Meridian Fund Q3 Report
The economy grew at a modest 1.3% in the second quarter. Housing starts, retail sales, industrial production and most important, job growth, all remained weak. Meanwhile, most states are cutting back services and attempting to raise taxes. It is hard to believe that additional fiscal stimulus or monetary easing will offer much help at this point. We already have record deficits and zero interest rates. The companies we talk with, for the most part, are cautious and reluctant to invest and hire. They are concerned with demand, for sure, but are also uncertain with regard to future tax policy, regulations and health care costs. A coherent long-term economic policy from Washington promoting economic growth, private sector jobs and making us competitive in world markets is needed. Interest rates remain low and inflation isn’t an issue at this point. It is our opinion that the economy will continue to grow at a modest pace for the foreseeable future.
Long-term investment results, history clearly shows, are improved by buying good companies or mutual funds consistently over an extended period of time. We welcome those new shareholders who joined the Meridian Funds during the quarter and appreciate the continued confidence of our existing shareholders.
Richard F. Aster, Jr.
Meridian Equity Income Fund® (MEIFX) The Meridian Equity Income Fund’s net asset value per share at September 30, 2011 was $9.18. This represents a decrease of 7.1% for the calendar year to date. The Fund’s total return and average annual compound rate of return since inception January 31, 2005 were 17.0% and 2.4%, respectively. At the close of the quarter, total net assets were $30,087,470 and were invested 5.1% in cash and other assets net of liabilities and 94.9% in stocks. At the close of the quarter there were 536 shareholders in the Equity Income Fund.
Our basic strategy remains unchanged. The Fund continues to seek to invest in companies with above-average dividend yields, along with strong financial returns and that have, in our opinion, the ability to grow dividends. The severe downturn in the economy and corporate profits resulted in dividend cuts for companies which previously were considered safe.
Dividends for good companies, however, have stabilized and are beginning to grow again as the economy improves. The Fund is diversified with 61 holdings representing 60 different industry groups. At the end of the September 2011 quarter, the portfolio’s average holding had a five-year average return on equity of 18.6% and an average dividend yield of 4.0%, both measures substantially higher than the average S&P 500 stock. The yield compares favorably also to the 1.9% yield on the ten-year Treasury bond. The average holding has a market capitalization of $34.6 billion, a debt to capital ratio of 38.8% and earnings per share that are projected to increase 9.45% annually during the next several years. We believe these financial characteristics will lead to positive long-term returns for the Fund.
During the quarter we purchased shares of Abbot Laboratories (ABT), General Electric (GE), Meredith Corporation (MDC), Safeway (SWY) and Staples (SPLS). We sold our positions in 3M (MMM), Baxter International (BAX), Harsco Corporation (HSC), Hudson City Bancorp (HCBK) and The McGraw-Hill Companies (MHP).
Wal-Mart Stores (WMT) is the world’s largest retailer, operating two major concepts, the Wal-Mart supercenters and Sam’s Clubs. Both concepts are well positioned for the current environment, offering a wide selection of merchandise at the lowest possible prices. The stores appeal to a wide demographic, but primarily to moderate and low income shoppers. Wal-Mart operates in the United States, Europe, Asia, South America and has recently entered Africa. The company has an experienced management team, an excellent return on capital, a strong financial position and continued growth prospects. The stock, based on historical measures, represents an excellent value at this point. The shares yield 2.65% and sell at 12 times earnings. Both measures compare favorably to the S&P 500 and, in our opinion, should lead to positive investment returns.
Meridian Growth Fund® (MERDX)
The Meridian Growth Fund’s net asset value per share at September 30, 2011 was $39.16. This represents a decrease of 12.2% for the calendar year to date. The Fund’s total return and average annual compound rate of return since inception August 1, 1984 were 2,065.7% and 12.0%, respectively. At the close of the quarter, total net assets were $2,092,675,761 and were invested 5.4% in cash, cash equivalents and other assets net of liabilities and 94.6% in stocks. At the close of the quarter there were 86,909 shareholders in the Growth Fund.
The economic outlook, as pointed out above, is cloudy and there is considerable pessimism. However we believe stocks will be alright, providing the economy continues to grow and interest rates remain attractive. There are also positives for long-term stock investors. First, it is not difficult to find excellent small and mid-cap growth stocks selling at attractive valuations these days. Second, most companies are operating cautiously and are better prepared for economic difficulties than they were during the 2008 recession. They have maintained conservative financial positions and their cost structures remain lean. We purchased shares in Advanced Auto Parts and sold our positions in Lumber Liquidators and NetScout Systems during the quarter. We have also shifted our stock weightings somewhat within the portfolio during the quarter. We hold fifty-four positions, representing small and medium sized growth stocks which, for the most part, have strong balance sheets, leading market positions, good long-term growth prospects and sell at reasonable valuations, in our opinion. Our heaviest areas of concentration remain software companies followed by consumer nondurables and then various financial, energy and industrial-related companies.
Bed, Bath & Beyond is the largest specialty retailer in the U.S. for general household merchandise, targeting the mass consumer market with large stores and value pricing. Emerging from the recent recession, the company managed to strengthen its competitive position as it gained market share while its largest direct competitor filed for bankruptcy. Today’s economic climate remains difficult but the company is generating positive comparable store sales growth and expanding operating margins. Bed Bath & Beyond (BBBY) will benefit in the future when U.S. employment and the housing industry eventually recover. The company has a pristine balance sheet with no debt, consistently generates a strong return on capital and is well managed. The stock sells at a reasonable valuation, especially considering the company’s competitive position and ability to do well in the current difficult environment.
The Meridian Growth Fund’s long term performance has earned several recent accolades. See In The News, below.
Meridian Value Fund® (MVALX)
The Meridian Value Fund’s net asset value per share at September 30, 2011 was $24.39. This represents a decrease of 15.6% for the calendar year to date. The Fund’s total return and average annual compound rate of return since June 30, 1995 were 583.9% and 12.6%, respectively. The comparable period returns for the S&P 500 with dividends were 177.9% and 6.5%, respectively. At the close of the quarter, total net assets were $665,697,838 and were invested 5.0% in cash, cash equivalents and other assets net of liabilities and 95.0% in stocks. At the close of the quarter there were 38,077 shareholders in the Value Fund.
Our investment strategy remains unchanged. We continue to seek out-of-favor companies exemplified by an extended period of declining earnings. In recent years most earnings problems have been related to poor economic conditions. With some stability in the economy, albeit tenuous, we now see more companies that meet our strategy for company-specific reasons. These investments are the traditional strength and point of differentiation of the Meridian Value Fund. We are gradually shifting the portfolio to more of these investments and expect that this should bode well for a return to the Fund’s historically strong performance levels. We hold 53 positions, representing 34 industry groups. We continue to invest in companies of all market capitalizations and our largest areas of concentration are technology, retail and transportation.
During the quarter we purchased shares of Denny’s Corp. We sold our positions in Curtis- Wright Corp. and Nalco Holding Co. LKQ Corporation is one of our largest holdings. The company is the leader in the alternative auto parts market. This market consists of recycled auto parts that have been salvaged from wrecks and aftermarket parts that are produced as private label alternatives to original manufactured parts. These parts are sold to mechanics and body shops at a 20 - 50% discount to dealer prices. Barriers to entry are high as it is unlikely that any company will replicate LKQ’s network of over 400 dismantling and distribution facilities. Earnings declined with lower auto repair volumes because of a decline in miles driven first due to high gas prices then by the economic downturn, combined with a steep decline in the price of scrap metal which is a by-product of the parts recycling process. Earnings growth resumed late in 2009 and continues to grow, driven by increased penetration of alternative parts as insurance companies and consumers seek to save money, along with market share gains against smaller competitors and through accretive acquisitions. We believe LKQ can perform well in challenging economic conditions and the valuation is reasonable on normalized earnings which we estimate could exceed $2.50 per share in the next 3 to 5 years.
In The News
• Meridian Growth Fund Ranks in Top Ten U.S. Small Caps, “The Best-Performing Mutual Funds”. Bloomberg Markets October 2011 • Meridian Growth Fund took home the Silver in the 2011 S&P Mutual Funds Excellence Awards for the Mid-Cap category. We took home the Gold in 2010. You can sign up for E-mail Alerts on our website at www.meridianfund.com. When you sign up for E-mail Alerts you will receive notification of news items, shareholder reports, SEC filings and other information regarding the Meridian Funds.
The Meridian Funds are no-load and there are no transaction fees or commissions charged when you purchase shares directly through our transfer agent, BNY Mellon Investment Servicing (U.S.), Inc. This is a very cost-effective way to purchase shares of the Meridian Funds if you do not need the services of a broker-dealer or if you make multiple purchases.
The information provided in this report should not be considered investment advice or a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in a particular Fund’s portfolio at the time you receive this report or that securities sold have not been repurchased. Securities discussed are presented as illustrations of companies that fit a particular Fund’s investment strategy and do not represent a Fund’s entire portfolio and in the aggregate may represent only a small percentage of a Fund’s portfolio holdings. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable, or that investment decisions Fund management makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Management’s views presented herein and any discussion of a particular Fund’s portfolio holdings or performance are as of September 30, 2011 and are subject to change without notice.