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Holly LaFon
Holly LaFon
Articles (8057) 

Bill Nygren: Oakmark Fund Q3 Letter to Shareholders; Bought Corning Inc.

The Oakmark Fund decreased in value by 14% in the past quarter, bringing the Fund to -1% for its September fiscal year. The S&P 500 lost 14% in the quarter and gained 1% for the fiscal year.

Looking back at the full fiscal year, we slightly trailed a disappointing 1% return for the S&P 500. Nine of our holdings returned over 20%: Apple (NASDAQ:AAPL), Baxter (NYSE:BAX), Bristol-Myers (NYSE:BMY), Comcast (CMCST), eBay (NASDAQ:EBAY), Exxon (NYSE:XOM), Harley-Davidson (NYSE:HOG), MasterCard (NYSE:MA) and McDonald’s (NYSE:MCD). Those strong performers tended to have below-average exposure to economic cycles or had above-average dividend yields. One of our best performing sectors was technology, where gains averaged 9%. Technology stocks now comprise approximately 29% of our portfolio. Those of you who owned Oakmark during the technology bubble of 2000 will remember that we had no exposure to technology stocks back then. In 2000, technology stocks traded at huge valuation premiums; today they sell at large discounts. We have always been attracted to technology businesses, but our process is driven by value. At today’s prices, we believe that many technology companies are not just great businesses, but also great investments.

These strong performers for the year were offset by nine stocks that lost 20% or more: Aflac (AFL), Allstate (NYSE:ALL), Bank of America (NYSE:BAC), Bank of New York (NYSE:BK), Best Buy (BBY), Cisco (CSCO), EnCana (ECA), Federal Express (FDX) and JPMorgan (JPM). Unlike our winners this year, this group did have an industry theme – financials. Increasing regulatory issues and fear of a weakening economy made it a tough year for this industry. Our financial stocks were not only the poorest performers for our fiscal year, they also dominated the list of worst quarterly performers. Aflac, Allstate, Bank of America, Bank of New York, Capital One, JPMorgan and State Street all lost more than 20% in the quarter.

About 13% of the portfolio is invested in financial companies. We believed these companies looked cheap before they fell, and we believe they are even more attractive now. Though we believe our financial holdings are selling at large discounts to value, there are two reasons why we are not upping our investment to the much higher portfolio weighting that some of our value peers have.

First, we find many stocks across many industries to be attractively priced today. Most of those companies have more near-term ability to return capital to shareholders through dividends and share repurchase than financial stocks do. Adjusting for that fact makes them look almost as undervalued as our financial holdings. Second, because we explicitly adjust our returns for risk, we want to invest where the risk-adjusted returns appear greatest. The balance sheet leverage inherent in financial services creates a higher hurdle for our investment. If two stocks appear to offer similar returns, we will almost always prefer one with a cash-heavy balance sheet to one that is heavily leveraged.

Despite the quarter’s difficult environment, there were bright spots in the portfolio: Apple, Bristol Myers, MasterCard, McDonald’s and Google (GOOG) all increased in value. As in the broader market, our strongest performers were those stocks that appear to be less exposed to the risk of economic slowdown. For example, the utility sector, which appeals to investors desiring higher current yield and lower economic sensitivity, was the only sector that increased in value during the quarter. We didn’t own any utilities and are unlikely to add any, as we believe other sectors offer much better value.

During the quarter we took advantage of the market decline to do some tax trading. We took losses that more than offset gains we realized earlier in the year, which will likely eliminate the need to pay a capital gains distribution in 2011. During the quarter we also eliminated two positions: GlaxoSmithKline and Walgreen. Glaxo had increased in price and was approaching its sell target. We opted to sell Glaxo a little below its sell target to reinvest the proceeds in stocks that had fallen far below our buy targets. Walgreen also performed positively during the year, but we sold it because our business value estimate decreased as a result of the company’s escalating war with Express Scripts. Corning was the only new position added during the quarter.

Corning Inc. (GLW – $13)[b][/b]Corning is the world’s largest supplier of industrial glass. Its glass is used in products that include televisions, tablet computers, smart phones, telecom networks and automobile-emissions systems. The reason your iPhone screen doesn’t break as easily as the first ones did is that they now are made with Corning’s Gorilla Glass. In 2000, when Corning was the main supplier for new fiber-optic networks, the company had EPS of $1.23 and its stock reached a high of $113. Today, fiber optics has taken a backseat to glass for displays. Corning earned over $2 per share last year and should come close to that level again this year. Despite a more diversified business mix, the stock now trades at less than seven times earnings and at less than book value. We believe that price represents an attractive entry point for purchasing a worldwide leader in glass technology.

We thank you for your patience enduring a year of being stuck in neutral. As was addressed in the commentary section, we believe the stock market is attractively valued today and extremely so when compared to other investment opportunities. We again encourage you to look at your overall portfolio and restore your equity allocation to its appropriate level.

William C. Nygren, CFA

Portfolio Manager

Kevin G. Grant, CFA

Portfolio Manager

Average Annual Total Returns (09/30/11)

10–year 4.13%

5–year 0.93%

1–year -0.67%

Expense Ratio as of 9/30/10 was 1.11%

Rating: 2.6/5 (14 votes)


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