperous New Year.
WILLIAM C. NYGREN
Portfolio Manager
bnygren@oakmark.com
January 6, 1999
10. Newly issued stocks quadrupling during their first month isn't normal.
9. Shopping.com has prices 25% below Amazon.com, which is 30% below the corner bookstore, which isn't a good business.
8. Rational price targets weren't high enough, so brokerage firms stopped using price targets.
7. P/E's over 100 times on next century earnings seem a bit high.
6. Catching up by buying hot performers wins less often than the Chicago Bears do.
5. Leading Internet retailers from 1995 spent less time at the top than "Godzilla" did.
4. Insiders are selling stock to finance the move from pocket protectors to Ferraris.
3. The line for a new Internet IPO is longer than the line to buy Furby.
2. Yahoo! market cap exceeds that of CBS (producer of The Late Show).
1. Amazon.com is on the cover of BusinessWeek.
THE OAKMARK SELECT FUND |
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Market Value |
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Common Stocks—92.2% |
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Apparel—3.2% |
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Liz Claiborne, Inc. |
1,397,400 |
$44,105,438 |
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Retail—8.0% |
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Gucci Group (b) |
2,283,900 |
$111,054,637 |
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Other Consumer Goods & Services—1.7% |
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Ralston Purina Group |
727,000 |
$23,536,625 |
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Banks & Thrifts—8.5% |
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Washington Mutual, Inc. |
1,730,000 |
$66,064,375 |
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People's Bank of Bridgeport, Connecticut |
1,877,000 |
51,852,125 |
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117,916,500 |
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Insurance—8.3% |
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PartnerRe Ltd. (c) |
2,522,600 |
$115,408,950 |
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Broadcasting & Cable TV—11.9% |
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Cablevision Systems Corporation, Class A (a) |
3,286,100 |
$164,921,144 |
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TV Programming—3.9% |
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Tele-Communications, Liberty Media, Class A (a) |
1,178,550 |
$54,286,959 |
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Information Services—4.1% |
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The Dun & Bradstreet Corporation |
1,818,600 |
$57,399,563 |
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Computer Services—9.0% |
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First Data Corporation |
2,100,000 |
$66,543,750 |
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Electronic Data Systems Corporation |
1,160,900 |
58,335,225 |
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124,878,975 |
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Medical Products—4.1% |
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Amgen, Inc. (a) |
550,000 |
$57,509,375 |
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Machinery & Industrial Processing—3.1% |
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Thermo Electron Corporation (a) |
2,556,400 |
$43,299,025 |
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Building Materials & Construction—8.9% |
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USG Corporation |
2,440,800 |
$124,328,250 |
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Other Industrial Goods & Services—3.5% |
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Premark International, Inc. |
1,428,800 |
$49,472,200 |
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Real Estate—4.2% |
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Host Marriott Corporation (a) |
3,940,100 |
$54,422,631 |
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Crestline Capital Corporation (a) |
255,010 |
3,729,521 |
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58,152,152 |
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Diversified Conglomerates—9.8% |
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U.S. Industries, Inc. |
7,314,000 |
$136,223,250 |
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Total Common Stocks (Cost: $1,055,266,723) |
1,282,493,043 |
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Principal Value |
Market Value |
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Short Term Investments—7.5% |
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U.S. Government Bills—2.2% |
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United States Treasury Bills, 4.27%–5.03% due 1/7/1999–1/28/1999 |
$30,000,000 |
$29,944,100 |
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Total U.S. Government Bills (Cost: $29,944,100) |
29,944,100 |
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Commercial Paper—4.0% |
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American Express Credit Corp., 6.00% due 1/4/1999 |
$15,000,000 |
$15,000,000 |
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Ford Motor Credit Corp., 5.35% due 1/7/1999–1/8/1999 |
10,000,000 |
10,000,000 |
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General Electric Capital Corporation, 4.70%–5.33% due 1/4/1999–1/13/1999 |
30,000,000 |
30,000,000 |
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Total Commercial Paper (Cost: $55,000,000) |
55,000,000 |
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Repurchase Agreements—1.3% |
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State Street Repurchase Agreement, 4.50% due 1/4/1999 |
$18,435,000 |
$18,435,000 |
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Total Repurchase Agreements (Cost: $18,435,000) |
18,435,000 |
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Total Short Term Investments (Cost: $103,379,100) |
103,379,100 |
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Total Investments (Cost $1,158,645,823)—99.7% |
$1,385,872,143 |
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Other Assets In Excess Of Other Liabilities—0.3% |
4,776,348 |
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Total Net Assets—100% |
$1,390,648,491 |
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(a) Non-income producing security.
(b) Represents an American Depositary Receipt.
(c) Represents a foreign domiciled corporation.
