When you get a chance, check out the annual letters by Fundsmith’s Terry Smith. His 2014 letter delivers his usual mix of dry wit, no-nonsense advice, and unwavering belief in buy-and-hold investing. After another strong year—up +23.3% versus +11.5% for the MSCI World—Smith opens by reminding readers, “We never tire of reminding people that we remain critical of attempts to measure investment performance over short periods of time.
Still, 2014 offered one big, round reason to celebrate: “The Fund finished 2014 with the improbably precise outcome of having doubled investors’ capital since inception.”
But Smith wasn’t getting carried away. Despite the bullish mood, he pointed to the “anaemic growth” and “considerable stimulus” driving global markets. He didn’t mince words about monetary policy, either: “Many of its [QE’s] proponents seem to assume that inflating asset values will lead to prosperity. I suspect this is the reverse of what should occur.”
Instead of macro speculation, Fundsmith’s edge is simplicity. “Our investment strategy is based first and foremost on buying shares in good companies.” But he noted that this obvious-sounding approach is surprisingly rare: “Fund managers will buy shares in bad companies… because they think that the economic or business cycle will improve… or they may just think the shares are cheap.”
The problem with this? “Whilst fund managers await the kiss that will turn their corporate frogs into princes, they steadily erode value.”
By contrast, Smith’s portfolio companies add intrinsic value over time. He backed it up with numbers: 29% return on capital, 60% gross margins, and 102% cash conversion. “Our Company makes things for £4 and sells them for £10. The market makes things which cost £6 and sells them for £10.”
Valuation skeptics? Smith acknowledged concerns that “shares in our portfolio have become more highly rated,” but pushed back: “We remain unimpressed by those who tell us about their concerns… No doubt they may prove to be right at some point but following their advice would have been very expensive in the interim.”
He also poked at market timers: “We aim to have our Fund fully invested in companies of the sort we like, thereby acknowledging that we do not possess any expertise in guessing the right moment—or even the right year—to invest or to sell.”
And the top performers? Familiar names: Dr Pepper Snapple, Microsoft, Domino’s Pizza, Stryker, and Becton Dickinson—four of which also topped the list the year prior. “So much for the theory that no-one ever did badly by taking a profit.”
You can find a copy of the entire letter here:
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