Equity Market Strategy

Given the returns generated by the major indices most common stock investors experienced disappointing results in 2002.

What were our major performance issues in 2002?

1. We elected to continue to hold large capitalization, quality growth names, which underperformed substantially in 2002. Of the ten largest negative contributors to the S&P 500’s 2002 results, five are broadly held in Oakwood’s clients portfolios. Yet these same negative contributors are large, well-known powerhouse organizations that have superb businesses, global market positions, solid finances and excellent management. These wonderful companies, specifically General Electric, IBM, Microsoft, Citigroup and American International Group, declined precipitously last year and contributed in a substantial way to negative results in many portfolios and the stock market. But we would rather hold outstanding companies through a downturn than to subject our clients to additional risk by stepping down in quality.
   
   
2. In deference to gathering war clouds and other market uncertainties, we elected to hold a larger-than-average cash position. This cash added a measure of risk control but it contributed to further underperformance as the market began to improve in the fourth quarter.
   
   
3. The inclusion of Tyco International in portfolios during the first half of the year cost many accounts almost four full percentage points of relative performance last year. Unlike Enron and WorldCom (which Oakwood did not own) Tyco has excellent businesses which, while admittedly affected by the recession, continue to generate earnings. Nobody knew or could have known about the debacle that unfolded in the corporate office.

What strategies will be employed to improve performance in 2003? How will we invest this year in order to ensure that your account has the highest likelihood of outperforming the market while not being exposed to undue risk?

1. Continued commitment to seeking stocks which offer growth: After three years of relative underperformance, quality growth stocks, with the exception of technology, are more reasonably priced than they have been in years. Furthermore, growth stocks have historically outperformed the market coming off recession bottoms. Hence, we estimate that growth stocks could be poised to offer portfolios solid results in 2003.
   
   
2. Use of cash position: While a market bottom may have been reached last October, individual sectors, industries and companies bottom at different times. To the extent that excellent stocks become available at reasonable prices, we expect to judiciously deploy cash to take advantage of these opportunities.
   
   
3. Capitalization: We select from a universe of 1000 securities. This universe encompasses both large capitalization issues ($5 billion market capitalization and above) and medium capitalization issues (approximately $1.25 - $5 billion in size). As mentioned earlier, we elected to hold primarily large capitalization issues last year but, depending on the opportunity being offered, we expect to increase our representation in medium capitalization issues this year. Some of these additions were already implemented in the fourth quarter.
   
   
4. Diversification: The risk control benefits of adequate diversification cannot be overemphasized. We expect to continue to own 30 - 45 stocks, depending on the strategy employed, and will fully distribute those stocks over ten major economic/market sectors and many industries. The market is not offering sufficient reward in any one sector or industry to justify concentration. While various sectors will be overweighted or underweighted throughout the year, depending on our assessment of the opportunities afforded, we do not underweight any major sector by less than 50% nor overweight it by more than 200%.
   
   
5. Stock selection: We continue to emphasize the stocks of companies with strong financial controls, demonstrated management excellence, domination of a product line or industry and identifiable competitive advantage. This year we are especially emphasizing “top line.” A company should not meet its growth rate merely by buying back its own stock or by internal accounting machinations. Instead, it must demonstrate growth by means of traceable, identifiable and organic increases in revenue, that is, growth in the “top line.” As a corollary to our top line focus, we would also continue to look for the ability to expand margins where practical and seek companies with the ability to consistently generate positive cash flow.
   
   We are also emphasizing dividends and dividend growth. With price appreciation having been volatile at best and non-existent at times, returning capital to shareholders through dividends takes on increasing importance. The President’s proposal to eliminate taxation on dividends will be perceived favorably.
   
   
6. Price/Earnings Ratio Forecast: Stocks are currently selling at 16.5 times estimated 2004 earnings. As the economic recovery progresses, we expect that 2004 earnings estimates could be subject to upward revision. In such an improving environment and assuming a continuation of low interest rates and low inflation, we expect that the market could sell closer to 18 times earnings, more closely resembling historically similar conditions.
   
   
7. Sell discipline: At Oakwood, all stocks, once subjected to adequate analysis and deemed appropriate for purchase, are assigned a “target” price, that is, the price at which the stock has met expectations and would be sold. Stocks will be sold when (a) the stock attains that target, or (b) the stock experiences unexplained underperformance relative to the market or its industry, or (c) the company experiences fundamental deterioration in its prospects or (d) a sell is merited on the basis of our 15 point quantitative sell discipline. We have also implemented a policy of designating a point below which a stock becomes a mandatory sell and expect that, over time, this should mitigate the extent of the downside.

Focused implementation of the above portfolio management tenets may not guarantee stellar results. But in the midst of volatile and rotating markets we believe we’ve made some positive assessments about what the market will reward this year and have taken the steps necessary to assure full participation by equity portfolios in an improving market environment.