Title

Athena Capital Management
Cumulative Growth Performance
Comparison of the change in value of $100,000 investment in ACM growth versus S&P 500 and Wilshire 5000 Cumulative Equity Income Performance
Comparison of the change in value of $100,000 investment in ACM equity income versus S&P 500 yield plus inflation Past performance is no guarantee of future results. As in all equity investing, there is a risk for potential loss. Performance results were calculated
after deduction of all management and trading fees. Portfolios were valued daily, trade date accounting was used, accrual accounting was used for dividends. Time-weighted rates of return that adjust for significant cash flows were used. Returns from cash were included. For ACM growth accounts, the S&P 500 was used as benchmark because it was deemed the most readily available and widely known growth composite. It should be noted that ACM growth accounts were more concentrated, sometimes had higher cash investments, included international investments, and were invested in companies with different market capitalizations and characteristics than the S&P 500. Although these differences existed, the accounts shown were invested for growth and not set to achieve any particular market capitalization or exposure. ACM equity income accounts used S&P 500 yield plus inflation because this combination of the most readily available equity yield and growth with inflation was deemed the most relevant benchmark for equity income accounts. These accounts are designed to provide an equity yield for income plus growth to maintain purchasing power over the impact of inflation. Both out- and under-performance of accounts shown were due both to individual security selection and to concentration of investments. Neither market nor economic conditions contributed significantly to account performance relative to benchmarks. ACM growth and equity income portfolios include all portfolios under management during all periods of management and include portfolio performance as of the first day of management. The accounts depicted used no leverage or derivatives. The S&P 500 and S&P 500 yield plus inflation returns shown do not reflect commissions, trading expenses, or management fees, which would have reduced both benchmarks’ results. Copyright 2010 Athena Capital Management Corp. All rights reserved. Permission is hereby granted to electronically link, forward, or store this document in its entirety or to quote passages as long as source is attributed to “Michael Rivers, CFA, Athena Capital Management.” Nothing in this letter should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this letter has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed. Athena Capital Management

April 14, 2010
pullback came from less patient shareholders selling Microsoft continues to be neglected because of the hype surrounding Apple and Google. I believe there’s room unpleasant roller coaster ride. In fact, I for all three businesses to thrive, but that Microsoft’s earnings power is the only one being grossly under- invest.” That wasn’t idle chatter: growth rated. Investors seem to be missing its upcoming Office release, the success of Windows 7, the upcoming portfolios are up 53%. Thank you for having confidence commercial upgrade cycle, Bing’s market share gains, its new mobile operating system, and its new gaming In this quarter’s letter, I’ll cover our performance; my view on markets and the economy; why cash, bonds and POSCO’s price declined this quarter, along with most emerging markets aren’t the best places to invest right Asian markets, as fears of a China slowdown spread. If now—and what is; and our investment in an unloved the world economy slows, POSCO’s competitive position will allow it to grab market share; if the world economy doesn’t slow, POSCO will benefit from rising steel prices. Performance this quarter
Either way, I think we’ll win in the long run. Growth portfolios out-performed for the
Equity income portfolios out-performed our
quarter, and over the last 1-, 2-, 3-, 4-year and
benchmark over the last quarter and year, but
since inception periods. Our portfolios grew
are still playing catch up over longer periods.
strongly as investors turned their attention away from Our progress through the quarter was excellent, and this the “dash to trash” and back to quality companies with allowed me to hedge our portfolios’ market exposure. established franchises. Looking forward, I think we’ll The benefit should be a glide-path to intercept and pass continue to benefit from this trend change (see Fighting our benchmark, but with less volatility than a portfolio fully invested in the stock market. Over time, this will generate smoother growth and higher yields. Growth’s out-performance this quarter came most notably from Sears (again) and Comcast.
Equity income out-performance this quarter came from Comcast and Phillip Morris International (see
Sears had another outstanding quarter, up 29.9%. How can a mediocre retailer keep racking up such excellent share price performance? Because investors expect so Phillip Morris was one of our laggards last quarter, but little, but get so much. Sears generated tons of cash and up 9.4% this quarter (including dividend). Concerns surprised many with its internet sales efforts. Further, about tax increases in Japan started to fade, and it’s looking for new channels to sell its brands, like investors were able to more clearly focus on its long term DieHard batteries that can now be bought outside Sears. growth prospects and underlying cash generation. In my Expect more innovation and upside surprises from this opinion, we can look forward to years of low double digit Comcast climbed 11.7% this quarter as investors finally Equity income’s under-performers were Pfizer and
began recognizing its competitive position and cash Verizon.
generation. After spending decades building its cable network, Comcast is finally reaping the benefits as I discuss Pfizer in much more detail below in the revenues grow and costs decline. This story is far from Investment Spotlight section, but I can briefly say its over because Comcast is just beginning to tap the price suffered as its developmental drug portfolio business market and its costs have much farther to fall. I continues to disappoint. If such setbacks continue, we’ll believe the Comcast story is still widely misunderstood be repaid with dividends and share repurchases as the on Wall Street, which means we’ll benefit as they come business downsizes. If not, Pfizer’s price will surely rally when it reports successes. I like our odds. Microsoft and POSCO were growth’s under-
Verizon’s sin this quarter was not selling Apple’s iPhone performers this quarter. As you may recall, both were or iPad, disappointing investors who were gambling on out-performers last quarter, and a good bit of their small such an announcement. Couple that with the cloud of Copyright 2010 Athena Capital Management Corp. All rights reserved. Permission is hereby granted to electronically link, forward, or store this document in its entirety or to quote passages as long as source is attributed to “Michael Rivers, CFA, Athena Capital Management.” Nothing in this letter should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this letter has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed. Athena Capital Management
Vodaphone’s 45% ownership of Verizon Wireless, and California, or the U.K. and Japan, governments are over- you have a recipe for short term under-performance. indebted and struggling to meet their obligations. Rapid Verizon, however, will resolve its situation with growth would fix these problems, but that happy Vodaphone as early as this summer, removing one cloud, and will resume generating cash from its wireline operations as it reduces capital expenditure this year, The U.S. economy, however, is in better shape
removing another. I don’t believe we’ll have to wait long than most. Our flexible labor force is redeploying to
more productive uses faster than in Europe or Japan. Our shareholder focused management teams have cut Market and economic outlook
capacity, liquidated inventories, paid down debt, and built up cash to successfully compete in world markets. The S&P 500 climbed 5.4% this quarter, a large margin Our population growth is a strength that Europe and over its 1.5% long term growth rate. It’s nice to see high Japan (and soon China), will wish they possessed to growth, but a faster than trend increases stretch alleviate growing government obligations. The world is valuations, thus leading to lower returns going forward. under-estimating U.S. potential, and not for the first With that, I expect 6 year annualized market returns of a low 4.2%. Wanting higher returns makes it more important than ever to be valuation focused. Our Our portfolios were constructed with these
issues in mind. We have less emphasis on finance and
housing, and more on technology and manufacturing. We own steady businesses in healthcare and Projected annualized returns over the next 6 years telecommunications, as well as rapidly growing foreign firms. Our businesses have superior economics and management teams, and sell at very low prices. In the next section, I’ll discuss my reasons for this positioning and why the best defense is a good offense.
Fighting the last war
How do I arrive at these numbers? Visit “Free Articles” at Generals frequently apply the lessons of the last war to The U.S. economy grew at a more than 5% rate in
their current one hoping to avoid the mistakes of the 4th quarter of 2009, and probably grew at a
predecessors. But, conditions change and wrong lessons faster than 3% rate in the quarter just ended.
are learned, thus generals suffer at the hands of unkind Manufacturing, in particular, has been rebounding strongly. One sign is railroad traffic that has re-achieved levels last seen in late summer 2008. Another is the Many investors are fighting the last war, too, by
statistic slowest to recover from downturns: investing in what worked last decade: Bonds and
employment, which just moved into positive territory for Cash, and Emerging Markets. After watching all
the first time since fall 2008. There are good reasons to three out-perform U.S. stocks, especially during the emotionally trying experiences of the last two bear markets, investors charged headlong into what worked Unless, of course, we’re not. The housing market
last time. By misreading today’s situation and last that seemed to be recovering late last year is rolling back decade’s lessons, however, today’s investing “generals” over in terms of sales volumes and prices. Banks and are likely to be easy targets for tomorrow’s historians. government programs are working to keep delinquent borrowers in their homes, but most workouts are failing within 9 months. Forebodingly, the mortgage market faces two more waves of adjustable rate mortgage resets, one in 2010 and one in 2011, that might set things back. The governments of the world, especially China
and the U.S., are trying to remove the massive
stimulus injected during the crisis. It remains to
be seen how smoothly that project goes. In exchanging public debt for private debt, sovereign countries have become the latest credit scare. Whether it’s Greece and Copyright 2010 Athena Capital Management Corp. All rights reserved. Permission is hereby granted to electronically link, forward, or store this document in its entirety or to quote passages as long as source is attributed to “Michael Rivers, CFA, Athena Capital Management.” Nothing in this letter should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this letter has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed. Athena Capital Management
however, used blitzkrieg to simply bypass those defenses simplistically investing in what worked over the
last 10 years. Following the Investing Herd is almost
Similarly, investors burned by stocks over the last 10 years recognized that Bonds and Cash were, in hindsight, Next, we must understand why prior victors succeeded. excellent investments, and hence joined the defensive 10 years ago, the Investing Herd hated Cash, Bonds and brigade. But, history’s broader lesson is that such
Emerging Markets. Why? Because all three performed investments do well when governments are
poorly over the prior 10 years! Investors thus dumped soundly financed and deflation occurs—not the
them en masse to purchase what was doing well at the case at present. Governments have huge spending
time—technology, media and telecom. That selling obligations, low tax revenues, and high debt burdens. depressed prices, making Bonds, Cash and Emerging They’re printing money in overdrive hoping to avoid Markets cheap relative to fundamentals and ready to default and jump-start their economies, consequently out-perform. As you’ve heard from me before, cheap,
creating future inflation. When they succeed, Bonds will unloved investments do very well over the long
suffer as interest rates increase and Cash will devalue, perhaps dramatically. Better investing options are likely to blitzkrieg past such seemingly defensive investments. What’s cheapest and most out-of-favor now? The
sector that’s done poorest over the last 10 years:
Military History 102: Successfully deployed since 750 global, large businesses. With weak investing
B.C. and climactically used to defeat the Persians at the returns, big companies have been discarded in the shift Battle of Marathon in 490 B.C., the phalanx was to Emerging Markets, Cash and Bonds. This depressed considered an indisputably superior military formation prices dramatically relative to fundamentals, which are by ancient Greece’s generals. After being crushed by much stronger than perceived. Large businesses have Rome’s legions, in maniple formation, at the Battles of spent the last decade learning to compete and expand Cynoscephalae and Pydna in 197 and 168 B.C., however, internationally. Just when most effective, they’ve the phalanx proved yet another accepted convention out- Finally, we should consider whether current conditions differ from the past. They do. As mentioned earlier, we can expect higher inflation, slower growth, and more governmental financial troubles. Large businesses
out-perform in such circumstances. With low debt
and strong franchises, they’re better credit risks than governments. They have pricing power, allowing them to mitigate inflation’s threat. And, they prosper during slower growth because they possess the scale and scope to lower costs when smaller companies can’t. To avoid fighting the last war, I’ve positioned our Likewise, aggressive investors enticed by a decade of portfolios with significant stakes in large businesses. Emerging Market out-performance have become Their unpopularity has led to one of the largest
increasingly convinced that good returns will always be valuation disparities in history (the true driver of
found there. However, its popularity has caused prices long term returns). In my opinion, they can handle to soar beyond historical norms. What was cheap 10
today’s unique circumstances better than other years ago is no longer low-priced enough to
alternatives. We may not achieve instant victory, but I’m regenerate past out-performance. Added to this,
quite confident our strategy will win this long term most emerging economies depend heavily on growth from developed economies (Europe, Japan United States), which face significant problems due to Investment
demographics and high debt burdens. Expensive and Spotlight: Pfizer
structurally dependent, Emerging Markets may find themselves out-maneuvered by more flexible options. If committing to yesterday’s winners is fighting the last war, how are we to avoid the historian’s critical pen? First, by not learning the wrong lessons—by not over-
Copyright 2010 Athena Capital Management Corp. All rights reserved. Permission is hereby granted to electronically link, forward, or store this document in its entirety or to quote passages as long as source is attributed to “Michael Rivers, CFA, Athena Capital Management.” Nothing in this letter should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this letter has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed. Athena Capital Management
but Pfizer fell from $48 to under $20 over the last 10 Instead, new drugs are increasingly coming from biotech years. The world’s largest drug maker (by sales)
competitors. The old chemicals-based (versus biologics- is unloved by the market even while increasing
based) business model that Pfizer has had so much free cash flow 15% a year over that period. How
success with is in decline. Adding insult to injury, did an upstanding company like Pfizer, a Dow Jones generic drug competitors have been successfully Industrial Average component, fall from its state of challenging patents before the 20 year exclusivity period grace, and what are its prospects in the future? is complete. Pfizer is facing competition from above by Pfizer was founded in 1849 as a fine chemicals
business by German cousins Charles Pfizer and
Charles Erhart. Its first product, santonin (yes, the
what’s the good news? Pfizer
funny names go back that far), was an antiparasitic. still makes a LOT of
Pfizer’s first big hit came with citric acid, used in the money selling its current
burgeoning growth industry of the 1880’s: soda stable of drugs. Even with
beverages like Coca-Cola, Pepsi-Cola & Dr. Pepper. After additional successes with vitamins C, B2, B12 and A, Pfizer’s second blockbuster was penicillin during World War II. It wasn’t until the 1950’s, though, that Pfizer became the research-based pharmaceutical we think of today. Although that research focus worked well for five decades, it’s starting to show its age. To understand why, it helps to understand a drug’s path from idea to growth. Such markets, especially emerging economies, have years of rapid growth ahead. Further, Pfizer has taken a page from its generic drug competitors and gone Only 1 in 1000 candidate drugs make it from the
into competition with biotech companies challenging laboratory to clinical trials, and of those only 1 in
patents and marketing its own generic biologics. This 5 are approved by the Federal Drug
could turn into a blockbuster business in its own right. Administration (FDA) and marketed. It costs $1 –
Finally, Pfizer still has a 500 candidate pipeline of drugs 2 billion to navigate that 1 in 5000 process. Candidate in six areas: oncology, pain, inflammation, Alzheimer’s drugs are awarded exclusive, 20 year patents, but the disease, psychoses and diabetes. It seems unlikely all clock starts ticking as soon as the candidate is discovered in the lab (before testing and approval). In other words, it takes 10 – 15 years to get through study and testing, so Granted, Pfizer faces daunting difficulties and has yet to a pharmaceutical company is lucky to have 5 – 10 years prove it can exploit its opportunities; but, its stock is selling developmentally costly drugs. That’s a narrow priced for extinction. If you put Pfizer’s business
window to earn back the time and money of research and into run-off, simply selling its current drugs
development. Even after a drug is successfully tested, it until they lose patent and then shut the business
takes another $½ – $1 billion to successfully market and down over time, you’d earn back the price we
sell the drug to doctors and patients. As a last insult, paid. That means we’re getting any potential drug
drug development and marketing costs have sky- successes, a generic biologics business, and rapid rocketed while successful development has declined international growth for free. At the price we paid, we’re precipitously. This makes Pfizer a bit of a good news, getting a 10.7% free cash flow yield, a 3.5% dividend while we wait (about the same as a 10 year Treasury bond, but with much better inflation protection), and potential growth opportunities. Pfizer isn’t a sure thing, but the odds seem nicely stacked in our favor. Until next quarter
come from a single drug: Lipitor, which goes off patent this year. Pfizer faces several additional patent
The past year has been extremely gratifying.
expirations over the next couple of years, too,
Clients who contributed additional capital in late 2008 and that makes investors understandably
and early 2009 are sitting on large gains. Part of that nervous. On top of that, Pfizer has failed to
was due to market dynamics and my research, but the successfully produce new drugs to replace its larger part was due to brave clients following my advice blockbusters. It’s like Honda knowing it can’t sell Civics and putting money to work when the opportunities were in a couple of years and not having a replacement. ripest. Thank you for that vote of confidence. Copyright 2010 Athena Capital Management Corp. All rights reserved. Permission is hereby granted to electronically link, forward, or store this document in its entirety or to quote passages as long as source is attributed to “Michael Rivers, CFA, Athena Capital Management.” Nothing in this letter should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this letter has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed. Athena Capital Management

I wish I could say the future looks as advantageous now
as it did a year ago. Though our long term return
prospects are excellent, the short term looks a
bit sketchy. There are some foreboding clouds on the
horizon, both geopolitical and macro-economic. The market rise is likely to continue longer than I expect (I’m almost always too early), but a repeat of the last year is Not everyone has weathered the last year as well as we have. If you know someone looking for better investment options, please put them in contact with me. In particular, I’m looking for more folks like you:
patient, long term focused individuals and families looking for a better than average long term returns and someone they can trust. I promise to take good care of them.

As usual, visit my blog to see my thinking
between letters: .
I continue receiving positive feedback that it’s both thought provoking and entertaining. If you enjoy it, send your friends and family there, too.
Please feel free to contact me with your
questions or comments. I always love to hear from
Michael Rivers, CFA Athena Capital Management 370 Waco Court, Colorado Springs, CO 80919 Copyright 2010 Athena Capital Management Corp. All rights reserved. Permission is hereby granted to electronically link, forward, or store this document in its entirety or to quote passages as long as source is attributed to “Michael Rivers, CFA, Athena Capital Management.” Nothing in this letter should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this letter has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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