Client Letter - 5/16/05

May 16, 2005

To Our Investors and Friends:

In recent weeks, we have watched with considerable interest the continuing financial decline of the U.S. automobile industry. It is hard to imagine that the vast debt obligations of General Motors and Ford are now rated “junk” by Standard & Poor’s. Yet, given our investment discipline, i.e. our requirement for each company’s internal rate of return on invested capital (ROIC) to exceed its cost of capital, this makes perfect sense. The auto industry (along with several others, such as airlines) has historically been unable to produce ROIC that even approximates their capital costs. That kind of underperformance, literally the destruction of value over many years, can ultimately only result in failure.

The reverse of this situation, i.e. owning only companies that consistently produce superior ROIC, gives us a great deal of confidence, even in the kind of lackluster market we are currently experiencing (the S&P 500 Index is down 4.8 % year-to-date and down 18.8 % for the last 5-years). History (plus our own investment results) has shown us that companies which consistently create value for their shareholders outperform the market, over time. For this reason, as well as our long-term confidence in the USA, we are comfortable being nearly fully invested, at this time.

This is not to say, of course, that we are unconcerned about U.S. macro-economic trends. Steadily increasing fiscal and trade deficits, as well as historically low saving rates, have created a virtual certainty that something (namely interest rates) has eventually got to give. As rates increase, coupled with higher oil prices, several areas of the economy, such as autos, housing and some retailers, are likely to experience a downturn, despite the fact that the current micro-economic climate, including such things as employment and capital spending, may stay reasonably strong.

Because of these concerns, we continue to position ourselves defensively within our overall ROIC strategy. For example, we have significant positions in food companies, dividend-paying companies, and companies that provide a hedge against a weakening U.S. dollar. As the year progresses, we may sell certain positions, either to lock-in profits, redeploy capital in more defensive, dividend-paying names, or simply to increase cash, allowing us to be opportunistic. Overall, however, it is our intention to remain substantially invested in companies meeting our ROIC criteria.

As always, we welcome your observations and/or questions.