WedgewoodPartners1stQuarter2018ClientLetter

HelloVolatility,MyOldFriend,I’veComeToTalkWithYouAgain

"Ihaveneverseenamarketthisvolatiletothisextentinmycareer…Nowthat’sonly66years…I'veseentwo50percentdeclines,I'veseena25percentdeclineinonedayandI’veneverseenanythinglikethis

before."

JohnBogle,FounderofTheVanguardGroup

ReviewandOutlookOur Composite (net-of-fees)i declined -0.65% during the first quarter of 2018. ThebenchmarkRussell1000GrowthIndexgained+1.42%.TheS&P500Indexdeclined-0.76%duringthequarter.Topfirstquarterperformancedetractors includeTractorSupply,KraftHeinz,Qualcomm,Celgene, and Facebook. Top first quarter performance contributors include EdwardsLifesciences,BookingHoldings,CognizantTechnology,Visa,andPayPal.

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Stockmarketvolatilityreturnedwithathunderclapduringthefirstquarter–consequently,wewerequitehappy–andquitebusy.WesoldT.J.MaxxandVeriskAnalytics.WeboughtFacebook(infact,weaddedtoFacebookthreetimesduringthequarter).WetrimmedAlphabettwice.WeaddedtoApple,PayPal,andRossStores.

1 Duringthequarterweliquidatedourpositions inVeriskAnalytics. Overthepastseveralyears,VeriskhasgoneoutsideitscorecompetencyofservingtheInsuranceIndustry,inanefforttodrivecontinuedrevenueandearningsgrowth.AlthoughtheCompanyhasexecutedwellintheinsurancevertical,wearelessimpressedwiththeexecutionoftheiracquisitionsintheenergy,healthcare,andfinancialverticals.Thoseverticalsstillrepresentaminorityoftheirprofitability(theyexitedhealthcarein2016);however,wethinkthereturnstodatehave not justified the balance sheet risk the Company has taken and would prefermanagement return capital to shareholders, rather than growing for growth’s sake. Wereinvestedproceedsintobetteropportunitiesthatwerepresentedduringthebriefboutsofheightenedvolatility.

1 Portfoliocontributioncalculatedgrossoffees.Theholdingsidentifieddonotrepresentallofthesecuritiespurchased, sold, or recommended. Returns are presented net of fees and include the reinvestment of allincome.“Net(Actual)”returnsarecalculatedusingactualmanagementfeesandarereducedbyallfeesandtransaction costs incurred. Past performance does not guarantee future results. Additional calculationinformationisavailableuponrequest.

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We liquidatedourpositions inT.J.Maxx andused theproceeds toadd to fastergrowingbusinesses. TheCompanycontinuestobeexceedinglywell-runandhaspioneeredmanynew concepts in the off-price retail industry and managed to expand the conceptinternationally, where price umbrellas have emerged. However, there are fewmarketswherethatoff-priceopportunityisbetterthanintheU.S.WethinkT.J.MaxxisfurtheralongthematuritycurveintheU.S.,relativetoanotherportfolioholding,RossStores,whichalsocompeteswellwithintheoff-pricespace. Rosscontinuestohaveampleroomtogrowitsfootprintinthehighlylucrativeoff-pricespacethroughcoreconceptexpansionandpotentialentryintonew,relativelyunderpenetratedretailsegments,particularlyinhome.Tractor Supply Company posted solid same-store sales (“comp”) growth of 4%, toppingconsensusexpectations.Despiteprovidinggoodcompguidanceforthecomingyear,andalonger-termplan foroperatingmarginexpansion, investors ignoredthisandshiftedtheirgazeto theCompany’s lowernear-termoperatingmarginguidance. Wethinktherecentselloff is overdone. Lowermargins are being driven by investments in distribution andpersonnelcapabilities,whichweretelegraphedafewquartersago;andthereforetheyarenotnewdevelopments. Wecontinuetothinkthereinvestmentofexcesscapitalintonewproductiveassetsandworkflowswillresultinsustainablelonger-termsalesandoperatingleverage.Further,grossmarginscontinuetobesteady,leavinglittlesignthattherehasbeenameaningful change in competitive encroachment. For example, we thinkmany of theCompany’smostpopularconsumable,usable,andedible(CUE)itemsdonotlendthemselveswell to fulfillmentby theU.S. Postal Service; instead they’ddowell to leverageTractor’sbrick-and-mortarlocations.Tractorhaslongfocusedonnichemerchandisingandservices– focusing on rural landownerswith higher than average income – that fall outside thepurviewoftypicalmass-marketretailers.WethinkexpectationsfortheCompanyarequitelow,asconsensusexpects flatmargins forseveralyears,despite theCompanyreachingapointwhereweexpecttheycanleveragetheiroverheadinvestmentsfromthepastseveralquartersanddrivelowdouble-digitearningspersharegrowth.Notably,thebenchmarkRussell1000GrowthIndexcappedits10thconsecutivegainandhasfinishedhigherduring20outofthepast21quarters.Despitethisrelentlessappreciation,therewasenoughvolatilitythisquartertoserveupafewgoodopportunities.MostofthevolatilityoccurredinFebruaryandMarchbutwasnotenoughtorepealJanuary’smeteoricgain.MostofourrelativeunderperformanceforthequarterwaspostedduringJanuary,asafewlargeweightingsinthebenchmark,namelyMicrosoft,NetflixandAmazon(thethreeroughly10%ofthetotalbenchmarkweighting),tackedonalmost$250billioninmarketcapinonly21tradingdaysandendedupdetractingaround130basispointsfromourrelativeperformanceforthefullquarter.Wecontinuetobeskeptical that thevaluetheaforementionedbusinessesarecreating isanywherenearenoughtojustifysuchpriceappreciation,butwearealsowellawarethatthisskepticism can be viewed as obstinacy. However, we continue to invest with the basicexpectationthatvaluecreationisnotjustarevenuefunctiondrivenbycustomerdelight;butinsteadisaseriesofprudentandsustainabletradeoffsbetweenrevenueopportunityandtheveryrealshareholdercapitalrequiredtoaddressthatopportunity.

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Further,whenabusinesssuccessfullymanages thatdifficultbalance, it isnotnecessarilysustainableforseveralyears,letalonedecades–orevencenturies.Wethinkamulti-centurytimehorizonispatentlyabsurd,yetthereareexceedinglylargepoolsofcapitalthatinvestinour universe using that framework.2 So although this capital continues to flow into thesystem,we continue to focus on stocks that reflectmuchmoremodest expectations. Ofcourse,wealsothinkourprudencewillberewardedinourlifetime,andevensooner–likelywithinthismarketcycle.“Adangerousfeedbackloopnowexistsbetweenultra-lowinterestrates,debtexpansion,assetvolatility

andfinancialengineeringthatallocatesriskbasedonthevolatility.”

VolatilityandtheAlchemyofRisk,ArtemisOctober2017

In our recent Client Letters, we have chronicled the astonishing, historically low stockmarketvolatilityoverthepastfewyears.Withtheclarityofhindsight,itlookslike2017wasacapstonetotheone-waydirectionbullmarket.InallduerespecttoMr.Bogle,webelieveMr.Marketjustmightbegettingwarmedup.Speakingofvolatility,thisiswhatwewrotejustlastquarter:Incredibly,theGreatBullMarketof2009-2017momentumactuallyincreasedduringthefourthquarter.Volatilityinthestockmarketappearstobeathingofthepast.(Wearedubious.)2017setnumerous

recordsforhistoricallylowvolatilityinboththestockandbondmarkets.Thefourthquarterrepresentedthe20thpositivequarteroverthepast21.

Thelastnegativequarterwastwoyearsagowhenthestockmarket“suffered”a-6.6%“collapse”duringthethirdquarterof2015.Infact,ifthecurrentbulladvanceswithoutatleasta-5%correctionbythethirdweekinJanuary,itwillthelongestsuchstreaksince1928.Further,thestockmarkethasnot

sufferedjusta-3%drawdowninover13months,byfarthelongestinhistory.

In2017alone,thestockmarketwasupeverymonth(acalendaryearrecord)andnowup14monthsinarow(arecord).95%ofthetradingdaysduring2017hadanintradayswingoflessthan1%-anotherhistoricrecord.TheDowJonesIndustrialAverageset71newhighsin2017–themostsince1910.Thesecondmostnewhighs(65)wasrecordedbackin1925.Thelastnotabledouble-digit“correction”wassixyearsagowaybackin2011.Thestockmarkethasrecordedpositivegains9consecutiveyearsand

14outofthepast15years.

WeneedtorepeatwhatwewroteinourlastLetter;“volatilityisadearfriendoftheactive,patient,value-sensitiveinvestor.Wemissitterribly.”

2 https://www.softbank.jp/en/corp/about/philosophy/vision/

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Well.Welcomeback,ouroldfriend.According to Jefferies, so far in2018 (earlyApril), theS&P500 Index sustained its thirdhighestsustainedvolatilitythisdecade,thefifth+10%correctionthisdecade.Infact,24ofthepast43tradingdayshaveexperienced+1%S&P500moves.OverattheNASDAQ(QQQ),oneweek realized volatility reached a +52 volatility – the third highest this decade. Inaddition,QQQregistered10different+1%movesinjustasingletradingday(March28th).Recall that back in early February a volatility spike bludgeoned a few exchange-tradedproductstothepointofforcedliquidation. Such“products”allowspeculatorstobetonavolatilityindexsuchastheCBOEVolatilityIndex(VIX).Asifspeculatingontheshort-termriseorfallonstocks,commodities,ormarketindicesthemselvesisdauntingenough,imaginespeculatingonthespeedofpricemovementsthemselves.ImaginebettingonhorsesattheKentuckyDerbyordriversattheIndy500.Nowimaginebettingonthespeedofthehorsesor race cars during the race. Sounds nuts, right? Yep. It might too sound like someinsignificant, perhaps even infinitesimal crap shootinggameplayed in the far corners offinancialmarketsbyuber-speculatorstoo,right?Nope.TheFinancialTimes(FT)estimatesthat there is$80billion in883globalvolatility-linkedleveragedandinverseETFsandETNs.Further,theFTestimatesthattheplungeinthestockmarketwaslargelyduetotheautomaticselling,triggeredbyaspikeinvolatilityofupto$200billioninsuchproducts.Youreadthatright,automaticselling.Oncethealgorithmicmachine selling starts, the viscous selling circle begets even more selling. Even moredauntingisthelackoffundamentalbuyerssteppinguptobuyagainstthemachines.Worsestill, suchstructural fundamentalbuyersdon’t exist. Here is anexampleof suchexotica;VelocitySharesDailyInverseVIXShortTermETN.

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Suchalgorithmicproductsgrewlikeweedsduringthelow-interestrateQEregimesoftheglobal central banks against a backdrop of historically low asset price fluctuations andflourishedforyearsinaseaofmarkettranquility.Alltold,Standard&Poor’sestimatesthat“financialengineeringstrategies”peggedtovariousalgorithmsoflow-volatilitystillcontrolfrom$1.5trillionto$2.0trillionofgasolinejustwaitingtobethrownuponeventhesmallestmarketfire.ThisisMaryShelly’sFrankensteinreduxofanother,frighteningorder.

Source:FinancialTimes

For some of ourmore senior readers,we confidently posit that such casino-like activitysoundsalltoofamiliartotheoh-so-sophisticatedPortfolioInsurancecrack-upcirca1987.We’llletWarrenBuffettcontinuethenarrativefromhere.Thefollowingisexcerptedfromhis1987Chairman’sLetter30yearsago:

Let'slookfirstatcommonstocks.During1987thestockmarketwasanareaofmuchexcitementbutlittlenetmovement:TheDowadvanced2.3%fortheyear.Youareaware,ofcourse,oftherollercoasterridethatproducedthisminorchange.Mr.

MarketwasonamanicrampageuntilOctoberandthenexperiencedasudden,massiveseizure.

Wehave"professional"investors,thosewhomanagemanybillions,tothankformostofthisturmoil.Insteadoffocusing

onwhatbusinesseswilldointheyearsahead,manyprestigiousmoneymanagersnowfocusonwhattheyexpectothermoneymanagers

todointhedaysahead.Forthem,stocksaremerelytokensinagame,liketheThimbleandFlatironinMonopoly.

Anextremeexampleofwhattheirattitudeleadstois

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"PortfolioInsurance,"amoney-managementstrategythatmanyleadinginvestmentadvisorsembracedin1986-1987.Thisstrategy

-whichissimplyanexotically-labeledversionofthesmallspeculator'sstop-lossorderdictatesthateverincreasing

portionsofastockportfolio,ortheirindex-futureequivalents,besoldaspricesdecline.Thestrategysaysnothingelse

matters:Adowntickofagivenmagnitudeautomaticallyproducesahugesellorder.AccordingtotheBradyReport,$60billionto$90billionofequitieswerepoisedonthishairtriggerinmid-

Octoberof1987.

Ifyou'vethoughtthatinvestmentadvisorswerehiredtoinvest,youmaybebewilderedbythistechnique.Afterbuyingafarm,wouldarationalownernextorderhisrealestateagenttostartsellingoffpiecesofitwheneveraneighboringpropertywassoldatalowerprice?Orwouldyousellyourhouseto

whateverbidderwasavailableat9:31onsomemorningmerelybecauseat9:30asimilarhousesoldforlessthanitwouldhave

broughtonthepreviousday?

Moveslikethat,however,arewhatportfolioinsurancetellsapensionfundoruniversitytomakewhenitownsaportionofenterprisessuchasFordorGeneralElectric.Thelessthesecompaniesarebeingvaluedat,saysthisapproach,themorevigorouslytheyshouldbesold.Asa"logical"corollary,the

approachcommandstheinstitutionstorepurchasethesecompanies-I'mnotmakingthisup-oncetheirpriceshavereboundedsignificantly.Consideringthathugesumsarecontrolledby

managersfollowingsuchAlice-in-Wonderlandpractices,isitanysurprisethatmarketssometimesbehaveinaberrationalfashion?

Manycommentators,however,havedrawnanincorrect

conclusionuponobservingrecentevents:Theyarefondofsayingthatthesmallinvestorhasnochanceinamarketnowdominatedbytheerraticbehaviorofthebigboys.Thisconclusionisdeadwrong:Suchmarketsareidealforanyinvestor-smallorlarge-

solongashestickstohisinvestmentknitting.Volatilitycausedbymoneymanagerswhospeculateirrationallywithhuge

sumswillofferthetrueinvestormorechancestomakeintelligentinvestmentmoves.Hecanbehurtbysuchvolatility

onlyifheisforced,byeitherfinancialorpsychologicalpressures,tosellatuntowardtimes.

Marketparticipantshave begun to react like somethingnew indeed is afoot in the stockmarket.Wecan’thelpbutthinkthatmoreandmoreinvestorsarestartingtorealizethattherecentunnervingvolatilityhaslittletodowiththebulls’andbears’time-honoredbattlingovercheapandexpensivestocks.

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Source:BiancoResearch

Wecertainlywelcomeouroldfriendvolatility,asitservesupopportunity.However,wearestillcognizantthateverymajorindex(andassetclass)isnearall-time,historichighs.Thatsaid,wearestillable–becauseofourFocus–toconstructaportfolioofgrowthcompanieswithmuchbettergrowthandprofitabilityprofiles,butatquitefavorablevaluations.Hereareafewmoregraphics(includingthefirsttwofromourlastLetter)thatspeaktoacurrentmarketenvironmentthatisquiteripeformanymorenumbingstockmarketflashcrashes.

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Source:Investech

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Last,butnotleast,thestockmarket’srecentboutofEKG-likevolatilityknockedtheGreatBullMarketof2009-2018’sninththbirthdaycelebrationoffthefrontpages.

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CompanyCommentariesEdwardsLifesciencesEdwardsLifescienceswasourtopcontributorinthefirstquarter.Honestly,wecouldn’tbemuchmorepleasedwiththewayfundamentaldevelopmentshaveplayedoutduringourownershipoftheCompany.Asyouknowfromourearliercommentary,theprimarydriverfortheCompanyisTranscatheterAorticValveReplacement(TAVR),wheretheCompanyhasa significant market leadership position. As a reminder, TAVR is a much less invasivealternativetoopen-heartsurgeryforthereplacementoftheaorticvalve,inwhichthenewvalveisputintoplacethroughacatheter,typicallyinsertedviaatinypinprickinapatient’sleg.TheaorticvalveisgenerallyreplacedduetoaconditionknownasAorticStenosis(AS),whichisanarrowingofthevalve,whichrestrictsbloodflowwithintheheart.TAVRhasseensuccessivewavesofgrowthastheprocedurehasbeenapprovedfirstforpatientsforwhomsurgerywasnotaviableoption,thenforpatientsathigh-andmedium-riskofcomplicationsfrom surgery. The Company is alsoworking on approvals for low-risk patients and forpatientscurrentlyshowingnosymptomsofAS.Ourresearchhasledustobelieve,fromthebeginning,thattheCompany’spublicly-statedintermediate-termexpectationsforthesizeofthepotentialpatientpopulationandmarketopportunitywerevastlyunderstated.Webelievedthatbothphysiciansandpatientshavetendedtodelayaddressingpotentialheartvalveissuesduetotherathertraumaticprospectofopen-heartsurgery. Withamuch lessinvasiveoptionnowavailable for treatment,wehavebelievedthatthepoolofpotentialpatientswouldprovetobemuchgreaterthananyonecouldhavetrackedpreviously,especiallyamongpatientswhowere“lesssick,”forlackofabetterterm.Asinitialapprovalshavebeenforpatientsalreadyknowntobethe“mostsick”–specifically,patientsalreadyknowntobesufferingfromsevereAS,andwhohaveothercomplicationsthatmakeopen-heartsurgeryarisk–theaddressablepatientpopulationintheearlystagesofTAVRrollouthasbeenfairlypredictable. However,asapprovalsmovetoward“lesssick”patientsovertime,wefirmlybelievetheaddressablepatientpopulationwillrepeatedlysurprisetotheupside.Therefore,ithasbeengratifyingtoseethispartofourthesisalreadyplayingout.Injustthepastyear,theCompanyhasincreaseditsguidanceforthetotalTAVRmarketby2021from$5billiontogreaterthan$5billion,alsonotingthattheopportunitybeyond2021 is significant. Specifically, theyhave said that theybelieve theprevalenceofASislargerthantheypreviouslyhadanticipated,meaningthattreatmentratesaremuchlowerthantheyhadanticipated.Furthermore, activity from competitors in the TAVRmarket has turned out to be morebenevolentthanwehadexpected.Medtronic’sCoreValveremainsthe#2competitor,anditis growing slightly faster than Edwards in TAVR, since it came to market later and iscapturingsomeshare,asEdwardsnolongerhasthemarkettoitself.Thisisexactlyaswehaveexpected.WealsoanticipatedthatBostonScientific’sLotusvalve,whichhashadsomequalityissuesandhasbeenoffthemarketforseveralquarters,wouldreenterthemarketandcapturemodestshareasa#3option,asourresearchhas indicatedthat thisvalve isbetterthantheothertwocompanies’offeringsinspecificsituationsbutisnotcomparablein

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themajorityof situations. Wealsoassumed thatpricingwoulddeclineacross theTAVRspaceasBoston’sproductcametomarket,becauseBostonwouldtrytocompensateforaninferior product with lower pricing. However, since our initial purchase, the followingeventshaveoccurred:1)BostonhasrepeatedlystruggledtogetLotusbackonthemarket;2)bothMedtronicandBostonhavebasicallyadmittedthatEdwardshasthebestproduct,and the other two will be slugging it out for second place; 3) Boston has claimed(optimistically,accordingtoourresearch)thatitsproductisjustasgoodasMedtronic’s,sotheywillhavenoneedtoresorttoapricewarinordertocaptureshare.Theseareallverypositivedevelopmentsinrelationtoourinitialexpectations.Inroughterms,weoriginallyhad expected something like a 45-45-10 eventual market share split between Edwards,Medtronic, andBoston Scientific, andwith a degradation in pricing; instead, Boston stillhasn’t managed to get back on the market yet, and we could eventually be looking atsomethingaspositiveasa60-20-20splitwithlittleornopricingdegradation,ifBostonistobebelieved–although,aspreviouslynoted,weareskepticalofsomeofBoston’sprojections.Finally,wewouldnote a couple of slightly less significant developments. First, an earlyrulinginsomeTAVRpatentlitigationbetweenEdwardsandBostonjustwentinEdwards’sfavor;weseethislitigationasroutinefortheindustryandbelieveitismostlikelytoendinsomefairlybenigncross-licensingagreementsbetweenthecompanies,butthisearlyrulingmaypoint toamorepositiveoutcomethanwehadexpected. Next,althoughwestillseesignificant long-term opportunity in TAVR,we are getting closer to the Company’s nextgrowthdrivers in transcathetermitral and tricuspidvalve repair and replacement, areasestimated by the Company to be at least a $3 billionmarket opportunity by 2025. TheCompanyexpectstolaunchatleastonenewproductintheseareasineachofthenextthreeyears.Lookingspecificallyatthestock,althoughinvestorswithshorter-termtimehorizonshaveoccasionally fretted over minor decelerations in TAVR growth rates—which have beennothing more than a function of mathematical realities, when the Company has lappedperiodsof theunleashingofpent-updemandafter launchingnewpatientpopulations inhigh-risk and intermediate-risk situations—we have focused on the long-term growthopportunitiesandhavebeenabletobuildourpositionatattractiveprices.Aswesaywithprettymucheveryoneofourpositionsinthecurrentmarket,thestock’svaluationclearlyisnot cheap; in the tenth year of a valuation-agnostic bull market, very little is, by anyreasonablehistoricalstandards.However,inamarketwheremoststockstradebeyondthetopendofhistoricalvaluationranges,Edwardsatleastistradingfirmlywithinthemiddleofitsnormalrangeduringthecurrentbullmarket,inthemid-to-high20sonaforwardP/Ebasis. Edwards also is generating very healthy double-digit percentage revenue growth(16%in2017)aswellasimprovingprofitability,withconsistentEPSgrowthover20%.Wecontinuetoviewthisasgoodvalue.

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FacebookWehavefollowedFacebookforquitesometime,firstasapotentialcompetitortoAlphabet(formerlyGoogle) andmore recently (thepast few years) as an investment opportunity.Facebookhashistoricallycarriedarichmultiplerelativetowhatwearewillingtotolerateforearningsgrowth. However,earningsgrowthhascontinuedatarobustpacewhilethestockhasnotkeptup.Forexample,fromyear-end2015throughyear-end2018(estimated),Facebookwillhavecompoundedrevenueandearningsbyover200%,whereasthestockhasappreciatedbyabout75%3. ThishasdrivenFacebook’s earningsmultiple to contract toaround16-17X2019earnings(ex.balancesheetcash)–anall-timelowforthestock,bothabsoluteandrelativetotheS&P500IndexandRussell1000GrowthIndex(n.b.P/Eisatparitywiththelatter).Webelievethisisaclassicvaluationsetupforourportfolio:astheCompanycontinuestocompoundearningsat20%+forseveralyears,aconservative, flatmultiple should still result in excellent absolute returns – and better still at deservedmultipleexpansion.Facebookexhibitsvastlysuperiorprofitabilitymetricsrelativetoitspeersinthemediaandadvertising industry. Inaddition,webelieveFacebook’svalueproposition isuniqueanddefensiblerelativetopeers,whichshouldenabletheCompanytogenerateindustryleadingreturnsoninvestedassetsforseveralyears.Thisvaluepropositionisfocusedonprovidingadvertising customers with highly attractive, triple-digit returns on advertising spend(ROIs).WhilemanyofFacebook’speersofferavaluepropositionthatentailsbetterROIs,itisoftenviaaninflexible,expensive,ormonolithicsolution.Incontrast,theCompany’slow-costvaluechain–especiallyitsmultibillionusersocialplatforms,andanarsenalofadmeasurementtools both acquired and internally developed over the past several years – providesadvertisersmultipleavenuestodrivesuccessfulROIs.Facebook’ssocialplatformsserveasverylow-costformsofusertrafficandcontent.ManyofFacebook’scompetitorspayasubstantialportionoftheiradrevenuesintheformoftrafficacquisition (sometimes referred to as “customer acquisition”) and/or content costs. Forexample, television advertising platforms are dominated by telecommunication andmultiservice-offering conglomerates. The advertising businesses of these platforms areoften carved out fromsubscriber economics,with the costof content typically being thelargest expense, by far, in running the ad platform. Even digital competitors such asMicrosoft Bing, while not having to spend quite as much on content, spend substantialportionsofrevenueontrafficacquisition.Facebook’sscaleacross itsplatforms– includingInstagramandWhatsApp–continuestodrivea“virtuouscycle”ofuserengagementandthereforelow-costcontentcreation.Somerecentmonthlyactiveuser(MAU)statsinclude2.1billionusersonFacebookasofDecember2017,1.5billionusersonWhatsAppasofJanuary2018,andInstagramMAUsnearingthe

3 DatafromFactset

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billion-usermarkaswell.Inaddition,Facebookcontinuestoreportstableuserengagement(asmeasuredbyDAU/MAU)at66%.Facebook’s recent actions of culling certain content is evidence of quality control and, ifanything,signalsthatthereisperhapstoomuchcontent.Whilethereistheriskthiscouldincreasethecostofcontent–especiallycuration–wedidnotseemuchevidenceofthatonthe recent conference call orearnings report. Wewill continuetomonitor therisksandopportunities related to theCompany’s advertisingROIsand low-cost contentplatforms,whichplaykeyrolesinmaintainingFacebook’ssuperiorindustryprofitability.Aswementionedearlier,we firstbegan followingFacebookasa competitor toportfolioholding,Alphabet.FacebookhassignificantbusinessmodeloverlapwiththeGooglearmofAlphabet,withbothcompanieshoovering-upshareinadspendingglobally,particularlyindevelopedmarkets.Thetwocompaniescombinedareestimatedtohaveaccountedforover60% of the digital advertising market in the U.S. in 2017; for example, with Google’spropertiesaccounting forover40%shareandFacebook’spropertiesaccounting forover20%.Toputthetwocompanies’dominanceinperspective,noothercompetitorevencracks5%oftheU.S.digitaladmarketshare.4Inthefaster-growingmobilesegmentofthedigitalmarket,whereFacebookderivestheoverwhelmingmajority(roughly90%)ofitsrevenues,thetwocompaniesaresimilarlydominant,withFacebook’sshare(nearly30%)muchclosertoGoogle’s(nearly35%).

4 www.emarketer.com

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Inabroadsense,ourentireportfoliohassomemodestoverlapwithFacebook(andGoogle)asadvertisingpartners.Advertisers’abilitytotargetcustomersindetailonbothplatformsmakes the platforms attractive to both traditional large-scale advertisers (includingconsumer products and services companies such as Kraft Heinz, Visa, Apple, orPriceline/Booking)andtocompaniesthatmightnothavebeenable to targetadvertisingeffectivelyontraditionalmassmedia,butwhocouldcost-effectivelytargetanadtoaspecificgrouportoaspecificuserbaseduponsearchhistory(Google)orsocialmediapreferences(Facebook).Webelieveourentireportfolioeitheris,orwillbe,customersofoneorbothofthesedominatingdigitalmediaplatforms.Facebookfounditselfinnewscrosshairsduringthequarter.First,newsemergedpertainingto ads purchased by Russia and posted on Facebook’s platform during the 2016 U.S.presidentialelectionwiththeintenttoswayvoteropinion.Acoupleweekslater,additionalnews surfaced regarding a data analytics firm and the harvesting of Facebook data forpoliticalgain.Inall,informationontensofmillionsofFacebookuserswasleaked,bringingtoquestionFacebook’sprivacypolicyandwhattheCompanyisdoingtoprotectitsuserdata.StepstopreventthistypeofbreachwereputinplacebytheCompanybackin2014,whenFacebookmadechangestothewaydeveloperappscouldaccessusers’and“friends”data.However,thestocksoldoff(toourinvestmentadvantage)onconcernthattheCompanywasnot performing appropriate due diligence on app developers’ use of data and theirsubsequentdeletingofthatdataoncetheywerenolongerusingit.TheCompanyvowstomakefurtherchanges,whichincludeconductingaudits,improvingitsprivacypolicy,andbanningthird-partydataservicesfromitsadtargetingplatform.WhileweexpecttheseactionstoincreaseCompanyexpenses,wedonotbelievetherewillbeanysignificantimpacttotheCompany'srevenuegrowthaswebelievetherearefewchannelsavailablethatcanmatchFacebook’sreturnonadspend.Weviewthepullbackinthestockas short-term headline risk, and we have used the opportunity to not only initiate ourposition inFacebookduringthequarter,butalsoaddtotheposition furtheratattractivevaluation levels. We believe strong advertiser demand and healthy ROI, along withFacebook'sabilitytoincreasepricingontheirads,leavestheCompanywithplentyofroomforgrowthintheyearsahead.QualcommQualcommwasa topdetractorduring the firstquarter. Shares retreatedafterPresidentTrumpissuedanordertoblockanyattemptbyBroadcomtoacquireQualcommsharesorstageaproxycontest,perresearchfromtheCommitteeonForeignInvestmentintheUnitedStates(CIFIUS).Asbestaswecantell,giventhelimitedpublicdisclosures,CFIUSspeculatedthatanychangeincontrolfromQualcommtoBroadcomcouldposearisktothenationalsecurity of the United States. Specifically, CFIUS claimed thatQualcomm’s research anddevelopment(R&D)effortswerecriticaltotheU.S.’leadershipinthedevelopmentofglobalwirelesscommunicationsstandards,andworriedthatanyeffortsbyBroadcomtodefundthatR&Driskeda“reductioninQualcomm’slong-termtechnologicalcompetitivenessand

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influence in standard setting [which] would significantly impact U.S. national security,”especiallyvisavisChina.5While we’re not surprised that this deal was terminated, we are surprised that it wasterminatedinthismanner.First,aswehavefrustratinglywitnessed,regulatorstheworld-over – including our own U.S. FTC – have pressured Qualcomm’s business model, andtherefore R&D, for years, either through fiat and/or lawsuit. Second, Apple (one ofQualcomm’s largest customers) has indemnified and compelled its Chinese contractmanufacturers to withhold several billion dollars in very high margin payments toQualcommoverthepast15orsomonthswithlittleornopushbackfromU.S.regulators.Inaddition,Huawei–aquasi-ChineseSOE–hasmimickedApple’sbehaviorandwithheld–whatweestimatetobe–severalhundredmillioninhighmarginrevenuedollarsoverthesametimeframe–again,noregulatorsseemtohaveaproblemwiththis. So,itmakesuswonderwhyCFIUSandU.S.POTUSdecidedthatBroadcom’sproposed~$80pershareofferforQualcommrepresentsthemostintolerablepotentialrisktothenationalsecurityoftheUnitedStates, when clearly Qualcomm has already been pressured by the actual activities ofgovernments, including the U.S. In fact, we’d argue that the actions (and inactions) ofregulators, particularly during the past 15 months, are what precipitated Broadcom’sattemptatunlockinggrowthandvalueatQualcomm.Despite thisdetour,wewillcontinuetobepatientwithourQualcommownership,aswethinkmanyinvestorshavebecomeoverlynegative.Forexample,itisconsensustoassumeclose to zero revenues from Apple and Huawei over the next year, and maybe longer.However,Apple(andwesuspectHuawei) isaccruingexpenses forapotentialsettlementwithQualcomm.Whilethatmightbeanaccountingnecessity,wethinkit’salsoindicativeofarealprobability.Second,QualcommhassetseveralhundredcommercialprecedentswithhandsetOEMs,mostrecentlywithSamsung–thelargesthandsetOEMbyunits–andofferedsimilarlicensingtermstoApple.SowearehighlyskepticalAppleisbeingtreatedunfairly,despiteitsclaims.Oncethesecommercialarrangementsaresettled,weexpectQualcomm’slonger-term organic growth to be driven by the global shift to 5G standards, whereQualcommhasdominanttechnologicalpositioning.Further,wethinktherecontinuestobeahighprobabilitythattheCompany’sacquisitionofNXPSemiconductorwillgetapprovedinthecomingmonths,whichcouldleadtosizableearningspershareaccretion. 5 https://www.sec.gov/Archives/edgar/data/804328/000110465918015036/a18-7296_7ex99d1.htm#Exhibit99_1_081114

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April2018DavidA.Rolfe,CFAMichaelX.Quigley,CFAChiefInvestmentOfficerSeniorPortfolioManagerMorganL.Koenig,CFAChristopherT.Jersan,CFAPortfolioManagerResearchAnalyst

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The information and statistical data contained herein have been obtained fromsources,whichwebelievetobereliable,butinnowayarewarrantedbyustoaccuracyorcompleteness.Wedonotundertaketoadviseyouastoanychangeinfiguresorourviews.Thisisnotasolicitationofanyordertobuyorsell.We,ouraffiliatesandanyofficer,directororstockholderoranymemberoftheirfamilies,mayhaveapositioninandmayfromtimetotimepurchaseorsellanyoftheabovementionedorrelatedsecurities.Pastresultsarenoguaranteeoffutureresults.This report includes candid statements and observations regarding investmentstrategies,individualsecurities,andeconomicandmarketconditions;however,thereisnoguaranteethatthesestatements,opinionsorforecastswillprovetobecorrect.Thesecommentsmayalsoincludetheexpressionofopinionsthatarespeculativeinnatureandshouldnotbereliedonasstatementsoffact.WedgewoodPartnersiscommittedtocommunicatingwithourinvestmentpartnersascandidlyaspossiblebecausewebelieveourinvestorsbenefitfromunderstandingour investment philosophy, investment process, stock selection methodology andinvestortemperament.Ourviewsandopinionsinclude“forward-lookingstatements”whichmayormaynotbeaccurateoverthelongterm.Forward-lookingstatementscan be identifiedbywords like “believe,” “think,” “expect,” “anticipate,” or similarexpressions. You shouldnot placeunduerelianceon forward-looking statements,whicharecurrentasofthedateofthisreport.Wedisclaimanyobligationtoupdateor alter any forward-looking statements,whether as a result of new information,future events or otherwise. Whilewe believewe have a reasonable basis for ourappraisals and we have confidence in our opinions, actual results may differmateriallyfromthoseweanticipate. The information provided in this material should not be considered arecommendationtobuy,sellorholdanyparticularsecurity.

iReturnsarepresentednetoffeesandincludethereinvestmentofallincome.“Net(Actual)”returnsarecalculatedusingactualmanagementfeesandarereducedbyallfeesandtransactioncostsincurred.