As the manager of what’s become the UK’s most popular fund (Fundsmith Equity), Terry Smith has helped to increase the wealth of many thousands of investors, including himself. As someone who picks my own stocks, I regularly draw on simple but powerful tips from the celebrated money manager. Here’s a small selection.
Don’t just buy what’s cheap
Terry Smith’s experience tells him that investors obsess over price. Indeed, he frequently mentions wishing he’d kept a diary since he started his career in 1974. This would have two columns — one for whenever someone asked him whether a stock was cheap and one for if it was a good company. Smith believes that he would have “overwhelmingly” more ticks in the first column than the second.
This is not to say that Smith thinks the price of a stock is irrelevant. No one wants to overpay if they can avoid it. For him, however, “it’s not the most important question“. Instead, he favours looking at the quality of a business first. One way of doing this is to look at its return on capital employed (ROCE).
Taking this on board, I’ve become a little less interested in valuation over the years and more interested in ROCE. I’ve already done well out of stocks like trading platform IG Group, laser-guided equipment manufacturer Somero Enterprises, kettle safety component supplier Strix and food-on-the-go retailer Greggs. All of these consistently generate high returns on capital (outside of a pandemic).
This is not to say that Terry Smith would buy these stocks. Nor is blindly buying businesses with high ROCE a guaranteed route to riches. Some I’ve owned have performed woefully. Nevertheless, I’m confident that my winners now outnumber my duds. And over an investment career, that’s what matters.
Don’t time the market
Given his stellar investment returns, one would assume that Terry Smith is rather skilled at timing the market: buying at the bottom and selling at the top. However, he’s very much against trying to do so. As he frequently reflects during speeches, there are “only two types of people I’ve ever met in investment: those who can’t do [time the market] and those that don’t know they can’t do it“.
However, this doesn’t stop Smith from buying on short-term weakness. He snapped up US coffee chain Starbucks and sportswear and trainer maker Nike during last year’s market crash. But these are quality stocks that were already on his radar.
This is why I’m continuing to push money into Smithson Investment Trust — a fund run by his colleagues. This adopts an identical strategy to Fundsmith but focuses on companies lower down the market spectrum. Smithson’s performance has been superb and I might be tempted to take profit. However, I’m continuing to buy nearly every month. Why? I simply don’t know when markets will sink.
I also try to keep my costs as low as possible. After all, there’s only one certainty with frequent buying and selling: it costs money. So, like Fundsmith Equity, I try to have a very low turnover of stocks. Unless I spot something I really don’t like (or spot a great opportunity), I don’t deal very often.
As Terry Smith has reflected, “over the long term, it’s what the company does that makes money, not what you do“.
Paul Summers owns shares in Fundsmith Equity, Greggs, Somero Enterprises, Inc, Strix, IG Group and Smithson Investment Trust. The Motley Fool UK owns shares of and has recommended Nike and Starbucks. The Motley Fool UK has recommended Somero Enterprises, Inc. and has recommended the following options: short October 2021 $120 calls on Starbucks. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.