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"Buy once, cry once" is the preferred strategy of the British fund manager Terry Smith, who has returned more than 500% in the stock markets since the inception of his "Fundsmith" back in 2010. Imagine that you are buying a car in two parallel universes. In one universe, you are purchasing an excellent quality car.
In the other, you are buying one which looks like it's ready for the dumpster. The nice one costs as much as three of the inferior one - giving you a reason for some mild sobbing at its initial purchase. But in the next ten years, the high-quality car takes you along the country roads and the city streets as if it was its sole mission in its life.
In the other universe, the cheap car gets even more rusty only after a couple of years, with brakes failing from time to time and the gearbox making some undefinable clunky noise. Over time, you'll end up crying much more in the universe where you picked the cheap option. This holds true for many things we consume and buy, and not surprisingly – it can also hold true for stock market investments!
Terry Smith, a British fund manager, has, since the inception of his Fundsmith T Class, kept on buying only the equivalent of quality cars in the stock market. This video will explore his methods for buying quality without overpaying. Fundsmith has been a 6-bagger in a little over a decade, so his investment strategy has served his investors well.
This is a top 5 takeaways summary of Investing for Growth - How to Make Money by Only Buying the Best Companies in the World, by Terry Smith. And this is the Swedish investor, bringing you the best tips and tools for reaching financial freedom through stock market investing. Takeaway number 1: Great Car?
Great Choice! Half a century ago, a professional gambler called Alex Bird liked betting on horse races. In Bird's days, photo finishes were not digital, and when it came to the very close races, it took a while to produce the film to know the outcome. The bookmakers continued setting odds during this time, even though the race was actually finished!
Bird developed a strategy that he used to his advantage. He learned that the horse furthest away from the crowd usually seemed like it moved the fastest and thus was believed to be the winner by many in the crowd. Bird realized that if he closed one eye, this illusion dismantled itself. Then he would place his bet - while knowing the actual outcome.
In this way, Bird made himself a fortune, with many hundred correct bets in a row. We also want to make a fortune! So should we screw this whole stock market thing we got going on and rebrand this channel to "The Swedish Horsegambler"? Naa, hold your horses! But there is a lesson for us here, and it's not "analyze companies with only one eye open".
Mr. Smith advocates an approach for investing much like Bird's betting on horses. Wait until you know who won and wait for the bookmakers - the market in our case - to set the odds. Then just take your pick among the winners. In the case of the stock market, you'll obviously have to be a bit more careful about the price, or the odds, than Bird had to be with the horses.
Who are these winners, and how do we recognize them? We can't compare businesses within the IT space with that of consumer goods, as both sectors have their winners. For example, Apple and Monster Beverages would both be considered winners. Warren Buffett has a test for this which he calls "the silver bullet".
Ask competitors within an industry who they'd like to shoot down with a silver bullet among their peers. The company that other companies are afraid of is typically a true winner in its industry. Buuut, if you're like me, and you don't have access to such opinions too easily, then you can look for the following: - High profit margins (gross and operating primarily) - High return on assets; and - Increasing market shares Make sure to compare apples with apples.
You do need to pay somewhat of a premium for these companies, but that is the cost of deep moats. There are instances when even such companies can be found at a discount, and we'll get to that in the 3rd takeaway, but first … Takeaway number 2: Don't Pay Extra for Unnecessary Gadgets You know the small TV screens for rear seats in cars?
I sort them into gadgets that no one needs, yet some individuals keep on insisting on their high importance. Dividend investors, cover your ears! - because the analogy is that those TV screens are much like dividends; sometimes nice, but not a factor to put very much weight in. A pretty common critique against fast-growing companies is that they often pay little or no dividends.
A person fresh out of college might state that "a company that pays no dividend is not worth anything" and point to some theoretical formula. Well, theoretically, this wise-ass is correct - given that there isn't, and never will be, any form of dividends. The flaw in their assumption is that because the company doesn't pay out any cash today, they assume it never will.
Okay, class! Time for a quick pop-quiz! And Charles, no sneak-peeking on Anna! It's 1980, and Berkshire Hathaway has had an impressive run so far under the control of our favorite guy, Mr. Warren Buffett. A few wise-asses are saying that Buffett must start paying dividends - it's the unconditional right of shareholders to take part in their investments' profits.
With the advantage of hindsight, I now ask you this - would Berkshire have created the same value for its shareholders, if it, for the last 42 years paid a yearly dividend of, say, 50% of the profits? The answer is … Not even close. There is no chance in hell that the long-term shareholders could have received the same value from Berkshire, would it have paid a dividend.
There are two reasons for this. Firstly, Berkshire Hathaway has generated more than $1 of value for every $1 kept in the business. Secondly, there are taxes on dividends, so investors lose an important chunk of their money each time anything is distributed. This leads to a significantly lower long-term compounding effect - much like the hindering effect of high costs in many actively managed funds.
Buffett has always been keen to keep these kinds of friction costs to a minimum. In practice, wealth building in the market is created by both stock appreciation and dividends. The point is that, quite frequently, it is more beneficial for the shareholders' total return if a company reinvests its earnings and skips the dividend altogether, given that the money is helpful in the business.
Exceptional management of superior companies should know when that's the case, and you should not discard an investment simply because there is no dividend. On the contrary, a lack of dividend might be a great signal in some cases! Therefore, buying only companies that currently pay a dividend is a lot like insisting on buying only a car with a semi-useless gadget.
Takeaway number 3: Wait for the Discount Most of us would agree that Tesla has an excellent opportunity for continued growth. You'd probably also agree that Microsoft has a durable moat with lots of sharks and crocodiles. Perhaps also that Apple enjoys the fruits of solid pricing power by being in the high-end spectrum of the electronics industry, much like LVMH in the luxurious part of the fashion industry.
But suppose you are only looking at the quality of a business without considering its price tag. In that case, you are a victim of first-level thinking. Another famous investor, Howard Marks, says: "There's no such thing as a good or bad idea regardless of price." Buying something that succeeds with growing 20% per year for the next 7 years will generate a crappy performance if the stock is valued for growing 30% per year for the same period.
For the patient and prepared, an opportunity is always around the corner. So is the chance of acquiring a quality company at a discount. Hey, who wouldn't want to buy the high quality-car from the intro at a 30 or 40% discount? Mr. Smith advocates an approach to try to pick up the darlings on occasions when they, for some reason, are less loved by the market.
And when you look at almost any excellent company story, like the 4 mentioned before, you will notice quite a few times when they fell dramatically in valuation. If you are prepared with a list of your most sought-after gems, you can be the lucky guy who picks one up some 40% from its top quotation.
There are some common themes among the situations when a darling is on an undeserved discount. Quarterly results below expectations. When a darling that trades at, let's say, P/E 40, reports only a mediocre quarter, with 20% growth instead of the market's expected 35%, it can cause its stock price to tumble.
When this happens, you should keep in mind what Terry Smith says: "A year is just a lap around the sun". And well, a quarter is just … you know … one fourth of that. Who says that business performance must adhere to the movement of heavenly bodies? There's nothing magic about it! Just a minor miss on a three-month basis can sometimes change the sentiment of a company to go from "this business is taking over the world" to "will this company even be around in 5 years?".
If you can keep a long-term view when everyone else is this short-sighted, you can pick up even great companies at fair prices from time to time. A general panic. As we saw in the Covid crash – when the whole herd of sheep starts running in the same direction (pushing the sell button in this instance) more or less everything tumbles.
You ever wonder why fund managers can't beat the S&P 500? Because they're sheep, and sheep get slaughtered. Yet, plenty of companies, and some whole sectors, actually benefited from the pandemic. Take Microsoft, for example; the stock took a hit of roughly 25%, even though it required quite some imagination to reach the conclusion that their operations would be negatively affected by the new virus.
So, if you are fishing in these waters of quality companies with above-average multiples, it's frequently a good idea to wait until the next storm to pull out your fishing rod. But how do you recognize when a business is a bargain? Takeaway number 4: Don't let the Paint Job Fool You I think most of you know what a P/E-ratio is.
Basically, it's a tool to assess how pricy a company is. But did you know that sometimes it can fool you just like a nice paint job on a crappy car? If you've ever purchased a used car before, you've probably experienced this. It looks fine on the outside and looks clean on the inside, but when you look under the hood … it's a mess.
In the stock market, the equivalent is the great-looking earnings that turned out to be not so great after all. Unfortunately, the earnings of a company, and therefore also our favorite P/E ratio, is quite easy to manipulate for the CFO with mischief on his mind. For example, the earnings per share may not be growing as fast as you thought due to investors being continuously diluted by the creation of additional shares.
The pie is getting bigger, but so is the number of shareholders that get to split it! Or, instead of the diluted shareholders, another reason for some mild sobbing could be the discovery of manipulated earnings. For instance, depreciation can be exaggerated or understated depending on the intentions of the CFO.
Or, sometimes, a company capitalizes more of their costs than might actually be warranted. Back to the car: How does an investor avoid finding out that it is a wreck only after hours of analyzing it? There's another, a more robust measurement that you can use instead of earnings, according to Mr. Smith.
This is the free cash flow, or FCF, yield per share. Go to the cash flow statement of a company. Calculate the cash flow from operations minus capital expenditures per share and divide it by the price of each share, and there you have it. Although Warren Buffett has never presented an explicit calculation of what he calls "Owner's Earnings", I think the FCF yield falls very close to that.
This is cash that can be used to acquire other businesses, pay a dividend to you as a shareholder, or just be saved for a rainy day. Takeaway number 5: No Car is a True All-Rounder A Tesla might be a great car to own if you drive primarily in the city. However, occasionally, you'll find that you will have to visit your mother-in-law, who lives 10 hours away.
Then you are probably going to wish that you had some other car. But should you throw away your Tesla just because of this? No! You can't find a car that is optimal and performs the best in every single situation – and that's true for stock market companies too. Many investors fall into the trap of trying to switch investment strategies, or perhaps fund managers, to always "chase performance".
Perhaps your "growth at a fair price" strategy was outperformed in 2021 by your friend who had a "leverage the S&P 500 by 300%" strategy. Is this a reason for switching? There are a lot of factors affecting what is hot and what is not in any given market. Investors' willingness to bear risk is ever-changing with macro factors such as interest rates, inflation, and believed position in the economic cycle.
Again, "a year is just the time it takes the earth to go round the sun". Why would one year be a reasonable period for you to measure your or anyone else's performance just because of some movement by heavenly bodies? More ideally is perhaps to evaluate results after a whole economic cycle, through both a bull and a bear market.
Only then can you tell who's strategy was actually the winning one. If you have a sound process, stay true to it, or you might end up buying high, selling low doomed to repeat until your portfolio is hollow. - Leaders of their respective industries oftentimes represent great potential investments - Dividends can be practical, but they are definitely no requirement - For the patient and prepared, there will be occasions when even the strongest companies can be snapped up at fair prices - Avoid getting mesmerized by a paintjob by going under the hood and investigating the FCF yield - Investing strategies should be examined over a full market cycle, at minimum.
Now, if you want to learn more, check out this video on “Picking Growth Stocks”, which is written by the father of growth investing – Thomas Rowe Price Jr. Cheers guys!
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