As of December 31, 2019, the net asset value (“NAV”) of the Parnassus Endeavor Fund (Trades, Portfolio) – Investor Shares was $38.19, and after taking dividends into account, the total return for the year was 33.29%. This compares to 31.49% for the S&P 500 Index (“S&P 500”) and 28.32% for the Lipper Multi-Cap Core Funds Average, which represents the average return of the multi-cap core funds followed by Lipper (“Lipper average”). The Fund had a great year, beating the S&P 500 by almost two percentage points and walloping the Lipper average by almost five percentage points.
Below is a table comparing the Parnassus Endeavor Fund (Trades, Portfolio) with the S&P 500 and the Lipper average over the past one-, three-, five- and ten-year periods:
This year marked a great comeback for the Parnassus Endeavor Fund (Trades, Portfolio). In last year’s annual report at the end of 2018, we wrote, “We’re very disappointed with our performance this year; it’s the first time in the 13-year history of the Fund that we’ve underperformed by such a large margin. Our goal is to do much better in 2019, and we’ll work hard to give you the kind of returns we’ve had throughout most of our history.”
We expected that we’d have a good year in 2019 when we wrote that, but we never dreamed that we would be up more than 30%. At the beginning of the year, the prevailing opinion was very negative about the market after the difficult year in 2018. No one that we know of was predicting gains of 30% for 2019. This year’s performance underlines the futility of market timing. It’s just too difficult to see into the future. At the Parnassus Endeavor Fund (Trades, Portfolio), we make no claims about knowing what the market will do in the year ahead.
The only skill we have is being able to make a reasonable estimate of the intrinsic value of a stock. Once we’ve done that, we wait until a stock is selling one-third below its intrinsic value, then we buy. Waiting for a stock to sink that low we believe, gives us a margin of safety. We hold onto that stock until the price reaches intrinsic value, then we sell. That sums up the strategy of the Parnassus Endeavor Fund (Trades, Portfolio).
Year in Review
As you might expect, there were a lot of stocks that did well last year. Eleven of them contributed 100 basis points or more to the Fund’s return. (One basis point is 1/100th of one percent.) There were no stocks that sliced more than 100 basis points off the NAV.
The one that hurt us the most cut 99 basis points off the Fund’s return. This stock was Regeneron Pharmaceuticals (REGN, Financial), which is a very interesting case. The stock actually went up during the year from our cost of $335 to $375 by the end of the year. What caused the loss was a sale of a lot of our shares at an average price of $315. The stock hit a low of $277 in September, and we became very discouraged about the prospects for the company. By the time it traded up to $315, we started selling, happy that it had gained quite bit from the low point of $277. As it turned out, we should have held on longer. Most of the time we have more patience with our stocks, and that’s why our long-term performance has been excellent. We’re taking the case of Regeneron as a cautionary tale and a reminder not to act too quickly. Regeneron is a biotechnology company that focuses on treatments for the eye, heart diseases, cancer and inflammation. Its blockbuster drug, Eyelea, faces pressure from a competing drug by Novartis, as well as a loss of patent exclusivity in 2023. The stock raced higher in the fourth quarter after a strong commercial launch and expanded indications for Dupixent, Regeneron’s drug for adolescent eczema.
Now let’s turn to the winners. The four best-performing stocks in the portfolio were all related to semiconductors. There’s a lot of irony in this situation, since sales declined and earnings dropped for the industry. Why would stocks with declining sales and earnings do so well? The answer is that the stock market is a discounting mechanism, so the present value of a stock is based on future expectations. In some ways it’s like a chess game, where you have to be five moves ahead of your opponent. If I (Jerry) ever played Magnus Carlsen in a game of chess, he would undoubtedly have me checkmated in five moves. However, I think I could beat him in a stock-picking contest, because I know the industry and know how the stocks move related to their fundamentals.
Getting back to semiconductors, we believe the outlook for 2020 is pretty good—especially in the second half – according to industry participants. That drove the stocks higher in 2019. However, when we bought most of these stocks in late 2018, the outlook was not good. Firms had just had a good year, but expectations were for difficult times ahead. The stocks were selling at cyclical lows when we invested.
Our biggest winner was Applied Materials (AMAT, Financial), a leading maker of equipment used to manufacture semiconductors. The stock contributed 524 basis points to the Fund’s return, as the stock rose from $32.74 to $61.04 for a total return of 89.9%. Companies making semiconductors ordered more equipment as demand picked up.
Next was Lam Research (LRCX, Financial), a competitor to Applied, which added 518 basis points to the Fund’s return, as the stock rose from $136 to $292 for a 119.3% total return. Despite the weak market for memory chips, Lam grew its installed base of machines, suggesting that demand for equipment had bounced off the bottom. Strong demand for semiconductor equipment in China, and an expected upswing in the memory chip market helped Lam.
Micron Technology (MU, Financial) added 421 basis points to the Fund’s return, as its stock climbed from $31.73 to $53.78 for a total return of 69.5%. The company makes memory semiconductors used in PCs, smartphones and data servers. Despite more supply than demand for chips last year, the stock did well due to the recovering server market, stabilizing pricing for memory chips and the industry’s efforts to limit capacity. Management has indicated that 2020 should be an inflection point with high teens growth in sales, led by demand for enterprise uses and the cloud, as well as long-term data-center demand and IOT (Internet of Things) trends.
NVIDIA Corporation (NVDA, Financial) added 291 basis points to the Fund’s performance, as its stock rose from $134 to $235 for a total return of 77.0%. The company started the year down over 50% from its recent highs, after the cryptocurrency bubble burst and management was forced to lower their financial targets. As the year progressed, NVIDIA exceeded earnings expectations and the company introduced new products. We believe in NVIDIA’s widening moat as demand for artificial intelligence chips continues to accelerate.
Biopharmaceutical company Celgene (CELG, Financial) boosted the Fund’s return by 257 basis points, as its stock jumped from $64.09 to our sale price of $92.45, for a total return of 50.6%. The company develops therapies that treat blood cancer and inflammatory diseases. Celgene’s stock price spiked when pharma giant Bristol Meyers announced plans to acquire Celgene for $74 billion, or about $102 per share, in cash and stock. The move helps Celgene diversify its existing drug pipeline and pools the combined company’s R&D resources. Though some of Bristol’s shareholders initially opposed the deal, Celgene’s stock got another boost when major proxy advisory firms effectively sealed the deal by coming out in favor of the combination.
Cummins (CMI, Financial), a leading maker of diesel engines, added 179 basis points to the Fund’s performance. Its stock rose from $134 to $179, for a total return of 38.1%. Although total orders for Class 8 trucks fell during the year, the company’s profits grew due to an increase in off-highway sales and lower warranty charges. We believe Cummins has the financial strength to invest through the cycle by continuing to launch new products and services that help improve fuel economy and lower diesel engine emissions.
Toy-manufacturer Mattel (MAT, Financial) added 144 basis points to the Fund’s performance, as its stock rose from $9.99 to our average selling price of $12.00 for a total return of 8.5%. The stock rallied to a high of $17.07 to start the year, as Mattel’s sales at the end of 2018 during the all-important holiday season were better than expected and profits increased significantly as a result. The stock gave back some of these gains after the company’s 2019 financial guidance failed to meet investors’ expectations, a reminder that Mattel’s turnaround remains a work in process. We sold our position in May, following the news that more than 30 sleeping infant fatalities had been linked to its Fisher Price Rock ‘n Play Sleepers. After engaging with the company, including the CEO, we found their explanation of Mattel’s product safety oversight to be inadequate to justify our continued investment.
Qualcomm (QCOM, Financial), the leading manufacturer of mobile phone chips, contributed 141 basis points to the Fund’s performance, as the stock soared from $56.91 to $88.23 for a total return of 60.7%. The stock saw its biggest one-day jump in nearly 20 years after Qualcomm reached an agreement with Apple to settle all litigation between the two companies worldwide. The years-long dispute centered around what royalties Apple should pay for the chip that powers the Apple iPhone. Ultimately, Apple paid Qualcomm for the chips it received, and further agreed to long-term license and supply agreements. Though Qualcomm’s victory was later tempered by antitrust rulings in the US and EU, we applaud management’s commitment to R&D, and believe the stock has more upside in the years ahead.
Hanesbrands (HBI), a leading manufacturer of undergarments and athletic apparel, contributed 131 basis points to the Fund’s return, as its stock rose from $12.53 to $14.85 for a 23.0% total return. Stronger-than-expected performances in the company’s Champion brand and international businesses led management to raise its revenue guidance for fiscal year 2019. The company also used its cash flows to pay down debt to improve its capital structure.
Credit card–issuer American Express (AXP) boosted the Fund’s return by 110 basis points, as the stock rose from $95.32 to $124.49 for a total return of 32.5%. The shares moved higher throughout the year, as the company delivered industry-leading revenue growth of 8% while maintaining its strong balance sheet.
Charles Schwab (SCHW, Financial) contributed 104 basis points to the Fund’s return, as its stock rose from $41.53 to $47.56 for a total return of 16.4%. The return on our average cost, however, was significantly higher at 52%. How is this possible, you may ask? In October, Schwab shocked the market by eliminating trading fees, causing its stock to fall sharply to a low of $35.10 as investors fretted over the lost profits. We added to our position after the drop, because we believed that eliminating trading fees would improve Schwab’s competitive position and highlight its diversified earnings model. Sure enough, Schwab took advantage of its enhanced competitive position faster than even we expected, when it announced in November that it would acquire competitor TD Ameritrade for $26 billion. The stock rallied to end the year, as investors celebrated the anticipated 15% to 20% earnings accretion from the acquisition.
Outlook and Strategy
The Parnassus Endeavor Fund (Trades, Portfolio) had a great year in 2019, so now we’re thinking about 2020. After last year’s run-up in stocks, the market as a whole, as represented by the S&P 500, is fully valued, and maybe even overvalued. The long-term average for the price/ earnings (P/E) ratio* of the S&P 500 is in the range of 16-17, and as of early January, that ratio is 23.0. This does not mean there will necessarily be a big move down in the stock market. Earnings could go much higher, while the market stabilizes, and this would bring down the P/E ratio. It does mean, though, that we may be unlikely to have another big year in the stock market.
Although the market is richly valued, the stocks in the Parnassus Endeavor Fund (Trades, Portfolio) are not. The P/E ratio of our stocks is only 16.8 compared to 23.0 for the S&P. This doesn’t mean that our stocks won’t go down in a market correction, but we believe it gives us a margin of safety.
Right now, the U.S. economy is strong, and the unemployment rate is very low—in the range of 3.4% to 3.5%. Consumer purchases are very strong, while business investments have dropped off. This probably means that companies are concerned that the economy may slow down. However, if unemployment stays low, and consumer spending keeps growing, business investment should pick up. Right now, there’s a lot of confidence in the economy.
Of course, the wild card in all of this is Donald Trump and what he will do in relation to China and Iran. As this report is being written, Trump has just ordered a missile attack that killed one of the most important Iranian generals. It’s highly likely that Iran will order some kind of retaliation against American interests. It could be a one-time incident or it could escalate into something worse. If it’s the former, it wouldn’t have too much effect on the stock market. However, if it’s the latter, then there would definitely be an impact, and all bets are off.
Right now, it looks like there has been a truce in the trade war with China. There are still many unresolved issues between the two countries, but it appears that there will be negotiations to settle our differences.
Both of these international issues could have an effect on the economy, and of course, they could also have a big impact on the stock market and our investments in the Parnassus Endeavor Fund (Trades, Portfolio). The actual effect, though, is impossible to predict.
Because of this, all we can do is focus on individual companies and invest in good stocks when they are out of favor. Right now, we’re happy with the stocks we have picked for the portfolio.
We would like to thank all of you for investing with us in the Parnassus Endeavor Fund (Trades, Portfolio).
Yours truly,
Jerome L. Dodson, Lead Portfolio Manager
Billy Hwan, Portfolio Manager
