April 9, 2001 For the first quarter of 2001 our average account declined -7.25%.     Before we write these letters to you, we read the previous half dozen, if only to keep the repetitions intentional, rather than accidental.  How vexing it is then to read our last year’s rantings on Internet excesses, only to discover in this year’s selling storm everyone winds up all wet.  We have too, and if we are less soaked than average experience it is cold comfort.     Nonetheless, we find ourselves cheerier around here than we have been for some time.  There are two ways to look at selling squalls quite so ferocious as this year’s.  One popular method is to fix on the worst day of the lot, multiply by 22 (the average number of trading days in a month), and conclude that your net worth is gone by the next monthly statement but one.     The other, slightly more nuanced method, is to remember there are underlying companies with strong cash flows behind the stock symbols, the companies may still be doing well, and the present value of their cash flows is likely to be worth more if the authorities grow as frightened as everyone else with current events, and lower interest rates.  The latter outlook on life has always proven the more profitable, but gets harder to keep as the immediacy of information increases.  Just because you can know the day’s events faster doesn’t mean you want to; in modern life the knowledge to noise ratio keeps getting louder all the time.     In our year end letter to you, we pointed out that none of the companies you own depend on access to the capital markets to survive, and if conditions are favorable, they may even thrive without outside funds.  Free cash flow is unusual, in that most companies, and indeed most industries, consume far more cash in capital spending and ordinary business operations than they ever generate.  Rapid growth, funded internally, is the best thing going and rare as hen’s teeth.  We have large positions in eight companies that are showing good growth in free cash flow well into the second quarter of a recession.  Led by Echostar’s fifty percent gain, they are Asia Satellite, Cabot, Countrywide Credit, Fidelity National, Moody’s, Scott’s and Qualcomm.  Include the real estate investment trusts we own, which have been shut out of the capital markets for over two years while still showing good growth, and this adds up to well over half your portfolio, still growing vigorously, while the world is slumping around us.  We have a few businesses suffering slowdowns too, but none of the businesses are being materially impacted by the bear market in stock prices, save perhaps for Gannett, whose USA Today no longer gets to publish page after page of dot.com promotions.  If that produces a flat year for Gannett, it will be a small price to pay for the end of a truly noisome mania.     We focus so intently on the quality of the businesses we own, and then also on their prices, because they are really the only things knowable in the investment business.  No one knows the near-term course of the stock market, or the economy, or whether one will be related to the other.  This does not stop the production of mountains of daily commentary on just these two topics, every bit of it worthless.  If we seem too cynical on this point, it is because our files are still bulging with last year’s rosy scenarios.  We are happy when executives know what is going on now in their businesses, and if they profess no opinion about the future, it’s the first sign of wisdom.     Since we cheerily admit to the same near-sightedness ourselves, why are we so optimistic?  Well, for one thing, it is impossible not to notice how much more profitable this slump is than any other before it.  The most recent twelve months’ profit of the S&P 500, divided by its book value, shows a return on equity of 25.3%.  This is undoubtedly a bit overstated, since the accounting for executive stock options is so poor, since the buyback of shares in recent years diminishes stated book value, and because the profits of the S&P companies are likely to contract a while more before they expand again.  But with all that in mind, it is still twice the usual profitability of corporations in the post-War years, and there were more than a few shenanigans in the past, too.  Still and all, why should you care that for most of the last century the return on equity of the major stock market averages hovered around 12%, and is now so much higher?     When people tell you that stocks are historically expensive today at 22 times the Standard and Poor’s earnings, they are implicitly telling you we are going back to the bad old days of meager profitability.  Otherwise, the observation makes no sense.  Businesses that have twice the return on capital are worth far more than twice the price of mundane businesses, in any quiet rational market.  If the higher recent returns on capital are permanent, then so are much higher multiples on earnings.  Are we then about to return to some mean of much meaner profitability?     We doubt it.  When Karl Marx seized the language to call the system we live under “capitalism”, he did it partly to vilify the upper crust everyone wishes to despise.  But he also needed to obscure the forces that give these “capitalists” their vitality.  If our system were known as “marketalism”, the rest of the world might have adapted it far faster, and it surely would have made for clearer thinking.  It is open markets, ubiquitous markets and vigorous markets that produce our wealth.  Twenty-five years ago, in America, the markets for energy, labor, corporate control, airline fares, residential rents, interest rates, and a great many things beside, were either closed or severely restricted.  The rest of the world was worse.  Our largest trade partner today is China.  America’s sole trade with China was in Ping Pong players just twenty-eight years ago.     We are forever vigilant that some new ideological turn will threaten the ascendancy of open markets again.  But barring that, the people who think that the collapse of the Internet mania can threaten our prosperity are not taking into account the resilience of free people trading in free markets.  The fall of communism really is something new under the sun, and this is our first chance to see what a slump looks like under the new regime.  If open markets are here to stay, then higher prices for capital assets are not far behind.     Wishing you all the best, we are, Sincerely yours, Edwin A. Levy Michael J. Harkins ____________________________________________________________________________________________________ Performance for Levy, Harkins Since January 1980-December 2000 Past Year………………………….………-13.68% Past 3 Years………………………………..+29.2% Past 5 Years…………..……..……………..+23.7% Past 10 Years………………………………+16.8% Past 21 Years……………………………….+16.4% NOTE:  The figures above represent the compound rates of return for all fully discretionary, balanced accounts.  These figures exclude accounts managed for less than 6 months, accounts using short selling and accounts consisting only of fixed income investment, to more accurately reflect the past performance of fully discretionary, balanced accounts.  However, past performance is no guarantee of future results.