This shareholder letter is part of the Bretton Fund 2019 Annual Report (pdf).
February 14, 2020
Dear Fellow Shareholders:
The Bretton Fund’s net asset value per share (NAV) as of December 31, 2019, was $40.63, and the total return for the year was 35.39%.
Returns as of December 31, 2019 (A)
| 4th Quarter | 1 Year | Annualized 3 Years | Annualized 5 Years | Annualized Since Inception | |
| Bretton Fund | 10.65% | 35.39% | 16.20% | 10.16% | 12.55% |
| S&P 500 Index (B) | 9.07% | 31.49% | 15.27% | 11.70% | 14.26% |
Calendar Year Total Returns (A)
| Year | Bretton Fund | S&P 500 Index |
| 2019 | 35.39% | 31.49% |
| 2018 | -1.94% | -4.38% |
| 2017 | 18.19% | 21.83% |
| 2016 | 10.68% | 11.96% |
| 2015 | -6.59% | 1.38% |
| 2014 | 9.79% | 13.69% |
| 2013 | 26.53% | 32.39% |
| 2012 | 15.66% | 16.00% |
| 2011 | 7.90% | 2.11% |
| 9/30/10 – 12/31/10 | 6.13% | 10.76% |
| Cumulative Since Inception | 198.49% | 243.31% |
(A) All returns include change in share prices and, in each case, include reinvestment of any dividends and capital gain distributions. The inception date of the Bretton Fund was September 30, 2010.
(B) The S&P 500® Index is a stock market index based on the market capitalizations of 500 leading companies publicly traded in the US stock market, as determined by Standard & Poor’s, and captures approximately 80% coverage of available market capitalization.
Performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. You may obtain performance data current to the most recent month-end here or by calling 800.231.2901.
All returns include change in share prices, reinvestment of any dividends, and capital gains distributions. Indices shown are broad-based, unmanaged indices commonly used to measure performance of US stocks. These indices do not incur expenses and are not available for investment. The fund’s expense ratio is 1.35%.The fund’s principal underwriter is Rafferty Capital Markets, LLC.
4th Quarter
Continental Building Products, our Virginia-based maker of drywall, announced in November that it was being acquired by French construction-materials giant Saint-Gobain for $37 per share in cash, 37% above where the stock was trading at the beginning of the quarter and 52% above our average cost. This nice little windfall boosted the fund by 1.6% in the quarter.
Our banks rallied in the quarter on improved interest rates and trading activity. Bank of America added 1.1% to the fund, while JPMorgan Chase added 0.9%.
The two laggards this quarter were Progressive and Armanino Foods, which took off 0.3% and 0.1%, respectively.
Contributors to Performance for 2019
In a big year for the market, none of our holdings declined in value. The largest contributors were Mastercard, which boosted the fund by 2.9%, Alphabet 2.4%, NVR 2.2%, and Bank of America 2.1%. Homebuilder NVR’s contribution was especially notable. A year ago, the sentiment on homebuilders was bleak and the stock beaten up, even though the business fundamentals were fine. A year later, NVR is building and selling houses at the same rate, and its stock is up 56%.
Even though all our stocks appreciated, a handful lagged the market materially, most notably Berkshire Hathaway, which still did contribute +0.5% to performance. A combination of Berkshire’s inability to deploy its growing pile of excess cash into produc- tive investments and its collection of slow-but-steady businesses left it trailing a hot market.
Taxes
For the second time in three years, we avoided making any tax distributions to shareholders despite the market appreciation. A combination of low turnover and attentiveness to tax implications has put our three-year tax burden 95% below the average fund in our category according to Morningstar.
Expense Ratio
As the fund has grown, we’ve been better able to cover operating costs, so we’ve lowered the expense ratio from 1.50% to 1.35%, effective January 1, 2020.
Portfolio
| Security | % of Net Assets |
| Alphabet, Inc. | 9.1% |
| Mastercard, Inc. | 6.7% |
| Union Pacific Corp. | 6.6% |
| Ross Stores, Inc. | 6.0% |
| Continental Building Products, Inc. | 5.9% |
| Bank of America Corp. | 5.7% |
| NVR, Inc. | 5.4% |
| Visa, Inc. | 5.2% |
| JPMorgan Chase & Co. | 5.1% |
| AutoZone, Inc. | 5.0% |
| The TJX Companies, Inc. | 4.9% |
| American Express Co. | 4.9% |
| The Progressive Corporation | 4.7% |
| Wells Fargo & Company | 4.6% |
| Canadian Pacific Railway Limited | 4.5% |
| Carter’s, Inc. | 4.4% |
| Berkshire Hathaway, Inc. | 4.0% |
| Discovery, Inc. | 2.6% |
| Microsoft Corporation | 2.1% |
| Armanino Foods of Distinction, Inc. | 2.0% |
| Cash* | 0.5% |
* Cash represents cash equivalents less liabilities in excess of other assets.
Consumer
We’ve now owned Ross Stores close to 10 years, and it’s been nothing if not consistently great. Off-price retail remains a thriving oasis in the retail apocalypse. Visits to the mall are down, but both Ross and TJX keep seeing more shoppers in their stores and do quite well among young shoppers, the demographic most likely to buy online. For enough of a bargain and the right “treasure hunt” experience, people are more than happy to get in their cars and peruse the aisles. Ross is on track to increase earnings per share an estimated 9% and TJX 7%. Earnings growth was a little below the usual pace as costs were a bit elevated due to higher wages and some infrastructure investments. Ross returned 41.3% last year and TJX 38.8%.
NVR was one of our best performers last year with its 56.3% return and a 14% earnings per share increase. We estimate earnings per share increased 9%.
AutoZone’s stock continued its rebound after an investor panic a couple of years ago over its susceptibility to being “Amazoned,” which didn’t end up materializing. AutoZone’s stock followed up a strong 2018—up 18%—with a 42.1% appreciation in 2019. Earnings per share increased 30%, in part from the prior-year tax law changes and partly from strong operating performance. “Good” weather, which in AutoZone’s case means lots of snow and rain that drive auto-parts purchases, also helped.
In yet another retail comeback story, Carter’s, our worst performer in 2018, bounced back with a 36.8% total return. Challenges remain—tariffs, the loss of Toys “R” Us, declining US births—but its core business of selling great, affordable baby clothes remains healthy. We estimate earnings per share increased 4%.
Discovery, having now digested the Scripps acquisition that brought Food Network and HGTV into its fold, has delivered on its promised benefits. It’s producing free cash flow of $3 billion, more than double its pre-acquisition levels. Debt has been paid down, and stock buybacks have resumed. It’s now on all the major online live-TV platforms (e.g., Hulu Live TV, YouTube TV), and its nascent efforts to directly build subscription video services for “superfans” of various interests like golf and cooking have started to bear fruit. Naturally, a cable TV company in a cord-cutting world has its work cut out for it, but the financials have held up well and the company is growing. We estimate last year’s earnings per share increased 78%; the stock rose 32.3%.
Armanino Foods’ earnings are on pace to increase a bit over the prior year, and the stock returned 26.4%. People keep buying frozen pesto sauce, and we keep seeing the returns.
Financials
Since our 2011 purchase of JPMorgan Chase, our total return is 182%, nearly a triple. In 2019 alone, the stock returned 47.3% as earnings per share increased 19%. Despite that run, it still trades for a mere 13 times earnings compared to 20 times for the rest of the market. After the financial crisis, banks were almost untouchable, and while both earnings and sentiment have since significantly improved, they’re still relatively out of favor. There will be another recession sooner than later, and our banks will see larger loans losses, but we think this is more than priced into the stock, and our banks are well reserved for that eventuality. Bank of America’s total return was 46.2% and earnings per share up 12%. Problem child Wells Fargo remains in the regulatory penalty box. Earnings per share declined 4% and the stock’s total return was 21.4%. We think highly of new CEO Charlie Scharf, and we also believe the regulatory and cost control issues will be manageable in the long run. We are concerned about its shrinking revenue and the timing of the regulatory relief, but we feel the stock is so cheap at these levels that we’ll do well from here.
American Express quietly put up a strong year, returning 32.5% and increasing earnings per share 12%. It expanded its merchant coverage to narrow the gap with Visa and Mastercard, fought off stiffer competition for its high-spending cardholders, and expanded its lending while maintaining pristine credit costs. Similar to the banks, it remains significantly undervalued compared to the rest of the market even with its above-average profitability and growth.
Progressive, whose results can be lumpy due to the nature of insurance underwriting and investment returns, saw a surge in premiums (+15%), policies in force (+10%) revenue (+22%), and earnings per share (+52%). Auto insurance in general isn’t a great business—the industry as a whole doesn’t break even on an underwriting basis—but through a combination of a direct-to-consumer business model, clever marketing, cost advantages from scale, and superior data analysis, Progressive both grows faster and is more profitable than the rest of the industry. We think its ability to collect and analyze more data, partly through its usage-based insurance program, is giving it an increasing competitive advantage. Despite its fast growth, its market share is still only 11%; it’s got a very long runway ahead of it. Its return was 25.1% last year.
Information Technology
Alphabet, better known by its main business Google, returned 29.1% and had another year of great revenue growth (+22%) but less-great earnings per share growth (+12%). Much of the increased costs came from ramping up its investments into future lines of business, some of which are likely to pay off handsomely, while others are likely to destroy shareholder value. The problem is that it’s not clear which ones are which. Google lumps these efforts into a category called “Other Bets,” which includes its much- touted self-driving-car initiative Waymo as well as its now-defunct effort to measure insulin levels in diabetics via chip-enabled contact lenses. If we had our druthers, we’d rather Google dial back its Other Bets a bit, but the core business is so strong that it’s unlikely to impact our investment too much. The company also announced cofounder Larry Page would transition the CEO role to Sundar Pichai, who’s been running the Google division for years. We don’t know much about Pichai’s capital allocation strategy and philosophy around corporate focus, but we do know cofounders Page and Sergey Brin were especially enamored of side projects.
Mastercard and Visa continued their run of great performance, increasing earnings per share 23% and 18%, and returning 59.2% and 43.3%, respectively. The stocks are no longer cheap, but with so many years of strong growth ahead of them, we think they’ll do well over the long run.
We added Microsoft to the fund in the fourth quarter and are up 14% to date. We describe the investment more fully below.
Industrials
Despite a 6% drop in freight volume, Union Pacific increased its earnings per share by 6%. There remains no cheaper way to ship bulk goods across the US than rail, and it’s effectively impossible to duplicate its network from scratch today. Its recent embrace of “precision railroading” has gone as well as can be expected, leading to improved on-time performance and significant cost reduction that’s allowed it to increase earnings in a year when volume contracted. We think there’s even more improvement to be had. Its stock returned 33.1%. Canadian Pacific enjoys similar structural competitive advantages as its US counterparts, yet with even greater profitability. Earnings per share improved 13%, and total return was 38.1%.
Berkshire Hathaway can be thought of as three distinct businesses: 1) a collection of wholly-owned, mostly industrial businesses like BNSF Railway and Benjamin Moore; 2) insurance, including GEICO and one of the world’s largest reinsurers; and 3) an investment function that manages the insurance business’s reserves (“float”). Investing insurance float, which is essentially borrowed money from policyholders, into businesses and stocks amplifies their returns. The operating businesses generate significant amounts of cash, and when combined with the ever-increasing float from insurance premiums, Berkshire is constantly putting greater amounts of cash to work. In a somewhat expensive market, that’s hard to do at scale, and Berkshire now has over $100 billion burning a hole in its pocket. Despite the cash drag, we estimate it increased book value per share by 20% last year, while its stock appreciated 11.0%. We think its collection of great businesses leveraged by its insurance operations will do quite well over time.
When we first bought Continental Building Products in 2016, we suspected it would be an acquisition target, but definitely weren’t counting on it. The business has grown nicely while returning capital to shareholders. The total return for the year was 43.1%.
Microsoft
It’s difficult to find the right vantage point to look at Microsoft. It is so massive that each of its three operating divisions (Office, Cloud, and Windows/Xbox) would, if spun off, be the second largest pure-play software company in the world. Its cash balance is about the size of the book equity of Goldman Sachs and U.S. Bank—put together. For over a decade and a half after the beginning of its antitrust litigation in 1998, it drifted on a strange form of cruise control: stupendously profitable and seemingly unconcerned with the future or even the present. Internet search took off, and Microsoft took a dozen years to respond to Google. Apple—rescued by a $150 million infusion of Microsoft cash in 1997—built its renaissance on easy-to-use, aesthetically pleasing devices; Microsoft left the field to its hardware customers. Apple built an innovative, simple phone operating system; Microsoft tried to make Windows run on a phone. The company seemed to be slowly drifting into irrelevance. Revenue growth slowed down to a mere 5–6% while Google and Apple were regularly putting up 20% and 50% growth rates.
Then a couple things happened: Microsoft got a new CEO, and corporate IT departments began shifting their computing operations to the cloud en masse. We are generally skeptical of attributing much corporate performance to the person who happens to be CEO. If a company has a genuine competitive advantage, we expect the leader to be replaceable. That said, the switch from Steve Ballmer to Satya Nadella was material, and we wish we had realized it sooner. Nadella came from the cloud-computing business and was able to end a corporate culture that prioritized Windows over all else. And, after flirting with outsourced computing for decades, businesses are now realizing the security, cost, and technical advantages of having Microsoft run their IT systems for them. The results have been extraordinary. Revenue is now growing in the mid-teens, pulled up by the 70% growth in its outsourced computing business, Azure. The shift to cloud computing is just getting under way. We are a little wary of owning such a goliath for 30 times earnings, but we think this is a special company.
Investments Initiated in 2019
Microsoft Corporation
Investments Exited During 2019
The fund did not exit any investments in 2019.
Investing Climate
Last year, we wrote, “Stock market multiples have contracted considerably. For people who are looking to buy earnings streams inexpensively, this is a major development. After years of struggling to find enough investments with a margin of safety to protect against economic shocks, we find ourselves in the somewhat unusual position of being modestly sanguine about the market.”
The market is up about a third, so, in a way, we’re a third less sanguinely optimistic. Stocks are more expensive than their historical average, but not excessively so, like the 1999–2000 market. This could mean the next 10 years won’t be as great as the last 10, which saw the S&P 500 return an annualized 14%. The average return for stocks is about 10% before inflation, so a repeat of the last 10 years isn’t likely, but that doesn’t mean the next 10 are going to be awful. We believe stocks still represent the most compelling asset class out there, and we feel our small collection of good businesses at reasonable prices will do quite well in the years to come.
As always, thank you for investing.
Stephen Dodson Raphael de Balmann
Portfolio Manager Portfolio Manager