“Investing is simple, but not easy.”
This timeless mantra is the essence of Terry Smith’s approach to investing. If you’ve never heard of Terry Smith, think of him as the “English Warren Buffett.” His straightforward and disciplined investment philosophy has made him one of the most successful fund managers of our time.
In this post, we’ll uncover three timeless investing lessons from Terry Smith that can help you achieve better results. Whether you’re just starting or you’ve been investing for years, these principles will resonate with anyone who values long-term wealth creation. But first, let’s get to know the man behind the strategy.
Who is Terry Smith?
Terry Smith isn’t just another fund manager. He’s the founder and CEO of Fundsmith, a globally recognized investment firm with a simple motto: “No gimmicks, just results.”
Here are some highlights from his remarkable career:
- Founder of Fundsmith (2010): Smith started Fundsmith with the goal of creating a fund that focuses on high-quality businesses. Since its inception, the Fundsmith Equity Fund has delivered an average annual return of over 15%, outperforming most competitors.
- Track Record: Under his leadership, Fundsmith’s assets under management have grown to over £40 billion (as of 2024).
- Notable Background: Before Fundsmith, Smith held senior positions at Tullett Prebon and Collins Stewart, gaining a reputation for his no-nonsense approach to finance.
Smith’s philosophy is refreshingly simple: buy high-quality companies, don’t overpay, and then do nothing. Let’s dive into these principles.
Terry Smith’s Book: Investing for Growth
Before we dive into Terry Smith’s lessons, it’s worth exploring his excellent book, Investing for Growth. This collection of essays, speeches, and letters offers a deeper understanding of his investing philosophy.
Key Takeaways from Investing for Growth
Stick to the Basics
Smith emphasizes the importance of simplicity in investing. He advises investors to avoid complex strategies, exotic financial instruments, and speculative bets. Instead, focus on businesses you can understand and evaluate.
Example: In the book, Smith discusses why he avoids sectors like banks and utilities. These industries often lack transparency and carry hidden risks, making them unsuitable for his straightforward, long-term approach.
Focus on Quality Over Quantity
Smith’s mantra is to invest in fewer, high-quality businesses rather than diversifying across a broad spectrum of mediocre companies. He argues that true diversification comes from owning the right kinds of businesses, not just owning more stocks.
Story: One of the essays highlights how focusing on high-quality consumer goods companies, like Unilever, has provided consistent returns while protecting against downturns.
Think Long-Term
A recurring theme in Investing for Growth is patience. Smith underscores that great businesses often take time to deliver returns. By holding onto quality companies, investors can benefit from compounding over decades.
Lesson: Smith shares anecdotes of holding companies through temporary market corrections, demonstrating the importance of staying the course instead of reacting to short-term noise.
The Importance of Free Cash Flow
Smith dedicates significant discussion to free cash flow as the lifeblood of a business. He highlights how companies with strong cash flow generation are better positioned to reinvest, weather economic downturns, and reward shareholders.
Key Point: By focusing on free cash flow yield, Smith has avoided pitfalls associated with overvalued growth stocks that fail to deliver tangible returns.
Why You Should Read It Investing for Growth isn’t just a book for professional investors—it’s a must-read for anyone looking to understand what makes a business truly great. The anecdotes and real-world examples Smith shares provide actionable insights that can improve how you think about building wealth.
Lesson #1 – Buy Great Businesses
Terry Smith’s investment strategy starts with identifying high-quality businesses. But what exactly makes a business “great” in his eyes? It comes down to three critical factors: high returns on capital, durable competitive advantages, and consistent free cash flow generation.
High Returns on Capital
Smith prioritizes companies that achieve exceptional returns on capital employed (ROCE). For instance, companies like Microsoft have consistently delivered ROCE above 30%, a hallmark of efficient capital use. High ROCE indicates a company’s ability to reinvest earnings at a high rate of return, which is crucial for compounding wealth over time.
Durable Competitive Advantages
Think of companies like Procter & Gamble, a Fundsmith favorite. Its global brand recognition and deep customer loyalty create a moat that protects its market position from competitors. Businesses with strong moats can maintain pricing power, fend off competition, and sustain long-term profitability.
Consistent Free Cash Flow Generation
Smith places significant emphasis on free cash flow (FCF) as a measure of a company’s financial health. For example, Novo Nordisk’s robust FCF has enabled it to fund research, expand its operations, and return capital to shareholders, all while maintaining a strong balance sheet.
Real-World Example
Consider Novo Nordisk, a leading diabetes care company and a top Fundsmith holding. Over the past decade, its annualized return has been nearly 20%. This success stems from its ability to innovate while maintaining profitability—a perfect example of the type of business Smith seeks.
Actionable Tip: When analyzing potential investments, look for companies with ROCE above 15%, consistent FCF growth, and identifiable moats such as strong brands, patents, or network effects. These are the characteristics of businesses built for long-term success.
Terry Smith believes in owning businesses that can generate high returns on capital and have a durable competitive advantage. Think of companies like Microsoft or Visa —leaders in their industries with products people use every day.
Why This Matters:
- Great businesses can grow earnings consistently, which compounds your wealth over time.
- They are more resilient during economic downturns.
Lesson #2 – Don’t Overpay
Even the best business can turn into a poor investment if you overpay. Terry Smith’s disciplined approach to valuation ensures that he avoids the common pitfall of chasing overpriced stocks.
The Pitfall of Overpaying
Think back to the dot-com boom of the late 1990s. Investors piled into high-growth tech stocks at sky-high valuations, only to face massive losses when the bubble burst. Smith’s strategy prevents such mistakes by focusing on fundamentals and refusing to pay excessive premiums for growth.
Case Studies: Companies Avoided
One notable example is Tesla. While the electric vehicle maker has achieved phenomenal growth, Smith has refrained from investing due to its valuation metrics being far above his comfort zone. Instead, he’s stuck with companies like Microsoft and Philip Morris, where free cash flow yields and price-to-earnings ratios align with his standards.
Key Metrics for Valuation
Smith emphasizes free cash flow yield (FCFY) as a primary tool. FCFY measures a company’s free cash flow relative to its market capitalization, providing a clear picture of whether the business is generating enough cash to justify its valuation. For example, Philip Morris consistently generates a free cash flow yield above 5%, making it an attractive investment even in uncertain markets.
Real-World Impact
By avoiding overhyped and overpriced stocks, Fundsmith’s portfolio has maintained a steady average annual return of over 15% since inception. This disciplined approach has also minimized the risk of large drawdowns during market corrections.
Actionable Tip: When analyzing stocks, prioritize companies with reasonable price-to-earnings ratios and robust free cash flow yields. Be wary of chasing trends or popular names without checking whether the fundamentals support their valuations.
Even the best business can turn into a poor investment if you overpay. Smith’s approach involves careful valuation to ensure he’s not paying a premium.
Lesson #3 – Do Nothing (Seriously)
Smith’s low-turnover strategy might seem boring, but it’s incredibly effective. By letting compounding do the work, Smith avoids the pitfalls of overtrading.
The Power of Compounding
Consider this: investing $10,000 in a stock that grows at 15% annually would grow to $163,665 in 20 years. Compare that to a scenario where frequent trading lowers your annual return to 10%. After 20 years, your portfolio would only grow to $67,275. The difference is staggering and highlights why staying invested is so crucial.
Why Most Investors Fail
Research from behavioral finance reveals that frequent trading often leads to subpar returns. According to a Dalbar study, the average investor underperforms the market by several percentage points annually due to emotional decision-making and excessive trading. Smith’s approach of “doing nothing” eliminates these risks and allows his investments to compound uninterrupted.
Evidence in Fundsmith’s Results
Fundsmith’s low turnover—typically less than 5% annually—has been a key driver of its success. For instance, the fund’s 15%-plus annualized return since inception is a testament to the power of holding onto high-quality companies through market ups and downs. Frequent trading, on the other hand, would have eroded these returns through transaction costs and missed opportunities.
Case Study: Warren Buffett vs. High-Turnover Funds
A similar low-turnover strategy has also worked for Warren Buffett. Compare his performance with high-turnover mutual funds over the past few decades, and you’ll see that his buy-and-hold approach has consistently outperformed.
Actionable Tip: Review your portfolio annually instead of monthly. Focus on long-term goals, not short-term market movements. To visualize the impact of compounding, use a free online calculator—it’ll motivate you to stay invested and resist the urge to trade unnecessarily.
Smith’s low-turnover strategy might seem boring, but it’s incredibly effective. By letting compounding do the work, Smith avoids the pitfalls of overtrading.
Terry Smith’s Top 5 Holdings (as of September 30, 2024)
According to Fundsmith’s latest 13F filing, here are its top five holdings:
- Microsoft (MSFT) – A tech giant with unparalleled growth in cloud computing.
- Meta Platforms (META) – Innovating in social media and virtual reality.
- Stryker Corporation (SYK) – Leading advancements in medical technology.
- Automatic Data Processing (ADP) – A leader in payroll and human capital management solutions.
- Visa (V) – Dominating the global payments industry with unmatched scale.
These holdings reflect Smith’s focus on quality, consistency, and durability.
Conclusion
Terry Smith’s investing secrets boil down to three timeless lessons:
- Buy great businesses.
- Don’t overpay.
- Do nothing.
These principles are simple but incredibly powerful. They’ve helped Smith build a world-class fund and can help you improve your investing results, too.
Which of these lessons will you start applying today? Share your thoughts in the comments below!
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