Sequoia Fund 2013 Letter: The Bullish Case For VRXVW Staff
SEQUOIA FUND, INC.
ILLUSTRATION OF AN ASSUMED INVESTMENT OF $10,000
With Income Dividends and Capital Gains
Distributions Reinvested in Shares (Unaudited)
The table below covers the period from July 15, 1970 (the date Fund shares were first offered to the public) to December 31, 2013. This period was one of widely fluctuating common stock prices. The results shown should not be considered as a representation of the dividend income or capital gain or loss which may be realized from an investment made in the Fund today.
The total amount of capital gains distributions reinvested in shares was $1,514,176. The total amount of dividends reinvested was $130,082, including return of capital distributions reinvested of $5,294.
No adjustment has been made for any taxes payable by shareholders on capital gain distributions and dividends reinvested in shares.
To the Shareholders of Sequoia Fund, Inc.
Sequoia Fund’s results for the quarter and year ended December 31, 2013 appear below with comparable results for the S&P 500 (INDEXSP:.INX) Index:
he performance shown above represents past performance and does not guarantee future results. The table does not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Current performance may be lower or higher than the performance information shown.
* The S&P 500 Index is an unmanaged, capitalization-weighted index of the common stocks of 500 major U.S. corporations. The performance data quoted represents past performance and assumes reinvestment of distributions.
The investment return and principal value of an investment in the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Year to date performance as of the most recent month end can be obtained by calling DST Systems, Inc. at (800) 686-6884.
The Fund underperformed the S&P 500 Index in the fourth quarter while outperforming the Index for the year. In what has become a refrain for us, 2013 performance was compromised by our large cash position. We began the year with 16% of the Fund’s assets in cash. During the year, we were modest net sellers of stocks, and we reached year-end a bit more than 18% in cash. Cash detracted from our performance as our stocks appreciated more than 42% during the year, net of our management fees.
Over the past five and ten years, the Fund has outperformed the Index. The Fund has operated with approximately 15%-20% of our assets in cash for most of the past six years. That helped performance considerably in the crash of 2008, but has depressed performance subsequently. As we’ve disclosed previously, the Fund experienced a net inflow of $930 million in 2011, and while we were active buyers of stocks that year, we slowed our purchasing activity late in 2011 as the market began a steep ascent: the S&P Index rose 12% in the fourth quarter of 2011, 16% in 2012 and 32% in 2013, for an increase of 72% over nine quarters. Against this backdrop of rising asset prices, we did not fully invest those inflows. We made no significant investments in 2013.
We often encourage healthy companies operating with excess cash to buy back their own stock. If their business is as good as they, and we, believe, share repurchase should generate reasonable returns over time. If we had taken our own advice and effectively repurchased Sequoia by deploying our cash into existing positions on a pro rata basis, our shareholders would have benefited. Sequoia was up 75% over the past nine quarters, inclusive of the negligible return on cash, and would have been up about 100% had we been fully invested in the stocks we already own for the entire period.
As we’ve reported to you previously, we’ve taken steps to restrict the flow of money into the Fund. In 2012, we closed the Fund to new investment from financial services platforms such as Charles Schwab, TD Ameritrade and E*Trade. In 2013, we took the additional step of closing the Fund to all new accounts, with exceptions for
new accounts opened by existing Fund shareholders and their immediate family members. These have had the desired effect, with inflows reduced significantly.
By our calculations our stocks advanced about 42% last year while underlying earnings growth for our portfolio was about 23%(1). The S&P 500, by comparison, gained 32.4% while underlying earnings growth was about 6%.(2) A significant component of equity gains for both Sequoia and the S&P Index came in the form of rising price-to-earnings ratios. Rising PEs are always helpful to returns, but over time it is sustainable earnings growth that fuels stock appreciation.
Sequoia benefited greatly from two transformative acquisitions announced in 2013: Valeant Pharmaceuticals Intl Inc (NYSE:VRX) (TSE:VRX)’s purchase of Bausch & Lomb and Advance Auto Parts, Inc. (NYSE:AAP)’ purchase of General Parts International. Both deals were game changers which will significantly increase these two companies’ earnings beginning in 2014. While we’ve long been partial to companies that can grow organically, Sequoia’s returns have been boosted considerably by companies that may have limited organic growth opportunities but have done smart serial acquisitions, such as Valeant Pharmaceuticals and Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B). Precision Castparts Corp. (NYSE:PCP) has been another serial acquirer that has created great value for shareholders.
We take considerable pride in our ownership of a fine collection of businesses and are pleased to report that of our top 10 holdings at year-end, eight outperformed the S&P Index and seven delivered a total shareholder return of at least 42%. Our top performing stock for the year was also our largest holding, Valeant Pharmaceuticals. It nearly doubled in 2013, rising 96%. At year-end, Valeant constituted 16.5% of the value of the Fund.
Other large holdings that generated significant outperformance included The TJX Companies, Inc. (NYSE:TJX), which rose 51%; Rolls-Royce Holding PLC (ADR) (OTCMKTS:RYCEY) (LON:RR), up 51%; Mastercard Inc (NYSE:MA), up 71%; and O’Reilly Automotive Inc (NASDAQ:ORLY), which rose 44%. We have owned each of these businesses for at least six years. We think our strategy of identifying great businesses, buying their stocks when they seem mispriced, then holding them as long as management continues to execute (and the share prices don’t become extremely overvalued) is working as well today as it ever has. We expect that our portfolio companies will grow earnings at a good rate in the future, but not at the 23% rate we saw in 2013.
We trimmed two large positions during 2013. Mohawk Industries, Inc. (NYSE:MHK) rose 65% during the year and along the way we sold a bit more than half the Fund’s stake. While we believe Mohawk is a very well-managed company that stands to benefit greatly from a recovery of the US housing market, we felt a lot of optimism about housing had become embedded in the stock price.
We sold a large portion of our holding in Advance Auto Parts shortly after the company announced a deal to buy General Parts International, parent of Carquest stores, in the fall. The stock price understandably soared on the news as Advance bought GPI on favorable terms and should be able to harvest significant synergies out of the deal, thus accelerating its earnings growth. However, we’d been concerned about poor execution in legacy Advance stores for some time and felt it prudent to reduce our holding as the stock price soared. If the company integrates GPI well and improves performance in its own stores, our sale may turn out to be a mistake.
At year-end, the 10 largest stocks in the Fund constituted 56.9% of our total assets and just shy of 70% of our investment in stocks. We are comfortable with this level of concentration but would note that in seven of the past 15 years, Sequoia’s return has been at least 10 percentage points different than the S&P 500 Index return. Four times we’ve outperformed by at least 1,000 basis points and three times we’ve underperformed by at least that much.
Looking ahead, we won’t try to predict the direction of the stock market, for the simple reason that we have a proven inability to do so. We certainly would not have predicted last year’s 32.4% increase in the Index. We believe we best serve Sequoia shareholders by doing what we have always done: endeavor to own a concentrated portfolio of stocks that has been intensively researched and carefully purchased, in the belief that such a portfolio will generate higher returns over time with less risk than a diversified basket of stocks chosen with less care. We offer the caveat that concentrated portfolios can (and often do) deliver results in a given year that do not correspond to the returns generated by the broader market.
We must also repeat that our large cash position has acted as an anchor on returns during this prolonged bull market. In a bear market, the cash might cushion the fall of stock prices and provide us with the flexibility to make new investments.
Richard T. Cunniff
Robert D. Goldfarb
David M. Poppe
Executive Vice President