SEQUOIA FUND, INC.

QUARTERLY REPORT

For the Period Ended September 30, 1999

 

 

 

 

 

 

 

Dear Shareholder:

Sequoia Fund's results for the third quarter of 1999 are shown below with comparable results for the leading market indexes:

September 30, 1999

Sequoia

Fund

Dow Jones

Industrials

Standard &

Poor's 500

Three months

-14.4%

-5.4%

-6.2%

Nine Months

-17.6%

14.0%

5.4%

 

1999 has been a serious disappointment for Sequoia Fund shareholders, including ourselves. Our expectations for 1999 performance going into the year were very modest in view of the unsustainably high rate of price increases of many our portfolio stocks over the prior three years. However, we did not expect to retrace our steps to the extent we have. It has been a humbling process and a great test of our patience.

Most of Sequoia's 1999 shortfall can be attributed to sharp declines in the share prices of three of our major long-term holdings, Berkshire Hathaway, Progressive Corporation and Freddie Mac.

The automobile insurance and reinsurance industries are experiencing cyclical profit difficulties to which Berkshire’s important GEICO and General Re subsidiaries, as well as Progressive, are exposed. Given robust growth in general corporate earnings and an almost manic excitement about technology stocks, we can appreciate the lack of investor interest and shift of funds from Progressive and Berkshire that has accounted for much of the decline in Sequoia's asset value this year.

However, we constantly ask ourselves "where will each of our companies be in five years and what are the prospects for a significant return on our money during that period?" We say our money because directly or indirectly the four of us have significant investments in each of Sequoia's holdings, as does every employee of our firm. We share the conviction that Berkshire and Progressive are likely to significantly increase their basic earning power over the next five years, both in absolute terms and relative to the likely gains in general corporate profits as well. Both GEICO and Progressive have produced spectacular returns for their owners over a long period of time. We believe both companies are in the forefront of a revolution in the way automobile insurance is sold. GEICO historically has been almost alone in the direct sale of auto insurance. Progressive, a leader in selling auto insurance through agents, has recently made major investments in a direct sales effort while maintaining and growing the core of its business through agents. Currently, the efforts of both companies to expand their direct sales channels call for continuing large investments in advertising and marketing/underwriting support infrastructure. These investments have significantly reduced near term profitability and exacerbated the cyclical profit squeeze.

Progressive’s management team has generated 20% compound annual earnings growth for the last 20 years. Their stated goal is to compound earnings at 15% plus inflation and we have confidence that their current plans are likely to achieve that goal over the next five years. Progressive’s management team is very innovative and has constantly driven change in an industry not known for creativity. In previous shareholder letters, we have cautioned that our tolerance for retaining stocks of companies that we believe have excellent long-term prospects may lead to volatile price performance that periodically borrows from the future. In the case of Progressive, it has clearly been a short-term error that we did not reduce our holdings more than we did earlier this year. We were caught off guard by the sharp reversal in cost trends that severely eroded Progressive’s underwriting margin. However, we believe that from its current price, Progressive should be a rewarding investment.

In the case of Berkshire Hathaway, we also think it likely that GEICO’s revenues and earnings will grow substantially over the next five years. Berkshire’s Executive Jet subsidiary will grow dramatically into a worldwide operation and will likely occupy a unique position in the aviation world. General Re is likely to revert to its historical norm of profitability, which with modest growth, could add hundreds of millions of dollars to earnings. In addition, we believe there is a high probability that Berkshire will be able to increase the profitability of the $36 billion or so it currently has invested in low-yielding fixed-income securities. We believe the next five years are likely to offer opportunities to redeploy this capital at higher returns in ways simply not available today. The combination of these factors should make Berkshire an attractive investment for many years.

After two consecutive years of stock price increases greater than 50%, we had modest expectations for our investment in Freddie Mac going into 1999. We did not, however, expect a price decline of the magnitude we have seen. Freddie Mac is having an outstanding, above-trend year, with 1999 earnings expected to increase by 27% over 1998. We believe the decline in Freddie Mac’s stock price this year has been driven primarily by the rise in interest rates. Freddie Mac operates in the mortgage industry, some parts of which are highly interest-rate sensitive. However, Freddie Mac’s earnings performance has proven over several interest rate cycles to be relatively insensitive to rate changes. In addition, in recent years the company has been reinvesting a portion of its strong earnings to continually reduce its already low exposure to interest rates.

Looking beyond our existing portfolio holdings, we believe our continuing disciplined focus on economic fundamentals rather than market fashion will allow us to find attractive uses for Sequoia's 23% in cash equivalents over time.

Momentum in the stock market has a way of feeding on itself and becoming self-fulfilling. Just in the past few weeks, there have been a number of initial public offerings of small companies with no earnings and almost no revenues, whose share prices have soared (in one case, by almost 700%) on their first day of trading. In many cases, investors have accorded these fledgling companies instant market values in excess of a billion dollars. According to a recent New York Times article, about one third of companies going public in 1999 paid more in investment banking fees than they booked in revenues in the preceding year! The last time we observed market momentum of this magnitude was in the early seventies, when it was fueled almost entirely by institutional investors. Today, some three thousand eight hundred equity mutual funds and other institutions are joined by millions of individuals (including some five to ten million day traders) who, with limited experience, have found that picking short-term winners has not been all that hard. This has lifted many stocks to levels that far exceed the reasonable margin of safety that we seek. Current conditions bring to mind economist Herb Stein’s wonderful comment, "When something cannot go on forever, it usually doesn’t."

Finally, we believe you will find the enclosed article very interesting. Mr. Buffett rarely goes public with his views of the future but when he has they have been remarkably farsighted.

 

Sincerely,

Carley Cunniff

Richard T. Cunniff

Robert D. Goldfarb

William J. Ruane

Executive Vice President

Vice Chairman

President

Chairman

 

 

 

SEQUOIA FUND, INC.

STATEMENT OF INVESTMENTS

SEPTEMBER 30, 1999 (UNAUDITED)

 

 

COMMON STOCKS (76.6%)

Shares

 

Value (a)

  BANK HOLDING COMPANIES (13.3%)  

5,958,662

Fifth Third Bancorp

$ 362,547,341

323,700

Mercantile Bankshares Corporation

10,014,469

1,145,900

National Commerce Bancorp

25,173,991

4,142,300

US Bancorp

125,045,681

   

522,781,482

  CONSUMER PRODUCTS (.1%)  

247,500

Sturm, Ruger & Company, Inc.

2,227,500

  DIVERSIFIED COMPANIES (28.3%)  

20,175

Berkshire Hathaway, Inc. Class A ( c)

1,109,625,000

  INSURANCE (7.9%)  

3,800,900

Progressive Corporation-Ohio (b)

310,486,019

  MANUFACTURING - MOTORCYCLES (6.1%)  

4,777,500

Harley Davidson, Inc.

239,173,594

  PERSONAL CREDIT (1.8%)  

1,765,000

Household International, Inc.

70,820,625

  SERVICES (16.8%)  

12,632,900

Freddie Mac

656,910,800

  Miscellaneous Securities (2.3%)

88,428,975

  TOTAL COMMON STOCKS

$ 3,000,453,995

 

U.S. GOVERNMENT OBLIGATIONS (23.0%)

Principal

Amount

Value (a)

$ 10,000,000

U.S. Treasury Bills due 11/4/99

$ 9,957,972

246,000,000

U.S. Treasury Notes, 5 5/8% due 12/31/99

246,345,938

259,000,000

U.S. Treasury Notes, 5 5/8% due 04/30/00

259,607,031

152,000,000

U.S. Treasury Notes, 5 3/8% due 07/31/00

152,071,250

236,000,000

U.S. Treasury Notes, 5 1/2% due 08/31/01

235,557,500

  TOTAL U.S. GOVERNMENT OBLIGATIONS

$ 903,539,691

 

SUMMARY

Common Stocks.. 76.6%

$ 3,000,453,995

U.S. Government Obligations.. 23.0%

903,539,691

Net Cash & Receivable.. 0.4%

17,476,222

Net Assets

$ 3,921,469,908

Number of Shares Outstanding

30,650,524

Net Asset Value Per Share

$ 127.94

 

  1. Securities traded on a national securities exchange are valued at the last reported sales price on the principal exchange on which the security is listed on the last business day of the period; securities traded in the over-the-counter market are valued at the last reported sales price on the NASDAQ National Market System on the last business day of the period; securities traded in the over-the-counter market and listed securities for which no sale was reported on that date are valued at the mean between the last reported bid and asked prices; U.S. Treasury Bills with remaining maturities of sixty days or less are valued at their amortized cost. U.S. Treasury Bills that when purchased have a remaining maturity in excess of sixty days are stated at their discounted value based upon the mean between the bid and asked discount rates until the sixtieth day prior to maturity, at which point they are valued at amortized cost.
  2. Affiliated Companies: Investment in portfolio companies 5% or more of whose outstanding voting securities are held by the Fund are defined in the Investment Company Act of 1940 as "affiliated companies."
  3. Non-income producing.

 

 

SEQUOIA FUND, INC.

767 Fifth Avenue, Suite 4701

New York, New York 10153-4798

Website: www.sequoiafund.com

  

DIRECTORS

William J. Ruane
Richard T. Cunniff
Robert D. Goldfarb
Carol L. Cunniff
John M. Harding
Francis P. Matthews
C. William Neuhauser
Robert L. Swiggett
Roger Lowenstein

 

OFFICERS

William J. Ruane Chairman of the Board
Richard T. Cunniff Vice Chairman
Robert D. Goldfarb President
Carol L. Cunniff Executive Vice President
Joseph Quinones, Jr. Vice President, Secretary & Treasurer

 

INVESTMENT ADVISER & DISTRIBUTOR

Ruane, Cunniff & Co., Inc.

767 Fifth Avenue, Suite 4701

New York, New York 10153-4798

 

CUSTODIAN

The Bank of New York

MF Custody Administration Department

100 Church Street, 10th Floor

New York, New York 10286

 

REGISTRAR AND SHAREHOLDER

SERVICING AGENT

DST Systems, Inc.

P.O. Box 219477

Kansas City, Missouri 64121

 

LEGAL COUNSEL

Seward & Kissel

One Battery Park Plaza

New York, New York 10004

 

 

This report has been prepared for the information of shareholders of Sequoia Fund, Inc.