As of December 31, 2016, the net asset value per share (“NAV”) of the Parnassus Fund – Investor Shares was $44.97, so after taking dividends into account, the total return for the year was 13.46%. This compares to a gain of 11.94% for the S&P 500 Index (“S&P 500”) and a gain of 10.25% for the Lipper Multi-Cap Core Average, which represents the average return of the multi-cap core funds followed by Lipper (“Lipper average”). In a volatile year for the stock market, the Parnassus Fund – Investor Shares performed very well, beating the S&P 500 by 1.52% and outpacing the Lipper average by more than three percentage points. We trailed the S&P 500 for most of the year, but we didn’t panic, because we believed that sooner or later the market would recognize the value we saw in our securities. We’re pleased that our patience and conviction paid off.
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. You will notice that we’re ahead of both benchmarks for all time periods. Most striking is the ten-year number, where we have gained an average of 9.66% per year, which is 2.73% per year ahead of the S&P 500 and 3.72% per year ahead of the Lipper average.
Company Analysis
Seven companies each contributed 100 basis points or more to the Parnassus Fund’s return this year, while only two subtracted 80 basis points or more from the return. The Fund’s weakest performer was Perrigo (PRGO, Financial), the leading producer of store-brand generic drugs, as its stock plummeted 42.5%, from $144.70 to $83.23, cutting 103 basis points from the Fund’s return. The shares sank in April after longtime CEO Joe Papa resigned to become the CEO of Valeant Pharmaceuticals. The stock continued to move lower throughout the year as the company cut its earnings guidance three times, from nearly $10 per share to just $7. The business underperformed due to declining prescription generic drug prices and soft growth from Omega, Perrigo’s European business. We sold our position during the year due to our concerns that the prescription generic pricing environment would get worse and that it would take longer than expected to fix Omega.
Our other laggard was Gilead (GILD, Financial), a biotechnology firm that makes therapies for HIV and Hepatitis C. Gilead sliced 98 basis points off the Fund’s return, as its stock declined 29.2%, from $101.19 to $71.61. The stock dropped due to weakness in the Hepatitis C business, as pricing came under pressure due to increased competition, and the patient population fell because Gilead’s drugs cure patients of this damaging disease. The stock is on the bargain table, and the company has a strong balance sheet and a proven track record of innovation, so we increased our position throughout the year.
The Fund’s best performer was Applied Materials (AMAT, Financial), the semiconductor-equipment manufacturer. The stock soared 72.8% during the year, from $18.67 to $32.27, increasing the Fund’s return by an astounding 216 basis points. Demand accelerated for the company’s equipment, spurred by the transition in NAND-flash memory architecture from planar to 3D and the adoption of organic light-emitting diode (OLED) screens in smartphones. Investors celebrated, as new orders and product backlog both hit all-time highs and the company forecasted more growth at its analyst meeting in September.
Micron Technology (MU, Financial) was right on Applied Materials’ heels, adding an amazing 215 basis points to the Fund’s return, as the stock raced higher by 54.8%, from $14.16 to $21.92. It was a rollercoaster year for Micron, as prices of its main product, dynamic random access memory semiconductor chips (also known as DRAMS), were falling sharply to begin the year. DRAM chips are commodities, and their pricing is volatile, going up sharply when demand exceeds supply and dropping suddenly when the balance tilts in the other direction. We invested because production capacity growth had slowed below demand, and we were confident that DRAM prices would eventually rise. Sure enough, in the second half of the year DRAM prices rose sharply, and we’re enjoying the upside.
International Business Machines (IBM, Financial), one of the world’s largest providers of information technology solutions and services, rose 20.6%, from $137.62 to $165.99, contributing 119 basis points to the Fund’s return. The stock moved higher as investors became more optimistic about the company’s transformation from a stodgy old provider of mainframes to an exciting trendsetter in data analytics, cloud software and cognitive solutions.
Trimble (TRMB, Financial) makes GPS positioning and precision-measurement products that increase the efficiency of construction workers, farmers and truck drivers. The stock soared 40.6%, from $21.45 to $30.15, increasing the Fund’s return by 107 basis points, as Trimble returned to earnings growth despite a downturn in all three of its end markets. A number of new products and the increasing adoption of the company’s software programs boosted revenue, while a renewed focus on cost management expanded margins.
Cummins (CMI, Financial), the diesel-engine manufacturer, boosted the Fund’s return by 104 basis points, as its stock gained 55.3%, from $88.01 to $136.67. We sold our position in the spring, when the stock shifted into high gear after Cummins’ 2016 earnings guidance, as management’s execution on its cost-cutting initiatives offset a cyclical downturn in truck sales.
John Deere (DE, Financial), world-renowned for its big green tractors, added 102 basis points to the Fund’s return, as the stock climbed 35.1%, from $76.27 to $103.04. The stock ploughed ahead, as Deere’s 2017 financial guidance exceeded expectations, giving investors hope that earnings have bottomed after three years of declines. Farmers coping with low crop prices have put off investing in equipment, but eventually they’ll need to buy new tractors. When they do, Deere’s earnings should move higher, so we’re holding onto our shares.
Charles Schwab (SCHW, Financial), the San Francisco–based bank and brokerage firm, rose 19.9%, from $32.93 to $39.47, contributing 101 basis points to the Fund’s return. Schwab’s earnings on its bank assets and money market funds move up and down with interest rates. The stock spent most of the year underwater, as interest rates fell and central bankers in Japan and Europe pushed their rates into negative territory. The tide started to turn in July, however, as the U.S. economy improved and interest rates rose. Schwab’s stock jumped as rates surged even market is fully valued, it won’t necessarily go down. It can stay fully valued for a long time without dropping significantly lower. The robust economy, combined with Mr. Trump’s proposed policies, could cause an acceleration in corporate earnings, which could push the market even higher.
We’re excited by how the Parnassus Fund is positioned as we turn the page to 2017. Two of our largest overweight sectors, relative to the S&P 500, are financials and information technology. We expect rising interest rates and fewer regulations to boost bank earnings and push their stocks higher. Within the information technology sector, we own a collection of competitively advantaged businesses with strong growth profiles that trade at compelling valuations.
As always, you can count on us to do what we know best—search for great businesses to invest in at bargain prices. We have a long list of stocks that we monitor, and any weakness in the market should make some of these stocks go down, which should provide us with some exciting opportunities.
Yours truly,
Jerome L. Dodson Robert J. Klaber Ian Sexsmith
Lead Portfolio Manager Portfolio Manager Portfolio Manager
