Investing for Growth: How to Make Money by Only Buying the Best Companies in the World by Terry Smith

The lessons of the first ten years
 INTRODUCTION BY TERRY SMITH
 I DECIDED to publish this book to mark the tenth anniversary of
 Fundsmith’s foundation. It comprises articles that I have published over that
 period together with my annual letters to investors in the Fundsmith Equity
 Fund.
 At the outset Fundsmith believed that direct communication with our
 investors was important because it gave us the best chance of explaining
 our investment strategy, how we were performing and what we are doing,
 without the intervention of intermediaries. This is particularly important
 when things don’t go well, which is inevitable from time to time, as it might
 prevent our investors taking actions which are injurious to themselves and
 our fund. To this end we not only publish an annual letter to investors, we
 also hold an annual meeting at which investors can pose questions and see
 us answer them live and in public. This is not mandatory and we are the
 only mutual fund in the UK which does it. It has become the best attended
 annual general meeting in the UK. This book is intended to contribute to
 that tradition of direct communication.
 I thought I would use this introduction to spell out some of the lessons we
 have learnt over the past ten years.
 One is that Fundsmith’s investment strategy works. Over the past ten years
 to the end of August 2020, our T-class accumulation units – which is our
 most popular class with direct investors and one in which I am invested -
have increased in value by 425% or 18.4% p.a. compared with a return of
 193.5% or 11.6% p.a. for the benchmark MSCI World Index. And 54% for
 the FTSE 100 Index.
 If you have read the financial press and commentary from various
 investment advisers you might be confused about why it has worked. You
 may have seen references to the period of low interest rates since the
 financial crisis of 2008–09 and the impact of quantitative easing (QE) in
 which central banks and governments bought large quantities of financial
 assets which they say has benefitted the performance of stocks of the sort
we invest in (and other stocks, I might observe). You may encounter certain
 buzzwords like “bond proxies” – the stocks we invest in reliably produced
 profits and cash flows like bonds. Bonds did very well over this period, and
 so stocks of the sort we like were turned to as an alternative by investors
 when bond yields approached or went below zero. There was much talk in
 the early years of Fundsmith’s existence about our strategy being all about
 consumer staples even though these stocks were never much more than half
 the portfolio at their peak. Latterly it is said to be all about tech stocks that
 are slated as a bubble about to burst even though such stocks have never
 been close to half our portfolio. I have been told by people that Fundsmith’s
 performance owes a great deal to fortunate timing in terms of when it was
 started, often by the same people who told me at the outset that it was a bad
 time to start a fund. The only explanation I haven’t heard very often is the
 correct one so I thought I would take this opportunity to try to set the record
 straight.
 Some of these naysayers are protagonists in the ongoing debate about so
called value investing, which they contrast with growth or quality investing.
 Value investing can be traced back at least to Ben Graham, the author of
 The Intelligent Investor and Security Analysis, who was Warren Buffett’s
 mentor. For Ben Graham, and Buffett in his early years, value investing
 meant buying a stock below its intrinsic value as the most important
 investment consideration, and then waiting for the two to converge -
hopefully by means of the share price rising rather than the intrinsic value
 declining. Latterly, in the hands of other practitioners, it has morphed into a
 simplistic approach of investing in stocks with low valuations, which is not
 the same thing – hence my use of the term “so-called”. A stock may have a
 low valuation but an even lower intrinsic value. Buying such a stock is not a
 recipe for investment success. Nor is growth or quality investing (I believe
 the latter is a more accurate descriptor for Fundsmith’s approach) best done
 irrespective of valuation. However, the level of valuation which may
 represent good value at which to buy shares in a high-quality company may
 surprise you. The following chart shows the “justified” PEs (price-to-
earnings ratios) of a group of stocks of the sort we invest in. What does that
 mean? It looks at the period 1973 to 2019 when the MSCI World Index
 produced an annual return of 6.2% and works out what PE an investor

Investing for Growth: How to Make Money by Only Buying the Best Companies in the World by Terry Smith