SECOND QUARTER HIGHLIGHTS
(August, 1999)
We are happy to report that there was a significant increase in the value of your portfolio during the second quarter. There are two main reasons for this increase. First, many of the companies had outstanding performances, such as: CPI Corporation, Electronic Data Systems, Equitable Resources, Galileo Corporation, Japan Funds, and Deb Shops. Deb Shops, specifically, has appreciated over the past year from $6.75 to its current price of $19. It is now approaching our sell point and we have been reducing this position accordingly.
Second, investors recognized how under-valued the small and medium-sized companies were relative to the S&P 500 index and other large-cap stocks. We have always maintained that while it is relatively easy to tell when companies are selling at a significant discount, it is very difficult to predict when and how long a stock will take to return to its fair market value. Stocks will eventually trade at their fair market value even though their current price can temporarily be discounted in the market due to psychology, misperception, temporary uncertainty or other non-fundamental reasons. It is for these reasons that we like to buy a company's stock during periods of change and maximum pessimism, because this is when you get the greatest discount to true value. This is the heart of our investment philosophy.
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There are many business reasons why stocks gravitate back to their fair market value. First, when the stock price of a company declines significantly below its fair market value, the executives who run that particular company and who know the value of its stock will buy back the shares because it is a good investment for the company. Second, these same insiders start buying the stock for their own personal accounts because they know the company is selling at a tremendous discount to its fair market value. Third, competitors realize that they can buy sales cheaper than they can create them from scratch by acquiring their competitor. Finally, knowledgeable investors, who have been watching the company, begin buying the stock as they see the value becoming recognized.
When all these events occur in a short period of time, the price of a stock can increase significantly due to these changes in investor psychology. During the second quarter, we experienced a major shift in investor psychology towards small and medium-sized companies.