THE OAKMARK SMALL CAP FUND
Report from James P. Benson and Clyde S. McGregor, Portfolio Managers
THE OAKMARK SMALL CAP FUNDReport from James P. Benson and Clyde S. McGregor, Portfolio Managers |
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| THE VALUE OF A $10,000 INVESTMENT IN THE OAKMARK SMALL CAP FUND FROM ITS INCEPTION (11/1/95) TO PRESENT (6/30/00) AS COMPARED TO THE RUSSELL 2000 INDEX | ||
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| 6/30/00 NAV $13.35 |
Total Return Last 3 mos. |
Average Annual Total Return* Through 6/30/00 From Fund Inception 11/1/95 |
| The Oakmark Small Cap Fund | -0.3% | 10.5% |
| Lipper Small Cap Fund Index** | 1.3% | 10.8% |
| Russell 2000 w/inc** | -3.8% | 14.2% |
| S&P Small Cap 600 w/inc** | 1.0% | 14.9% |
| *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 or funds whose composition is different from the Fund. The Lipper Small Cap Fund Index is comprised of 30 Small Cap Funds. The Russell 2000 Index measures the performance of smaller companies, and represents approximately 10% of the total value of publicly traded companies in the U.S. The S&P 600 Index measures the performance of selected U.S. stocks with small market capitalization. Past performance is no guarantee of future results. |
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The second calendar quarter of 2000 was a more typical period for stocks as investors began to question the business models of many of the new technology companies that came into existence over the past two years. The dependence by these firms on untested business plans, often inexperienced managements and an overly zealous pursuit of revenue growth despite negative cash generation created an environment that was likely to lead to disappointing investment results for these companies. Our focus on more established enterprises with positive cash flow characteristics aided our investment returns in the second quarter. For the quarter, your Fund was down 0.30% versus the Russell 2000 Index which fell by 3.78%. While pleased by the 3.48% outperformance of the Russell 2000, we continue to work to position your Fund to improve our absolute returns. For much of the balance of this report, we would like to detail for you some of the changes that have been underway at your Fund that we expect will have a positive impact on future results.
Tactical Changes
Over the past two quarters we have intensified our focus on stocks that offer improved liquidity and stocks that suggest near-term catalysts that might help reveal the underlying value of the company in which we are investing. Improving the liquidity of the portfolio should reduce our trading costs which should translate into better investment performance over the long-term. While liquidity in an individual stock can change over time (which makes precise estimates of portfolio liquidity difficult), we would estimate that we have completed the majority of the moves we needed to significantly improve the portfolio's liquidity. Two examples of low liquidity stocks that we sold are Northwest Savings and Northwest Pipe, where we sold the entire positions. We also trimmed many other stock positions to bring our position size down to a level that is more tradable should we need to sell the position. While we improved the portfolio's liquidity, we did not change the basic focus of this Fund and that is to own positions in attractive value-oriented small cap equities.
Our focus on companies with near-term catalysts is our response to "investment clutter." In today's world there are thousands of domestic small cap companies all trying to capture the attention of investors, but only a subset of this universe will accomplish this goal. We are no longer in a world where we can buy sound small cap companies trading at inexpensive prices and then wait for other investors to discover the company and bid the shares higher. Rather, we believe that we are in an impatient market that will quickly reward those firms that exhibit positive catalysts such as great new products, accretive share repurchases, aggressive cost controls and above expectations earnings growth. We want to be positioned in undervalued equities that exhibit some or all of these traits.
Portfolio Overview
As we begin the third quarter, the Fund's portfolio consists of forty stocks that are trading on a weighted average basis at 9.1 times estimated year 2001 earnings. Despite the low P/E ratio, we have not sacrificed growth as the expected earnings per share growth from 2000 to 2001 for this portfolio is approximately 25%. These two figures translate into a PEG (price/earnings ratio to expected growth rate) of 0.36 in a market where a ratio of under 1 is considered reasonably good by most investors.
We would like to highlight two stocks your fund owns: ITT Educational Services (ESI) and Micron Electronics (MUEI). Both of these stocks have interesting new developments that we expect to positively impact their share prices over the next few quarters. First, ESI is experiencing robust enrollment growth in their computer and internet-related educational courses. This growth is being somewhat mitigated by lower demand for some of ESI's older educational offerings, but we expect the strong growth in ESI's computer-related courses to begin to overwhelm the softness in the older offerings over the next year. This should result in an upturn in ESI's revenue and profit growth. With this stock trading at a significantly lower multiple to earnings than its peers, we expect ESI to do quite well over the next several quarters.
MUEI is an efficient manufacturer of personal computers (slightly more efficient than Dell!) with a memory chip remanufacturing operation and a rapidly growing web hosting business. MUEI's biggest problem in recent periods was lack of demand due to a weak brand position. However, we believe they may have solved the issue of demand generation for their PC business by teaming up with Best Buy and other retailers. MUEI will provide the retailers' customers with made-to-order PC's that are ordered in the store and shipped from MUEI's manufacturing plant a day or two later directly to the customer. This looks like a win-win situation as MUEI realizes increased volume for its manufacturing facilities while the retailers reduce their inventory costs by stocking fewer PC's in their stores. Several additional retailers have signed on with MUEI following a promising start at Best Buy. If this model works well, the upside in MUEI's revenue growth and profitability should be substantial.
Portfolio Manager Change
At the end of June, Steve Reid stepped down as portfolio manager of the Fund following an extended leave of absence. We thank him for his valuable contributions and we wish him all the best. Clyde McGregor has joined me to provide the portfolio management team for your Fund. Clyde has successfully managed The Oakmark Equity and Income Fund since its inception in 1995 (a role that he will continue to perform) and he has over two decades of professional investment experience. We look forward to a successful collaboration.
Once again we would like to thank our shareholders for your support of The Oakmark Small Cap Fund.
James P. Benson, CFA
Portfolio Manager
jbenson@oakmark.com
Clyde S. McGregor, CFA
Portfolio Manager
mcgregor@oakmark.com
July 3, 2000
| THE OAKMARK SMALL
CAP FUND Schedule of Investments—June 30, 2000 (Unaudited) |
| Shares Held | Market Value | |
| Common Stocks—93.5% | ||
| Food & Beverage—7.0% | ||
| Ralcorp Holdings, Inc. (a) | 465,000 | $5,696,250 |
| Del Monte Foods Company (a) | 800,000 | 5,450,000 |
| International Multifoods Corporation | 150,000 | 2,596,875 |
| M & F Worldwide Corp. (a) | 300,000 | 1,687,500 |
| 15,430,625 | ||
| Retail—5.9% | ||
| Ugly Duckling Corporation (a) | 1,750,000 | $12,359,375 |
| The Great Atlantic & Pacific Tea Company, Inc. | 39,900 | 663,338 |
| 13,022,713 | ||
| Hardware—0.9% | ||
| Jore Corporation (a) | 376,000 | $2,044,500 |
| Other Consumer Goods & Services—5.6% | ||
| Department 56, Inc. (a) | 800,000 | $8,800,000 |
| Barry (R.G.) Corporation (a) | 885,000 | 3,429,375 |
| 12,229,375 | ||
| Banks & Thrifts—8.6% | ||
| People's Bank of Bridgeport, Connecticut | 400,000 | $7,350,000 |
| BankAtlantic Bancorp, Inc., ClassA | 1,082,500 | 4,059,375 |
| PennFed Financial Services, Inc. | 250,000 | 3,531,250 |
| Golden State Bancorp Inc. (a) | 150,000 | 2,700,000 |
| Finger Lakes Financial Corp. | 175,500 | 1,250,437 |
| 18,891,062 | ||
| Insurance—7.8% | ||
| The PMI Group, Inc. | 190,000 | $9,025,000 |
| The MONY Group Inc. (a) | 240,000 | 8,115,000 |
| 17,140,000 | ||
| Educational Services—6.0% | ||
| ITT Educational Services, Inc. (a) | 750,000 | $13,171,875 |
| Information Services—4.6% | ||
| National Data Corporation | 435,000 | $10,005,000 |
| Data Storage—0.0% | ||
| StorageNetworks, Inc. (a) | 700 | $63,175 |
| Computer Software—4.3% | ||
| Mentor Graphics Corporation | 300,000 | $5,962,500 |
| MSC.Software Corp. | 200,000 | 1,862,500 |
| Symantec Corporation (a) | 30,000 | 1,618,125 |
| 9,443,125 | ||
| Computer Systems—4.7% | ||
| Micron Electronics, Inc. (a) | 825,000 | $10,312,500 |
| Security Systems—1.7% | ||
| Checkpoint Systems, Inc. (a) | 500,000 | $3,750,000 |
| Pharmaceuticals—3.3% | ||
| Dura Pharmaceuticals, Inc. (a) | 500,000 | $7,187,500 |
| Medical Centers—1.1% | ||
| Veterinary Centers of America, Inc. (a) | 180,000 | $2,475,000 |
| Medical Research—0.8% | ||
| Covance Inc. (a) | 200,000 | $1,762,500 |
| Medical Products—2.2% | ||
| Hanger Orthopedic Group, Inc. (a) | 1,000,000 | $4,937,500 |
| Automotive—2.1% | ||
| Standard Motor Products, Inc. | 280,000 | $2,380,000 |
| Stoneridge, Inc. (a) | 245,000 | 2,143,750 |
| 4,523,750 | ||
| Automobile Rentals—1.3% | ||
| Dollar Thrifty Automotive Group, Inc. (a) | 151,500 | $2,793,281 |
| Transportation Services—3.0% | ||
| Teekay Shipping Corporation (b) | 200,000 | $6,575,000 |
| Machinery & Industrial Processing—5.9% | ||
| Columbus McKinnon Corporation | 495,000 | $6,868,125 |
| Sames Corporation | 235,000 | 3,701,250 |
| MagneTek, Inc. (a) | 300,000 | 2,400,000 |
| 12,969,375 | ||
| Chemicals—3.5% | ||
| Ferro Corporation | 210,000 | $4,410,000 |
| H.B. Fuller Company | 70,000 | 3,189,375 |
| 7,599,375 | ||
| Real Estate—11.7% | ||
| Catellus Development Corporation (a) | 907,800 | $13,617,000 |
| Prime Hospitality Corp. (a) | 800,000 | 7,550,000 |
| Trammell Crow Company (a) | 427,700 | 4,597,775 |
| 25,764,775 | ||
| Diversified Conglomerates—1.5% | ||
| U.S. Industries, Inc. | 275,000 | $3,334,375 |
| Total Common Stocks (Cost: $241,680,521) | 205,426,381 | |
| Call Options Written—(0.1%) | ||
| Equity Options—(0.1%) | ||
| Computer Software—(0.1%) | ||
| Symantec Corporation, July 75 Calls | (30,000) | $(11,250) |
| Mentor Graphics Corporation, July 17.50 Calls | (40,000) | (117,500) |
| (128,750) | ||
| Computer Systems—0.0% | ||
| Micron Electronics, Inc., July 15 Calls | (27,500) | $(1,718) |
| Total Call Options Written (Cost: $(237,698)) | (130,468) | |
| Par Value | Market Value | |
| Short Term Investments—6.0% | ||
| Commercial Paper—3.2% | ||
| General Electric Capital Corporation, 6.80% due 7/3/2000 | 7,000,000 | $7,000,000 |
| Total Commercial Paper (Cost: $7,000,000) | 7,000,000 | |
| Repurchase Agreements—2.8% | ||
| State Street Repurchase Agreement, 6.25% due 7/3/2000 | 6,187,000 | $6,187,000 |
| Total Repurchase Agreements (Cost: $6,187,000) | 6,187,000 | |
| Total Short Term Investments (Cost: $13,187,000) | 13,187,000 | |
| Total Investments (Cost $254,629,823)—99.4% | $218,482,913 | |
| Other Assets In Excess Of Other Liabilities—0.6% | 1,307,002 | |
| Total Net Assets—100% | $219,789,915 | |
(a) Non-income producing security.
(b) Represents foreign domiciled corporation.