Bill Nygren (Oakmark Fund) Third Quarter Commentary to shareholders
The Oakmark Fund increased 7% during the past quarter, which brings the gain to 27% for the fiscal year ended September 30. The S&P 500 gained 5% in the quarter and gained 19% for the fiscal year. While we are thrilled with these strong results, we remind shareholders that our style doesn’t typically lead to such dramatic outperformance in periods of broad market gains.
Looking back at the fiscal year, we outperformed a very strong 19% return for the S&P 500 with leading performance from the financials and information technology sectors. We still find these two sectors to be attractively valued, and they currently represent a combined 47% of our portfolio. For the fiscal year, 26 of the Oakmark Fund’s holdings gained over 30%, and only Apple declined by more than 20%. Despite Apple’s poor full fiscal year performance, it was one of the Fund’s top two performers for the third quarter, gaining 21%. After a period of skepticism surrounding the company’s ability to create compelling new products, Apple is once again experiencing strong demand for its recently introduced iPhones. We remain pleased that the company is allocating more of their $145B cash balance to share repurchases and dividends. Throughout the market, even as equity valuations have increased, we are still finding attractive opportunities in businesses with strong balance sheets, high free cash flow, and a management committed to return a substantial portion of excess capital to shareholders through dividends and share repurchases.
During the quarter, we eliminated positions in Boeing and Northrop Grumman as both approached our sell targets. We started new positions in Nestle and Qualcomm, which are described briefly below:
Nestle S.A. (NSRGY – $70)(NSGRY)
Nestle is a global leader in packaged foods with $100 billion of revenue and operations in over 70 countries. The company has more than 25 brands with sales over $1 billion, with leading market share in most of their product categories. With broad exposure to high-growth emerging markets, Nestle has enjoyed strong and consistent revenue growth. Like many of our holdings, Nestle generates more cash than they need to run the business, so the company has used a significant portion of its excess cash to repurchase shares and pay dividends. Over the past four years, Nestle has reduced their share count by over 10%. We think this is a high quality, stable business that deserves to sell at a premium, so we initiated a position when Nestle was priced at a discount to other global consumer products companies due to concerns about Europe.
Qualcomm Inc. (QCOM – $67)(QCOM)
Qualcomm is the global leader in wireless technology licensing and mobile device chipsets. Qualcomm has dominant market share in both businesses, and it uses the strong recurring cash flow from its licensing business to reinvest in its chipset business. The company owns intellectual property that defines many of the standards used for 3G and 4G wireless communication, which allows it to collect royalties from handset providers that license these ubiquitous standards. Qualcomm’s licensing business accounts for only a third of the company’s revenue, and it is often underappreciated. However, its licensing business has unusually high profitability and represents close to two-thirds of Qualcomm’s profits. The majority of the world’s mobile handset users are still using older 2G technology, which is not a focus area for Qualcomm, so when these customers upgrade to 3G and 4G, Qualcomm should be well positioned to enjoy robust incremental revenue. The company is also the leading provider of chipsets, which function as the brains for wireless devices. Qualcomm’s industry-leading product breadth and peer-leading R&D investment should drive the company’s chipset growth. We expect Qualcomm to earn over $4.50 per share in a couple of years, and after adjusting for $20/share of cash, this high-quality business is priced at a forward P/E of just 11x.
William C. Nygren, CFA