Oakmark Fund: Third Quarter 2011
September 30, 2011
The Oakmark Fund decreased in value by 14% in the past quarter, bringing the Fund to -1% for its September fiscal year. The S&P 500 lost 14% in the quarter and gained 1% for the fiscal year.
Looking back at the full fiscal year, we slightly trailed a disappointing 1% return for the S&P 500. Nine of our holdings returned over 20%: Apple, Baxter, Bristol-Myers, Comcast, eBay, Exxon, Harley-Davidson, MasterCard and McDonald’s. Those strong performers tended to have below-average exposure to economic cycles or had above-average dividend yields. One of our best performing sectors was technology,where gains averaged 9%. Technology stocks now comprise approximately 29% of our portfolio. Those of you who owned Oakmark during the technology bubble of 2000 will remember that we had no exposure to technology stocks back then. In 2000, technology stocks traded at huge valuation premiums; today they sell at large discounts. We have always been attracted to technology businesses, but our process is driven by value. At today’s prices, we believe that many technology companies are not just great businesses, but also great investments.
These strong performers for the year were offset by nine stocks that lost 20% or more: Aflac, Allstate, Bank of America, Bank of New York, Best Buy, Cisco, EnCana, Federal Express and JPMorgan. Unlike our winners this year, this group did have an industry theme – financials. Increasing regulatory issues and fear of a weakening economy made it a tough year for this industry. Our financial stocks were not only the poorest performers for our fiscal year, they also dominated the list of worst quarterly performers. Aflac, Allstate, Bank of America, Bank of New York, Capital One, JPMorgan and State Street all lost more than 20% in the quarter.
About 13% of the portfolio is invested in financial companies. We believed these companies looked cheap before they fell, and we believe they are even more attractive now. Though we believe our financial holdings are selling at large discounts to value, there are two reasons why we are not upping our investment to the much higher portfolio weighting that some of our value peers have.
First, we find many stocks across many industries to be attractively priced today. Most of those companies have more near-term ability to return capital to shareholders through dividends and share repurchase than financial stocks do. Adjusting for that fact makes them look almost as undervalued as our financial holdings. Second, because we explicitly adjust our returns for risk, we want to invest where the risk-adjusted returns appear greatest. The balance sheet leverage inherent in financial services creates a higher hurdle for our investment. If two stocks appear to offer similar returns, we will almost always prefer one with a cash-heavy balance sheet to one that is heavily leveraged.
Despite the quarter’s difficult environment, there were bright spots in the portfolio: Apple, Bristol Myers, MasterCard, McDonald’s and Google all increased in value. As in the broader market, our strongest performers were those stocks that appear to be less exposed to the risk of economic slowdown. For example, the utility sector, which appeals to investors desiring higher current yield and lower economic sensitivity, was the only sector that increased in value during the quarter. We didn’t own any utilities and are unlikely to add any, as we believe other sectors offer much better value.
During the quarter we took advantage of the market decline to do some tax trading. We took losses that more than offset gains we realized earlier in the year, which will likely eliminate the need to pay a capital gains distribution in 2011. During the quarter we also eliminated two positions: GlaxoSmithKline and Walgreen. Glaxo had increased in price and was approaching its sell target. We opted to sell Glaxo a little below its sell target to reinvest the proceeds in stocks that had fallen far below our buy targets. Walgreen also performed positively during the year, but we sold it because our business value estimate decreased as a result of the company’s escalating war with Express Scripts. Corning was the only new position added during the quarter.
Corning Inc. (GLW – $13)
Corning is the world’s largest supplier of industrial glass. Its glass is used in products that include televisions, tablet computers, smart phones, telecom networks and automobile-emissions systems. The reason your iPhone screen doesn’t break as easily as the first ones did is that they now are made with Corning’s Gorilla Glass. In 2000, when Corning was the main supplier for new fiber-optic networks, the company had EPS of $1.23 and its stock reached a high of $113. Today, fiber optics has taken a backseat to glass for displays. Corning earned over $2 per share last year and should come close to that level again this year. Despite a more diversified business mix, the stock now trades at less than seven times earnings and at less than book value. We believe that price represents an attractive entry point for purchasing a worldwide leader in glass technology.
We thank you for your patience enduring a year of being stuck in neutral. As was addressed in the commentary section, we believe the stock market is attractively valued today and extremely so when compared to other investment opportunities. We again encourage you to look at your overall portfolio and restore your equity allocation to its appropriate level.
William C. Nygren, CFA
Kevin G. Grant, CFA
Average Annual Total Returns (09/30/11)
Expense Ratio as of 9/30/10 was 1.11%
Past performance is no guarantee of future results. The performance data quoted represents past performance. Current performance may be lower or higher than the performance data quoted. The investment return and principal value vary so that an investor’s shares when redeemed may be worth more or less than the original cost. To obtain the most recent month-end performance data, view it here.
As of 9/30/11, Apple, Inc. represented 2.2%, Baxter International, Inc. 1.4%, Bristol-Myers Squibb Co. 2.3%, Comcast Corp., Class A 2.4%, eBay, Inc. 2.2%, Exxon Mobil Corp. 2.0%, Harley-Davidson, Inc. 1.3%, MasterCard, Inc. Class A 2.3%, McDonald’s Corp. 1.9%, Aflac, Inc. 1.7%, Allstate Corp. 1.7%, Bank of America Corp. 1.0%, Bank of New York Mellon Corp. 1.1%, Best Buy Co., Inc. 1.5%, Cisco Systems, Inc. 1.0%, Encana Corp. 1.1%, FedEx Corp. 2.0%, JPMorgan Chase & Co. 1.7%, Google Inc., Class A 1.1%, Capital One Financial Corp. 2.3%, State Street Corp. 1.3%, GlaxoSmithKline PLC 0%, Walgreen Co. 0%, Express Scripts Inc. 0%, and Corning Inc. 1.6% of the Oakmark Fund's total net assets. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
The S&P 500 Index is a broad market-weighted average of U.S. blue-chip companies. This index is unmanaged and investors cannot actually make investments in this index.
EPS refers to Earnings Per Share and is calculated by dividing total earnings by the number of shares outstanding.
The discussion of the Funds’ investments and investment strategy (including current investment themes, the portfolio managers' research and investment process, and portfolio characteristics) represents the Funds’ investments and the views of the portfolio managers and Harris Associates L.P., the Funds' investment adviser, at the time of this letter, and are subject to change without notice.