Dubbed ‘Britain’s Warren Buffett’, Terry Smith has produced an annualised return of 17.4% since 2010 for investors. I think that makes him worth listening to.
Here are three take-home messages I’ve spotlighted from his latest letter to shareholders.
Running winners
The real Warren Buffett once quipped that his ideal holding period was ‘forever‘. While Smith hasn’t gone this far, he has frequently made it very clear that part of Fundsmith’s strategy is not to trade very often and run its winning picks.
He made this point again last month:” Someone once said that no one ever got poor by taking profits. This may be true but I doubt they got very rich by this approach either.“
As an illustration of his commitment to not jumping in and out of stocks on a whim, Smith still holds seven companies that were originally bought when the fund kicked off in 2010. That might not seem like many. However, his fund is highly-concentrated, only holding between 20 and 30 shares at any one time.
A quick check reveals that I’m a lot worse at running profits than Smith. Positively, I am getting better, having held Somero Enterprises, IG Group and Greggs for a few years now. I’ve no intention of selling up either!
Buy quality
Buffett famously bought into very cheap stocks early in his career and made a killing. That said, his investment strategy would later change to buying only the highest-quality companies he could find. These had some kind of ‘moat’, or competitive advantage, over rivals. This may take the form of a very strong brand or enormous marketing budget or control over distribution. Think Coca-Cola.
Smith adopts a similar approach, name-checking Buffett in January’s letter. In his view, “the biggest problem with any investment in low-quality businesses is that on the whole, the return characteristics of businesses persist.”
This is why Fundsmith’s leader vehemently refuses to temporarily invest in stocks that may benefit the most from the post-pandemic recovery in economic activity. So no IAG or easyJet for Smith.
Having owned one, two or seven real stinkers in my time, I’m now a fully signed-up member of ‘Team Quality’. In addition to my stake in Fundsmith Equity, I’ve been topping up my holding of Smithson — the small/mid-cap-focused investment trust that also adopts Smith’s strategy.
Don’t obsess over price
Having highlighted the importance of buying good businesses, Smith then turns his attention to the issue of valuation. In his view, “highly rated does not equate to expensive any more than lowly rated equates to cheap.“
For me, this has links to Buffett’s suggestion that it is better to buy a great company at a reasonable price than the other way around.
Not obsessing over the price I’m required to pay for a stock has taken me years of practice. I’ve lost count of the number of times I’ve waited for the prices of great stocks to ‘correct’ only for this to never happen. More often than not, a top growth company’s valuation has remained fairly constant while its share price has soared.
However, I do think that I’m steadily getting better at it. In fact, there’s one FTSE 100 stock that I’d be very happy to buy right now, despite still being very highly rated.
