Portfolio manager Terry Smith, who manages the Fundsmith Equity fund, is generally regarded as one of the UK’s top stock pickers. Such is his track record (he’s turned every £10k of investor money into nearly £50k in less than a decade), that people even refer to him as ‘Britain’s Warren Buffett’.
One thing I like about Smith is that he’s not afraid to share his wisdom. Every year, he writes a detailed letter to his investors in which he provides plenty of great advice. With that in mind, here are some quotes from Smith that could potentially help you make more money from stocks.
“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.”
Here, Smith is talking about the importance of letting your stock market winners run. Generally speaking, the big money in investing comes from holding on to a winner for the long term.
All too often, investors buy a stock, make a quick gain of say 20%, and then sell to bank their profits. This approach can be profitable. However, holding on to winners for the long term can be far more profitable.
Hold a winner for five years instead of five months and you might be looking at a gain of 2,000%, instead of 20%.
“Markets are not perfect but they are not totally inefficient either and most of the stocks which have valuations which attract value investors have them for good reason – they are not good businesses.”
What Smith is pointing out here is that stock valuations generally incorporate most of the information that is available to investors. In other words, if a stock is cheap, it’s cheap for a reason.
Quite often, investors spot a cheap stock and think it’s a bargain. What they fail to understand, however, is that everyone else knows it’s cheap including institutional investors, hedge funds, and professional investors. What do they know that the professionals don’t?
Smith’s approach is to ignore cheap stocks and instead, focus on high-quality businesses.
“Consistently high returns on capital are one sign we look for when seeking companies to invest in.”
One of the key elements of Smith’s investment approach is that he focuses on companies that are highly profitable. Specifically, he looks for companies that can sustain a high return on operating capital employed. These types of companies generally tend to generate strong investment returns over time.
Smith believes that over the long term, the returns on a stock portfolio will tend to gravitate to the returns generated by the companies in the portfolio themselves (which he points out “are low” for most ‘value’ stocks).
In other words, if you build a portfolio of high-quality businesses that are very profitable, you’ll probably do pretty well in the long run.
“We have a simple three-step investment strategy: buy good companies, don’t overpay, do nothing.”
Finally, this is a great quote that highlights the simplicity of Smith’s investment strategy.
Investing doesn’t need to be complicated. To generate good returns, you don’t need to use options, or derivatives or short stocks.
All you really need to do is invest in great companies at reasonable valuations and hold them for the long term.
That three-step plan could just be the key to making money from stocks.
Views expressed 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.