Bill Nygren's Commentary on the Oakmark and Oakmark Select Funds; On Unilever (UL)

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Jan 13, 2011
The Oakmark Fund increased in value by 8% for the quarter ended December 31, 2010 and 12% for the calendar year. Although both are good absolute gains, both fell short of the respective 11% and 15% increases for the S&P 500 for the quarter and year.

Michael Jordan: “I’ve missed over 9,000 shots in my career. I’ve lost almost 300 games. Twenty-six times I’ve been trusted to take the game winning shot and missed. I’ve failed over and over again in my life. And that’s why I succeed.”

As a sports fan, this is an exciting time of year. Hockey and basketball seasons are nearing the halfway point. It’s bowl season in college football, leading up to next week’s BCS Championship game. In the NFL, the final week of the regular season is positioning teams for the playoffs, and most every game is life or death for some team. Emotions run high in all of these late-season football games, to the point that rules needed to be created to prevent excessive celebration. How tough was it to watch the player who, late in a bowl game and trailing by eight, caught a touchdown pass and saluted the crowd. His excessive celebration penalty made the potential game-tying two-point conversion almost an impossibility. Watching all of the celebrations, many of them by players on mediocre teams that were losing, got me to thinking that even the most successful value investors don’t get many opportunities to celebrate.

One of the reasons our celebrations are tempered is that we focus on long-term results. When we have a bad quarter, we ask our shareholders to focus on longer time periods, like a decade. So it would be hypocritical if, after a good quarter, we started waving the Oakmark foam finger. An additional reason we don’t often celebrate is that we have consistently articulated two goals – to achieve positive returns and to outperform the stock market. If you aren’t going to make money owning our mutual fund, then there’s no point in buying it. And if you aren’t going to make more money than you would have in an index fund, then our fund serves no purpose. You’ve often seen our reports that state “We achieved a good return in the quarter, but less than the market” (as in both the Oakmark and Oakmark Select reports this quarter) or “We beat the market but still lost money” (as in most of our reports for 2008 and early 2009). It’s quite infrequent that we get to say “We made you meaningfully more money last quarter than you would have made in an index fund.”

Using The Oakmark Fund as an example, over the past decade we’ve written 40 quarterly reports to our shareholders. Seventeen times we’ve reported that we lost money and 19 times we’ve reported that we underperformed the S&P 500. Since there was some overlap in those two groups, it left 12 quarters when we made money and we outperformed the S&P. If I set a slightly higher hurdle - one in which the Fund made meaningfully more than the S&P (with “meaningful” defined as a full percentage point) - only eight of 40 quarters qualified as winners. That’s like hitting .200 in baseball. The dreaded Mendoza Line is just one out away from a sure ticket to the minor leagues.

For value investors, much of the value we add is by protecting capital during down markets. We often don’t keep up with strong markets, but make up for it by losing less during market declines. As we’ve frequently said, expectations are typically quite low for companies we own, which means they don’t usually fall as much as the market does when times get tough. Nobody exchanges high-fives for losing less than the market, but that’s how our eight-for-40 record translated into a very good decade.

For the 10 years just ended, the S&P 500 provided investors with a total return of 15%. While that was way below its historical average, it was far better than the trailing 10 years looked at the end of 2009. By dropping the results from a weak 2000, when the Internet bubble popped, and replacing them with a strong 2010, the S&P’s 10-year performance at least turned positive. Over the same decade that the S&P returned 15%, The Oakmark Fund returned 74%. According to Morningstar, that put Oakmark in the 4th percentile of its peer group, meaning that our investors fared better than they would have in 96% of competing funds. There were a lot of chest-bumping football players who weren’t performing in the top 4%. Fully 38% of the 32 NFL teams make the playoffs, and 13% of the 120 NCAA football teams make its 16-team playoff. (Oops! Wishful thinking. Unfortunately, there isn’t a playoff yet, President Obama still has some work to do on that one, but at least his idea has bipartisan support.) A top 6% performance for an NFL team puts them in the Super Bowl. So, even though we are almost always frustrated with our performance, the end result has been a fist-pump-worthy decade for our shareholders.

We enter 2011 again positive on the outlook for equity returns. The current market price is still only about 13 times projected forward earnings, which is below the long-term historical average of about 15 times. Despite last quarter’s decline in the bond market (meaning yields increased), the S&P 500 dividend yield about matches the five-year government bond yield, which is historically unusual. Also, money-market cash remains high relative to the S&P 500 capitalization and corporate balance sheets are less levered than they normally are. We expect to see companies do more share repurchases, more dividend increases and more acquisitions. Putting their cash to productive use will, we believe, help drive positive earnings surprises. And we expect investors to begin selling bonds to buy domestic equities, reversing the flows that have created headwinds for equities for the past two-plus years. All of these factors lead us to the conclusion that today’s long-term investors will likely achieve higher returns in equities than they did in the past decade and higher returns than they could obtain in other investments. If we are right, when we salute our loyal shareholders, hopefully there won’t be a penalty flag for excessive celebration.

Have a Happy and Prosperous New Year,

Unilever (UL - $31)

Unilever is among the world’s largest packaged goods companies, selling home-care, personal-care and food products. Its well-known brand names include Dove, Lipton, Knorr and Ben & Jerry’s. With roots that go back to the 19th century, Unilever’s brands are well-known across the globe. Most appealing to us is the 50% of revenue it generates from emerging markets. This gives it the largest percentage among its peers in what have been, and what we believe are likely to continue being, the fastest-growing markets. Despite that, Unilever stock sells at only 13 times projected earnings for 2012, a discount to most of its peers. Unilever stock is down from a high of $38 at the end of 2007 despite EPS increasing about 20%. The stock also has an attractive dividend yield of 3.6%, meaning that owners of Unilever do not need to sacrifice current income to gain exposure to its attractive growth potential.