Investment Adviser
Legg Mason Fund Adviser, Inc.
Baltimore, MD
Board of Directors
Raymond A. Mason, Chairman
John F. Curley, Jr., President
Richard G. Gilmore
Charles F. Haugh
Arnold L. Lehman
Dr. Jill E. McGovern
T. A. Rodgers
Edward A. Taber, III
Transfer and Shareholder Servicing Agent
Boston Financial Data Services
Boston, MA
Custodian
State Street Bank & Trust Company
Boston, MA
Counsel
Kirkpatrick & Lockhart LLP
Washington, DC
Independent Accountants
Coopers & Lybrand L.L.P.
Baltimore, MD
This report is not to be distributed unless preceded or accompanied by a
prospectus.
Legg Mason Wood Walker, Incorporated
------------------------------------
111 South Calvert Street
P.O. Box 1476, Baltimore, MD 21203-1476
410 (bullet) 539 (bullet) 0000
(recycled logo) Printed on Recycled Paper
LMF-009
1/97
Report to Shareholders
For the Quarter Ended
December 31, 1996
The
Legg Mason
Special
Investment
Trust, Inc.
Primary Class
Putting Your Future First
(Legg Mason logo)
FUNDS
<PAGE>
To Our Shareholders,
The Special Investment Trust ended 1996 with a 28.7% total return (share
appreciation plus reinvested distributions), well ahead of a 16.2% return on the
broad-based Value Line index of 1700 stocks and 23% return on Standard & Poor's
index of 500 large-company stocks. In the quarter ended December 31, the Trust's
total return was 8.2%, compared to returns of 6% and 8.3% on the Value Line and
Standard & Poor's indices, and net asset value per share rose from $26.17 to
$27.83. The latter figure is after payment in December of a $.485 per share
long-term capital gain distribution.
On a longer-term basis, an investment of $10,000 in the Trust when it was
established in December, 1985, would have grown to $41,793 by December 31, 1996
(assuming reinvestment of dividends and distributions), an average annual return
of 13.9%.
The Trust continues to invest primarily in common stocks of small and
medium-sized companies which, based on our research and analysis, appear to be
undervalued in relation to their earnings, book value and/or future prospects.
We believe that buying such stocks when they are out-of-favor, having the
patience to wait until their value is recognized by others, and being willing to
sell when others become enthusiastic buyers, should continue to produce
favorable long-term investment results.
Beginning on page 2, Bill Miller, the Trust's portfolio manager, comments
on the investment outlook.
Sincerely,
/s/ John F. Curley, Jr.
John F. Curley, Jr.
President
January 31, 1997
<PAGE>
Portfolio Manager's Comments
Your fund had an excellent year in 1996, rising 28.65%. This exceeded the
results of most of the major market indices and the results of mutual funds that
invest in small and mid-size companies. Comparative data are as follows:
3 months 1 year
- ------------------------------------------------------
Special Investment Trust 8.24% 28.65%
Small Company Funds+ 2.48 20.15
Mid-Cap Funds+ 2.36 17.92
S&P 500 8.33 22.96
Dow Jones Industrial Average 10.22 28.91
Russell 2000 5.20 16.49
As you can see, it was another year where the largest companies again
dominated the market's returns. The narrowness of the advance is evident when
one realizes that just five stocks provided all of the return of the S&P 500:
Intel, Microsoft, GE, Coke, and IBM. The other 495 companies underperformed, in
the aggregate.
Our returns were driven by solid results from our financial stocks, such as
Washington Mutual Savings (+80%), Orion Capital (+40%) and United Asset
Management (+50%), and exceptional returns from our technology holdings such as
Gateway Computer, Inacom, Storage Technology, and Western Digital, all of which
doubled over the past twelve months. These were offset somewhat by poor
performances from holdings such as Somatix Therapy, Physicians Corporation of
America, and Players International, all of which declined over 40% in an up year
for the market.
We do not know when the period of outperformance for the big companies will
end. Over the past 70 years smaller companies have returned about 200 basis
points (100 basis points = 1%) more per year than large companies, but they have
substantially underperformed in the past three years. The underperformance was
especially severe from May through November of this year, when small stocks (as
measured by the Russell 2000) declined about 2% while large companies went up
15%. That 17 percentage point difference was the largest ever recorded in the
almost 20 years since the Russell index was created.
+As measured by Lipper Analytical Services, Inc.
Small stocks appear to offer better value than their bigger brethren, but
have lacked earnings momentum. This has been a momentum driven market and small
stocks have suffered on a relative basis. A veteran trader recently remarked
that the one thing he's learned in the markets is that no matter what the
valuation, you have to own Intel, Microsoft, GE, and Coke if you expect to
outperform. When this kind of conviction becomes widespread, even among
knowledgeable market players, you are usually not too far from a reversal.
After almost 15 years during which the S&P 500 has averaged 17.39% per
year, bargains in big companies are rare and the benefits of low inflation,
steady growth, and high corporate profitability have been well reflected in
today's level of stock prices. The index sells at about 17x 1997 estimated
earnings, a level we regard as fair in an extended expansion that has seen
earnings grow almost 20% per year on average.
We are often asked what we think of the market, the question recently
seeming to take on greater urgency with the strong returns of the past few
years. Many people appear to have firm opinions about what is in store for 1997,
a position we find surprising since no one is vouchsafed privileged access to
what the future holds. There appears to be general agreement that stock prices
are elevated, with even Fed Chairman Alan Greenspan wondering whether
"irrational exuberance" may be affecting asset prices.
The price level of any freely functioning market or of any stock is the
price at which buyers and sellers are evenly balanced. At any level of stock
prices, you will find bulls and bears, though the decibel count may differ
according to the emotional state of the protagonists.
The short-term direction of stock prices is unknowable, a "random walk" as
the professors like to say, but the long-term direction is clear: higher. People
always seem surprised when the stock market is at an all time high and they
often fear a correction or worse. But GDP is at an all time high, corporate
profits are at an all time high, inflation has never been lower in the 6th year
of an expansion, monetary policy is stable, the deficit continues to decline and
is the smallest relative to our economy of any industrial nation. The surprise
would be if the market was not at an all time high.
2
<PAGE>
We will not rehash the arguments of the bears, except to note that this
year the most commonly cited reasons for pessimism are based on numerology:
years ending in 7 have historically been bad years, and years that are prime
numbers have been really bad (such as 1907, 1929, 1937, and 1987). Moreover,
after two great years in a row, the market usually suffers, having fallen
two-thirds of the time after cumulative gains of 60% or more.
Those who are often bearish seem to us to suffer from simultanagnosia, a
disorder in which one can pick out parts and features of some situation, but
where one is unable to organize them into a coherent or meaningful whole. The
long-range picture does not provide much support to the pessimists.
Since 1870, real (i.e., after inflation) returns in the stock market have
averaged 6.6% per year. Over the past 70 years, real returns have been over 7%
per year, and since 1982 they have been over 12% per year. We are six years into
an expansion that shows no signs of ending, but in which profits growth is
decelerating.
Corporate profits growth was 15% in 1995, over 10% last year, and should be
between 5-10% this year. Over long periods of time, stock prices track profits
growth adjusted for changes in the price earnings multiple. The P/E multiple is
driven by interest rates, which in turn are a function of inflation. The
disinflationary trend of the past 15 years is well recognized. Core CPI
inflation was 2.6% last year and should be about the same this year. It is
unlikely we are due for much more multiple expansion unless interest rates fall
from current levels.
This means the central tendency of stock prices in 1997 should be
moderately (5-10%) higher, with perhaps above average volatility as the bulls
and bears square off over the next economic number or the next news item on the
tape. If the Fed bumps interest rates higher to constrain inflation, we are
likely to see a moderately strong sell-off; or if long rates rise much above
present levels the market is also likely to come under some pressure.
The overall picture seems to be that it makes sense to have diminished
expectations relative to the returns achieved over the past two years. We remain
confident, though, that we will continue to generate acceptable returns and we
are committed to working diligently on your behalf.
As always, we appreciate your support and welcome your comments.
Bill Miller, CFA
January 31, 1997
DJIA 6813.09
3
<PAGE>
Performance Information
Legg Mason Special Investment Trust, Inc.
Total Return for One, Five, Ten Years and Life of Fund,
as of December 31, 1996
The returns shown are based on historical results and are not intended to
indicate future performance. The investment return and principal value of an
investment in the fund will fluctuate so that an investor's shares, when
redeemed, may be worth more or less than their original cost. Average annual
returns tend to smooth out variations in the fund's return, so they differ from
actual year-to-year results. No adjustment has been made for any income taxes
payable by shareholders.
The fund has two classes of shares: Primary Class and Navigator Class. The
Navigator Class, offered only to certain institutional investors, pays fund
expenses similar to those paid by the Primary Class, except that transfer agency
fees and shareholder servicing expenses are determined separately for each class
and the Navigator Class does not incur Rule 12b-1 distribution fees.
Total returns as of December 31, 1996 were as follows:
Cumulative Average Annual
Total Return Total Return
- -----------------------------------------------------------
Primary Class:
One Year +28.65% +28.65%
Five Years +95.24 +14.32
Ten Years +289.33 +14.56
Life of Class+ +317.93 +13.87
Navigator Class:
One Year +30.04% +30.04%
Life of Class++ +60.52 +25.44
- -------------
+Primary Class inception--December 30, 1985
++Navigator Class inception--December 1, 1994
Selected Portfolio Performance
Biggest gainers for the 4th quarter 1996*
-----------------------------------------------------
1.Boomtown Inc. +112.1%
2.Hollywood Park, Inc. +93.5%
3.Western Digital Corporation +41.7%
4.Conseco, Inc. +29.4%
5.Storage Technology Corporation +25.7%
6.Calpine Corporation +25.0%
7.Standard Federal Bancorporation +24.3%
8.Resource Mortgage Capital Corporation +23.7%
9.The Bear Stearns Companies Inc. +19.9%
10.Peoples Heritage Financial Group, Inc. +19.8%
Biggest laggers for the 4th quarter 1996*
---------------------------------------------------
1. Somatix Therapy Corporation Warrants -100.0%
2. Players International, Inc. -26.2%
3. Bell & Howell Company -25.2%
4. Somatix Therapy Corporation -23.2%
5. Madge Networks N.V. -21.8%
6. Physician Corporation of America -17.5%
7. Cidco, Inc. -15.7%
8. Mirage Resorts, Incorporated -15.6%
9. Grupo Financiero Serfin S.A. de C.V. ADR -13.2%
10. Argyle Television, Inc. -12.9%
* Securities held for the entire quarter.
Portfolio Changes
Securities Added
--------------------------
Anchor Gaming
Colt Telecom Group PLC
Shoney's Inc.
Ultrafem, Inc.
Securities Sold
--------------------------
Stewart Enterprises, Inc.
4
<PAGE>
Portfolio of Investments
Legg Mason Special Investment Trust, Inc.
December 31, 1996 (Unaudited)
(Amounts in Thousands) Shares Value
- --------------------------------------------------------------
Common Stocks and Equity Interests -- 97.7%
Advertising -- 4.8%
WPP Group P.L.C. 10,200 $ 44,211
WPP Group P.L.C. ADR 89 3,821
--------
48,032
--------
Apparel -- 0.2%
Salant Corporation 450 1,463(A)
--------
Banking -- 2.6%
Grupo Financiero Serfin S.A.
de C.V. ADR 1,313 5,414(A)
Peoples Heritage Financial Group, Inc. 750 21,000
--------
26,414
--------
Biotechnology -- 0.7%
Somatix Therapy Corporation 1,980 6,559(A,B)
Somatix Therapy Corporation Warrants 152 0(A,B)
--------
6,559
--------
Broadcast Media -- 0.7%
Argyle Television, Inc. 267 6,542(A)
--------
Computer Services and Systems-- 22.3%
America Online, Inc. 1,425 47,381(A)
Bell & Howell Company 353 8,377(A)
Gateway 2000, Inc. 500 26,781(A)
InaCom Corp. 765 30,600(A,B)
Intergraph Corporation 922 9,451(A)
Madge Networks N.V. 1,925 19,009(A)
Storage Technology Corporation 900 42,863(A)
Western Digital Corporation 700 39,813(A)
--------
224,275
--------
Energy -- 2.8 %
Calenergy, Inc. 750 25,219(A)
Calpine Corporation 165 3,300(A)
--------
28,519
--------
Entertainment -- 9.5%
Anchor Gaming 185 7,446(A)
Boomtown Inc. 900 7,875(A,B)
Circus Circus Enterprises, Inc. 825 28,359(A)
Hollywood Park, Inc. 1,775 26,625(A,B)
Mirage Resorts, Incorporated 548 11,846(A)
Players International, Inc. 2,400 13,500(A,B)
--------
95,651
--------
(Amounts in Thousands) Shares Value
- --------------------------------------------------------------
Finance -- 6.5%
Federal National Mortgage Association 350 $ 13,038
Mego Financial Corporation 343 3,004(A,C)
Mego Financial Corporation Warrants 300 2,265(A,C)
The Bear Stearns Companies Inc. 525 14,634
United Asset Management Corporation 1,238 32,962
--------
65,903
--------
Food, Beverage and Tobacco -- 2.9%
Cott Corporation Quebec 4,100 29,725(B)
--------
Health Care -- 7.4%
Magellan Health Services, Inc. 950 21,256(A)
Physician Corporation of America 1,694 16,936(A)
Sunrise Medical, Inc. 817 12,975(A)
Ultrafem, Inc. 167 2,917(A)
Value Health, Inc. 1,041 20,305(A)
--------
74,389
--------
Insurance -- 14.7%
CMAC Investment Corporation 750 27,562
Conseco, Inc. 517 32,987
Enhance Financial Services Group Inc. 550 20,075
John Alden Financial Corp. 975 18,038
Orion Capital Corporation 590 36,064
PennCorp Financial Group, Inc. 354 12,751
--------
147,477
--------
Manufacturing -- 2.1%
Briggs & Stratton Corporation 227 9,988
Danaher Corporation 236 11,004
--------
20,992
--------
Miscellaneous -- 0.2%
Olsen & Associates AG 300 2,241(A,C)
--------
5
<PAGE>
Portfolio of Investments--Continued
Legg Mason Special Investment Trust, Inc.
(Amounts in Thousands) Shares Value
- --------------------------------------------------------------
Real Estate -- 2.0%
Resource Mortgage Capital Corporation 696 $ 20,436
--------
Restaurants -- 0.7%
Shoney's Inc. 1,016 7,113(A)
--------
Savings and Loan -- 6.9%
Standard Federal Bancorporation 635 36,121
Washington Mutual, Inc. 770 33,351
--------
69,472
--------
Specialized Services -- 2.1%
CUC International, Inc. 897 21,313(A)
--------
Specialty Retail -- 7.3%
Home Shopping Network, Inc. 1,498 35,587(A)
Mac Frugal's Bargains o Close-outs Inc. 1,439 37,586(A,B)
--------
73,173
--------
Telecommunications -- 1.3%
Cidco, Inc. 663 11,603
Colt Telecom Group PLC 100 1,925(A)
--------
13,528
--------
Total Common Stocks and Equity
Interests
(Identified Cost-- $647,058) 983,217
- --------------------------------------------------------------
Principal
(Amounts in Thousands) Amount Value
- --------------------------------------------------------------
Repurchase Agreement -- 2.4%
Prudential Securities, Inc.
7.15% dated 12-31-96, to be
repurchased at $24,394 on
1-2-97 (Collateral: $6,985
Federal National Mortgage
Association Mortgage-backed
securities, 10% due 10/1/20,
value $3,097 and $21,780
Federal Home Loan Mortgage
Corporation Mortgage-backed
securities, 7.5% due 9-1-26,
value $21,868)
(Identified Cost-- $24,384) $24,384 $ 24,384
- ---------------------------------------------------------------
Total Investments -- 100.1%
(Identified Cost -- $671,442) 1,007,601
Other Assets Less Liabilities -- (0.1)% (1,002)
----------
Net assets -- 100.0% 1,006,599
Net asset value per share:
Primary Class $27.83
======
Navigator Class $28.27
======
(A) Non-income producing
(B) Affiliated Companies--As defined in the Investment Company Act of 1940
an "Affiliated Company" represents Fund ownership of at least 5% of
the outstanding voting securities of the issuer.
(C) Private placement
6
