December 2024 Quarterly Review

January 16, 2025

Dear Clients and Friends:
Re: Q4 Investment Review

Another banner year for the S&P 500 but not so much for our favorite stocks. Most everyone is aware of
the role played in the success of the S&P by the “Magnificent 7” and other technology stocks,
particularly those related to Artificial Intelligence or “AI”. In some cases, performance was justified by a
combination of very strong earnings growth and improved expectations for the practical uses of AI.

But the rest of the market was not so fortunate as the rush to the highest expected growth companies
drew money out of many other perfectly fine high quality, dividend-paying stocks, even when earnings
exceeded expectations. In contrast to the S&P 500 return of 25%, the unweighted average return of the
stocks in the S&P was only about 12%. The S&P 500 performance is weighted by the total value of the
stock outstanding for each company and this computation resulted in the Magnificent 7 accounting for
over 30% of the entire Index. As the average return of the Magnificent 7 was 55%, more than half the
S&P return of 25% can be attributed to these stocks alone. Without them, the return would have been
very close to the average long-term return from this measure of the market

Benchmark Index Total Returns	Year Ending 12/31/2024	Quarter Ending 12/31/2024
Lipper Balanced Fund Index	10.83%	-1.24%
S&P Dividend Aristocrats	7.08%	-6.22%
S&P 500 Stock Index	25.02%	2.41%
Russell 1000 Value Index	14.37%	-1.98%
3-Month U.S. Treasury Bill Index	5.30%	1.17%
S&P 7-10 Year U.S. Treasury Bond Index	10.93%	5.69%
S&P U.S. Gov & Corporate 30-Year Bond Index	-8.13%	-9.37%

Interest Rate Cuts have finally arrived

In comparison, the Dividend Aristocrats Index was especially impacted as the annual return there was
only about 7%. Even though these are strong reliable companies with reasonable earnings growth who
have long histories of increasing dividends, last year it didn’t matter.

This had a major impact on our results last year as dividend aristocrats are the type of investments we
favor. However, in spite of recent lagging performance, it should be remembered that over a number of
years, these stocks actually outperformed the S&P. We came across a recent study that traced the
performance of these stocks for thirty years ending in 2020 and over that significant Ɵme frame, the
dividend aristocrats outperformed the S&P by a full two percentage points per year or on average about
20% above the S&P. This period, of course, includes the dot com bubble that happened in the late 1990s
through 2000 which was another period when our favorite stocks lagged. So, what we have
experienced recently is very unusual.

As you all know, our approach is conservative. Our investment objective has always been to participate,
though not necessarily lead, in bull market gains but to better hang on to these gains during periods of
decline. And in this we have been successful. In addition to reasonable long-term returns, we want all
of our clients to sleep well at night without worrying about the kind of downside volatility that can afflict
high growth companies if earnings don’t quite meet expectations. In fact, this is why many of you have
employed us to manage your investment assets.

We are confident in the companies you (and we personally) own. We strongly believe that the AI bubble
will eventually burst and send Mag 7 stocks back toward reality. Many tech stocks have stock prices that
have substantially outperformed their earnings and fundamental progress, and this is how stock market
bubbles are created. Risk doesn’t always manifest itself on a schedule we can determine, but it is always
present. We believe risks are high today.

Other Factors impacting the Market

As we enter 2025, the economic backdrop for investing remains strong. Gross Domestic Product for the
fourth quarter of 2024 is expected to come in at a very respectable reading of about +2.5%. Jobless
claims remain low, and inflation sensitive commodities are showing price stability. Though interest rates
remain higher and stickier than most would like, the overall picture is one of reasonable balance.
Offseƫng this is the ever-growing fiscal deficit and its servicing (paying interest on the debt) that has
now reached a level where the consensus seems to be that we need to do something about it.

As has been widely reported, interest payments alone on the debt are now as large as our budget for
defense spending. None of us knows where the tipping point is with respect to the harm an overly
burdensome national debt can cause, but history has shown many times that a large devaluing of a
currency is not compatible with economic wellbeing. This is not necessarily an immediate problem but,
like Social Security, it is inexorably moving toward becoming one.

There are a lot of moving parts in an economy as complex as that of the United States today. And this is
further exacerbated now by a new presidency and all the internal change that implies. To mention a few
items, there are the threatened new tariffs on foreign goods, the upcoming debt ceiling renewal,
dramatically changed U.S. border policy, a pullback on regulatory policy and restrictions, a new energy
policy, potentially major changes in tax policy for both business and individuals and finally a new federal
budget that, if the current budget hawks get their way, could be highly disruptive to the current
momentum in a number of areas. It would be unusual to get through all of this without some disruption
along the way.

The other issue that has been discussed in many quarters is the high starting valuation of the stock
market today at 23-24 times 2005 expected earnings. The long-term average is about 15. This is both a 3
shorter-term issue as market confidence ebbs and flows over the market cycle, and a long-term issue for
further stock market progress as anticipation of a bright future for stocks and their earnings is already
priced in. It does not imply that we will have a poor stock market showing this year. Rather, it means
that further progress will be almost entirely linked to improvement in earnings. Those companies that
come up short of expectations will likely be hard hit.

Though our process of selecting individual stocks is not macro market or economic focused – we mostly
just try to buy high quality companies at depressed prices when they occur – it does create uneasiness
on our part. But if any of the potential problems listed do become a more major problem, we are
confident that our stocks will hold up better than the market averages. As a pure guess, it wouldn’t
surprise us if the market is relatively flat or even down in 2025.

Top 20 Holdings

We had only minor changes in our top holdings this last quarter, as Ameriprise and JPMorgan joined
our list, bumping out U.S. Bancorp and Essex Properties. The main reason for the change was
performance, as both Ameriprise and JPMorgan had excellent quarters – both were up around 14%,
higher than Essex and USB. We also, in the quarter, began to trim back some of our bank holdings
including USB, as they have performed extremely well since our initial purchases and collectively
have grown as a percentage of most accounts. Below you will find a snapshot of our top twenty list.

12/31/2024 Top Holdings

ABBV	AbbVie Inc	ITW	Illinois Tool Works Inc
AMGN	Amgen Inc	JPM	JPMorgan Chase & Co
AMP	Ameriprise Financial Inc	LNC	Lincoln National Corp
CAT	Caterpillar Inc	LOW	Lowes Companies Inc
CSCO	Cisco Systems Inc	MSFT	Microsoft Corporation
CMCSA	Comcast Corporation	QCOM	Qualcomm Inc.
DLR	Digital Realty Trust Inc	XLK	SPDR Technology Sector ETF
EPD	Enterprise Products Partners LP	SWK	Stanley Black & Decker
FAST	Fastenal Company	TGT	Target Corp.
G	Genpact Limited	TFC	Truist Financial Corp

Looking at our top five securities (the ones most clients collectively own in the greatest amounts), there are a few patterns that emerge. As of the end of the year our biggest holdings included Microsoft (MSFT), Qualcomm (QCOM), Enterprise Products (EPD), The Technology Sector SPDR Fund (XLK), and Genpact (G). The annual and fourth quarter returns were as follows:

		2024 Total Return	Q4 Total Return
MSFT	Microsoft Corp	12.9%	-1.8%
QCOM	Qualcomm Inc	8.3%	-9.2%
EPD	Enterprise Products Partners LP	28.0%	9.7%
XLK	Technology Select Sector SPDR Fund	21.6%	3.2%
G	Genpact Ltd	25.8%	9.9%
SPY	SPDR S&P 500 ETF Trust	24.9%	2.5%

As you can see, three of our top holdings are in the technology sector. Our top two holdings, Microsoft and Qualcomm, (two of our biggest long-term success stories), both had a below average year in terms of performance. The better of the two, Microsoft, only returned about half as much as the market, while Qualcomm returned even less. The technology sector as a whole (XLK) fared substantially better with closer to market performance, the biggest difference being that the total sector includes many of the big winners in AI which have helped to drive the market to new highs last year, particularly Nvidia. In case you are curious, the winning sector for 2024 was Communication Services, XLC, (which includes Mag 7 holdings Meta, Google and Netflix as its largest three holdings, all originally “technology” stocks until the sectors were rejiggered in 2018). XLC returned close to 35% last year.

Microsoft stock had a strong first half of the year, but lost traction in the second half. Results for the most recent quarter were well ahead of expectations for both earnings and revenue, nevertheless the stock price dropped over 6% the following day. Apparently, investors were spooked by the company’s planned increases in spending on generative AI. Meanwhile, Microsoft is a leader in cloud computing and in our opinion seems to be making investments into all the right areas of AI. With projected revenue and earnings growth for the next few years in the mid-teens, Microsoft stock seems reasonably valued even though it is trading around 30 times earnings. The dividend is “small” when compared with our typical holding, but it has increased steadily since 2010 (we originally bought Microsoft when it was very much out of favor and the dividend yield was about 2%). The company has one of the strongest balance sheets in the world. In the short term, the stock may be volatile, but as a long-term holding Microsoft continues to look strong and we have no great fundamental concerns about the company as we look out toward the next 3-5 years.

Qualcomm stock followed a similar trajectory as Microsoft, peaking in June of 2024 with some setbacks since then. The company also surpassed expectations in the most recent quarter with 18% revenue growth over the previous year. The stock’s underperformance is most likely linked to a few specific risks including the potential for Apple to supply iPhones with its own chips by 2027 as well as some long-running legal issues with ARM Holdings over alleged intellectual property infringement. While we cannot be entirely confident in either outcome, the market seems to be more than pricing in the risk and Qualcomm has done a great job of resolving problems in the past. Trading at just fourteen times next year’s expected earnings, Qualcomm’s expected growth is a bit more moderate than Microsoft. At the current price it will likely prove to be a bargain if Qualcomm can successfully navigate these known risks. We plan to pay close attention as events unfold but believe that the current price is very reasonable after taking everything into account.

Long-term holding Enterprise Products Partners, LLC had a fantastic year, returning 28% including its generous dividend. The current dividend yield is around 6.6%. At its core Enterprise Products is a best-in-class company that provides midstream services; the pipelines and infrastructure that are used to transport oil and natural gas. Its network of pipelines works like a toll road. The company ispaid a relatively fixed price to move materials through, and it does not build a new pipeline unless it has enough committed users to make the project worthwhile. Historically they have been one of the best in the business in their deployment of capital. Success is not particularly tied to the price of oil though the stock often moves in the same direction. We have always liked this approach, as we know oil prices can be extremely volatile. Despite the recent increases, the stock price remains reasonable.

Rounding out our top five is a new holding this year, Genpact. Initial purchases were made in early 2024, and we have continued to add to the position since then. A provider of business outsourcing and IT services, Genpact was spun off from GE in 2007. The stock caught our attention early last year because the price had been cut in half from December ’21 highs. Meanwhile revenues, earnings and cash flows all increased over that two-year period while the stock price was in a free fall, making the stock extremely cheap by all metrics. Of special interest to us is the fact that they are working to expand their AI-related consulting business so it is a backdoor participation in artificial intelligence. So far results have been good as the stock has begun to recover from its April lows. We would not hesitate to buy more today.

There is an old saying about investing – don’t love your winners because they won’t necessarily love you back. So, we try to look at all of our holdings with a critical eye, whether they have done well or poorly in the marketplace. And as we look at these top five holdings we do not see much to worry about from a fundamental point of view although admittedly, we are keeping a closer eye on Qualcomm so that we can evaluate how they are addressing the current challenges. We currently give them the benefit of the doubt as, historically, they always seem to have come out on top. This is the benefit of being a long-term investor. Many investors have a much shorter time frame than we do. As a result, we can ignore a lot of the “noise” that leads to stocks under or over performing over a relatively short time frame and, instead, give them the time needed for the fundamentals to work in our favor.

A final word on Tariffs

The Trump plan to impose tariffs on China, in particular, has been much in the news lately. The headline often refers to tariffs of 25%. But this is misleading as we already apply tariffs to a number of imports from China. The e􀆯ective increase from today’s levels will therefore be considerably less.

After the 25% headline the next line is often that tari􀆯s are inflationary. In the very short-term, this may be correct, but immediately, final sellers in the U.S. will try to limit price increases by reducing their own profit margins. Consumers will respond by buying less of the now higher priced products. This is actually deflationary. And American suppliers will also look for substitute, lower priced products produced in North America. Finally, U.S. manufacturers will try to increase production which is the final reaction.

The point of this is that you shouldn’t be swayed by the headlines alone. They are generally too simplistic and often wrong or misleading. As stated earlier in this letter, our economy is highly complex. But a free economy is also highly flexible given time to respond. This is one of the main economic advantages we have versus command-and-control countries such as China.

In any event, this is one of the reasons we continue to believe that the U.S. remains one of the best countries in the world in which to invest for the long-term.

Please let us know if you have any questions about any of the material discussed above or about your account in particular.

DML/ELS/JJS/LRO