lountzis asset management annual letter 2013

8/12/2019 Lountzis Asset Management Annual Letter 2013

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February 15, 2014

RE: 2013 YEAR-END REVIEW

The stock market had one of the strongest years in its history in 2013 continuing itsstrong performance since the equity markets hit bottom in March 2009.

A breakout of the performance for the past two years of the S&P 500 and Dow JonesIndustrial Average, both with dividends reinvested, is given below

Stock Market Index 2013 Performance 2012 Performance

S&P 500 32.4% 16.0%Dow Jones Industrial Average 29.6 10.1

Performance of Key Holdings

Below is the breakout of the performance of our largest holdings in 2013, which followeda strong performance in 2012.

% Change % ChangeCompany for 2013 Company in 2012

Mohawk 64.6% Mohawk 51.2%

AbbVie Inc. 50.4 Lowes Companies 40.0TJX Companies 50.1 Thor Industries 36.5Thor Industries 47.6 TJX Companies 31.1Bed Bath & Beyond 43.6 Bank of New York 29.1Lowes Companies 39.5 Martin Marietta 25.0UnitedHealth Group 38.8 Wells Fargo & Co. 24.0Bank of New York Co. 36.0 US Bancorp 18.1Wells Fargo & Co. 32.8 Berkshire Hathaway 17.6Berkshire Hathaway B 32.2 Abbot Laboratories 16.5Progressive Corp. 29.2 Brown & Brown 12.5US Bancorp 26.5 Progressive 8.2Mercury General 25.3 UnitedHealth Group 7.0

Abbott Laboratories 24.7 Pepsico, Inc. 3.1Brown & Brown 23.3 Lab Corp 0.8Pepsico, Inc. 21.2 Washington Post -3.1Martin Marietta Materials 6.0 Bed, Bath & Beyond -3.6Lab Corp. 5.5 Mercury General -13.0World Fuel Services 4.8


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Our 2013 year-end review is longer than usual because we felt it was important todiscuss Berkshire Hathaway at length when Warren E. Buffett is no longer leading the companyfollowed by our thoughts on several topics raised by our clients and we close by discussing ourportfolio of holdings. We feel it is important for our clients to better understand ourthinking and we try to include the information that we would want if our roles werereversed. Our letter consists of several parts.

First, while we have shared our views on Berkshire Hathaway many times over theyears, we have never gone into detail about Berkshire Hathaways future when Warren E.Buffett is no longer leading the company. Given that Berkshire Hathaway is our largestholding, we feel it is appropriate to share our views in some detail.

Second, we discuss some of our concerns regarding the stock market includingsegments on: overall stock market valuation levels, valuation levels for smallercompanies, corporate profit margins, margin debt levels and the commoditization ofbusinesses.

Third, is our discussion of several positive factors that bode well for long-term

investors in stocks, despite current elevated market levels. These segments include: fewercompanies listed on U.S. exchanges, pension funds, and the overall stock allocation ofendowments.

Fourth, we discuss our views on several issues raised by our clients including thedomestic energy revolution, housing, inflation/deflation and income and wealthinequality.

Finally, we discuss our portfolio activity including sections on preferred stocks,municipal bonds and stocks.

THE FUTURE OF BERKSHIRE HATHAWAY WITHOUT WARREN E. BUFFETT

Berkshire Hathaway remains our firms largest holding and, while we have discussedthe company in the past, several clients have asked the question, What is the future ofBerkshire Hathaway should Mr. Buffett no longer be the CEO for a variety of reasons? Inresponse, we would like to share our thoughts on this unique enterprise and the irreplaceableand extraordinary Warren Buffett who created and continues to guide the firm.

As many of our clients may know, I have followed Mr. Buffett and Berkshire Hathawayfor over four decades, though with more insight over the past three decades. It has been anenormous privilege and pleasure watching him and Berkshire Hathaway evolve and grow in somany ways through the years. Today, Berkshire Hathaway represents the largest holding in ourclient portfolios, and we have never sold a share. As such a large holder on behalf of our clients,

I have tried to think deeply about Berkshire Hathaway both in its current structure, but evenmore importantly, to when Mr. Buffett is no longer the CEO, for whatever reason. I have tried tosummarize some of my key thoughts below without going into great detail, as to some of myconcerns regarding Berkshire Hathaway without Mr. Buffett. Despite these concerns which Idiscuss, I strongly believe Berkshire Hathaway is well positioned overall for a future without him.


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While I hope Mr. Buffett finds the Methuselah gene, which he has often referred to as itwould provide him another 885.5 years to live, and, if I find it, I will split the years with himequally extending each of our lives for 484.5 years. Based upon actuarial tables he will likely liveinto his early to mid-90s. I certainly hope it is even longer. I also believe a greater risk toBerkshire Hathaway than Mr. Buffetts absence, would be a deterioration of his capabilities,rather than his passing. However, he has given the Board approval to take away the keys if hebegins to lose his mental sharpness.

In Mr. Buffett there is embedded a broad and deep multi-dimensional set of skills thatare simply not found in any other single individual. As the founder, builder and controllingshareholder of Berkshire Hathaway, his values and vision have been deeply integratedthroughout the organization. Furthermore, his unique, set of multi-dimensional skills, along withhis history with the firm, provide him with an unparalleled capability to evaluate and assess themany subsidiaries, management teams and acquisitions. There are some deals, from thepurchase of entire companies, as well as one-off deals such as during the financial crisis, thatcome to Berkshire Hathaway exclusively because of Mr. Buffetts integrity, track record,reputation and so on, that will be irreplaceable.

Berkshire Hathaway remains an extraordinary company, with a Rock of Gibraltar

balance sheet, a collection of many world class businesses, stable and growing cash flows fromdiverse sources, and an outstanding team of managers leading many of its businesses.However, when Mr. Buffett (who is irreplaceable) is no longer the CEO, what will that mean forthe future of Berkshire Hathaway?

In assessing the future, I have tried to consider the historical evolution of both Mr. Buffettand Berkshire Hathaway to gain some insights as to how best to prepare for that future withouthim. In Ralph Waldo Emersons words, Every institution is the lengthened shadow of oneman.No organization better exemplifies that quote than Berkshire Hathaway. However, Mr.Buffett has done an outstanding job, fundamentally transforming the company over theyears so that today the company is far less dependent upon him than ever before inpreparation for when he is gone.

There are four areas of focus in my thoughts: corporate governance, leadership,operating structure, and valuation,each of which I will address.

Under Mr. Buffetts leadership, corporate governance has been exemplary on everycount as measured by evaluating the following four areas:

1. Rights and equitable treatment of shareholders and all stakeholders;

2. Role and responsibilities of the Board of Directors;

3. Integrity and ethical behavior;

4. Disclosure and transparency.

Given Mr. Buffetts demonstrated track record of excellence in each of these areas,Berkshire Hathaways corporate governance, while non-traditional, has been relativelyunchanged. Given BRKs current corporate governance, it will be more difficult to preventchanges in the future under new leadership due to government regulators and external forcesthat will not be as forgiving as they have been under Mr. Buffett. For example, BerkshireHathaways disclosure and transparency based upon the firms SEC filings, and annual reportsactually offer very little information relative to the enormity of the organization.


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Mr. Buffett has often indicated that his role will be broken into two separate functions: aCEO (management) and a CIO (investment). The Chief Investment Officer team will includeTodd Combs and Ted Weschler, both recruited over the past few years. Todd and Ted havedemonstrated outstanding investment skills combined with the personal characteristics thatBerkshire Hathaway seeks. Tracy Britt Cool joined the firm a few years ago and has helpedoversee several of the smaller companies in the Berkshire family. I believe that the investment

segment should consist of both an investment team (Ted, Todd, perhaps a 3rd

investor) and anoperating team (Tracy Britt Cool and another individual) that work closely together but havedistinct roles as required by Berkshire Hathaway. The investment team would focus on investingBerkshire Hathaways prodigious cash flows into equities, debt securities, the purchase of entirecompanies, both public and private, and assisting the subsidiaries in making bolt-onacquisitions. The operating team will be more internally focused on working closely with the topmanagement teams of many subsidiaries. The investment and operating teams will workcollaboratively to enhance the collective knowledge and improve Berkshire Hathawaysinvestment and operating performance. Furthermore, working together they may find new waysto enhance Berkshire Hathaways future cash flows and management depth. Having both atalented investment team (externally focused) and operating team (internally focused) withsome overlap will provide Berkshire Hathaway with a fuller complement of skills to better serve

the company in various ways.

The new leadership of Berkshire Hathaway and the many operating companies willpresent challenges going forward that cannot be understated. The new CEO will simply nothave the historical background, extraordinary set of skills, and broad freedom that Mr. Buffetthas appropriately gained from a multitude of experiences and constituencies over the years.However, with the collective synergies of a very talented group of leaders working together,Berkshire Hathaway can be expected to prosper and grow.

The operating structure of Berkshire Hathaway should be more formalized, whilemaintaining the unique corporate culture, decentralized operating subsidiaries and centralizedcorporate resources and cash allocation (above defined levels).

Finally, Berkshire Hathaways valuation remains below its intrinsic value as measured ina variety of different ways: float based model, two column approach, multiple of book value, orcombinations of these valuation methods. On September 26, 2011 Mr. Buffett instituted the firstrepurchase program in the companys history to buy back stock when it trades for a 10% orlower premium to stated book value. On December 12, 2012 this price limit was increased to1.2x book value and the company repurchased $1.2 billion of stock in one transaction. This haseffectively placed a floor on Berkshire Hathaways stock price which we believe remains farbelow intrinsic value. While I have mentioned several approaches above, my preferredapproach would be to value the float and then value each individual company within theBerkshire Hathaway family based on their individual financials, and the qualitativecharacteristics of each to determine their likely value to a rational private buyer. The result

would be a much higher price for Berkshire Hathaway than the current price or any of the valuesgenerated from the earlier methods discussed above or in the example illustrated below.

A sum of the parts valuation done by Keefe, Bruyette & Woods which utilizes a valuationfor the float and combines it with a valuation for the various operating companies using priceearnings multiples follows.


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With regard to Berkshire Hathaways valuation, we believe the company is clearly worthsignificantly more than its 1.3x stated book value or the valuation above. Both understate thevalue of many of Berkshiresoutstanding businesses as they are lumped together in segments.Furthermore, should acquiring companies be either strategic or private equity, the valuationscould be much higher given cost cutting and other synergies that could be achieved leading tohigher individual company valuations. Accordingly, we believe that Berkshire Hathawaysvaluation is significantly greater than the current stock price.

Lets assume that Mr. Buffett is no longer the CEO. Several changes will be made overthe ensuing year or so, with some immediately and others taking longer, but which will inevitablytake place.

First, a new CEO will be appointed. I believe that will be Ajit Jain with two backupcandidates. Second, the Board of Directors will be reconfigured over time. Third, several of theCEOs of subsidiaries will retire. Fourth, new CEOs and leaders will need to be chosen toreplace the departing CEOs. Fifth, a dividend will most likely be instituted to reduce the need toinvest the prodigious cash flow coming into headquarters. Sixth, while historically, divisionswere managed to generate excess free cash flow to send back to Omaha, going forward someof that free cash flow will be redirected toward building the enterprise via bolt-on acquisitionsand internal growth. Seventh, the stock price will probably decline 10-20% or more, which, in my

view, will present an extraordinary buying opportunity.

The new CEO will be managing more with a dividend focus and improving operationsinternally within Berkshire while also focused upon buying entire companies along with Toddand Ted. Mr. Buffett often states that his job is to allocate capital and determine thecompensation of the top management teams at the subsidiary level. I believe the new CEO willalso do both but in a more collaborative way with Todd, Ted and even other executives.


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Structurally, while currently many of the CEOs report directly to Mr. Buffett, the newCEO will need a more formalized structure to facilitate his (her?) ability to lead Berkshire. Thelarge subsidiaries such as BNSF, Iscar, Lubrizol, Marmon, Mid-American and Geico willcontinue to report directly to the new CEO. I have outlined a structure at the end of this letter asto how this might appear. The remaining companies need to be segregated and placed under aseparate group president. Segregated areas might be housing related companies,manufacturing and service firms, and retail operations, to name three. Some of this is already

being implemented by Tracy Britt Cool, but going forward I believe this would help the new CEOin dealing with the managers that oversee many of those businesses, rather than as with thecurrent structure where they all report to Mr. Buffett. The role of each group president will behaving several subsidiaries reporting to them, creating very little bureaucracy, yet still providingthe subsidiaries with a thoughtful executive from the outside to bounce ideas off of and toenhance their leadership. Each group president would have several of the 60 operatingsubsidiaries reporting to them and they will in turn report to the new Berkshire Hathaway CEO.This will enable Ajit, or whomever, to remain focused on the insurance operations, by simplifyinghis responsibilities with a minimal number of direct reports-the fewer the better.

My biggest concern relates to the new generation of operating subsidiary managementteams and keeping them in place. Many of the original managers that sold their companies to

Berkshire Hathaway were in unique positions, very different from those the next generation ofleaders will face. These original managers sold their firms to Berkshire Hathaway for manyreasons: avoid going public, avoid private equity which would need a liquidity event in the yearsahead (going public or sale), liquefying their wealth from the firm for cash to diversify and forestate tax planning purposes, maintaining autonomy, finding a permanent home, and beingknighted by Mr. Buffett an enormous honor. These original managers love Mr. Buffett for theseas well as other reasons. However, the new generation of managers will likely not feel the sameloyalty or, frankly, love for the new CEO that their predecessors felt for Mr. Buffett. We areconcerned as to whether the new management teams will remain as loyal to the new BerkshireHathaway as the prior leadership.

Despite Mr. Buffett being unquestionably the greatest investor who has ever lived and

given his excellent track record in choosing people, I believe that Todd and Ted were excellentchoices and will do a terrific job allocating capital in the years ahead. Certainly, they cannotreplicate Mr. Buffetts success given the anchor of size and the unlikely probability that, whilethey may be outstanding, they will not be as extraordinary as Mr. Buffett. I also think their roleshould include visiting potential Berkshire-like companies that fit into the Berkshire Hathawayprofile to learn about the respective businesses and also to build relationships with managementteams/owners of both public and private firms keeping their names at the top of the list shouldthat company decide to sell. Berkshire Hathaway is unique in many ways, including its financialstrength and quasi-permanent capital, providing the company with the capacity to do deals ofenormous size while still providing a unique blessing available to few investors -- the greatoption of doing nothing unless potential investments meet all of their parameters.

Todd and Ted along with the new CEO will work together on large acquisitions forBerkshire Hathaway of both private and public companies, while also assisting in searching forappropriate subsidiary bolt-on acquisitions. Historically, Berkshire Hathaway typically acquired100% ownership of companies. A few exceptions were Mid-American, Iscar and Fechheimer,where a portion of the equity was left in the business to incentivize management teams goingforward. I believe that it will be more common in the future without Mr. Buffett and I believe itwill be prudent for BRK to structure more deals this way so great leaders and managementteams can financially participate in what they are helping to build beyond just earning a salary,albeit a very generous one. I believe that the investment team would benefit from traveling to


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meet companies both public and private to learn more about their businesses and to meetmanagement teams always building relationships in the process, which could yield solidacquisition opportunities over time. There is nothing like meeting people in person to build uponrelationships and to learn about businesses, and Berkshire Hathaway should place a greateremphasis on this kind of ongoing focus. Major banks and brokers structurally define suchactivities as an important means of staying in touch and generating new prospects. BRK couldand should implement some sort of similar ongoing program.

Historically, many of the Berkshire subsidiaries were managed to maximize free cashflow to send to headquarters. Going forward they will be more focused upon using that free cashflow to invest in internal capital projects and bolt-on acquisitions before sending excess freecash to headquarters. This represents a meaningful change for many of the management teamsrequiring a broader set of skills in building and growing an enterprise rather than just managingfor free cash flow to send to Omaha.

Can the new leadership at Berkshire Hathaway continue to maintain the delicate balanceof decentralized operations at the subsidiary level and yet have companies work together incertain areas where there are mutual benefits? For example, will the furniture companies worktogether to gain advantages by leveraging their collective buying power in advertising, or buying

products-Jordan in the northeast, Nebraska Furniture Mart in the mid-west, RC Willey in thewest? Will they discuss operating capabilities that they can share in the form of best practiceswith their sister companies? For example, say a Berkshire company has installed SAP softwarewhich has resulted in better inventory control, expense management, and other strengths.Sees Candies has developed unique knowledge on handling part-time work forces. Is this beingshared with other sister companies? Will the various companies within Berkshire benefit fromthese best practices and utilize those to enhance each of their own operations? However, this isa very delicate balance that needs a few unique individuals to assure that the decentralizedculture is not adversely impacted in any way, being that this has been an important aspect tosustaining the magical Berkshire Hathaway culture. My sense is there are many areas, wheremoney could be saved if companies shared best practices and leveraged their buying power incertain areas, which would result in the creation of significantly increased excess cash flows.

Surely there will be important benefits from a greater emphasis on cross company collaboration.

I also believe that many of Berkshires strengths are not fully utilized by the operatingsubsidiaries as much as they could be, leveraging Berkshire Hathaways competitiveadvantages to the benefit of subsidiaries could present opportunities on several fronts from itsbalance sheet to issues raised above with sister companies learning and helping one another toimprove in various areas. What are the true benefits of being part of the Berkshire Hathawayfamily, and how will these be more fully utilized?

I remember interviewing Ed Schollmaier, the former CEO of Alcon Laboratories. In thatinterview Ed repeatedly mentioned the enormous benefits of being owned by Nestle, whosedeep pockets provided Alcon with the luxury of a long-term horizon, enabling the firm, to grow

and build its businesses without the short-term requirements of dealing with Wall Street. Today,Alcon is the dominant player in the eye care industry and leads in virtually every area in thatfield. Ed attributes their success to many factors, but among the most important has been themany benefits of Nestles ownership. How can Berkshire better exploit these types of benefitsfor its own subsidiaries? Certainly a great deal of this may already be in place, but I am sure itcould always be enhanced and improved.

I should mention Bill Gates as a member of the Board being one of the only individualsin the world with the global stature, reputation and intellect likely to play a key role as a potential


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chairman of Berkshire Hathaway working along with the non-executive chairman HowardBuffett. I expect Bill Gates will continue to play such a role in the BRK hierarchy given his age,love for Mr. Buffett and his desire to sustain Mr. Buffetts long term goals for the companyhelping to assure that Berkshire remains well managed, and presumably reflect a continuingescalation in the stock price. The higher the BRK stock price the greater the value of charitablecontributions of Berkshire Hathaway stock donated to the Bill and Melinda Gates Foundationwhich, in turn, will lead to positively impacting many more lives around the world.

Berkshire will announce the payment of a dividend after Mr. Buffett is gone, with animmediate and meaningful rise in the stock price given that many large institutional investorsand other investors that have mandates forbidding the purchase of non-dividend paying stockswill then be able to purchase the most solid dividend payer in the world. BRKs diverse set ofrevenue streams and Rock of Gibraltar balance sheet promise continued ability to sustain amajor dividend flow.

Berkshire Hathawaysunique culture is unlike any other business that I can recall overthe past 50 years. It remains to be seen if this incredible institution built by Mr. Buffett cansurvive him, and if so for how long, given that few if any past conglomerates have survived,including Teledyne, Gulf & Western, ITT and several others. While Berkshire is far different and

unlike any of these earlier conglomerates, there are many forces both internal and primarilyexternal that could lead to the potential possibility of a total or partial break-up of the company.While the probability remains low in the short term after Mr. Buffetts pa ssing, the possibilityrises years later for various primarily external reasons such as losing the controlling shareholderand many other large current stockholders that have remained very loyal in the past. A new andlarge short-term focused shareholder could be one example that could potentially present futurechallenges to Berkshire Hathaway, particularly if the firm is not performing as expected.

In the chart below, I briefly list a simple possible breakout of segments reporting directlyto Ajit Jain. This certainly has many variations for example the smaller companies area iscurrently or could be run by Tracy Britt Cool while the other three larger groupings could becombined into two rather than three. Nevertheless, I think the operating structure needs to besimplified for the new CEO as no individual can operate Berkshire Hathaway as Mr. Buffett has.


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In conclusion, BRK remains, in our view, perhaps the most compelling anddeserving holding in almost any long-term portfolio, with or without the extraordinaryleadership it has enjoyed throughout the reign of Warren E. Buffett.

Stock Market Valuation

Over the past 16 years, since 1997, the U.S. equity markets have fluctuated a great deal

with significant volatility, as illustrated in the table below.

S&P 500 Index at Inflection Points

As the table above illustrates, there were three distinct periods, beginning in 1997 andending in 2013 with stock market values rising 106%, 101% and 173%, respectively, withdeclines of 49% and 57% in between. We are not market prognosticators and we are notpredicting another precipitous decline. However the above table illustrates this volatility, whichhas been common in the stock market over the past 16 years. One must remain mindful of thatgoing forward.

Several stock market valuation measures for the S&P 500 index and how they compareover multi-year periods is given below.


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Overall, the stock markets recent rise since the bottom in March 2009 has been broadand deep, as illustrated in the following table.

Returns and Valuation by Sector

As the market has continued its rise, we continuously evaluate the growth in companyearnings and dividends, as well as the price earnings multiples applied to those earnings. Wealways become more concerned when the multiples expand faster than the growth in earnings,and that has begun to take place over the past couple of years. As the tables below show,stock market multiples have accounted for the majority of the increase in stock marketvaluations both domestically and abroad, far more than the increase in companyearnings. This situation is unsustainable for long periods of time. Going forward earningsneed to rise to continue to justify valuation levels.

Sources of Total Returns


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Mr. Buffett prefers that the ratio of stock market capitalization to GDP be in the 70-80%range, or lower. Historically, this condition has yielded outstanding long-term returns. Today,this measure is 109%, significantly above his preferred target range of 70-80%.

Valuation Levels of Smaller Companies

Our preference is to go wherever values are most attractive regardless of company size.

That said, we do prefer smaller companies for several reasons.

1. Companies with market capitalizations between $1 - $10 billion, are typicallyour sweet spot and represent the largest percentage of companies we own inour client portfolios. The reason for this preference is that these companies aresmall enough to have significant growth potential for years to come, while atthe same time having broad and deep management teams, product diversity,geographic diversity, and solid balance sheets. Often times much smallercompanies lack many of those components and much larger companies simplylack the outstanding long-term growth prospects.

2. It has been very difficult over the past few years to find smaller capitalization

companies that meet our valuation parameters. The tables below illustrate thatsmall capitalization companies are currently significantly more expensive thanlarger cap companies.

Nevertheless, while larger capitalization companies are more attractive on a valuationbasis, we will remain diligent in our search for high quality smaller companies patiently waitingfor them to come into our price range.


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Corporate Profit Margins

The two tables below illustrate that corporate profit margins are at all-time highs, havingrisen significantly throughout the recent economic recovery. The first table shows corporateprofit margins for the S&P 500 companies and the second table depicts after-tax corporateprofits in the third quarter of 2013 which topped 11% of GDP for the first time since recordswere being kept in 1947.

Two primary factors that have accounted for the large increase in corporate profitabilityare a significant reduction in net interest payments and a reduction in corporate income taxes,both as a percentage of sales, as illustrated in the table below.


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Below is a table that also illustrates the excess retail space we have in the United Statesrelative to the rest of the world.

Sears recently announced the closing of its flagship downtown Chicago store. Otherstore closing announcements include Macys and JC Penneys, as well as a reduction ofemployees at Targets headquarters in Minneapolis. Retail square footage may be reduced byone-third to one-half over the next decade.

These retailers will have to transform themselves from solid brick and mortar operationsto become adept on the Internet as an additional way to better serve all their customers. Irecently read that no indoor mall has been built in this country since 2006 and I dont know ifthat is accurate. Regardless, indoor malls are the ones facing the greatest challenges; evenmore so than stand-alone stores, strip malls, and outlet centers.

As Mr. Buffett so eloquently described in his 1999 Fortune article, The key tosuccessful investing is not assessing how much an industry is going to affect society, orhow much it will grow, but rather determining the competitive advantage of any givencompany and, above all, the durability of that advantage. The products or services thathave wide, sustainable moats around them are the ones that deliver rewards toinvestors.

Fewer Companies Listed on U.S. Exchanges

Interestingly, over the last 20 years, the number of companies listed on the U.S. stockmarket exchanges has declined significantly, as shown in the following table.


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The number of companies peaked in 1997/1998 at just under 9,000 and has fallen to4,916 towards the end of 2013. This supply/demand issue has had implications and perhapscontributed to rising stock prices.

In describing the significant decline in the number of companies listed on U.S.exchanges, the majority of the decline has come from mergers and acquisitions as shown in thefollowing table.

Pension Funds

Over the past several years, many corporate defined benefit pension plans went frombeing fully funded to 20-30% under-funded, resulting from the 2008 financial crisis. Fortunately,2013 was a strong year for corporate defined benefit pension plans, as strong investment

performance combined with higher discount rates has helped shrink the pension obligation andincreased the value of plan assets. This has resulted in a significant improvement in pensionplan funded status, as shown in the table below.


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It is estimated that the funded status of pension plans of the 267 companies in the S&P500 that provide detailed pension disclosure, rose by $328 billion to $94 billion underfunded(94% funded) at the end of 2013 from $422 billion underfunded (77% funded) at the end of2012.

We believe that stronger more fully funded pension plans will enable companies to

generate higher accounting earnings due to lower pension costs, positively impacting earningson the income statement, and reflecting lower pension liabilities on balance sheets. All thesefactors are positive for corporate America going forward into 2014 and beyond. This will result inmore free cash flow for companies to buy back stock, pay dividends, pay down additional debt,make acquisitions or re-invest internally when attractive opportunities present themselves.

Furthermore, investing in stocks remains a very attractive option for pension fundsgoing forward.

Stock Allocations

There has been a large reversal in the asset allocation of endowments over the past 10

years, as illustrated below.

We believe this shift of endowment assets from equities to alternatives including privateequity, hedge funds, timber, and other investments can present significant challenges. Whilealternatives can be an attractive asset class for those institutions that have the time horizon andthe balance sheets to deal with illiquid investments for many, many years. Liquidity, which isoften taken for granted, vanished during the financial crisis at which point many endowments

were forced to sell at bargain basement prices. Combined with their high fees, lack oftransparency, and long-term commitment of 5 10 years, as well as the illiquidity describedearlier, many challenges remain in these alternative asset classes.

We believe the decline in equity allocations will reverse in the years aheadresulting in rising allocations to stocks, with positive long-term implications for stockmarket investors.


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U.S. Energy Revolution

Daniel Yergin, the outstanding writer who wrote: The Prize; The Epic Quest for Oil,Money, and Power, for which he won the Pulitzer Prize, recently discussed how gas and oilcoming fromAmericas shale is fundamentally changing the global energy markets. This has a

broad range of implications for countries around the globe. Not only is it impacting coststructures in many industries, but also has a profound impact on global politics, such as

Americas role in the Middle East to name one.

U.S. gas prices today are a third of those in Europe and one-fifth of the price paid in Asiaresulting in significant competitive advantages for our country. Tight oil, which comes fromshale, utilizing the same technology as shale gas, has raised U.S. oil production 56% from just 5years ago and is larger than the output of two-thirds of OPEC countries. It is estimated that theUnited Sates will overtake Saudi Arabia and Russia in the years ahead and become the worldslargest oil producer. Furthermore, our need to import less oil has had a profound impact on ourbudget deficits. In fact, as the table below illustrates, federal deficits have declined from almost10% of GDP in 2009 to 4% in 2013 helped by a number of factors, including a slowly improving

U.S. economy, as well as a large reduction in oil imports. Hopefully, that will continue to benefitthe U.S. on many fronts.

I stated in my semi-annual letter that despite the many challenges we face the UnitedStates remains the best house in a much challenged global block. I particularly focused oninnovation in our country and how our unique ability to create and innovate has historicallypositioned us well throughout the world. The shale energy revolution is another shiningexample of American creativity and innovation, which is profoundly impacting globaleconomic and political power much to our benefit.

Housing

Despite weak sales of new homes in the month of December, the Census Bureaureported that annual sales of new homes for the full-year 2013 were up 16.4% from 2012.Thus, annual new home sales in 2013 of 428,000 were the highest level since 2008, as thefollowing table illustrates.


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Annual New Home Sales

Year Sales (000s) Change in Sales

2004 1,203 10.8%

2005 1,283 6.7%

2006 1,051 -18.1%

2007 776 -26.2%

2008 485 -37.5%

2009 375 -22.7%

2010 323 -13.9%

2011 306 -5.3%

2012 368 20.3%

2013 428 16.4%

Despite a solid 16.4% increase from 2012, the table above illustrates the significant falloff in annual new home sales from the peak in 2005 of almost 1.3 million to the bottom of only306,000 in 2011. Like the rest of the economy, housing continues to slowly improve, but likeemployment is still well below the peak levels achieved several years ago.

Despite the sharp increase in new home sales over the last couple of years from the lowin 2011, 2013 is still the sixth worst year for new home sales since 1963, as shown in the table

below.Worst Years for New Home Sales since 1963

Rank Year New Home Sales (000s)

1 2011 306

2 2010 323

3 2012 368

4 2009 375

5 1982 412

6 2013 428

7 1981 436

8 1969 448

9 1966 461

10 1970 485

11 2008 485


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Home prices across the United States at the end of the third quarter of 2013 were at thesame level that they had reached by the end of the second quarter of 2005, more than 8 yearsago. Only now are they rebounding to more normal historic levels. It is estimated that thenumber of shared households, as a percentage of total households (that rose to 24 million in2011) has declined to 23.5 million and will continue to decline as the unemployment rate for 25

34 year olds also comes down, as shown in this chart.

The Blackstone Group, a leading private equity firm, has spent almost $7.5 billionacquiring 40,000 homes in the past 2 years, creating the largest single family rental business inthe U.S. Blackstone has begun issuing bonds backed by lease payments generated from theselease rentals. It is estimated that Blackstone, along with hedge funds and other private equityfirms and real estate investment trusts, have raised over $20 billion to purchase as many as200,000 homes to rent over the past few years after prices plunged from the 2005 2006 peak.Demand for rentals has grown steadily, fueled by many that went through the foreclosureprocess, leaving large numbers that are unable to qualify for a mortgage, or those who simplyare not ready to settle in.


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The homeownership rate, which peaked at over 69% in June 2004, has declined to 65%today. It is anticipated to stabilize in the 62-63% range over the next few years, resulting in morethan 2 million households becoming renters. Wall Street continues with its innovative ways tocreate products, as securitizing rental cash flow is the newest Wall Street twist since thefinancial crisis in 2008. It appears there will be solid demand for these rental bonds given theirpayment of higher yields than government backed mortgages and other fixed-income

instruments. As with all securitizations, there are concerns with rental securitizations includingliquidity risk and operating risk. This new Wall Street phenomenon has been named theinstitutional buy-to-rent industry, which today approximates just under $20 billion in size and isestimated to reach over $100 billion within the next several years.

Inflation or Deflation

While we make no predictions regarding potential inflation or deflation and certainly donot make investments based on our macro views of inflation or deflation, we do seek outbusinesses that have the capability to raise prices in an inflationary environment, which appliesto only a few great businesses.

Recently in looking at personal consumption expenditures (PCE) which is the Fedspreferred inflation measure, the PCE price index had grown less than 1% in 2013, the lowestgrowth on a quarterly basis in inflation since 2009. In fact, many economists refer to the currentsituation based on this measure of PCE as disinflationary, as shown in the following chart.

The result is very tame inflation, even collectively below the 2% Fed target. Europe isalso experiencing deflationary challenges. Again, while we do not make any predictions, weremain concerned because deflation can lead to long-term downward spirals, as pricesof goods and services continue to decline with consumers waiting to buy at ever lower

prices. This can be very devastating for a country and, frankly, the entire world.

In a recent article from Morgan Stanleys former Asia-Pacific economist Andy Xie, hediscussed in detail issues related to deflation, specifically stating that while demand is local,supply is global, and that has had a profound impact on how economies work around the world,including our own U.S. economy.
http://4.bp.blogspot.com/-TUIQjGPYIg4/UuqfLlI5YLI/AAAAAAAAdqI/kuz43Uj6KS4/s1600/Quarterly+PCE.PNG


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While demand is and always has been local, the supply side has become genuinelyglobal, as both manufacturing based blue collar jobs and many white collar jobs can be placedanywhere in the world. With todays information technology, companies can employ peoplethroughout the world in research and development, marketing, accounting and finance, as wellas management, resulting in declining prices for most goods and services on a global scale.

Income and Wealth Inequality

Over the last couple of years there has been a great deal of discussion regarding a two-tiered economy, one for those well-educated and benefiting from the technological changesoccurring in our economy and around the world and the challenges faced by more traditionalareas such as manufacturing and blue collar jobs.

Two tables below illustrate the inequality in our society. The first compares the share ofincomeowned by the top 10%in the U.S., as well as several other countries, and the secondcompares the share of wealthowned by the top 10%in the U.S. and several other countries.

The tables above illustrate that the top 10% of income earners in the United States earn48% of our countrys income, while the top 10% in the U.S. control 74% of all wealth. Thisdisparity has been growing since 1970. In addition to the large disparity in wealth, real medianhousehold income in the United States has declined from $56,000 in the late 1990s to $51,000today, which is equivalent to the same real median household income achieved in 1989 asshown on the chart on the following page.
http://www.mybudget360.com/wp-content/uploads/2013/12/wealth-inequality.png


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Portfolio ActivityFixed-Income and Equities

During the year, we sold our long held Washington Post position and WestamericaBancorp.

Westamerica Bancorp is one of the finest banks in the country. However, the stock was

selling for 3.5x tangible book value and 19x earnings, both representing excessive valuationlevels. Furthermore, the net interest margin continued to decline from 5.11% over a year ago tounder 4% today. Finally, with no growth in loan volumes and limited opportunities in theinvestment portfolio, we felt it was time to sell at a gain of over 40% including dividends.

I discussed our sale of the Washington Post in detail in our last letter. Other sales werevery light trims of our Bed, Bath & Beyond, Brown & Brown, Mohawk, UnitedHealth Group andWells Fargo holdings.

We purchased U.S. Bancorp and Wells Fargo after they had declined in mid-2013, aswell as purchasing World Fuel Services and three bank preferred stocks that we believe presentan attractive risk reward for our clients, which I discuss in greater detail below.

Portfolio Activity - Preferred Stocks

We have purchased the preferred stocks of three outstanding banks with the specificsillustrated below.

Company Original Coupon Current Yield Adjustable Rate/Date (if not called)

US Bancorp 6.5% 6% 1/15/2022 3-month LIBOR + spread 4.468%PNC 6.125% 6% 4/30/2022 3-month LIBOR + spread 4.0675%Wells Fargo 6.625% 6.3% 3/15/2024 3-month LIBOR + spread 3.69%

Historically, preferred stocks have dated back to 16th Century England and they were

issued in the United States in the 1850s, later becoming a major financing tool in the 1980s usedby utilities. Over the past several years, financial institutions have been the biggest issuers.

What drove our purchase decision were several factors beginning with the excellentcredit quality of the banks. We have followed each of these three banks for over 20 years andhave significant stock ownership in both US Bancorp and Wells Fargo; two of the finest banks inthe world while PNC is also an excellent bank.
http://www.mybudget360.com/wp-content/uploads/2013/12/median-household-income.png


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We purchased these preferred stocks below, at, or slightly above par over the past year.The dividend payments on each of these at purchase were yielding approximately 400 basispoints above 10-year treasury obligations and also significant tax benefits. They also begin asfixed rate securities and convert to an adjustable rate if they are not called by the respectivebanking institutions. This rare adjustable rate feature reduces both interest rate risk and thesecuritys duration.

The key risks we identified here are: 1) they are perpetual securities with no maturity ormandatory redemption date, 2) credit risk, as they are junior to most securities other thancommon stock, 3) regulatory risk, as Dodd-Frank and other regulations may change, resulting inthe banks redeeming these securities early at par and, 4) tax law changes that may impact thequalified dividend treatment for these issues.

An important benefit for our clients with taxable accounts is that these dividendsrepresent qualified dividend income, or QDI, and are considered dividend income for federal taxpurposes, which is taxed at favorable capital gains tax rates. For most of our clients that will beeither 15% or 20%, which now includes an additional 3.8% tax from the healthcare bills medicalsurtax, resulting in rates of 18.8% to 23.8%. These rates are still well below the ordinaryincome tax rates exceeding 42%.

While historically most preferred stocks did not qualify for our purchase, we believethese three satisfy our rigid criteria and we have purchased them for accounts in which we feelwe can hold them until they are either called several years from now or adjust to the 3-monthLIBOR rate and the very favorable interest rates added to that. Furthermore, we have locked invery solid cash flows for our clients going forward for several years at rates much higher thanavailable from 10-year or 30-year treasuries with only minimally more credit risk. While each ofthese preferred stocks is currently selling at a 4-12% premium over our purchase price. Shouldinterest rates rise meaningfully over the next several years, they may trade at a discount to paror our purchase price, but we do not anticipate selling them then either. We simply focused onlocking in solid cash flows until they are either called or adjust to the very favorable adjustablerates mentioned.

Fixed-Income / Municipal Bond Purchases

The fixed-income markets remain challenging. After over 30 years of declining interestrates, virtually all fixed-income investments are yielding historically low yields including;Treasury Bills, Notes and Bonds, Municipals, Corporates, Agency and Mortgage BackedSecurities, Bank Loans and High Yield Securities.

Our primary focus in our fixed-income investments remains capital preservationand income secondarily. While rates of return remain at historically low levels, we areunwilling to either lower our standards in credit quality or take undue interest rate risk bypurchasing long dated maturities. As a result, during the year we purchased a number of

high quality municipal bonds. The maturities of all our municipal bond purchases were typicallyless than 5-7 years and the majority of our purchases carried call options which give the issuerthe ability to buy back the bonds earlier than their maturity dates. This call option featuresacrifices some yield in order to gain greater interest rate protection. The majority of ourpurchases of short duration municipal bonds are generating yields to maturity of as much as2.5%, however, if interest rates rise significantly and the municipal bonds are not called awayearly, the yield to maturity rises to over 4% resulting in taxable equivalent yields for many of ourclients of over 6%. With rare exceptions, we always hold our fixed-income securities tomaturity.


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BANK OF NEW YORK MELLON (BK) is a leading trust bank with assets under custodyand management exceeding $27 trillion. They are a global leader in several segments in whichit operates. Few competitors have their global reach and scale. Approximately 80% of itsrevenues are reoccurring and fee-based focused on institutional services with less reliance onthe higher credit risk from lending.

In 2013, BK generated operating revenue of $14.9 billion and pre-tax income of $3.7

billion. The banks results were helped by their continued efficiency initiatives which generatedover $650 million in annual savings. Low interest rates continue to negatively impact results asthey have over the past few years. The bank continues to work diligently on its initiatives to cutexpenses and selectively raise prices on many of its products. We believe the bank can earn$2.45 in 2014 representing a multiple of just over 13x earnings, while paying a 3% dividendyield.

BED BATH & BEYOND(BBBY) is the leading home furnishing retailer with just under1,200 stores. For fiscal year 2014, which ends February 28th, BBBY should generate revenueof just under $11 billion and earnings per share of $4.80.

While the stock price has declined from its high, we still believe the companys solid

balance sheet, excellent merchandising capabilities, improved focus on electronic commerce tobetter compete with the Amazon threat, will enable the company to continue to prosper as theleading home furnishing retailer in the country. The company should generate in excess of$900 million in free cash flow and, with no long-term debt on the balance sheet and $5/share incash, we believe the company remains well positioned to continue its leadership position in thehome furnishing industry.

BROWN & BROWN (BRO)is a leading insurance broker with an outstanding corporateculture that helps generate the highest margins in its industry. Net income for the 4thquarter of2013 was $47.2 million, or $0.32 per share, which was a 10% increase from 2012. Total 2013revenue was $1.4 billion, a 13.6% increase from 2012, while earnings rose 18% to $1.48 pershare.

After several years showing sparse growth, Brown & Brown has begun to groworganically while continuing to maintain the highest profit margins in the industry. In fact, duringthe 1997 to 2007 insurance cycle, Brown & Brown grew EPS at 20% per year but, since that2007 earnings peak, organic growth slowed significantly. In fact, 2012 and 2013s earningsgrowth was the best in several years and we believe earnings growth should continue in the 10-15% range over the next couple of years; helped primarily by acquisitions.

LOWES(LOW)is a leading home improvement retailer that generated revenues of over$53.4 billion in fiscal 2014 with net income of $2.3 billion. Diluted earnings per share should be$2.10 and we see that rising in 2015 to $2.60/share. The company continues to generatesignificant free cash flow exceeding $3 billion in 2013 providing for a solid dividend yield of just

under 2% and continued share repurchases. While Home Depot continues to perform betterthan Lowes, as measured by same store sales, we believe that Lowes will continue to improveits merchandising operations and continue to buy back significant amounts of stock and improveits performance relative to Home Depot. Lowes stock price appreciated 40% in both 2012 and2013 and we believe the stock price is nearing its intrinsic value. Lowes continues toaggressively repurchase stock and we anticipate that from the 1st quarter of 2011 with $1.3billion fully diluted shares, that by 2016 the number of shares will be under 800 million resultingin a buyback of almost 40% of their shares outstanding.


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MARTIN MARIETTA MATERIALS (MLM) is the second largest domestic producer ofconstruction aggregates and a producer of magnesium based chemicals and dolomitic lime.

Aggregates refer to the business of selling crushed stone, rocks and sand and is an attractivebusiness. It enjoys significant barriers to entry, including the challenges in gaining permits fornew quarries, as well as the low value to weight ratio of aggregates creating local oligopoliesthat enable solid pricing power. As I mentioned in prior letters, it is one of few businesses Ihave ever studied that have experienced enormous volume declines yet have been able to

continue to raise prices illustrating the power of their business model.

We believe that MLM is well positioned for solid growth in its largest markets, Texasrepresenting 19% of sales and North Carolina 17% of sales, for solid growth. Their top fivestates of Texas, North Carolina, Iowa, Georgia and South Carolina represent almost 60% oftheir 2013 sales. Sales in 2013 were $1.9 billion with operating earnings of $155 milliontranslating into fully diluted earnings per share of $2.61 on their 46 million shares outstanding.While MLMsstock price has appreciated over 25% in 2012 and 6% in 2013, we still believe thecompanys assets remain undervalued and the company will continue to generate attractiverevenue and profit growth as the undeniable need for infrastructure spending continues to grow.

MERCURY GENERAL (MCY) is the largest auto insurer distributing policies through

independent agents in California. They had a challenging but improved 2013.

Net written premiums in 2013 were $2.7 billion, up from $2.6 billion in 2012. While 2013was an improvement over 2012 for the company, we still believe the companys outstandingCalifornia franchise makes it an excellent acquisition candidate for several firms seeking togrowth their California operations. Furthermore, the companys excellent claims capability andsolid distribution throughout California should enable the company to return to its historicalexcellent underwriting results going forward.

We have enormous respect for George Joseph, an industry legend, who is now in hisearly 90s, and he, along with his ex-wife, control more than half of the 54.1 million sharesoutstanding.

MOHAWK INDUSTRIES (MHK) is a leading manufacturer of flooring products whoserevenues continue to increase as the economy and, in particular, the housing markets continueto rebound. Sales in 2013 should exceed $7.3 billion with net earnings of just over $400 million.

The company continues to aggressively make acquisitions, including the purchases ofMarazzi Group, the fifth largest producer by volume in the ceramic tile industry as well as Pergoand Spano. Combining Mohawks existing ceramic division Dal Tile with the Marazzi Groupcreates the largest ceramic tile company in the world on a revenue basis. Currently, about 9%of U.S. flooring consumption in value is made of ceramic tiles, a much lower percentage than inmost other nations around the world. In Western Europe, tile represents 30%, and in countrieslike Italy tile can exceed 55- 60%.

We anticipate continued improvement in the housing markets and in the U.S. economy.Mohawk sales should rise to approximately $8.1 billion in 2014 and generate net income of over$500 million or $7.10 per share.

PEPSICO (PEP)is the leading global snack and beverage company that manufacturesand markets a variety of salt and convenience snacks, carbonated and non-carbonatedbeverages and foods. The company operates through four segments: Beverages North

America, Frito-Lay North America, PepsiCo International and Quaker Foods North America.


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PepsiCos fourth quarter 2013 earnings were $1.05. This was better than expected withstronger than anticipated volume and top-line growth, as it attained its full year performanceobjectives. Revenues generated in 2013 were $66.4 billion and earnings before interest andtaxes of $9.7 billion and $4.32 in earnings per share.

We believe the company can generate in excess of $10 billion in cash flow in 2014 withover $7 billion in free cash flow. PepsiCos return on equity exceeds 26% with an attractive 3%

dividend yield. We continue to believe PepsiCo remains a solid long-term holding with a P/Emultiple of 17x 2014 earnings.

PROGRESSIVE (PGR) is the fourth largest auto insurer in the country and generatedrevenues of $17.4 billion in 2013 with operating income per share of $1.59. We projectProgressives net premiums written to exceed $18.2 billion in 2014 generating operating incomeover $1 billion and fully diluted operating earnings per share of $1.60.

UNITEDHEALTH GROUP (UNH)is a leading diversified managed health care companyserving 75 million individuals and operating through two segments: UnitedHealth care, andOptum. The UniteHealthcare segment serves employers and individuals, communities, states,Medicare and retirement. The Optum service businesses include Optum Health, Optum Insight

and Optum RX. Overall company revenues in 2013 exceeded $109 billion with earnings fromoperations of $8.9 billion and earnings per share of $5.50.

The UnitedHealth care Segment has the #1 market position in several areas including:Medicare Advantage, Medicare Supplement, Medicaid and are #2 in commercial insurance.Furthermore, the companysgeographic and product diversity serve to reduce business risk.

The Optum segment of UnitedHealth Group is a health services business serving thebroad health care marketplace, including payers, care providers, employers, government, lifesciences companies and consumers. Using advanced data, analytics and technology, Optumhelps improve overall experience and care provider performance. Revenues for the OptumSegments in 2013 were $37 billion with earnings from operations of $2.3 billion. Of the three

segments, Optum Insight is a leader in healthcare data analytics and generated earnings fromoperations of $603 million, representing a 19% margin. The company is projecting 2014revenues exceeding $128 billion and earnings from operations between $9.9 - $10.3 billion.

US BANCORP (USB) is one of the top 10 largest banks in the country with assets of$357 billion at year end 2013. The company has an outstanding credit culture, resulting in fewcredit losses and generates substantial fee income providing greater stability and predictabilityin its earnings. In 2013 the company generated $10.9 billion in net interest income and $8.8billion in fee income. Operating revenues were $19.6 billion and net income was $5.6 billion or$3.00 per share.

The companys financial metrics are among the best in the industry with a return on

common equity of over 16%, return on tangible common equity exceeding 23% and a return onassets of 1.6%. We believe US Bancorp is well positioned to continue to build upon itsoutstanding franchise both organically and through selective acquisitions in the years ahead.The company should earn in excess of $3.10 in 2014 representing a price earnings multiple of12.5x earnings-a favorable valuation for an outstanding diversified financial institution. Whileinterest rates remain low, when they do rise the bank is well positioned to grow its net interestincome and margins. Furthermore, with a large fee income stream the bank is better able toweather low interest rate periods than most competitors who lack such a large recurring feeincome stream.


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WELLS FARGO (WFC) is the fourth largest bank in the country with assets of $1.4trillion at year-end 2013. The company generated operating revenues of $83.8 billion in 2013with net income of $21.9 billion and reported earnings of $3.89 per share.

The company is a diversified financial services company operating in a broad range ofmarkets including the east and west coasts of our country, as well as several businesssegments including, banking, insurance, investments, mortgage, and commercial and consumer

finance through over 9,000 locations, 12,000 ATMs and the Internet. Wells Fargo, like USBancorp, also generates significant fee revenues providing a more stable and recurring revenuestream less impacted by the declining interest rates that have negatively impacted net interestmargins over the past few years. In 2013, the company generated net interest income after theprovision for credit losses of $40.5 billion while generating fee revenue of $41 billion. Netincome for 2013 was $21.9 billion or $3.89 per diluted share.

We believe that Wells Fargos diverse business model will continue to thrive in variouseconomic environments and will benefit when interest rates rise, augmenting the net interestmargin to once again exceed 4%; a level it has fallen below over the past several quarters.Nevertheless, Wells Fargo remains an outstanding financial services company generating areturn on tangible common equity of 17%, and a return on assets of 1.4%. The company also

maintains leadership positions in several businesses including a leading originator and servicerof mortgages. In fact, the company originates one of every three mortgages in this country.

Over the next several years in a more normalized interest rate environment, we believethat Wells Fargo can generate in excess of $5 per diluted share in earning power. We estimatethe company can earn in excess of $3.55 in 2014 and $3.80 in 2015.

WORLD FUEL SERVICES (INT) is a global leader in fuel logistics, engaged in themarketing, sale, distribution and financing of aviation, marine and land fuel products and relatedservices. The company provides one stop shopping for customers in this highly fragmentedindustry. World Fuel Services was founded in 1984 and in 2013 generated $41.2 billion inrevenue and $203 million in net income. We believe the company has a long runway to continue

to grow organically by expanding its customer base, geographic reach and additional productand service offerings, as well as through acquisitions.

While a legal issue resulting from a devastating rail accident transporting oil in Canadaremains a cloud over the company, we believe the companys insurance and strong balancesheet will be adequate to satisfy the legal claims. The company should generate earnings of$3.20 in 2014, representing a multiple of 14x.

We want to thank you for the privilege and opportunity to serve you and we are gratefulfor the confidence and trust you have placed in us. We will continue to work diligently seekingattractive investment opportunities with a primary focus on capital preservation and a secondaryfocus on achieving attractive rates of return. Wishing you a delightful springtime filled with

warmer days.

Sincerely,

Paul J. LountzisPresident

lountzis asset management annual letter 2013

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