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from Outstanding Investor Digest's July 31, 2000 Edition

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LONGLEAF PARTNERS FUNDS'
MASON HAWKINS, C.T. FITZPATRICK & STALEY CATES

(continued from preceding page)

Our companies did just fine last year....
    Mason Hawkins: ...Over the last 12 months, almost all of our investees made good, solid, fundamental corporate progress. Their revenues increased as they sold more units and, in many cases, raised their prices. In our real estate companies, occupancies were stable to higher and rents and room rates were raised.
    Operating cash flows grew. And after subtracting out working capital needs, required capital expenditures and taxes, our free cash flows rose quite materially. Thus, our corporate values moved steadily higher as most of these cash earnings were retained.

And their private market values reflect their progress.
    Hawkins: Even more important, our intrinsic values per share moved faster still because the vast majority of our businesses repurchased and retired significant amounts of their discounted shares.
    Were Longleaf a partnership investing in private companies, we'd have marked up our investments and reported healthy returns to our partners. However, we operate as an SEC-sanctioned investment company in the arena of publicly-traded securities. Thus, we must mark our holdings daily to the last marginal quotational value - a price that can be most ephemeral, and some might even describe as capricious....

Our long-term returns have still been quite satisfactory.
    Hawkins: In 1999, a number of our stocks' prices failed to match the progress of their underlying companies. In a few situations, the businesses disappointed. And in quite a few cases, the gaps between share prices and our appraisals widened. Longleaf's quotational returns were not foregone, but they were deferred as many impetuous shareholders voted to seek fast fortunes supposedly promised by the internet and other technology enterprises.
    It's the longest time that value investing has been out of favor. Ibbotson just published data going back [about] 100 years on value versus growth. And value has done a couple hundred basis points better than growth investing over 100 years. It clearly hasn't over the last five years. Value has certainly lagged.
    But we don't look at it that way. We don't view ourselves as pursuing value or growth, but rather a combination of both. But the Longleaf Funds made less progress last year than we've grown to expect.... An equal-weighted investment across our funds over the past nine years under your current managers resulted in a compound return of 18% per year. And importantly, these returns have been achieved in diverse asset categories, without leverage and we believe with a minimum exposure to business, financial and market risk.

A stock market mania may have begun to lift....
    Hawkins: Now for the good news. Beginning in the second week of March, the market began to weigh our companies more fairly when speculators seemed to experience almost an epiphany.... There's been a tectonic shift in investor sentiment since March 10th. Mindless momentum-following began, as the Brits say, to give way to what we consider to be rational thinking - that customers, revenues and cash flows do matter. They are what determine corporate values.
    As though returning from never-never land, they began to realize that many NASDAQ firms needed more than conceptual business plans in order for them to prove successful - they were going to need customers, revenues and operating profit margins high enough to deliver earnings to support demonstrable values that compared favorably to share prices.

The baby hasn't been thrown out with the bathwater....
    Hawkins: So the wide dichotomy between established, dominant businesses and nascent, evolving "adventures", as we'd call them - not ventures - began to close back on March 10th. Yet, many skeptics doubted that the NASDAQ's excesses, including an aggregate valuation of 135 times earnings, could be corrected without dragging down further an undervalued value universe.
    Well, ... Dr. Graham's description of the market being a weighing machine in time is beginning to take effect. Fortunately, from that day in the middle of March, our world is up very dramatically. Some of the speculative, superfluous stuff has begun to wane. I don't know if there's been a time in market history when you've had that kind of magnitudinal diversion occur that quickly....
    Now you've seen from peak to trough almost a 60% relative change. The Partners Fund was up 25% at its peak from March 10th - and the NASDAQ was down 35% [at its low]. So a 60% change in about 65 days. I don't remember anything quite as dramatic - even in '73-'74....

Internet bubble rivaled any bubble ever - even tulip bulbs.
    Hawkins: The speculative mania that was hyped in the net rivaled any previous bubble - including the one in 1620 with tulips. The speculative mania that hyped the net separated a heck of a lot people from their capital. And it did so permanently. It wasn't just a matter of share prices deviating from value, but rather, in many cases, one of share prices disappearing and not reappearing....