THE VALUE OF A $10,000 INVESTMENT IN THE OAKMARK FUND FROM ITS INCEPTION (8/5/91) TO PRESENT (12/31/99) AS COMPARED TO THE STANDARD & POOR'S 500 INDEX
12/31/99 NAV $27.20	Total Return Last 3 mos.	Average Annual Total Return* Through 12/31/99 From Fund Inception 8/5/91
The Oakmark Fund	-6.7%	21.2%
Standard & Poor's 500 Stock Index w/inc**	14.9%	19.9%
Dow Jones Industrial Average w/inc**	11.7%	20.0%
Value Line Composite Index**	3.2%	7.1%
*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 Dow Jones Average includes only 30 big companies. The Value Line Index is an unweighted average of more than 1,000 stocks. Past performance is no guarantee of future results.

At the Millennium, A Return to Basics

Many of us know the proverbial lesson that teaches us that it is far better to educate someone how to fish for a lifetime rather than to simply give him a fish to eat. As I observe the current investment scene, it seems that this lesson is very timely for today's mutual fund investor. Many, if not most, individual investors throw money at those stocks and funds that are "going up," with little underlying intellectual justification. Many folks have gotten very comfortable chasing the hot stocks and funds because in the last couple of years this approach has "worked." Going forward, I believe these people are going to learn the expensive lesson that this is not the kind of investment approach that will lead to satisfactory LIFETIME investing results, which, after all, is the goal of most of us.

At The Oakmark Funds, we have always wanted to attract investors who understood and agreed with our investment philosophy rather than to attract people solely because of recent returns. Thus, we have produced substantive quarterly letters in the hopes of creating great "fishermen," or people who will grow their wealth optimally over the long term. So, let me take this opportunity at the beginning of a new century (the producers of "Jeopardy" would disagree, but that's another story) to review The Oakmark Fund's philosophy. I also want to discuss a couple other important issues.

In our first quarterly in 1991, I outlined our philosophy and listed the five guidelines we use in investing your hard-earned money. In a nutshell, we frame the investment process as buying an ownership piece of a business for the long term, not a mere piece of paper in the short run, and employ the following guidelines:

1) Invest in companies selling at market prices that represent a significant discount to underlying value, or what a rational businessperson would pay to own the entire enterprise forever;

2) Invest with owner-oriented managements whose interests are aligned with us;

3) Concentrate; put our assets into our best ideas and do not over-diversify;

4) Invest for the long term; trade as infrequently as possible to achieve our goals; and

5) Think independently; do not let "Street" market psychology or business issues interfere with investment decisions.

We have adhered to these guidelines every day the Fund has been in existence and we will continue to do so. We do so because we believe passionately that following this approach will lead to the best results over the long term, which I would define as anywhere from three to five years to forever. We realize that many if not most mutual fund investors today have far shorter time frames, but we cannot change that.

Some would say this approach is dead and that one must not use "traditional" valuation measures to value the "New Economy" companies that have dominated the market over the past couple of years. Hogwash! Whether a company is deemed "Old" or "New," it must generate at some point in the foreseeable future revenues and profits (and dividends) sufficient enough to justify its valuation. Today's high flyers—be it Yahoo, Red Hat, eToys, Cisco, or a host of others—are very unlikely to do so. Can they continue to "go up?" Yes. Will that bother us? No. Why? Because as we analyze these stocks today, we are hugely skeptical they can achieve these goals, and we know that if we are right, these stocks will eventually find their true underlying level. In fact, many may pierce that level and actually become good values (for a stock like Yahoo, the consensus around here is that it would be at a price 1/20th of today's market price).

Let me reiterate that we are very familiar with these companies and would own them in the Fund if they were priced right. To us, a great growth company can be every bit a value as the most mundane of manufacturers—it all depends on price.

The second topic I want to discuss is expectations. The last decade was the best decade for US stocks ever, both in nominal and real terms. It has caused the average investor to have way-too-high expectations for future returns, and he is probably taking on far too much risk in the hopes of getting juicy returns. With inflation around 2%, an investor should assume US stocks would return 7%, producing real returns before taxes of 5%. Normally, I would hope The Oakmark Fund would outperform by 2% annually, or have annual returns of 9%. However, at the current time, considering the (modest) valuations of our holdings versus the (lofty) valuation of the S&P 500, my hopes are far better than this.

Last, let me briefly discuss taxes. Most of you are aware that The Oakmark Fund has paid abnormally high distributions in the last two years. As I have written here, these are due to the steady and high level of redemptions we (and virtually every other value-oriented fund) have experienced.

However, it is important to look forward. At the current time, The Oakmark Fund has a net unrealized loss. This means that, if redemptions continue, we are unlikely to make future large distributions. So, our tax problems are behind us, whereas the growth funds will experience them—and probably far more onerous!—if investors sour on growth funds, something that is inevitable in my view.

In summary, it remains a privilege to manage your money, and I truly appreciate your support and the trust you show in us. While the last few years have been frustrating, I can honestly say that we have never been tempted to abandon our philosophy. I can also say that, while strong performance is obviously pleasing and redemptions are painful, we do not let emotionalism enter into our decision making. We do not allow euphoria to seep in during the good times, nor do we allow depression to seep in during the bad times. Again, these are impediments to successful long-term results, which are all that matters.

Fortune Brands

I would like to discuss one of our larger holdings, Fortune Brands (FO), which represents about 5% of our total assets at the current time, and is followed by my partner, Kevin Grant. Fortune combines many things I like in a stock: strong, understandable branded businesses, a reinvigorated top management, and, most important, market valuation that does not come near to underlying value.

FO has three business segments: Home and Office (about half the business, including brands such as Moen faucets, Master Lock, Aristokraft cabinets, Day-Timer time management systems, Swingline staplers); Golf (Titleist, FootJoy, and Cobra); and Spirits (Jim Beam, Dekuyper). Fully 80% of sales are from brands that rank either #1 or #2, and have earned these franchises through many years of effective brand management. These are moderate-growth brands, but ones that are very well known within their markets and should enjoy strong persistence.

The Company is headed by Norm Wesley, a fairly young individual who had previously run the Home and Office division. We have met Norm several times and find him to be a very straight shooter whose first big move was relocating corporate headquarters from opulent space in Old Greenwich, CT, to more utilitarian space in suburban Chicago. While a cost-saving measure to the tune of $30 million per year, more important, it sends a message to the operating divisions that top management is not in an ivory tower. We are very comfortable with Norm, who will lead an extensive portfolio review of the Company early this year.

Financially, FO is a steady grower whose steady growth should continue. Also, it is a Company that throws off a lot of cash flow. In the year 2000, Kevin estimates that after capital expenditures, FO will generate free cash flow of about $350 million before dividends. This is almost as much as FO's after-tax net income and is a very high 5% of sales. FO will use this money to pay dividends, make acquisitions (FO is a consolidator in all its divisions), and buy back shares or retire debt.

Of course, with us valuation is most important. At its current price of $31, FO trades at the extremely modest multiple of EPS (plus amortization) of only 11x, far less than half the multiple of the S&P 500, and has a business value (i.e., market value of equity plus net debt)-to-sales ratio around 1, again a huge discount to the market. In our view, FO is worth approximately twice its current stock price.

Some may ask, "Yeah, yeah, yeah, but what's the catalyst?" Will FO be a frequent topic of discussion on CNBC? No. Does it have a cool Internet story to tell? No. Does the stock have any momentum? No, it was flat last year. So why even bother? Well, in a market that is indifferent to valuation, we are always focused on valuation. And, given the quality of the business, and the quality of the management, we are very confident that FO sells at far below what it is worth. Our philosophy is a patient one, and presumes that market price and underlying value come together in the long run. If it takes too long, either FO will buy back stock at prices well below value—the company repurchased nearly 7 percent of its shares in 1999!—or the Company will be bought in its entirety by someone exploiting the value gap. Either way, we will capture the large gap between the current price and value.

FO is the kind of solid, well-run, and cheap stock that is not in the headlines, but is in our Fund. It is the kind of holding that gives me the confidence that our Fund will significantly outperform in the long run.

Robert J. Sanborn

Portfolio Manager
rsanborn@oakmark.com

January 7, 2000

(a) Non-income producing security.