Investing For Growth
Click here to buy the book.🚀 The Book in 3 Sentences
Investing For Growth is an anthology of Terry Smith’s writings from 2010-2020.
Throughout the articles and shareholder letters, Smith elaborates on his simple, three step approach to make money in the stock market: Buy good companies, don’t overpay, do nothing.
This book is great for anyone in search of a simple and straightforward approach to successful investing.
🧠 Key Takeaways
An investor’s main objective is to own above average businesses at lower than average prices.
When management is doing something they don't want others to look closely at or question, they often use indirect language to make it seem less serious or problematic than it actually is.
Return on capital employed is one of the most important measures of corporate performance — it is the profit return that the management earns on the capital provided by shareholders.
Instead of chasing after risky investments that might generate high-flying returns, investors are likely better off focusing on investing in stable, established companies that are more predictable, which tend to have predictable earnings and are more likely to pay consistent dividends.
On Wall Street, there's always a new fund or investment product being touted as revolutionary or game-changing. However, the creators of these products aren't necessarily focused on helping investors build wealth; their primary goal may be to extract fees and profits for themselves.
Rather than trying to time the market or predict its movements, a better approach is to concentrate on investing in businesses that have the potential to thrive over the long term. Markets will inevitably experience both ups and downs, but by selecting resilient companies, you position yourself to survive these fluctuations and benefit from sustained growth.
You want to avoid investing in businesses that rely on borrowing money to achieve decent profits. Instead, you want to look for businesses that can generate satisfactory returns on their own without needing to take on significant debt.
The over-complication of investing can cause investors to miss the forest for the trees. They become so focused on intricate details that they overlook the bigger picture, and forget to ask the most crucial question: Is it a good business?
You should aim to buy stocks that are undervalued, meaning they're priced lower than they should be. However, just because a stock is cheap doesn't mean it's undervalued. Sometimes stocks are cheap for a good reason, and if you're thinking about investing in them, you'll want to dig deeper to find out why.
Many investors dismiss the idea of investing in a company because they hold negative views about its products. While it's understandable if they choose not to spend their money there, they're missing out on a potentially valuable investment opportunity by failing to approach the business objectively.
Many people believe that to make a lot of money, you have to invest in something unusual, complicated, and not well-known to others. However, sometimes the most successful investments are the most straightforward and easy to understand. And instead of searching for something obscure, the best opportunities might actually be the most obvious ones.
Many investors are too concerned about selling when they've made a profit. But if you've earned money from an investment, it could mean you own a piece of a valuable business worth keeping.
When you're choosing which companies to invest in, one smart strategy is to look at businesses where families are heavily involved or have a significant say in how things are run. These families often have a long history with the business, going back to its beginnings. Even during tough economic times, these family-influenced companies tend to be very consistent with their dividend payments.
✍️ Memorable Quotes
“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.”
This is a pretty important insight into what type of business Terry Smith looks to invest in, and his words here are pretty on par with what I think about something like Proctor and Gamble.
When times are tough, consumers will more likely cut back on unnecessary food items at the store (snacks, certain drinks, etc.) rather than essentials like pet food or household products.
While there may be variations in brand loyalty across different product categories, the overarching theme remains: consumers gravitate towards trusted brands for their everyday needs. This reinforces the resilience of businesses offering indispensable products, which is why they make such great long-term investments.
“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.”
Put simply, the goal is to own above average businesses at lower than average prices. Pretty straightforward.
“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 price which at best undervalue their returns and at worst value them fairly.”
When you own a share of a company's stock, you essentially own a portion of the money the company makes.
As an investor, your goal is to invest in companies that generate a lot of cash relative to the money they've invested (cash returns on capital). These companies should also pay out some of their profits to shareholders as dividends, while using the rest to grow the business.
You want to buy shares of these companies when they're priced lower than what their returns suggest they're worth (undervalued), or at worst, when they're priced fairly.
“We do not regard equity investment as a sophisticated game of pass the parcel in which we buy shares in companies that we don’t understand, which may be poorly performing businesses and/or which are overvalued, hoping to sell them to a greater fool when they have become even more expensive as a result of some fad or share price ramp. Such games are best left to video consoles unless your hobby is losing money whilst investing, which I rather suspect it is for some people.”
Some people treat investing like a video game, and try to make a quick profit by buying stocks without understanding the companies, their value, or their risks, hoping to sell them to someone who understands even less than they do. However, this is a short-sighted approach that will more likely result in losing money instead of making it.
“One of the rules that I have found in business life is that when management is doing something they really don’t want examined they use polite euphemisms to camouflage the reality of the situation. Thus, the payments by IBM to the banks are termed ‘adjustments’ in its accounts not ‘extra costs’ or even ‘losses.’”
When listening to a quarterly earnings call, you’re bound to hear the word “adjustment” at least once. Companies make adjustments for all sorts of things.
In general, it’s best to be suspicious of this sort of language. When management is doing something they don't want others to look closely at or question, they often use indirect language to make it seem less serious or problematic than it actually is.
Doing so makes it sound like a normal part of business rather than something potentially problematic or wasteful. So, if you come across this sort of language and get the sense that management is being squirrely, the “adjustment” in question may be worth looking more into.
“Return on capital employed is one of the most important measures of corporate performance — it is the profit return which the management earns on the capital shareholders provide.”
Return on Capital Employed (ROCE) is important because it shows how efficiently a company is making money from the money (capital) it has invested (employed) in its operations.
Imagine you have $100,000 to start a margarita bar. You buy tequila, lime, salt, cups, and everything else you need to get going. After your first year of business, you end up with $120,000. Your return on capital employed would be 20%. This means that for every $1 you invested, you made 20 cents in profit.
A high ROCE (like 20%) means the company is generating solid profits relative to the money it's invested, whereas a low ROCE (like 5%) might tell you that the company is not using its resources effectively.
Obviously, you want to invest in companies with a tendency to generate a high ROCE. You'd be more likely to see higher returns on your investment over time compared to investing in less efficient companies.
Additionally, a consistently high ROCE might indicate that a company has a sustainable competitive advantage or a strong business model. At the very least, it suggests that the company can maintain its profitability over the long term, which is important for investors seeking consistent returns over a long period of time.
And most importantly, high ROCE companies tend to create more value for their shareholders. As the company grows and becomes more profitable, shareholders may see increases in dividends, share prices, or both.
“A quarter is too short a period to judge performance reasonably, and even a year is just the time it takes the earth to go round the sun. It is not a natural time period over which to measure the performance of any business or investment unless it is linked to the earth’s orbit. To assess an investment strategy or a fund, you need to see its results across a full economic cycle with both bull and bear markets.”
People online often rush to criticize a particular investment approach, especially when it comes to dividend investing. I often experience this firsthand.
This criticism extends to individual companies as well. Critics tend to focus on short-term performance, like the past year or five years, as if that alone determines how suitable an investment (or an investment strategy) is or will be.
Interestingly, most of these critics are passive investors who believe that anything other than investing in a broad market index is pointless. They have their reasons ("why bother trying to beat the market when the market usually wins?"), but it's easy (and feels good) to judge others when you prefer a more hands-off approach to investing and/or are a defeatist, and therefore don’t have an interest in actively investing yourself.
It seems that the only ones facing this scrutiny are investors who don't follow the masses and just "buy the market.” Instead, these investors actively choose to make their own investment decisions, and prefer to have more control over their investment fate—for better or for worse.
In effect, they choose to stray from the status quo, and the status quo doesn’t tolerate dissent.
For the individual investor, this can have either a positive or negative effect. The more you deviate from “the market,” the more your returns will as well, and it can go in either direction.
Because of that, if the individual investor doesn't beat the market for a year, two years, or even five years, they're labeled as failures by the passive investors, who wastes no time saying, "I told you so."
What’s not taken into consideration is that the situation is constantly fluid. Investing is an infinite game that never ends, and an investor may underperform for a year, or for 3 years, or for 5 years in a row.
But in the grand scheme of things, does that really mean anything? If the game is still being played, is it fair to judge someone's performance over such short periods, especially when we've been in a strong bull market for the past 12 years and have yet to see the other side?
I don't think so. In fact, I believe these same investors who might not do as well in a booming market will have the opportunity to shine when the market heads south. That's because their strategy isn't about chasing high returns when times are good; it's about minimizing losses when times are bad, which can ultimately lead to better performance over the long haul.
Many of these self-proclaimed critics haven't experienced a true bear market yet. Neither have I. But it's not right to judge others when we've only seen one side of the market's behavior, and it’s especially not right to judge others’ investment decisions when you make no decisions yourself.
“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.”
Don’t get me wrong, investing can be a lot of fun, but it’s not supposed to be like spinning the roulette wheel at the Bellagio.
Instead of chasing after risky investments that might generate high-flying returns, investors are likely better off focusing on investing in stable, established companies that are more predictable, which tend to have predictable earnings and are more likely to pay consistent dividends.
While no investment is entirely risk-free, established companies with a track record of success generally have lower risk compared to newer or less-proven companies. This reduces the likelihood of significant losses for investors, which arguably, can be more important than fast, significant gains.
In contrast, chasing after "100-1 shots" or risky, obscure investments might seem exciting, but it often leads to disappointment and losses. These investments may have the potential for high returns, but they also come with a higher likelihood of failure.
Overall, as difficult as it may be, investors should resist the temptation to seek out excitement and instead focus on investing in high-quality, predictable companies. Over the long term, this approach is more likely to result in sustainable and potentially higher returns with lower overall risk.
“Terry Smith’s 10 Golden Rules of Investment”
If you don’t fully understand it, don’t invest.
Don’t try to time the market.
Minimize fees.
Deal as infrequently as possible.
Don’t over-diversify.
Never invest just to avoid tax.
Never invest in poor-quality companies.
Buy shares in a business which can be run by an idiot.
Don’t engage in “greater fool theory.”
If you don’t like what’s happening to your shares, switch off the screen.
“John Bogle, the legendary US investor and founder of Vanguard, calculated that during the 81 years to 2007, reinvested dividend income accounted for approximately 95% of the compound long-term return earned by the companies in the S&P 500. The bull markets of 1981-2000 and 2003-07 may have misled investors into thinking that equity investment is mainly about share price appreciation. But history suggests otherwise.”
When share prices seem to be doing nothing but going up, it's understandable to be captivated by the allure of soaring stock prices.
The recent, remarkable performance of companies such as META, COST, and NVDA can easily lead investors to overemphasize capital appreciation. And for some, it can leave them with a strong case of F.O.M.O.
However, it would be a good idea for every investor to heed the insights from the thorough research done by John Bogle, the founder of Vanguard. His findings, spanning over eight decades up to 2007, showed the profound significance of reinvested dividend income. An astonishing 95% of the long-term returns generated by S&P 500 companies were attributed to dividends, a statistic that warrants considerable reflection.
While the current market sentiment may cause many investors to dismiss dividend investing as less exciting or lucrative, such sentiment is short-sighted, and clearly comes as a result of recency bias. Many of us have been only been investing for a decade or less, so for the most part, all we’ve experienced is a market on the up-and-up.
But the market won’t always be hot, and dividend-oriented strategies have been shown to be more resilient during times of market volatility and downturns, serving as protection against adverse conditions.
When the market is heading south, others may find themselves exposed to heightened risk. But dividend investors often find solace in the steady stream of income provided by their holdings. This not only cushions against losses but also positions dividend-focused portfolios for potential outperformance in down markets.
Overall, while it's tempting to pursue rapid share price appreciation when the market is doing well, a disciplined, and level-headed focus on dividends can offer a more resilient approach to investing, and can help you weather the storms that will inevitably come throughout your investing journey.
“Time and again we are told that someone has devised a new technique of investing, or a new investment product. The truth is that in this area of human endeavor there are few, if any, new products or methods. By and large, we have seen it all before.”
This is akin to "shiny object syndrome" - the tendency for investors to be drawn to the latest flashy investment “opportunity” without fully understanding its risks or long-term viability.
On Wall Street, there's always a new fund or investment product being touted as revolutionary or game-changing. Take, for example, Covered Call ETFs like TSLY. These products promise unbelievable (and unrealistic) yields by writing call options on specific holdings like Tesla or NVIDIA. They catch the eye of investors who don’t know any better and are seeking passive income, and they’re lured in by the funds’ obscene yields.
However, behind the curtain of these shiny new investments lies a less glamorous (and in my opinion, obvious) truth: they often serve the interests of Wall Street insiders more than those of the investors. The creators of these products aren't necessarily focused on helping investors build wealth; their primary goal may be to extract fees and profits for themselves.
The reality is that many of these flashy investment vehicles may not be as solid or sustainable as they appear. They're designed to be easily marketable and sellable, often exploiting investors' desire for quick returns or high yields. But as history has shown time and again, chasing after these shiny objects can lead to disappointment and losses for the unwary investor.
Instead of being swayed by the allure of the latest investment fad, it's better to stick to tried-and-true strategies. Investing in solid companies with strong fundamentals, and holding for the long term, will forever be the most reliable path to building wealth.
While it may not be as exciting as the latest shiny object, it's a strategy grounded in sound principles that have stood the test of time.
In the end, there are no shortcuts to building long-term wealth - just patience, diligence, and a commitment to keep climbing.
“People often ask us what we think the outlook is for the economy and/or the market. Apart from prefacing any response with the phrase “we don’t know,” we usually point out that whatever the outlook it will not alter our methodology of investment.”
Predicting the future is a waste of time. It's impossible to accurately forecast macro-level events, so building an investment strategy around such predictions doesn’t make a whole lot of sense.
Rather than trying to time the market or predict its movements, a better approach is to concentrate on investing in businesses that have the potential to thrive over the long term. Markets will inevitably experience both ups and downs, but by selecting resilient companies, you position yourself to survive these fluctuations and benefit from sustained growth.
“We seek to buy our portfolio companies when their free cash flow (FCF) yield (the free cash flow they generate divided by their market value) is at or above the yield we would expect to get on long-term government bonds in the same currency. Please note: not the current yield on bonds, which in most cases has been depressed by governments buying their own bonds, but the yield we think might apply if this were to stop and all bonds had to be sold to third-party investors. Our starting guess for the yield that might then be required is 1% 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.”
I thought this gave some good insight on how they go about valuing stocks. Put more simply than in the quote, they want to buy companies when the free cash flow yield is at least 1% above the expected rate of inflation. This assumption reflects the notion that investors typically demand a premium above inflation to compensate for risk and to ensure a real return on their investment.
By comparing the FCF yield of potential investments to this estimated yield on government bonds, investors can gauge whether they're capturing value. If they can purchase shares in companies with FCF yields higher than the estimated bond yield, and these companies are expected to grow over time, the investment strategy suggests that value has been acquired.
This is because the FCF yields, combined with anticipated growth, offer the potential for higher returns compared to the fixed coupon payments from bonds.
As an example, the expected rate of inflation at the time of writing is 3.09%, which means that you would look to buy a company if the FCF yield is at least 4.09% or above.
There are actually quite a few companies in my portfolio right now where that is the case:
EPD: 7.04%
PG: 4.22%
SBUX: 4.20%
SNA: 7.59%
WSM: 7.58%
“One of my basic tenets is never to invest in a business which requires leverage or borrowing to make an adequate return on equity. Most of the companies that we invest in at Fundsmith have some borrowing. But they do not require it in order to survive, and they make decent returns before the use of debt, rather than making small returns on their assets and then financing most of those assets with debt.”
You want to avoid investing in businesses that rely on borrowing money to achieve decent profits. Instead, you want to look for businesses that can generate satisfactory returns on their own without needing to take on significant debt.
Although it's common for most companies to carry some level of debt, the focus should be on those not contingent on borrowing for survival. For example, compare the debt profile of Williams-Sonoma (WSM) to that of AT&T (T).
The companies you want to own should already be profitable before considering the use of debt, and they should be able to generate decent returns on their assets without relying heavily on borrowed money to finance their operations.
“I remain amazed at the number of people who talk about investment and spend most or all of their time talking about asset allocation, regional allocation, sector weightings, economic forecasts, bonds vs equities, interest rates, currencies, risk controls... but never mention the need to invest in something good. I naively supposed that the experience of the financial crisis might have taught investors a lesson about the inability to generate good returns from bad assets.”
Investing can often seem incredibly complex, and there are a couple of reasons why this happens:
Investors want the highest possible returns. They believe that analyzing as much data as possible will lead to better outcomes, so they leave no stone unturned.
There's a tendency to associate complexity with intelligence. People want to appear smart, so they make things more complicated than they need to be.
However, this pursuit of complexity can cause investors to miss the forest for the trees. They become so focused on intricate details that they overlook the bigger picture, and forget to ask the most crucial question: Is it a good business?
“Another obsession I have been surprised about is that with “cheap” shares. I have been asked whether a share is cheap many more times than I have been asked whether the company is a good business.”
"Cheap" is often thought to mean the same thing as "undervalued," but that's not always the case.
You should aim to buy stocks that are undervalued, meaning they're priced lower than they should be. However, just because a stock is cheap doesn't mean it's undervalued.
Sometimes stocks are cheap for a good reason, and if you're thinking about investing in them, you'll want to dig deeper to find out why.
Upon doing so, you might find that the drop in price is temporary or due to factors outside the company's control, like a short-term issue or a broader economic trend. But other times, you'll uncover underlying problems within the company itself, which can justify the cheapness.
Unfortunately, investors often focus too much on whether something is cheap, and pay no mind to the quality of the investment. This is the wrong approach.
Instead, you should strive to invest in high-quality businesses, even if they're not cheap. Quality companies are more likely to perform well in the long run, whereas not all cheap stocks will.
“It is important to ignore the siren song of those who have views on stocks which you hold, particularly if they are based on prejudices about their products. I also lost count of the number of comments I read about how Microsoft was finished as it ‘wasn’t Apple.’”
My version of this would be Starbucks.
Many investors dismiss the idea of investing in the company because they hold negative views about its products. They think it’s overpriced coffee, and consider it a waste of money. However, I believe their prejudice against Starbucks is misguided.
While it's understandable if they choose not to spend their money there, they're missing out on a potentially valuable investment opportunity by failing to approach it objectively. Instead of solely focusing on their personal preferences, they should consider why so many others choose to visit Starbucks every day.
While you may not enjoy Starbucks coffee, it doesn't necessarily mean the company is a bad investment. You have to differentiate between purchasing the product and investing in a company.
“People often assume that for an investment to make a high return it must be esoteric, obscure, difficult to understand and undiscovered by other investors. On the contrary - the best investments are often the most obvious.”
Many people believe that to make a lot of money, you have to invest in something unusual, complicated, and not well-known to others. They think the only way to win is by finding the diamonds in the rough.
That’s certainly one way to go about it, but it’s not the only way. Sometimes, the most successful investments are the most straightforward and easy to understand. And instead of searching for something obscure, the best opportunities might actually be the most obvious ones.
“Run your winners. Too often investors talk about “taking a profit”. If you have a profit on an investment it might be an indication that you own a share in a business which is worth holding on to. Conversely, we are all prone to run our losers, hoping they will get back to what we paid for them. Gardeners nurture flowers and pull up weeds, not the other way around.”
Many investors are too concerned about selling when they've made a profit. But if you've earned money from an investment, it could mean you own a piece of a valuable business worth keeping.
On the other hand, we often hold onto investments that aren't doing well, hoping they'll bounce back to the price we paid. This is like watering your weeds and hanging your flowers out to dry.
“If you regard a high return on capital as the most important sign of a good business, few are better than businesses which operate through franchises, as most of the capital is supplied by them. The franchiser gets a royalty from revenues generated by other people’s capital.”
When you buy into a franchise, you're essentially buying a business model and the rights to use a well-known brand. The parent company, or franchiser, provides support, marketing, and expertise. But the bulk of the investment—the actual stores, equipment, and day-to-day operations—is funded and maintained by the franchisee.
This means that the franchiser can earn significant returns on its capital without having to invest much of its own money. Instead, the franchiser collects royalties or fees based on the revenues generated by the franchisees.
As an example, imagine you're considering investing in a fast-food franchise. Think something like Burger King, Popeye’s, or Tim Horton’s — all owned by a company called Restaurant Brands International (QSR).
The franchiser, QSR, might spend money to develop the brand, create advertising campaigns, and provide training to franchisees. But the franchisees are the ones investing in the physical locations, equipment, and staff.
Now, when those franchise locations start making money, a portion of those revenues will go back to QSR in the form of royalties. And because QSR didn't have to shell out much capital upfront, the returns on investment can be quite high.
In essence, investing in businesses with strong franchise models allows investors to benefit from the success of many small businesses operating under a well-established brand. It's a win-win situation: franchisees get to run their own businesses with the support of a larger company, while the franchiser can enjoy significant returns without needing to invest huge sums of money itself.
Some other examples of franchise based companies include:
McDonald’s (MCD)
Domino’s Pizza (DPZ)
Wendy’s (WEN)
Yum! Brands Inc. (YUM) which owns Kentucky Fried Chicken, Taco Bell, and Pizza Hut
“A bear market will occur at some point. We may indeed already be in one. The best stance is to ignore it since you can’t predict it or position yourself effectively to avoid it without impoverishing yourself by forgoing gains. But you have to possess the emotional and financial stability to stick to this stance when it strikes.”
Bear markets are a natural part of the market cycle. They inevitably happen from time to time, and it's impossible to predict exactly when they'll occur or how severe they'll be.
So what can you do? Pretty much nothing, and that’s what you should do.
When you find yourself in the midst of a bear market, don’t panic, and don’t throw the baby out with the bathwater. Instead of trying to predict these bear markets and instead of swapping out your investments to avoid losses, stay calm, stay strong, and keep on keeping on.
“If you insist on investing for dividend income, consider investing alongside a family which founded and has control of a public company. Out of the 47 stocks in the Stoxx Europe 600 that are “family influenced”, only three have cancelled or postponed dividends. Very often these extended families, descended from the business founder, rely on the dividend income from the family business.”
When you're choosing which companies to invest in, one smart strategy is to look at businesses where families are heavily involved or have a significant say in how things are run.
These families often have a long history with the business, going back to its beginnings. Even during tough economic times, these family-influenced companies tend to be very consistent with their dividend payments.
The reason behind this reliability is that these families typically rely on the dividend income themselves. It's like a regular paycheck for them. So, they're motivated to keep the payouts steady, even when times get tough.
Here in the US, there are plenty of companies with strong family influences. Some notable examples include:
Walmart: The Walton family, descendants of founder Sam Walton, own about 45% of Walmart's outstanding shares through the trust and their main investment vehicle, Walton Enterprises.
Campbell Soup Company: While not as prominent as it once was, the Dorrance family still holds significant influence in Campbell Soup. Together, they own 41% of the company at the time of writing.
Estée Lauder Companies Inc.: Founded by Estée and Joseph Lauder, this cosmetics giant is still heavily influenced by the Lauder family, with members holding key positions in the company. The Lauder family owns approximately 38% of total common and about 86% of the voting power at the time of writing.
New York Times Company: This news and media behemoth is majority-owned by the Ochs-Sulzberger family through elevated shares in the company's dual-class stock structure held largely in a trust, in effect since the 1950s. As of 2022, the family holds ninety-five percent of The New York Times Company's Class B shares.
Brown-Forman Corporation: This company, known for brands such as Jack Daniel's and Woodford Reserve, has been controlled by the Brown family for over a century. Today, the Brown family owns about 50% of the company.