William Smead
Chief Executive Officer
Chief Investment Officer

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Dear Fellow Investors:

The floating bridge between Seattle and Bellevue in Washington State is being rebuilt and will be paid for by tolls. The Narrows Bridge between Tacoma and Gig Harbor crossing Puget Sound has been rebuilt and folks are paying a toll to cross back and forth. I paid for toll privileges in the rental car when I was in New York in May visiting clients. You can’t pass back and forth without using these roads and, therefore, the lock you have on the customer and your pricing power are immense. Warren Buffett used to talk a great deal about toll bridges among companies and why it makes for a great business.

A toll bridge company is one which everyone or a great number of people must cross or do business with and the best ones require very little labor and additional capital investment to maintain. It can be a utility in nature like electricity, phone, prescription drugs or cable service. Or in today’s world it can be ESPN or internet search or an internet payment system. At Smead Capital Management we believe that toll bridge companies are being underestimated in the current market. The primary reason for this underestimation is the time frame which most investors operate, the worldwide scope of today’s toll bridges and their connection to technologies/futuristic nature.

Toll bridge companies typically involve receiving a small amount of money from millions or billions of people for a long time. They are most rewarding to investors with long holding periods. Since the New York Stock Exchange reported recently that the average holding period for stocks traded on its exchange had fallen below one year and since that is the lowest figure since the late 1920’s, we can safely assume there are very few real long-term buy and hold investors out there today. Since there are few long-term investors and very little money demanding these types of investments, we can also assume there are very few people analyzing toll bridge aspects of a business which would lead to long duration success. Under those assumptions, it is safe to assume that there is drastically less than normal demand for the common stock of these companies. Toll bridge companies have a tendency to produce very high levels of free cash flow, have wide moats (barriers to competition) and are shareholder friendly (stock buybacks and dividend increases). It means the supply of common stock shares have a strong possibility of declining. If anything happens to cause a normal or higher level of demand for longer-term investment in common stock, higher prices could follow.

Toll Bridge companies are underestimated because of their worldwide scope. PayPal serves the world as the most popular payment system on the internet. Billions of transactions will pay them a small toll. Most humans have only had 5 to 10 years experience buying and selling online. It is safe to assume that as the population ages and today’s tech savvy twenty something’s become the Mom’s and Dad’s of the future that online transactions could grow exponentially around the world. It is hard for even me to wrap my mind around that fact. It is even harder for investors with 6 to 12 month time frames in mind to even care about considering this. ESPN (80% owned by Disney) controls almost every fan of US sports in one way or another. They have Monday Night Football, the World Series of Poker and mountains and mountains of College sports programming. And they don’t have to pay most of the actors and actresses. In the World Series of Poker the actors and actresses pay $10,000 each to act for free! ESPN then rebroadcasts the main event over and over and over much like Disney resells cartoon movies made by artists from decades gone by without any additional production expense. Like Jack Nicholson’s character said in As Good as It Gets, “the fact that I understand this makes me feel good about myself.”

The best toll bridges might be passing people my age (51) by because they have emerged in the last ten years and have new technologies connected to them. Most of the respected value investors in this country are over the age of 50 and more than likely are not regular users of the future’s best toll bridges. I have never personally bought or sold anything on Ebay. Cloud computing sounds to me like something that requires use of psychedelic mushrooms. Ordering whatever you want to watch on TV at exactly the time you want to watch it probably makes a great deal of sense to Brian Roberts, CEO of Comcast, but matters very little to multibillion dollar money managers who read annual reports for a living and live and die by how they do each quarter. Roberts is buying what we believe are deeply undervalued entertainment assets to add to his toll bridge in cable service and high-speed internet access. Short-term oriented money managers and investors think he is a fool for doing it.

In conclusion, we are excited about the long-term potential of investing in toll bridge companies and believe that underestimation equates to undervaluation.

Holiday Best Wishes,

William Smead

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. The securities identified and described in this missive are a sample of issuers being currently recommended for suitable clients as of the date of this missive and do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.

The information contained in this tv appearance represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. The securities identified and described in this tv appearance do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.

William Smead
Chief Executive Officer
Chief Investment Officer

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Dear Fellow Investors:

Eight years after Mount St. Helens blew up, my wife and I drove from Seattle into the north side of the National Park at St. Helens. We were driving through the thick forest and suddenly popped out into the area that had been devastated by the mountain’s massive eruption. While we drove, I noticed that on the left side of the road it looked like the moon. On the right side of the road was a great deal of young greenery and shorter foliage. Why was there such a difference between the two sides of the road?

The park ranger was glad to tell me. The left side of the road had been reclaimed by Weyerhaeuser and other forest product companies to recover whatever useful wood remained. The right side had been untouched by man since the mountain had blown. Where man had meddled it looked like the moon. Where the ashes and decomposed wood were allowed to take nature’s course, a bright future among the greenery was quite evident. It was as different as night and day.

The U.S. economy is slowly recovering from the worst recession we’ve had since 1982 and the worst financial panic since the 1930’s. Policy makers have tried many approaches to reclaim the economy and they have had the same results as they had in the park between 1980 and 1988. First, there is loan modification. The Obama administration is putting pressure on lending institutions to find a way to keep people in their homes. You don’t cleanse the system of people living outside their means by helping them live outside their means. Let the market clear itself by helping the lending institutions admit their errors as quickly as possible and allowing the foreclosed homes to be placed in the hands of someone who can afford to own them at the price it takes to make that happen. Second, you have the $750 billion dollar stimulus package. Someone needs to tell Congress and the Senate that public works programs have been completely ineffective in pulling Japan out of their 18-year deflationary funk and are an inefficient way to stimulate business. Even if they succeed, the jobs exist only until the project is done and then you are right back where you started. Huge budget deficits are what you get in trade.

In her book, The Forgotten Man, Amity Shlaes argued that all the meddling that the Roosevelt Administration did in the economy from 1932-1938 probably held the economy back and contributed to the recession which started in 1938. What evidence do we have today that the untouched side of the economy is restoring itself? First, in California the residential real estate markets have firmed, inventory has been worked down and in many ways the market is clearing itself at lower prices. California was the epicenter of the subprime crisis and one of the first markets to go in the tank. Government officials got their loan modification projects going too late to stop nature from restoring it through foreclosures, short sales and the pain of lower prices. There is green foliage in many California residential real estate markets today.

The stimulus plan does little to stimulate small businesses, which do about 75% of the hiring in the U.S. in a typical year. Ultimately, this downturn and its high unemployment levels will trigger a huge number of new small businesses as people choose to get away from being fired by being the one who owns the business. The job summit in Washington, D.C. doesn’t have the two largest small business groups in the U.S. even represented there. How many people in Washington have ever owned or run a business? No wonder the employment picture has been as bleak as the moon’s landscape.

A number of our companies are doing what it takes to get back into restoration and the government could take a few tips. Starbuck’s and Nordstrom’s made abrupt expense reductions and found a way to be very profitable at lower sales levels. As their sales pick up, they will be in a position to expand and hire. Comcast is scooping up half of NBC Universal at cyclical low prices and can use their massive free cash flow and entrepreneurial talents to unleash better business instincts than its former non-entertainment conglomerate parent GE could.

We at Smead Capital Management are optimists. We believe that there are very smart and well meaning folks leading our government. They want to help. Individual investors have stayed on the sidelines partially because they got clobbered last year, but also because they have assumed since March that the economy would not naturally restore itself. We believe the economy will give them their confidence back sooner or later, but also believe much like 1982-1987 and 1991-1999 they will enter the U.S. stock market long after the best gains have been seen. . The stock market has historically anticipated the restoration way ahead of the actual results and lower unemployment levels. As usual, it’s not different this time.

Best Wishes,

William Smead

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. The securities identified and described in this missive are a sample of issuers being currently recommended for suitable clients as of the date of this missive and do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.

William Smead
Chief Executive Officer
Chief Investment Officer

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Dear Fellow Investors:

Thanksgiving break I read a book by Professor Thomas Sowell titled “A Conflict of Visions”. He explains that most of the political and economic debates of the last three hundred years come down to two conflicting underlying visions of how we should operate. Understanding these visions could tell us at Smead Capital Management and you as investors where we could be going over the coming years in the markets.

Sowell sees people accepting either a constrained or unconstrained vision of the future. Adam Smith’s “Invisible hand” and “laissez-fair economics” were poster children for the constrained vision. Constrained visionaries believe in respecting systems, processes and repeated history to bring moral outcomes. They believe each person acting in their own self interest will create the most public and social good.

Unconstrained visionaries believe that as human beings advance intellectually, they should expose an enlightened minority who can lead. Their leadership should have sincerity and a moral vision to benefit everyone. The unconstrained vision is best exemplified by William Godwin’s “Enquiry Concerning Political Justice”. To Godwin, man’s understanding and disposition were capable of intentionally creating social benefits. Godwin regarded the “intention” to benefit others as being “of the essence of virtue”.

Much of the debate and nervousness surrounding our current markets can be tied to these conflicting visions. Policymakers have used numerous Keynesian (Unconstrained) economic policy maneuvers to intervene in the markets the last 15 months. Enlightened economists seriously doubt the constrained view that individuals acting in the marketplace on their own self interest will heal our economy. Conservative (Constrained) economists believe lower home prices, stock prices, low interest rates and abundant cheap labor are ingredients for a long lasting recovery.

Therefore, both visions are at work and those who don’t agree with the opposition vision seem to believe we are going “into Hell in a hand basket”. Tea Party folks are scared to death of heavy-handed government intervention. Those with the unconstrained view fear that residential real estate markets and the lending institutions crippled by their weakness can’t heal themselves. They are willing to pay the price down the road for running huge government deficits. They feel that this is a once in a lifetime opportunity to use the economic difficulty to get us headed down the right path for the future. Both visions are attracted to the emerging markets and commodities like gold and oil. Adam Smith fans (constrained) can see the “invisible hand” in worldwide growth and Godwin’s Backers (unconstrained) love the “enlightened” feeling they get from being cutting edge worldwide investors. Unfortunately, it looks much like the 1998 tech stock cutting edge to us.

Investors in common stocks have put premiums on those sectors which appear to have the most to gain from the unconstrained or enlightened view of the future. We must admit we like the idea that the companies which operate with the best systems, processes and have the best histories will provide the most future success for the least amount of capital. Our view assumes that enlightened reason almost always comes at too high a price and doesn’t work often enough to generate market beating returns.

It took me the first ten years in the investment business to learn to get away from investing by trying to predict the future and assuming that humans are getting better as they get more sophisticated. We want to rely on owning great companies for long-term holding periods and let both of the conflicting visions fall where they may.

Best Wishes,

William Smead

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. The securities identified and described in this missive do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.