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
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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 (3/31/03) AS COMPARED TO THE RUSSELL 2000 INDEX16 | ||||
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| Average Annual Total Returns1 | ||||
| (as of 3/31/03) | ||||
| Total Return Last 3 Months* |
1-year | 5-year | Since Inception (11/1/95) |
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| Oakmark Small Cap Fund | -7.58% | -28.44% | -4.58% | 7.57% |
| Russell 2000 | -4.49% | -26.96% | -4.11% | 4.23% |
| S&P Small Cap 60017 | -5.79% | -24.81% | -0.88% | 7.51% |
| Lipper Small Cap Value Index18 | -5.77% | -22.51% | -0.14% | 7.83% |
| The graph and table do not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares. | ||||
| Past performance is no guarantee of future results. Investment return and principal value vary, and you may have a gain or loss when you sell shares. Average annual total return measures annualized change, while total return measures aggregate change. | ||||
| * Not annualized | ||||
During the first calendar quarter of 2003 investors appeared to focus on geopolitical developments and the stock market surged and slumped along with news developments. Overall, the just concluded quarter could be characterized as lackluster. Stocks slipped in value as the S&P 500 Index4 fell by 3% and the Russell 2000 Index declined by 4%. Your Fund experienced a loss of 8% during the last three months which we believe reflects the near-term volatility of the uncertain times in which we live.
Where Do We Go From Here?
We are not going to waste time with a review of the most recent news events that have been impacting stock prices since that would be redundant given the saturation news coverage accorded the hostilities in Iraq. Future economic activity, or lack thereof, is likely to be the key determinant of stock prices and we are reasonably upbeat with what we are seeing. Six major economic indicators are, we believe, pointing towards a more robust economy. These six include: 1) positive fiscal stimulus as federal and many state budgets experience operating deficits; 2) monetary policy from the Federal Reserve has been accommodative; 3) inventories are generally at low levels; 4) costs have been reduced at many companies; 5) the decline in the dollar makes U.S. exports more attractive to foreign buyers and 6) interest rates are near post World War II lows. If energy prices decline following the cessation of military action, the economy will have yet another source of stimulus. Collectively, we believe these indicators point toward stronger future economic activity. However, there are still trouble spots in the U.S. economy ranging from debt burdened consumers to tepid capital spending from businesses, but we believe the positives are likely to overwhelm the negatives over time. Successful long-term investing often hinges on seeing opportunities and accessing risks well ahead of the crowd. In constructing the portfolio for your Fund, we have been able to invest in many quality companies selling for single digit multiples of their estimated earnings and cash flow. We believe these valuation levels are extremely attractive when compared to current interest rates and we remain hopeful these stock valuations improve prospectively.
| Highlights |
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What Are We Looking For?
The easy answer to the forgoing question is an inexpensive stock that will appreciate rapidly over the next several years. While our goal is easily defined, finding companies that are likely to be additive to your Fund's portfolio performance is the difficult task assigned to our analytical staff. While no investment process that we are aware of generates a perfect track record, we work diligently to uncover stocks that are undervalued relative to their private market value. A couple of examples of stocks that we own should help clarify how we think about the investment process.
One stock that we continue to like is eFunds Corporation. This firm provides electronic transaction processing, ATM solutions, risk management and business process outsourcing services to financial institutions, government agencies and retailers worldwide. What most investors seem to be focused on is eFunds disappointing earnings performance over the past few quarters and this has caused the stock to decline. What we see is a financially robust company (the company has over $100 million in net cash) that generates a large amount of operating cash flow. In fact, eFunds' stock (less net cash) has recently been trading at just over three times the firm's pre-tax cash flow generation. We believe eFunds' outlook is also aided by the new management team that was hired in 2002. The new team appears to be proactively repositioning eFunds' product and service offerings to improve the company's revenue growth, earnings levels and cash generation capability. For those investors that just focus on reported earnings, most of eFunds progress has been hidden in recent quarters, but if reported earnings begin to improve we would anticipate other investors may become aware of the value of this company.
Another company the Fund owns that makes a good case study is Checkpoint Systems. Checkpoint develops, manufactures and sells security systems that help retailers control shoplifting. Checkpoint's two major revenue sources are the sales of equipment (often seen at the entrances of stores) and the source tags that are embedded in the items for sale in a store. During an economic slowdown, the number of retailers willing to upgrade their security systems tends to decline (this relates to the slowdown in capital spending point mentioned earlier) while the number of source tags sold also slows as retailers sell fewer units of merchandise. Both sources of revenue slowed for Checkpoint during 2002, but the firm remains well positioned to benefit from an economic upturn. Additionally, despite the sluggish economic environment in 2002, Checkpoint was able to generate slightly more than $100 million in cash from operations. With a stock market capitalization of approximately $330 million, Checkpoint is currently being valued at just over three times cash flow. While we have been disappointed with the recent performance of eFunds' and Checkpoint's stocks, we are encouraged by the underlying financial trends at these companies. These are a couple of examples why we remain optimistic on the long-term future of small cap equities.
Portfolio Update
During the past quarter we deleted three stocks from your Fund's portfolio while we added one new company. The companies we sold were Elan Corporation, H.B. Fuller Company and ITT Educational Services. ITT Educational had been a strong performer for the Fund for a couple of years and we elected to liquidate this position principally due to its valuation relative to many other stocks in the portfolio. Both Elan and H.B. Fuller were small positions where we wanted to redeploy the capital invested in these companies into other stocks that we believe represent better values. The one stock we purchased during the quarter was Advanced Medical Optics Incorporated. This company is a leading provider of eye care products including replacement lenses for cataracts as well as contact lens care products. We were attracted to Advanced Medical's stock for reasons including strong market shares for several of the company's products, good cash flow generation and favorable macro demand trends being generated from an aging population.
In Closing
We would like to thank our shareholders for your ongoing interest in and your support of The Oakmark Small Cap Fund. We look forward to communicating with you again next quarter.
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| James P. Benson, CFA Portfolio Manager jbenson@oakmark.com |
Clyde S. McGregor, CFA Portfolio Manager mcgregor@oakmark.com |
| THE OAKMARK SMALL CAP FUND |
Schedule of Investments—March 31, 2003 (Unaudited)
| Name | Shares Held | Market Value |
| Common Stocks—94.9% | ||
| Food & Beverage—7.7% | ||
| Ralcorp Holdings, Inc. (a) | 575,000 | $14,973,000 |
| Del Monte Foods Company (a) | 1,230,000 | 9,175,800 |
| 24,148,800 | ||
| Household Products—3.7% | ||
| Tupperware Corporation | 850,000 | $11,747,000 |
| Other Consumer Goods & Services—5.0% | ||
| Department 56, Inc. (a)(b) | 760,000 | $7,463,200 |
| Callaway Golf Company | 475,000 | 5,643,000 |
| Central Parking Corporation | 250,000 | 2,500,000 |
| 15,606,200 | ||
| Security Systems—3.0% | ||
| Checkpoint Systems, Inc. (a) | 968,300 | $9,528,072 |
| Apparel—2.4% | ||
| Oakley, Inc. (a) | 671,200 | $5,537,400 |
| R.G. Barry Corporation (a)(b) | 900,000 | 2,070,000 |
| 7,607,400 | ||
| Automobile Rentals—1.9% | ||
| Dollar Thrifty Automotive Group, Inc. (a) | 350,000 | $5,827,500 |
| Building Materials & Construction—3.1% | ||
| Insituform Technologies, Inc., Class A (a) | 732,500 | $9,852,125 |
| Hotels & Motels—1.3% | ||
| Prime Hospitality Corp. (a) | 810,000 | $4,179,600 |
| Information Services—3.2% | ||
| eFunds Corporation (a) | 1,477,600 | $10,151,112 |
| Marketing Services—1.4% | ||
| DoubleClick Inc. (a) | 500,000 | $3,885,000 |
| Grey Global Group Inc. | 1,000 | 616,990 |
| 4,501,990 | ||
| Restaurants—1.3% | ||
| Triarc Companies, Inc. (a) | 150,000 | $4,177,500 |
| Retail—2.8% | ||
| ShopKo Stores, Inc. (a)(c) | 740,000 | $8,621,000 |
| Bank & Thrifts—7.3% | ||
| BankAtlantic Bancorp, Inc., Class A | 1,000,000 | $9,790,000 |
| People's Bank of Bridgeport, Connecticut | 360,000 | 9,090,000 |
| PennFed Financial Services, Inc. | 150,000 | 3,982,500 |
| 22,862,500 | ||
| Insurance—3.3% | ||
| The PMI Group, Inc. (c) | 400,000 | $10,220,000 |
| Other Financial—2.5% | ||
| NCO Group, Inc. (a) | 530,000 | $7,685,000 |
| Real Estate—3.7% | ||
| Catellus Development Corporation (a) | 360,000 | $7,560,000 |
| Trammell Crow Company (a) | 495,000 | 3,940,200 |
| 11,500,200 | ||
| Medical Products—7.7% | ||
| Hanger Orthopedic Group, Inc. (a) | 950,000 | $10,858,500 |
| CONMED Corporation (a) | 400,000 | 6,564,000 |
| Sybron Dental Specialties, Inc. (a) | 300,000 | 5,235,000 |
| Advanced Medical Optics, Inc. (a) | 100,000 | 1,345,000 |
| 24,002,500 | ||
| Pharmaceuticals—5.4% | ||
| Pharmaceutical Resources Inc (a) | 400,000 | $16,992,000 |
| Computer Services—2.9% | ||
| CIBER, Inc. (a) | 1,805,000 | $8,591,800 |
| Interland, Inc. (a) | 800,000 | 528,000 |
| 9,119,800 | ||
| Computer Software—8.2% | ||
| Sybase Inc (a) | 800,000 | $10,360,000 |
| MSC.Software Corp. (a) | 1,300,000 | 10,075,000 |
| Mentor Graphics Corporation (a) | 587,000 | 5,247,780 |
| 25,682,780 | ||
| Computer Systems—1.3% | ||
| Optimal Robotics Corp., Class A (a)(d) | 723,500 | $4,167,360 |
| Data Storage—2.2% | ||
| Imation Corp. (a) | 182,000 | $6,774,040 |
| Office Equipment—1.6% | ||
| InFocus Corporation (a) | 935,500 | $4,621,370 |
| MCSi, Inc. (a) | 895,000 | 304,300 |
| 4,925,670 | ||
| Instruments—0.5% | ||
| Measurement Specialties, Inc. (a) | 550,000 | $1,567,500 |
| Machinery & Industrial Processing—4.6% | ||
| SureBeam Corporation, Class A (a)(b) | 4,000,000 | $14,040,000 |
| Columbus McKinnon Corporation (a) | 254,800 | 410,228 |
| 14,450,228 | ||
| Other Industrial Goods & Services—1.0% | ||
| Integrated Electrical Services, Inc. (a) | 750,000 | $3,202,500 |
| Oil & Natural Gas—5.9% | ||
| St. Mary Land & Exploration Company | 350,000 | $8,767,500 |
| Cabot Oil & Gas Corporation | 250,000 | 6,000,000 |
| Berry Petroleum Company | 250,000 | 3,750,000 |
| 18,517,500 | ||
| Total Common Stocks (Cost: $356,774,501) | 297,617,877 | |
| Par Value | ||
| Short Term Investments—5.4% | ||
| U.S. Government Bills—1.6% | ||
| United States Treasury Bill, 1.155% due 4/3/2003 | $5,000,000 | $4,999,679 |
| Total U.S. Government Bills (Cost: $4,999,679) | 4,999,679 | |
| Repurchase Agreements—3.8% | ||
| IBT Repurchase Agreement, 1.25% due 4/1/2003, | ||
| repurchase price $10,000,347 collateralized by | ||
| U.S. Government Agency Securities | $10,000,000 | $10,000,000 |
| IBT Repurchase Agreement, 1.01% due 4/1/2003, | ||
| repurchase price $1,932,573 collateralized by | ||
| U.S. Government Agency Securities | 1,932,519 | 1,932,519 |
| Total Repurchase Agreement (Cost: $11,932,519) | 11,932,519 | |
| Total Short Term Investments (Cost: $16,932,198) | 16,932,198 | |
| Total Investments (Cost $373,706,699)—100.3% | $314,550,075 | |
| Shares Subject to Call | ||
| Call Options Written—0.0% | ||
| Retail—0.0% | ||
| ShopKo Stores, Inc., June 17.50 Calls | (100,000) | $(25,000) |
| Total Call Options Written (Premiums Received: $(102,097))—0.0% | $(25,000) | |
| Shares Subject to Put | ||
| Put Options Written—(0.1%) | ||
| Household Products—(0.1%) | ||
| Tupperware Corporation, July 15 Puts | (50,000) | $(91,250) |
| Retail—0.0% | ||
| ShopKo Stores, Inc., June 10 Puts | (100,000) | $(72,500) |
| Total Put Options Written (Premiums Received: $(180,794))—(0.1%) | $(163,750) | |
| Other Liabilities In Excess Of Other Assets—(0.2%) | (708,812) | |
| Total Net Assets—100% | $313,652,513 | |
| (a) | Non-income producing security. |
| (b) | See footnote number five in the Notes to Financial Statements regarding transactions in affiliated issuers. |
| (c) | A portion of this security has been segregated to cover written option contracts. |
| (d) | Represents a foreign domiciled corporation. |
See accompanying notes to financial statements.