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Letters to Investors
July 11, 2003
Suncoast Equity Management (SEM) performance results versus the Standard & Poor's 500 Index for various periods ended June 30, 2003:
| Time Period (Ended 6/30/2003) |
SEM % Return* |
S&P 500 % Return |
SEM - Value of $1,000,000 |
S&P 500 - Value of $1,000,000 |
| Six Months-Year to Date |
8.11% |
11.84% |
$1,081,100 |
$1,118,400 |
| One-Year |
3.91% |
0.32% |
$1,039,100 |
$1,003,200 |
| Three-Year |
-2.55% |
-11.20% |
$925,300 |
$700,100 |
| Five-Year |
5.76% |
- 1.62% |
$1,323,100 |
$921,800 |
Since Inception
(5 1/2 Years) |
8.59% |
1.48% |
$1,573,600 |
$1,084,300 |
*Composite results of all SEM managed accounts, net of all fees.
Note: Performance results for three-year, five-year and since inception periods represent the annual average rates of return. |
Effron/PSN's new manager rankings will not be released until August but you can review SEM's top 2% ranking as of year-end 2002 and current performance at www.SuncoastEquity.com.
America held its breath in mid March as we entered Iraq. By early April the country breathed a deep sigh of relief as Baghdad fell and the immediate events escaped a potentially horrific spike in global instability. As the uncertainty of Iraq dissipated, the stock market rebounded. Lower quality stocks with undesirable finances have led the way, yet as time passes we expect that earnings and quality will prevail.
Economic performance, not accounting performance, determines earnings quality and this is what matters most to the true investor. One of the popular measures of a company's progress is the accountant's calculation of earnings per share. Yet the reliance on this measure is one of the basic causes of poor performance. Earnings per share net of appropriate adjustments from a true-owners perspective equals free cash flow. Free cash flow is a more accurate contributor to economic performance.
Many investors rely on unadjusted earnings per share when valuing an equity investment and justify this practice by commenting that the "stock market" uses this measure of value. But this is a half-truth at best. As we discussed in our February 2003 letter, return on capital plays a most important part. A business with an above average return on capital and quality free cash flow is an economically superior investment.
To illustrate our point, lets compare two companies and assume we bought one share of each in 1993:
| 1993 |
International Paper (IP) |
Anheuser-Busch (BUD) |
| a) Price Paid (Avg Hi/Lo) |
$31.60 |
$12.95 |
| b) Net Cash Flow Per Share |
$1.04 |
$0.76 |
| c) Return on Capital |
5.4% |
14.9% |
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|
|
| Price to Net Cash Flow (a/b) |
30.3 |
17.0 |
| Net Cash Flow Yield (b/a) |
3.3% |
5.9% |
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|
|
| 2003 |
|
|
| d) Current Price |
$36.12 |
$50.98 |
| e) Net Cash Flow Per Share |
$0.65 |
$2.35 |
| Return on Capital |
6.5% |
22.0% |
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|
|
| 10 Year Total Return |
|
|
| Price Change (d-a) |
$4.52 |
$38.03 |
| Dividends Paid (1994-2002) |
$8.76 |
$4.96 |
| f) Ten Year Total Return |
$13.28 |
$42.99 |
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|
|
| % Ten Year Total Return (f/a) |
42% |
332% |
| Annual Average Rate of Return |
3.6% |
15.8% |
| Current Net Cash Flow Yield (e/a) |
2.1% |
18.1% |
BUD has superior economics as compared to IP. Here are a few observations to illustrate this point: First, we adjusted accounting earnings per share to arrive at net cash flow per share, a more meaningful measure. Net cash flow per share adjusts for capital equipment purchases not accounted for in the accountant's calculation of earnings per share. As you can see over the ten-year period, IP's net cash flow per share has declined and BUD's has increased quite nicely.
Second, the true investor understands that the annual average rate of return to the investor mirrors the return on capital of the business. Note the very low return on capital for International Paper, of 5.4%, 6.5% respectively in 1993 and 2003, results in a minimal annual average return to the investor of 3.6%.
Finally, BUD, our superior company, boasts an increasingly higher cash flow yield, as we now receive $2.35 on that one share of stock we bought in 1993 for $12.95.
The Suncoast Equity Management-Disciplined Investment System focuses its efforts on owning a small collection of superior businesses. Overall consumer confidence is improving, though it ebbs and flows similar to business activity in the near term. Iraq is still a dangerous place (never forget the women and men still serving our country) and other global issues still remain. Notwithstanding, we remain positive and have never felt that near-term economic or political predictions have any value to the long-term investor.
Thank you for your interest and please call if we can be of service to you or someone you know.
Sincerely,
Donald R. Jowdy
President
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