The first quarter of 2005 was disappointing. While we enjoyed strong performances from some stocks, we had weak returns from several others including our largest and most successful long-term holding, Doral Financial. In Doral’s case the share price has been cut by two thirds, contributing to our worst performance relative to the S&P 500 since September of 1997. These episodes are infrequent, but painful nonetheless.

Doral’s recent underperformance was driven by an abrupt loss of confidence in the company by Wall Street analysts and, subsequently, some large shareholders. Scrutiny is focused on assumptions that management made when valuing financial assets on the balance sheet, as required by regulators and accounting rule makers. Some felt that these assumptions, which came to light when the company reported fourth quarter earnings, were too aggressive and overstated the value of the assets in question. Doral’s management has decided to switch to a more conservative accounting treatment and business model, the first step in putting this issue behind them.

We use Wall Street research only peripherally, preferring instead to do our own primary research and look to independent sources to validate or disprove our investment thesis. As such, we can objectively assess the business itself. Is the franchise damaged? No, we do not think so. We feel that the same dynamics that made Doral an attractive investment years ago remain in place. Is management credible? We believe so, but they do need to focus on running the business and capitalizing on their market position.

Doral was not the only detractor: Boston Scientific and Varian Medical were also weak in the quarter. In both cases we remain comfortable with the long term prospects despite the near term pressures on their stock prices. Finally, growth stocks underperformed the market, and commodity plays, namely energy stocks out performed. We are typically underweight undifferentiated cyclical companies.

Notes From the Road by Cassandra Hardman…

I recently returned from a trip to the Far East, which began in Hong Kong. My first trip to what is now a "special administrative region" of China was in the mid-80’s, when the British influence was very evident. Today, there are remnants of the colonial era, but to this visitor, Hong Kong has become strikingly more "Chinese". In the ‘80’s, most of the analysts I met with were British; on this trip all were Chinese. While the capitalist feeling remains, Hong Kong’s renowned entrepreneurial spirit seemed less evident; perhaps not so much diminished, as less maverick and more orderly.

Traveling on through China, signs of the booming economy were abundant. Even in smaller cities, cranes could be seen everywhere, building high-rise office and apartment towers. The contrasts remained: street sweepers and groundskeepers in traditional bamboo hats, looking much as they would have 50 years ago, while young women in tight designer jeans and stilettos bicycled past them on their way home from office jobs; luxury cars passing ox-drawn carts filled with vegetables. And everywhere, an overabundance of workers, from restaurants to small shops, evidence of the potential for productivity improvements over time.