Fundsmith portfolio manager Terry Smith has a phenomenal track record when it comes to picking stocks. Over the last five years, his flagship global equity fund has delivered a return of around 130% – far higher than the MSCI World index or the FTSE 100.
What’s interesting is that Smith’s investment process is very simple. Instead of trading in and out of stocks, shorting companies, or using options, he simply invests in high-quality businesses and holds them for the long term while they grow their profits. With that in mind, here’s a look at a FTSE 100 stock held by Fundsmith that I’d be happy to buy for my own portfolio today.
Cloud-based service provider
Sage (LSE: SGE) is a leading provider of cloud-based accounting and payroll solutions. Trusted by millions of businesses worldwide, the group helps its customers manage finances, operations, and people. The stock has been a member of the FTSE 100 since 1999, and currently has a market capitalisation of £8.1bn.
There are a number of things I like about Sage from an investment point of view. For a start, the company is very profitable. Over the last three years, return on capital employed (ROCE) has averaged 17.2%.
Companies that are as profitable as this tend to be good investments in the long run. This is summed up well by Warren Buffett’s business partner Charlie Munger who has said: “If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return – even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you’ll end up with one hell of a result.”
Secondly, Sage operates in a high-growth industry. According to the company, its market is growing at 7% per year with cloud spending growing at 13% per year. It also believes its total addressable market size is $36bn/72m businesses.
This industry growth is important. As Smith said in his most recent letter to fund investors, high returns are not much use if the business doesn’t have growth opportunities. Sage’s most recent trading update (for the three-month period to 31 December) showed group revenue growth of 6.7% – higher than a lot of Footsie companies are generating right now.
Finally, I like the fact Sage has a strong competitive advantage. Once businesses sign up for Sage’s solutions, they’re unlikely to move to another provider as that would involve substantial switching costs. This means recurring revenues are high (nearly 90% of revenue in the last quarter was recurring), which is a big plus, as that translates to consistent earnings and dividends. Looking at Sage’s dividend history, the group has a fantastic long-term growth track record.
Wonderful company at a fair price
Sage is certainly not the cheapest stock in the FTSE 100. Currently, its forward-looking P/E ratio is 25.4. However, I believe the stock is worth a premium given its quality attributes. As Buffett says: “It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.”
Edward Sheldon owns shares in Sage and has a position in Fundsmith Equity. The Motley Fool UK has recommended Sage Group. 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.