April 30, 1997
Dear Shareholder:
As of March 31, 1997, the net asset value per share (NAV) of the
Parnassus Fund was $35.88 so the overall return for the quarter was 4.33%. This
compares to a return of 2.68% for the S&P 500 and a loss of 1.28% for the
average growth fund. We beat the S&P by 1.65% and the average growth fund by
5.61%. This is the second straight quarter we've topped both the S&P and the
average growth fund by substantial margins so it appears as if we're out of our
slump. I realize, however, that we have to keep outperforming for several more
quarters before we can make up for the disappointing returns for the 15-month
period ending on September 30, 1996.
It's interesting to note, though, that our strong six-month performance
has lifted our 12-month record to a gain of 20.62% which is better than the
19.84% of the S&P and the 11.75% of the average growth fund.
Below you will find a table summarizing our average annual returns as
of March 31, 1997 for the one, five and ten-year periods as well as for the life
of the Fund. The overall return figures give investment performance only while
the total return figures are reduced by the amount of the maximum sales charge
(3.5%).
<TABLE>
- --------------------------------------------------------------------------------
<CAPTION>
Average Annual Average Annual Overall
Total Return Return
<S> <C> <C>
One Year 16.40% 20.62%
Five Years 12.40% 13.20%
Ten Years 9.61% 10.01%
Since Inception (12-31-84) 11.99% 12.31%
<FN>
Past performance is no guarantee of future returns. Investment return and
principal value will fluctuate and an investor's shares, when redeemed, may be
worth more or less than their original cost.
</FN>
</TABLE>
INDIVIDUAL COMPANIES
As you can tell from the fact that the average growth fund lost money,
the quarter was a difficult one. After stocks got off to a strong start this
year, Alan Greenspan, Chairman of the Federal Reserve Board, raised interest
rates and the stock market dropped sharply. Although the S&P had a gain for the
quarter, the NASDAQ Composite Index (which is heavily weighted with technology
stocks) actually declined 5.22% during the period.
We had eight stocks that dropped more than 10% during the quarter.
Genus, the maker of semiconductor manufacturing equipment, dropped 28.4% as its
stock went from $5.50 to $3.94 a share. The company posted a loss due to reduced
spending for semiconductor capital equipment. Acme Metals declined 19.4% as
start-up costs on a new plant exceeded expectations; the stock went from $19.38
to $15.63.
Broderbund, a producer of educational and productivity software and a
recent purchase, saw its shares fall 17.5% as they went from our cost of $26.50
to $21.88. A weak Christmas season and extremely competitive conditions in the
consumer software industry pushed the stock price down.
TJ International, the Boise, Idaho-based maker of engineered lumber,
had a 15.6% decline in its stock as higher interest rates threatened the
construction industry. The stock dropped from $22.50 to $19.00.
Mentor Graphics, the software firm based outside Portland, Oregon,
suffered a 14.1% stock price decline as it went from $9.75 to $8.38. Tandem
Computers, the Silicon Valley-based maker of fault-tolerant computers, saw a
13.6% drop in its stock price, going from $13.75 to $11.88.
Mylan Laboratories, the manufacturer of generic pharmaceuticals, had a
decline of 11.9%---from $16.75 to $14.75. A slower than normal approval process
at the FDA has hurt earnings of all the generic drug companies.
Finally, Cypress Semiconductor saw a decrease of 11.5% in its stock
price as it went from $14.13 to $12.50. Continued weakness in the company's
sector of the semiconductor industry caused the decline.
STRONG PERFORMING COMPANIES
Fortunately, there were more than enough strong performers to outweigh
the laggards. The superstar of the quarter was Advanced Micro Devices (AMD)
whose stock soared 61.7%, going from $25.75 to $41.63. For the first time in
history, AMD beat Intel to market with a new microprocessor. In this case, it
was the K-6 with MMX (multimedia extension) which beat Intel's comparable chip
(the Pentium II) to market by a month. Intel will still have most of the market
for the sixth generation chip that will power most personal computers, but AMD
will probably be able to get 15-20% of the market and that will make the company
highly profitable.
Lam Research, another semiconductor equipment maker, increased 37.5%
from the beginning of the quarter until the time we sold it at $38.67. (At the
beginning of the year, the stock was at $28.13). We sold the stock because its
price had gotten ahead of the company's fundamentals.
Quantum Corporation, the maker of disk drives and other data storage
products, saw its stock price rise from $28.63 to $38.63 or 34.9%. Strong demand
for disk drives because of increasing sales of personal computers pushed
Quantum's stock to higher levels.
Herman Miller's shares went up 20.5%, going from $56.63 to $68.25.
Strong sales of office furniture meant strong earnings for the company. Delta
Air Lines saw its stock price rise 18.7% as it climbed from $70.88 to $84.13.
Delta's higher earnings are the result of better cost control and increased
demand for air travel.
Liz Claiborne's shares went up 12.9%, climbing from $38.63 to $43.63.
Attractive designs, strong sales and strong management were responsible for the
increase.
Sullivan Dental increased 11.4% as its stock went from $13.13 to
$14.63. A stronger sales force and tight cost control improved earnings at the
company.
WHY I SOURED ON APPLE
Those of you who carefully examine our portfolio statement this quarter
will notice that Apple is gone. We sold our entire position for an average price
of around $18. We bought the stake three years ago for $37 a share so we lost
half our investment. For a long time now, many people have been telling me to
sell Apple and now many of them will be saying, "I told you so." The difficulty
with being a contrarian is that you are always buying out-of-favor stocks and
someone is always saying "Sell!".
In looking back on the reasons for the purchase, Apple had some
impressive assets including 25 million users, great products, wonderful
employees and a household name. On the other hand, the company had two distinct
liabilities: an operating system under siege by Windows and management that
ranged from mediocre to poor.
My investment thesis was that Apple's poor management and vulnerable
operating system could be outweighed by its abundant assets. I still think that
Apple could have withstood the Windows onslaught had the company had better
management. The lesson I've learned from the Apple episode is that a company can
compensate for many weaknesses, but management is not one of them. In the
future, my new rule is not to invest in a company if I don't think the
management is significantly above average.
When Gil Amelio took over as Apple's CEO in February of 1996, I decided
to give the company 18 months before making a decision on his stewardship. The
time is not yet up, but my disagreements with his management decisions have made
me say "enough."
First, I was unhappy with the decision to pay $400 million to buy Steve
Jobs' company called NEXT. In my view, Apple paid too much. Even if the new
NEXT/Apple system (called Rhapsody) is successful, I don't expect to see any
results for more than 12 months.
Second, I disagreed with Amelio's restructuring and layoff policies.
While it's true that on occasion companies have to lay off employees, it's
better to make all the layoffs at the beginning of the process rather than going
through a series of layoffs and restructurings like Apple has done.
Unfortunately, Amelio only reduced the Apple workforce by 1,500 people at the
beginning of his term. Recently, he's had to terminate an additional 4,000
people. This is terrible for morale and not a humane policy. It's also bad from
a business standpoint. Moreover, the most recent layoff included a lot of people
who could have helped the company succeed.
Third, Apple never made the required effort to get developers to
emphasize making Macintosh software. Amelio's gestures were too little and too
late.
I don't expect Apple to go bankrupt. The company's technology and
millions of Apple users will keep the enterpirise afloat, but prospects for the
future are not very good. Most likely, a much smaller Apple will become a niche
player.
Two days after the press reported Parnassus' sale of Apple stock, the
Saudi Arabian Prince Al-Waleed Bin-Talal announced his purchase of 5% of the
company's stock. I wish him well.
COMPANY NOTES
On April 5,500 Atlanta-based Delta flight attendants finished
construction on a Habitat for Humanity house in Riverdale, Georgia. The house
was funded entirely by the proceeds from the sale of recycled aluminum beverage
cans collected on Delta flights. Delta employees' program of turning cans into
homes is continuing. Also, Delta Employees Fair Share Program, a charitable
organization funded and directed by employees, has financed the construction of
Habitat homes in Los Angeles, Atlanta and Salt Lake City.
From February through September, 600 teams of Junior Achievement high
school students from 30 countries will match wits as managers of
computer-simulated businesses in the Second Annual Hewlett-Packard Global
Business Challenge. Teams of students make decisions about marketing, pricing,
production and distribution of a fictional product and then send their decisions
via e-mail to a central processing center in Cambridge, Massachusetts.
Mentor Graphics sponsored a program on February 21 to bring 12-to-14-
year old girls from schools in Oregon to visit company headquarters. Eileen
Boerger, an engineer and Mentor Vice President of software design, hopes to
attract young women to the high-tech field and inspire them to study math and
science. Thirty female students will take apart cellular phones and computers to
study the chips inside. They will also participate in a hands-on development
exercise and interact with women engineers.
Although the "Company Notes" section of our quarterly reports is
usually devoted to newsworthy items about positive social aspects of businesses
we already own, I thought it might be interesting to shareholders if upon
occasion we discussed companies that we considered, but did not invest in for
social reasons. Two recent examples are Wal-Mart and The Sports Authority.
As some of you may know, Wal-Mart's stock has recently declined to a
point where it could be considered undervalued. We looked at the company from a
social and a financial viewpoint. On the positive side, we liked the fact that
Wal-Mart brought greater selection and lower prices to consumers---especially
those in rural areas. There is no doubt that this has a positive impact. On the
other hand, a new Wal-Mart in town has the effect of drawing business from the
traditional center of small towns. In this regard, the decision was a close one
as there were factors pointing each way. In the final analysis, we chose not to
invest in Wal-Mart because there were not enough positive factors from a social
standpoint. Although many employees enjoy working at the company and in many
cases, there is a strong spirit among the workers, the pay is pretty low and the
benefits are not particularly attractive. Wal-Mart has improved its
environmental responsibility in recent years, but it is not exceptional in this
regard. There were just not enough positive factors to justify inclusion in our
portfolio.
Another company of note is The Sports Authority. This Florida-based
chain of large sporting goods stores has excellent management, quality
merchandise at low prices and good prospects for future growth. In the course of
our research, though, we discovered that the company sells handguns in its
stores. While we don't have a specific criterion for handguns, our judgement is
that this retail activity does not have a positive impact on society. We also
wrote the chief executive officer of the company to tell him of our views.
OUTLOOK AND STRATEGY
As I write this report in mid-April, the market has just gone through a
correction---dropping about 8% from its peak in late February. Even after this
drop, though, the major stock market indices---the Dow Jones Industrials and the
S&P 500---still look fully valued. Those indices are certainly not trading at
bargain levels.
One thing that many people don't realize, though, is that the major
indices represent relatively few companies. The Dow Jones Average consists of
just 30 large companies. While the S&P consists of 500 companies, the average is
weighted according to the size of each business so that the 100 largest firms
account for the vast majority of the index.
What's not widely known is that most companies are not trading at
extremely high valuations. While the Dow and S&P were up about 2.7% for the
first quarter, the NASDAQ and the Russell 2000 index of smaller companies
actually lost 5.2% each for the period. There are somewhere around 5000
companies that are publicly-traded and large enough for institutional investors
to put their money in. I would suspect that most of these companies are trading
at very reasonable valuations. Given this situation, we're not pulling back from
the market, but we're continuing to remain almost fully invested.
As I indicated six months ago in the discussion entitled "Confessions
of a Contrarian", we have made an important change in our strategy. We still
look for out-of-favor stocks, but we are paying more attention to the prospects
for an earnings turnaround in the subsequent 12 months. This has lead us to
choose growth stocks that have stumbled rather than picking companies that have
extremely low valuations. We're paying a little more in terms of our contrarian
ratios than we used to, but we think we're getting more value and therefore not
really deviating from our contrarian strategy. So far, the strategy is working
as you can tell from the Fund's performance over the past six months.
To give you an idea of why I think the broader market is not overvalued
and also to give you a flavor for our new strategy, I would like to briefly
discuss five of our recent investments.
Whole Foods Markets, a large retailer of natural foods, is a rapidly
growing company. The stock traded above $37 a share in September of 1996 and
it's now around $22. Weakness in its Los Angeles-area stores and some other
factors we regard as temporary have reduced the price of the stock to what we
consider bargain levels.
Macromedia, a San Francisco-based multimedia company, traded above $60
per share in December of 1995 and the stock is now below $10. Sales have not
grown as much as expected and the stock dropped an incredible 83%. We think
earnings growth will resume as new products come to market later this year. The
company also has a lot of cash which will help it bounce back from adversity.
Intuit, the maker of Quicken and Turbo-tax software, traded over $80 a
share in December of 1995 and it's now at $23 a share for a drop of over 70%.
The company makes excellent products and we think its worth far more than its
current market quotation.
Nellcor, a maker of medical equipment, traded as high as $36 a share in
March of 1996 and it's now below $17. The company had some difficulties after a
merger, but earnings should rebound before the end of the year.
Finally, there is Broderbund, a producer of educational software
including the Carmen San Diego series. Its stock sold for more than $78 in
September of 1995 and it's now at $22 a share. Competitive conditions in the
consumer software industry brought down the stock price. However, the company's
strong product line and the coming release of the sequel to its best selling
computer game called Myst should help earnings substantially.
TRUSTEES AND STAFF
Below you will find a photograph of the Trustees and staff of both the
Parnassus Fund and the Parnassus Income Fund. The photograph was taken on
December 9, 1996. Seated from left to right are Trustees Howard Shapiro, Herb
Houston, Joan Shapiro, Jerome Dodson, Gail Horvath and David Gibson. Standing
from left to right are staff members Anh Cornell, Jane Liou, Keith Bang, Yen
Chau, Thomas Tran, Howard Fong, David Pogran, Vince Wood, Susan Loughridge,
David Parvin, Marie Chen, Todd Ahlsten, Minnie Chen, Bill Fraser, general
counsel Richard Silberman, Sheila Alfaro, and Ben Liao.
Finally, I would like to thank all of you for investing in the
Parnassus Fund and supporting socially responsible investing.
Yours truly,
Jerome L. Dodson
President
<TABLE>
- --------------------------------------------------------------------------------
<CAPTION>
The Parnassus Fund Portfolio: March 31, 1997*
<S> <C> <C> <C>
# of Shares Issuer Market Value Per Share
- ----------- ------ ------------ ---------
160,000 Aetna, Inc. $13,740,000 $85.88
80,000 Advanced Micro Devices, Inc. 24,975,000 41.63
600,000 ATC Group Services, Inc. 5,325,000 8.88
382,000 Broderbund Software, Inc. 8,356,250 21.88
76,900 Centigram Communications 773,806 10.06
800,000 Cypress Semiconductor Corp. 10,000,000 12.50
100,000 Delta Air Lines, Inc. 8,412,500 84.13
600,000 Electro Scientific Industries 15,150,000 25.25
350,000 FEI Company 2,975,000 8.50
654,000 Genus, Inc. 2,575,125 3.94
60,000 H.B. Fuller Company 2,895,000 48.25
45,000 Herman Miller, Inc. 3,071,250 68.25
80,000 Hewlett-Packard Company 4,260,000 53.25
60,000 Houghton Mifflin Company 3,240,000 54.00
100,000 Inland Steel Industries, Inc. 1,950,000 19.50
300,000 Intuit, Inc. 6,975,000 23.25
20,000 Liz Claiborne, Inc. 872,500 43.63
279,500 Macromedia, Inc. 2,532,969 9.06
400,000 Mentor Graphics Corporation 3,350,000 8.38
1,000,000 Morgan Products, Ltd. 7,750,000 7.75
508,000 Mylan Laboratories 7,493,000 14.75
352,500 Nellcor Puritan Bennett, Inc. 6,212,813 17.63
303,500 Protocol Systems, Inc. 2,769,437 9.13
395,000 Quantum Corporation 15,256,875 38.63
200,000 Ryerson Tull, Inc. 2,775,000 13.88
100,000 Southwest Airlines Company 2,212,500 22.13
500,000 Sullivan Dental Products, Inc. 7,312,500 14.63
252,500 Sun Company, Inc. 6,596,563 26.13
500,000 T. J. International, Inc. 9,500,000 19.00
800,000 Tandem Computers, Inc. 9,500,000 11.88
375,000 The Limited, Inc. 6,890,625 18.38
500,000 Toys "R" Us, Inc. 14,000,000 28.00
320,000 United Healthcare Corporation 15,240,000 47.63
600,000 Wellman, Inc. 10,500,000 17.50
340,000 Whole Foods Market 7,055,000 20.75
------------
Total Portfolio $253,743,713
Short Term Investments and
Other Assets 15,950,548
------------
Total Net Assets $269,694,261
============
The Net Asset Value as of
March 31, 1997 $35.88
<FN>
* Note: Portfolio is current at time of printing, but composition is subject
to change.
</FN>
</TABLE>
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THE PARNASSUS FUND
Distributed by Parnassus Investments
One Market-Steuart Tower #1600
San Francisco, California 94105
415-778-0200
800-999-3505
This quarterly report must be preceded or accompanied by a current prospectus.
Recycled Paper
