Q2 Commentary (2007)

October 10, 2007

Interestingly, despite all of the headlines and worries about housing, the credit crunch, increasing energy prices and a weakening domestic economy, the S&P 500 was still able to post solidly positive returns for the month, quarter and therefore the calendar year-to-date ending September 30, 2007.  This end result certainly belies the volatility and uncertainty that occurred thus far.  There have been three fairly serious down months and six significantly up months over the last 3 quarters.  Our portfolio generated performance that was competitive with the index in both the quarter and year-to-date, but in a slightly different fashion; we gained relative performance during the down months, and basically kept up during the stronger periods.  Looking to the balance of the year, we would not at all be surprised to see a continuation of the current volatility and uncertainty.

Looking over the trailing one, three, and five year periods, one might conclude that Coho Partners has been poor relative to the S&P 500. We would respectfully disagree because all of these periods have essentially been strongly positive and we are pleased to have captured the lion’s share of all these advances. If you include any of the down periods from 2000 to 2002, our performance dramatically improves. On a trailing 7 year basis, we handily outperformed the benchmark.

During the quarter, our overweighting in both energy and consumer staples proved helpful.  Within the energy sector, with oil prices soaring, so have our holdings, and we took the opportunity to modestly trim positions in Chevron and Royal Dutch on strength.  In our consumer staples area, Coca Cola, Colgate, Procter and Gamble and Wrigley were all standout performers.  We eliminated our stub position of Kraft which had been spun out from Altria earlier this year, and reallocated some cash to re-establish a position in UST, the leading manufacturer of moist smokeless tobacco.  That position had been sold for a nice profit at the very beginning of the year, and we were able to buy it back almost 20% cheaper last month, despite the up market and continuing strong fundamentals for the company.   Detracting from performance this quarter were some of our consumer discretionary holdings, most notably Home Depot and Footlocker. 

The portfolio received a nice tailwind from our underweight in financial stocks.  While tantalized by the significant relative underperformance and seemingly inexpensive valuations (and commensurately high dividend yields) of diversified financial stocks, these companies are not without their issues. We appreciate that the financial statements of these companies are relatively opaque and highly complex, their earnings rather volatile and we suspect that we may be reasonably early in a down cycle for most of these stocks.  Thus we plan to be very deliberate in any additions to this group, despite our current significant underweight.

Technology presents a different dilemma and had a modest negative impact to the portfolio; outperformance from a group where we are underweighted.  We are generally biased against this group from a philosophical standpoint as their earnings streams and stock prices tend to be hyper cyclical and there is generally little in the way of dividend income to steady the returns.  We remain focused on opportunities within this sector that meet our criteria of less volatility in earnings, significant cash flow and reasonable dividend yields.

Overall, the portfolio remains defensive and focused on businesses that can grow their earnings, dividends and cash flows consistently through all phases of the economic cycle.  These portfolio “shock absorbers” are important in achieving our downside protection objective and yet these same characteristics have enabled us to capture the lion’s share of most broad upward advances. 

Please feel free to contact us with any questions or concerns that you might have regarding our outlook or the portfolio.

Sincerely,

Peter A. Thompson

Back