There’s a market-stomping mutual fund you’ve probably never heard of. Between 1970 and March 31, 2014, it averaged a 14.67 percent annualized return. That will double your money about every five years. Those investing $10,000 at its inception would have nearly $4 million today. It’s called the Sequoia Fund. It walloped the S&P 500 by nearly 4 percent annually for 44 years.
Studies prove the S&P 500 outperforms most stock pickers. But what about the Sequoia fund and Warren Buffett? If they can do it, why can't you? I won't say it's impossible. But beating the market requires brilliance and more than a few hidden horseshoes.
If you’re still up to the challenge, you may want to study those who have actually done it.
In 1956, Buffett ran a limited partnership. He pooled investors’ money, bought cheap stocks and charged investors a percentage of the profits. Many liken it to a hedge fund. But it doesn’t compare.
Investors were only charged when the fund beat 6 percent in a calendar year. Buffett would then take 25 percent of the profits. The typical hedge fund charges more: 2 percent each year and 20 percent of the gains.
Buffett’s fund soared. Between 1956 and 1966, it gained 705 percent after fees, compared to 123 percent for the Dow. By 1969, despite continuing to trounce the market, Buffett closed the partnership. Investors were given the choice to keep shares in the ailing textile company, Berkshire Hathaway, or have their cash returned. Many took the cash. But they had one question: “Who can manage our money?”
Buffett recommended one guy: Bill Ruane. They had studied together at Columbia University under Benjamin Graham.
The two great investors are worthy guides. Bill Ruane died in 2005. But his legacy lives with those running his fund today. Here are three of their shared tenets.
1. Never Buy A Stock For Ten Minutes That You Wouldn’t Hold For Ten Years
Buffett is famous for his commitment to stocks, citing his favorite holding period as “forever.” According to Morningstar, Sequoia’s fund turnover is a scant 2 percent per year.
Studies prove the more that investors trade, the less they usually make.
2. Buy Stocks With Low Debt And High Return On Total Capital
Warren Buffett hasn’t written a book. But that doesn’t mean he doesn’t have disciples. Some good books describing his strategies include Robert P. Miles’ Warren Buffett Wealth, Robert Hagstrom’s The Warren Buffett Way, and The New Buffettology, by Mary Buffett and David Clarke. Lawrence Cunningham has also done a great job thematically compiling The Essays of Warren Buffett.
The multi-billionaire says that he loves companies with high returns on total capital. It’s a measure of efficiency. If a growing business earns $5 billion a year with total assets (manufacturing assets, facilities, cash etc.) equaling $100 billion, he might not be impressed. The return on total capital, in this case, would be just 5 percent per year.
But he may look twice at a company making $1 billion a year, with less than $5 billion in total company assets. Its return on capital would be 20 percent. Buffett loves businesses coupling low debt with high efficiency.
3. Buy Simple Businesses With Predictable Earnings
Buffett says if we buy our own stocks, we should pick companies we understand, with predictable earnings. If their profits continue to grow, their stock prices should follow. No business is entirely predictable. But companies like Colgate, Coca Cola and Procter & Gamble are far more predictable than businesses like Apple, Google and Netflix. Buffett famously shuns technology stocks because they have to stay ahead of the R&D curve just to maintain their competitive positions. And they can be tough to understand.
Sequoia’s holdings reveal much the same premise. Tech stocks comprise less than 5 percent of the fund’s assets. Most of Sequoia’s stocks have also regularly increased their business earnings.
Can You Really Pick Stocks Like These Guys?
If you think lightening keeps hitting the same trees, watch what these gurus buy.
Buffett’s Berkshire Hathaway stock picks are reported in regulatory filings each quarter. You can find them at Gurufocus.com. The Sequoia fund reports its holdings every quarter on its website. If you’re afraid you’ll miss out on their latest picks by purchasing two months after they do, you’re likely missing the point. These people buy and hold.
Will you beat the S&P 500? Probably not. But if you think like Buffett and the Sequoia managers, you should perform better than most.