April 20, 2011

It’s little consolation that our poor timing is another’s good fortune!
Dear Fellow Members and Those that May Be Future Members,
In a break from our usual tradition, we will first provide some follow-up from our previous letter in which we spoke at great
length about the role and history of cash in our portfolio. While we won’t rehash the details, the synopsis of our cash
strategy is that we may hold extra cash to take advantage of opportunities that suddenly arise, but the level of cash is really
being driven by the number of quality ideas we can find in which to put that cash to work. One important thing we’d like to
add that we didn’t share in our last letter is that there may come a time when we will strongly urge investors to add to their
accounts, due to an abundance of bargains, and we aspire to a time when our investors will seriously consider the call.
We always encourage investors to add to their accounts when they have capital they can invest with a five-year-or-longer
timeframe, but we want to make a special point that there may come a time when we find so many great things to invest in
that we are able to put most of our cash to work. In such a scenario, we may come knocking, calling, emailing, and text
messaging investors especially often to add to their accounts. It may even be at a time when the markets are falling, fear is
rampant, and merely thinking about putting more money in the stock market makes you sick. But those are times when the
best profits can be made. As Sir John Templeton put it, “To buy when others are despondently selling and to sell when
others are euphorically buying takes the greatest courage but provides the greatest profit.” We hope our investors’
willingness to consider an investment after such a call will distinguish them from other investors in other funds.

We Never Claimed to Be Very Good at Timing Things!

During the first quarter of 2011 we experienced a run-in with a bit of bad timing. Now, timing is not something long-term
value investors usually ever think about, but in the last three months we’ve surely had our fair share of bad luck in this
department. The following two anecdotes, while difficult to digest, share a bit of what transpired in the quarter.

In January, we came across an extremely interesting company in Australia. We will wait a quarter or two before offering you
a description of the company, as it is an instructive case study, but we hope to be able to purchase additional shares under
the right circumstances in the future. Most people who know us know we don’t make decisions quickly or easily, and in this
case, that cost us! We studied the company (Company E) for about seven straight days (including weekends) and in normal
circumstances we take much longer than seven days to make a decision, but it was obvious in that short period of time that
we ought to own shares of this company. On a Friday we placed orders to purchase shares with the intention of making
Company E a 5% position. Unfortunately, the market was already closed in Australia. On Monday we came in and found to
our dismay that the company had released a preview of its half-year results and the company’s stock soared 65% in two days!
Our orders, needless to say, were not filled. The stock then came down just briefly and we bought an approximate 2%
position at 25% above the price of our first orders. The company finished the quarter up 113% from the day we called in
our first orders, but believe it or not, the stock remains attractively priced!

Also in January we came across a company in the United Kingdom that was very interesting: Lincat Group plc (AIM: LCT).
The company manufactures and distributes restaurant equipment primarily in the UK and Europe. We did our customary
work on the company and eventually placed orders to buy shares. Unfortunately, we were trying to be a bit too picky with
our share purchases and didn’t buy a single one. When the company released results late in March it also announced a tender
offer by US company The Middleby Corporation, an outcome that we explicitly considered when doing our work. We had
attempted to buy shares at 650 pence when the stock was just above that level. The bid from Middleby was at 1,050 pence!

While we hope the quarter was unique in its events, it will do little to change our method of operation. We will continue to
conduct our diligence on companies until we are comfortable in making a decision and we will continue to be picky about
our purchase prices. It goes to show that the competition for great ideas in the investment world is significant, as many
other parties are searching equally diligently for prudent places to allocate capital. One must not forget just how true that is.

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While we understand it is foolhardy to consider the “ifs” in life, much less in investing, we couldn’t help but be slightly
irritated by the sequence of events in the quarter. Having missed perhaps an additional 7% gain in capital, we slept no more
comfortably knowing that someone else holding shares of each of these two companies was a bit richer by the end of the
quarter! We will continue to seek those situations where the sellers of shares know not the value of what they are selling.
Hopefully in the future we’ll be able to act before they get lucky!

What Are You Doing with All These International Companies?

One of the 13 virtues Ben Franklin included in his process for moral improvement was resolution. His instruction for this
virtue was, “Resolve to perform what you ought. Perform without fail what you resolve.” We are set up to look for and
invest in undervalued small- and micro-cap stocks. Our resolution to investors is to perform this task as we would want it
performed if our roles were reversed.

During the first quarter, we spent a considerable amount of time searching for value in international, English-speaking
markets, and were able to find a couple of new investments that we believe meet our strict investment criteria. Our efforts
have centered on Canada, the United Kingdom, Ireland, Australia, Hong Kong, Singapore and South Africa, and while we’ve
owned companies in Canada for several months now, we added shares of companies in the United Kingdom and Australia
during the quarter. We think it is important that our investors understand that we do so only with a cautious mindset. We
are only beginning to learn about some of these markets, their business customs and histories. We would be foolish not to
consider additional margins of safety as we look at these companies.

We conduct our diligence on international companies in much the same way as we do for US companies. In some cases we
speak with management, in some cases we visit management, and in all cases we get to a point where we understand these
businesses to the best of our ability. We do not cut corners because of the distance between us and them.

One of the issues that we have spent considerable time debating is the role of currencies as we look at these international
companies. Generally and simplistically, we are happy to have exposure beyond the US dollar in our portfolio. To date, we
have not chosen to hedge the currencies of the countries in which we own shares. While we recognize that this will
introduce a new variable into our returns—the movement of exchange rates—we are wary of our expertise in hedging and
the potential costs involved. To date, our results have been aided by a net benefit from the depreciation of the US dollar,
though that is clearly a condition that may or may not persist in the future. Over a long period of time it is currently our
belief that, at worst, any gains will approximately offset any losses. While we will continue to debate and examine the use of
hedges, for the foreseeable future we will continue to operate as we do currently. If we decide to make a change, we will
seek permission from our investors only after sharing our thoughts with you.

A Final Note on Fremont

We have discussed Fremont Michigan InsuraCorp (FMMH.OB) on multiple occasions in the past and, given the size that the
holding represented at certain points in our history, it is prudent that we comment on the exit of the investment in the first
quarter. This is perhaps especially true considering that our exit at approximately $26 per share was considerably below what
we believed to be a qualified offer to buy the company by Biglari Holdings (NYSE:BH) at $31, which we were aware of at
the time of our sales, and substantially below a new superior offer from Auto Club Insurance Association (ACIA) at $36.15,
which surfaced after the end of the quarter.

Our decision to exit the investment centered around three primary concerns: Fremont Michigan InsuraCorp
Combined Ratio Details

 Our growing disagreement with the board’s handling of recent acquisition overtures 2009 2010

 The deteriorating and now meaningful poor performance of the business (see table) Full Year 95.0% 104.4%

 Our perception of a poor risk/reward profile given our worries above Q4 88.5% 108.6%

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The overall gain, including dividends, on the Fremont investment was approximately 28.5%. We originally purchased shares
in May 2008 and purchased additional shares as late as August 2010. While we are pleased with the positive return generated,
especially in light of the subsequent financial market disruptions following our initial purchases, we were not satisfied with
the compounded performance of the investment. This is especially true in light of the ACIA transaction.

Economics and Illusions

“Today, monetary easing and fiscal stimulus augment consumer demand, increasing risks not only regarding the integrity and sustainability of
securities prices but also those surrounding the sustainability of business results. It is hard for investors to get their bearings when they cannot
readily distinguish durable business performance from ephemeral results. Endless manipulation of government statistics adds to the challenge of
determining the sustainability--and therefore the proper valuation--of business performance.”
– Seth Klarman (The Baupost Group 2010 Letter to Limited Partners)

The Hammer (or Hammerhead) orchid of Australia is a type of flower that has developed a unique method for achieving
pollination. At the end of one of its stems rests an object that looks and smells like a female Thynnid wasp. This deception
tricks the male wasps into thinking they’ve found a female ready to mate. As the male wasp attempts to mate with what he
thinks is a female, a hinge on the stem of the flower moves the wasp backwards so that its back rubs up against the orchid’s
pollen sacs, from which pollen sticks to the male. As he finally gets tired of—or maybe comes to the unfortunate realization
of—trying to mate with a flower, he flies away with the pollen firmly placed on his back. As he later performs this same act
with another orchid (boys will be boys), the pollen previously attached to him gets deposited into the stigma of the new
orchid, and pollination occurs.

Navigating the markets today can make us feel a little like the male Thynnid wasp, although we’re looking to find
undervalued stocks, not female wasps. To do so, we need to first come up with an estimate of what we think a business is
worth and why we think the market isn’t valuing it at the right price. We look to gain a thorough understanding of the
business and the way in which it makes money, and then make a determination as to whether or not the future looks as
bright or brighter than its past. But like the obstacle facing the male wasp above, there are other interests involved in this
process that may cause things not to be what they appear to be on the surface.

Few stocks or other assets are so bad that they can’t be a good investment at a low enough price. And no stocks are so good
that they should be bought at any price. Valuations drive our buy and sell decisions, and as the above quote from Seth
Klarman (one of the all-time great investors) illustrates, government intervention in the markets might be distorting the
overall health of the economy and business in general. As just one example, Mr. Klarman notes, “…if the CPI (Consumer
Price Index) were calculated using the methodologies of 1990, the rate would reportedly be not the published 1.5% but 4.5%;
with 1980 methodologies, 8.5%. Birth-death adjustments, seasonal adjustments, hedonic price adjustments, and substitution
effects (to name a few) are representative of the endless manipulation and distortion of government economic data.”
Economics, inflation, and interest rates help drive business demand and profit margins. We don’t take positions or put too
much weight on macroeconomic forecasts, but we do pay attention to the big picture from a risk management perspective
and try to incorporate a range of possible scenarios into our requirement for an adequate margin of safety before putting
capital to work.

The stock market indices taken as a whole are very likely overvalued (see Index Summary Data
accompanying chart) and profit margins are back near record highs. This Russell 2000 and S&P 500

doesn’t mean we expect a near-term correction in the stock market. We Russell 2000 S&P 500
believe market forecasts are mostly worthless, especially if they involve
Average Median Average Median
short-term predictions. What it does mean is that the odds are stacked
against the investor who invests in the broad indices. The S&P 500 is priced P / E (ttm) 32.4 x 20.5 x 24.0 x 18.4 x

to deliver low single-digit to flat returns over the next 7-10 years while the P / BV 3.7 x 1.9 x 3.6 x 2.6 x
Russell 2000 is priced to deliver negative returns over that timeframe (while
Source: Capital IQ
we don’t necessarily develop such projections ourselves, we respect the work

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of GMO, Hussman Funds, and Crestmont Research). It doesn’t mean it will happen that way, just that the odds are
extremely unfavorable for earning a good return investing in those indices at these levels.

On the other hand, our current holdings have an average price-to-earnings ratio of 9.7, an average return on equity of 15.6%,
and an average price-to-book ratio of 1.3. Those numbers are extremely favorable relative to the indices or, in other words,
our investments are of higher quality and are trading at better prices. But a relative advantage only matters if it turns into real
dollars and real returns over time. We can’t say that this advantage will certainly get us to our goals, but we like our odds,
and we like how our businesses are positioned to prosper under a wide range of economic backdrops.

No information contained herein is intended as securities brokerage, investment, tax, accounting or legal advice, as an offer or solicitation of an offer
to sell or buy, or as an endorsement, recommendation or sponsorship of any company, security, or fund. Any statements that express or involve
discussions with respect to predictions, expectations, beliefs, plans, projections, objectives, goals, assumptions or future events or performance are not
statements of historical fact and may be "forward looking statements." Forward looking statements are based on expectations, estimates and
projections at the time the statements are made that involve a number of risks and uncertainties which could cause actual results or events to differ
materially from those presently anticipated. Forward looking statements in this action may be identified through the use of words such as "expects",
"will", "anticipates", "estimates", "believes", or statements indicating certain actions "may", "could", or "might" occur. Any non-factual
statements, including those regarding possible future events, constitute views and/or present intentions and are not representations or warranties and
are subject to change. Past performance is no guarantee of future results and all investing involves risk.

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