It is a classic case study that success in finance doesn’t require extraordinary talents. But Ruane did have the insight to clearly recognize a great idea: Berkshire Hathaway (BRK.A)(BRK.B). He also had the courage to back up the truck. Buying Berkshire Hathaway and riding it all along was perhaps the single best idea that turned an average student into a legendary investor.
If you take Berkshire out of Ruane’s portfolios, the track record would perhaps be less remarkable. This is the ultimate proof that you only need a few great ideas in a life time, and you don’t need an IQ beyond 125 to become a superinvestor. You do need, however, a religious belief in the power of the Graham-Buffett system and the discipline to follow through.
The Greatest Book on Research
When the late Bill Ruane walked into the annual meetings for the investors of his fund, his shining smile could brighten up the entire room. A year before his passing, I asked the legendary value investor to inscribe something in my 348th copy of a limited printing of the 1934 edition of Security Analysis by Benjamin Graham and David Dodd. Ruane wrote: “To Brian: Enjoy the greatest book on research. Bill Ruane.” In his view, Graham’s "Security Analysis" is the Bible of Wall Street, the Old Testament.
The Fund Manager Recommended by Warren Buffett
In 1969, Warren Buffett was running out of things to buy. He knew that in every bull market Mr. Market gradually becomes used to paying more and more for a business -- and eventually the prices get so high that there just is no smart choice but to stay in cash and wait for the unavoidable crash.
The year 1969 was four years past the 1965 peak of the bull market that started in 1942, but the market was still overpriced, so Buffett stayed mainly in cash -- and his investors were getting restless. Some were voicing their disappointment that Mr. Buffett had been sitting mostly in cash for a long time and, as a result, they were not making the wonderful 20% plus returns of the past decade. They wanted him to invest. Now what? Should he pay more for a good business or fold the partnership? Would the market do what it had always done and crash, or somehow continue to defy “financial gravity?"
Buffett has always maintained that the only way to invest successfully is to buy wonderful businesses at attractive prices -- and if you can't, don't invest. Therefore, in 1969, he closed the partnership rather than violate the basic valuation principle of investing that had given him so much success.
At that point, many of the partners wanted to know who to invest with. Buffett told them that they could buy Berkshire Hathaway stock but not to expect him to do anything except wait for better opportunities. But if they wanted to be in the market, he recommended only one fund manager: William J. Ruane, manager of the Sequoia Fund. After management fees are subtracted, the Sequoia Fund returned 15.48 percent annually since inception from 1969 to 2007 compared with 11.68 percent for the S&P 500 during the same period.
A Mechanical Idiot Went to Harvard
William John Ruane was born on Oct. 24, 1925, in a middle class neighborhood in Chicago, and grew up in the suburb of Oak Park, Ill., where he attended Catholic schools and was an average student. He graduated from the University of Minnesota in 1945 with a cum laude degree in electrical engineering. He immediately joined the Navy and was on the way to Japan when World War II ended.
After the war, he worked briefly for General Electric (GE), only to discover that he disliked engineering. "I'm a mechanical idiot," he told Forbes in 1999.
He enrolled at Harvard Business School and found his calling when a professor urged his class to read the classic textbook ''Security Analysis: Principles and Techniques" (1940), which helped him to focus his interest. Although he knew nothing about stocks, he was impressed with the approach authors Benjamin Graham and David Dodd took to financial analysis. After graduating in 1949, he went to work for Kidder Peabody, where he remained for almost 20 years.
Mr. Ruane recalled interviewing with a Wall Street investment firm and being told that college graduates were paid $35 a week, while Harvard Business School graduates were paid $37.50. ''And there you have the value of a Harvard Business School degree in 1949," he remarked in 2004. ''Things have changed."
Meeting Warren Buffett
In 1950, Ruane and Buffett sat in on a class Benjamin Graham taught at Columbia University, where they learned that the quality of earnings was just as important as growth in earnings.
Ruane and partner Richard T. Cunniff founded their investment management firm in 1969 after raising $20 million from investors. Most of their customers came to them on the recommendation of Warren Buffett, Ruane's former classmate and a close friend.
Bill Ruane was a phenomenally successful career man and an even more remarkable human being. Bill approached his philanthropic work with the same keen intelligence, meticulous attention to detail, concern for others, and wonderfully easygoing humor that he brought to the business world. He also funded an "Accelerated Reader" program for 26 New York public schools and for 19 schools in Monroe, La., as well as schools on reservations.
Mr. Ruane applied business principles to the project, giving people bonuses for positive changes in their lives. He bet one man $250 that he could not stop smoking, and was happy to lose the wager. One day each summer, he provided a small carnival with rides on the street, including pony rides.
Four Key Elements of Ruane’s Success
Reading through Bill Ruane’s paper trails, we can come up with four key components that could explain his success:
1. Keen Intelligence
2. Meticulous Attention to Detail
3. Concern for Others
4. Wonderfully Easygoing Humor
Ruane’s Four Rules of Smart Investing
During a class he taught at Columbia University, Ruane laid out the four rules that guided his investment career:
1. Buy good businesses. The single most important indicator of a good business is its return on capital. In almost every case in which a company earns a superior return on capital over a long period of time it is because it enjoys a unique proprietary position in its industry and/or has outstanding management. The ability to earn a high return on capital means that the earnings which are not paid out as dividends but rather retained in the business are likely to be re-invested at a high rate of return to provide for good future earnings and equity growth with low capital requirement.
2. Buy businesses with pricing flexibility. Another indication of a proprietary business position is pricing flexibility with little competition. In addition, pricing flexibility can provide an important hedge against capital erosion during inflationary periods.
3. Buy net cash generators. It is important to distinguish between reported earnings and cash earnings. Many companies must use a substantial portion of earnings for forced reinvestment in the business merely to maintain plant and equipment and present earning power. Because of such economic under-depreciation, the reported earnings of many companies may vastly overstate their true cash earnings. This is particularly true during inflationary periods. Cash earnings are those earnings which are truly available for investment in additional earning assets, or for payment to stockholders. It pays to emphasize companies which have the ability to generate a large portion of their earnings in cash. Ruane had no taste for tech stocks. He stressed the importance of understanding what a company’s problems might be. There are two kinds of depreciation: 1. Things wear out. 2. Things change (obsolescence).
4. Buy stock at modest prices. While price risk cannot be eliminated altogether, it can be lessened materially by avoiding high-multiple stocks whose price-earnings ratios are subject to enormous pressure if anticipated earnings growth does not materialize. While it is easy to identify outstanding businesses it is more difficult to select those which can be bought at significant discounts from their true underlying value. Price is the key. Value and growth are joined at the hip. Companies that could reinvest at 12% consistently with interest rate at 6% deserve a premium.
Brian Zen, PhD, CFA, is founder of Zenway Group, a New York-based investment advisory firm that provides family wealth creation coaching programs and tutoring services to children and their parents. Through newsletters, family learning parties, face-to-face tutoring and online classes, Zenway-certified Financial Tutors teaches children the craft of investing and helps their parents to grow family wealth. Dr. Zen appreciates your questions and feedback at: info (at) zenway.com.
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