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Terry Smith: Back in Action at Fundsmith Annual Shareholders Meeting
"If you're seeking an investment that will outperform in every market condition and in every reporting period, I suggest that you watch on Netflix the four-part docudrama on [Bernie] Madoff."
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Last month, British investor Terry Smith took the stage at Central Hall Westminster (London) for Fundsmith’s annual shareholders meeting.
Smith, looking especially dapper with a new silver beard in tow, discussed his fund’s performance over the past year and answered pre-selected questions from the crowd.
And, as always, he did not disappoint.
Thankfully, Fundsmith posted a video of the event on YouTube so that riff-raff like me could still watch (and learn from) Smith’s insightful commentary.
Here are five big lessons that I took away from the event…
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Trust the process
Despite being the first in-person shareholders meeting since the pandemic (and Terry Smith’s typical good humor and self-deprecation), this wasn’t an entirely celebratory affair.
In 2022, Fundsmith (-13.8%) trailed its preferred benchmark, the MSCI World Index (-7.8%), by six points. Smith didn’t shy away from these subpar results or deny that some mistakes were made, but he also refused to allow such a small blip to shake his faith in a time-tested investing process.
Smith’s history speaks for itself: He started Fundsmith on November 1, 2010, and has soundly beaten the market ever since. Even with 2022 being a rare down year for the fund, he has recorded an impressive 15.5% compounded annual return over thirteen years of operation. That’s better than both the MSCI World Index’s 11% and the S&P 500’s 12.4% over that same period.
So, what is Fundsmith’s process?
Buy good companies
Strict adherence to this process has filled the Fundsmith portfolio with strong companies that outperform the wider market on important metrics like return on capital employed and operating profit margin.
But even that is no guarantee that every year will be a winner.
If you are seeking an investment that will outperform in every market condition and in every reporting period, I would suggest that you watch on Netflix the rather fine four-part docudrama on [Bernie] Madoff.
I think it’s a very good series, by the way, but it’s the only way you’re ever going to get consistent performance in every period. Until, suddenly, you don’t…
Investments aren’t meant to go up and to the right in perpetuity without any temporary setbacks or downturns. If anyone ever promises you such (impossibly) smooth returns, my advice is to run screaming in the opposite direction.
Long-term success cannot be achieved without weathering lots of short-term volatility.
A big part of Fundsmith’s long-term success comes from its simple investment strategy — and the trust Terry Smith and head of research Julian Robins have in it.
When times get tough, there’s no panic, self-doubt, or frantic shifting of gears to whatever’s the flavor of the week on Wall Street. Fundsmith just dusts off its three-step investing process and gets back to work, with an honest acknowledgement that it can’t beat the market every single year.
Mum’s (not always) the word
Unlike the Berkshire Hathaway crew, Terry Smith can be quite forthcoming about specific companies in the Fundsmith portfolio.
During his introductory remarks at the annual shareholders meeting, Smith rattled off the reasons behind every purchase and sale that he made in 2022.
And, when asked which current Fundsmith holding he considers the most undervalued, Smith didn’t hesitate to answer.
Meta Platforms, I think, is the cheapest stock that we own. It’s on a P/E of about 15 and, notwithstanding all of the bad vibes that some people have about this, it’s still one of the two leading digital advertising businesses in the world.
Some of this is masked, at the moment, by the noise surrounding the metaverse. We can wax lyrical about that to a degree, even though we don’t know the answer [to whether the metaverse is a smart investment or not].
But I almost feel we don’t need to know the answer because if they stopped spending on the metaverse today, we would have a business on a single figure P/E that’s one of the top digital advertising businesses in the world.
I’m not sure [stopping metaverse spending] is a good thing for them to do, by the way. I’m uncertain about that. But I do know that they could just stop it. I think if they just stopped it, the share price would roof it.
Smith and Robins delivered similarly frank assessments of other companies, too.
As an investor, I still prefer the tight-lipped discretion of Warren Buffett and Charlie Munger. But, as a student of the money game, I greatly appreciate when leading figures — like Terry Smith — draw back the curtains on how they evaluate specific companies.
Check the trash can for good ideas
Back in 2014, Terry Smith brushed off Apple as “a fashion company”. And, he added dismissively, Fundsmith would not be investing in any fashion companies.
Times change, though.
Fundsmith opened a small position in AAPL 0.00%↑ near the end of 2022 and, he revealed at the meeting, continued to buy the dip at opportune moments in the new year.
Why had Smith originally snubbed Apple?
During the dot-com bubble, he saw how companies like Nokia claimed that their hardware/software ecosystem would provide a moat that competitors could not cross. When that proved false (and the likes of Nokia crashed and burned), he soured on the whole idea of moat-like ecosystems.
As a result, Apple was the proverbial baby thrown out with the bathwater.
But, to Smith’s credit, he regularly goes back over discarded ideas and seeks out fresh eyes to see if he missed anything in his original analysis. When he did this with Apple, he noticed its strongly-growing Services segment.
“It’s a Services business that’s being sold to a very good socioeconomic group,” Smith said. He then pointed out that iOS users outnumber their Android counterparts by about three-to-one among the presumably well-off Fundsmith investor base.
And, in just about the most un-Buffett-like move imaginable, he stated outright that $125 is his target price for Apple shares.
My reasoning was if I can get [Apple for] $125, it’s on about the same rating as the S&P index — and this is a better business than the S&P index.
Smith sounds like a man patiently waiting to add more.
Some industries are more idiot-proof than others
At one point during the Q&A session, Terry Smith was asked about the unusual amount of activity at Fundsmith over the past year. After all, “Do nothing” is one of the cornerstones of the firm’s investing approach.
In 2022, Fundsmith’s portfolio turnover rate clocked in at 7.4%. Higher than most years, but still quite low by Wall Street standards.
“Do nothing” is more of an aspiration than an iron-clad promise. Sometimes, events occur that demand a reaction. No one wants to entrust their money to an investment manager who stubbornly goes down with the ship after a bad decision.
To illustrate his point, Smith offered a new corollary to an old investing maxim. (The maxim in question is “Invest in businesses that are so wonderful that even an idiot can run them — because, sooner or later, one will.”)
The fact of the matter is that it’s an awful lot better to invest in certain businesses that are run by idiots than others. Things like consumer products companies, whilst it’s not ideal to have an idiot in charge, you’re probably going to survive.
But when you get into certain areas, like technology, it’s a lot less easy to survive. It’s not impossible — it’s just less easy.
This explains why Fundsmith remains more cautious — and quicker to react to adverse events — with technology holdings. Basically, the capacity for fast-acting, permanent damage is much greater in that field than in others.
As such, he showed little patience with Intuit and PayPal in 2022 — and hinted that Adobe might meet a similar fate in 2023.
On the other hand, despite high-profile disagreements with departing Unilever CEO Alan Jope, Smith has never sold a share of the UK conglomerate. “It’s not Unilever we don’t like,” he said, “it’s the management.”
Smith may not be a fan of Jope — probably a massive understatement — but he doesn’t believe that subpar leadership can permanently tarnish Unilever’s strong brands and unparalleled distribution network.
The same cannot be said for a tech company, which could get lapped by a promising startup in a matter of months. In that arena, idiots must be dealt with swiftly.
Focus on companies, not macroeconomic conditions
At Fundsmith, investing decisions are made based on the strengths and weaknesses of particular companies — not by attempting to read the tea leaves of future macroeconomic conditions.
Julian Robins: One of the things that I always urge people to think about when we’re talking about inflation and interest rates and recessions … and volatility — think about a great company and then write down the top five or ten reasons as to what has made it a [great] company.
You’d probably get great products [or] products that people love; great brands; great distribution; a succession of decent managers who have done well; the company has tapped into a secular theme.
If you’re looking for good companies, you shouldn’t be worried about this [macro] type of stuff.
Terry Smith: The likelihood that they’re going to sit there and describe interest rates as the reason for [a company’s] multi-decade success is not high, is it?
Turn on CNBC or pick up The Wall Street Journal and you’ll likely be inundated with handwringing over unanswerable questions like: What will the Fed do next? How high will interest rates go? When will the stock market turn around?
Smith compares this mindless chattering to impatient little children riding in the car.
What’s the phrase that you hear very early on in the journey?
“Are we nearly there yet?”
I don’t know whether we’re nearly there yet. I haven’t got a clue, frankly, but I do know that keeping asking isn’t going to make it happen [any quicker]. It isn’t going to make us all feel any better, either. Who knows whether we’re nearly there yet?
And, I might add, if you’re focused on buying wonderful companies over a decades-long time horizon, who cares if we’re there yet?