Mar 2004 Quarterly

Written by Sanchit Chokhani, Nicholas Hirschey, Greg Huebner, Chris Villa

Overview

The Dow Jones and Nasdaq stock markets have experienced both significant gains and losses in recent times. In the last four days alone, the Dow Jones Industrial Average has gone down 400 points, losses that are reflected in the SEIG portfolio as well. Since last December, we have seen the gains from SEIG climb up to $18,000 (approx.) to its recent gains of around $12,000 (approx.).

Despite the recent losses, which can be attributed to the trade deficit, the economy is still gathering speed akin to pre-boom times of late 1990s and 2000. Thus, SEIG has also been looking into value addition of the portfolio by acquisition of new stocks and possible sell-off of stocks that may add little value to the portfolio in the future. As has been our purpose throughout, we would like to maintain focus on investments in companies that exhibit superior forward-looking appreciation potential.

Portfolio Design:

Since our last report in November, the structure of the portfolio has seen little change, aside from the selling of Goodyear. We would like to change that with acquisition of two more stocks, Freddie Mac and MBIA Inc., and sale of Sprint PCS. These acquisitions, we believe, will further diversify our portfolio and reduce the risk arising from one particular industry. Despite poor performance by some of our holdings, such as EDS recently, we still maintain an interest in holding them due to our belief in their future appreciation potential. Also, we are departing from our most profitable stock, PCS, because we believe that the restructuring of the stock by Sprint puts us into unknown grounds with less growth and appreciation potential.

CURRENT HOLDINGS

EL PASO CORP - EP 6.92

The potential of this stock looks very good over the course of the next year, especially given that the energy industry is not expected to do well. EP is expected to almost double in growth with a negative growth rate in the industry. EP is expected to a take a $1 billion pre-tax charge after cutting its proven natural gas reserves estimates in mid-February. It seems to have hurt the future value of the stock as its estimates over the course of a year went down a $1 to the $12 to $14 range. EP still looks very attractive at the current price, but due to the uncertainty with this energy, it would be best to hold and wait until the next quarter. The stock has increased about a $1 average over the past year, but in order to buy more there needs to be a clearer future ahead for EP and the industry. Greg Huebner Decision: Hold

ELECTR. DATA SYS. - EDS 19.05

Electronic Data Systems is in the information technology industry. With a sluggish past few months this company is expected to rebound. Due to an overall downturn in the technology industry EDS hasn't experienced the gains we would like to. However, with a back order stock equal to four times their yearly revenue EDS is a promising stock. In the long-run EDS should display gradual increases in value and prove to be a profitable stock. With the information technology industry on an upswing this stock should begin to show positive valuation. As it stands, this stock was last traded at 19.41 and has displayed gradual increases as it recently increased by 2.70%. With net receivables at an increasingly high amount and low net payables this stock should display gain future gains. We are taking a long-term perspective on this stock, hit hard because of short-term concerns. The SEIG expects exposure to the downside to be limited at these prices and that this year's well publicized earnings decline is already factored into the price. We are also willing to wait a couple of years to take advantage of the great expected appreciation. Chris Villa Decision: Hold

J.P. MORGAN - JPM 42.03

The J.P. Morgan Chase and Company is a financial services leader. Earnings from this business took a hit with the recent economic downturn, but it is starting to bounce back in style. Profits improved dramatically in 2003, and it looks to continue over the next year. With the recent market recovery, the stock has improved alongside expectations. Those expectations are expected to continue throughout 2004. In the current quarter, JPM has increased 18.8% where the industry has increased 8.4%. The next year estimates indicate a 10% growth for JPM in an industry expected to increase 10.8%. The main reason for this is people are starting to invest more of there money now with the upturn of the market, and JPM represents a big chunk of that investment. JPM recently sold off $1.6 billion in debt in late February and the expected merger with Bank One will definitely increase JPM's market share and profitability. The stock is expected to rise to around $50 by the end of the year. Due to the recent increase i n the stock, it is recommended that we hold onto the stock and not buy more. Greg Huebner Decision: Hold

MAYTAG - MYG 28.91

The Maytag Corporation has been struggling for almost a year now to revitalize its Hoover vacuum cleaner division. Hoover has been a big drag on earnings, counteracting the improving performance of Maytag's appliance division. Consequently, 2003 full-year earnings were lower than they have been for quite some time. But the company has continued to build stockholders' equity and cut costs. Maytag succeded in reducing debt by $140 million during 2003. We expect these measures will lead to decreased leverage and higher earnings.

The source for the most dramatic earnings improvements in 2004 will be Hoover. After reshuffling the management team of that unit during early-summer 2003, Maytag has focused the division on designing new products to compete with cheap Asian competitors. These new products are hitting store shelves this spring and should be more price competitive with Hoover's rivals. Expectations are that Hoover will be able to win back customers it lost in the last year or so.

On a broader scale, 2004 will be the first year in which the synergies from the purchase of Amana in 2001 make themselves apparent on the bottom line. The company should reap savings from the closing of a Galesburg, Illinois, refrigeration plant. The work previously done at that plant is being transferred to the Amana plant in eastern Iowa. Some manufacturing has also been shifted to Mexico to further reduce costs.

Recently, Maytag announced a partnership with Samsung to co-produce Korean manufactured washers and dryers to augment the Maytag product line-up. This move is a likely response to fierce price competition from cheap foreign-made imports. This proposal is still too new for us to discern the worth of the move to work with Samsung.

We expect Maytag to earn about $2.00 a share in 2004. With a recent market price around $28, it seems the company still has potential to appreciate from its current levels despite its 30% rise since our purchase in mid-May. Furthermore, the Maytag, Amana, Jenn-Air, and Hoover brands are well known and valuable names that are getting increased exposure in stores such as Home Depot. Our one big concern with Maytag is that the situation at Hoover will not improve. However, we are optimistic that vacuum-cleaner sales will rebound and, with it, Maytag's stock price. Nick Hirschey Decision: Hold

SPRINT PCS - PCS 9.13

Sprint PCS is benefiting from an overall rebound in the telecommunications sector. Not long ago, PCS was trading hands at less than half its current value. The company has done well, improving its performance since last year by cutting its net loss by 23% compared to last year's 4th quarter. Still, I feel we've gotten lucky with the performance of the stock the past few months. Our May 2003 investment has more than doubled. This would be a good time sell the investment and take our profits, especially considering the weekend announcement that the PCS tracking stock will soon be recombined with the FON stock and cease trading as a separate issue. The owner's of PCS will receive .5 shares of FON for every share of PCS they own. Consequently, the price of PCS will now be determined solely by the fluctuations of FON. When buying PCS 9 months ago, we figured to profit off a revaluation of the cell phone industry and the growth of that segment of the market. The FON business is subject to different economi cs which we do not feel offer as much upside. For these reasons, we'd like to sell our 1000 share position in PCS. Nick Hirschey Decision: Sell

LUCENT TECH. - LU 3.91

In the past six months, Lucent's stock has surged from lows of 1.41 to a recent high of 5.00 dollars, which was our optimistic target estimate. However, the stock value has since dropped to more realistic levels. Economically, the company is still in shambles, and the only reason we would still like to hold this stock is for purely academic reasons. With a low operating margin of 3.6% and declining revenues, the company has not been able to add much economic value or shareholder wealth. However, overseas contracts in China and Iraq have opened up new avenues for the company. Despite that, the company is still expected to struggle, especially when conditions experienced by the company are industry-wide. Due to the little value added by its sale, and the commission costs, we believe that it will be better to hold the stock and view the change in market perceptions of the company, especially with regards to 1-2 quarters of profits that we believe the company can still generate. Sanchit Chokhani Decision: Hold

AGERE SYSTEMS - AGRb 3.26

The recent performance of Agere has been disappointing, since the company was expected to do a lot better, and is currently one of the only loss bearing entities in our portfolio. Revenues have fallen 15.5%, and the company seems to be performing at a lower gross margin that its competitors. However, we believe that the current fluctuations in the stock value are not indicative of the company's worth, and it is still taking a step in the right direction, with net losses coming down from $326 million to $262 million. This still does not justify its lackluster performance though. Despite that, we think that the stock has suffered unfairly in the most recent downturn in the stock markets, which has brought its value down by more than 10%. In the long run, this stock is unlikely to add much value to the portfolio, but for now we would like to hold it and analyze its operations further. Sanchit Chokhani Decision: Hold

BAXTER INT'L - BAX 29.45

Baxter has been one of the best performers in our portfolio (after Sprint and J.P. Morgan), with a value addition of 28-30% on average, and we expect the trend to continue. The company is in a strong position and has seen an earnings growth of 27%, even though revenue has grown only 5.8%. Its strong operating and profit margins (15 and 10% respectively) and a free cash flow of $617 million means that the company is expected to perform in accordance with our expectations in the future as well. Along with this, the search for a new CEO with a strong marketing background has helped the company's future outlook. With a new CEO, preferably a former employee, Baxter should regain its stronghold of its blood products line soon. Sanchit Chokhani Decision: Hold

PFIZER INC - PFE 36.37

Recently, PFE hit a 52-week high of 38.89, after reporting dividends of $0.17 per share. Since then, though, the stock value has declined, owing primarily to what we believe is lack of significant revenue growth (0.4% last year), versus the substantial growth reported by most of its competitors, such as Merck and Novartis. It is also well below the industry average of 16%. The stock value has also recently been hit by a lawsuit from the state of Pennsylvania, directed at all drug makers. The company has also been unable to make any significant breakthroughs or introduce new products that might help give its price a boost. However, Pfizer is still expected to grow above industry average for the forthcoming year, which is likely to give its stock a boost, and add value to our portfolio. Sanchit Chokhani Decision: Hold

NEW PURCHASES

200 SHARES EACH OF Freddie Mac (FRE) and MBIA(MBI)

This past year, the SEIG portfolio has been led, with the exception of PCS, by profitable companies selling at low valuation multiples. MBIA and Freddie Mac are two companies of this same breed. Both companies sell for below-market P/E multiples despite the quality and steady growth of their earnings. Much of this stems from fear that these two businesses are exposed to large potential losses from derivative contracts or poor hedges against rising interest rates. Despite the merit of such fears, MBIA and Freddie Mac seem to be bargains.

MBIA is in the business of insuring municipal bonds, and now also corporate issues, against default. The business has been extremely profitable; MBIA has never actually had to pay out on a policy. But the most intriguing aspect of the company is the consistent 10% annual earnings growth the company achieved in the last decade. With a P/E just over ten and potential for earnings growth, MBIA is a great business at a reasonable price. 2003 was another exceptional year for MBIA. Net income during the year increased 40% versus 2002. Because of the quality of the company's recent performance, the current market price is not particularly cheap, however, we expect to earn profits on the performance of the company, not on revaluation. A P/E of between 10 and 15 is pretty fair. The idea is to put some of our large cash position into a well-run company with good long-term growth prospects. We are not trying to make a big spectacular killing with this one investment, we'd be happy with 10% a year.

Freddie Mac is similarly very profitable, helped by the fact it enjoys a government-chartered oligopoly. Freddie Mac buys home mortgages from banks and creates a second market for them by repackaging them into mortgage pools and selling them to institutional investors and others. Freddie Mac makes a profit by paying out about 1% less on its mortgage pools than it collects on the mortgages. While the company has achieved pretty steady earnings growth, the company's stock price has been held down recently as a result of concerns about the company's accounting, exposure to derivative contracts and interest rate swings, potential for revocation of the company's government charter, and discovery this past summer that the company had been managing its earnings to smooth out quarterly swings. As a result, the stock is currently trading hands at a P/E of about 10. We think this is cheap. The chance their charter is revoked seems remote, irregular earnings growth is not that much a problem for us as long as earn ings are in fact still growing, and since Freddie Mac has thus far managed its risk responsibly, we feel comfortable they will continue to do so in the future. Still, the business is not so transparent as that of an appliance maker or soft-drink syrup manufacturer. However, despite these concerns, we expect FRE to provide at least a market level return over the next year. Nick Hirschey