QUARTERLY REPORT
DECEMBER 31, 1999
Fiduciary
Capital Growth
Fund, Inc.
A NO-LOAD
MUTUAL FUND
Fiduciary
Capital Growth
Fund, Inc.
January 27, 2000
Dear Fellow Shareholder:
When not in the office researching securities, your management team can
occasionally be found at one of our local gymnasiums, playing a pickup game of
basketball for relaxation. Frankly, we're pretty decent, and during such games,
an oft-sited refrain on the basketball court is the phrase, "nothing but net!"
Of late, that same refrain is uttered around our office, with the tag on
"nothing but net!" (as in internet), "technology!" and "telecom!" These three
sectors have been the driving forces in the stock market for the past 24 months.
Candidly, as you are aware, it has been a very difficult time for a value
manager such as Fiduciary Management. In 1999, we experienced modest single
digit gains in our stocks, well behind the major averages such as the S&P 500
and Dow, and significantly behind the Nasdaq, which is a technology- and
Internet-laden Index. Technology and Internet stocks currently represent about
32% of the S&P 500 Index, up from only 7.5% in 1992, when this sector was viewed
negatively. The last time any industry had this large a weighting in the S&P
500 Index was 1980, when the energy sector represented 27.1% of the S&P 500
Index. That represented the peak in valuations for energy stocks as well as the
beginning of a significant period of under-performance for that sector; today,
after years of struggling, the energy sector makes up 6% of the S&P 500 Index.
Technology and Internet securities represent approximately 52% of the Nasdaq
Index today -- the largest industry weighting ever. While we certainly believe
in, and embrace the world of technology, and particularly the Internet, we just
can't embrace the valuations. Our 32 years of investing, if anything, has
taught us one thing: valuation does matter, and those that don't pay attention
to valuations, but rather get caught up in the "mania of the moment" are
destined to eventually suffer significant erosion of capital.
Barton Biggs, the chief investment strategist at Morgan Stanley, probably
summed it up best when he said, "The technology, Internet and telecom craze has
gone parabolic in what is one of the great, if not the greatest manias of all
times. We understand the net, and its implications for this economy, we just
don't understand the valuations. The history of investing in 'paradigm-changing
industries' such as today's Internet, has almost always been profoundly based on
revolutionary developments that eventually do change the world. However,
without exception, the bubble stage of the craze ends with a massive destruction
of wealth." We couldn't agree more with Mr. Biggs. Our investing history has
allowed us to witness the go-go investing era of the late 1960's, the Nifty
Fifty bubble in the 1972 market, the energy stock mania in the early 1980's
(remember the $100 per barrel oil predictions?), the personal computer craze of
the 1982-83 period, and bio-tech bubble in the late 1980's. All of those had
one common thread; the market, and investors, perceived a new paradigm, and
valuations went to extreme levels. They all ended in the same fashion, however,
with significant declines in share values. But nothing in the last 100 years
rivals the valuations placed on big cap technology, Internet, and
telecommunications companies in today's market. The specter of riches and quick
profits lure investors in increasing numbers (5.4 million day traders, according
to Charles Schwab) into the investment arena. Suddenly, and for some yet
unknown reason, a few of the investors will head toward the exit; then, the rest
of the investment wildebeests will charge for the door. Greed turns into panic,
and share prices ultimately crumble. In what we consider the Bible for
investment managers, Ben Graham's The Intelligent Investor, the investment
process is defined as follows: "The investment operation is one which, upon
thorough analysis, promises safety of principal and an adequate return.
Operations not meeting these requirements are speculation." In the
aforementioned sectors of today's market, we can find no instances of the first
part of this definition present, but we can find plenty of speculation. In
fact, in today's investment environment, we find only a continuation of the
momentum investing theme which has been present for the last two years, when
investors buy only those securities that are moving up in price, with little
consideration for the underlying valuations as Mr. Graham would define them.
The momentum investors continue to funnel money into those securities and
sectors which are working, and that list of stocks that have continued to work
is getting shorter and shorter.
In 1999, over half of the stocks in the Nasdaq and Russell 2000 Indices were
down, as were 61% of those securities on the New York Stock Exchange. According
to Bob Farrell of Merrill Lynch, "In late 1999, companies with no earnings
advanced an average of 52%; the average stock with earnings declined by 2%."
Most stocks have gone nowhere for the last two years - in fact, the average
stock has been in a bear market for the past 2 years.
One final anecdotal point, with regard to the Internet. As we indicated,
there is no question that the Internet and its impact on all of our lives is
significant and sustainable. As value investors, however, we can not reconcile
this impact with the valuations being placed upon these companies. Wall Street,
however, has chosen to look beyond any semblance of investment reality, and fund
Internet companies in an unprecedented way. In a recent Barron's article, Mary
Meeker of Morgan Stanley, who is the acknowledged guru of Internet investing,
herself admits that valuations for many of these stocks are probably at peak
levels, and are unsustainable. As she stated, "When 59% of all venture capital
flows into one industry, as it has done through the first nine months of 1999,
one has to be at least somewhat cautious." While perusing the most recent Amazon
quarterly report and 10Q, we found it interesting that the Company stated the
following: "Although our revenues have grown, we cannot sustain our current rate
of growth. Our growth rate will certainly decrease in the future. We will
continue to incur substantial operating losses for the foreseeable future, and
these losses may be significantly higher than our current losses. In addition,
we have significant indebtedness, and we may not be able to meet our debt
service obligations. If our cash flow is inadequate, we could face substantial
liquidity problems. If we are unable to generate sufficient cash flow for
required payments, we will be in default."
At the current rate at which Amazon is burning cash, they will be out of
money somewhere between June and September of this year. As long as Wall Street
continues to fund the Company as it did recently with a convertible debt
offering, Amazon will continue to fuel its revenue growth. We would never
submit our capital, or yours, to this kind of risk; these types of stocks simply
do not pass Mr. Graham's "safety of principal" test. We've seen this "movie"
before and the ending is unhappy. For calendar 1999, the Fiduciary Capital
Growth Fund appreciated 6.5%. The annualized rates of return are reflected in
Figure 1.
FIGURE 1
1 YEAR 3 YEARS 5 YEARS 10 YEARS
Fiduciary Capital Growth Fund 6.50% 9.33% 14.12% 11.87%
Russell Value Index -1.49% 6.69% 13.14% 12.46%
Russell Growth Index 43.09% 17.83% 18.99% 13.51%
Russell 2000 Index 21.26% 13.08% 16.69% 13.40%
The graph in Figure 2 depicts the significant divergence between the growth
and value components of the Russell 2000. The same phenomena that have fueled
the S&P 500 and the Nasdaq advances of the past several years have also been
prevalent in the Russell Indices, i.e. technology, telecommunications, and the
Internet. Specifically, the top 50 contributors to the Russell 2000 in 1999 had
45 representatives in these three areas. The median multiple in those 50
companies is 99 times earnings and 16.1 times sales. (By comparison, your
portfolio sells at 14.5 times 1999 earnings, and 12.0 times 2000 earnings, and
roughly 1.14 times sales.) Those 50 top performing companies in the Russell
2000 Index experienced a cumulative gain of almost 40% in 1999, which is to say
that the other 1,950 companies in the Russell were collectively down about 20%
on average. It was the same with almost every index; a very small handful of
companies accounted for the performance, and those companies tended to be the
most expensive companies in the marketplace. It is also interesting to note
that these 50 companies in the Russell 2000 cumulatively lost almost $900
million in the last 12 months. As Keith Mullins, Chief Investment Strategist at
Salomon Smith Barney recently stated, "The best investment strategy for 1999 has
been to invest in companies that lose money."
FIGURE 2
RUSSELL 2000 GROWTH VS. RUSSELL 2000 VALUE
(12/31/98-12/31/99)
Date R2000 Growth R2000 Value
12/31/98 $100.00 $100.00
1/31/99 $104.50 $97.73
2/28/99 $94.94 $91.06
3/31/99 $98.32 $90.31
4/30/99 $107.00 $98.55
5/31/99 $107.17 $101.58
6/30/99 $112.82 $105.26
7/31/99 $109.33 $102.76
8/31/99 $105.24 $99.00
9/30/99 $107.27 $97.02
10/31/99 $110.02 $95.08
11/30/99 $121.65 $95.58
12/31/99 $143.09 $98.51
When we look back at the second half of 1999, after a very strong second
quarter when your portfolio was up in excess of 20%, we can draw a couple of
conclusions with regard to what happened. The table below details the growth
rate in earnings for the S&P 500, and for the companies in your portfolio:
As discussed in our September quarterly report, our companies' growth rates,
as seen in the table in Figure 3, began to accelerate from their 8.2% rate of
growth in 1998, and remained at double-digit rates throughout all of 1999.
Interestingly, however, the growth rate slowed in the third and fourth quarter
for our companies, and was not as strong as the S&P 500 in the final six months
of this year. In discussions with our companies, there was a slowdown in
business, much of which can be related and traced to the concerns about Y2K,
particularly in 1999's fourth quarter. Additionally, rising interest rates had
an adverse affect on our stocks in the last half of the year. However, most of
our companies expect very strong growth in 2000. After recent discussions with
each one of our managements and reasonably conservative analysis, we expect
earnings to grow 17.8% in 2000, versus Merrill Lynch's estimate of about 11-12%
for operating earnings in the S&P 500. While estimates are often precarious, and
sometimes wide of the mark, our contacts with all of our companies indicate that
this is a reasonable expectation for the year 2000. IF WE ARE CORRECT, YOUR
PORTFOLIO WOULD BE GROWING ALMOST 50% FASTER THAN THE S&P 500, YET SELLING AT A
MULTIPLE OF 12 TIMES NEXT YEAR'S EARNINGS, LESS THAN HALF THE VALUATION OF THE
S&P 500. On a relative basis, this would be one of the most attractive levels
at which your portfolio has sold in the last 25 years. While certainly not
guaranteeing anything, previous episodes of such extreme relative valuation gaps
have been the precursor of strong investment results.
FIGURE 3
S&P 500 S&P 500 FUND CHANGE
PERIOD OPERATING CHANGE FROM FROM PRIOR
EARNINGS PRIOR YEAR YEAR
1st Quarter 1998 $10.85 1.4% 11.1%
2nd Quarter 1998 $11.50 1.6% 9.1%
3rd Quarter 1998 $10.68 -4.9% 4.6%
4th Quarter 1998 $11.76 2.3% 8.0%
Calendar 1998 $44.79 0.1% 8.2%
1st Quarter 1999 $11.41 5.2% 10.4%
2nd Quarter 1999 $12.75 10.9% 14.7%
3rd Quarter 1999 $12.93 21.1% 13.4%
4th Quarter 1999 (Est.) $13.83 17.6% 11.1%
Calendar 1999 (Est.) $50.92 13.7% 12.4%
Calendar 2000 (Est.) $56.06 11-12% 17.8%
Fiduciary Management, Inc. estimates.
In that regard, we are often asked what our expectations are for our
portfolio going forward. Recall the table in Figure 4, similar to that which we
used in our shareholder letter dated October, 1999:
FIGURE 4
PRICE/ YOUR PORTFOLIO - EARNINGS PER SHARE GROWTH
EARNINGS ----------------------------------------------------------
RATIO 6.00% 9.00% 12.00% 14.00% 16.00% 18.00%
----- ------ ------ ------ ------ ------ ------
9 -3.91% -1.19% 1.53% 3.35% 5.16% 6.97%
12 1.78% 4.66% 7.55% 9.47% 11.39% 13.31%
15 6.43% 9.44% 12.45% 14.46% 16.47% 18.48%
18 10.38% 13.51% 16.63% 18.71% 20.80% 22.88%
21 13.84% 17.06% 20.28% 22.43% 24.58% 26.73%
24 16.92% 20.23% 23.54% 25.74% 27.95% 30.15%
If, as we believe, there is reasonably good economic growth with modest
inflation and our companies deliver strong growth, valuations for our companies
should be a nadir. Without any price/earnings expansion, portfolio returns
would mirror our expected earnings growth of approximately 17-18% in 2000.
Certainly, based upon what we have experienced with our companies for the past
two years, this may seem ambitious, but we think returns of that magnitude are
clearly possible not only for 2000, but for the next 3 years. IN FACT, THE LAST
TIME WE HAD RELATIVE VALUATIONS SIMILAR TO THOSE WE EXPERIENCED TODAY WAS BACK
IN 1990, AND OUR EQUITY PORTFOLIOS MORE THAN DOUBLED IN THE ENSUING 3-YEAR
PERIOD OF 1991-1993.
While many people have turned very cautious - if not negative - on the value
investing philosophy we employ, we have never been more optimistic about the
companies we own in your portfolio, nor the prospects for them over the next 12-
36 months. This is not a time, in our opinion, to be looking at indexes that
have performed so admirably over the last several years, or to play the game of
momentum investing, wherein a handful of extremely expensive stocks provide all
of the gain. It is certainly not the time to chase performance in large-cap and
technology mutual funds or get caught up in the short-term phenomena of what the
Federal Reserve will do with rates in the next quarter. The long-term
opportunity in your portfolio is simply too important to ignore. Based upon the
fact that 31 (75%) of the companies in your portfolio have major share buybacks
underway, managements must agree as well. We truly believe we are at a
watershed period, when value investing, which has performed extremely well over
any long-term time horizon, will again give independently thinking investors the
best absolute and relative rates of return for the next several years.
It has been a difficult time for value investors such as ourselves, but we
think the stage is set for an especially rewarding investment period in the
years ahead, and we fully expect to participate.
As always, we thank you for your continuing confidence in Fiduciary Capital
Growth Fund, Inc. and our investment style, and wish you all the best in the
year 2000 and beyond.
Sincerely,
/s/ Ted D. Kellner /s/ Donald S. Wilson /s/ Patrick J. English
Ted D. Kellner, C.F.A Donald S. Wilson, C.F.A Patrick J. English, C.F.A.
President Vice President Portfolio Manager
225 E. Mason St. o Milwaukee, WI 53202 o 414-226-4555
Fiduciary Capital Growth Fund, Inc.
STATEMENT OF NET ASSETS
December 31, 1999 (Unaudited)
QUOTED
MARKET
SHARES VALUE (B)<F2>
------ -------------
LONG-TERM INVESTMENTS -- 100.1% (A)<F1>
COMMON STOCKS -- 96.0% (A)<F1>
BANKS/SAVINGS & LOANS -- 1.1%
13,000 Associated Banc-Corp. $ 445,250
CHEMICAL/SPECIALTY MATERIALS -- 7.6%
47,000 Cambrex Corp. 1,618,562
21,700 Minerals Technologies Inc. 869,356
21,000 Sigma-Aldrich Corp. 631,313
-----------
3,119,231
DISTRIBUTION -- 7.2%
74,000 Arrow Electronics, Inc. 1,877,750
74,000 Pioneer-Standard
Electronics, Inc. 1,068,375
-----------
2,946,125
ELECTRONICS -- 1.2%
15,500 Methode Electronics, Inc. 497,936
HEALTH INDUSTRIES -- 19.4%
133,000 Covance Inc. 1,438,062
68,000 Dentsply International Inc. 1,606,500
27,000 Haemonetics Corp. 642,938
45,000 IDEXX Laboratories, Inc. 725,625
38,500 National Data Corp. 1,306,594
55,700 STERIS Corp. 574,406
65,000 Sybron International Corp. 1,604,688
-----------
7,898,813
INDUSTRIAL SERVICES -- 7.4%
64,000 Casella Waste System, Inc. 1,208,000
125,000 Republic Services, Inc. 1,796,875
-----------
3,004,875
INSURANCE -- 7.6%
43,350 Delphi Financial Group, Inc. 1,300,500
15,500 Financial Security Assurance
Holdings Ltd. 807,938
74,000 Old Republic
International Corp. 1,008,250
-----------
3,116,688
MISCELLANEOUS-BUSINESS SERVICES -- 15.7%
37,000 G & K Services, Inc. 1,197,875
37,000 Keane, Inc. 1,174,750
104,200 Modis Professional
Services, Inc. 1,484,850
40,000 Morrison Management
Specialists, Inc. 862,500
60,600 NFO Worldwide, Inc. 1,355,925
24,600 Romac International, Inc. 330,562
-----------
6,406,462
MISCELLANEOUS-TECHNOLOGY
MANUFACTURING -- 4.1%
35,100 Bell & Howell Co. 1,116,619
67,600 Paxar Corp. 570,375
-----------
1,686,994
PAPER/PACKAGING -- 3.9%
48,000 AptarGroup, Inc. 1,206,000
31,000 Wausau-Mosinee Paper Corp. 362,313
-----------
1,568,313
PRINTING/PUBLISHING/FORMS -- 1.6%
39,000 Wallace Computer
Services, Inc. 648,375
PRODUCER MANUFACTURING -- 2.8%
55,500 Regal-Beloit Corp. 1,144,687
RETAIL TRADE -- 7.3%
119,000 Casey's General Stores, Inc. 1,242,063
57,000 Consolidated Stores Corp. 926,250
46,500 Family Dollar Stores, Inc. 758,531
10,000 Stein Mart, Inc. 56,875
-----------
2,983,719
SOFTWARE/SERVICES -- 9.1%
29,000 NOVA Corp./Georgia 915,313
19,000 Reynolds & Reynolds Co. 427,500
16,000 Sterling Commerce, Inc. 545,000
77,500 SunGard Data Systems Inc. 1,840,625
-----------
3,728,438
-----------
Total common stocks 39,195,906
REITS -- 4.1%(A)<F1>
86,400 Prologis Trust 1,663,200
-----------
Total long-term
investments 40,859,106
SHORT-TERM INVESTMENTS -- 0.0% (A)<F1>
VARIABLE RATE DEMAND NOTE 0.0%
$14,830 Wisconsin Corporate Central
Credit Union $ 14,830
-----------
Total investments 40,873,936
Liabilities, less cash and
receivables (0.1%) (A)<F1> (54,221)
-----------
NET ASSETS $40,819,715
-----------
-----------
Net Asset Value Per Share
($0.01 par value 10,000,000
shares authorized), offering
and redemption price
($40,819,715 / 2,416,548
shares outstanding) $ 16.89
-----------
-----------
(a)<F1> Percentages for the various classifications relate to net assets.
(b)<F2> Each security, excluding short-term investments, is valued at the last
sale price reported by the principal security exchange on which the
issue is traded, or if no sale is reported, the latest bid price.
Securities which are traded over-the-counter are valued at the latest
bid price. Short-term investments are valued at cost which
approximates quoted market value.
FIDUCIARY CAPITAL GROWTH FUND, INC.
225 East Mason Street
Milwaukee, Wisconsin 53202
414-226-4555
BOARD OF DIRECTORS
BARRY K. ALLEN
GEORGE D. DALTON
PATRICK J. ENGLISH
TED D. KELLNER
THOMAS W. MOUNT
DONALD S. WILSON
INVESTMENT ADVISER
AND ADMINISTRATOR
FIDUCIARY MANAGEMENT, INC.
225 East Mason Street
Milwaukee, Wisconsin 53202
TRANSFER AGENT
AND DIVIDEND DISBURSING AGENT
FIRSTAR MUTUAL FUND SERVICES, LLC
615 East Michigan Street
Milwaukee, Wisconsin 53202
800-811-5311 or 414-765-4124
CUSTODIAN
FIRSTAR BANK MILWAUKEE, NA
615 East Michigan Street
Milwaukee, Wisconsin 53202
INDEPENDENT ACCOUNTANTS
PRICEWATERHOUSECOOPERS LLP
100 East Wisconsin Avenue
Suite 1500
Milwaukee, Wisconsin 53202
LEGAL COUNSEL
FOLEY & LARDNER
777 East Wisconsin Avenue
Milwaukee, Wisconsin 53202
This report is not authorized for use as an offer of sale or a solicitation of
an offer to buy shares of Fiduciary Capital Growth Fund unless accompanied or
preceded by the Fund's current prospectus. Past performance is not indicative of
future performance. Investment return and principal value of an investment may
fluctuate so that an investor's shares, when redeemed, may be worth more or less
than their original cost.
