January 3, 2011

Progress Report

Dear Investor,

In last year's letter I offered the opinion that "... for 2010, the market may fluctuate within a relatively narrow range." Indeed, that's what transpired for most of the year before the market headed higher in the fourth quarter. The Dow ended at its highest level in more than two years, up 1,149 points to 11,578, though it stands 18% below its peak. Other market averages fared somewhat better as smaller companies outperformed the giants.

One can't review 2010 without mentioning the "flash crash" of May 6th. That sharp decline of 1,000 points was a very unnerving experience caused by high frequency trading algorithms run amok. Since the SEC has done nothing to restrict high frequency trading, it may well happen again. What we need to keep in mind, however, is that extreme volatility may now be a fact of life on Wall Street but it is irrelevant to the type of long term investing in which we engage.

Regarding the long term, we like what we see. The economy, which has been gradually improving, should continue to do so. Interest rates are low, inflation is low, growth remains strong in the developing world and stocks are not particularly expensive. Most industrial companies regained their footing in 2009 and have been growing nicely since. Banks are finally emerging from their state of suspended animation and are getting back to the business of lending. The government may be hamstrung trying to reduce the deficit while stimulating the economy, but the economy should continue to grow without further government assistance.

Within FIM, I’m pleased with the performance of our investment committee. Consisting of Jonathan, Monica, Alan and myself and in existence now for well over a year, it is the committee which gives the green light for the purchase of all securities we place in portfolios. The addition of a stock to the "buy" list requires favorable votes from at least three of the four members. Our bi-weekly meetings, at which we compare notes from our individual research efforts, have proven to be educational, informative and effective. The information we share, by the way, is gathered from an aggregate number of approximately 660 company conference calls, 125 personal visits with company executives, 90 company presentations in person and another 230 company presentations that we accessed on-line. To paraphrase an old maxim, four heads are better than one.

We now have a succession plan in place. Jonathan Reichek has been appointed Vice President of Research. He will begin acquiring an ownership position in FIM as may others within the firm. For the past year Jonathan has been managing approximately 20% of our portfolios and has been doing a fine job. His responsibilities will grow over time.

With better technology at hand, Jenny and Mona are running our front office more efficiently than ever. Overall, I’m very pleased with the state of affairs at FIM and very proud of the gang for their continuing contributions. I plan to remain intimately involved in all aspects of FIM, though my work schedule may ease up a bit. For most people, a job is the road to retirement. For me, however, it is the journey itself that I find most rewarding.

Now for the hard part -- predicting the future. Here are some nuggets:

* The price of gasoline will rise noticeably, partly due to the higher cost of crude and partly due to additional taxes.

* Washington will try to reduce the deficit while stimulating the economy. They won't succeed at either, but the economy will find a way to grow nonetheless.

* Growth in China will moderate as they struggle to contain inflation.

* Despite the rapid growth of the US money supply, inflation will remain subdued due to relatively low factory utilization and an excess supply of labor.

* The cyclical component of unemployment will fall as the economy recovers, but the structural component, due to wider use of the internet, will be with us for some time.

* Most important to us, corporate earnings will continue to rise.

I hesitate to project too much optimism, but I believe we are in the early stages of a bull market which will carry the major market averages to new records over the next few years. Given rising earnings, low interest rates and inflation, international economic cooperation and (hopefully) world peace, it would not surprise me if the Dow hit 13,000 before the end of this year. In any case, we are standing by our prediction, made in May of 2009, that the Dow will reach 15,000 by 2015.

In the meantime, we plan to continue our focus on the types of special companies that have rewarded us over the years. Ten years ago, the Dow stood at 10,673. Since then it has advanced approximately 900 points for an average annual gain of less than 1% (not including dividends). Over that same time span our average portfolio has more than doubled. Not bad for a handful of individuals armed with nothing more than desktops and laptops.

To those of you who endured the worst bear market in the last 70 years, I extend a special note of gratitude for staying the course with us. Thankfully, we have succeeded in recovering most of the losses even though the market remains far from its all-time high. I’m convinced that the worst is past and the future holds promise.

Have a very happy and healthy new year.

For the team at FIM,

Jeff Friedberg