Q1 Commentary (2005)

After such a nice close to 2004, the first quarter of 2005 has been quite difficult and frustrating. We believe our companies actually performed very well this quarter, although performance would not suggest that. This is what frustrates us, but as long term investors, our confidence about the future is even higher. The specter of higher inflation fueled by further Fed tightening and rising energy prices depressed investor enthusiasm for US financial assets. The only real standout areas were commodity related industries and we tend to avoid such sectors because of the difficulty in consistently predicting the price of the underlying commodity.

Nevertheless, when all the dust settled, we outperformed in the quarter and stayed competitive in March. This performance is congruent with our investment philosophy, which is designed to protect principal during difficult times and still remain competitive during the rising periods.

2005 would appear to be shaping up as another year in which stock selection will be critical. Coho Partners tends to do well in such environments because of our rigorous research approach and our investment disciplines. It is quite possible to produce good risk adjusted return even if we face persistently higher energy prices, further increases in interest rates and the omnipresent threat of terrorism.

One force that seems to be gaining traction is that of global freedom. We have mentioned this in the past but feel it is still worth reiterating. Freedom creates opportunity and hope. Capitalism can only work within the construct of a free society. Capital will flow to areas where freedom is replacing repression, as long as those with the capital believe in the long term permanence of a free and stable economy. The road to freedom is never smooth, and as such, we need to not be disheartened by inevitable setbacks. Freedom is a powerful motivator and once it gets started, the momentum is virtually unstoppable.It will take time for the repercussions of global events in the Middle East and Eastern Europe to be felt in our markets, but it will happen. Initially, there will be the inevitable need to rebuild a weary infrastructure. This will be followed by a growing demand for consumer goods and staples, which are the rudimentary building blocks of day to day living. These items tend to be reasonably low cost and yet they provide major benefits to one’s quality of life.

Despite the slow start to this year, we remain encouraged about the full year outlook. Earnings for the S&P 500 should improve to mid single digits, which when added to the present dividend yield produces a high single digit return for the year. This assumes no change in the overall P/E for the S&P 500. As of this writing, the 2005 P/E for the S&P is reasonable at about 17x. Coho Partners should do somewhat better than this given that the portfolio has a dividend yield advantage, a better earnings growth rate and a lower overall P/E multiple.

The companies that we have chosen to invest in are all high quality companies with well articulated operating and financial strategies that are realistic. If we have done our homework correctly, these holdings have the ability to consistently grow their earnings, which will allow for steady dividend growth and when appropriate, share repurchase. So far in 2005, roughly two thirds of our holdings have already increased their dividend rate for this year. Moreover, we anticipate that about 90% of our holdings will also reduce their outstanding share count in 2005. Those rather innocuous financial strategies have enormous power when you overlay the fact that the portfolio’s P/E trades at a discount to that of the S&P 500. Being long term investors, we will be patient as the fundamentals of our holdings evolve over time.