Investing for Growth: How to Make Money by Only Buying the Best Companies in the World – an Anthology of Investment Writing, 2010–20 - Terry Smith (Highlight: 185; Note: 0)
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◆ Foreword by Lionel Barber
▪ What Terry has taught me, and I suspect many others, is that there is little to be gained from venturing into the speculation business.
▪ I have little to contribute to the debate about the return of inflation. I would merely add that, in the spirit of Sir Isaac Newton’s third law of physics, at some point the extraordinary actions of the central banks must produce an opposite (if not necessarily equal) reaction.
◆ Introduction by Terry Smith
▪ we also hold an annual meeting at which investors can pose questions and see us answer them live and in public. This is not mandatory and we are the only mutual fund in the UK which does it. It has become the best attended annual general meeting in the UK
▪ There was much talk in the early years of Fundsmith’s existence about our strategy being all about consumer staples even though these stocks were never much more than half the portfolio at their peak. Latterly it is said to be all about tech stocks that are slated as a bubble about to burst even though such stocks have never been close to half our portfolio.
▪ A stock may have a low valuation but an even lower intrinsic value. Buying such a stock is not a recipe for investment success.
▪ As the sayings go, every dog has its day, and a rising tide floats all ships. In a strong bull market, especially in a recovery from an economic downturn, companies of this sort are apt to outperform the shares of the high-quality businesses we own. After all, the high-quality companies have nothing to recover from. If this worries you then Fundsmith’s approach is not for you.
▪ we regard the phrase “foreseeable future” as an oxymoron
▪ Very few companies make it through our filtering system as potential investments and even fewer make it into our portfolio.
▪ One of the lessons this illustrates is that you may only get to invest in really good businesses at a cheap rating when they have a problem.
◆ Straight Talking, 28 September 2010
▪ The only way to focus your fund manager on performance without gifting him or her most of your returns is to ensure he or she invests a major portion of their net worth alongside you in the fund and on exactly the same terms.
◆ Fundsmith, January 2011
▪ research clearly shows that if times are hard, consumers will reduce their spending on food for themselves or their children rather than cut back on their pets’ food
◆ Investment Week, 11 April 2011
▪ Simply by executing a share buyback rather than paying out dividends, companies can inflate their earnings per share (EPS) and are almost universally seen to have created value for shareholders when mostly they clearly have not.
◆ The Telegraph, 24 May 2011
▪ The ETF holdings are not all backed by assets of the sort investors expect, even if they understand what the ETF is meant to do.
◆ Straight Talking, 4 July 2011
▪ many companies seem to pay little or no apparent heed to the implied returns from share repurchases or even the price at which they buy back shares. With an ASR they literally have no idea at what price they are repurchasing them. They have in effect agreed to write a blank cheque to the investment bank to cover the cost of eventually purchasing the shares
◆ The Guardian, 18 July 2011
▪ Return on capital employed is one of the most important measures of corporate performance – it is the profit return which the management earns on the capital shareholders provide.
◆ Investment Week, 16 September 2011
▪ there is a certainty that ETFs are being mis-sold to the retail market and that the risks that are being incurred in running, constructing, trading and holding them are not sufficiently understood
◆ Financial Times, 12 November 2011
▪ making money is not the hard bit – holding on to it is
◆ Fundsmith, January 2012
▪ We prefer to judge our investments by what is happening in their financial statements than by the share price.
▪ If a fund which is described by the words “synthetic”, “derivative”, “swap” and “counterparty” does not cause you obvious concerns, I suggest you may need to study the events of the Credit Crisis of the past four years more carefully.
▪ So why buy an ETF rather than an index fund? You can deal daily in most index funds. The only people who want to deal more frequently than daily are hedge funds, high-frequency traders, algorithmic traders and idiots (these terms are not mutually exclusive).
▪ There may be no connection between the country in which a company is listed and its area of operations.
▪ No one exports significant amounts of bulky low-value items such as detergent.
▪ you cannot borrow and spend your way out of a crisis caused by overleverage
▪ holding shares in major, conservatively financed companies which make their profits from a large number of small, everyday, predictable events is a relatively safe place to be if you have the patience, fortitude and liquidity to ride out the share price volatility which is likely to occur in such circumstances
◆ The Guardian, 1 July 2012
▪ most banks serve their employees well, but few serve their customers or shareholders
▪ Traders are all about the short term and their myopia leads them to do things for short-term profit which risk ruination in the longer term.
◆ Financial Times, 23 November 2012
▪ Searching for an investment strategy or fund manager who can outperform the market in all reporting periods and varying market conditions is as pointless as trying to find a rider who can win every stage of the Tour.
▪ As the old saying goes, there are only two types of investor: those who can’t time the markets, and those who don’t know they can’t time the markets.
▪ Like the Tour, investment is a test of endurance, and the winner will be the investor who finds a good strategy or fund and sticks with it.
◆ Fundsmith, January 2013
▪ the rising tide of liquidity floats all ships
▪ It might be worth thinking about the implications when a business which sells some meals for one dollar is struggling to grow sales.
▪ So I did what you should always do when you get it wrong (but which all of us rarely manage to):
a) admit this (most importantly to yourself)
b) reverse the decision.
▪ It is always a mistaken strategy to wait for the shares to get below the point at which you sold them before repurchasing, or the even more common trait of waiting for a loss-making share purchase to get back to break-even before selling.
▪ almost every time we sell a position in a quality company we get to regret it in terms of subsequent share price performance
▪ We work on the assumption that government bonds would need to yield at least 1% over the expected rate of inflation to attract rational investors, and so we seek to invest in companies only when their FCF yield is the same as or more than that required bond yield.
▪ longevity and resilience
▪ you get better returns from investing in predictable high-quality companies than in smaller, riskier, more obscure company shares
▪ performance from increasing valuations is a finite game which also tends to even out over long periods of time
▪ Yield is an important element of investment return. Over the long run, it has contributed a higher percentage of equity performance than share price appreciation. But I would caution against a blind search for higher yields.
▪ New issuance has boomed in high-yielding real-estate investment trusts, and so-called master limited partnerships in energy stocks and pipeline companies (I wonder how many investors can explain how they work).
▪ At certain levels of yield, all that is happening is that the investor is being paid back some of the capital value of his or her investment as income, and taxed upon it.
▪ income tax is higher than capital gains tax and much more difficult to avoid or defer
▪ We think that investors should not focus solely upon yield but rather on the total return they derive from a share or a portfolio
▪ more QE to keep an otherwise stagnant economy across the developed world alive on life support
▪ governments will be able to fund their profligate spending programmes by getting the central bankers to print more money and buy their bonds until the employment or nominal growth targets are achieved, or even beyond
▪ At some point, the inevitable consequence of this is inflation
▪ they will all depreciate against hard assets, or to put it more simply – inflation
▪ macro views and developments have no bearing on our strategy
▪ our stocks are likely to be a relatively good hedge against a resurrection of inflation
◆ Financial Times, 18 January 2013
▪ market returns increase with relative CROCI. Better companies made better investments
◆ Financial Times, 15 February 2013
▪ Stocks are a “Giffen good” for most investors – demand paradoxically rises as their price increases.
▪ We don’t enjoy the lonely feeling of the contrarian who invests when everyone else is selling and sells when everyone else is bullish.
▪ A good company is one that regularly makes a high return in cash terms on capital employed, and can reinvest at least part of that cash flow in order to grow its business and compound the value of your investment.
▪ With a good company, time is on your side.
▪ Only buy investments that you really want to own and at a price at which you are happy to own them.
▪ If you don’t like what’s happening to your shares, switch off the screen
▪ If you have chosen shares in good companies or a fund at reasonable prices, and you find gyrations in their prices unsettling, then simply stop looking at the share prices.
◆ Financial Times, 1 March 2013
▪ If you missed the best 30 days, your returns would be negative.
▪ Do you really think you are good enough to spot those days and make sure you are fully invested and ready for them? I know I’m not.
▪ there are only two types of investors – those who know they can’t make money from market timing, and those who don’t know they can’t
◆ Financial Times, 15 March 2013
▪ You will rarely read much about a company’s return on capital employed (ROCE).
▪ If you buy a share in a company, you are in effect purchasing your share of its capital.
▪ Those that make a return above their cost of capital create value for their shareholders, while those that make a return below their cost of capital destroy value.
▪ as an investor you should only be truly interested in companies whose returns are so high that they exceed any feasible cost of capital
▪ Warren Buffett described return on capital as the primary test of performance in managing a company. It has often puzzled me why such a clear statement from such a successful investor is so widely ignored.
▪ when you own shares in a company that generates returns well above its cost of capital. You don’t need to hold out for a takeover, a boardroom coup or a change in the business cycle, because you can be assured that its intrinsic value is growing practically every day. Time is on your side.
◆ Financial Times, 28 March 2013
▪ We are often blinded by the ability to avoid tax.
◆ Financial Times, 12 April 2013
▪ the more stocks you own, the more you are likely to have to compromise on quality
▪ It is also a fact that the more stocks you own, the less you know about each of them and I have never found a theory of investment that suggests that the less you know about something, the more likely you are to generate superior returns.
▪ Security Concentration and Active Fund Management: Do Focused Funds Offer Superior Performance? by Travis Sapp and Xuemin Yan
◆ Financial Times, 29 April 2013
▪ In other words, more than 100% of the expected income on portfolios is being absorbed by charges.
◆ The Telegraph, 18 October 2013
▪ be wary of anyone who begins a statement with “to be honest”, as it begs the question of whether they are normally dishonest
▪ If so, perhaps he would also be happy to “group together” (can you group apart?) and do some “forward planning” (what other sort is there?).
▪ At Fundsmith we keep a banned word count for the companies we analyse because we think they provide an insight into their management.
▪ A classic example is Domino’s Pizza, which began a turnaround in 2009 by publishing harsh criticism from its customers such as ‘Pizza was cardboard’. You only do that if you intend to change. Since then, shares have risen from $8.50 to $68. It has been one of our largest holdings since the inception of the fund.
◆ Financial Times, 6 December 2013
▪ But tontines soon caused problems. Their structure created an obvious incentive for members to kill each other
▪ Goldman Sachs sold “Autocallable Contingent Coupon Buffered Equity-Linked Medium-Term Notes” (here’s a clue: what does it do? If you don’t understand it, don’t invest)
◆ Fundsmith, January 2014
▪ no one has ever established a correlation between GDP growth and the performance of stock markets
▪ markets were more concerned that economic recovery would lead to the withdrawal of this stimulus than they were bullish about the recovery itself
▪ whatever the outlook it will not alter our methodology of investment
▪ we have yet to find an industry which can grow without committing additional capital in order to do so
◆ Financial Times, 7 February 2014
▪ If you see a bandwagon, it’s too late.
◆ The Telegraph, 14 February 2014
▪ even if we are good at what we do, we are capable of producing a bad result because we allow our own emotions to defeat us
▪ owns enough shares to roughly track an index – and you don’t need more than about 25 randomly chosen shares to do so in most markets
◆ Financial Times, 24 February 2014
▪ Mr Buffett, who identified return on capital as the primary test of company performance in his 1979 annual chairman’s letter
▪ I suspect the reality is that very few investors or analysts read annual reports and 10-K filings any more
◆ Financial Times, 8 March 2014
▪ The idea of investing with a century as a time horizon is clearly unrealistic. Not much lasts forever in the world of equity investment.
◆ Financial Times, 11 April 2014
▪ factors including property rights, corruption, size of government, regulation, flexibility of labour and liberality of markets.
Places such as Singapore, Switzerland and Hong Kong rank near the top. The highest-ranked Bric is Brazil at number 114 (out of 186), followed by India at 120, China at 137 and Russia down in 140th position.
◆ Financial Times, 1 August 2014
▪ A strategy of investing in consumer staples companies with the bulk of their operations in developing markets has substantially outperformed the other emerging markets investment strategies that I reviewed in my previous article, over the past five to ten years.
◆ Financial Times, 1 November 2014
▪ never to invest in a business which requires leverage or borrowing to make an adequate return on equity
◆ Fundsmith, January 2015
▪ Our investment approach is thankfully not based upon our view of the global economic outlook.
▪ In short, our “company” has much better financial performance than the market as a whole and is more conservatively funded.
▪ we have yet to find an industry which can grow without committing additional capital in order to do so
▪ our mantra is: “Don’t just do something, sit there.”
◆ Financial Times, 9 January 2015
▪ A company that can sustain a return on capital above its cost of capital creates value for its shareholders, who should want it to retain at least part of its profits to reinvest at these attractive rates of return rather than handing them all over as dividends or using them to buy back shares.
▪ a company’s cost of capital is not easy to define and can only ever be an estimate
▪ a company can be busy destroying shareholder value even as it increases its earnings
◆ Financial Times, 6 February 2015
▪ confusing creating shareholder value with making the share price go up
▪ managers usually look to reduce the capital employed by “de-equitising” the business, using debt to buy back shares
▪ The cost-cutting and share buybacks are certainly finite – you can’t shrink your business to growth.
◆ Fidelity, 27 February 2015
▪ When you own shares in a good company, you can be sure that its value will rise over time.
◆ Financial Times, 22 May 2015
▪ They do not seem to realise that without a business selling something which customers want, no amount of financial wizardry will create lasting value.
◆ The Telegraph, 12 June 2015
▪ The reality is that we don’t seek to predict who will win, but rather to bet on a company that has already won.
▪ We simply need to wait until the market misprices these shares in order to get our chance to bet on a certain winner.
◆ What investors can learn from Sir Alex Ferguson’s success
▪ Sir Alex Ferguson’s
◆ The Telegraph, 19 June 2015
▪ investors should be wary when a long-standing and highly successful chief executive leaves a business
◆ Financial Times, 26 June 2015
▪ If you plan to hold a share for the long term, the rate of return on capital it generates and can reinvest at is far more important than the rating you buy or sell at.
◆ Financial Times, 17 July 2015
▪ You do not achieve this result if you invest in equities and take the dividend and spend it.
▪ You would have had a better result than in Mr Bogle’s example if you had invested dividends not in the whole index, but in companies that delivered a return superior to the index; and/or if instead of paying a dividend the companies had simply retained all the earnings and reinvested them, assuming they could deploy the additional cash at an adequate rate of return.
◆ Financial Times, 24 July 2015
▪ the solution is simply to redeem some of the capital sum
◆ Daily Mail, 9 November 2015
▪ We still have the same strategy that we launched with five years ago. We only buy shares in good companies, try not to overpay and then do nothing.
◆ Financial Times, 21 November 2015
▪ no one has ever managed to demonstrate a positive correlation between GDP growth and stock market performance
▪ If you are a long-term investor, owning shares in a good company is a much larger determinant of your investment performance than whether the shares were cheap when you bought them.
▪ I have also learnt that selling a stake in a good company is almost always a mistake.
▪ Run your winners. Too often investors talk about “taking a profit”. If you have a profit on an investment it might be an indication that you own a share in a business which is worth holding on to.
▪ The franchiser gets a royalty from revenues generated by other people’s capital.
▪ In a business which can service the debt there is a transfer of value to the equity holders as the debt is paid down and the equity is de-risked.
◆ Fundsmith, January 2016
▪ In the long term one will follow the other, and it is not the fundamentals which will follow the share price.
▪ When they do things which are different, exciting and outside their core area of competence we become worried. Hence our sale of Choice Hotels.
◆ Financial Times, 15 January 2016
▪ tendency for professionals to concentrate on their work and neglect their own needs – even in their own area of speciality
◆ Financial Times, 8 September 2016
▪ the acquired businesses started to produce returns and growth rates which began to drag the acquirers’ performance down to their level.
◆ Financial Times, 14 September 2016
▪ The term refers to a period in the 1960s and 70s when 50 large-cap stocks on the New York Stock Exchange that were widely regarded as solid buy-and-hold growth stocks reached towering valuations. The stocks were often described as “one-decision”. They were viewed as extremely stable, even over long periods of time, so that only a decision to buy them was required as they never needed to be sold.
◆ The Telegraph, 29 October 2016
▪ If you are a long-term investor, buying shares in a good business is more important than valuation. If you are not a long-term investor, what are you doing investing in the stock market?
◆ Fundsmith, January 2017
▪ I remain amazed (I could stop this sentence there) by the number of commentators, analysts, fund managers and investors who seem to be obsessed with trying to predict macro events on which to base their investment decisions.
▪ I am reluctant to agree with the commentators who suggest that you or I should sell our portfolio of great companies and invest in a portfolio of assorted junk in the hope that it will go up
◆ Financial Times, 17 February 2017
▪ If money pours into markets via ETFs it will cause the shares of the largest companies in the index to perform well irrespective of their quality or value, or lack of it
▪ an active fund manager should regard this as an opportunity to own more of the shares which are better than the index average and will eventually produce superior returns if the manager and the investors have the patience necessary to wait for this to occur
◆ Financial Times, 20 April 2017
▪ It is the reinvestment of retained earnings, not dividends, which provide the majority of the growth in the value of equities.
▪ if a company is able to invest retained earnings at a high rate of return then the last thing you would want it to do is pay you a dividend
◆ Financial Times, 4 August 2017
▪ the odds of any one compound making it through all the stages of clinical trials and to market are about one in 10,000. Moreover, even when a drug is successful, patents have a limited life and the drug companies are running on a treadmill which requires more and bigger discoveries and product development to drive growth
◆ Fundsmith, January 2018
▪ Thankfully, I spend little or no time trying to apply predictions about macro events in order to manage our portfolio.
▪ our fund will only own a maximum of 30 shares
▪ a few sectors which have the characteristics we seek: consumer staples, some consumer discretionary products, healthcare and technology
▪ we have never found a business which can cut its way to growth
▪ the sort of people and approaches you need to grow businesses tend not to flourish in cultures in which the emphasis is on cost-cutting
▪ Warren Buffett is notoriously opposed to hostile takeovers.
◆ Financial Times, 18 January 2018
▪ What return does a company get on its capital expenditure? If it is inadequate it will fail.
◆ Financial Times, 31 August 2018
▪ This chart is an “efficient frontier” to use the jargon of the investment business.
▪ What it shows is that if you changed 35% (seven blobs) of your portfolio to MSCI World Small Cap you would get a higher return for the same risk.
◆ Financial Times, 3 October 2018
▪ There appears to be something so alluring about dividend income that it often seems to lead investors to abandon common sense or be encouraged to do so by the investment industry.
▪ If you are in the UK and a higher-rate taxpayer, dividend income will be taxed at 32.5%, so you will only be left with 67.5 cents out of every dollar of dividend to reinvest.
▪ A portion of the returns that companies generate are retained and automatically reinvested on your behalf. This creates more value than you can ever capture by reinvesting dividends – except, of course, when the reinvestment is done badly, with management investing when returns are inadequate.
▪ This advantage of equities is magnified if instead of investing in an average company you invest in a company with a higher than average rate of return on capital.
▪ The need to get spending money from your investments once you’re retired is obvious. But why does it have to come from dividends? Surely the right approach is to invest for the maximum total return you can achieve and then redeem whatever units you have to provide for your spending needs.
◆ Financial Times, 7 November 2018
▪ The reason that equity index returns beat US Treasuries while most of the stocks in them do not is really quite simple. Large positive returns from a few stocks offset the modest or negative returns from the vast majority of stocks.
▪ Most alarmingly, the median stock entering the market since 1977 did not just underperform Treasuries but had a negative return.
▪ the returns from active stock selection can be large if the investor selects a concentrated portfolio of the few stocks which offer positive returns
◆ Fundsmith, January 2019
▪ the article described a recent one-day fall in the Dow of 3.1% as ‘eye-popping’. The fall of seven times that scale in 1987 would surely have led them to exhaust the lexicon of hyperbole. Who knows what might have popped then?
▪ Bull markets do not die of old age so ignore warnings which are based on a phrase such as “This bull market has gone on for a long time.” They usually die from some event, often but not always rising interest rates.
▪ just the “FAANGs” (Facebook, Amazon, Apple, Netflix and Google)
▪ A bear market will occur at some point. We may indeed already be in one. The best stance is to ignore it since you can’t predict it or position yourself effectively to avoid it without impoverishing yourself by forgoing gains. But you have to possess the emotional and financial stability to stick to this stance when it strikes.
▪ When this occurs, the value investor seeks to realise his or her gains and move on to find another value stock on which to repeat this performance.
▪ companies in our portfolio continue to have significantly higher returns on capital and better profit margins than the average
▪ we have often found that the only time you can hope to buy stock in great businesses at a cheap valuation is when they have a glitch
▪ We think good businesses are identifiable from the numbers they produce.
▪ in trying to reach for short-term targets essential product development might be neglected
▪ Are you really smart enough to not only a) predict a market fall but also; b) figure out how this translates into individual stock movements; c) get your timing sufficiently correct that you do not either forgo gains which far outweigh any losses you protect against or suffer some of the downturn; d) have sufficient mental agility and nerve to start buying when your prediction of a market fall has become reality; and e) get the timing roughly right on that side of the trade so that you don’t end up catching the proverbial falling knife or missing some or all of the recovery? If so, I doubt you will be reading this letter on your private island. But above all, I doubt you exist.
◆ Fundsmith, January 2020
▪ With 3M we were acting on growing doubts about the current management’s capital allocation decisions, and in the case of Colgate-Palmolive we grew tired of waiting for an effective growth strategy to emerge.
▪ the most likely source of such a reversal – a rise in interest rates
▪ product innovation and R&D, strong brands, control of distribution, market share, customer relationships, installed bases of equipment or software, management, successful capital expenditure and acquisitions
▪ A lot of superior returns have been had from those allegedly expensive stocks
▪ most of the stocks which have valuations which attract value investors have them for good reason – they are not good businesses. This means that the value investor who buys one of these companies (which are indeed lowly rated but which rarely or never make an adequate return on capital) is facing a headwind.
▪ whilst the value investor is waiting for the lowly valuation to be recognised and the share price to rise to reflect this
▪ Value investing is not something which can be pursued with a buy-and-hold strategy.
▪ The only uncertainty concerns our ability to forecast returns far ahead, which is why we prefer to invest in relatively predictable businesses.
▪ retention of earnings which are reinvested in the business can be a powerful mechanism for compounding gains
▪ If you were a great (and long-lived) value investor who bought the S&P 500 at its low in valuation terms, which was in 1917 when America entered the First World War and it was on a PE of 5.3×, and sold it at its high in valuation terms in 1999 when it was on a PE of 34×, your annual return during that period would have been 11.6% with dividends reinvested, but only 2.3% p.a. came from the massive increase in PE and 9.3% (80% of 11.6%) came from the companies’ earnings and reinvesting their retained earnings.
▪ proportion of your return from the companies’ reinvestment activities is even more extreme when you invest in a good company with a high return on retained capital
▪ Time is the friend of the wonderful business, the enemy of the mediocre.
▪ S&P 500 (USD) which peaked on 9 October 2007 but had regained its 2007 high by 2013 and at 31 December 2019 stood 189% higher
▪ there are some commentators who say that one way to address this is to have a portion of your portfolio invested in both strategies – some in quality growth and some in value. I think the assertion that there is no harm in this diversification approach has been disproved rather comprehensively by Warren Buffett
▪ all seem to have become extraordinarily rich by concentrating their investment in a single high-quality business and not trading regardless of valuation. So much for it not doing any harm to diversify across strategies.
▪ are the only mutual fund in the UK which holds an annual meeting at which our investors can question us and see their questions answered publicly
▪ There will be no style drift at Fundsmith.
◆ Fundsmith, 31 March 2020
▪ Will the extreme measures taken by governments to maintain the economy lead to inflation?
▪ I try to spend very little time considering matters which I can neither predict nor control and focus instead on those which I can affect
◆ Financial Times, 30 April 2020
▪ I have long said that no one should invest in equities for income.
▪ The best way to approach this is to invest for the highest total return you can achieve and sell whatever shares or units you need to provide cash. However, I realise that for many investors, the idea of realising part of their capital to provide income is anathema.
▪ If you insist on investing for dividend income, consider investing alongside a family which founded and has control of a public company.
▪ Very often these extended families, descended from the business founder, rely on the dividend income from the family business.
◆ Financial Times, 2 July 2020
▪ Should you risk foregoing any significant portion of that gain for a maximum upside of 0.4% per year?
◆ Global Finance Mauritius, August 2020
▪ “When do you think things will get back to normal?” What makes the questioners think that the state of affairs which existed before the pandemic was normal?
▪ It’s easier to stimulate asset prices than it is to stimulate an economy.
▪ The only type of market which ends in a recession is a bear market – markets are forward-looking discounting mechanisms.
▪ Looking back, it seems that crises, including pandemics, accelerate some existing economic trends.