In the Fundsmith Owner’s Manual, Terry Smith discusses the importance of not just seeking a high rate of return but a sustainably high one. Key to this is repeat business, particularly from consumers who make frequent, regular purchases.
Companies selling daily consumer goods tend to provide more consistent returns compared to cyclical or “lumpy” businesses like steel manufacturers or property developers. Businesses that sell capital goods or to other businesses are often less stable due to deferred purchases and cost-cutting pressures.
However, some capital goods companies and business service firms, especially those with repeat service revenue, can still meet the criteria for sustainable returns.
Here’s an excerpt from the Owner’s Manual:
Note that we are not just looking for a high rate of return. We are seeking a sustainably high rate of return.
An important contributor to this is repeat business, usually from consumers. A company that sells many small items each day is better able to earn more consistent returns over the years than a company whose business is cyclical, like a steel manufacturer, or “lumpy,” like a property developer.
This approach rules out most businesses that do not sell direct to consumers or which make goods which are not consumed at short and regular intervals. Capital goods companies sell to businesses; business buyers are able to defer purchases of such products when the business cycle turns down.
Moreover, business buyers employ staff whose sole raison d’être is to drive down the cost of purchase and lengthen their payment terms.
Even when a company sells to consumers, it is unlikely to fit our criteria if its products have a life which can be extended. When consumers hit hard times, they can defer replacing their cars, houses, and appliances, but not food and toiletries.
However, not all companies which sell capital goods or which sell to businesses are outside our investible universe. A business service company may have a source of consistent repeat business, and some capital goods companies earn much of their revenue, and sometimes more than all their profits, from the provision of servicing and spare parts to their installed base of equipment.
These can satisfy our criteria.
You can find the entire Fundsmith Owner’s Manual here:
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