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Dodge & Cox Funds First Quarter Commentary

- By Holly LaFon

The Dodge & Cox Stock Fund had a total return of 5.0% for the first quarter of 2017, compared to 6.1% for the S&P 500 Index.

The Fund underperformed the S&P 500 by 1.1 percentage points during the quarter.

Investment Commentary

On the heels of strong performance in 2016, the U.S. equity market continued to appreciate during the first quarter of 2017. The S&P 500 reached an all-time high in early March and ended the period up 6%. During 2016, the U.S. stock market leaders and laggards were divided into two distinct camps: traditionally stable, defensive sectors with higher dividend yields (e.g., Consumer Staples, Real Estate, Telecommunication Services, Utilities) and more economically sensitive sectors likely to benefit from an improving economy and higher interest rates (e.g., Energy, Financials, Information Technology). However, in the first quarter of 2017, there was less clarity as the best and worst performing sectors were mixed. Information Technology was the strongest sector of the S&P 500; Energy was the weakest sector amid lower oil prices, and Financials also trailed the Index.

Since U.S. equity valuations are now near recent historic highs, we have adopted a more tempered return outlook for the overall market. However, as an active manager with a value-oriented approach, we remain optimistic about the long-term prospects for the portfolio. On March 31, the Fund's portfolio of 62 equity holdings traded at 15.8 times forward estimated earnings, a significant discount to the S&P 500 (which traded at 18.3 times forward estimated earnings). As a result of individual security selection, the portfolio continues to be tilted toward more economically sensitive companies: Financials comprised 28% of the portfolio, Information Technology accounted for 19%, and Energy was 8%. We are also finding what we regard as compelling long-term investment opportunities, and we recently added to selected companies, including several in the Health Care sector (e.g., AstraZeneca, Bristol-Myers Squibb, Novartis).

We see evidence of higher economic growth, rising interest rates, and increasing corporate earnings, which would benefit the Fund's investments. The economic data released during the quarter was generally strong, indicating that the U.S. economy remains on a solid path. In addition, the Trump administration's goals for tax cuts and infrastructure spending could further stimulate growth. Interest rates should rise with higher inflation, and the Federal Reserve has signaled that multiple rate hikes are forthcoming in 2017. These factors, combined with accelerating global GDP growth, a recovery in energy and commodity prices, and corporate cost reductions could propel corporate earnings higher and enhance current market valuations.

We believe the rewards of active management are most likely to accrue to those investors who have the discipline to maintain a long-term investment horizon. We thank our fellow shareholders for your confidence in Dodge & Cox.

First Quarter Performance Review

Key Detractors From Relative Results

The Fund's average overweight position (30% versus 15%) and holdings in the Financials sector (up 1% compared to up 3% for the S&P 500 sector) detracted from results. Goldman Sachs (GS) (down 4%), Capital One Financial (COF) (flat), and insurance companies AEGON (AEG) (down 7%) and MetLife (MET) (down 1%) were weak.

Information Technology was the strongest sector of the index (up 13% for the S&P 500). The Fund's weaker relative returns in the sector (up 11%) detracted from results.

The Fund's average overweight position (9% versus 7%) and selected holdings in Energy hurt returns, as it was the weakest sector of the market (down 7% for both the Fund and for the S&P 500). Apache (down 19%), Anadarko Petroleum (down 11%), and Baker Hughes (down 8%) performed poorly.

Several stocks we do not own, including Apple, Facebook, Amazon, and Netflix, were particularly strong performers and hurt relative results.

Key Contributors to Relative Results

The Fund's average overweight position (12% versus 3%) and holdings in the Media industry (up 10% compared to up 9% for the S&P 500 industry) helped performance, especially Twenty-First Century Fox (FOXA) (up 16%) and Charter Communications (CHTR) (up 14%).

Returns from holdings in the Telecommunication Services sector (up 3% compared to down 4% for the S&P 500 sector) helped results.

Returns from the Fund's holdings in the Pharmaceuticals industry (up 9% compared to up 7% for the S&P 500 industry) helped results. AstraZeneca (up 18%), Roche (up 16%), and Sanofi (up 12%) were strong.

HP Inc. and Priceline (both up 21%) also contributed.

1 The Fund's total returns include the reinvestment of dividend and capital gain distributions, but have not been adjusted for any income taxes payable by shareholders on these distributions or on Fund share redemptions. Index returns include dividends but, unlike Fund returns, do not reflect fees or expenses. The S&P 500 Index is a market capitalization-weighted index of 500 large capitalization stocks commonly used to represent the U.S. equity market.

This article first appeared on GuruFocus.