July 6, 2010

Dear Fellow Shareholder:

The stock market declined during the second calendar quarter and we gave back some of our first quarter gains. Fortunately, our Funds went up more than the market in the first quarter and down less in the second. The table below shows results for our Funds and for the general market, as measured by the S&P 500, as of June 30, 2010. An additional performance table, which can be obtained by clicking here, shows returns for our Funds and several market indices over various holding periods.

Thanks to good relative returns over the past several quarters, mutual fund tracking services such as Morningstar and Lipper have been giving our Funds high marks, but we are more proud of the longer-term results that we have posted over the past 27 years.

The Balanced Fund also turned in strong results for the first half, thanks to gains in the equity portion of its portfolio. Total return for the first half of 2010 was +2.5% vs. -2.2% for its “Blended Index” (60% stocks and 40% bonds). This fund is designed for endowment and pension funds and for individuals who want a conservative mix of stocks and bonds.

Our bond funds—Short-Intermediate Income, Nebraska Tax-Free Income, and Government Money Market—remain conservatively positioned and are doing their jobs of providing modest income and safe havens for shareholders’ capital.

Our Funds held their own reasonably well during a weak second quarter and widened their lead over the S&P 500. Although the S&P showed a relatively small decline (-6.6%) for the first half of the year, it fluctuated over a wide range (+9% to -8%) over the six month period. There are still plenty of things to worry about in the U.S. and global economies, and (intermittently) investors are worried.

We took advantage of the volatility of the first half to sell stocks that approached our estimates of their business values and to make opportunistic purchases on weakness. (In a few cases, we were able to repurchase stocks that we had sold just a few weeks earlier after they had fallen 25-30%.) After the sharp decline in May and June, quite a few stocks look very attractive, and although they represent a number of different industries, most have one set of characteristics in common—they are large, high quality “growth” companies that once carried market valuations (price-earnings ratios) that “value” investors would not pay.

During the late 1990’s, large capitalization growth stocks—especially those with any connection to technology and the Internet—were stock market leaders. Investors were so focused on the largest 25-50 stocks that these stocks became over-valued (and the small- and mid-cap companies’ stocks languished at relatively cheap valuation levels).

Since then, the tables have turned. Over the past ten years, the small-cap Russell 2000 Index has risen by 3% per year (or 34% on a cumulative basis) while the large company-dominated S&P 500 has actually declined by -1.6% per year (or a cumulative -15%). During this period, many of the large- and mega-cap companies grew nicely, but their valuations shrank. For example, suppose a company earned $1 per share in 2000 and sold at 30 times earnings, or $30. If earnings tripled over the next ten years to $3 per share but the price-earnings ratio fell to 10 times, the stock would trade at the same $30 per share, even though its business was clearly more valuable ten years later.

There are a number of reasons for this reversal of fortunes. We believe that the most important is that “value matters” and since the large-cap growth companies entered the decade over-valued relative to the smaller companies (thanks to the tech bubble), it was natural that they under-performed in the subsequent ten years. Another factor was the shift in asset allocation by pension and endowment fund managers from U.S. (primarily large-cap) stocks to private equity and hedge fund “alternative investments” over the past ten years. Also, since all of these companies are global businesses, there is probably concern that the European debt crisis will depress their earnings. Finally, “performance chasing” investors probably helped carry this trend too far by selling their stock laggards and buying those that were “working.” Whatever the reasons, the result is that a number of terrific companies with many good years of growth in front of them are selling at very cheap prices.

The diversity of businesses is surprising—consulting services (Accenture), insurance brokerage (Aon), computer hardware, software and services (Dell and Microsoft), spirits and beer (Diageo), advertising (Omnicom), industrial gases (Praxair), electronic components (Texas Instruments), and package delivery (UPS). It is almost as if “large” and “high quality” have become disqualifying characteristics. We believe that these stocks are cheap and well-positioned for a rising stock market and strong and defensive enough to hold up well if the economy were to suffer a “relapse.” Here are capsule comments on some of our favorites:

(1) Accenture (ACN—$39—$28B market capitalization) is a global consulting and outsourcing company. Earnings dipped slightly during the worst of the recession but are rising again. The business generates more cash than it needs to reinvest in the business and management has bought back roughly 30% of outstanding shares over the past seven years. The stock is selling for less than 11x our estimate of 2011 (fiscal year ending in August) free cash flow;

(2) Aon (AON—$37—$10B mkt cap) is the world’s largest insurance broker. Aon earnings were flat for several years, but new management has done a good job of reengineering the business, integrating previously acquired businesses and improving profitability. Growth has been slowed by a “soft” insurance market (insurance brokerage commissions are partly a function of premium levels) and low interest income earned on cash “float” (premiums collected but not yet remitted to the insurance company). Aon is selling at about 10x estimated 2011 earnings per share (eps) and at about 60% of our estimate of its business value per share;

(3) Dell (DELL—$12—$24B mkt cap) is a “turnaround” story. The company lost its number one position in the personal computer industry as others became more efficient at using a direct sales model. Michael Dell has returned to run the company and has added a retail distribution channel and acquired Perot Systems to enhance its corporate IT consulting services business. With a cyclical recovery in P/C sales, a new Microsoft product cycle (replacing the troubled Vista operating system with Windows 7) and a renewed emphasis on cost cutting and execution, we believe the odds are very high that Dell’s earnings growth will resume. The stock is very cheap, with $5 per share in cash and selling at just over 10x current year eps. We value the business in the low $20’s and we believe that value will grow over time;

(4) Diageo (DEO—$63—$40B mkt cap) is the world’s largest producer of premium spirits and beer (Johnnie Walker, Smirnoff, Tanqueray, and Guinness). Profit growth slowed during the recession and recent weakness in European business and currency values have dampened enthusiasm for the stock. Diageo now sells at less than 13x current fiscal year eps and its dividend provides a 2.8% yield. This is a durable, predictable business with moderate growth prospects and we value the company at over $80 per share;

(5) Microsoft (MSFT—$23—$209B mkt cap) dominates the market for personal computer operating systems and is a very important provider of office software, video game consoles, cloud computing services, etc. Earnings dipped in 2009 but are now growing again. Microsoft’s days of rapid earnings growth are over, but this super-tanker has durable franchises and generates prodigious amounts of cash. It currently sells at 10.5x its next 12 months’ eps and yields 2.2%. We value the business at about $40;

(6) Omnicom (OMC—$34—$11B mkt cap) is a major global advertising and marketing company. Omnicom’s mix of business has changed over the years and the industry has been disrupted by the advent of Google and other online advertising competitors. Nevertheless, revenues and earnings grew throughout the past decade until the recession caused a sharp decline in traditional advertising in 2009. Earnings are growing again, and the stock sells at about 11x our estimate of free cash flow for 2011. We estimate that the value of the business is over $50;

(7) Praxair (PX—$76—$24B mkt cap) is the leading producer of industrial gases in North and South America and number three worldwide. Industrial gases are used in manufacturing, food processing, oil recovery and refining, and a long list of prosaic but essential businesses. Praxair generally sells under long-term contracts and while its customers are in cyclical businesses, Praxair’s revenues and earnings are relatively predictable. PX sells at about 15x 2011 eps and we value the business at $100 per share. The stock has risen lately, but at less than 80% of its business value, we are very comfortable being long-term owners;

(8) Texas Instruments (TXN—$23—$28B mkt cap) makes embedded processors and analog chips for consumer and industrial products. We generally avoid high tech companies because they often face short and unpredictable product life cycles, but TXN’s products tend to be more customized, longer-lived, and sold to a highly diversified group of end users. The company expanded during the recession while smaller competitors were contracting and TXN expects strong revenue growth and margin expansion over the next several years. The company has used $17 billion to buy back stock over the past five years, shrinking the shares outstanding from 1.8B to1.2B. We expect them to continue aggressive share repurchase, further increasing eps. Investors seem to be fearful about near-term prospects for the stock because a major portion of TXN’s cell phone business (13% of revenues) is being phased out, but we believe the company is worth at least 50% more than the stock is selling for;

(9) United Parcel Service (UPS—$57—$57B mkt cap) is the world’s largest integrated air and ground package delivery company. The business is cyclical and earnings fell over 40% during the recession but are currently rebounding strongly. UPS has enormous scale advantages, earns high returns on capital, and is positioned for strong growth over the next several years. The stock sells at less than 15x our estimate of 2011 eps and yields 3.3%. We value the business at more than $80 per share.

The fact that these kinds of stocks have lagged the market for some time may help explain why our Value Fund, which focuses on large-cap companies, has risen less than our other Funds recently (although it has done well compared to the S&P 500 and other large-cap funds). We believe that these stocks will eventually be strong contributors to the Value Fund’s results. We have also increased our allocation of many of these companies to the Partners Value and Partners III Funds which can “go anywhere” from a market cap perspective. (Since the Hickory Fund is focused on small- and mid-cap stocks, it cannot take advantage of these large-cap bargains, but even after its first half gains, the average price-to-value of its portfolio is still in the 65-70% range.)

We believe that the recovery in the U.S. economy that began over a year ago will continue slowly and unevenly. Unemployment, a depressed housing market, municipal and federal government financial stress, and all the headwinds we have been writing about may continue to cause periodic bouts of investor nervousness.

It seems very plausible that we will see another year or more of the tug-of-war between these negative macro-economic forces and the positive reality of rising company earnings and business values. Government and private balance sheets need to be repaired. New regulations and tax laws need to be studied (and, a cynic might add, reverse-engineered for avoidance). Also, perhaps most importantly, investors’ psyches need time to heal after the trauma of the “unthinkable” events and market losses of the past few years.

We feel reasonably confident that a new bull market will eventually emerge from this period of economic recovery and repair. In the meantime, we will buy good, growing businesses at reasonable prices and wait patiently for “the market” to reward us. Thanks again to our shareholders for their patience and confidence.

Sincerely,

Wallace R. Weitz	Bradley P. Hinton
wally@weitzfunds.com	brad@weitzfunds.com

Investors should consider carefully the investment objectives, risks, and charges and expenses of the Funds before investing. The Funds’ Prospectus contains this and other information about the Funds and should be read carefully before investing. Portfolio composition is subject to change at any time and references to specific securities, industries, and sectors referenced in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. See the Schedule of Investments in Securities included in the Funds’ quarterly report for the percent of assets of each Fund invested in particular industries or sectors.

Weitz Securities, Inc. is the distributor of the Weitz Funds.