Terry Smith's Investing Strategy

11/23/2022

Joseph Carlson specifically looks for these attributes before investing in a stock ...

  1. Buy high-quality companies that compound over time.

  2. Companies that have strong moats,

  3. Have great balance sheets,

  4. Momentum with their growth,

  5. Tons of growth opportunities, and

  6. The company earns a lot of cash (flow).

Terry Smith, a highly regarded and successful hedge-fund investor as seen in the video, follows three principles...

  • Buy good companies

  • Don't extremely Overpay

  • Do nothing

Okay, sounds great, but what is a "good company" as defined by Terry Smith?

  • A good company has a significant Return on Capital Employed (ROCE). Another way of saying ROCE is.... can a company generate more returns with the capital that they are utilizing, employed, and placed at risk?

"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 six percent on capital over forty years, and you hold it for that forty years, you're not going to make much difference than a six percent return; even if you originally bought the stock at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expense booking price, you'll end up with one hell of a result."
-Charlie Munger

To explain Charlie Munger's quote...
The earnings of a company, over the long term, are far more important than worrying about if you bought the company at a premium or discount. Make a note of the stock price, but don't solely worry about the stock price all the time during the moment of investing in the stock. Worrying about the stock price is potentially equivalent to timing the market.

To use a company as an example, Costco...
The average rate of growth of Costco's earnings (EPS Diluted Growth YoY, 5-year average) has been around 14.93%. How much the business grows its earnings, year over year. Now, compare that metric to the annual return of the stock...it's around 15%. Again, this is in line with Charlie's quote.

Let's continue on more qualities of a "Good Company"...

  • Growth to allow reinvestment of their cash flows that result in high rates of returns.

    • The company must be able to find new places, services, or avenues to make more money. Similar to how Apple went from selling iPhones to making the Apple Credit Card, iCloud + etc.

    • Have developing or developed growth in a secular environment. For example, the whitespaces in today's economy would be-- eyes, digital payments, and toothpaste.