Takeaways From Fundsmith’s Annual Letters (Terry Smith)

Last Updated on March 6, 2021 by Oddmund Groette

Terry Smith, the CEO/CIO of Fundsmith, writes an interesting annual report that is well worth reading. He goes one step further than most money managers by delving into a range-wide of subjects, usually with the intelligent and sarcastic British humor. The letters are not so long, but as a reference, we have quoted the most interesting comments (and sometimes funny) parts of the letters. Mr. Smith lets his mind speak freely, especially about the fund managing business.

How good is Fundsmith?

The flagship fund, Fundsmith Equity, recently celebrated ten years since its inception. It has been a very impressive ten years, to say the least. The fund’s performance has been exceptional: 18% CAGR since the start in 2010. The fund has yet to experience any true bear market, except for the short downturn in the 4th quarter of 2018 and the Covid-19, however, Fundsmith outperformed both periods. Still, the performance history is quite short. Will it last? We believe so. Mr. Smith seems to have the discipline to follow the strategy, which we believe is solid (see more below).

Is Fundsmith still a good investment?

The good performance has attracted a lot of capital, and currently, the AUM is about 20 billion GBP. In a recent interview, Mr. Smith argues they still can manage double the amount before facing any problems of finding investable companies. Fundsmith only invests in large-cap, and the most recent average market cap in their 27 stock portfolio was 140 billion GBP.

Who runs Fundsmith?

Fundsmith has four owner-partners and was founded by Terry Smith, born in 1953 and a resident of Mauritius. Fundsmith Equity is managed by Mr. Smith and Julian Robins. The other funds, listed below, is managed by others but ultimately overseen by Terry Smith.

What funds offer Fundsmith?

Fundsmith currently manages four funds:

  • Fundsmith Equity (the original)
  • Fundsmith Sustainable Equity Fund
  • Fundsmith Emerging Equities Trust (a closed-end fund established in 2014 to focus on emerging market equity- the tickercode is FEET on LSE)
  • Smithson Investment Trust (a closed-end fund established in 2018 to focus on global mid-cap equities – the tickercode is SSON)

What companies does Fundsmith invest in?

Fundsmith aims for large-cap stocks. One of the reasons is liquidity. Fundsmith is an open-ended mutual fund and Terry Smith has repeatedly mentioned he wants to avoid redemption difficulties in case many investors want to redeem at the same time. Apart from that, you need to understand the investment philosophy of Fundsmith:

Fundsmith’s investment strategy:

Fundsmith has a “simple” three-step investment strategy:

  • Buy good companies
  • Don’t overpay
  • Do nothing

The investment process boils down to finding companies that have a high return on capital employed, high gross margins, high operating margins, high cash conversion, low leverage, an acceptable earnings yield, and ample opportunities to reinvest retained earnings back into the business. The quotes further below gives more examples of what they are looking for.

The letters can be found on this link.

The 2010 letter:

————————————————-

Benchmarks are useful for measuring performance, provided a long enough time scale is used. Problems arise when fund managers start to use them for portfolio construction. At Fundsmith we do not endeavour to track any index or to minimise our “tracking error” versus any index (even the use of the expression tracking “error” tells you that an active fund manager has the wrong mindset).

————————————————-

Pet food is typical of the sort of product we seek to invest in. It is a small ticket, consumer, non-durable. As a small ticket purchase, no credit is required to buy it. The consumer has no opportunity to bargain on price -the price the supermarket or pet store displays is the price you pay. Consumers are typically brand loyal, and once it has been consumed there must be a replenishment purchase-there is no opportunity to defer this by prolonging the life or ownership of the product as there is with a consumer durable, like a car. Moreover, research clearly shows that if times are hard, consumers will reduce their spending on food for themselves or their children rather than cut back on their pets’ food.

————————————————-

On takeovers:

Whilst it would be churlish to suggest that we do not like receiving a premium for our investments in cash, such events are not without their downside as we have to find an equivalent investment for our cash. The fact is we really want to own our stakes in the companies in our portfolio and benefit from the good cash returns on capital which they generate. We are not simply hoping to on-sell the investment at a higher price. This changes perspectives on events such as takeovers.

————————————————-

The historic dividend yield on the Fund at year-end was 2.47%. This dividend was covered over 2.5 times by earnings. Only one stock in the fund does not currently pay a dividend. This is significant: dividends have historically provided a significant portion of the total return on equities.

————————————————-

The average company in our portfolio was founded in 1883. We are investing in businesses which have shown great resilience over a long period of time-in most cases surviving two world wars and the Great Depression.

————————————————-

What we can say with a high degree of certainty is that our portfolio has a FCF yield higher than the average for the market. Yet it is inconceivable in our view that it is not of higher than average quality in terms of longevity, resilience, predictability, profit margins, return on operating capital and the conversion of profits into cash. Put simply this means that we own shares in businesses which are higher quality than the market on a valuation lower than the average for the market. Whilst that is not a total solution to successful investing, it strikes us as at least a good start.

————————————————-

We regard an equity holding as a claim on a share of the cash flow produced by a business. In the Fund we seek to own companies which produce high cash returns on capital and distribute part of those returns as dividends and re-invest the remainder at similar rates of return. And we want to own those companies shares at prices which at best under-value their returns and at worst value them fairly.

————————————————-

On ETFs:

This year’s rant is a warning about the misunderstanding and misuse of Exchange Traded Funds (“ETFs”)…… So what’s the problem? I suspect that the average investor regards all ETFs as just another form of index fund, and indeed many of them are. But many aren’t and therein lies the potential for misunderstanding. Or worse……Some ETFs do indeed replicate the performance of an index by purchasing a weighted package of all or most of its constituent securities. But many so-called synthetic ETFs do not do so and instead use so-called swap agreements with counterparties who agree to provide a monetary return which matches the underlying asset class or the index the ETF is seeking to track. Anyone who has studied the events of the Credit Crisis should be able to spot a potential problem here: what if the counterparty supplying the swaps defaults? This risk may once have been considered theoretical, but after the collapse of Lehman and the need to rescue AIG in order to prevent the contagion from a default it surely no longer is. True the ETF should be holding collateral against such a failure, but collateral is an imperfect science even where it is held which isnot in all cases. Moreover, in some cases the sole counterparty. Moreover, synthetic ETFs are often used at access markets which are not directly accessible to retail investors such as the Chinese A-share market or where liquidity in the underlying investments is poor such as equities in some emerging markets. The opportunity for the performance of the ETF to diverge from the performance of the underlying assets and therefore from the investors’ expectations in these cases seems obvious. The idea that a counterparty will provide you with a contract which matches the returns from underlying illiquid assets which you cannot directly own should give pause for thought-not least about how the counterparty will fulfil those obligations, for example in the case of extreme market movement and a liquidity crisis-a not unlikely combination. I would bet that a large proportion of ETF investors do not realise that leveraged and inverse ETFs can produce these apparently perverse results. The moral of this is that these sort of ETFs are really day trading tools. If they are held for more than one day, they will begin to diverge from the performance of the underlying index or asset class. However, it would not be surprising if in many cases they were being used inappropriately as if they are index funds.

…….Investors in ETFs may be quite logical in avoiding most active management, but many of their ETFs are not as inactive as they think.

————————————————-

Finally, returning to our own active fund, we look forward to the year ahead. ……it is because we enjoy running The Fundsmith Equity Fund. Robson Walton, the Chairman of Wal-Mart and son of its founder Sam Walton said, “My dad did not set out to make Walmart the world’s largest retailer. His goal was simply to make Walmart better every day, and he thought constantly about how to do just that……..Please be assured we are doing the same with Fundsmith.

The 2011 letter:

Turnover in the Fund in 2011 was 15%. This was higher than we would ideally like although still significantly lower than most funds…..Excluding dealing in Del Monte and Clorox (takeovers), the turnover was 4% which is much closer to the level we seek (zero ideally).

————————————

We prefer to judge our investments by what is happening in their financial statements than by the share price.

————————————

Share Buybacks-Friend or Foe?……..in which we concluded that buybacks were rarely accompanied by any reasoned justification; that they had become almost universally regarded as a good thing and contributing to shareholder value irrespective of the price paid or the valuation implied, which simply cannot be true; and in many cases their timing was poor.

————————————

During the year we wrote to the management of those companies within our portfolio which have engaged in share buybacks to ask for some insight into their rationale. The responses ranged from prompt, personalized (by the CEO) and well reasoned to being completely ignored. We regard the greatest risk for our investors after the obvious potential for us to buy the wrong shares or pay too much for shares in the right companies, as being reinvestment risk: we seek to buy companies which deliver high returns on capital in cash. What the management then does with these cash returns is one of the major factors affecting future returns on the portfolio.

————————————

So, for example, having determined to return a portion of earnings to shareholders, how does a management decide between a dividend and a buyback? In many cases we do not know as the management does not give any detailed rationale and we suspect that the answer is with the “benefit” of advice from their investment bankers who get fees, commissions, bid-offer spreads and maybe proprietary trading profits for advising companies to pursue buybacks but get nothing when a dividend is used. No prizes for guessing which way the advice is slanted.

————————————

I have long and publically maintained that the best equity investment for most investors most of the time is an index fund because of its low cost and outperformance of most active fund managers.

————————————

ETFs are almost certainly being mis-sold…..Synthetic ETFs do not hold underlying securities of the sector or market they are supposed to replicate….SyntheticETFs are of particular concern….ETFs are represented as low cost investments. Yet research published during the year demonstrated that ETFs were amongst the largest profit generators for some banks. This seems counter intuitive: how does a low cost product become a major profit contributor? The answer of course is that synthetic ETFs in particular provide banks with innumerable ways to “clip the ticket” of the ETF……My advice on this matter is simple. A broadly-based index fund is often the best investment you can make in the equity markets. But if you decide this is correct, buy precisely that, an index fund, not an ETF…….The only people who want to deal more frequently than daily are hedge funds, high frequency traders, algorithmic traders and idiots (these terms are not mutually exclusive). Why join them? If you don’t want active management, and mostly you shouldn’t, buy an index fund.

————————————

We are often asked by investors whether we hedge currencies. The answer is a firm ‘No’. How would we do so? Should we base it on the currency of the country in which the companies are listed? This obviously would not work.

————————————

However, in contrast, the Credit Default Swaps of Nestle have been less expensive than the cost of insuring against default on the debt of European governments and the US Treasury for some time. We are far from believers that the market is always right, but this does suggest that holding shares in major, conservatively financed companies which make their profits from a large number of small, everyday, predictable events is a relatively safe place to be if you have the patience, fortitude and liquidity to ride out the share price volatility which is likely to occur in such circumstances. And that’s exactly where and how our Fund is invested.

The 2012 letter:

Moreover, the year was characterised by what is in my opinion is a naïve view that the words spoken or (more rarely) actions taken have somehow helped to resolve the financial crisis which we have been living with since 2007. I cannot see how the supply of liquidity can solve a crisis caused by over-leverage and insolvency. These events were exemplified for me when the Financial Times declared Mario Draghi, the President of the European Central Bank as its Man of the Year. This was based upon the fact that in July Mr. Draghi pledged to do ‘whatever it takes’ to save the Euro, which was followed by him doing precisely nothing and yet the borrowing costs of the major European problem countries, and most notably Spain, dropped and the Eurozone crisis went into remission.

————————————

In my view there is a moral here for investors. What we are trying to achieve with Fundsmith is to win the investment equivalent of the Tour de France for you-to outperform over a long period of time. However, we do not expect to outperform all the time or in all markets conditions. Rather our expectation is that we will perform relatively well in bear market conditions, and may struggle to keep pace in more bullish conditions, which is why I am surprised that we outperformed the market albeit modestly in 2012. It is important that our investors recognise that this is what we are aiming for. Too often investors seek to find fund managers who can outperform all the time and in all market conditions. The trouble is that no such person exists. But the attempt to find this mythical creature leads to some investors moving their assets between managers, incurring costs and most frequently ditching a manager who’s investment style is out of step with the current market in favour of one with recent good performance just as they are about to switch positions.

————————————

It is always a mistaken strategy to wait for the shares to get below the point at which you sold them before repurchasing, or the even more common trait of waiting for a loss-making share purchase to get back to break-even before selling. As I am fond of saying, the shares are unlikely to follow this desired pattern since they do not know whether you own them or not or at what price you bought or sold.

————————————

The weighted average free cash flow (“FCF”) yield, which is our primary valuation yardstick, of the companies in the portfolio started the year at about 5.8% and finished it at about 5.7%…….The yield is also significantly higher than the yield on government bonds which was previously known as the risk-free rate before investors started to relearn that governments default. This is significant. The coupon on those bonds cannot grow over time whereas the free cash flow from our companies can. So if we can buy them with a higher FCF yield than the bond yield then we have probably created value.

———

As investors we are taught that to obtain higher returns you must assume higher risk, but much of the evidence contradicts this assumption. The fact is that for much of the time you get better returns from investing in predictable high quality companies than in smaller, riskier, more obscure company shares. But there appears to be a human desire to indulge in excitement and back the 100-1 shot rather than the favourite, and to engage in complicated bets such as the Yankee defined as “four selections and consisting of 11 separate bets: 6 doubles, 4 trebles and a fourfold accumulator”. Can you accurately calculate whether the odds on such a bet are fair, in your favour or the bookmakers’ favour? If you can’t, then the bookmaker has the advantage. For bookmakers, read “market”. The principle is the same.

————————————

For many investors the search for yield is satisfied by investing in an income fund which invests in high yielding equities. This can be a mistake. At certain levels of yield all that is happening is that the investor is being paid back some of the capital value of his or her investment as income, and taxed upon it. All bar one of the income funds in the IMA Global Equity Income sector apply their charges not to income but to capital in order to maximise their stated yield. This has some obvious disadvantages, not the least of which is that it maximizes the investor’s tax bill as Income Tax is higher than Capital Gains Tax and much more difficult to avoid or defer. It also exaggerates the true yield, which has obvious marketing advantages for the funds……We think that investors should not focus solely upon yield but rather on the total return they derive from a share or a portfolio, and should not take the dividend yield as an exact indicator of what they can afford to remove from the fund periodically and spend

————————————

At some point, the inevitable consequence of this is inflation and currency depreciation. The newer generation of central bankers such as Mr. Carney have yet to experience that. When they do, they may discover that when inflation takes hold it does not conveniently stop at some predetermined target rate. They may also find that the only device they have to control inflation is the blunt instrument of interest rates, and a significant rise in rates would have some interesting effects on the affordability of government debt, private debt and the economy in its current condition.

The 2013 letter:

With our low portfolio turnover we are in effect leaving the allocation of capital generated by the wonderful returns earned by our portfolio companies to the management of those companies. When one of them looks likely to take a business with good, predictable returns and do something large, exciting and risky, we have a strong impulse to run away.

————————————

Our starting guess for the yield that might then be required is one percent over the expected rate of inflation. If we can buy shares with FCF yields higher than that and which will grow, unlike the coupon on the bonds, we should have captured some value. There are still shares within our portfolio which look good value on this basis, albeit not as many or as cheap as they were a year or two ago.

————————————

Another way of looking at it is that you could therefore have paid a PE of 3.6x the market PE for Coke and 4.9x the market PE for Colgate in 1979 and still matched the market performance over the next 30 years. The reason is the differential rate of compound growth in the share prices (to a large extent driven by growth in the earnings) of those companies over the 30 years. They compounded at about 5% p.a.faster than the market. You may be surprised that this differential can have such a profound effect upon the outcome. It’s the magic of compounding.

————————————

Take Nestle for example, at the end of December 2013 its 2018 bonds had a redemption yield of 0.21% whilst its ordinary shares yielded3.1%. Leaving aside fund managers who are limited to investing in bonds by their mandate, why would anybody in their right mind own the bonds rather than the shares? The answer is that some investors are willing to overpay for the apparent certainty which the bonds bring.

The 2014 letter:

You may think that this part of our strategy is so obvious that it must surely be the case that all fund managers seek to invest in good companies. However, this is certainly not the case. Fund managers will buy shares in bad companies, by which I mean companies which do not consistently create value for their shareholders or even worse which destroy value some or even all of the time. If they have a reason for doing this it usually boils down to some expectation that the performance of the companies will improve at least temporarily because they think that the economic or business cycle will improve and those companies will start to make adequate returns, or there will be a change of management which will improve their performance or a takeover bid, all of which may benefit the share price. Or they may just think that the shares are cheap.

The 2015 letter:

….the most common suggestion, it seems, is that you should consider switching into more cyclical stocks because they are more lowly rated and their returns are too volatile to be considered as bond proxies. Switching into cyclical stocks in anticipation of a rise in interest rates, what could possibly go wrong?

————————————

As ever, spotting potential problems with our or any other investment strategy is not that difficult. In all my years in business I have never found that identifying a problem is quite as difficult as solving it. Likewise, suggesting what it is you should switch into that is immune from problems which may result from an interest rate rise is a bit more difficult.

————————————

What does this table demonstrate? In short, that our companies have much better financial performance than the market as a whole and are more conservatively funded.

The 2016 letter:

I remain amazed (I could stop this sentence there) by the number of commentators, analysts, fund managers and investors who seem to be obsessed with trying to predict macro events on which to base their investment decisions. The fact that they are seemingly unable to predict events does not seem to stop them trying. During 2016 we had the spectacle of all the major polling organisations and the mainstream media failing to predict the outcome of the EU referendum in the UK or the US presidential election. Yet many of the same people are now busy telling us what the effect of Mr. Trump’s economic policies will be and how they will affect our investments.

————————————

Even if you could correctly predict how these matters would develop, and the timing of that, this would not enable you to use this as a basis of investment decisions. Markets are a so-called second-order system-to usefully employ your predictions you would not only have to make mostly correct predictions but you would also need to gauge what the markets expected to occur in order to predict how they would react. Good luck with that.

————————————

Rather like the management of some of the companies we most admire, I waste little or no time trying to guess what will happen to factors I cannot control or predict and deploy most of my time and effort on things I can control. Two of those are whether we own good companies and what valuation we pay to own their shares.

The 2017 letter:

They also seem to have missed the point that voicing your views in an echo chamber is not likely to lead to a challenging debate in which to test your opinions.

————————————

In which case, the period of sluggish economic growth and low interest rates which we have experienced over the past decade may persist for some considerable time. I think this is likely for the simplest of reasons: little or nothing has been done to correct the problems which led to the Financial Crisis.

————————————

As an aside,I would suggest that the headlong expansion of credit in much of the western world which preceded the Financial Crisis was an attempt to compensate for the effects of deflation. Instead of accepting that the loss of manufacturing and service jobs to the developing world meant we had to accept lower pay and lower standards of living to compete we opted for an expansion of the state, the mushrooming of non-productive jobs and borrowing to maintain our spending patterns.

————————————

So instead I am going to quote his business partner and Berkshire Hathaway’s Vice Chairman, Charlie Munger:‘Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return—even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result’ (emphasis added)….I have no idea why Mr. Munger chose those particular rates of return but what I do know is that he is not voicing an opinion. What he is describing is a mathematical certainty. If you invest for the long term in companies which can deliver high returns on capital,and which invest at least a significant portion of the cash flows they generate to earn similarly high returns, over time that has far more impact on the performance of the shares than the price you pay for them. Yet I have been asked far more frequently whether a share, a strategy or a fund is cheap or expensive than I am asked about what returns the companies involved deliver and whether they are good companies which create value or not.

————————————

Our inability to take a really long-term view, particularly through the periods when our chosen strategy and companies are not performing as well as less good companies, which are enjoying their period in the sun, is our greatest enemy……So why we should think about what happens over shorter time periods, like quarters or even years is a bit of a puzzle.

————————————

Leveraging up the balance sheet to buy back stock is a frequent demand of activists and is invariably described as ‘returning cash to shareholders’ and not only when it is suggested by activists. The correct description for this action should be ‘returning cash to exiting shareholders as we remaining shareholders don’t receive any of it and this perhaps best encapsulates the problem we identify with this practice.

The 2018 letter:

Black Monday may have been tumultuous, but did it really matter? Take a look at the chart below of the Dow Jones and see if you can spot Black Monday. You will need good eyesight or reading glasses to do so…..  In the long term, it did not matter.

————————————

What some people mean by value is lowly rated. A stock may be lowly rated but not good value if the (lack of) quality of its business and/or its prospects mean that its intrinsic or fundamental value is still below its lowly valuation……The sort of stocks which trade on low enough valuations to attract value investors are unlikely to be those which we seek –businesses which can somewhat predictably produce a high return on capital employed, in cash, and can invest at least part of that cash back into the business to fund their growth and so compound in value.

————————————

Unlike our strategy which is to seek such stocks and hold onto them, letting the returns which the company generates from this reinvestment produce good share price performance, value investing suffers from two handicaps. One is that whilst the value investor waits for the event(s) which will crystallise a rise in the share price to the intrinsic value that has been identified, the company is unlikely to be compounding in value in the same way as the stocks we seek. In fact, it is quite likely to be destroying value. Moreover, it is a much more active strategy. Even when the value investor succeeds in reaping gains from a rise in the share price to reflect the intrinsic value he identified, he or she needs to find a replacement value stock, and as events of the past few years have demonstrated, this is far from easy. Moreover, this activity has a transaction cost. Our strategy has the merit that inactivity is a benefit.

————————————

However, meeting management is not our primary test of whether a business is of sufficient quality for us to invest. We think good businesses are identifiable from the numbers they produce. Nor do we meet management to give them our views on how to run the business. If they don’t know how to do so we are in serious trouble.

The 2019 letter:

Someone once said that no one ever got poor by taking profits. This may be true but I doubt they got very rich by this approach either.

————————————

Consistently high returns on capital are one sign we look for when seeking companies to invest in. Another is a source of growth—high returns are not much use if the business is not able to grow and deploy more capital at these high rates.

————————————

The biggest flaw in value investing is that it does not seek to take advantage of a unique characteristic of equities. Equities are the only asset in which a portion of your return is automatically reinvested for you. The retained earnings (or free cash flow if you prefer that measure, as we do) after payment of the dividend are reinvested in the business. This does not happen with real estate—you receive rent not a further investment in buildings, or with bonds—you get paid interest but no more bonds.

————————————

This retention of earnings which are reinvested in the business can be a powerful mechanism for compounding gains. Some 80% of the gains in the S&P 500 over the 20thcentury came not from changes in valuation but from the companies’ earnings and reinvestment of retained capital. If you were a great (and long-lived) value investor who bought the S&P 500atits low in valuation terms, which was in 1917 when America entered world war one and it was on a P/E of 5.3x, and sold it at its high in valuation terms in 1999 when it was on a P/E of 34x,your annual return during that period would have been 11.6% with dividends reinvested, but only 2.3% p.a.came from the massive increase in P/Eand9.3% (80% of 11.6%) came from the companies’ earnings and reinvesting their retained earnings.

————————————

We regard it as a lack of professional courtesy to comment upon our competitors except when we are asked to do so by our investors. We only wish others in the industry would maintain the same stance.

The letter addressing the Covid-19 crisis, published in March 2020:

As Rick Mears, one of only three drivers to win the Indianapolis 500 Race four times, said ‘In order to finish first. You must first finish.’

————————————

The fact that most of the emergency measures taken in 2008—09 –deficit spending, low or zero interest rates and Quantitative Easing –were still in place 10 years after the crisis demonstrated that the patient –in this case the global economy –was not back in rude health when the virus struck. Cue a market panic.

The 2020 letter:

Someone once said that no one ever got poor by taking profits. This may be true but I doubt they got very rich by this approach either. We are not the sort of people who ever declare victory—we invest with a strong sense of paranoia—but it continues to be pleasing to note the contribution of Facebook which was certainly our most controversial stock purchase and led to more questions (and demands for its sale) from some of our investors than any other company. We had similar views expressed to us when we purchased Microsoft. You rarely get to purchase high quality businesses at cheap prices unless there is a ‘glitch which provides an opportunity to do so.

————————————

The main assets of the companies we seek to invest in are often intangible. Some examples of intangible assets are brands, copyrights, patents, know-how, installed bases of equipment which require servicing and maintenance and so produce customers who are locked-in to the supplier, software systems which are critical to a business or person and so-called network effects. They are distinct from tangible assets such as real estate, machinery and equipment, and vehicles.

————————————

The return on intangible assets is higher as they mostly need to be funded with equity not debt and attract an appropriate return. Lenders seem to crave the often false security of lending against tangible collateral. Intangible assets can also last indefinitely if they are well maintained by advertising, marketing, innovation and product development and the duration of an asset is an important factor in figuring out its real returns.

————————————

The net result is that for any given level of investment in assets, the profitability of a company building an intangible asset is likely to be depressed versus a company building or buying a tangible asset. This makes a mockery of the comparison of their valuations which are done by some commentators and investors who simply compare their price-to-earnings ratios(‘PE’).

————————————

I lived through the rise and fall of the Japanese equity market. When it reached its peak in 1989with a PE of over 60 we were told that this was because Japanese company accounting was much more conservative than western companies. In fact, their shares were just expensive. So I am wary of explanations for why we should accept high valuations, especially if they are based upon theories about accounting.

————————————

However, there are some clear signs that existing trends have been accelerated by COVID. For example:

  • E-commerce
  • Online working from remote locations using the cloud or distributed computing
  • Home cooking and food delivery
  • Online schooling and medicine
  • Social media and communications
  • Pets—which have become more important in isolation and when their owners are at home more
  • Automation and AI

 

Disclosure: We are long Fundsmith T Class Acc. We are not financial advisors. Please do your own due diligence and investment research or consult a financial professional. All articles are our opinions – they are not suggestions to buy or sell any securities.  

 

  •  
  •  
  •  
  •  
  •  
  •