The Superinvestors of Graham-and-Doddsville: Bill Ruane

“Table 4 [below] shows the record of the Sequoia Fund, which is managed by a man whom I met in 1951 in Ben Graham's class, Bill Ruane. After getting out of Harvard Business School, he went to Wall Street. Then he realized that he needed to get a real business education so he came up to take Ben's course at Columbia, where we met in early 1951…" -- Warren Buffett's introduction to Bill Ruane in his essay: The Superinvestors of Graham-and-Doddsville.

This is the third part of a six part series on Warren Buffett's essay, The Superinvestors of Graham-and-Doddsville. You can find the first and second parts of the series here and here. Buffett's essay was a homage to the value investing philosophy of Benjamin Graham. It referenced seven of Graham's former employees who went on to become some of the greatest investors of all time. Number three on the list was a man called Bill Ruane.

The Sequoia Fund

At the time of winding down his early investment partnerships, Buffett asked his friend Bill Ruane to set up the Sequoia Fund to ensure that the partners would have their money well looked after.

Buffett didn't just pick Ruane's name out a hat. He chose him because he was taught by and worked with Ben Graham. And since leaving the Graham-Newman partnership, Ruane's performance had put many other asset managers to shame.

Buffett said: “There's no hindsight involved here. Bill was the only person I recommended to my partners, and I said at the time that if he achieved a four-point-per-annum advantage over the Standard & Poor's, that would be a solid performance. Bill has achieved well over that, working with progressively larger sums of money…"

During its first 14 years of operation -- from 1970 to 1984 -- The Sequoia Fund outperformed the S&P 500 by an average of 8.2% per annum:

Unlike Buffett's other 'Superinvestors', Ruane didn't select small and micro-cap deep-value stocks for his portfolio. Instead, he looked in the large-cap section of the market.

There are many reasons for focusing on the small and micro-caps. The most common is the fact that many smaller stocks can fly under the radar of other investors and high-flying Wall Street hedge funds. And when a stock is not well-known, it's often the case that the market is undervaluing the company.

Take, for example, Special Diversified Opportunities Inc a US micro-cap. You won't find the company in any newspaper, share mag, or analyst report, but recently its market value was less than the value of cash on its balance sheet -- a deep-value investors dream. You just can't find situations like this in the large-cap space.

Still, investors can learn a lot from Bill Ruane's large cap value strategy.

Large-cap value

Ruane achieved his impressive returns over the years by using a strategy many investors will be familiar with: taking concentrated positions in good businesses that appeared to be trading at attractive valuations. It's a strategy similar to the one Buffett uses today.

And here are eight key traits of Ruane's investment strategy that helped him outperform the market consistently during his time running the Sequoia Fund.

 1. First of all, forget the level of the wider market. Nobody knows what the market will do today, tomorrow or two years from now. It's pointless to try and figure out whether the market will go up or down. The only thing that matters is the specific situation having to do with your stocks. The level of the FTSE 100 is not going to affect the everyday business activities of many companies.

2. Secondly, change your perception of the market. Look at the company as a whole, not as a piece of paper or stock ticker on a screen. If you spend your time concentrating on a company's stock price, you're a speculator, not an investor. Invest in the underlying business. You don't need inside information. You don't need charts and mumbo jumbo. It isn't about momentum.

3. Use your own research when deciding whether or not to make an investment. This is only way you can truly get to know a company. If you don't understand how to assess an investment correctly, find someone to manage your portfolio. Your own research is key in developing the positive convictions required to own and hold concentrated investment positions. After conducting your own, detailed analysis you're less likely to make a silly mistake that costs you money; like selling too early.

4. Look for value in companies with little or no debt, which can generate enough free cash flow to be self-funding. Value investing is about minimizing the downside. Companies that have high levels of debt should be avoided. Companies that are burning through cash should also be avoided. Don't confuse profit with cash generation and don't confuse EBITDA for profit.

5. Rule five may not be suitable for most investors, but it offers some good food for thought: Put most of your money in six or seven stocks that you've really studied. The key here is to really study each company, get to know each company inside out. It's easier to do this for six or seven stocks than 15 or 20. Once again, the more you know and understand the company in question, the stronger your conviction, which reduces the risk that you'll make a silly mistake.

6. You don't act rationally when you're investing borrowed money. Don't borrow money to invest.

7. Never try to time the market. Buy good value when you find it. If your shares fall further, buy more. (If you're struggling to buy more when the market's falling, see points above.) If you know and understand the companies you're invested in, your conviction will remain high enabling you to continue buying. Once again, a high conviction reduces the chance you'll make a silly mistake, like selling too early.

8. If stocks are expensive stay away. You don't have to be invested at all times. Don't change your investment criteria just because the market as a whole has moved higher. If you can't find an attractive opportunity, hold cash or short-term bonds.

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