Here’s a great interview with Fundsmith’s Terry Smith at Money Matters in which he discusses how good stocks will ‘talk’ to you if you do extensive analysis. Here’s an excerpt from that interview:
Question: In a broadly efficient market how can these anomalies arise, I ask? Or, to put it another way, how much skill is there in stock selection?
Smith: “I think there is some skill. It involves some analytical work, although most of the analytical work is much less complex than people think it is. It’s not that difficult. I think the difficulty is combining the calculation portion of analytical work – what’s the free cash flow yield? What’s the return on capital employed? What’s the cash conversion? And so on – with an understanding of how the company makes its money”.
“You need that to gain some insight into two very important questions. One is: will the company be able to defend its margin and its returns – a competitive advantage, in other words? And secondly, will it continue to grow? Has it got something to grow into? A new market, a new demographic, a new price point, a new product and so on, whatever it is. The bit that’s really interesting in many ways is not the numerical bit, which anybody competentcan do, I think. It’s translating that into analysing those two safety factors, I think”
“Then I think there are some other bits of skill as well. One of them is discipline, saying ‘I really, really, really like Coloplast, the Danish catheter and tube company that makes medical equipment – which I do, by the way – but it’s never been cheap enough for me to buy, so I’ve never bought it. If you are right in terms of your outlook, that discipline is an important thing to bring to it. Fund management is a weird balance on the one hand of realising that you’re going to be wrong about some things, and having the humility to be able to accept that from time to time you’re wrong and do something about it, combined with other times realising that you’re right to stick to your guns, and not going off and doing those things”.
“And then finally there’s a really weird bit of it, which is that the stocks kind of talk to you in the end, if you do all these things. If you spend enough time reading 10Ks and annual reports and 8K quarterly filings, and industry publications, and attending conferences and so on, something sometimes tells you what’s good and what’s bad. You can put your finger on it to a degree, but only to a degree”.
You can read the entire interview here:
Terry Smith Interview (Money Matters)
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