Brian Rogers' T. Rowe Price Equity Income Fund Semi-Annual Report 2013
As shown in the Performance Comparison table, your fund generated a return of 14.12% for the past six months compared with 13.82% and 13.39% for the S&P 500 Index and the Lipper Equity Income Funds Index of similarly managed funds, respectively. (Returns for the Advisor and R Class shares were lower, reflecting their different fee structure).
On June 25, 2013, your Board of Trustees declared a second-quarter dividend of $0.13 per share, which was paid on June 27. You should have received your check or statement reflecting this distribution. The second-quarter dividend brings the total for the year to date to $0.26 per share. (Second-quarter dividends were $0.11 and $0.10 for the Advisor and R Class shares, respectively.)
Several portfolio holdings performed very well in the first half of the year, while a smaller number were disappointing. Technology positions, including Microsoft, Cisco Systems, and Hewlett-Packard, were particular bright spots. Consumer holdings such as Time Warner, Walt Disney, Ford Motor, and Avon also performed well, as did our handful of holdings in the retail sector. Pharmaceutical stocks, including Pfizer, were strong, and we were pleased with the results from several of our larger holdings in the financial services sector, such as American Express, Wells Fargo, JPMorgan Chase, and SLM. (Please refer to the fund's portfolio of investments for a complete list of holdings and the amount each represents in the portfolio.)
A few weaker sectors lagged the broad market advance. The energy, telecommunication services, and utilities groups gained ground but at a slower pace than most other S&P 500 sectors. Hess was a welcome exception in energy. Most of our investments in the lagging sectors moved higher but trailed the broad market. Our most disappointing energy holdings shared a common theme: exposure to the mining industry. As concerns about the pace of global economic growth intensified, particularly in emerging markets like China, our positions in Cliffs Natural Resources, Newmont Mining, and Joy Global were negatively affected. Fortunately, these composed relatively small positions in the portfolio. The Major Portfolio Changes table on page 8 shows the stocks in which we were active buyers and sellers during the first half of the year. We initiated positions in Apple (NASDAQ:AAPL), Joy Global (NYSE:JOY), Hospira (NYSE:HSP), and Western Union (NYSE:WU), all of which had stumbled in the eyes of investors, resulting in sharply falling share prices before we decided to invest in them. Consequently, the companies' stock valuations became more attractive to us. We normally favor companies whose share prices have declined because of cyclical worries, sector concerns, or company-specific issues. When a stock falls in value, its price/earnings ratio usually declines while its dividend yield increases, characteristics we look for as value investors. The strategy can be rewarding as long as the company's fundamentals are still sound.
When we decide to sell a position, it is usually for the opposite reason: A company's rising stock price makes its relative valuation less compelling. The companies we eliminated or reduced positions in have appreciated. They included Thermo Fisher Scientific, Whirlpool, SLM, Ingersoll-Rand, ConAgra, Energizer, and Amgen. The valuations of those stocks became extended, and we took advantage of the opportunity to sell shares and invest in companies with more attractive relative valuations. Our sales were based on share price valuations and did not reflect our views of the quality of the companies mentioned.
In our annual report at the end of 2012, we commented on the likelihood of moderate economic growth in 2013, reasonable stock valuations, and the potential for investors to allocate more assets to the equity market as sentiment improved. Through the first half of 2013, we experienced the moderate growth we anticipated, as well as a reallocation of funds from low-yielding fixed income markets into reasonably valued equities. As we look forward to the second half of the year, we expect a somewhat more challenging investment environment as ongoing moderate economic growth dampens the pace of earnings growth.
Stock prices have advanced sharply over the last four years. Investor sentiment is likely to be affected by the rhetoric coming out of Washington, with increasing focus this fall on the debate over a continuing budget resolution and an increase in the federal debt ceiling. Investors will also be following news emanating from Europe and from the larger emerging markets, such as China and India, for indications of the level of economic growth in those regions.
We will continue to seek out promising investments with attractive dividend yields and appealing valuations, but there are fewer opportunities available now than there were six months ago. Therefore, we anticipate more modest returns over the balance of the year as we apply our investment strategy to achieve attractive long-term results for our shareholders.
As always, we appreciate your continued confidence and support.
Brian C. Rogers President of the fund and chairman of its Investment Advisory Committee
July 18, 2013
The committee chairman has day-to-day responsibility for managing the portfolio and works with committee members in developing and executing the fund's investment program.
Risks of Investing in the Fund
Value investors seek to invest in companies whose stock prices are low in relation to their real worth or future prospects. By identifying companies whose stocks are currently out of favor or misunderstood, value investors hope to realize significant appreciation as other investors recognize the stock's intrinsic value and the price rises accordingly. The value approach carries the risk that the market will not recognize a security's intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced.
Glossary Beta: A measure of the market risk of a stock showing how responsive it is to a given market index, such as the S&P 500 Index. By definition, the beta of the benchmark index is 1.00. A fund with a 1.10 beta is expected to perform 10% better than the index in up markets and 10% worse in down markets. Usually, higher betas represent riskier investments. Dividend yield: The annual dividend of a stock divided by the stock's price. EBITDA: A measure of earnings before interest, taxes, depreciation, and amortization that is used to focus on a company's liquid cash flow. Earnings growth rate—current fiscal year: Measures the annualized percent change in earnings per share from the prior fiscal year to the current fiscal year. free cash flow: The excess cash a company is generating from its operations that can be taken out of the business for the benefit of shareholders, such as dividends, share repurchases, investments, and acquisitions. Lipper indexes: Fund benchmarks that consist of a small number (10 to 30) of the largest mutual funds in a particular category as tracked by Lipper Inc. Price/book ratio: A valuation measure that compares a stock's market price with its book value; i.e., the company's net worth divided by the number of outstanding shares. Price-to-earnings (P/E) ratio—current fiscal year: A valuation measure calculated by dividing the price of a stock by its reported earnings per share from the latest fiscal year. The ratio is a measure of how much investors are willing to pay for the company's earnings. The higher the P/E, the more investors are paying for a company's current earnings. Price-to-earnings (P/E) ratio—next fiscal year: A valuation measure calculated by dividing the price of a stock by its estimated earnings for the next fiscal year. The ratio is a measure of how much investors are willing to pay for the company's future earnings. The higher the P/E, the more investors are paying for the company's expected earnings growth in the next fiscal year .
Price-to-earnings (P/E) ratio—12 months forward: A valuation measure calculated by dividing the price of a stock by the analysts' forecast of the next 12 months' expected earnings. The ratio is a measure of how much investors are willing to pay for the company's future earnings. The higher the P/E, the more investors are paying for a company's earnings growth in the next 12 months. Projected earnings growth rate: A company's expected earnings per share growth rate for a given time period based on the forecast from the Institutional Brokers' Estimate System, which is commonly referred to as IBES. Return on equity (ROE)—current fiscal year: A valuation measure calculated by dividing the company's current fiscal year net income by shareholders' equity (i.e., the company's book value). ROE measures how much a company earns on each dollar that common stock investors have put into the company. It indicates how effectively and efficiently a company and its management are using stockholder investments. S&P 500 Index: An unmanaged index that tracks the stocks of 500 primarily large-cap U.S. companies
The views and opinions in this report were current as of June 30, 2013. They are not guarantees of performance or investment results and should not be taken as investment advice. Investment decisions reflect a variety of factors, and the managers reserve the right to change their views about individual stocks, sectors, and the markets at any time. As a result, the views expressed should not be relied upon as a fore - cast of the fund's future investment intent. The report is certified under the Sarbanes-Oxley Act, which requires mutual funds and other public companies to affirm that, to the best of their knowledge, the information in their financial reports is fairly and accurately stated in all material respects