Since its inception in 1970, the Sequoia Fund has outperformed the S&P 500 by an average of 2% a year. And right now, the firm has over 8% of its portfolio in Rolls-Royce (LSE:RR) shares.
That makes it Sequoia’s largest individual stock investment. It’s unusual to find US investors betting big on a UK stock, so it raises the question of whether investors like me ought to do the same thing.
What is the Sequoia Fund?
The Sequoia Fund was launched in 1970 by Bill Ruane and Rick Cunniff. Those names might not mean a lot to most people, but the first name might ring a bell with investors who have a sharp eye for detail.
Bill Ruane was a friend of Warren Buffett, having met at a Ben Graham investing seminar. When Buffett closed his investment partnership in 1969, Ruane was the person he advised his associates to invest with.
The Sequoia Fund is very much committed to the same approach investors might associate with Buffett. According to its website:
“Bill Ruane and Rick Cunniff launched Sequoia in 1970 because they believed that a carefully selected and intensively researched collection of businesses, purchased at attractive prices and help for the long term, would outperform the stock market over time”.
The fund is set up for the long term and has been effective on that basis. A £10,000 investment in Sequoia in 1970 would be worth £8.46m today, whereas a similar investment in the S&P 500 would have a market value of £3.24m.
Why Rolls-Royce?
It’s unusual to find UK stocks in an outperforming US fund, but it’s especially notable in the case of Sequoia, which says that it invests primarily in US companies. Sometimes, though, an opportunity’s too good to miss.
In their most recent letter to investors, the firm sets out its rationale for owning Rolls-Royce shares. And the key point is that the stock looks good value even after its exceptional performance over the last year.
Earlier this year, Sequoia said it expects the company to generate more than 50% of its market-cap in free cash flow in the next few years. The stock’s up since then, but it’s still a bargain if those projections are right.
The key is the upgraded engines Rolls-Royce is producing. According to Sequoia, the more powerful products it’s deploying today should lead to greater servicing revenues and profits than its previous offer.
The Civil Aerospace division makes up around half of Rolls-Royce’s revenues. And Sequoia estimates the latest upgrades should drive revenue growth in excess of 10% a year and faster profit growth for the next few years.
Should I buy the stock?
A fund that focuses primarily on US shares committing heavily to a UK stock is unusual. And it’s especially interesting when it’s a fund that invests using Buffett’s principles.
There are risks with Rolls-Royce shares – investors need a very short memory to forget what happened to the business when demand for air travel collapsed. And discounting this possibility in future would be reckless.
Sequoia says it still thinks the stock’s attractive, though it hasn’t been buying it recently. But the stamp of approval is enough to keep Rolls-Royce shares firmly on my radar.
