We need to take care of a housekeeping chore. Once a year the SEC requires us to offer clients an updated copy of the "Disclosure Statement" you received when you opened your account with us. If you would like one, please contact us.

The price one is willing to pay for any investment is a function of its expected return and risk. Likewise, the most important factor to be mindful of in guessing future stock market pricing is the rate of return expected on reinvested capital. Since businesses grow by reinvesting excess cash flow from operations back into the business, an investor will pay a higher price for the business when the expected return on reinvested cash flow is higher. Economic conditions characterized by 1) low inflation and interest rates, 2) reasonable taxation, 3) a constructive world trade environment, and 4) government restraint from regulating businesses foster higher rates of return on reinvested capital.

Conditions currently are excellent for expectations of return on reinvested capital, explaining the high level of stock prices. A change in these conditions will do a lot of damage, so we must watch for clouds on the horizon. The interest rate on the 30 year Treasury bond has risen from 5.0% to 5.9% this year, because of heightened inflation expectations. We will be concerned if the long bond clears 6.0%. Next year, we are facing a change in government. An end of the stalemate of power engendered by a Republican Congress vs. a Democratic administration would give the markets considerable pause. At the same time, the recovery of foreign markets will help our international businesses, and the spread of the Internet will bring the people of the world closer, hopefully helping both world trade and world peace.

Regarding our portfolios, Qualcomm continues to lead the way with continued extreme appreciation. Just think what it will be like when Gillette and Coke kick in! A resumption of GDP growth in currently recessed/depressed foreign economies will kick-start a resumption of earnings growth in these two terrific businesses, and likely lead to stock price appreciation.

Farm prices and seed prices are very weak right now, because the recessions in developing countries have reduced the affordability of food imports and meat. Foodstuff demand, which grew for years at a rate of about 2.5%, absorbing the once large grain stores of the US, fell flat in 1998. Overseas economic recovery will lead to an increase in the demand for foodstuffs, an increase in grain prices, and an increase in seed prices. The stock market has looked at depressed seed prices and, in turn, overlooked the economics of Monsanto. We view it likely that this state of affairs will end in the next year. One cannot help but wonder where Monsanto’s stock will go if, someday, a food shortage develops.

Management opened up about their growth expectations for the next five years at an analyst’s meeting last week. Earnings growth estimates were guided into the range of 20 to 25% over the next five years. Between now and 2002, Monsanto expects seed income to grow 9 fold and seed trait revenues to rise 38% per year. 61 new trait products will be introduced between now and 2001, compared to 14 total introduced by the end of 1998. Expected accelerated crop yields of as high as 15% are viewed as a $15 billion annual revenue opportunity (Monsanto did $8.6 billion in total revenues last year.) RoundUp volumes continue to grow at a rate of 20%, although continued price cuts reduce annual revenue growth to about 10%.

Monsanto also is successful on the pharmaceutical front. Celebrex, invented by Monsanto’s Searle division and co-marketed by Searle and Pfizer, is the most successful new drug in the history of the U.S. pharmaceutical market. Profits from Celebrex will fund repayment of debt and amortization of seed company acquisitions, easing concerns the financial markets had regarding Monsanto’s ability to fund its huge investments.

Although last year’s failed takeover attempt by American Home Products inflated Monsanto’s stock price to $62, a level we have not seen since, you can see why I found this acquisition most depressing. It is very rare to find a company of Monsanto’s heritage and quality that has such explosive growth simmering under its quiet surface. I think Monsanto will be a lot of fun to own over the foreseeable future.

Mindful of this, we have re-evaluated our ownership of Autodesk. In our opinion, Autodesk management triggered a substantial decline in the value of its stock by embarking on a casebook study of how to dilute the ownership stake of its shareholders. Against a backdrop of years of ownership dilution from the hyperactive granting of incentive stock options to employees (mostly to top management), Autodesk entered into an acquisition that will be dilutive to its shareholders. Specifically, Autodesk sold some of its stock at a cheap, stock-market-determined price, in order to fund the purchase of Discreet Logic at a negotiated and very expensive price. In our analysis, management gave more intrinsic value to the acquiree than it received in return. This means that Autodesk shareholders had the intrinsic value of their ownership position diluted by this acquisition.

This damage is compounded by the fact that Autodesk, in order for the acquisition to be accounted for as a "pooling" under GAAP and SEC accounting rules, had to regurgitate three million shares of common stock repurchased over the last three years. And these shares had been repurchased largely to offset dilution from management’s hyperactive incentive stock option give-away program.

Management is convinced that the acquisition will improve the long-term growth rate of Autodesk, thus increasing its intrinsic value. However, when acquisition judgements and projections are made by the same management that has decided to dilute shareholders (including themselves), this is far from a certainty. At the same time, the acquisition decision proves that management is willing to issue shares at a discount price, even if its hurts loyal owners of the business.

Accordingly, Autodesk, which has many fine business characteristics, has once again had its stock creamed. We are just entering a major new product release cycle that should help the currently cheap stock price. The company has $10 per share of cash on the balance sheet and no debt. Free cash flow last year was over $3.00 per share. The stock is stunningly cheap at the current $26 price. When it recovers to a price more representative of our estimate of intrinsic value, we intend to switch to companies that support a constituency of high quality, long-term oriented shareholders.

Why not sell it now? Unlike management, we detest selling our stock at unfavorable prices.

Steven L. Re´, CFA May 14, 1999

The above is for information purposes only and is not to be construed as a recommendation to purchase or sell securities. The above information is from sources deemed reliable but is not guaranteed. It should not be assumed that investments in any of the above mentioned securities will be profitable, and past performance is not a guarantee of future results. Earnings projections often miss, and markets don’t always go up. The employees and families of Quality Growth Management, Inc. may own the above mentioned securities in their own accounts, and may trade them at any time without notice.