To Our Shareholders, For the quarter ended December 31, 2013, the net asset value (“NAV”) per Class A Share of The Gabelli Value 25 Fund Inc. increased 8.4% compared with increases of 10.5% and 10.2% for the Standard & Poor’s (“S&P”) 500 Index and the Dow Jones Industrial Average, respectively. See page 2 for additional performance information.
Name Change – 2013
The Board of Directors approved a change to the name of the Fund, effective December 9, 2013, to The Gabelli Value 25 Fund Inc. The name change highlights the Fund’s overweighting of its core 25 equity positions and underscores the upcoming 25th anniversary of the Fund’s inception.
The fourth quarter provided a fitting end to a remarkable year. Despite recurring drama in Washington, recession in Europe, and turmoil in emerging markets, the U.S. equity market ended the year 170% above its March 2009 low, representing a compounded annual return of over 22%. Unfortunately, the past is little help in divining the future: stocks do not go up because they went up, and they do not go down because they went up. Stocks ultimately move because of changes in their fundamentals. Our job is to understand those fundamentals and balance the risk and reward of each stock selection. At any given moment, the market presents stocks that are cheap and those that are dear. Finding cheap stocks may be more difficult than it was five years ago, but this just means we need to dig a little deeper.
We are optimistic, as it appears for the first time in many years that the world is poised for a synchronized recovery. Indeed, the U.S. is entering its fourth consecutive year of expansion. The housing market is rebounding, job growth is slowly improving, and government policy, which heretofore probably has not added to growth, is unlikely to hinder the rebound as pre-election gridlock sets in. Even the geopolitical stage seems free of major conflict, though flashpoints throughout the Middle East, between China and Japan, and between Russia and its neighbors remain concerning.
The actions of the world’s central banks are also key to the nominal value of stocks. After Ben Bernanke’s eight-year run at the helm of the Federal Reserve, there is a new person – Janet Yellen – behind the curtain. By most accounts, Chairman Yellen is likely to continue the Fed’s current policy of monetary accommodation, even with the announced $10 billion reduction in its monthly bond purchases to $75 billion (i.e., the so-called “taper”). Whether in anticipation of the taper or due to other factors, rates did rise in 2013, with the yield on the benchmark 10 Year U.S. Treasury increasing from 1.76% to 3.03%.
As we have written here in the past, all else equal, increasing rates should reduce the price of risk assets, like stocks. The problems with this equation are that: (a) all else is never equal, i.e., an increase in economic growth should be able to outweigh any deleterious effect of rising rates and (b) the magnitude of a rate rise is likely to be small. Rates remain low compared with the 1960 – 2011 average on the 10 Year U.S. Treasury yield of 6.7%. Current rates still leave mortgages eminently affordable and stocks as a better alternative than cash or bonds. This also means that the hurdle rate for corporate activity, whether in the form of internal investment, share repurchases, or mergers and acquisitions, is relatively modest. Combining this with low organic growth but improving confidence, we think is a formula for robust M&A – an environment for which our style is particularly well-suited.
People + Process + Philosophy = Performance
We are often asked what makes us different, so at year end, we hold up a mirror to ourselves much as we might evaluate a prospective investment. Our success boils down to three factors:
People. We take great care in hiring, training and motivating (Y)our research team. These 30+ analysts hail from around the world but share a passion for stocks. We look for inquisitive and critical thinkers who can formulate and express an independent long-term view of their industry and its participants. Importantly, (Y)our team also includes a group of top-notch traders, client service and operational professionals.
Process. Over the 36 years our firm has been in business, we have institutionalized a repeatable methodology for gathering, arraying, projecting, analyzing, and communicating data about potential investments. We believe in old-fashioned hands-on research that includes company visits, plant tours, trade show attendance, etc. (Y)our analysts generate a lot of frequent flier miles. Along the way, they construct proprietary cash flow models and document their work in written reports that enhance accountability.
Philosophy. Our stock selection is based upon the principles first articulated in 1934 by the fathers of security analysis, Benjamin Graham and David Dodd. We contributed to the canon of value investing by introducing the concept of Private Market Value (PMV) with a Catalyst™. We define PMV as the price an informed buyer would pay to own 100% of an enterprise. The discount in the public price of a security versus its PMV provides us with “margin of safety,” as coined by Graham & Dodd in their seminal work, Security Analysis. We seek one or more catalysts – events or circumstances such as M&A, financial engineering, change in management, and change in regulation – that could drive the public price of a security closer to its PMV. Taken together, these elements, along with a patient and long-term bias, have allowed us to deliver superior performance. We may not outperform the market in every year, but we believe we can do so over an entire investment cycle.
Deals, Deals and More Deals
Worldwide M&A volume totaled $2.4 trillion in 2013, a decline of 6% from 2012. Fourth quarter worldwide volume was particularly disappointing, down approximately 30%. Despite this pause in deal making, the Fund benefited from a number of transactions in 2013, including Joh. A. Benckiser’s acquisition of D.E Master Blenders, Conagra’s purchase of Ralcorp, Media General’s (0.7% of net assets as of December 31, 2013)
merger with New Young Broadcasting, and Verizon’s announcement that it would purchase the 45% of Verizon Wireless owned by Vodafone (0.4%).
Financial engineering activity, on the other hand, was very strong, with 27 spin-offs completed in the U.S. and over 20 already announced for 2014. Among the 2013 spin-offs held by the Fund are News Corp. (0.4%) and CST Brands (0.4%). A key attraction of financial engineering, in our view, is that it facilitates future tax- efficient M&A. This dynamic adds to our conviction that 2014 will be a busier year for deals.
Let’s Talk Stocks
The following are stock specifics on selected holdings of the Fund. Favorable earnings prospects do not necessarily translate into higher stock prices, but they do express a positive trend that we believe will develop over time. Individual securities mentioned are not necessarily representative of the entire portfolio. For the following holdings, the percentage of net assets and their share prices stated in U.S. dollars or U.S. dollar equivalent terms are presented as of December 31, 2013.
The Bank of New York Mellon Corp. (0.5% of net assets as of December 31, 2013) (BK)($34.94 – NYSE) is a global leader in