William Smead
Chief Executive Officer
Chief Investment Officer






Dear Clients and Prospective Clients:

Jim Collins is the author of a book that I have mentioned from time to time called “Good to Great”. He has attempted to help us understand the difference between merely good companies and the few great ones which have been demonstrating “greatness” over the years. What these “great” companies do in the most difficult business circumstances could give us some clues on what to do in this current economic and investment environment. The current environment is already establishing itself as the most difficult set of circumstances we have faced since the 1930’s.

To help us understand the approach of “great” companies in difficult circumstances, Collins retells the story of James Stockdale, a POW camp survivor from the Vietnam War. Stockdale withstood the kind of long imprisonment which Senator John McCain withstood and is still fresh in our memories. This survivor explained that it wasn’t the pessimists or the optimists which survived, but rather the realists. Pessimists died early on trying to escape, knowing that they didn’t have it in them to hold on for years. Optimists expected the very best and would say things like, “We will be out of here by Thanksgiving.” Thanksgiving would come and go and the optimist would turn to Easter as the point where it would all be better. Eventually, a number of optimistic deadlines would pass and the optimist would lose hope and turn into a pessimist. The realist said, “I will do whatever it takes to get through this regardless of how long it takes to get through it.” There is an inherent optimism in the position taken by the realist. The grim reality must be balanced against the great blessing for you on the other side of the valley.We are in the midst of a business coma and stock market liquidation that has to do with financial sins committed over the last ten years. It is holding all participants (workers, investors and companies) prisoner regardless of whether or not we or our companies were part of creating the problem. We do not know how long the “business coma” will last, how long stocks will be liquidated to find a bottom and how soon the inevitable rebound will come! However, we must survive.

At Smead Capital Management we have staked the survival of our portfolios on the balance sheet strength of our companies, the necessary nature of their products and the enduring quality and “mind control” of their brands. In other words, we have sought to own the realist companies which can get through this regardless of how long it takes. And we do this to not only survive, but also because the reward on the other side of the valley is huge from a historical point of view. If you made it all the way through the Great Depression to 1937 with your blue chip stocks, you saw a huge rebound in stock prices from the 1932 lows.

What can you do to be a realistic owner and steward of your assets? Make sure you are investing money in the stock market which can stay invested for at least three to five years. Put the money you need in the next two years in a safe financial instrument like a Certificate of Deposit or money-market fund. Reduce portfolio withdrawals until things improve. Where possible, liquidate non-liquid assets like boats, cars and non-income producing real estate or use them as a charitable donations in a substitution for cash outlays. If needed, review your portfolio with us regardless of whether or not we oversee all the assets.

What should we look for to get a sense that this storm is passing? First, look for low enough new home sales figures to put some of the weaker publicly traded homebuilders into Chapter 11 bankruptcy. Second, look for Arizona, California, Florida and Nevada unsold home inventories to decline. Thirdly, look for some highly respected, nationally recognized stock portfolio managers to give up or get fired (it happened right before the Tech bubble broke in early 2000). Lastly, look for the interest rate differential to narrow between high-grade corporate bonds and Treasury bonds.

We intend to survive these circumstances with you and are here to serve you in any realistic way we can.

Warmest regards,

1. It has a great balance sheet and massive alumni support.
2. It has a long history of success, including numerous Rose Bowl victories and two National Championships.
3. It has strong insider ownership and has had recent insider buying.
4. It has a strong Moat, because it is the only major college football team in the Puget Sound Metropolitan Area and the stadium is surrounded by water.
5. It generates such good free cash flow that it funds the non-revenue sports on both the Men’s and Women’s side.
6. It is economically essential. Football is the single best way to mass advertise your college around the country.
7. It is fan and donor friendly. There is something special about amateur athletics and going back to college six Saturday’s each year.
8. It has never been more out of favor than now with a record of 0-10. The only time it has been this far out of favor was at the end of the Jim Owens era in the late 1960’s and early 1970’s when Don James came in to coach.

We own a bunch of stocks that fit the same criteria and we think that the football team and our stocks are going to have a great deal of success in the future.

William Smead

2. We believe we are in the third and hopefully final phase of liquidation in the worst financial panic, credit crisis and business coma that we have seen since the 1930’s. The first phase of liquidation was tied to sub-prime mortgages and the financial institutions that got caught up in them. The second phase of liquidation was the de-leveraging of hedge funds, private equity funds and businesses and investors who were counter parties to failed institutions like Lehman Holdings, AIG and WAMU. The third phase, which we are in right now, is the liquidation by stock market participants (primarily mutual funds and other institutional investors) of company shares due to concerns that the temporary business coma could become a two-year coma.

3. We believe that the strength of our company’s balance sheets and the elimination of their existing and potential competitors by the business coma will cause them to not only be survivors, but to prosper. Sprint is crippled in comparison to AT&T and Verizon. Disney’s theme parks, Movie division and Cable Network gain market share from less well financed industry foes. New drug companies aren’t getting funded while Merck, Pfizer, Abbott Labs and Amgen sit on billions of cash, are gushing free cash flow and fund incredible research. WalMart and Nordstrom’s are seeing major competitors declare Chapter 11 bankruptcy. JP Morgan, Wells Fargo and the Bank of New York/Mellon appear to be the cream of the remaining banks.

4. We believe that we under-estimated the severity and length of this liquidation and over-estimated the attractiveness of our necessity businesses and how well their balance sheet strength and dividend payments would defend our capital.

5. We believe that the bull market that follows this bear market will be ten to fifteen years long and will repay those of us that make it through this current financial misery many times over. However, we don’t know how soon the “Next Great U.S. Stock Market” will begin or what the magnitude of any additional liquidation will be.

We sincerely appreciate you considering our thoughts,

William Smead