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Sequoia Fund Shareholders Meeting1

May 13, 2005 New York, NY

Bob Goldfarb: accomplished people on his board, but I

I want to welcome all of you to strongly doubt that any of the independent
Sequoias 35th annual meeting and thank you board members had a deep understanding of the
for taking the time to attend. myriad of businesses in which the company was
Exactly two months ago today, on engaged or the ability to assess how
March 13, Hank Greenbergs reign as CEO of management was performing.
AIG, the huge, international insurance company What Greenberg was pointing out was a
that he built over four decades, came to an fundamental limitation that applies to nearly
abrupt and unceremonious end. The company every outsider who serves on the board of a
was mired in a very serious accounting scandal public company in the United States: Directors
that directly implicated Greenberg. The board almost inevitably know less and understand less
convened in New York on a Sunday to deal with about the business than the CEO does and
the latest untoward developments. As the Wall therefore function at a severe disadvantage
Street Journal reported, the companys directors when tasked with evaluating issues such as
discussed the future of the firm without its business strategies.
legendary CEO at the helm, while Greenberg, It is hard to imagine, for example, a
calling from his yacht in Florida, berated them better candidate for director of a public
over the speaker phone, telling them that they company than Robert Rubin. Yet in his book, In
couldnt and I quote even spell the word an Uncertain World, he is quite modest about
insurance. Within hours, the board formally his role as a director at Ford Motor: The
stripped Greenberg of his chief executives role difficulties at Ford, Rubin wrote, brought
and later forced him out of the company home for me how little you can know as an
entirely. The fall of Hank Greenberg will surely outside board member of a company, even if
make a fascinating book someday Roger you are very conscientious about your duties.
Lowenstein, are you busy? Today let it serve as An outside board member has an obligation to
my point of departure. learn as much as possible about the issues
I would like to talk about the limits of facing the company. But in truth, its very hard
corporate boards as well as two steps that I to know enough to disagree confidently with
believe boards should take to improve business management about a problem until matters have
practices. I agree that we have the worst system reached a relatively serious state.2 Such
of corporate governance in the world, but I modesty may seem surprising at first coming
would add the qualifier: except for all the other from a person who has enjoyed the success in
systems. So the steps that I propose are both business and public service that
non-invasive surgery. Indeed, I think a Robert Rubin has. In an ideal world, directors
significant re-working of our system would would function as smoke detectors. In the world
probably be a mistake. as we find it, boards are much more likely to
Hank Greenberg is an exceptionally function as fire extinguishers.
capable businessman with a tremendous Here is Rubin again reporting his
understanding of the many intricacies of AIGs real-world experience: At Ford board
businesses. He is also, obviously, a man with meetings, the issues that ultimately led to
some serious and ultimately fatal flaws. So he Nassers departure were often raised. My
may seem like an unlikely ally in the quest to immediate reaction to hearing them would be:
improve what goes on in board rooms. My God, we really do have a problem here and
However, the more I thought about the topic for we have to deal with it. Then Nasser would
today, the more I found myself sympathizing respond. Hed either say that some issue that
not with what he said exactly, but with what I sounded like a problem really wasnt for the
think he meant. following reasons. Or hed say, Yes, there is a
I am sure that Greenberg was not problem, but heres our plan for dealing with it.
questioning the spelling ability of the Thats a good answer, Id think, listening to

Remarks have been edited for clarity.
P. 317.
A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

him. Theres really not a problem. Or: Theres a There are exceptions. For example, a
problem here, but he really does have a plan for member of the board may have worked with a
dealing with it.3 As we know, the board finally person who is being considered as a successor
decided that Nassers plan wasnt working and to the CEO, or a director with a financial bent
Bill Ford took his place. may be more insightful than the chief executive
Rubins candid report is strong about the benefits of a share repurchase
evidence indeed that even the most program. But the current system does not
conscientious and dutiful directors, who spend prevent board members who may be
at most a few dozen hours every three months particularly knowledgeable in an area from
attending to their duties, simply will not know asserting themselves. And of course, the
as much about the business as the CEO who is situation is completely different when the CEO
on the job full-time day in and day out. In short, is mediocre or failing. Directors can and do flex
Hank Greenberg had a point even if he made it their muscles under such circumstances,
with a blunt instrument. although of late, some boards have probably
Increasing the power of directors, as been slower to act that they should have been.
many proposals for reform would do, in and of Activists are promoting a model of
itself does nothing to address the underlying corporate governance similar to what is
issue of the asymmetry of information, commonly found in the UK and Europe. A key
knowledge and understanding of the business component of this model is a board that would
that exists between CEOs and their boards. For amount to a second layer of management.4 Such
that reason, shifting power from the CEO to the a move would bring in its wake a raft of
board may do more harm than good. unintended consequences that could affect the
Under the current system, design operations of a business every day, not just
usually bows to common sense. Directors have when the company is in crisis. Let me refer one
authority over a variety of matters including last time to Rubin: The European system also
voting on potential acquisitions and approving has real drawbacks, he wrote, the biggest
succession plans. In the real world, however, the being that what is in some measure
amount of actual power that directors choose to management by committee leaves companies
exercise varies considerably from company to less agile and adaptable, less willing to
company, and I believe it should. It is my experiment and take risks, and less decisive.5
observation that when CEOs are successful the As laudable as the spirit of reform may
board will usually defer to them. That makes be, it also has a dangerous tendency to apply
good sense. It is just not realistic, for example, one-size-fits-all solutions. And I firmly believe
to expect most directors to have a deeper we live in a bespoke world. Good governance
understanding of the potential risks and rewards requires a structure appropriate for the
of an acquisition than the person whose hands particular demands of the business and the
are on the wheel. Likewise, chief executives individual talents of the people involved. For
with strong track records often anoint their instance, governance watchdogs6 propose that
successors, relying on the board only for the roles of chairman and chief executive
approval. CEOs almost always have a better always be separated and that the chairman be an
understanding of the capabilities of the various
outsider. In many companies this would be the
candidates relative to the demands and
exactly wrong thing to do. In the case of
responsibilities of the job.

The so-called Higgs Report is a study of corporate governance practices in the UK. According to the
report the board, among other things, is collectively responsible for the promoting the success of
the company by directing and supervising the companys affairs. The boards role is to provide
entrepreneurial leadership of the company within a framework of prudent and effective controls
which enable risk to be assessed and managed. The board should set the companys strategic aims,
ensure that the necessary financial and human resources are in place for the company to meet its
objectives, and review management performance. Review of the role and effectiveness of non-
executive directors, Derek Higgs, The Department of Trade and Industry, London, 2003. (p.21)
p. 318
The Conference Board Commission on Public Trust and Private Enterprise, January 2003.
A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

Berkshire Hathaway, I am certain that the the litmus test of independence. It would have
absolutely right person serves as both chairman been a grave mistake to disqualify these
and CEO. Jeff Lorberbaum, Chairman and CEO visionary men, who built their companies
of Mohawk, and Peter Rose, Chairman and practically from scratch and who have deep
CEO of Expeditors International, are two understanding and knowledge of their
additional compelling exceptions to such a rule. businesses and industries.
On the other hand, not only does one Even when companies seem quite
size not fit all, it does not fit all all of the time. similar, one size does not fit all. In 1999,
Mr. Buffett has made it clear that his son will Progressive, in an effort to improve the
succeed him as non-executive chairman of performance of its investment portfolio, decided
Berkshire. The CEO will be a non-family to emulate Geicos management structure.
member. Sequoia owns four other companies Geico employs co-CEOs. Tony Nicely runs
with a similar governance structure a operations; Lou Simpson manages investments.
non-executive chairman representing the At Progressive, putting that structure in place
controlling family and a strong CEO with no turned out to be a mistake, and the company
family ties. abandoned the effort less than a year later. The
Only one company in Sequoias CEO of the insurance operations, Glenn
portfolio has a policy of having an independent Renwick, was and continues to be exceptional.
non-executive chairman GTech, which But the investment side of the business, as Peter
operates lotteries. But events at this company Lewis put it, spent too much time coming to
over the past few years show that the neat sub-optimal consensus decisions. The model
separation of powers that such a structure that was terrific for Geico was disastrous for
creates does not survive the mess of reality all Progressive because it did not have anyone with
the time. Bruce Turner, the current chief the investment acumen of Lou Simpson.
executive of GTech, actually started out as a Rather than the right forms of good
director at the company. He was a member of governance as defined by the conventional
the board in 2000, when the company was wisdom, what is really important, in my
rocked by a scandal and its CEO at the time left experience, is that management have the right
under a cloud. Turner stepped down from the stuff. In selecting stocks for over 30 years, I
board to serve as interim CEO until a cant recall a single instance in which the
replacement was found. Eight months later, a composition of the board or the governance
permanent CEO was brought on, and Turner structure was a factor in our investment
returned to board duties, this time as the decision. Rather the choice has always turned
non-executive chairman. But 16 months later, on the quality of and the prospects for the
Turner stepped back into the chief executives business, the price of the stock relative to its
shoes for good when the not-so-permanent underlying business value, and the capabilities
CEO left the company. In this case, and integrity of the CEO and other members of
circumstances blurred the lines separating the top management.
board and the CEO, and I would add, rightly so. We dont think that we should insist on
In many situations, having the retired perfection in our managers, however. Its most
CEO and now Chairman looking over the desirable, but all human beings are flawed. We
shoulder of the current CEO would be a will gladly settle for the 99 44/100th% purity
disaster. But not always. In fact, at three of our standard of Ivory soap. We have made mistakes
companies, Progressive, Fastenal, and TJX, about CEOs and we will continue to make
former CEOs serve as non-executive chairmen. them, no matter how much due diligence we put
For these companies and the individuals into the selection. Consider: Its hard to imagine
involved the system works very well. any choice of a CEO that is subject to more
Furthermore, the proposed reforms would scrutiny from the press and the public than the
disqualify all these chairmen Peter Lewis of election of a president of the United States. Yet
Progressive, Bob Kierlin of Fastenal, and Ben weve made some huge mistakes as voters. If
Cammarata of TJX because they fail to meet such a fine-toothed comb still fails to tease out

A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

some terrible presidents, why should we expect distrust is the music of change. This is an ideal
a far less intensive process to avoid all the time for directors to act.
clinkers? Boards will surely hear a chorus of
After hearing all I have had to say about resistance to ending earnings guidance and
the limitations of the power of directors, it may earnings management, but the loudest among
seem as if there couldnt possibly be anything the nay-sayers will be voicing a misperception.
that directors can do to address the problems There is a widespread feeling that companies
that have been roiling the business world. But that show steady, rapid earnings growth win
there is. I have two suggestions for making higher valuations for their stock. A moments
boards more effective. First, they should vote to reflection will no doubt bring examples to
end earnings guidance. Business is inherently mind. But I can think of a plethora of
unpredictable. Supplying narrow earnings outstanding companies that report earnings
guidance, sometimes down to the penny per honestly and that have been and are accorded
share, suggests a degree of control over the premium multiples despite reporting erratic, but
world that very few enterprises truly have for strongly growing earnings. We happen to own a
any extended period of time. number of these companies. In the current
Red-faced CEOs are reminded of environment of skepticism, it is highly probable
reality every quarter, of course, but the real that this type of company will be awarded the
danger is not executive embarrassment. It is that higher multiple by investors precisely because
having made a specific and unrealistic the uneven pattern of profit growth is more
commitment to shareholders and Wall Street, credible. Credible because it more accurately
managers will inch closer to the slippery slope reflects the way our common sense tells us the
of earnings management. And earnings world works.
management leads executives to focus on near- Already, the practice of managing
term results often at the expense of maximizing outcomes has spread into critical areas of
the long-term economic value of the enterprise. society such as health care and higher
This brings me to my second education. There is no question, for example,
suggestion for improving business practices: that a number of surgeons and hospitals reject
Directors should forbid earnings management patients who need surgery but are poor
and make it an impeachable offense. Further, candidates for success because failure would
the board should insist that the chief executive affect the hospitals ratings and marketing
communicate this policy of straight-forward efforts. Nor is there a shortage of universities
accounting and sole focus on building the that tinker with the application process and
maximum long-term value of the business to all manipulate admissions and acceptance data as
of the companys constituencies. if the schools ratings in US News & World
The notion that a company can steam Report were the academic equivalent of
ahead through all kinds of economic weather quarterly earnings per share.
steadily ratcheting up its income X% every So, there is really no reason why we
three months flies in the face of experience and should be surprised to read two stories in a
makes no common sense. More importantly, not single edition of the Wall Street Journal, the
only does earnings management lock a paper devoted to profit-making businesses. One
companys focus on the near-term, it story told how a public utility was tired of the
significantly increases the risk that managers natural-gas markets increasing volatility,
will engage in false, misleading, and even which can turn off analysts and investors
fraudulent accounting and reporting. keen on steady earnings. The utility will, the
Boards should act promptly, while the story goes, propose to state regulators that it be
trumpets for corporate reform are loud and allowed to raise customers bills during the
clear. Not since the 1930s has there been a warm weather and cut them during cold, a
period of greater skepticism about the validity process the company refers to as weather
of corporate financial reporting. That very normalization.

A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

Another article in that same issue in this room. She was a real pro and played a
reported how a well-regarded company with a special role as a mentor to many of the key
long and reputable history reported a workers on our present team.
restructuring charge in the first quarter that just Before I turn things back over to Bob,
so happened to be exactly offset by the income Id like to mention that I was out at the
from a court settlement. Such serendipity is Berkshire annual meeting, at which time
rampant. Shortly after we established a small Warren Buffett suggested to the people in the
position in a company, its management reported audience that they buy a book that was available
earnings that included charges for three non- among the many other products You could
recurring items, which in aggregate amounted have bought a couple of trainloads of paint,
to the same sum as an extraordinary gain from a some cowboy boots, Sees Candy. But there was
tax credit. Needless to say, this position will a book that he recommended: It is called Poor
remain small or be eliminated. Charlies Almanack. Its a wonderful,
Despite the games that companies play wonderful book, which will not be available in
with earnings and regardless of whatever bookstores. Its a compilation of many of
changes, if any, come about in the practices of Charlie Mungers thoughts on investing and on
the board room, what will not be eliminated or life. And in many ways, its also a tale of the
lessened in the slightest degree is our dedication investment thinking of both Warren and Charlie,
to thorough research and analysis and investing and the history of their relationship. I heartily
for the long-term. When I look at the universe of recommend it. And if you are interested in buying
companies that our research is dedicated to it, you might want to make a note of this: You can
finding I do not expect to see orderly increases go on to The
in earnings per share quarter after quarter or a cost of the book is $49. If you want it signed by
consistent system of corporate governance. Charlie, its $99 I dont know how he figured
What I do expect to see are companies that have out his signature was worth $50. In any event, it
demonstrated sustainable competitive is not a commercial book. All of the profits will
advantages and sell for reasonable prices given be going to the Munger Research Center at the
the companies growth prospects, companies Huntington Library. It weighs about five
that are run by managers of extraordinary pounds; so its not something to tuck under your
capability and integrity. And I firmly believe arm to read on the bus. However, I promise that
that we have constructed a portfolio of such if you read through it you will not only have a
companies run by such managers. lot of fun, but you will come away with so many
This concludes my formal remarks, and marvelous thoughts on investing from both
Ill turn the microphone over to Bill. Warren and Charlie.
Bill Ruane:
Going beyond that, one of the
Thank you, Bob. I would like to make a characteristics of the firm that Bob has
few comments. Not only is this the 35th year of continued to enhance enormously reminds me
the Sequoia Fund, but it also represents the of a phrase that caught my eye about ten years
seventh year that Bob Goldfarb took over as ago when we were looking at all the banks. I
Chief Executive and Co-Manager of the Fund. came across Fifth Thirds annual report, and it
Well, Ruane, Cunniff & Goldfarb are still sitting said that they only work half a day, from
up here as we were seven years ago. I believe seven a.m. to seven p.m. And that actually was
that Bob has enormously enhanced the strength true. It was one of our major holdings and it had
and depth of our organization during that time, a very special culture. And it was very good to
while sticking to the fundamental values of our us over the years.
approach of investing in fine companies that We dont have that exact same culture.
will enhance your capital over the long term. We certainly do not have a time clock to punch
On a sad note, I regret to tell you that at Ruane, Cunniff & Goldfarb, but the amount
our partner, Carley Cunniff, passed away a few of research that our professionals produce has
months ago after a long battle with cancer. Her an enormous amount of depth and hard work
wonderful qualities endeared her to many of us put into it. Some of the fellows are in there very

A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

early in the morning, like Bob, and do that Bhakoo, Arman Gokgol-Kline, Jonathan Gross,
seven to seven, or six to eight, more than half-a- whos the new kid in town, John Harris, Jake
day. Hennemuth, Terence Par, whom I want to
And I want to just make a note of one of thank for helping me with todays speech, and
our very, very special members of the team, Greg Steinmetz. Would you all stand up? Thank
who really has proven a great investor and is you. With that, I think were ready for your
one of the nicest people I know. Hes sitting two questions.
spots away from me Greg Alexander. Theres Question:
a true story that goes around about Greg. Before As Berkshire is by far the largest
I met him, I heard that Greg had read annual holding in the Fund, my question is about it, and
reports all the way through Yale. But he was I apologize if its a little long. My basic concern
able to handle the other subjects on the side. We seems obvious: Are you concerned about
were fortunate to receive a letter from him many Berkshires inability to find suitable
years ago. Greg, how long is it now? investments and as a result carrying ever larger
Greg Alexander: sums of money on the balance sheet at minimal
More than 20 years. cash returns?
Bill Ruane:
And there are really two different
An unspecified number more than 20. aspects to the question. I believe Berkshires net
He wrote me a letter, and he said, Id like to worth has grown about 8% per year for the last
come to work as a summer intern. And I know five years, which is okay. Its certainly not
that if you meet me, youll hire me. And he was stellar and doesnt compare remotely to the
absolutely right. He worked that summer, and prior 30 years. But the question is this: Are you
then we asked him to join us permanently after concerned about Berkshires recent $20 billion
that. And I cant tell you how happy I am that bet against the U.S. dollar? I recall a very
we did. interesting commentary by Bill Miller recently
But I just want to give you this one in which he noted that structural economic
illustration. When Gregs wife, Chiu, whos problems have curious and unpredictable ways
very lovely, was in labor at the hospital with of resolving themselves, the implication being,
their last child, of course Greg was there. At one I think, that a collapse of the dollar is now not
point it became clear that it was time to head for necessarily the result of what will happen with
the delivery room. So they went in, but Greg the U.S. trade deficit.
was on the phone ordering more annual reports. And the second question really relates
So this may be an extreme example of how to Buffetts inability to find stocks to buy. I
diligent we are, but I know it will pay off for all think I mentioned last year when I asked this
of us long term. Greg, thank you very much for question that he hasnt made a really sizeable
being here. investment for 11 years, which is a long time.
He seems to be waiting, from his
Bob Goldfarb: commentary, for a major market collapse of
Bill once remarked that youll never some sort, which may, of course, occur and may
have to work another day in your life if you like not occur. In the meantime, I note that other
what youre doing. And Id add to that, major value funds such as Oakmark, Longleaf,
especially if you like all the people youre Clipper and Legg Mason Value Trust, for
working with. So I guess I didnt put in a single example, a few years ago made very sizeable
days work in the last year, because Im commitments to companies such as Comcast,
introducing the same team as I did a year ago, McDonalds, Walt Disney, American Express,
with one additional member. Vivendi Universal and Tyco very major
To my right, I think youve already companies, which at the time were, or at least
been introduced to Joe Quinones and Greg hindsight suggests, extremely cheap. I think that
Alexander. To my left are, of course, Bill the group of six has doubled in the last three
Ruane, Rick Cunniff, Jonathan Brandt and years, a compound return of 27% per annum.
David Poppe. In the audience are Girish

A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

Now I understand from Buffetts point Bill Ruane:

of view that these may not be 10 or 20 year Well, I might generalize about a
investments, which is his ideal, but at the same number of the comments you made. Your
time, they were extremely undervalued remark that he hadnt really made any big
securities, and substantial money was made by investments in 11 years, thats true, I think, in
very successful value funds. Its almost as if terms of buying a part of a company. But he
Buffett has sort of cornered himself by certainly made a huge investment in General Re
developing an investment philosophy that will in 1998. And in a period such as weve been in
not allow him to buy a stock that he doesnt since the end of the tech bubble, he hasnt
intend to hold for 10 or 20 years. And these bought any very large chunks of equities. But I
other funds probably will not hold those think if you saw the list of Berkshires equity
investments for 10 or 20 years. But doubling holdings, youd be surprised at the number.
your money in three years is something that Some of them were purchased by Geico, which
anyone can be proud of. Lou Simpson manages. Thats about
$2.5 billion. Lou is often buying stocks.
Bob Goldfarb:
As to my concern about the $43 billion
Ill just start with a brief response to
or $44 billion dollars he has in cash, I have
your last point, and Ill turn the microphone
none. Im delighted that it is in the hands of
over to Bill and Jon Brandt. Buffett has bought
somebody who has such marvelous patience. I
and sold some publicly traded stocks within a
think this current period is one where there
relatively short period of time. HCA comes to
really are very few significant bargains around.
mind as one that he bought, and I think sold
Three of the companies youve mentioned
fairly recently. Jon, arent there others?
Disney, American Express, and McDonalds
Jon Brandt: actually are stocks that we have owned over a
The leasing company in Chicago, period of time.
GATX. He bought 15% of the company and
Bob Goldfarb:
subsequently sold it all. There are other ones.
And Warren owned those three. He has
He bought and subsequently sold some of his
no Tyco common, but he has owned Disney,
H&R Block. He sold most of his Costco. He
McDonalds and American Express. Hes the
still owns a little, but hes in and out of some
largest shareholder of American Express.
Bill Ruane:
Bob Goldfarb:
You know, I dont think you have to
Yes, those are all examples of
make an investment. Thats one of the problems
investments he made, which he didnt hold for a
that we have today in the investment field.
very long period of time. He also made big bets
People think they have to be doing something
during the period that youre referring to on a
when the prudent thing might be to not do
number of junk bonds when distressed debt had
anything. And there are times when things are
yields to maturity in the twenties and thirties.
ridiculously high, and there are times when
And he made a lot of money on those. He
things are ridiculously low. And there are times
acknowledged recently, although I dont think
when you have distortions in particular
this was his exact analogy, that he probably
industries. At this particular time, I find in most
should have used a shotgun rather than a rifle.
areas where you can invest a lot of money, the
That would have enabled him to put even more
prices simply are unlikely to reward you in a
money to work than he did in distressed debt.
significant way, whether its real estate or the
In addition, his activities in fixed
bond market or stocks. And Warren has stated
income arbitrage, which we discussed last year,
that over the next 15 years, and I think it will
were relatively short-term. Given those
probably turn out to be less than that, hell
examples in both common stocks and debt, I
probably have an opportunity to put that money
wouldnt agree with your conclusion that hes
to work at some fairly nice returns. But you just
only interested in instruments that he can buy
and hold for 20 years.

A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

never know when the opportunities will think the insurance tables might lead you to
develop. think that he could live that long well, I am
I think about my ownership and your making a bet that he will. And then you take the
ownership of Berkshire Hathaway as having a difference between the 3% and the 10%, and
reserve available, managed by the greatest you come up with a fairly large number that is
investor of all time, of having $40 billion ready potential earning power just sitting there
to go when there are some real bargains around. waiting for the right opportunity.
And Im quite sure he can do things that we Its not calling the market. Its just
dont try to do. During the period were talking waiting for something that hits you in the gut.
about, as Bob mentioned, he loaded up on junk Weve owned many hundreds of stocks over the
bonds in a major way. He put about $7 billion or life of Sequoia, but we made most of our money
$8 billion to work and he wished he had gone in a couple dozen securities that we bought at
ahead and bought another $7 billion or the right price and stayed with. Today I think
$8 billion. They were yielding 30%, and he sold its fair to say that we see very little that we
them when they were probably yielding about really want to pound the table on. Im only
6% or 7% a couple of years later. And he made speaking personally, but I think that Bob feels
billions. You know, that would get a lot of pretty much the same way. Warren made a
attention if it was a stock trade. comment that he was buying something
Another major action was in fixed recently and that it was a sensible thing to do.
income arbitrage. This got very little attention, But he also said that he was relatively
but he made a couple of billion dollars on it. It indifferent to whether he bought it or not.
was a fairly low risk investment, but not one Lets go back to the late seventies.
that we are knowledgeable enough to handle. Gillette was selling at eight times earnings with
Now everybody is aware of the possibility of a wonderful growth rate, an absolutely great
the depreciating dollar. But he saw that two and brand, and 75% of the razor and blade market.
a half years ago, and, again, it led to a couple of If they simply just held their earning power at
billion dollars in gain while he has been that level, youd get the inverse, a 12% return.
gathering a war chest for a different climate. Now thats simplistic. And, of course, the return
He would put it all to work tomorrow if over the next 10 or 12 years was enormous. So
he could find something that he thought really theres nothing like patience. I dont have that
had all the qualities that he looks for, whether its much patience, but I think weve got some, and
a privately owned company, a publicly owned Im a big fan of that $44 billion dollars. Bob, do
company, or some combination of both. But Ill you have any thoughts?
tell you, I admire his patience. He has a Bob Goldfarb:
$105 billion portfolio now. Some $39 billion are Yes. Jon Brandt correct me if Im
in stocks that hes held for quite a while; wrong, but I think it was in the 2003 Annual
$44 billion is in cash; and $22 billion is in bonds. Report that Warren Buffett acknowledged that,
I think one of the interesting things while his managers had done an outstanding job
about evaluating Berkshire is just considering of running the businesses, he had not done a
that youve got the smartest investor of all time, comparable job in investing the capital. So to
as far as I know Keynes or somebody might some extent he acknowledges your concern and
give me an argument on that but you have your criticism.
Warren carrying a portfolio of $105 billion that Secondly, I think it was a real sea
yields less than 3% after taxes. And heres a change that two weeks ago in Omaha at the
person who historically has averaged a total annual meeting, for the first time he said that if
return of about 21% after taxes. When we tell in a couple of years he found that he couldnt
you Sequoias total return is 16%, thats before put much of the cash to work, he would
taxes. Warren will not make a 21% return in the consider paying a dividend. So I thought that
future. But if you ask me, is he capable and was a very marked change in his posture toward
healthy enough, etcetera, to make a return of the cash.
10% or 12% over the next ten years and I

A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

Jon Brandt: at a time and totally analyze them. But I think

I just want to add a couple of thoughts, hes starting to adjust to the fact that he cant do
acknowledging your point in general, and things one at a time any more. I saw some notes
maybe giving you some facts on the specifics. I of someone who was at the Wesco annual
think most of the stocks you talked about that meeting. They were brief notes, but they
the other funds were buying were purchased seemed to suggest that Warren and Charlie are
probably in the 2002 era. Bill and Bob already reducing their hurdle rate. Warrens been saying
mentioned that Buffett did buy $8 billion in for the last couple of years that he doesnt want
junk bonds. One of those buys was of Tyco to put money to work at anything less than 12%
bonds. Some of the other firms you mentioned or 13% pre-tax. But I think its going to be hard
bought Tyco stock. Buffett bought nearly a for him to make that much on the Anheuser-
billion dollars worth of Tyco bonds. And he Busch purchase. Its not a bad buy. But I think
also bought them in Euros. So he got a double thats perhaps an indication, as well as what
dip in dollars from the appreciation of the bonds Bob said about maybe returning money to
and from the appreciation of the currency. shareholders. So theyre going to lower their
I dont have the Berkshire annual in hurdle rate a little bit. I dont think hes going to
front of me, but Ill give my best guess of other put all $40 billion to work at only a 9% pre-tax
investments he made in 2002 that were neither return, but weve had an environment thats just
currency nor arbitrage. In the apparel industry, the enemy of the Buffett-style investor.
he bought Garan and Fruit of the Loom for Weve had really, really low interest
about $1 billion. Those two companies together rates and pretty uniformly highly priced assets,
are now earning almost $300 million pre-tax. as opposed to these little pockets of distress,
When he buys entire businesses, they dont get where hes been able to do something. And
marked to market; so you dont see unrealized interestingly, he could be wrong about the
appreciation as you would in a mutual fund. currencies, but so far, hes made a couple of
Theres no privately quoted market value for billion dollars on it, and, he says its a long-term
Fruit of the Loom and Garan. He bought two bet. Its a five year or ten year thing. But so far,
pipelines in the summer of 02. Depending on its working out. Greg might have something to
whether you include the debt or not in the say about that.
purchase price, he paid something between
Greg Alexander:
$1.4 billion and $2.4 billion. He bought the
I have just a few very quick comments.
Pampered Chef for something over $1 billion. I
First of all, Warren often says that he has
cant remember whether Buffett bought the
$40 billion of cash, but I dont personally think
$300 million White Mountain convertible
of it as cash to quite the same extent as you
preferred in 01 or 02. The value of that
might if you have a $100 balance in your
security, which has been converted to common,
brokerage account and no debt, but $40 of it is
has tripled. He bought the outstanding minority
sitting in cash. The reason is that almost all of
interest in Shaw in January of 02. Again, thats
the $40 billion is from the float on his insurance
not marked to market, but Mohawk, which we
businesses. And so I think the urgency of
own, is up 60% from that time. Then he bought
deploying every penny of that is less. If that
the poster-framing company, Albecca. If you
were all deployed, he would, to my way of
add all those purchases up, youve got
thinking, be more than 100% invested and
$4 billion, $4.5 billion. Then you have the
perhaps safely so, because he has so much
$8 billion in junk bonds. He didnt even have
equity. But I wouldnt quite think of it as
the $40 billion plus portfolio of cash back then,
entirely $40 billion of excess cash.
but he did put over $12 billion to work in
Secondly, he really has five options. I
approximately one calendar year.
mean, he has gotten so big. One option is to find
It would have been nice if he had put
some huge new holdings. And Im talking really
$30 billion to work, but hes a by-the-piece kind
big, $5 billion, $10 billion at a time, and maybe
of guy. And thats worked for him for a long
several of those. Another option is a huge
time. I think its in his nature to buy things one
addition to those few of his holdings that he

A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

might want to make really huge additions to. oil. So I dont see how the problem solves itself.
Would it make sense to buy a huge portfolio of There you are.
20 different $1 billion positions, many of which Bob Goldfarb:
he might end up selling in a few years? He is in Ill just add one final comment. Warren
the corporate form, so he would pay taxes on remarked recently how quickly a glut of cash,
the gains. And then we might someday in our which has really driven up the prices of almost
estates etc. Its sort of double taxation. I think every category of assets, can disappear within a
thats one reason hes oriented towards very short period of time when circumstances
long-term investments. and psychology change.
And then lastly, I would just state that I
think its fairly obvious that in the recent decade Question:
or so that Warren has a preference for owning My question has to do with the
entire companies and controlling their future investment in Fifth Third. I enjoyed reading the
capital allocation. And so, if the environment post-mortem comments that you made on it.
ever did change, one or two $10 billion And certainly a 17% return over time is nothing
acquisitions if a bunch of hedge funds dont to be embarrassed about. But Im wondering
take the companies over first might put it to when you look at what I think you labeled a
work pretty quickly. And then the last option, of mistake in not selling earlier, do you think that
course, is to return capital at some point. I think you fell in love with the stock and that you may
that is pretty much the universe of have lost some objectivity and ignored some
opportunities. early warning signals that otherwise might have
On currency, I dont have any profound caused you to sell earlier?
thoughts, but to my mind the current account Bob Goldfarb:
deficit if it is in fact correctly reported is I might start by saying that its not
a near to insoluble problem. I think theres some always clear at the time whether youre seeing a
doubt in my mind whether its really quite as temporary stumble or a sea change in a
big as people say, because the United States is business. We clearly saw a number of stumbles.
the preeminent service economy and maybe it is And we probably should have done a better job
hard to measure exports of services. That said, of connecting the dots, if you will, which would
if the numbers are anywhere near correct, I just have led to the conclusion that it was more
dont know how theyre going to be fixed. I likely an inflection point as opposed to a
mean, whatever we still buy from Europe temporary stumble.
Italian shoes, French handbags, wine most of
the people who are buying those things with Jon Brandt:
todays higher currency valuations, they just Id agree with you, Bob. I think one of
want them and theyre not a major part of their the issues was they were earning a lot less than
life spending. And I really dont know that those they would have been earning in a higher
habits are going to change, irrespective of interest rate environment. A lot of things were
where the currency goes. bothering us, but we kept asking ourselves how
Then you have all the countries where long can this period of extraordinarily low
the wage rates are very low. So lets say the interest rates, which are depressing net interest
Chinese yuan goes up by 25%, and people who income and earnings, persist? But as each little
are currently making a $1 an hour make a $1.25 problem became evident, the market always
an hour. Is that going to suddenly bring industry seemed to adjust. And certainly I take the blame
back to the United States because it compares for not connecting the dots. A sequence of
less favorably to our wages here? To me, it things that were not optimal were going on
doesnt seem likely. The oil price has doubled in there, but the price always seemed to discount
dollars, although it hasnt actually gone up it. We liked the people, and while there were
nearly as much in Euros. Are we importing any things that bothered us, the market was always
less oil? Were just spending more money on kind of keeping pace with the disappointments.
But certainly, I think we could plead somewhat

A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

guilty to the charge of falling in love with the opportunities around the world for them to grow
culture. and be a healthy business.
We saw little things that we really But what I worry about is the fact that
didnt like such as what they did in early in 2000, Tiffany earned a 23% return on equity.
January of 04. They were trying to protect their Last year it earned about 12% on equity. Sales
earnings stream by entering into derivative throughout that period have basically been quite
contracts to protect their net interest income, good, despite September 11th and the recession
even if rates went down further. It always that we went through. It remains one of the
bothered us a little bit that they were trying to great aspirational brands. They have plenty of
keep a smoother progression in their earnings. growth opportunity. You saw this morning in the
But when that became public, the stock went earnings report that the U.S. comp is 11%,
down a couple of points. There were just a lot of which is terrific. Its partly inflated by the fact
things like that. that its very cheap for Europeans to come here
They had some problems with one of and shop right now. Japan remains weak. But I
their subsidiaries. I met the man who ran it think Japan is not a killer given that they have
several times. And it turned out the fellow was opportunities to grow in other places.
a good manager except when things went bad. What everybody should be focused on
Id like to think that Im a good judge of people, is whether or not they have the self-discipline to
but its hard to tell how someone you dont reign in the spending if they are not getting the
know well will deal with stress. The CEO and returns. So I would want to see results in that
the other people leading the company thought area before adding to the position.
he was a good choice. And he turned out not to Bob Goldfarb:
be a good choice. They made a mistake, and I The board did finally acknowledge the
made a mistake. problem that David is speaking of by making
George Schaefer still probably has one return on assets one of the factors that will
of the most terrific records as a bank CEO in the determine the compensation of Tiffanys CEO,
country. But you know, theres that book, Good Mike Kowalski. So, again, it is another example
to Great. Fifth Third has probably gone from of what I was talking about in my speech. Could
great to good. We were close to it. And we saw the directors have done a better job? Could they
some erosion, but definitely made a mistake in have voted down some of the proposals for
not seeing it more clearly before the market, investing significant capital that didnt turn out
which is what you guys pay us to do. to produce much of a return? But they are
Bob Goldfarb: seeing some fire, which they hope to extinguish
To go back to the phrase I used in my by trying to improve the return on assets.
talk earlier, we should have smelled smoke and Question:
realized that when we were smelling smoke we Bill Miller has characterized the debate
were detecting a fire. on the trade deficit as overly simplistic. One of
Question: your holdings is Wal-Mart, which alone drives a
Can you comment on Tiffany as it not insignificant part of the deficit. And the
relates to the weakness in Japan, and perhaps reason that is happening is that the free markets
having an opportunity to add to your position? are working the way that they are supposed to.
And which is worse, the currency risk now or It seems to me that a lot of the deficit is being
the equity risk? driven by things which are fundamentally
David Poppe:
economic forces working the way they are
Tiffanys weakness in Japan in some supposed to. So I would like you to respond to
ways is less of a concern than the overall that. Are people missing something? Is it overly
carelessness with capital that theyve displayed simplistic? Another question is about improving
over the last three or four years. I think Japan is corporate governance. One idea is to make sure
a problem. I dont think they have a solution for that directors are qualified to serve as advisors
making it better. But I think there are other to CEOs. Do you think that people who serve on

A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

boards of directors should be required to have because Target is smaller, its harder to
some kind of training or actually pass an exam? demonize. Wal-Mart has some other issues that
Bob Goldfarb:
also make it easy fodder for The New York
In response to the second question, I Times. But at bottom, its a consumers
would say that when I was thinking about this decision, and people go to Wal-Mart because
subject as I prepared todays speech, Jon Brandt the prices are lower, and if the prices were
suggested that each director might hire an higher, they would stop going. And so, theyre
assistant who would do the same kind of sort of doing what they want to do. I dont think
research that we try to do before we buy the theres any political reason for what theyre
stock in a company. And that assistant might doing, and I dont think theres necessarily an
continue to work with that director on an on- easy political fix either. The consumer speaks.
going basis. So that is one suggestion. Question:
In response to your first question on How to you calculate the intrinsic value
free trade, Wal-Marts share of the trade deficit of Walgreen?
is often exaggerated. I personally happen to be Bob Goldfarb:
in your camp of being a free trader. And I do We would calculate the intrinsic value
believe in comparative advantage, that the of Walgreen the same way we would calculate
world is better off buying from whatever source the intrinsic value of every other company
has the lowest cost of production. I think clearly whose stock we look at, which would be the
we are pretty far along in the transition from stream of all free cash flows until kingdom
being a manufacturing-based economy to come discounted back at an interest rate.
becoming a knowledge- based economy. What Theres nothing about Walgreen, to my mind,
you do with unfair trade is another issue. that would cause us to apply a different standard
Warren Buffet with his proposal addressing the of measurement from that of any other
trade deficit has come down for managed trade. company. David follows Walgreen.
If you wanted to import goods, you would have
to buy the right to do so from an exporter. Its a David Poppe:
very simple rule that would eliminate the trade Implicit in that comment is that you
deficit automatically. Its not one that Im have much further to go before you get to
necessarily in favor of, but I dont think terminal value with Walgreen than you have for
anybody can ignore a recommendation that almost any other business that we follow. And
comes from such a thoughtful and were either right about that or were wrong
knowledgeable source. Does anyone else have about that. But we think the runway, if you will,
feelings about either the trade deficit or how is extremely long. The population is getting
boards can improve? older, filling more prescriptions every year.
Walgreen, we believe, is the low-cost filler of
David Poppe:
prescriptions certainly in retail by far the
On Wal-Mart specifically, I think what I
low-cost producer, and I think, overall,
would say is, theyre an easy target to criticize,
compared to any other source, mail order, or
but the American consumer has shown for
anything you want to look at, has a very low
40 years that he has no interest in Buy
cost to fill.
American, has zero interest in paying more; we
Also, layered over that, Walgreen is an
drive Japanese cars and we eat Mexican
extremely good retailer. And that also generates
produce and buy Airbus airplanes. Wal-Mart is
traffic, generates loyalty, and generates business
doing basically what the market demands it do,
for the pharmacy side of the store. You know,
which is provide the lowest price to the
they talk about their plans for 7,000 stores in
consumer for the best quality of merchandise
2010, and 10,000 stores ultimately. At this
they can get. Theyre easy to demonize because
point, theres no reason to believe that those
of their size. But I think if you looked at it,
arent very realistic numbers. Their market
probably Target sources a higher percentage of
share is about 14% right now. Retail pharmacy
its total sales overseas than Wal-Mart does. But
is filled with inefficient and poor competitors.

A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

The opportunity to take market share and go Bob Goldfarb:

from 14% to some much higher number is Yes, I would say that if you extend the
there. Theyre fortunate. They have some very question to a broader universe, whether you
good competitors excellent competitors but want to go back to Pearl Harbor or 9/11, when
there are still 20,000 independent pharmacies in mistakes are made, its usually not something
this country. So, why do we own Walgreen at thats terribly complex in retrospect. Its usually
this very high multiple? Its because we believe some kind of simple human error such as our
that the growth rate is not just for the next four failure to connect the dots with regard to Fifth
or five or six years, but they could grow at a Third. I think thats a broader view than perhaps
pretty rapid clip for a much longer time. what youre searching for, but the answer Id
Certainly theres some risk there because over give is to look at the mistakes that have been
ten or twelve or fifteen years, all sorts of crazy, made in all areas of human endeavor and see if
unexpected things could happen. But implicit in you can find some common threads.
our ownership is the fact that we think theres a Bill Ruane:
good and a very long-term growth rate for them. Again, I go back to Warren Buffet, as I
Bob Goldfarb: do so often. He has two rules of investment:
In at least the previous couple of annual Rule #1, Dont lose money. Rule #2, Dont
meetings, Ive given you an update on the forget Rule #1. We try hard not to forget those
higher multiple stocks that weve bought and two rules.
those would include Walgreen, Expeditors, Bob Goldfarb:
Fastenal, Patterson, which is a small position, I would add that while we have been
unfortunately and Ill just repeat what I said pretty good at avoiding mistakes of
last year, which is so far, so good. We realize commission, we have made significant errors of
we are paying a high price. So we need a lot of omission. I think that if I had to point to one big
years of rapid earnings growth to prove that our mistake we made, it was putting undue
investment has been a good one. And when we emphasis on possible macro economic
gather a year from now, Ill be glad to give you problems and overreacting to some that seemed
a further progress report on that same issue. overwhelming at the time but were dealt with
Question: reasonably well. {Editors note: An even greater
Looking back over the past 35 years, opportunity cost was incurred by our
could you tell us about a couple of mistakes that shareholders during much of the 1980s as
you made as a team and what we can learn from RC&G kept large cash positions as much as
them? 61% of the Funds assets waiting for a return
of the golden era of the late 1970s when a
Bill Ruane:
plethora of outstanding companies would again
At this meeting a couple of years ago,
be selling for single digit multiples.}
we calculated the ratio of the number of stocks
Another thing Id add is that its
on which we realized gains to the number of
extremely important in my mind to be and stay
stocks on which we realized losses. And the
humble. There may be a clerk working in a
ratio was something like 80:1. One of the things
drugstore somewhere who has knowledge about
we try very hard to do is to buy a stock only
Walgreen which is superior to that of most of
when the company is right, the price is right,
the directors of Walgreen, going back to my
and we have real conviction about it. And the
speech. There could be a clerk in a Walgreen
nice thing about not doing a lot of things, but
store, or a Wal-Mart store, for that matter, who
having a real conviction when you do is that
knows more than most of the directors, as well
when it goes down, you can add to it and
as the investors. So that leads me to two
ultimately make money. Weve certainly made
conclusions: One is stay humble, and the other
mistakes, but using the standards weve had
is something weve referred to in the past
over the years, weve been fortunate to avoid
abide by Phil Fishers scuttlebutt theory. Do an
any major ones.
intense job of research and talk to as many

A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

people as you can who are likely to have component in the cost of furniture; so whether
knowledge thats of value in analyzing the one of the guys makes a buck or a buck twenty-
situation. Dont just do a top-down the five is not the driver. I think the freight to get it
numbers have been great extrapolation. back and forth is more than the labor. But right
now the Chinese have made a decision that this
Id be curious as to your thoughts on the is an industry that employs a lot of people, and
competitive advantage of Ethan Allen what they want to be really large. And so deflation
those are today, and have they eroded, or has the continues. At some point, perhaps it stops, and
business been changed by the importation from the industry will get better. I think Ethan Allen
furniture from Asia? is well-positioned if things get better. But I
dont have a good handle on when that might
David Poppe: happen.
I think that the competitive advantage
Bob Goldfarb:
has eroded more than we probably expected.
I would just add this in response to the
But theyre still performing well versus their
two previous questions, one on free trade and
peer group. Its a very, very difficult industry. I
the other on sources of mistakes. In my own
think a good comparable for Ethan Allen is
experience Adam Smiths Supply & Demand
actually Berkshire Hathaways furniture group
explains a lot. If you just think about supply and
because theyre strong retailers run by pretty
demand, and youre constantly making
good entrepreneurs. And if you read the 10-Q
estimates of both, thats going to be predictive
that came out the other day, the retail furniture
of the success or failure of a lot of industries
comp was probably somewhere in the minus
and companies. And we were clearly aware of
four, minus five range. Ethan Allens comps in
the increase in manufacturing from China. I
the recent quarter were right around that level,
remember I dont know how many years ago
and theyve probably been not necessarily
it was I talked about The China Syndrome.
better than Buffetts group but better than the
Farooq Kathwari, whos the Chairman and CEO
peer group throughout the last four or five years.
of Ethan, has also been open about discussing
But deflation has been much more
the threat from China. But we should have
harmful than I think we realized it would be, or
listened to ourselves a little more closely, and
anticipated. I think Ethan Allen continues to be
taken Farooqs words a little more to heart than
a very well-run company. Theyre doing better
we did and realized that there was a sea change,
than virtually everyone else in their group. You
and that this was a business whose fundamentals
could argue that at times they can be penny-
were deteriorating very dramatically in a
wise and pound-foolish and not do everything
relatively short period of time. And, again, if
that they could possibly do to strengthen the
you detect smoke, you should probably leave
brand and the brand image, primarily in terms
the room.
of things like advertising and just being
consistently in front of consumers with the David Poppe:
brand name. But by and large, I think Ethan Right. I would say in that regard, Ethan
Allens a case where the industry just got still makes a lot of its product in the U.S., and
extremely difficult extremely fast. And, as Bob still makes excellent margins on that U.S.
said, sometimes things come at you and surprise product, even having to price it and compete
you. Unfortunately, Ive got to say that against Chinese-made goods. So you know that
happened to me a little bit. It happened a little labors not a huge component of the cost basis
bit faster and was a little bit more intense than I of the product. I think what we missed was that
anticipated. I think going forward, I dont Chinese-made product wouldnt be cheaper
know: can everyone have negative comps because the labor was so much less. It would be
forever? Can the Chinese continue to make cheaper because they wanted the market share,
cheaper and cheaper furniture when the price of and they wanted to control this market. We just
energy and the price of freight and the price of didnt foresee the deflation being so extreme
wood continue to go up? Labor is not a huge because the labor component of the product was

A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

not that extreme. But if you have a competitor lottery services to states. If they want the
who doesnt need to make a return on capital for contract, they can bid the lowest. Scientific
some period of years, that can make your life Games is a very good competitor and a very
pretty difficult, and thats what happened. good company, but not as large as GTech and
Bob Goldfarb:
not as efficient as GTech. And you could argue
David, do you have any idea of what about which one is better, which one runs a
percentage of furniture sold in the United States better lottery, which one does more for the state.
was made in China, say, five years ago versus But, you know, state contracts tend to be low-
today? bid-oriented. And if youre the low bidder, and
youre the most efficient player, youre going to
David Poppe: win your share over time. I would say Bob
It has grown tremendously over the last mentioned Bruce Turner in his speech we
five years. Wood furniture its probably over have a good degree of confidence in Bruce and
50%. Upholstery a lot of its still made here, his team, and their ethics and standards going
but thats moving overseas too. forward. And if you have confidence in that,
Bob Goldfarb: boy, its a very, very powerful market position
Now, when you see that kind of a that they have. I will turn it over to Terence on
change in that short a period of time, thats far Danaher.
more than enough to alter the fundamentals of Terence Par:
any industry significantly. On Danaher, weve been asked this
Question: question before. Basically, Danaher is an
I would like to ask about three industrial conglomerate in some very slow-
companies. The first one is GTech, the second growth businesses. And it expands by virtue of
one Danaher, and the third one is AutoZone. Its acquisition. They take their excess capital and
my understanding that GTech lost a couple of go out and buy other companies and apply the
contracts to a Greek company. With Danaher, Danaher Business System, which, essentially,
how long do you think their wonderful de-capitalizes these manufacturing concerns
corporate culture and their wonderful business and increases the amount of free cash they
model of buying industrial market leaders and throw off.
greatly increasing their profitability can I wish we owned more of it because
continue? Finally, you bought and sold each year, somebody asks this question, or a
AutoZone rather quickly. What made you do so? variation of it. But its hard to get comfortable
with a business that always seems to be selling
David Poppe: at a relatively high multiple versus other
GTech has an enormously dominant manufacturing companies, and that has to go
position in the lottery business, both in the U.S. out into the marketplace and buy companies to
and worldwide. I think they control about 70% get any kind of excess return. Its very risky, and
of lottery contracts worldwide and a similar it gets riskier the bigger the company gets. It
number in the U.S. Intralot is a Greek company. gets more and more difficult to find acquisitions
The only business they have in the US that Im that are of size that they can apply the Danaher
aware of offhand is Nebraska. Is that what Business System to. Its not unlike the
youre taking about? Intralot won the Nebraska difficulties that Warren Buffett faces at
contract about a year ago, but honestly, its Berkshire Hathaway. He has excess cash, and
almost an inconsequential contract in size. hes supposed to go out and buy stocks or buy
Intralot wanted to be in the U.S. market, and companies. He has the advantage in that he
they bid it to lose a large amount of money over generally leaves those companies alone. He will
seven or eight years. GTech was willing to walk pay a lower price than Danaher will because
away from Nebraska. hes not figuring to do anything dramatic to the
What I would say about GTech is Im business. He buys Shaw Industries and leaves it
not sure they can be underbid if they want a alone. He buys Flight Safety and basically
contract. They are the low-cost provider of leaves it alone because the returns that it will

A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

generate over time are just fine. Danaher cant uncertain to us that theyd be able to earn the
do that. They have to pay up, and theyve got to same returns on their capital in the future as
effect a transformation of the businesses they they had in the past.
get into. The other thing that concerned us was
Theyve been very good at it; Ive seen that as we did more research, we found that our
no diminution in the strength of the culture. Its view of reality differed somewhat from
just inherently a more risky way to go about managements. From different perspectives
running your business. And so, its difficult to reasonable people will often see the same thing
get comfortable with a larger position. If it got in different ways, and I think we just felt that, as
really, really cheap for some reason, maybe we a result of those two things, we werent really
could own more of it. But at this price, given comfortable owning the business for five or ten
their business model, as much as we admire years. And I think our general rule of thumb is
their track record and as much as we admire that if were not comfortable owning it for a
their culture, its hard to buy more, and there long, long time, then were not comfortable
you are. John? owning it for a very, very short period of time.
John Harris:
And so we sold.
AutoZone, for those who dont know, is Bob Goldfarb:
the leading retailer of auto parts and accessories And Id say with regard to AutoZone
for people who fix their cars themselves. We that whenever you see a business that has
looked at it for a long time last year, and I think already been milked so much, youre probably
its probably a good example of a challenge that better off just getting out of the way because at
we have faced, and will always face, which is some point, its not sustainable
that when we see what looks like a good price, Question:
which, as a few people have said earlier, is Would you please comment on the
increasingly rare in todays environment, the differences in the cultures you see between Wal-
question is, when in our research process do we Mart and Costco?
act? Our preference is always to do all of our
research first, and then make a decision with David Poppe:
complete information. Wal-Mart ultimately is more focused on
Unfortunately, good prices dont last the owner. They are both great. They both have
forever, and so, we probably hurried on well, admirable management cultures. They are very
we didnt probably hurry we did hurry on aggressive at what they do, excellent at what
AutoZone. We bought the stock before we had they do. Costco deservedly has a reputation for
finished our research, and that was partially my being a very, I say this in the best sense of the
fault. We learned as we proceeded with our word, paternalistic employer and a good place
research that the company has a number of to work. Wal-Mart does not have such a good
advantages and earns an extraordinary return on reputation. But they both really do have unique
capital for a retail business, and the price at the and, I think, driven cultures.
time we bought it I think we probably paid The difference to me, and this is a point
about ten times earnings for our holdings we argue about a lot, is that Wal-Mart is really
was incredibly attractive for a business with owner-focused. That is they want to make a
those characteristics. But as we did more return at the end of the day. I think their return
research, we learned two things that concerned on assets and their return on invested capital are
us. The first was that they had clearly benefited significantly higher than Costcos even though
from weak competition during the late 90s and Costco has the most productive stores in
the early part of this decade. American retail. It is hard to criticize people
And that situation was changing, and it like Jim Sinegal and Richard Galanti and the
continues to change today. And it was clear to Costco management team when they are so
us that they werent making investments in the good at what they do. But I think if faced with a
business necessary to deal with the increased problem or a crisis Jims first response would
competitive threat. And, as a result, it was always be to give something back to the

A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

consumer, and secondly to make sure the As for our business, well a lot has
employees dont feel it. And thirdly, the owners changed. We came into it at probably the perfect
will get what they get. And that is okay. But it time. In my particular class at the Harvard
has resulted in a company that is absolutely Business School, we had 645 graduates. And
world class at what it does, but does not only eight came to Wall Street, which is an
generate world class returns. Wal-Mart, on the indication of some sort. We were a
other hand, I think is world class at what it does, manufacturing-dominant country. And the
and generates world class returns. And I think it interest in finance was about zero. We happened
is arguable whether they do things that we to really enjoy it, and that is why we went into
would all prefer they didnt do to get them. But the business with low expectations. But I am an
you know, it is not a sweatshop. They dont optimist. I think that we can come up with
chain anybody to the desk, and they dont buy scenarios that will lead to some bumps. But, I
apparel or other imported goods that arent think our country will do just fine. And I think
widely available to every retailer in the world. that if you continue to think about your
And every other retailer in the world, in fact, investments on a five year basis, rather than
buys all of those goods in China; they just are over any short term period of time, and maintain
not as big as Wal-Mart. And that, to me, is the a reserve for your needs over the next five years
major difference. I love Costco, by the way. I that isnt connected with the ups and downs of
hate to say anything that is not totally flattering the stock market. I think five years from now
to Costco. But, it is what it is. and ten years from now, we will all be better off.
A question for Rick and for Bill, are Rick Cunniff:
you more optimistic or pessimistic about the I think that the biggest change that we
future than you were, say, in the last 35 years? have seen is in the level of competition. It is just
Bill Ruane:
unbelievable. As Bill said, there were eight
Well I am basically an optimist. But people in his class who went to Wall Street. I
over the last 55 years since we came in the was one year later, and we had ten. There was
business, the United States was just so no interest in investments, in Wall Street. The
dominant, and that will change over decades government bond rate was about 2 5/8%. And
with the enormous growth of China, India and the Dow Jones Industrials yielded 6% and was
the rest of the world. And I think productivity, selling at eight times earnings. This was 1950.
you know, crosses borders now. Eventually, the You can see what a tremendous change has
rapid growth of the Asian superpowers will occurred in all aspects of the business and in the
result in the loss of American economic valuation of stocks. So its very hard to say it is
dominance and maybe military hegemony. But going to be as good as it was with the tail wind
it will take a long time. that we had. But ours is a marvelous,
I think that we have a wonderful competitive country. We will keep our fingers
country, and I think that we have a great system crossed.
of government and enormous resources and Bill Ruane:
fundamentally really honest people managing I thought you might be interested, when
the government. So I am confident that the US I came down to Wall Street looking for a job; I
will remain dominant for several decades sent some letters out and got some responses.
certainly. I think the odds over the next ten And I went to one investment firm, a great
years are that we will see some bumps. Rick and investment firm. They interviewed me. And at
I have seen a number of them over the last the end of the interview I met a number of
50 years. And there will be some more. But I am people in the firm. They said that they would
very optimistic that we will do just fine for a like to offer me a job. And I met with the senior
long, long time. And I hope the two of us stick partner and he said, Now for college graduates,
around to see whether I am right. we pay $35 a week. However, since you went to
the Harvard Business School, we will make it

A Record of the Sequoia Fund Shareholders Meeting, May 13th 2005 New York, NY

$37.50. And there you have the value of a

Harvard Business School degree in 1949.
Things have changed.
Bob Goldfarb:
One last question.
Setting Fifth Third aside, Sequoia used
to own several bank stocks, and now owns very
few. Why is that?
Jon Brandt:
I would just say its company specific. I
dont think we have an industry view. We used
to own six bank stocks, but we sold for reasons
that were more company specific than industry
specific. We used to own Bank of Hawaii. We
sold that for one reason. We used to own Banc
One. We sold that for another reason. Bob,
would you connect the dots more than I am
Bob Goldfarb:
Well I would say with regard to the
large money center banks, we have avoided
them because of the risk inherent in their
activities, and those risks have only increased in
recent years with the explosive growth in
derivatives. That would preclude our interest in
that subset of the banking industry. You know, it
is interesting a number of years ago Warren
Buffett said that he was surprised at the
profitability of the banking business. It
inherently struck him as more of a commodity
business, which shouldnt lend itself to a very
high return on investment. Right now we are
seeing compressed margins on both the deposit
side and the lending side. We have seen those
situations before, and they have been
temporary. And I think the very valid question
which you raise is, Could it be more than
And with that we will adjourn. Thank
you very much. We look forward to meeting
with you again next year.