The letter below was printed in February 2010 as a Letter to Shareholders in the Eagle Capital Growth Fund, Inc. (NYSE MKT: GRF) 2009 Annual Report:
Dear Fellow Shareholders,
For 2009, the Eagle Capital Growth Fund's net asset value (NAV) increased slightly over 24%. At the risk of being repetitive, we note that we measure investment performance by looking at NAV---not the stock price. Over an extended time period, the Fund stock price should mirror the changes in NAV.
We lost a little ground to our S&P 500 (total return) index benchmark, which appreciated 26.5% during the year. Set forth below is a chart which compares the Fund's NAV to the S&P 500 (total return) index since the beginning of 2000.
During 2009, companies with weak balance sheets and/or poor operating performance, many of whom were left for dead early in the year, performed best. Our focus has been, and will continue to be, on platinum-quality companies with fortress-like balance sheets, strong operating results and quality management. Johnson & Johnson (NYSE: JNJ) and Colgate-Palmolive (NYSE: CL) fit the bill for "our" kind of companies. We are not interested in investing in low-quality companies, even at the risk of underperforming for a period of time.
There is an extraordinary phenomenon in business, where some industries tend to be quite profitable for long periods of time while companies in other industries eke out small profits in good years and incur large losses in bad years. Profitable industries are characterized by patent or trademark protection on products, lack of price competition, and high returns on assets. Unprofitable industries tend to compete on the basis of price, have generic products, and accept low returns on assets. In evaluating suitable companies to invest in, we single out certain industries to avoid. One example of a 'bad-for-shareholders' industry is the airline industry.
The International Air Transport Association, an airline industry trade group, recently predicted that the performance of the worldwide airline industry should improve significantly in 2010----net losses should only be $5.6 billion, a big improvement over the $11 billion in net losses predicted for 2009.
We're amazed that investors continue to put money into an industry when the combined results are so horrific. It is not as though the airlines have had their heads stuck in the sand---they continue to cut costs and invest in more fuel-efficient aircraft. Unfortunately, the principal drivers of industry performance (e.g., huge ongoing capital expenditures, excessive reliance on fuel costs, difficult unions and intense competition) haven't changed materially during the past decade, and are unlikely to change materially in the future. The names of the competitors may well be different a decade from now, but the poor financial performance is virtually certain to be the same.
Our assessment of the airline industry is one of the hallmarks of our investing philosophy. We completely avoid industries with poor economics (e.g., the airline industry, the auto industry, etc.); they are not worth a moment of our time. There are plenty of profitable industries. There's too little time to sort through competitive industries for the one possible standout; we're dedicating our time and money to the fruitful industries, where it's difficult not to generate profits.
We talked about our then-recent investment in Alcon (NYSE: ACL) in last year's Semiannual Report. Fortunately (or unfortunately), Alcon shares rocketed up during 2009 and ultimately reached a level where this great company was, in our view, fully priced. It was painful to say good-bye to such a great company, but once the valuation gets to nose-bleed levels, we start looking for the exit.
We appreciate your ongoing support and confidence. We will strive to continue to earn it.
We love hearing from our shareholders, subject to the ground rules that we've previously laid out: we can't discuss what security or securities we've sold, nor can we discuss what companies we're thinking about buying. With those few caveats, everything is fair game.
Luke E. Sims David C. Sims
February 15, 2010