THE OAKMARK SELECT FUND
Report from Bill Nygren and Henry Berghoef,
Portfolio Managers
THE OAKMARK SELECT FUNDReport from Bill Nygren and Henry Berghoef,
|
|
| THE VALUE OF A $10,000 INVESTMENT IN THE OAKMARK SELECT FUND FROM ITS INCEPTION (11/1/96) TO PRESENT (6/30/00) AS COMPARED TO THE STANDARD & POOR'S 500 INDEX | ||
 |
||
| 6/30/00 NAV $19.02 |
Total Return Last 3 mos. |
Average Annual Total Return* Through 6/30/00 From Fund Inception 11/1/96 |
| The Oakmark Select Fund | -5.2% | 27.4% |
| Standard & Poor's 500 Stock Index w/inc** | -2.7% | 23.7% |
| Standard & Poor's MidCap 400 Index w/inc** | -3.3% | 22.2% |
| Value Line Composite Index** | -4.8% | 3.7% |
| *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. |
||
Although some of our stocks were up significantly in the quarter ended June 30, The Oakmark Select Fund fell by 5% compared to 3% losses in both the S&P 500 and the S&P Midcap 400. Our gain of 3% for the calendar year-to-date is superior to most midcap value funds and better than the S&P 500.
During the quarter we suffered from declines in two big holdings, USG Corp. and Reynolds & Reynolds (REY). USG stock fell from $42 to $30 as construction spending slowed and earnings estimates fell from over $8.00 to over $7.00. We believe this earnings decline is an expected result of economic slowing and that USG's annual earnings per share will vacillate from $3 to $9 based on the economic cycle. At 10 times trough earnings and just over 3 times peak earnings, we believe USG stock is very attractive. USG management apparently agrees. They have repurchased about 2% of their outstanding shares per month this year.
We also believe REY is extremely attractive. During the quarter REY sold its business forms division and plans to use the proceeds for its rapidly growing automotive information business as well as for share repurchase. REY also announced a transaction with GM that will further the company's lead as the dominant Information Technology provider to auto dealers. Both transactions sacrificed a small amount of near-term earnings in exchange for much more rapid earnings growth. We feel they were positive developments, albeit misunderstood by REY's shareholders. Because the immediate result of those transactions is a higher P/E on next year's earnings, shareholders reacted negatively. Our estimate of REY's value is higher than it was last quarter, and we believe the stock is now at a much greater discount to its value.
Share Repurchases
Our stock selection criteria have always included identifying companies where the value grows as time passes. That growth in value comes mostly, but not only, from sales gains. Lately, investors have become so focused on sales growth that other sources of growth seem to be unrewarded by the market. However, we own many companies that have moderate levels of sales growth but generate more cash from their operations than is required to support that growth. Management can return that cash to shareholders as dividends, or they can invest it in new business opportunities, acquisitions of other businesses, debt paydown, or share repurchases. Because of the tax-inefficiency of dividends, we generally prefer companies that reinvest excess cash. We prefer investment of that excess cash because it creates incremental earnings and thus sustainable earnings per share growth that is significantly higher than sales growth alone. And when their own stock sells at a large discount to business value, we love to see excess cash invested in share repurchase.
While competitive bidding for acquisitions usually forces prices to a fully-valued level, share repurchases can occur at prices far below fair value. Share repurchase also is an investment in the business management understands best as opposed to the uncertainties associated with new business opportunities or acquisitions. Lastly, we take share repurchases as a confirmation that management shares our belief about the undervaluation of their stock. A recent Barron's article cited a decline in corporate share repurchase announcements as an indication that the stock market has become more fully valued. We're pleased to say that our portfolio's holdings are not responsible for that decline. During the most recently reported quarter 14 of our 20 holdings repurchased shares. And six of those repurchased shares at an annual rate of more than 10% of their outstanding shares. We believe that per share growth that comes from shrinking the share count is just as valuable as growth that comes from increasing sales. We commend our managements that have embraced the concept of growing value by shrinking!
Drop the Chalupa!
When a financial magazine asked last quarter for a stock recommendation investors could buy and hold for a decade, our answer was a recent addition to our fund, Tricon Global Restaurants (YUM). The writer seemed to expect that, with the luxury of an extended time frame, our choice might be a high-priced, high-growth favorite. One of today's most popular rationales for paying very high P/E multiples is that future growth will compensate for the high purchase price and that as time passes, the "over-pricing" will be eliminated. A problem with that logic is that it is most frequently applied to companies in rapidly changing industries, making a long-term forecast a very fuzzy one.
So, why would we pick a company in an industry that often shows how fickle our taste buds can be? Tricon owns and operates three fast food chains: KFC, Pizza Hut and Taco Bell. As you forecast out a decade, what trend seems more likely to continue than America's, and increasingly the world's, growing appetite for fast food? And as more of our meals are eaten on the run, the demand for food other than hamburgers grows even more rapidly than does the fast food industry. In the non-hamburger category, Tricon owns the three leading chains serving chicken, pizza and Mexican. Those leadership positions have been unchallenged for years and are, in our opinion, quite likely to remain intact. Outside the United States, KFC, Pizza Hut and Taco Bell are all growing extremely rapidly.
Why does a company with such strong fundamentals become a value stock? Tricon was spun-off from Pepsi in 1997 with earnings from operations of $1.59 per share, and the stock traded in a range of $28 to $36. During 1998, operating EPS grew to $1.79, and Tricon secured exclusive rights for Star Wars promotions. The stock hit a high that year of $51. Last March, after a highly successful launch of Pizza Hut's "Big New Yorker Pizza" and amid growing anticipation of Star Wars, Tricon stock peaked at $74 per share.
Since then Tricon has had some issues: Star Wars was a disappointment; KFC's new and successful chicken sandwich cannibalized sales of higher-profit on-the-bone-chicken; after very strong sales from the New Yorker introduction, Pizza Hut saw sales decline in this year's first quarter; and AmeriServe, the highly-leveraged supplier from which Tricon buys its food, declared bankruptcy. Despite these issues, Tricon's strong international sales and better expense control allowed 1999 operating EPS to grow to $2.58, and its earnings are expected to exceed $3.00 this year. Tricon stock, at $29, down over 60% from its high, now trades at a P/E of about 9 times, barely one-third of the multiple of the S&P 500. We expect the AmeriServe situation to be resolved soon, and we were pleased to see Wal-Mart indicate an interest in acquiring it. AmeriServe's situation should not meaningfullyimpact Tricon's earnings.
Over the next few years, sales and earnings at Tricon should grow at about 10% per year. As cash flow is used to reduce both debt and outstanding shares, we believe the annual EPS growth rate will be in the teens. Although the 30 times earnings at which Tricon traded in early 1999 seems like an overly optimistic target, we believe the P/E multiple should increase substantially from 9. The market's over-reaction, combined with Tri-con's strong growth outlook, makes Tricon a great long term holding and a great addition to our portfolio.
Thank you for your support.
William C. Nygren, CFA
Portfolio Manager
bnygren@oakmark.com
Henry R. Berghoef, CFA
Portfolio Manager
berghoef@oakmark.com
July 6, 2000
| THE OAKMARK SELECT
FUND Schedule of Investments—June 30, 2000 (Unaudited) |
| Shares Held | Market Value | |
| Common Stocks—92.0% | ||
| Apparel—4.0% | ||
| Liz Claiborne, Inc. | 1,748,600 | $61,638,150 |
| Retail—13.4% | ||
| Toys 'R' Us, Inc. (a) | 9,048,500 | $131,768,781 |
| Tricon Global Restaurants, Inc. (a) | 2,615,400 | 73,885,050 |
| 205,653,831 | ||
| Household Products—4.8% | ||
| Energizer Holdings, Inc. (a) | 4,041,400 | $73,755,550 |
| Other Consumer Goods & Services—4.2% | ||
| Ralston Purina Group | 2,130,200 | $42,470,863 |
| H&R Block, Inc. | 685,000 | 22,176,875 |
| 64,647,738 | ||
| Banks & Thrifts—14.6% | ||
| Washington Mutual, Inc. | 7,579,800 | $218,866,725 |
| People's Bank of Bridgeport, Connecticut | 274,400 | 5,042,100 |
| 223,908,825 | ||
| Insurance—4.0% | ||
| PartnerRe Ltd. (b) | 1,737,300 | $61,565,569 |
| Other Financial—1.4% | ||
| MBIA, Inc. | 440,800 | $21,241,050 |
| Information Services—11.0% | ||
| The Dun & Bradstreet Corporation | 3,143,600 | $89,985,550 |
| Ceridian Corporation | 3,284,500 | 79,033,281 |
| 169,018,831 | ||
| Computer Services—8.9% | ||
| Electronic Data Systems Corporation | 1,750,000 | $72,187,500 |
| First Data Corporation | 1,277,200 | 63,381,050 |
| 135,568,550 | ||
| Computer Software—7.5% | ||
| The Reynolds and Reynolds Company, Class A | 6,279,700 | $114,604,525 |
| Telecommunications—0.2% | ||
| Citizens Communications Company | 192,000 | $3,312,000 |
| Pharmaceuticals—2.1% | ||
| Chiron Corporation (a) | 668,900 | $31,772,750 |
| Machinery & Industrial Processing—4.6% | ||
| Thermo Electron Corporation (a) | 3,369,000 | $70,959,563 |
| Building Materials & Construction—7.2% | ||
| USG Corporation | 3,634,900 | $110,410,087 |
| Diversified Conglomerates—4.1% | ||
| U.S. Industries, Inc. | 5,141,600 | $62,341,900 |
| Total Common Stocks (Cost: $1,441,253,970) | 1,410,398,919 | |
| Par Value | Market Value | |
| Short Term Investments—8.0% | ||
| U.S. Government Bills—1.3% | ||
| United States Treasury Bills, 6.10% due 11/24/2000 | 20,000,000 | $19,528,800 |
| Total U.S. Government Bills (Cost: $19,505,222) |
19,528,800 | |
| Commercial Paper—4.2% | ||
| American Express Credit Corporation, 6.75% due 7/6/2000 | 10,000,000 | $10,000,000 |
| Ford Motor Credit Corp., 6.54%-6.72% due 7/3/2000-7/5/2000 | 20,000,000 | 20,000,000 |
| General Electric Capital Corporation, 6.80% due 7/3/2000 | 35,000,000 | 35,000,000 |
| Total Commercial Paper (Cost: $65,000,000) | 65,000,000 | |
| Repurchase Agreements—2.5% | ||
| State Street Repurchase Agreement, 6.25% due 7/3/2000 | 38,779,000 | $38,779,000 |
| Total Repurchase Agreements (Cost: $38,779,000) | 38,779,000 | |
| Total Short Term Investments (Cost: $123,284,222) | 123,307,800 | |
| Total Investments (Cost $1,564,538,192)—100.0% | $1,533,706,719 | |
| Other Liabilities In Excess Of Other Assets—(0.0)% | (725,844) | |
| Total Net Assets—100% | $1,532,980,875 | |
(a) Non-income producing security.
(b) Represents foreign domiciled corporation.