Dear Client:

Listed below are Suncoast Equity Management's (SEM) performance results versus the Standard & Poor's 500 Index for the period ended September 30, 2006:

Our performance perked up a little during the quarter and the stock market added to gains achieved earlier in the year. A hint of a slowing economy that is still on solid footing is the order of the day. This economic scenario is favorably received versus the alternatives, either an overheated economy with strong inflation or a strong drop-off in activity leading to a recession. Importantly, we remain resolute that the SEM-DIS portfolio, which we all invest in, remains very attractive in comparison to the overall stock market and versus fixed income yields.

Inflation fears began receding about 10 weeks ago with the news of housing finally slowing. Aiding the cause is the recent drop in oil prices and the fed official's decision to pause the rise of short-term interest rates. You might agree that the least surprising event in 2006 would be a general housing slow down, yet in spite of the national news and price corrections in severely inflated areas, many remain in denial as a visit to California and observations about our own Florida market would attest. Our suspicion is that we have further to go on the downside. The recent drop in the price of a barrel of crude oil to $63 from $77 in early August and lower prices at the pump have both a psychological and real effect on the pocketbook of the consumer.

For most of this year, investors continued to have an insatiable appetite for investing in commodities or the companies that produce them. What you may find amazing is that oil, gold, silver and copper have generated virtually no inflation-adjusted returns in over 100 years. As researched by some of our colleagues, copper in the $3.50 range today has dropped from $4.50 a pound in 1855. Since the introduction of the Consumer Price Index in 1921, gold has increased only 1.5% annually and silver has risen less than 0.5% per year since 1792. Oil's future will be interesting to watch because since 1869 oil has averaged $19 a barrel (in 2005 dollars) and sold as low as $10 in 1998. By comparison, the Dow Jones Industrial Average debuted in May of 1896 and has earned a 9.9% nominal rate and 6.3% annual rate of return in constant dollars.

Commodities in general have experienced boom and busts, not the growing patterns of intrinsic value through increased earnings and free cash flow. Many "experts" believe that the high values of commodities today can not be compared to those of the past because of the short history and magnitude of several emerging countries (China and India). Although we acknowledge this line of thinking (and only time will tell), it calls for great caution and can be quite risky.

Investing in commodity type assets falls under the "alternative investments" label and the most popular vehicle is the hedge fund. The short history of inflated commodity prices parallels the short operating history of many hedge funds. In fact one common haven for the registration of these funds, the Cayman Islands, has experienced enormous growth. They boast 8,000 hedge funds, with growth of more than 2,000 or 33% since 2005, including more than 1,000 this year. Compare this against 1,500 or so investment portfolios whose performance is compiled and ranked by an industry leading scorekeeper Effron/PSN. It was told to us by a panelist at a recent consultant conference that a six-month to one-year track record is what it takes to judge the investment acumen of a hedge fund enterprise. Our experience is that these same groups of consultants request that investment managers (like us) have 7+ year track record. In light of the recent collapse of Amaranth, losing $6 billion betting on natural gas prices, we urge caution and we recommend that investors keep in mind Warren Buffett's only rules on investing: (1) Don't Lose and (2) Don't forget the first rule. It is far more common to witness blow-ups of this kind than the demise of the disciplined investor maintaining a portfolio of businesses whose value marches slowly and methodically upwards over time.

Interest Rate Redux......Relative Value Persists
Another story for the summer of 2006 has been lower long term interest rates, amidst the backdrop of rising short term rates for over two years.

The current interest rate and economic environment signals that the two mostly likely scenarios within the next year are that either the economy weakens further and the fed will begin cutting short-term rates or the economy picks up strength and long term rates will rise. Here again, we just observe we don't predict.

Today, lower interest rates support higher stock valuations as does another yard stick, a higher earnings yield for stocks versus bonds. SEM's earnings yield (the inverse of price to earnings ratio) at 5.9% compares favorably against AAA Corporate bond yield of 5.6%. When the two yields are in parity, or if the earnings yield on stocks is higher, it generally favors stocks because the "coupon" is fixed for the bond but can grow for a common stock. One additional factor supporting our portfolio, which we discussed in letters earlier this year, is our favorable valuation as compared to the general stock market. This has not changed. Our portfolio is valued in the general range of the market despite of our ownership of a small collection of premium companies.

Time is better spent and risk of capital significantly reduced if we spend no time predicting the future price of commodities or direction of the economy. Rather, preserving and growing your wealth is all about owning a share in a small collection of very good businesses and constantly evaluating the relative value to other stocks and to long term interest rates. Thank you as always for your continued support and please call anytime.

Sincerely,
Donald R. Jowdy
President