Fundsmith portfolio manager Terry Smith is often called ‘Britain’s Warren Buffett’. It’s easy to see why – since he launched his fund in 2010 he has delivered enormous returns for investors.
Recently, Smith started a new position in his flagship fund and I’m wondering if I should follow him and buy the stock (which has fallen about 40% since late November) for my own portfolio. Let’s take a look.
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‘Britain’s Warren Buffett’ has spotted an opportunity
The stock Smith has been buying recently is Adobe (NASDAQ: ADBE). It’s a leading provider of creative software (Photoshop and Premiere Pro are two of its key products). It also offers marketing and data analytics software that helps e-commerce businesses give customers better experiences.
Listed in the US, Adobe currently trades at around $390, down from near $700 in November last year. At the current share price, it has a market-cap of about $184bn.
A classic Fundsmith stock
I can see why Smith likes Adobe. For a start, the company is generating strong top-line growth on the back of the expanding digital content market (i.e. YouTube). Over the last three financial years, revenue has climbed from $9bn to $15.8bn. This year (ending 3 December), Wall Street expects revenue of $17.9bn.
Secondly, profitability is very high. Over the last three years, return on capital employed (ROCE) has averaged 25.7% (Smith loves high ROCE companies). Meanwhile, gross profit margin has averaged 86% over this period. A high gross margin should protect it from inflation.
Additionally, the company has a very strong brand and reputation. Adobe’s Premiere Pro, for example, is generally seen as the gold standard in video editing software. This provides a competitive advantage and gives it pricing power (which could also help it beat inflation).
Finally, it has a strong balance sheet with a low amount of debt. So overall, Adobe is a classic Terry Smith stock.
Should I buy Adobe shares?
Adobe is actually a stock I’ve been monitoring pretty closely recently. I think it has a lot of appeal, and in July last year, I highlighted it as a stock I wanted to buy in the next stock market crash.
At the time, the valuation was very high. With the share price near $600, the forward-looking P/E ratio was near 50. Today however, it’s a different story. With analysts expecting earnings per share of $13.70 this year, the P/E ratio is now only 28.
At that valuation, Adobe is a ‘buy’ for me. This is a high-quality business with plenty of growth potential. Now that the P/E ratio is under 30, I see growth at a reasonable price. I’d be comfortable buying the stock for my own portfolio at that valuation.
Of course, the big risk here is that technology stocks could continue to underperform. This year, rising interest rates have hit the tech sector hard. There could be further pain for the sector ahead in the near term.
However, in the long run, I think there’s a good chance this stock will do well. That’s because it’s set to benefit from the growth of both the digital content and the e-commerce industries.