William John Ruane was born on Oct. 24, 1925, in a middle class neighborhood in Chicago, and grew up in the suburb of Oak Park, Ill. He graduated from the University of Minnesota in 1945 with a cum laude degree in electrical engineering. He immediately joined the Navy and was on the way to Japan when World War II ended.
After the war, he worked briefly for General Electric (GE), only to discover that he disliked engineering.
He enrolled at Harvard Business School and found his calling when a professor urged his class to read the classic textbook ”Security Analysis: Principles and Techniques” (1940), which helped him to focus his interest. Although he knew nothing about stocks, he was impressed with the approach authors Benjamin Graham and David Dodd took to financial analysis. After graduating in 1949, he went to work for Kidder Peabody, where he remained for almost 20 years.
In 1950, Ruane and Buffett sat in on a class Benjamin Graham taught at Columbia University, where they learned that the quality of earnings was just as important as growth in earnings.
Ruane and partner Richard T. Cunniff founded their investment management firm in 1969 after raising $20 million from investors. Most of their customers came to them on the recommendation of Warren Buffett, Ruane’s former classmate and a close friend.
Ruane’s Four Rules of Smart Investing
During a class he taught at Columbia University, Ruane laid out the four rules that guided his investment career:
1. Buy good businesses. The single most important indicator of a good business is its return on capital. In almost every case in which a company earns a superior return on capital over a long period of time it is because it enjoys a unique proprietary position in its industry and/or has outstanding management. The ability to earn a high return on capital means that the earnings which are not paid out as dividends but rather retained in the business are likely to be re-invested at a high rate of return to provide for good future earnings and equity growth with low capital requirement.
2. Buy businesses with pricing flexibility. Another indication of a proprietary business position is pricing flexibility with little competition. In addition, pricing flexibility can provide an important hedge against capital erosion during inflationary periods.
3. Buy net cash generators. It is important to distinguish between reported earnings and cash earnings. Many companies must use a substantial portion of earnings for forced reinvestment in the business merely to maintain plant and equipment and present earning power. Because of such economic under-depreciation, the reported earnings of many companies may vastly overstate their true cash earnings. This is particularly true during inflationary periods. Cash earnings are those earnings which are truly available for investment in additional earning assets, or for payment to stockholders. It pays to emphasize companies which have the ability to generate a large portion of their earnings in cash. Ruane had no taste for tech stocks. He stressed the importance of understanding what a company’s problems might be. There are two kinds of depreciation: 1. Things wear out. 2. Things change (obsolescence).
4. Buy stock at modest prices. While price risk cannot be eliminated altogether, it can be lessened materially by avoiding high-multiple stocks whose price-earnings ratios are subject to enormous pressure if anticipated earnings growth does not materialize. While it is easy to identify outstanding businesses it is more difficult to select those which can be bought at significant discounts from their true underlying value. Price is the key. Value and growth are joined at the hip. Companies that could reinvest at 12% consistently with interest rate at 6% deserve a premium.