As of March 31, 2019, the (“NAV”) of the Parnassus Endeavor Fund — Investor Shares was $34.19, so the total return for the quarter was 18.43%. This compares to 13.65% for the S&P 500 Index (“S&P 500”) and 13.14% for the Lipper Multi-Cap Core Funds Average, which represents the average return of the multi-cap core funds followed by Lipper (“Lipper average”). For the quarter, the Fund earned more than five percentage points more than the Lipper average and almost five percentage points more than the S&P 500. Below you will find a table giving the total returns for the one-, three-, five- and ten-year periods for the Fund, the S&P 500 and the Lipper average. We’re ahead of both indices for the three-, five- and ten-year periods. For the one-year period, we’re behind the S&P 500, but ahead of the Lipper average.
Our performance of over 18% for one period is one of the best we’ve ever had for a quarter. However, there’s more here than meets the eye. As most of you will remember, we lost 13.49% last year, so the 18.43% for this quarter cancels out last year’s loss and gives a nice gain for the past 15 months. What really happened is that late last year, most of our stocks were forced down far below their intrinsic value because of recession fears and the stock market sell-off. As fears dissipated this year, stocks returned to more realistic values—especially our stocks.
The lesson here is that the best time to invest is when other investors are not thinking clearly, and they sell stocks far below their intrinsic value. This is easier said than done. It’s difficult emotionally to buy stocks after they have had a big drop—even though it’s the best time to do it. Even I (speaking here as Jerry Dodson only) have concerns when stocks move sharply lower, even though I’ve been doing this for 35 years. I have to force myself to put aside my emotions, keep a cool head and make a rational calculation of a stock’s intrinsic value. If a stock goes down to a price less than two-thirds of its intrinsic value, it’s a buy. The stock may go down even further, so there’s no way to know where the bottom is. However, if one has made a correct calculation of intrinsic value, the stock will come back.
If you look at the previous table, you can see that the Parnassus Endeavor Fund has had a great long-term track record, so this may give you some comfort in difficult times.
First Quarter Review
There were seven stocks that each boosted the Fund’s return by more than 100 basis points. (One basis point is 1/100th of one percent.) There was no stock that decreased the Fund’s return by that amount, though one company subtracted 69 basis points from the Fund’s return.
That stock was Biogen (BIIB, Financial), a biopharmaceutical company. It sliced 69 basis points from the Fund’s return, as the stock plunged 21.5% from $300.92 to $236.38. (For this report, we quote total return to the portfolio, which includes price change and dividends.) Advanced clinical trials for Biogen’s new Alzheimer’s drug failed, prompting the drug’s withdrawal. The failure dashed the hopes of Biogen’s shareholders, scientists and society, which still grapples with this devastating and incurable disease. Despite the setback, we believe Biogen can recover based on the company’s leadership positions in the treatment of multiple sclerosis and spinal muscular atrophy. Both businesses generate strong cash flows that can support the stock.
Our biggest winner this quarter was also one of our most recent additions. Celgene (CELG, Financial) is a biopharmaceutical company focused on the treatment of blood cancer and inflammatory diseases. Its stock added 222 basis points to the Fund’s performance, as it jumped from $64.09 to $94.34, for a total return of 47.2%. The stock spiked when drug company Bristol Meyers announced plans to acquire Celgene for $74 billion, or about $102 per share, in cash and stock. Although some of Bristol’s shareholders later opposed the deal, Celgene’s stock got another boost when major proxy advisory firms came out in favor of the combination.
Hanesbrands (HBI, Financial), a leading manufacturer of undergarments and athletic apparel, contributed 177 basis points to the Fund’s return, as its stock rose from $12.53 to $17.88, for a total return of 43.8%. Hanesbrands had a strong finish to its fiscal year 2018, posting its highest quarterly sales growth in eight years and its first annual sales increase since 2014. Management noted continued strong growth of its global brand Champion, international innerwear growth, increased sales for underwear and shapewear in the U.S. and the expansion of its direct-to-consumer sales channel. The company also used its cash flows to pay down debt and expects to further reduce leverage in 2019.
Toy manufacturer Mattel (MAT, Financial) added 172 basis points to the Fund’s performance, as its stock rose from $9.99 to $13.00, posting a total return of 30.1%. Sales during the all-important holiday season were better than expected, and Mattel regained its position as the #1 global toy manufacturer in 2018, according to market researcher NPD Group. Management’s restructuring plan is also ahead of schedule, and profits increased significantly as a result. The shares soared to a high of $17.07 in February, as investors cheered the upbeat quarterly results. We were reminded that the road ahead remains bumpy, however, as the stock plunged after Mattel’s 2019 financial guidance didn’t meet investors’ recently elevated expectations. We were pleased by the green shoots that started to show this quarter, and we believe the bumpy ride will be well worth it in the end.
Semiconductor-manufacturing equipment-maker Lam Research (LRCX, Financial) contributed 172 basis points to the Fund’s performance, as its stock rose from $136.17 to $179.01, yielding a total return of 32.3%. Earnings beat investor expectations for the 21st quarter in a row, driven by strong growth in Lam’s base of installed equipment. Guidance also remained upbeat, despite a slowdown in shipments due to inventory digestion. We view Lam’s shares as attractively valued, especially because today’s technological advancements require device makers to pay more for their manufacturing equipment.
Micron Technology (MU, Financial) added 160 basis points to the Fund’s performance, as its stock climbed from $31.73 to $41.33 for a total return of 30.3%. The company makes dynamic random-access memory (DRAM) chips and other types of memory chips used in PCs, smartphones and data servers. Prices for DRAM continued to decline, yet the stock rose due to the company’s aggressive efforts to reduce industry overcapacity. Management also said that cloud customer inventory would normalize by the end of the year, suggesting that investors have been too pessimistic about the cycle. We like Micron, as strong demand from datacenters and the Internet of Things (IoT) should increase sales of its memory chips for years to come.
NVIDIA (NVDA, Financial) contributed 134 basis points to the Fund’s return, as its stock jumped from $133.50 to $179.53, for a total return of 34.6%. The company makes graphics processing units (GPUs), which are customized chips central to gaming, machine learning and autonomous driving applications. After a big sell-off in 2018, the stock rebounded sharply as investors looked past an inventory glut caused by a bubble in cryptocurrency mining. In March, NVIDIA bought computer networking company Mellanox Technologies to extend its reach in the growing data-center market. The deal’s sound strategic and financial merits sent the stock higher.
Applied Materials (AMAT, Financial) increased the Fund’s return by 128 basis points, as its stock soared from $32.74 to $39.66, yielding a total return of 21.8%. Applied Materials is the world’s leading supplier of manufacturing equipment, software and services for the semiconductor industry. Sales and profits came in better than expected, supported by strong industry demand drivers such as high-performance computing, artificial intelligence and big data. The long-term trajectory of the business remains positive and the stock is inexpensive, so we held on to our position.
Outlook and Strategy
With the market up 13.7% in the first quarter, as measured by the S&P 500, the stock market looks as if it’s close to being fairly valued. However, the stocks in the Parnassus Endeavor Fund are still trading far below their intrinsic value. The price/earnings (P/E) ratio of the S&P 500 is 19.9 based on earnings for the last 12 months, while the P/E ratio for the stocks in the Parnassus Endeavor Fund are trading at only 11.9 times last year’s earnings. This is an enormous difference, so it’s one indication that the Parnassus Endeavor Fund could outperform the market going forward, or at least it’s an indication that our stocks are selling at bargain prices compared to the market as a whole.
As we write this in early April, it looks like the U.S. and China will conclude a trade agreement. Clearly, that would be great for the economy and for the stock market. If there is no agreement, that would definitely be a negative. It seems that both countries have strong incentives to make a deal. In fact, China should be even more eager for an agreement, because they have the most to lose. They export around $500 billion a year in goods and services to us, while we only export about $150 billion to them. A trade war would hurt us, but it would hurt China even more, since millions of their workers are dependent on America consumers for their jobs.
Even though we at Parnassus follow international economic developments closely, they do not affect our investment strategy very much. It’s just not possible to predict the economic future with any degree of certainty. For example, if we thought there was going to be a trade war, the logical thing to do would be to sell stocks and hold a lot of cash. However, if a trade war did not materialize, the stock market would move higher, and we would be stuck in cash with very little return.
At the end of December, things did not look very good. The economy was not very strong, there was the possibility of a trade war and the stock market had dropped quite a bit. Had we decided to sell a lot of our stocks because of the dismal outlook, we would have missed the surprisingly strong market of the first quarter.
Our policy, then, is to remain as fully invested as possible. From time to time, you may notice that cash will build up in our portfolio. That’s not an indication of market-timing, it just means that we haven’t found a good place for that money. We don’t invest our money unless we can find stocks of good companies that are selling at bargain prices.
As the market moves higher, it becomes harder to find stocks selling at bargain prices. This forces something of a build-up in cash in the portfolio. When the market moves lower, there are more bargains around, so we can find enough stocks to become fully invested. This phenomenon is a hallmark of our investment style.
By the time this report goes out to you, the economic landscape could look very different. Even though financial conditions are changing all the time, these reports will give you some idea of how we think about investing and what we’re doing with the portfolio.
We would like to emphasize that we appreciate having you as shareholders, and we’ll do our best to give you a good return on your investment. Also, you should know that as portfolio managers, we have our own money invested in the Fund. Lead portfolio manager Jerry Dodson owns no individual stocks and only invests in the stock market through the Parnassus Endeavor Fund and the other Parnassus Funds. We eat our own cooking, and our interests are aligned with yours.
Yours truly,
Jerome L. Dodson Billy J. Hwan
Lead Portfolio Manager Portfolio Manager
