In this interview with Morningstar Europe, Terry Smith discusses why he focuses on good companies that earn high returns on capital, rather than buying bad companies and waiting for a catalyst. Here’s an excerpt from the interview:
Smith: What we are screening for is to get rid of bad companies. We think there are very few good companies in the world; companies that consistently make a return on their capital above their cost of capital right across their business and economic cycle. You can rely on not to destroy any value for you while you are holding them.
Now most fund managers will hold, all kinds of companies good and bad and there is more than one way of investing, I’m not saying it’s the only way of doing it, but one of the problems of owning the bad companies in life is, whilst you are waiting for those companies is sort of steel companies and the chemical companies and the airlines or the banks of this world to have an event. Which is what people are really waiting for change of management, a takeover, the business cycle to turn up. They basically destroy value just the same as it would destroy value for you personally if you took in money at a cost of 10% and you invested it at 5%, that’s what they are doing.
The companies we own taking money at cost of let’s call it 10% and then make 30%. You can rely on the fact that we may get the share price right or wrong when we buy them not whilst they are sitting there in that portfolio they consistently create value. So that’s what our screening process is about. It’s about looking for companies that right across the business and economic cycle have fundamentals that actually create value by making a high return on capital in cash.
You can watch the entire interview here:
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