Sequoia's New (and Old) Positions: Great Long Term Bets

Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Over the past ten years, the five-star rated (by Morningstar) Sequoia Fund has significantly diversified its holdings, from 15 holdings to more than 40. Though still more concentrated than the majority of mutual funds, its foray into multiple new holdings should be closely analyzed given the fund's unbelievably consistent outperformance over the last four decades. Two new Sequoia Fund positions are of particular interest: Waters Corporation (NYSE: WAT) and Linear Technology (NASDAQ: LLTC)

Investing in Buffett-Like Moats

Sequoia follows Warren Buffett's investment philosophy, buying companies with economic moats, or durable competitive advantages, and holding them for very long periods. In fact, the fund maintains an impressively low annual portfolio turnover rate of just 3%. In other words, the typical Sequoia investment makes a great potential investment for the long-term investor. The majority of Sequoia's investments have fared very well, evident in the fund's returns displayed below:

<img src="/media/images/user_13783/sequoia-fund-performance_large.jpg" />

(image source: SequioaFund.com)

Many investment managers claim to follow Buffett's economic moat mantra, but few follow it as religiously as the managers at Sequoia. 

Since June of 2011, co-managers Bob Goldfarb and David Poppe have added 11 new stocks. McDevitt points out that every one of the new additions that Morningstar covers has been assigned an economic moat by Morningstar. Two of these additions were awarded Morningstar's highest competitive advantage designation of "wide moat": Waters and Linear Technology.

Waters

Waters supplies analytical instruments, including liquid chromatography, mass spectrometry platforms, and thermal analysis tools to industrial, biochemical, and pharmaceutical customers. More than half of Waters' revenue comes from instruments, and the remaining revenue comes from related consumables and services.

Waters' thermal instrument segment is the company's cash cow, with operating margins exceeding 20%. Needing minimal capital investment, the returns on invested capital for this segment are much higher than the other segments. Furthermore, Waters has a solid market position in India and China, both proving to be growth markets for the company.

With a leadership position in many of its markets, especially chromatography, Waters is able to earn returns on invested capital well above its peers. This is clear evidence of the firm's economic moat.

Measured by price-to-book value, Waters seems expensive at 5.7 compared to the industry average of 2.5. But the company trades at just 15.6 times forward earnings despite over ten years of solid and reliable earnings and revenue growth.

Linear Technology

Linear Technology's production of high-performance analog (HPA) integrated circuits is backed by expertise and disciplined strategic focus, increasing barriers to entry. As a leading designer and manufacturer of these HPA chips, Linear Technology has a durable competitive advantage that helps the company print cash like nobody's business; the firm generates operating margins in excess of 40%.

The firm is fairly priced at 15.8 times forward earnings. But it would be unrealistic for investors to expect Linear Technology to trade much lower considering its ability to throw off cash; the company manages to turn 44 cents of every dollar of sales into free cash flow. Furthermore, the company has a strong dividend yield at 2.94%.

Sequoia's Three Largest Holdings

Though these two new positions are definitely deserving of a good look, it's worth noting that Sequoia still keeps the majority of its portfolio very concentrated. In fact, 27% of Sequoia's holdings are invested in just three stocks: Valeant Pharmaceuticals (NYSE: VRX), TJX (NYSE: TJX), and Berkshire Hathaway (NYSE: BRK-B), representing 11%, 8.1%, and 7.56% of the portfolio, respectively. Yet another testament to Sequoia's ability to pick winners, these top three holdings have all outperformed the S&P 500 in the last three years. Even more impressive, Sequoia's top two holdings have crushed the market: Valeant Pharmaceuticals by more than three times over and TJX by five times over.

<img src="http://media.ycharts.com/charts/9a34a9671ff76ca0fb058e5a4875d933.png" />

BRK.B data by YCharts

The Bottom Line

Coattail investing, or mimicking the investments of highly successful investors, is a practice that has been around for a long time. But the best way for the individual investor to practice coattail investing is not to mimic successful investors blindly, but instead to use successful investors' investments as a source of ideas. Waters and Linear Technology both have characteristics of a business with a durable competitive advantage, making the stocks good long-term bets. But if you are not confident in your stock picking abilities, you might want to start your search with Sequoia's top three holdings given Sequoia's obvious confidence in these picks.


DanielSparks has no positions in the stocks mentioned above. The Motley Fool owns shares of Berkshire Hathaway. Motley Fool newsletter services recommend Berkshire Hathaway and Linear Technology. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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