30 Investing Lessons from Terry Smith
Before we get into today’s article I wanted to you wish you all a Happy New Years, hope you are all doing well.
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Now coming back to the topic of today’s article, Terry Smith is an investor from England and current CEO of Fundsmith which has awarded its investors with a 15.8% annualized return since its inception in 2010.
The bedrock of Fundsmith’s strategy is the following:
Buy great companies.
Don’t overpay.
Do nothing.
Below I’ll share you with 30 investing lessons I learnt from reading all of his Shareholder Letters (there’s many more, so if you want to see a second part of this you can let me know in the comments).
You should look to own stakes in companies and benefit from the good cash returns on capital they generate over many years, not simply hope to on-sell the investment at a higher price in a few months/years.
“Just as we counsel you not to become overly enthusiastic about share price rises . . . we hope that you will understand when we are explaining that price falls within the portfolio will often represent an opportunity for investment on even more rewarding ratings rather than an opportunity for soul searching and recriminations.”
“Whatever our view on the economy, The Fundsmith Equity Fund will always be fully invested in high quality companies which satisfy our exacting criteria on financial performance and have done so for many decades.”
Share buybacks can contribute to shareholder value creation when they are used correctly, which is when shares are purchased when they are under-valued and no better investment opportunity is available.
You should look to own businesses which have shown great resilience over a long period of time. (For example a business that was founded in 1920 would have survived through the great depression and two world wars.)
You should regard an equity holding as a claim on a share of the free cash flow produced by a business, not as a random ticker on which to speculate on.
You should seek to own companies which produce high cash returns on capital and to own those companies’ shares at prices which at best under-value their returns and at worst value them fairly.
Avoid regarding equity investment as a game in which you buy shares in companies that you don’t understand hoping to sell them to a greater fool when they become even more expensive as a result of some fad or share price ramp. Unless your goal is to lose money, of course.
“We remain critical of attempts to measure investment performance over short periods of time. Even a calendar year is too short for this purpose-it is the time it takes the Earth to go around the Sun and has no natural link to the investment or business cycle.”
“We prefer to judge our investments by what is happening in their financial statements rather than by the share price.”
“We seek to buy companies which deliver high returns on capital in cash. What the management then does with these cash returns is one of the major factors affecting future returns on the portfolio.”
Frequent dealing (constantly buying and selling out of positions) is the enemy of a good investment performance.
“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).”
Holding shares in major, conservatively financed companies which make their profits from a large number of small, every day, predictable events is a safe place to be if you have the patience, mental fortitude and liquidity to ride out share price volatility.
It is impossible to outperform in every reporting period or in all market conditions, what we should seek is to outperform over long periods of time.
“Too often investors seek to find fund managers who can outperform all the time and in all market conditions. The trouble is that no such person exists.”
Whenever the share price of what you consider to be a high quality business goes down to a reasonable valuation because of a temporary hiccup, you should be willing to use this as an opportunity to buy stock.
Whenever we get it wrong we must a) Admit it - most importantly to ourselves, and b) Be willing to reverse our decision.
“Almost every time we sell a position in a quality company we get to regret it in terms of subsequent share price performance. The good news is that we don’t do it very often.”
“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. As I am fond of saying, the shares are unlikely to follow this desired pattern since they do not know whether you own them or not or at what price you bought or sold.”
“We seek to invest in companies only when their FCF yield is the same as or more than that required bond yield.”
“Yield [Dividend 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.”
“People often ask us what we think the outlook is for the economy and/or the market. Apart from prefacing any response with the phrase, “we don’t know”, we usually point out that whatever the outlook it will not alter our methodology of investment.”
Minimizing cost of investment is a vital contribution to achieving a satisfactory outcome as an investor, we can do this by reducing portfolio turnover which will reduce taxation and trading fees.
When we have a buy and hold strategy, we are leaving the allocation of capital generated by the returns of the businesses we own to their management. When one of them looks likely to take a business with good, predictable returns and do something large, exciting and risky, we must be willing to walk away.
Whenever a company decides to not pay a dividend, we need to be convinced that their reinvestment opportunities and capital allocation decisions warrant the absence of a dividend.
“Seeking to profit from short term valuation anomalies or changes is not part of our strategy but given the upside which has been generated from these policies [Quantitative easing and zero interest rates which existed in 2013] , I have little doubt that we will have to live through some character testing times when they are withdrawn.”
“We rarely look at PE’s, usually only doing so to make such comparisons as other market commentators use them. We prefer instead to rely upon free cash flow yields when evaluating our investments as not all E’s, or Earnings, are created equal.”
“We do not attempt to make any so called ‘market timing’ judgments. We aim to have our Fund fully invested in companies of the sort we like, thereby acknowledging that we do not possess any expertise in guessing the right moment or even the right year in which to invest or to sell.”
“We are sensitive to the possibility of permanent loss of value which disruptive change can cause and on the whole we seek to avoid investing in companies which could be affected by it.”
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