ValueInvestor

October 30, 2009

The Leading Authority on Value Investing

INSIGHT
Found in Translation Inside this Issue
F E AT U R E S
“A good business is a good business no matter where it’s based,” says David
Herro. His expertise: identifying just such businesses when their stocks are cheap. Investor Insight: David Herro
Betting on companies well positioned

D
avid Herro remembers reading a
poster on the wall of his high
school Spanish class, which
extolled students to “Join the Jet Age: Learn
a Second Language,” and thinking, “When
would I ever need that?”
Lucky for Herro's investors, his foresight
has improved markedly since adolescence.
The Oakmark International Fund he has
run since 1992 has earned an annualized
return of 10.5%, vs. 6.5% for the MSCI
World Index (ex-U.S). As CIO of Harris
Associates’ international equity business, he
oversees nearly $14 billion in assets.
Betting today on companies best posi-
tioned to prosper from a cyclical
upturn, Herro is finding value in financial
services, temporary help, semiconductors,
carpet retailing and gloves. See page 2
INVESTOR INSIGHT
David Herro
Harris Associates
Investment Focus: Seeks high-return
companies run for shareholder benefit
when the market isn’t seeing beyond short-
term cyclical or operational challenges.
for brighter days ahead, including
Rohm, Adecco, Ansell, Allianz, Credit
Suisse and Carpetright. PAGE 1 »
Investor Insight: CastleRock
Looking for possible sources of unex-
pected surprises and finding them in
Equinix, Yahoo, Gap, Syniverse and
Warner Chilcott. PAGE 1 »
Of Sound Mind: Dan Ariely
Taking aim at those persistent and
stealthy forces that inappropriately
influence our decisions. PAGE 17 »
Uncovering Value: GM/Ford
A bullish case for a North American
automaker – with a built-in airbag in
case of high-speed collision. PAGE 20 »
Editors’ Letter
Paving the route to high performance
without high drama; How “junky”
has the rally really been? PAGE 22 »

INVESTMENT HIGHLIGHTS

INVESTMENT SNAPSHOTS PAGE

Adecco 6
Average Annual Total Returns as of 9/30/09
Ansell 7
Inception Exp. Ratio
1-Year 3-Year 5-Year 10-Year Carpetright 8
(date) as of 9/30/08
OAKMARK INTERNATIONAL FUND 17.71% -1.26% 8.15% 8.65% 10.52% 1.10% Equinix 11
(9/30/1992)
Gap 14

The performance of the Funds does not reflect the 2% redemption fee on shares redeemed GM/Ford 20

within 90 days. The performance data quoted represents past performance. Past perform- Rohm 5

ance does not guarantee future results. The investment return and principal value will Syniverse 16
fluctuate so that an investor’s shares, when redeemed may be worth more or less than their Warner Chilcott 15
original cost. Current performance may be lower or higher than the performance data Yahoo 13
quoted. To obtain most recent month-end performance data visit oakmark.com.
Other companies in this issue:
Allianz, Bank of America, Best Buy, Cisco,
Credit Suisse, Domtar, Goodrich,
International Paper, Lloyds, Petrohawk,
Precision Castparts, Richemont

www.valueinvestorinsight.com

Investor Insight: David Herro
Oakmark Funds' David Herro describes the “biggest reason quality companies sell at discounts,” why his direct
emerging-market exposure is currently so low, the best advice he'd give someone looking to invest outside the United
States, and why he sees significant upside potential in Rohm, Adecco, Ansell, Allianz and Carpetright.
You’re not that old, but you’ve been run-
ning international equity portfolios for
almost 23 years. Has your strategy
evolved in any key ways over that time?
David Herro: As a value investor, I was
initially almost exclusively focused on
companies with good balance sheets sell-
ing at low valuation multiples. There’s
nothing inherently wrong with that, but
I’ve learned from experience that when
cheapness blinds you to not-so-hot busi-
nesses or poor management, it’s a recipe
for disaster. We still only buy bargains,
but we pay a lot more attention to things
like whether the company’s returns on
capital are as good as they should be and
at how adept and disciplined manage-
ment is at allocating cash flow. When
returns are inadequate or capital is allo-
cated recklessly, equity value is usually
destroyed.
Another thing that’s been particularly
important in analyzing foreign companies
is to rely far more on cash flow than
reported earnings. This always made
sense to me. When I was in graduate
school, my brother-in-law hired me to do
some temporary work at a canning com-
pany. One project was to go through a
pile of invoices and pull out anything that
looked at all like a capital purchase, even
for things like tires and other pretty basic
recurring expenses. I finally asked why I
was doing that, and he said the CFO
wanted to capitalize anything that
remotely looked like capital spending so
they could write it off over time.
The lesson in that for me was that a
clever accountant can make financial
statements say whatever he wants in the
short term. That conclusion has only been
reinforced over time, especially as the dif-
fering tax regimes and accounting con-
ventions you see overseas can make com-
parisons based on reported net income
even more meaningless.
October 30, 2009
I N V E S T O R I N S I G H T : David Herro
What is the market often missing in the
situations that attract you?
DH: I would assert the biggest reason
quality companies sell at discounts to
intrinsic value is time horizon. Without
short-term visibility, most investors don’t
have the conviction or courage to hold a
stock that’s facing some sort of challenge,
either internally or externally generated.
It seems kind of ridiculous, but what most
people in the market miss is that intrinsic David Herro
value is the sum of all future cash flows
discounted back to the present. It’s not Accidental Tourist
just the next six months’ earnings or the
next year’s earnings. To truly invest for It says something about the prominence of
the long term, you have to be able to non-U.S. investing at the time that David
withstand underperformance in the short Herro was chosen in 1986 to create an
term, and the fact of the matter is that international equity product for what is
most people can’t. now the Principal Financial Group in Des
If you look at some of the newer par- Moines, Iowa. He had just earned a
ticipants in global equity markets, like Masters degree in Economics from the
hedge funds, think about how they get University of Wisconsin, but at 25, he had
paid. Their financial incentives are heavi- no actual investing experience. He started
ly weighted to one-year performance, so
out reporting to the head of fixed-income
what are they going to go after: compa-
private placements. Until he took the job,
nies they think will have a big share-price
he hadn't even been outside the U.S. “You
spike in the short term. Having more
could say there was no grand plan that I
trading driven by investors with a com-
was destined to be an international
pletely different time horizon than we
investor,” Herro says.
have can be very helpful in creating
opportunity.
After successfully launching the new
product for Principal and then doing the
Is this inefficiency more or less pro-
same for the State of Wisconsin
nounced in non-U.S. markets?
Investment Board, by 1992 Herro was in
demand as an experienced international
DH: It’s everywhere – animal spirits are
investor. That year he joined Harris
animal spirits. What may be somewhat
Associates to launch and manage its
more common outside the United States,
Oakmark International Fund. Today he’s
especially in smaller companies, are ideas
responsible for some $14 billion in non-
for which fewer people seem to be paying
U.S. equity assets for Harris. “I stumbled
attention, leading to something truly
interesting going unrecognized. Even as into this side of the business, but it was
some of our funds have gotten so large in love at first sight,” he says. “There's an
terms of assets, we still prospect for those added dimension and excitement to it that
types of overlooked small- and mid-cap I feel as much today as I did 23 years ago.
ideas. It's funny how things work out.”
www.valueinvestorinsight.com Value Investor Insight 2

We assume taking a longer-term perspec-
tive has proven painful at times over the
past year.
DH: Of course. We were early into finan-
cials as we thought valuations got so far
removed from what we expected “nor-
mal” to eventually be, but as you know,
the gap got painfully wider before it start-
ed to turn the other way. We spoke with
you about Credit Suisse [CSGN:VX] in
January [VII, January 30, 2009] and the
stock proceeded to fall another 30% by
March, to less than 22 Swiss francs. Since
then it’s up more than 150% [to a recent
56.65 Swiss francs].
Another similar example is Allianz
[ALV:GR], the giant German insurer and
financial services company which many
U.S. investors know as the parent compa-
ny of Pimco. We’ve always considered it
well-managed, but it got painted with the
same brush as all financial companies as
the crisis unfolded and its stock got
crushed. But we saw them taking steps to
focus on their core strengths in property
and casualty insurance, life insurance and
asset management, while getting out of
businesses like commercial banking. We
also saw them benefiting over time from
the extreme distress of one of their largest
global competitors, AIG.
Our feeling then – which hasn’t
changed – was that Allianz would be very
well positioned to come out of the crisis
in a strong competitive position with a
lot of earnings leverage. Of course, the
market couldn’t have cared less about
any of that in November of last year or in
March of this year, when the shares went
below €50. The stock has come back to
around €80, but we still have a big posi-
tion because we believe the intrinsic
value based on normalized earnings is
closer to €150.
Do you still consider Credit Suisse shares
attractive?
DH: Yes. Its tier-one capital ratio is over
15%, its private-banking franchise goes
from strength to strength and its invest-
ment bank has survived relatively intact
in a business in which a lot of big com-
October 30, 2009
I N V E S T O R I N S I G H T : David Herro
petitors have disappeared. We sold some
shares as the price increased – maintain-
ing around a 3% portfolio position – but
we still believe the sum-of-the-parts value
is closer to 115 Swiss francs.
Talk about one financial that didn’t work
out so well, the U.K.’s Lloyds.
DH: One of the more common unhappy
reasons we sell is if management proves
not to be the worthy steward of our cap-
ital that we thought. Lloyd’s did some-
thing colossally stupid in buying a finan-
cial train-wreck called HBOS last
September. Lloyds was a company that
ON CHINA:
We’ve never owned a mainland
Chinese company – there’s too
much potential conflict between
shareholders and the state.
could have come through the crisis almost
unscathed, but they stole defeat from the
jaws of victory by buying HBOS. We lost
money on it, but the only consolation is
that we got out when the shares were
around £1.20 and it’s now trading under
£0.90. You have to be able to take a loss
in this business – we ended up putting
that money mostly in other financials like
Credit Suisse or BNP Paribas, which have
done very well.
How do you organize your research
effort?
DH: We have eight people focused on
international research, with seven of our
analysts responsible for at least two dis-
tinct geographic regions. We’re abso-
lutists, so we don’t want people to say
things like “this is cheap for a German
company,” but instead focus on whether
it’s an attractive international idea.
We do some regular quantitative
screening for what looks cheap and of
good quality – say, looking at enterprise
value to EBITDA relative to return on
www.valueinvestorinsight.com
equity. For things that look attractive, our
next step is to interview management and
try to fully understand the return charac-
teristics of the business and how manage-
ment makes capital-allocation decisions.
Is interaction with management more dif-
ficult outside the U.S.?
DH: There are still language barriers,
particularly in Japan, but that’s gotten
better over the years as English has
become firmly entrenched as the interna-
tional language of business. Culturally, in
some parts of the world we’re up against
a kind of social-democracy attitude, that
says shareholders are equal constituents
with employees and customers and sup-
pliers and banks. I don’t ascribe to that at
all, so in some cases we have some con-
vincing to do. Most often, if that attitude
is too prevalent we just won’t be very
active.
Your portfolio is heavily weighted to
established rather than emerging
economies. Why?
DH: For our type of investing, which
involves buying big stakes in companies
and investing for the long term, we need
transparency and a firmly established rule
of law. If we can’t believe the financial
statements or we see too much risk of the
rules being changed after the game starts,
the whole exercise is pointless. As a
result, we won’t invest in Russia. We’ve
also never owned a mainland Chinese
company, because most of them are con-
trolled by the state and there’s too much
potential conflict between shareholder
and state interests. Say the government
wants independence in inter-coastal ship-
ping, so directs a shipping company to
buy ships that might produce lousy
returns. That’s terrible for shareholders.
Our emerging-markets exposure has
been as high as 25%, but is now for both
our large- and small-cap funds in the 4-
6% range, with most of that in Mexico,
South Korea, Israel and Malaysia. The
most-asked question I get in the past three
or four months is, “Why aren’t you more
heavily in emerging markets, don’t you
Value Investor Insight 3

know that’s where all the global growth is
coming from?” I do know that, but that
doesn’t mean there are cheap stocks to
buy there. We’re just seeing much better
value today in developed markets.
I’d add that most of the companies we
own in developed countries have consid-
erable exposure to emerging markets,
giving us that exposure at better prices
and with less risk. Richemont [CFR:VX],
for example, which owns luxury brands
like Cartier and Montblanc, will benefit
dramatically from growth in emerging
markets. As people move into the upper
middle class, one of the first things they
want to do is let other people know
they’ve done so. You can walk around
any major metropolitan area in China
and see that. Just because the consumer
may be dead for some time in the U.S.,
we don’t believe that’s going to be the
case in much of the rest of the world.
Are there industries you avoid?
DH: As long as it’s a good-quality busi-
ness selling at an attractive price, I don’t
care much about what the company
makes or sells.
One thing we are very conscious of is
the degree of leverage in a business. That
can be financial leverage, which is reflect-
ed on the balance sheet. It can be opera-
tional leverage, where you look at how
much of the cost base is fixed or variable.
It can also be the degree of leverage to a
particular industry or geography. In gen-
eral, I’m uncomfortable with companies
that are vulnerable to more than one of
those kinds of leverage going against
them at the same time. A cyclical business
that has a lot of fixed costs, for example,
should not have a lot of financial leverage
or be too levered to one geography or
industry. If things go the wrong way,
management has its hands tied in trying
to get out of trouble. This is a big reason
we rarely find opportunity in more com-
modity-type businesses.
Describe your valuation methodology.
DH: We forecast cash flows out five
years, and then discount the first four
October 30, 2009
I N V E S T O R I N S I G H T : David Herro
years back to the present and add to that
the present value of the fifth year’s cash
flow after applying a multiple to it. The
setting of that multiple, of course, is very
important and is where we have the
most debates in our approval process.
There are quantitative and qualitative
aspects to it. We’ll maybe start with peer
multiples or the multiples at which deals
have been done, for example, but that’s
not the only input because every compa-
ny is different. We also take into consid-
eration things like the consistency of the
business, its financial strength and the
ON CONCENTRATION:
We believe in being concen-
trated because we think our
research is fairly accurate and
want to fully benefit from that.
operating prowess of the management
team. For Heineken, for instance, we
like their brands and profitability but
we’ll ding them a bit on the multiple
applied because they haven’t been so
smart about M&A.
Once we arrive at an intrinsic value,
we require at least a 30% discount in
order to buy something. All else being
equal, the stocks trading at the highest
discount have the largest positions in the
portfolio.
How concentrated are your funds?
DH: Our top ten holdings usually make
up at least 30% of the portfolio, which
usually has around 60 total positions. We
believe in being concentrated because we
think our research is fairly accurate and
we want to make sure we fully benefit
from that. Beyond 65-70 positions, I’d
consider us over-diversified.
How do you manage currency exposure?
DH: As we do with stocks, we also cal-
culate the underlying value of the curren-
cies we’re exposed to, based primarily on
www.valueinvestorinsight.com
purchasing-power parity as calculated by
the OECD [Organization for Economic
Co-operation and Development]. If a cur-
rency is 20% or more overvalued, we will
hedge against it, with the amount of the
hedge basically rising along with the level
of the overvaluation.
Right now we’ve hedged about 30%
of our Swiss franc and Japanese yen expo-
sures and about 15% of our exposure to
the euro.
We haven’t spoken of any opportunities
in Japan. What’s your investment thesis
for chip-maker Rohm [6963:JP]?
DH: We had always admired the compa-
ny for its profitability, innovation and
competitiveness. They are a broad-based
maker of specialty semiconductors, fol-
lowing a basic model that their customers
design with Rohm what they need, and
then Rohm manufactures it at its own
plants or the plants of third parties. We
consider this Japanese manufacturing at
its best. Right now roughly 70% of their
customers are Japanese, with 30% out-
side Japan.
What kept us from owning the stock,
however, was that we didn’t at all like
how the company allocated capital. It
wasn’t at all unusual for them to be sit-
ting with 60% of the entire market value
of the company in cash. We didn’t
believe it until we saw it, but that’s
changed. They have bought back 10% of
the company’s shares. They increased the
dividend payout ratio from almost noth-
ing to more than 30%. Beyond giving
back to shareholders, they’ve also made
some smart acquisitions to fill out the
product line and expand geographically.
When a company starts behaving this
way, the return structure usually
improves significantly.
How cyclical is Rohm’s business?
DH: It is cyclical, but we’re positive on
the long-term growth prospects as more
advanced chips continue to be used in a
broader array of applications. Your cell
phone and PC are loaded with chips that
manage power and improve graphics in
Value Investor Insight 4
 I N V E S T O R I N S I G H T : David Herro

addition to managing more basic func-
tionality. That Rohm is so well estab-
lished as a go-to developer for original-
equipment manufacturers allows them
to stay on the leading edge of technolo-
gy and leverage their R&D spending
quite well.
Profitability today is quite low. Why?
DH: Part of that is cyclical, but another
important factor is the integration the
company is going through of the chip
business it bought last year from Oki
Electric. The Oki business was losing
money, but by all indications Rohm is
turning that business around and taking
advantage of some pretty substantial cost
synergies. On the top line we’re modeling
mid-single digit annual revenue growth,
INVESTMENT SNAPSHOT
Rohm
(Tokyo: 6963:JP)
Business: Japan-based producer of inte-
grated circuits and discrete semiconductor
devices primarily used in the manufacture of
digital consumer electronics products.
Share Information
(@10/29/09, Exchange Rate: $1 = ¥91.42):
Price ¥6,000
52-Week Range ¥3,690 – ¥7,130
Dividend Yield 2.2%
Market Cap ¥691.8 billion
but we believe improving economic con- DH: Including net cash on the balance
ditions and upside from the acquisition sheet – which is still nearly one-third of
will move margins well into the mid- the total market cap – we estimate intrin-
teens – from 6-7% in the current fiscal sic value to be roughly twice today’s share
year – within a few years. Given the cus- price, or ¥12,300.
tom nature of much of what Rohm does, One could argue they still have too
this business can have nice margins – much cash, but our feeling is that the
operating margins have been above 20% company has fundamentally changed its
in the past. orientation toward shareholders and we
By fiscal 2014 we’re looking for ¥100 expect more good news in that regard
billion in earnings before interest and going forward. And, by the way, having
taxes [EBIT], significantly better than the some excess cash isn’t the worst thing in
¥20 billion expected in the year ending the world.
next March. That may sound like a big
increase, but it basically just gets them What attracted you to temporary-help
back to the earnings level they had in fis- firm Adecco?
cal 2003.
DH: We first became shareholders three
At a recent ¥6,000, what upside do you years ago when Adecco bought a German
see for the shares? competitor that we owned called DIS.
The plan was to install DIS management
to run the overall company, which we
thought was a great idea for turning a
sleepy company into a first-class industry
player. Adecco, like a lot of staffing com-
Financials (For FY2009) panies, had been on an acquisition spree
Revenue ¥317.14 billion
that expanded its global footprint –
Operating Margin 3.3%
which was strategically important – but it
Net Profit Margin 3.1%
chronically overpaid. As a result, prof-
Valuation Metrics itability was much lower than we thought
(Current Price vs. TTM): it should be.
Rohm S&P 500
What do you like about the temp-help
P/E 66.8 77.7
business?

ROHM PRICE HISTORY DH: Some people kind of dismiss this

15000 15000 business as body renting, but if you’re
positioned in the right sectors – specifical-
12000 12000 ly, focused more on professional jobs
rather than clerical ones – and you’re
9000 9000 global so you can service big clients, it
can be a very good business. It’s cash-
generative, most of the costs are variable,
6000 6000
and you need almost no fixed capital.
We still believe there is secular growth
3000 3000
2007 2008 2009 in the industry, particularly in Europe and
Japan, as companies increasingly turn to
THE BOTTOM LINE temporary help in order to have more
The market isn’t recognizing the potential profitability of the company’s “custom” chip flexibility in managing headcount. The
business, its improving shareholder orientation, and the savings it should realize from a downside of that flexibility from a
recent acquisition, says David Herro. Assuming a return to 2003 profit levels within the staffing company’s perspective, of course,
next few years, his intrinsic value estimate for the company’s shares is above ¥12,000. is that spending on temps is one of the
first things – along with advertising – to
Sources: Company reports, other publicly available information
be cut in a downturn.

October 30, 2009 www.valueinvestorinsight.com Value Investor Insight 5

 I N V E S T O R I N S I G H T : David Herro

Is this essentially another of your time- 1 billion Swiss francs by 2013, up rough- DH: We think it makes a lot of sense. At
horizon ideas? ly 10% from 2008. what should be close to the bottom of the
cycle, they’re buying a company that is
DH: An important part of the story today How does your resulting intrinsic value focused on professionals – primarily in IT,
for Adecco is that while temp help has estimate compare to today’s share price of finance and engineering – and paying
been cut way back, it’s one the first things just under 48 Swiss francs? only around 10x EBITDA. After syner-
to come back. Companies are careful in gies, they expect to end up paying only 6-
the early stages of a recovery to not add DH: We use a 12.5x EBIT multiple on 7x EBITDA. With the Swiss franc as
too quickly to their more permanent cost 2013 numbers to capture the long-term strong as it is, we also think it’s the per-
base. But we don’t have to make heroic cash flows, which we think is justified by fect time for a Swiss company to be buy-
turnaround assumptions for this to be an the low fixed-asset requirements, strong ing a U.S. one.
attractive opportunity. Looking out to balance sheet, diversified base of business
2013, we see operating margins rising and profitability-oriented management. What risks do you see here?
from tight cost control and a better rev- After all other adjustments, we end up
enue mix to around 5%, versus 4.5% in with an intrinsic value estimate of about DH: Given the variable-cost nature of the
2008. We expect revenues to fall more 100 Swiss francs. business and its geographic and industry
than 20% this year, stay flat in 2010 and diversification, we don’t consider this
then grow again until getting back to Adecco earlier this month announced a particularly risky. We will keep a close
around 2008’s sales level by 2013. U.S. acquisition, of MPS Group, for $1.3 watch on this latest acquisition and any
Overall we expect EBIT to reach around billion. What’s your take on that? others to make sure the integration and
cost-saving targets are being hit. Any
trouble on those fronts would be a cause
INVESTMENT SNAPSHOT
for concern.
Adecco
(Switzerland: ADEN:VX)
Describe the potential you see in glove
Business: Provider of human-resources Financials (Year-end 2008) and condom maker Ansell [ANN:AU].
services worldwide, including temporary Revenue CHF 19.96 billion
staffing, permanent placement, outsourcing, Operating Margin 3.7%
DH: This is one of the surviving compa-
consulting and outplacement. Net Margin 2.5%
nies after the breakup of the old-line
Share Information
Valuation Metrics Australian conglomerate Pacific Dunlop.
(@10/29/09, Exchange Rate: $1 = CHF 1.02):
(Current Price vs. TTM): Ansell operates in three main businesses,
Price CHF 47.60 the first of which is industrial gloves,
52-Week Range CHF 30.16 – CHF 58.00 ADEN S&P 500
used primarily to help protect your
Dividend Yield 3.1% P/E 286.4 77.7
hands while allowing you to do things
Market Cap CHF 9.01 billion
like screw in a screw. Given how big a
ADEN PRICE HISTORY problem hand injuries are on production
100 100 lines, there’s a strong case to be made for
using these kinds of protective gloves.
80 80 The second business is latex gloves used
in the healthcare industry. The final
60 60 business is condoms, sold under a vari-
ety of brand names, including LifeStyles
40 40 in the U.S. The current sales breakdown
is 47% industrial, 33% healthcare and
20 20
20% condoms.
2007 2008 2009 Management has done an excellent job
to keep sales growing at a healthy clip
THE BOTTOM LINE over the past five years, while at the same
The company is well positioned to take advantage of a rebound in global temporary- time increasing operating margins into
help spending, one of the first areas to come back in a cyclical recovery, says David the low teens. Some of the positive drivers
Herro. Assuming a moderate increase in operating margins and a return by 2013 to we see for the business going forward are
revenues achieved in 2008, he pegs the shares’ intrinsic value at 100 Swiss francs. greater safety awareness in industrializing
nations, continued expansion of basic
Sources: Company reports, other publicly available information
healthcare spending worldwide, and

October 30, 2009 www.valueinvestorinsight.com Value Investor Insight 6

 I N V E S T O R I N S I G H T : David Herro

ongoing efforts by governments to pro- expecting operating margins to maybe Are you concerned about the CEO leav-
mote condom use for disease prevention fall from 11% to 10% for the fiscal year ing early next year?
and birth control. Ansell has the global ending next June. Looking out to fiscal
footprint and scale to take advantage of 2014, we’re expecting revenue to grow DH: He’s taking a bigger job to run
each of those. 4-5% per year, to A$1.6 billion, and International Flavors and Fragrances, but
Also on the subject of management, operating margins to return to around the remaining Ansell team in place, in
we believe they’ve been excellent stew- 12%, which is where they were in 2005 particular the CFO and the Board, is very
ards of capital. They’ve been disciplined and 2006. The margin improvement is strong. We’re not concerned about a tran-
in making acquisitions and investing in partly driven by a healthier economy, sition leading to trouble.
organic growth, while buying back plenty but is also from fully integrating some
of stock with the cash left over. The share acquisitions the company has made, Describe what you think the market is
count has fallen from 161 million in 2005 mostly in the condom business in less- missing in U.K.-based Carpetright
to what should be 135 million by the end developed markets. [CPR:LN].
of the current fiscal year. The stability of the business, along
with very low asset intensity, low debt, DH: This is the U.K.’s biggest retailer of
Is this business overall more stable than and shareholder-friendly management, floor coverings, mostly carpeting. It’s
some of the others we’ve talked about? leads us to use an 11.5x multiple on the managed by Lord Philip Harris, who has
out-year EBIT. That results in a target been in the business a long time and who
DH: Yes. Revenues have been fairly sta- value of A$17.50, against a current share I consider one of the best CEOs any-
ble through the downturn and we’re price of around A$10.20. where. He has carpet retailing down to a
science, running the business with nega-
tive working capital and with operating
INVESTMENT SNAPSHOT
margins and returns on capital that are
Ansell the envy of competitors. The company
(Australia: ANN:AU)
has allocated capital well and in a variety
Business: Operates in three primary busi- Financials (Year-end 6/30/09) of ways: buying stores from bankrupt
nesses: protective industrial gloves, surgical Revenue A$1.35 billion
competitors, investing in organic growth
and non-surgical gloves used in the health- EBIT Margin 10.5%
outside the U.K., buying back stock, pay-
care industry, and latex condoms. Net Profit Margin 8.9%
ing dividends. Lord Harris himself owns
Share Information
Valuation Metrics 25% of the company, so his interests are
(@10/29/09, Exchange Rate: $1 = A$1.09):
(Current Price vs. TTM): well aligned with ours.
Price A$10.18
52-Week Range A$7.51 – A$13.83 ANN S&P 500
Is this basically a bet on an industry
Dividend Yield 2.7% P/E 11.4 77.7
leader at a time when its industry is par-
Market Cap A$1.37 billion
ticularly challenged?
ANN PRICE HISTORY
15 15 DH: The business is closely tied to the
level of new and used home sales, which
fell off a cliff in the economic crisis. So
12 12
Carpetright is very leveraged to a cyclical
upturn, even more so because the #2 com-
petitor in the market, Allied Carpets, is
9 9
operating under bankruptcy protection.
Allied has sharply cut its store base and
pulled back from businesses selling to
6 6
2007 2008 2009 insurance companies and homebuilders,
so we think there’s no question
THE BOTTOM LINE Carpetright will take share as all aspects
The quality and stability of the company’s glove and condom businesses are not ade- of the business start to come back.
quately reflected its it current valuation, says David Herro, especially given its excellent
balance sheet, low asset intensity and shareholder-focused management. His target How do you see the rebound working
value for the shares is A$17.50, more than 70% above the current market price. through Carpetright’s financials?
Sources: Company reports, other publicly available information
DH: We expect operating margins, which

October 30, 2009 www.valueinvestorinsight.com Value Investor Insight 7

 I N V E S T O R I N S I G H T : David Herro

fell to 4-5% in the downturn, to get back
to what had been a more normal level of
around 13%. With the cyclical and struc-
tural kick to the business, we’d also
expect revenues to rise 20-25% off the
bottom, and then grow 5-6% per year
beyond that. Our estimate for 2013 EBIT
is close to £100 million, which is a strong
increase from a more normal level of £50-
60 million in the past.
What’s your intrinsic-value estimate for
the shares, which recently traded at
around £8.85?
DH: Because this is a high-quality, well-
run company, we use a 12x multiple of
the fifth-year cash flow before discount-
ing back. Discounting back the earlier
years, subtracting net debt and adding
INVESTMENT SNAPSHOT
Carpetright
(London: CPR:LN)
Business: Discount-priced carpet, floor-
covering and bed and mattress retailer with
more than 700 stores in the U.K., Ireland,
Holland, Belgium and Poland.
Share Information
(@10/29/09, Exchange Rate: $1 = £0.60):
Price £8.84
52-Week Range £3.11 – £9.70
Dividend Yield 1.0%
Market Cap £594.4 million
CPR PRICE HISTORY
15
12
9 9
6 6
back some things like excess real estate, You wrote recently about the macro sub-
we arrive at a per-share intrinsic value of ject of inflation. To what extent are you
around £15. concerned about that?
What general advice would you give U.S. DH: I’m actually not that concerned
investors trying to become more active about it at this stage. The global economy
internationally? is soft and there’s plenty of excess capaci-
ty, so I believe inflation is still very pre-
DH: It’s very important not to get too ventable. That said, there is an incredible
caught up in the macroeconomic or polit- amount of dry kindling out there – all you
ical currents and just focus on the funda- have to do is look at the Fed’s $2 trillion
mentals of individual businesses. Bigger balance sheet. I do happen to believe,
issues obviously matter, but they should though, that we have a wise central bank
just be a part of the many inputs you look chairman who knows that when the time
at in assessing the quality of the business, comes he’s going to have to sell the stuff
its prospects and what you think it’s on his balance sheet and take liquidity out
worth. It doesn’t matter how well you of the system. If the economy starts hum-
handicap the next presidential election if ming and the Fed’s balance sheet isn’t
you can’t discern a good business from a slimming down, then it’s time to worry.
bad one. My biggest macro concern would be
new laws and regulations that prevent the
free flow of goods, services and capital
across boundaries. Things like carbon
taxes and idiotic tariffs on tires will inhib-
it growth – that makes me far more nerv-
Financials (FY2009) ous at the moment than inflation.
Revenue £482.8 million
Operating Margin 4.7%
When we spoke in January you were opti-
Net Profit Margin 2.4%
mistic about the global economy’s ability
Valuation Metrics to right itself and grow. Has anything
(Current Price vs. TTM): happened to shake that confidence?
CPR S&P 500
DH: I still believe the greater trend of the
P/E 50.4 77.7
emerging world consuming more and
moving hundreds of millions of new peo-
ple into the middle class will compensate
15 for the fact that the largest economy, the
U.S., is suffering from a big hangover.
12 Even the old-world economies in Europe
have the potential to bounce back quick-
er because consumers there, while scared
to death by the economic crisis, at least
didn’t leverage themselves to oblivion like
so many people in the U.S.

3 3
2007 2008 2009 You were once on track to become an
economics professor. Is that still on your
THE BOTTOM LINE to-do list?
Run by “one of the best CEOs anywhere,” says David Herro, the company is capitaliz-
ing on the distress of its closest competitor and should increase market share and DH: I’d still like to teach economics, but
earnings power in an eventual recovery in the U.K. home-sales market. If that happens, I’m a big believer that if you love what
Herro believes the shares’ fair value is closer to £15, a 70% premium to today’s level. you’re doing, don’t mess with it. Why
gamble on the grass being greener on the
Sources: Company reports, other publicly available information
other side? VII

October 30, 2009 www.valueinvestorinsight.com Value Investor Insight 8

As of September 30, 2009, the funds held the follow securities as a % of total net assets:
OAKMARK INTERNATIONAL OAKMARK INTERNATIONAL SMALL
SECURITY TITLE
FUND CAP FUND
Adecco 2.45% 0.0%
Allianz 3.56% 0.0%
Ansell 0.0% 2.24%
BNP Paribas 1.62% 0.0%
Carpetright 0.0% 2.25%
Credit Suisse 2.70% 0.0%
Heineken 0.26% 0.0%
Lloyds 0.0% 0.0%
Richemont 3.47% 0.0%
Rohm 2.27% 0.0%
Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.

As of September 30, 2009, the following geographic distributions were held as a % of the total net assets:
OAKMARK INTERNATIONAL OAKMARK INTERNATIONAL
FUND SMALL CAP FUND
EUROPE 73.5% EUROPE 67.2%
Switzerland 23.6% United Kingdom 18.4%
United Kingdom 16.6% Germany 14.6%
France 11.5% Switzerland 10.0%
Germany 9.9% France 8.4%
Sweden 2.9% Italy 6.2%
Ireland 2.8% Netherlands 3.9%
Netherlands 2.7% Norway 3.4%
Spain 2.1% Greece 1.9%
Italy 1.4% Sweden 0.4%
ASIA 14.2% ASIA 15.1%
Japan 13.7% Japan 11.1%
South Korea 0.5% Malaysia 2.6%
LATIN AMERICA 3.7% Philippines 0.8%
Mexico 3.7% South Korea 0.6%
NORTH AMERICA 3.0% AUSTRALASIA 8.2%
Canada 3.0% Australia 6.0%
AUSTRALASIA 1.0% New Zealand 2.2%
Australia 1.0% NORTH AMERICA 1.8%
MIDDLE EAST 0.3% Canada 1.8%
Israel 0.3% LATIN AMERICA 1.4%
Emerging Markets 4.5% Brazil 0.9%
Emerging Markets consists of: Mexico 0.5%
South Korea, Mexico, and Israel MIDDLE EAST 1.3%
Israel 1.3%
Emerging Markets 6.7%
Emerging Markets consists of:
Malaysia, Philippines, South
Korea, Israel, Brazil, and Mexico

Investing in value stocks presents the risk that value stocks may fall out of favor with investors and underperform growth stocks during given periods.

Investing in foreign securities represents risks which in some way may be greater than in U.S. investments. Those risks include: currency fluctuation;
different regulation, accounting standards, trading practices and levels of available information; generally higher transaction costs; and political risks.

The stocks of smaller companies often involve more risk than the stocks of larger companies. Stocks of small companies tend to be more volatile and have
a smaller public market than stocks of larger companies. Small companies may have a shorter history of operations than larger companies, may not have
as great an ability to raise additional capital and may have a less diversified product line, making them more susceptible to market pressure.

The MSCI World ex U.S. Index (Net) is a free float-adjusted market capitalization index that is designed to measure international developed market equity
performance, excluding the U.S. This benchmark calculates reinvested dividends net of withholding taxes using Luxembourg tax rates. This index is unmanaged
and investors cannot invest directly in this index.

The discussion of investments and investment strategy of the funds (including current investment themes, the portfolio manager’s research and investment process
and portfolio characteristics) represents the investments of the funds and the views of David G. Herro and Harris Associates L.P., the Funds’ investment adviser, at
the time of this article, and are subject to change without notice.

For a prospectus and more information about The Oakmark Funds, including management fees and expenses and the special risks of investing, please visit
oakmark.com or call 1-800-OAKMARK. Please read the prospectus carefully before investing. An investor should consider a fund's investment objectives, risks,
and charges and expenses carefully before investing. This and other information about the Funds are contained in the Funds' prospectus.

Harris Associates Securities L.P., distributor. Member FINRA. 11/09