Lessons From Fundsmith’s Shareholder Letters

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In this week’s episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed Fundsmith’s CEO Terry Smith, and his shareholder letters. Here’s an excerpt from the episode:

Tobias Carlisle: So, tell us about the Fundsmith letters. What’s the most recent Fundsmith letter?

Bill Brewster: Well, I mean, Terry Smith is a guy out of the U.K. that I would not know about but for Twitter. And what he basically says… we buy good businesses, we pay reasonable prices, and then we do nothing. Now, he doesn’t do nothing, because he sold 3M, but his turnover is super, super low.

Tobias Carlisle: Has that been a mistake or not?

Bill Brewster: Not for him. No, he’s destroying everything.

Tobias Carlisle: No, selling 3M

Bill Brewster: Oh, no, I don’t think so. Actually, I just saw today that it’s apparently getting crushed, but I don’t follow it very much. That entity is sort of in my too hard pile; it’s more of a macro bet than anything, in my limited understanding.

Bill Brewster: So, anyway… he owns things like Estee Lauder. He owns stuff like Philip Morris. His gross margins and his portfolio… I really like how he lays out his portfolio versus the indexes. His look-through gross margins are north of 60 percent. His return on capital employed, I’m pretty sure, is north of 20 percent, probably 30 percent, but I’m not looking at it right now. It’s a really interesting way to approach the world.

Bill Brewster: And I think one of the… I bet he and Russo think very similarly. I haven’t looked at all of his holdings, but they seem to be slower-moving industries that… brands matter, distribution matters, and you can sort of buy and own for the long-term. I’m sure somebody is going to correct me on that, but that’s what it looks like, to me.

Tobias Carlisle: Yeah, I had a look at that letter. I love the way he writes, and I like the layout of that letter, too. He’s much closer to that compounding style than he is to my style, but that’s worked really well for a lot of years now, and I think that it’s going to work in the future, whatever happens to deep value. I think it’s a very robust approach.

Bill Brewster: You know something interesting? When we were talking about HEICO, I said something silly, and it was sort of flippant when I said it. I said, well, it’s 2.8 percent free cash flow yield; it could go down to five. And then I’m sitting around thinking, and I thought, “Well, that is a 50 percent haircut.” So, if you don’t care about the difference between making 2.8 percent or 3 percent, buying today really doesn’t matter if you’re going to hold forever.

Bill Brewster: But the thing that sucks when you’re paying those prices is share buybacks don’t get you much juice, and a 50 percent draw down when you’re looking at a 2, 3 percent free cash flow yield every year… that’s a lot of return. You’ve got to really believe for 16 years, 17 years.

Tobias Carlisle: That was the feeling that I had, looking at all the HPCs, the high-performance compounders that Mark Leonard lists out. I was looking at them like… their returns are ridiculous, and I understand the strategy really well, so I would definitely buy these companies at a price. But it’s just so hard to get comfortable with them when something like… Constellation, I think, was approaching a 50 PE, so you’re getting a two percent yield. It’s growing fast still; it’s still growing in the 30s, I think, which is monstrous growth.

Tobias Carlisle: And then, you look at your yield and you add on the growth, and all of a sudden, it’s an interesting position, but the growth is such a big component of it that you have to be right on that, and that’s where all of the other questions… like Jake’s first question was my first question: How big is this universe of stuff that they can keep on buying? At what stage does the edge of the empire just get too big and start to crumble away? Don’t know the answer to those; got to be right, though.

Bill Brewster: Well, I know I bring it up a lot, but look at 3G. I mean, they had done pretty well, and then they got to size… where maybe both entities are suffering from this; I’d like to think that Bud isn’t, but it could be suffering from a size problem, and now the best brand in their entire portfolio has a virus attached to it, which isn’t great!

Tobias Carlisle: Who knows? It might help. I haven’t seen so much Corona advertising.

Bill Brewster: Well, it’s hard enough… to China right now. I’m not sure we need a Coronavirus!

Tobias Carlisle: I have seen more Corona advertising than I’ve seen anything else for the last few weeks.

Bill Brewster: Good. Jesus, Lord, people, if you’re outside of the U.S., buy some AB InBev products, please. Corona… I don’t care what. And if you’re in the U.S., buy Stella!

Tobias Carlisle: Continental wife-beater, they call it, in the U.K.

Bill Brewster: Stella?

Tobias Carlisle: Stella.

Bill Brewster: Yeah. It’s interesting how brands do that. People have said Stella is just trash over there, in a similar way that Budweiser is here, but then Budweiser is supposed liked globally, from what I understand.

Tobias Carlisle: Budweiser was a premium product was when I was working in the… there’s a drive-through. You guys might not know what a drive-through is, but that’s where, in Australia, someone can drive up and buy alcohol!

Bill Brewster: Nice!

Tobias Carlisle: That’s a real thing! I used to work in one. You had to run around. The Buds were premium products, as they were imports and they were expensive, and so, they were kept in a special locked case so that people couldn’t make off with it.

Jake Taylor: Holy shit. Wow. That’s impressive.

Bill Brewster: It’s interesting how brands can take on different meanings in different geographies. The Budweiser… the Asian IPO documents are pretty interesting to look through, if anyone is somewhat interested. I wouldn’t recommend it. Stay away. It’s bad for your health. Leverage and volume declines.

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