2022 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 -18.11% including dividends in 2022. Our composite returned -8.29% (individual results may vary). Since inception on 01/01/2000, our composite has returned 432.29% vs. 304.13% for the S&P 500. That represents a compound annual return of 7.54% for the composite vs. 6.26% for the S&P 500 with dividends.

We suggested in last year’s letter that the combination of rising interest rates and Fed tightening would prove to be a major headwind to stock valuations (particularly for stocks with high price/earnings multiples) and that indeed turned out to be the case. While the S&P 500 returned -18.11%, the tech-heavy NASDAQ fared far worse with a return of -33.10% in 2022. In many of the more speculative areas of the market- often those characterized by active retail trading- the damage was even greater with losses of 70-80% in some individual issues. These types of losses are very difficult to rebound from; a loss of 70% requires a subsequent return of 333% just to get back to even. Put another way, after such a loss your portfolio would have to compound at an annual rate of 12.80% for a decade to return the original sum. Risk management matters.

It has been said that investing is simple but not easy. Although the statement may appear to be just an exercise in semantics, there is an important distinction. To be a good investor, it is important to understanding the language of business. And in business, that language is accounting. While one need not be a CPA, the ability to interpret a balance sheet, income statement and cash flow statement is a necessary skill. This skill can be learned and represents the “simple” component of investing. “Easy” is defined as something that can be achieved without great effort. When it comes to investing, that effort often involves overcoming our own impulses urging us towards activity. And those impulses are everywhere, from green and red flashing numbers to anxious commentary from leading financial news organizations. The amplification of price moves from a variety of sources and the ability to trade anytime on any device has made it more difficult to remain focused and disciplined. More than towering intellect or the ability to forecast with perfect precision (an impossibility) sales and earnings 5-10 years into the future, the ability to sit still counts for a lot.

I recently came across an interview with Bill Nygren, CIO for the Oakmark Funds, in which he described the role of an analyst at the fund. He commented that young analysts often thought their role was to build the perfect earnings model, when, in fact, the goal was to develop a conviction about when the consensus was wrong about something important and then seek to

quantify the valuation impact. We analyze securities in much the same way but have one important advantage over some of the larger funds. Because of their large size (the Oakmark Fund has $14.5 billion in assets) these funds are effectively limited to investing in larger companies. Most large publicly traded companies are covered by many analysts (Microsoft & Apple each have about 40). Many of the small and mid-cap companies we invest in have very limited coverage, if any at all. One of last year’s purchases- U-Haul- had but a single analyst following the company despite having a ubiquitous product and a market capitalization of almost $10 billion at the time of purchase. In this case, there was no need to challenge the consensus as none really existed. Opinions were as scarce as the number of analysts who were following the company. At a well-attended auction there are many bidders and plenty of price competition making it more difficult to buy at an attractive price. Sparsely attended auctions are the place to be if you’re shopping for bargains!

Of course, as Warren Buffett once famously observed “Price is what you pay, value is what you get”. In the case of the U-Haul Inc., we got both; a very attractive purchase price and business that has been able to compound capital at high rates. Most people think of U-Haul as a place to rent trucks and trailers, but over the last dozen years the company has quietly become the 3rd largest owner of self-storage space in the U.S. with over 78 million square feet of available space. The economics of the self-storage business offer extremely attractive returns and as the occupancy rate goes up on newly constructed units, operating income will as well. Based on our analysis of comparable public storage companies, the value of the storage business alone was enough to justify our purchase price leaving the 23,000 self-moving business locations with $1 billion in operating profits thrown in for free.

In addition to U-Haul, positive contributors to last year’s performance were energy companies including CNX Resources and Williams Companies. Detractors were Camping World Holdings, and the entertainment companies and home building/remodeling companies including Warner Brothers Discovery, Charter Communications, Liberty Broadband and Mohawk Industries. Except in cases where clients have requested tax-loss harvesting, we have not made any material changes to our ownership of the above companies. We typically sell when shares have reached our appraisal value or because our original evaluation of the underlying business value was wrong. With respect to the companies mentioned, we remain bullish on their prospects.

Stock prices often deviate by large amounts from their underlying business worth. This creates opportunities for both the enterprising investor and for managements with share repurchase programs in place. We look for, and own, companies committed to growing per share intrinsic value. Over the years we have been involved with excellent businesses that have excelled operationally at growing their sales and earnings but at the same time were continually issuing shares. Over time, earnings may have doubled, but so did the share count. This share issuance at prices below intrinsic value destroyed shareholder value. Despite the overall growth of the business per share value did not grow. Contrast the preceding with a management that aggressively repurchases shares at a very high internal rate of return (IRR) and you create an environment for rapid per share intrinsic value growth with the benefits accruing to the continuing shareholders. As a shareholder, you will have a greater ownership interest in that corporation (and of the overall profits) without having spent an additional dollar. Quite literally, something for nothing.

Although interest rates have risen materially over the past few months, by almost any valuation metric, the companies we own represent good value and we expect them to generate very satisfactory returns going forward. They have been purchased because their valuation was compelling, the underlying economics of the business was favorable, their managements were skilled capital allocators and perhaps most importantly, they view their shareholders as business partners.

A favorite aphorism is from Niels Bohr, the famous physics Nobel laureate, who said it was difficult to make predictions, especially about the future. This doesn’t seem to discourage the Wall Street prognosticators who begin each new year with forecasts on the direction of the stock market, interest rates, employment, recession, inflation, favorite industry groups, etc. While all these forecasts may make for entertaining viewing or reading, they rarely if ever provide actionable insights. We look for companies that can create value for their owners and expect to own many through a variety of business cycles.

Please feel free to contact us with any questions or comments. As always, we thank you for your trust and patience

Very truly yours,

Eckart A. Weeck
Senior Managing Director