2021 Client Letter

Enclosed are the return calculations for your account(s). Where applicable, three, five, ten year and returns since inception are included as well. The S&P 500 returned 28.71% including dividends in 2021. Our composite returned 19.60% (individual results may vary). Since inception on 01/01/2000, our composite has returned 480.41% vs. 393.50% for the S&P 500. That represents a compound annual return of 8.32% for the composite vs. 7.53% for the S&P 500 with dividends.

While U.S. stock prices (as measured by major U.S. equity indices) enjoyed good performance in 2021, the new year has begun on a more challenging note. Interest rates, which had been near zero for short-dated bonds and only modestly higher for longer-dated issues, have begun to move up. At a news conference in late January, the chairman of the Federal Reserve, Jerome Powell, acknowledged that inflationary pressures were mounting, and the time had come to end the extraordinary support provided to the U.S. economy since the pandemic. As a practical matter we should expect several increases in the Fed funds rate and an end to the Fed’s bond buying; the era of free money seems to have ended. From an investment standpoint, we have no special insights into the magnitude or duration of the upcoming rate hikes, only that they will likely cause headwinds for stock valuations. Particularly vulnerable are those that are richly valued with far off earnings streams.

To understand why it is that high-multiple stocks are disproportionally impacted by higher interest rates, one can use a discounted cash flow formula. The present value of any business is the current value of future cash-flows. In order to obtain present value, future cash flows need to be “discounted”. When interest rates are near zero, future cash flows – no matter how far off – are as valuable as current ones, and thus stock price values – based on those far off cash flows – can become grossly inflated. This may account for the extreme valuation disparity between expensive stocks (those defined as having a price to sales multiple of 10X) and the cheapest quintile of stocks (also as measured by price to sales). By late last year the expensive cohort were worth $14 trillion versus $4 trillion for the cheapest. This valuation disparity is similar in scope to that of the dot.com boom of the early 2000’s. We wrote about the subsequent 78% peak to trough decline in the NASDAQ in last year’s letter and believe mean reversion is likely with respect to the high price to sales cohort.

A quick comment on speculative excess. The speculation referenced above concerning the dot.com boom was largely confined to internet related stocks. The current speculative frenzy has included meme stocks, NFTs (non-fungible tokens) and various crypto currencies. Since these

are assets that generate no cash flow, it becomes very difficult to assign a value, or even a possible range of values. Many advocates/promoters argue that there is a scarcity value assigned to these assets due to their limited availability. While we acknowledge the desirability and appreciation potential of famous artists’ paintings or sculptures, we remain skeptical that digital images of cartoon apes in various incarnations or individual tweets are durable stores of value. We will see.

Overall, our activity was relatively muted last year when compared to 2020. We exited our position in Evoqua Water Technologies with substantial gains and sold most of our position in Discovery Communications Inc. when the shares more than doubled in the early part of the year. After the sharp run-up, the shares experienced a sharp sell-off and then fell further following the announcement of the merger with Warner Media. We were able to re-establish a full position at very attractive prices and believe the future for the combined media company remains very bright.

A new position was established in Aramark Inc., one of the world’s largest providers of food & catering, facilities, and uniform services. Aramark was particularly hard hit by the pandemic shutdowns as it services many sports arenas and stadiums as well as food service for universities and colleges. We paid an average price just under $32 per share or about 12X our estimate of normalized 2023 earnings. We think food service outsourcing and the uniform rental business have long runways for growth and are encouraged by the new leadership and board members brought in late 2019 by the activist Mantle Ridge LP. Unfortunately, many of the new initiatives and operational improvements outlined by the new management were overshadowed with the arrival of the Covid-19 pandemic. Going forward, we expect to see accelerating business performance and a share price approaching pre-pandemic highs.

In addition to always being on the lookout for new ideas, we spend a lot of time reviewing our current holdings. This involves reading company financial filings, research reports, trade journals and listening to quarterly conference calls. This allows us to make sure our original investment premise is still intact, and that management has followed through on their previous articulated goals. It was while reading a trade journal that we came across some new and detailed information on a subsidiary of one of our core holdings, Berkshire Hathaway, Inc.

We have followed the company and its chairman, Warren Buffett, for over 35 years and have owned the shares (both for managed accounts and personally) for over 30. Although Buffett is widely thought of as one of world’s greatest investors, Berkshire is only followed by a few analysts. This is in part because the company rarely engages the big Wall Street banks for investment banking services and in part because the company doesn’t provide guidance or participate in quarterly conference calls. The attention that is paid to the company is largely on its investment portfolio of publicly traded securities and the decisions to buy or sell with respect to the portfolio. Rarely mentioned, except by Buffett himself in his annual letter, is the large and growing impact of one of the Berkshire subsidiaries, Berkshire Hathaway Energy (BHE).

In last year’s annual letter, Buffett highlighted one of BHE’s most important competitive strengths; unlike other utilities it pays no dividends on its common stock, allowing it to invest heavily in new transmission capabilities. Part of that investment – $18 billion- will go towards

rebuilding and upgrading the outdated energy grid that transmits energy throughout the western United States. Buffett had the following to say about the enormity of the project:

“BHE’s decision to proceed, it should be noted, was based upon its trust in America’s political, economic and judicial systems. Billions of dollars needed to be invested before meaningful revenue would flow. Transmission lines had to cross the borders of states and other jurisdictions, each with its own rules and constituencies. BHE would also need to deal with hundreds of landowners and execute complicated contracts with both the suppliers that generated renewable power and the far-away utilities that would distribute the electricity to their customers. Competing interests and defenders of the old order, along with unrealistic visionaries desiring an instantly-new world, had to be brought on board.”

Despite these large investments, BHE owned utility companies have some of the lowest electric rates in the country and enjoy generally good relationships with regulators. These investments will ultimately work their way into the rate base and will generate meaningful income for BHE and Berkshire for decades to come. We believe this asset has been largely ignored and underappreciated by the investment community. A link to the full 82-page presentation can be found here .

Although this letter began with commentary about the expected upcoming course of interest rates, we rarely try to forecast macro events or base our investment decisions on other people’s forecast. We have assembled what we believe to be a reasonably diversified portfolio of companies, at favorable prices, that should generate good returns over time.

As always, we thank you for your trust and patience.

Very truly yours,

Eckart A. Weeck
Senior Managing Director