Portfolio Manager's Commentary
Dec 31, 2008

Kent Croft
Russell Croft

Manager's Commentary - 4Q 2008

Market Environment

2008 has entered the books as one of the worst years in history for the stock market. Furthermore, the depth and duration of the bear market and economic recession are yet to be determined. From Washington to Wall Street to Main Street, there is plenty of blame to go around. Rather than enumerating here all the factors that brought us to this point, an assessment of our current situation is in order. With the caveat that the next few(+) months will be a period of maximum economic weakness, we are optimistic for the following reasons:

1. After fits and starts, government actions addressing the credit crisis are now having positive results. The biggest issues (housing and jobs) are being targeted more directly. One example: Mortgage applications have increased dramatically since the beginning of December.

2. Stock valuations are very low, implying that a tremendous amount of risk and continued bad news is being discounted in the market.

3. The stock market has started to react positively on days of significant bad news.

a. The S&P 500 closed up 4% on a day in December when reported job losses for the month of November were 150,000 worse than expected.
b. The S&P 500 closed up over 3.1% on January 2nd, 2009 after a report showed that U.S. manufacturing activity was at its lowest level since 1980.

4. Lower energy prices are stimulative (an estimated $300 billion economic benefit from peak oil price to current levels).

5. The political leadership vacuum is ending.

6. There is currently more cash available to buy equities than at any time in almost two decades. The $8.85 trillion held in cash, bank deposits, and money market funds is equal to 74% of the market value of U.S. companies, the highest ratio since 1980. Even a small percentage move into stocks can have a meaningful effect on the market.

7. The impact of hedge funds and highly leveraged security transactions is waning.

8. Infrastructure spending stimulus plans are being implemented in the United States, China, Germany, France and other countries.

9. The S&P 500 dividend yield of 3.0% is currently greater than that of a 10 year treasury bond at 2.4%.

10. We should not underestimate the resourcefulness and entrepreneurial spirit of the American people.

11. Fear, panic, and pessimism rule the headlines. This can change.

12. Long term investing opportunities abound.

We believe the above reasons taken together could be considered to offer a fairly powerful base of stabilization.

Our most important task is to position our portfolios to take advantage of the opportunities that arise out of severe market instability. This involves continued assessment of the existing holdings as to their long term potential. It also involves scrutiny of new areas of investment that have opened up due to severe valuation declines in certain industries, the new political climate, and the impact of globalization.

One constant throughout the history of investing is human psychology. Just as we create overly speculative markets, extreme fear causes us to overreact on the downside. It is painful, but excesses are being flushed out. Every day brings us closer to the end of this crisis and stocks tend to rebound prior to any evidence of economic improvement.

Generating Ideas

At Croft-Leominster, we are value oriented with a contrarian bent. Through extensive research, we generate hundreds of ideas from a variety of sources - both internal and external. From over 1000 stocks, we continually monitor about 200. We are classic stock pickers who look at stocks from the bottom-up.

A patient investment strategy is our hallmark. We look for gaps between a company's business value and its current stock price, and then carefully evaluate its strengths and risks, investing in those whose stock prices don't fully reflect their true value. We typically hold these stocks for at least 3-5 years. We believe this approach offers our investors the potential for higher returns with lower risk. Striving to reduce risk is inherent in our investment philosophy.

Our multi-cap approach allows us to opportunistically take advantage of market rotations. During these market cycles, we apply our proven investment process to companies of all sizes and sectors, identifying what we believe are undervalued small-, mid- and large-capitalization stocks.