THE VALUE OF A $10,000 INVESTMENT IN THE OAKMARK SMALL CAP FUND FROM ITS INCEPTION (11/1/95) TO PRESENT (12/31/00) AS COMPARED TO THE RUSSELL 2000 INDEX17
12/31/00 NAV9 $13.69	Total Return Last 3 months*	Average Annual Total Return10 Through 12/31/00 From Fund Inception 11/1/95
The Oakmark Small Cap Fund	-5.98%	10.72%
Lipper Small Cap Value Fund Index18	3.50%	11.83%
Russell 2000 w/inc	-6.91%	11.39%
S&P Small Cap 600 w/inc.19	1.26%	14.30%
*Not annualized.

Calendar year 2000 was, to say the least, a volatile period for equity valuations. During the past year the NASDAQ Index² plunged 39.29% (its worst decline since 1971), the Standard & Poors 500 Index¹ dropped 9.10%, the Dow Jones Industrial Average¹¹ slipped 6.39% while the Russell 2000 small cap index slid a modest 3.02%. Despite a negative fourth quarter, we are pleased to report that your Fund had a gain of 4.39%⁵ for 2000. As can be seen across The Oakmark Family of Funds this year, value investing made a comeback during the last three quarters of 2000 as investors began to realize that the disparity between growth stock valuations and value stock valuations had simply become too large. We believe that although a narrowing occurred between value and growth stocks over the last three quarters of 2000, significant upside still exists for value investors in 2001.

2001 Outlook

The economy clearly cooled in the final quarter of 2000, which makes profit projections for companies in 2001 a more challenging endeavor. The Federal Reserve's recent interest rate cut should provide a boost to economic activity, but given the lag effect of interest rate reductions on the economy it will probably take a couple of quarters for the Federal Reserve's actions to seriously impact economic activity. Therefore, we believe that it is likely that corporate earnings disappointments over at least the first half of 2001 are probably going to outweigh the positive surprises. Generating positive investment results in this environment will be difficult, but we believe we are well positioned.

We believe there are three essential elements to investing in an uncertain economic environment. The first element is a portfolio dominated by stocks selling at low price/earnings ratios. By owning companies with low P/E's⁸ we are not only earning a higher return on our investment (the earnings yield on a common stock investment is the reciprocal of the P/E) but we also have a greater margin of safety when a company reports below expectations earnings. Currently, the median P/E of the stocks owned in the Fund is 8.1 times our research staff's estimate of 2001 earnings. This is not only substantially less than the market multiple, but it also results in a very compelling earnings yield of 12.3%. Secondly, we are well diversified among industry groups — please refer to our holdings list that is segmented by industry. Since the impact of economic weakness on each industry is difficult to pinpoint in advance, having a well-diversified portfolio is a good defensive strategy. The third element is knowing the companies well that our Fund owns. This is a key reason that we keep the number of investments in the Fund to a reasonable size (typically 40-50) versus some other funds that own hundreds of stocks. We believe that over time an in-depth understanding of a company's fundamentals should result in solid investment returns.

Recent Portfolio Changes

During the fourth calendar quarter of 2000, the Fund's portfolio actually shrank from forty-six stocks to forty-three stocks as we sold four stocks and purchased one. We sold Mentor Graphics and The MONY Group for nice gains after these stocks achieved our sell targets. International Multifoods was sold opportunistically following a good sized rally in the fourth quarter despite our view that their long-term fundamental value was waning. Lastly, Finger Lakes Financial was sold for a better opportunity. Also during the quarter, Dura Pharmaceuticals became Elan Pharmaceuticals following the consummation of Elan's stock-for-stock purchase of Dura. The one stock that we purchased was Frontline Ltd., which is the world's largest independent operator of modern super-tankers used to transport crude oil. The stock trades under five times expected 2001 earnings and the replacement value of their fleet significantly exceeds its stock price.

Two Inexpensive Stocks

Two stocks that your Fund owns that we would like to highlight are investments that have declined in price since they were purchased. The companies are Micron Electronics and ShopKo Stores. Generally, fund managers prefer to discuss their winners, but we thought it would be informative for our investors to understand how we approach dealing with the losers. First, stock prices are often more volatile than business value, thus when a stock price declines we reevaluate the business value that underlies the stock. If our analysis shows that the company's business value continues to significantly exceed its stock price, we will continue to own the stock. On the other hand, if our revised estimate of business value is equal to or less than the stock's price we sell the stock.

With this approach in mind, let us examine Micron Electronics. This stock price has declined to approximately $4.25 per share which gives Micron a stock market capitalization of $409 million. As of November 30, 2000, Micron's last quarter end, the firm had net cash of $301 million (net cash is defined as cash plus investments minus current debts). If we deduct the net cash of $301 million from Micron's market capitalization of $409 million, then this means the market is valuing the company at a mere $108 million. This valuation is less than 7% of Micron's $1.6 billion sales base and it ignores Micron's recent success in re-igniting the sales growth in its personal computer division as well as the ongoing growth of its web hosting division HostPro. Not only do we view this valuation as very compelling, but from a tax efficiency prospective if this stock appreciates back to our cost this would create a sizable gain from today's Fund share price without generating net capital gains.

ShopKo is somewhat similar to Micron, except that the hidden balance sheet asset is not cash but real estate. ShopKo is one of the few retailers that own many of their stores (most other retailers lease their store locations), and we estimate that the value of ShopKo's real estate exceeds its debt levels. This would imply that ShopKo's retail operations that generate over $3.5 billion in sales are being valued at less than 5% of the firm's stock market capitalization of $170 million. Both of these companies are quality firms with solid balance sheets, talented management teams and very low valuations.

The Year Ahead

As the above examples illustrate, we can find many small cap stocks that are selling at attractive valuations. Therefore, we believe that the resurgence of small cap value stocks that began in 2000 should continue in 2001.

Once again we would like to thank our shareholders for your support of The Oakmark Small Cap Fund and we would like to wish you good health, happiness and prosperity for the New Year.

James P. Benson, CFA

Portfolio Manager
jbenson@oakmark.com

Clyde S. McGregor, CFA

Portfolio Manager
mcgregor@oakmark.com

January 5, 2001