Ron Baron Second Quarter 2014 Shareholder Letter

“This company could survive for a long time without its CEO. It couldn’t last through lunchtime without its welders.” Mogens Bay. Chairman and CEO. Valmont. May 2014.

On average, three to four corporate management teams visit us every day. Management meetings provide us with context about businesses that we research and in which we invest. These meetings also enable us to ask questions about long-term strategies, growth opportunities, challenges and competitive advantages. As importantly, they give us a chance to qualitatively assess management talent and personalities. That may be what is most important of all and in keeping with our mission statement, “we invest in people.”

A large part of stock market volume is comprised of short-term traders who own stocks for a few months, weeks, days, seconds, milli-seconds or nano-seconds. Accordingly, we get managements’ rapt attention when we tell them we manage $26.8 billion; our firm has an average investment holding period of six to seven years; and, our largest fund, $8.3 billion Baron Growth Fund, invests in businesses for on average nine years! What we think deserves the attention of Baron Funds’ shareholders is not only that we invest for the long term, but that over the long term, Baron Funds have performed better than the benchmark indexes against which we are compared. You can see this from the performance charts on pages 10-14 immediately following the “Letter from Linda.”

Ron Baron: Recent visit by Valmont Chairman and CEO is a case in point

I nearly always find something relevant and memorable in management meetings I attend, whether in our office or theirs. A recent visit by Mogens Bay, Chairman and CEO of Valmont Industries, Inc. (NYSE:VMI), a diversified industrial company, is a case in point. We have had a modest sized investment in Valmont since 2009. We have since about doubled our money.

We think Valmont’s towers business will benefit from increased spending by utilities on more efficient electricity transmission and is well-positioned to grow. This is because the Federal Energy Regulatory Commission, in order to reduce our country’s energy consumption, has granted utilities significant incentives to invest in transmission.

We believe Valmont Industries, Inc. (NYSE:VMI)’s world leading irrigation business is also exceptionally attractive and poised for growth. With the world’s population expected to increase 30% by 2050, there will be increased demand for food. The world cannot meet its crop requirements without irrigation. This is because irrigated farmland provides better yields. Only 20% of cultivated agriculture worldwide is irrigated. Center pivot irrigation uses the least water, a scarce resource, and produces the best yields. Valmont has a 45% share of center pivot irrigation systems in North America and is increasing its share in the rest of the world. Center pivot irrigation has also been steadily increasing its current 56% share of irrigation.

Ron Baron on Mogens Bay’s visit

When Mogens visited us recently to provide an update, he mentioned that he tries to visit all of his firm’s more than 100 worldwide plants regularly. When he does, he always talks to his factory workers. When I asked whether he has prepared remarks or speaks from the heart, he told us it was the latter. He explained that “the culture of a business is what’s important.” He said that he wants his general managers to be entrepreneurs “who are passionate about what we do…make highways safer, protect the environment, don’t cut corners and commit to continuous improvement.” Mogens went on to say “with plants around the world, somewhere someone is doing something wrong.” He finds ‘Can I show you what I do?’ an effective way to communicate and train. “You need to look yourself in the mirror every day and make sure you don’t need to look down. It’s all about how you treat your employees and customers. How you expect people to behave.” Mogens then remarked that “you need to show people that you respect them and care about them.” To make that point, he frequently tells his fellow employees that Valmont “could survive for a long time without its CEO. It couldn’t last through lunchtime without its welders.”

Valmont Industries, Inc. (NYSE:VMI)’s home office is in Omaha, Nebraska. Omaha also happens to be the home of the world’s most prominent investor. When Mogens finished updating us, I remarked that “there must be something in the water” in Omaha. Mogens is an individual I think about when I tell our investors that “we invest in people.” It’s too bad we don’t have a larger investment in his business, I thought. It’s also too bad we didn’t invest earlier. If we had invested in 1993, we would have earned 16.6% compounded annual growth for the past 21 years. The S&P 500 Index earned a compounded annual return over the same period of 9.4% per year.

“I am very uncomfortable with current valuations of stocks.” Joseph Stiglitz. Economics professor. Columbia University. 2001 Nobel Memorial Prize in Economic Sciences. July 7, 2014. Dow Jones 17,000.

Ron Baron on stock market prediction

During my 44 year investment career, I have known many brilliant investors, analysts and regulators. I have not met any, however, able to consistently predict how stock markets will perform. For example, in 1996, then Fed Chairman Alan Greenspan thought stock prices were “irrationally exuberant.” The Dow Jones Industrial Average was then 6,000. Highly regarded Yale economics Professor Irving Fisher in the autumn of 1929, shortly before the market crashed, thought “stock prices have reached what looks like a permanently high plateau.” Many institutional and individual investors today agree with Professor Stiglitz’s view that stocks are expensive. Perhaps influencing their judgment is that they may not have owned stocks as they rebounded from their low point during the Financial Panic that ended in March 2009. They, as a result, continue to hope for a decline to give them another chance.

To provide you with historic perspective on stock valuations, U.S. stock prices have increased less than 26% from their peak levels nearly seven years ago in 2007 and less than 30% from their peak levels in March 2000,over 14 years ago.* In contrast, U.S. stock prices over the past century have doubled about every 10 years. Stock valuations at present approximate 16 times earnings. That is the median level for the past hundred years. Stock prices are based on many factors. Among them are interest rates and our economy’s growth prospects. Interest rates have never been lower in the history of our nation. Low interest rates make stocks more valuable. If investors expected rates to remain at present levels, stock multiples would now be much higher. Further, our economy is steadily growing; unemployment is steadily falling; and our nation is fast becoming energy independent. These are all good things. You can google other stock market predictions by well known investors over the years to see for yourself how accurate they have been.

By contrast, Warren Buffet, the most successful investor of our time, says that “I have no idea what the stock market is going to do. Not the faintest idea. We are not in that business.” He then remarked that, “If I had known in 1973 what would happen in 1974, I never would have bought stocks in 1973.” Buffett did invest in 1973. The Dow Jones

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