As of March 31, 2016, the net asset value (“NAV”) of the Parnassus Fund - Investor Shares was $40.00, resulting in a loss of 1.14% for the first quarter. This compares to a gain of 1.34% for the S&P 500 Index (“S&P 500”) and a gain of 0.42% for the Lipper Multi-Cap Core Average, which represents the average return of the multi-cap core funds followed by Lipper (“Lipper average”). We’re off to a slow start this year, so we’ll have to work hard to catch up.
Below is a table comparing the Parnassus Fund with the S&P 500 and the Lipper average over the past one-, three-, five- and ten-year periods. Although the Fund is behind the S&P 500, we’re ahead of the Lipper average for the one-year period. The Fund is ahead of both its benchmarks for all other time periods. Most striking is the ten-year number, where we have gained an average of 8.82% per year, compared to 7.00% for the S&P 500 and 5.80% for the Lipper average. This is 1.82% per year ahead of the S&P 500 and more than three percentage points per year ahead of the Lipper average.
Company Analysis
Starting this quarter, we’re describing the impact of our winners and losers in percentage terms (or basis points, where one basis point is equal to 0.01%, or one one-hundredth of a percent). Previously, we gave you the impact on the Fund’s NAV in cents, but we think that percentages, i.e., basis points, will make it easier to understand. If you get confused, just remember that there are 100 basis points in one percent.
Five companies contributed 40 basis points or more to the Fund’s return this quarter, while four subtracted 40 basis points or more from the return.
Micron Technology (MU, Financial) was our worst performer, as its stock fell 26.1% from $14.16 to $10.47 and reduced the return by 114 basis points. Micron makes semiconductor memory chips, and its stock fell after weaker-than-expected demand for personal computers caused memory chip prices—and Micron’s earnings—to decline. This issue has been affecting the company for over a year now, and the stock has fallen dramatically from its peak of $36.49 in December of 2014. We don’t know precisely when memory chip prices will stabilize, but we’re confident they eventually will. Memory chips benefit from the long-term trends of increasing smartphone penetration in emerging markets; the proliferation of Internet-connected devices, such as watches, cars and industrial machines; and the rapid growth of data centers. Micron is now trading below its book value of $11.80, and we took advantage of the deeply discounted price to add to our position.
McKesson (MCK, Financial), the largest drug distributor in the nation, sliced 50 basis points from the Fund’s return, as the stock declined 20.3% from $197.23 to $157.25. The stock moved lower after management provided weaker-than-expected guidance due to weaker generic drug prices. McKesson also lost some drugstore customers, as several chains were acquired by firms using other distributors. Despite these headwinds, we expect revenue to recover through organic growth and attracting new customers. McKesson provides significant value to consumers by improving the efficiency of drug procurement and delivery, which we believe will generate shareholder value over the long term.
American Express (AXP, Financial), a global credit card company, saw its stock drop from $69.55 to $61.40, for a loss of 57 basis points. While the company beat earnings expectations this quarter, forward guidance for 2016 and 2017 were lowered. The company is facing a major headwind because of the loss of its co-branded Costco credit card portfolio to Citigroup. The company has also pointed more broadly to the increased competition in co-branded credit cards. To address these challenges, American Express is actively shifting its strategy to focus more on its lending business. Longer term, we believe the company will be able to continue to grow earnings by improving operational efficiency, buying back stock and finding a new avenue of growth through its lending focus.
Semiconductor manufacturer Intel (INTC, Financial) subtracted 40 basis points from the Fund’s first quarter return, as its stock dropped 6.1% from $34.45 to $32.35. The stock was down during the quarter because the company tempered its outlook of double-digit growth expectations for its largest business segment, the data-center group. Macroeconomic weakness hurt enterprise demand in that segment and caused lower revenue than management had expected. The company’s commentary for 2016 also included incremental caution across its businesses due to weaker market conditions in China.
Our biggest winner was Cummins (CMI, Financial), the diesel-engine manufacturer, which boosted the Fund’s return by 100 basis points, as its stock rose 24.9% from $88.01 to $109.94. Investors breathed a sigh of relief after the company’s earnings guidance for 2016 was not as disappointing as many expected. While the outlook for machinery and truck demand in 2016 is weak, the management team is executing on its restructuring and cost-cutting initiatives to weather the current cyclical downturn. The company also intends to return more cash to shareholders than in previous years through stock repurchases and dividends.
Applied Materials (AMAT, Financial), maker of equipment used in semiconductor manufacturing, added 74 basis points to the Fund’s return, as its stock jumped 13.4% from $18.67 to $21.18. The company provided an inspiring outlook, including 14% revenue growth next quarter and further strength in the second half of the year. Applied Materials also commented on its long-term optimism for the display business, as the industry is accelerating investments in new manufacturing technology, which should lead to more orders for the company’s equipment.
Trimble Navigation (TRMB, Financial) makes GPS positioning and precision-measurement products that increase the efficiency of construction workers, farmers and truck drivers. The company’s upbeat outlook for 2016 boosted the stock by 15.6% from $21.45 to $24.80, increasing the Fund’s return by 53 basis points. Trimble’s sales to farmers have declined over the past two years, but a number of new products, as well as the increasing adoption of the company’s software programs, are pulling this segment out of its slump.
International Business Machines (IBM, Financial), one of the world’s largest providers of information technology solutions and services, rose 10.1% from $137.62 to $151.45, adding 48 basis points to the Fund. The stock slumped early in the quarter after the company delivered weaker-than-expected earnings due to stiff currency headwinds and sluggish demand for its legacy software. However, the stock rebounded, as investors became more optimistic about IBM’s growth prospects related to its newer software offerings and the Watson Data Analytics Platform. Investor sentiment continued to move higher after IBM announced several strategic acquisitions, including a $2.6 billion purchase of a private healthcare analytics provider. We still see plenty of upside in the stock as IBM gains further traction with its high-growth software and analytics offerings, which should result in higher earnings in the future.
Motorola Solutions (MSI, Financial), a provider of communications services and networks for public safety workers, added 44 basis points to the Fund’s return, as its stock rose 10.6% from $68.45 to $75.70. Investors cheered the acquisition of Airwave, Great Britain’s public safety communications network, which will increase Motorola’s earnings by more than 20%.
Outlook and Strategy
The S&P 500 finished the quarter with a modest gain, but it took a wild ride to get there. 2016 began with a market decline of 11% to a two-year low, as investors worried that China’s economic slowdown, falling commodity prices and the rising U.S. dollar would push the U.S. economy into recession. But that didn’t happen, as the economy created an impressive 209,000 jobs per month in the first quarter and the stock market rallied.
We wrote last quarter that the stock market looked fully valued, but not overvalued. After this quarter’s modest gain, our view remains the same. However, the risks to the economic outlook have increased, and have caused the Federal Reserve to slow its pace of interest rate increases. After seven consecutive years of positive returns for the S&P 500, our outlook for the stock market has become more cautious. The extreme volatility during this quarter was a warning shot across the bow, and we’ve taken notice.
We’re stock pickers, and we don’t invest based on economic forecasts. Instead, this quarter we battened down the hatches to focus on our highest conviction ideas. We trimmed the Parnassus Fund from 39 stocks to 37, and the Parnassus Endeavor Fund from 28 to 25, and we took advantage of the opportunity to invest more in some of our favorite stocks at lower prices.
We’re invested in socially responsible businesses with sustainable competitive advantages, good prospects and low debt levels that are undervalued. Whether the market’s next move is up or down, we believe these stocks are well positioned to outperform.
Yours truly,
Jerome L. Dodson Ian Sexsmith
Lead Portfolio Manager Portfolio Manager
