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    TIP526: Quality Investing: Lessons from Terry Smith

    enFebruary 21, 2023

    About this Episode

    On today’s episode, Clay Finck discusses the investment philosophies and framework of Terry Smith, who is the founder and CEO of Fundsmith and also known as the Warren Buffett of Great Britain.  Smith started Fundsmith in 2010, and ever since has returned 478% to his investors versus his benchmark returning 256%. He did this using the simple framework of buying good companies, not overpaying, and holding them for the long-term. IN THIS EPISODE YOU’LL LEARN: 00:00 - Intro 02:12 - Why Terry Smith only seeks to own high-quality companies. 04:52 - How investors can go about determining the quality of a business. 08:01 - How Terry Smith compares the valuation of his portfolio against that of the S&P 500. 15:15 - Why investors must be cognizant of stock-based compensation when valuing a company. 29:28 - Why macroeconomic views and opinions are irrelevant for investors in quality businesses. 46:39 Why stocks are the best long-term investment relative to other asset classes. 53:51 - What Terry Smith’s top US equity holdings are today. Disclaimer: Slight discrepancies in the timestamps may occur due to podcast platform differences. BOOKS AND RESOURCES Join the exclusive TIP Mastermind Community to engage in meaningful stock investing discussions with Stig, Clay, and the other community members. Terry Smith’s Shareholder Letters. Rebecca’s Article on Mean Reversion. Don’t miss our review of Four Wide Moat Stocks for 2023. Check out our takeaways from Warren Buffett's Shareholder Letters. Follow Clay on Twitter. NEW TO THE SHOW? Check out our We Study Billionaires Starter Packs. Browse through all our episodes (complete with transcripts) here. Try our tool for picking stock winners and managing our portfolios: TIP Finance Tool. Enjoy exclusive perks from our favorite Apps and Services. Stay up-to-date on financial markets and investing strategies through our daily newsletter, We Study Markets. Learn how to better start, manage, and grow your business with the best business podcasts.  SPONSORS Support our free podcast by supporting our sponsors: River Toyota Linkedin Marketing Solutions Fidelity Efani Shopify NDTCO Fundrise Wise NetSuite TurboTax Vacasa NerdWallet Babbel HELP US OUT! Help us reach new listeners by leaving us a rating and review on Apple Podcasts! It takes less than 30 seconds, and really helps our show grow, which allows us to bring on even better guests for you all! Thank you – we really appreciate it! Learn more about your ad choices. Visit megaphone.fm/adchoices

    🔑 Key Takeaways

    • Investing in quality companies that consistently create value by making high returns on capital in cash, and avoiding bad companies that can destroy value, helps investors achieve better returns in the long term, compared to chasing quick gains.
    • Terry Smith's portfolio can provide insight into quality companies worth adding to your portfolio. Don't base investment strategy on short-term returns and use caution in the current economic climate.
    • Companies must prioritize capital allocation to maintain cash flows for today by investing in higher quality and higher returning companies with sustainable growth, rather than focusing solely on free cash flow.
    • Stock-based compensation should not be ignored when determining a company's normalized earnings, even if it is excluded from non-GAAP earnings figures. Terry Smith's investment strategy involves promoting change in companies' practices. Valuations of companies continue to grow despite low US Treasury yields.
    • Quality investing involves looking beyond stock-based compensation and focusing on a company's fundamental performance, high returns on invested capital, and opportunities for growth. It may require paying a higher price-to-earnings multiple, but the investment will pay off in the long run.
    • Investing in companies with superior financial products and services and little competition can lead to impressive returns. Quality companies with high returns on invested capital are worth paying slightly more for, and time is their friend.
    • When investing, prioritize business fundamentals over biases and narratives, be cautious of dividend stocks, consider the impact of central bank policies on inflation and currency depreciation, invest in high-quality companies with a track record of financial performance, and recognize that higher risk does not always equal higher returns in practice.
    • Investing in companies with consistently high returns on invested capital is essential for long-term success. Focus on quality, minimize fees, avoid poor companies, and don't over diversify. Boring, underappreciated stocks can provide excellent returns.
    • Invest in good companies with strong fundamentals and stick to a set of principles, ignoring popular opinion. Owning shares in a good company is more important than buying cheap shares, and reinvesting in the business offers unique advantages for long-term performance. Terry Smith's bold approach to investing is commendable.
    • Invest in strong, ethical businesses with long-term growth potential. Running winners and investing in franchisers with lower operating costs can be profitable. Avoid solely relying on value investing. Focus on concentrated top holdings, like long-term compounders.
    • Terry Smith invests in high quality companies with strong moats and consistent performance. Recent purchases include Adobe, Amazon, and Alphabet, with each offering unique benefits for long-term growth.

    📝 Podcast Summary

    Terry Smith's Investment Philosophy: Investing in Quality Companies.

    Terry Smith's investment philosophy is centered around buying and holding quality companies that consistently create value by making high returns on capital in cash, regardless of economic cycles. He does not overpay for his stocks and avoids bad companies that can destroy value. By following this strategy, he has outperformed the market and achieved better returns for his investors compared to those achieved by value fund managers. This philosophy helps investors understand what to look for in a company and emphasizes the importance of sticking to a long-term strategy. Smith's approach highlights the need to focus on the fundamentals of a company and avoid the temptation of seeking quick gains through trading or buying cheaper, poor-quality stocks.

    Investing in Quality Companies for Long-Term Value Creation

    Investing in quality companies that compound in value consistently over long periods of time can be more valuable than investing in companies that grow faster. Terry Smith's portfolio, which includes companies like Microsoft, Google, Amazon, PepsiCo, Lauder, Adobe, and Nike, can be used as a resource for getting ideas for quality companies to add to your own portfolio. Although his fund has underperformed the market in certain years, Smith's investment strategy has historically outperformed the market. Underperformance is expected, and one should not base an investment strategy solely on short-term returns. Most active managers underperformed in 2022 except those that exclusively invested in the energy sector. The government's large fiscal deficits, low interest rates, and attempts to suppress volatility may exacerbate future economic and financial crises.

    Capital Allocation in the Post-Easy Money Era

    The era of Easy Money has ended and companies are forced to be more deliberate with their spending and investments in order to provide cash flows for today. The allocation of capital is now more important than ever, and companies should cut anything that doesn't show much promise. Terry Smith invests in higher quality companies than the s and p 500, with higher returns on capital employed and better margins. Moreover, his companies are trading at roughly the same free cash flow yield as the s and p 500. Companies should focus on consistently high returns on capital while seeking sources of growth, and not worry too much about the slight decline in free cash flow since 2021.

    Importance of Factoring Stock-based Compensation in Valuation

    Stock-based compensation is a real expense for companies that needs to be factored in when determining the cash a company produces for valuation purposes. It is an increasingly prominent part of some companies' expenses, especially among companies in the technology sector. Share-based compensation is removed from non-GAAP earnings figures by some companies to boost profits. Excluding stock-based compensation from GAAP earnings may make sense, but it should be accounted for when determining normalized earnings. Terry Smith's fund strategy includes holding onto long-term investments and putting companies on public display to push for change. Valuations of companies have grown significantly over the years despite similar US Treasury yields.

    Quality Investing in Stocks and Stock-Based Compensation

    When investing, it is important to consider stock-based compensation but not to dismiss companies solely because of it. Terry Smith advocates for quality investing, which includes companies with high returns on invested capital, opportunities for growth, and a long-term investment horizon. This approach may require paying a higher price-to-earnings multiple for a company, but if the company is fundamentally strong, the investment will pay off in the long run. The focus should be on a company's fundamental performance rather than its low rating or cheapness. Smith challenges assumptions about passive investing, value investing, and risk. Quality investing lies somewhere in the middle between low-quality and speculative stocks.

    Investing in Quality Companies for Impressive Financial Returns.

    Investing in quality companies that offer superior financial products or services to customers and are able to maintain higher than average returns on invested capital over a long period of time can lead to impressive financial returns. Such companies are able to compound capital at higher rates of return and have some kind of defense, which enables them to fend off competition. While every company has some sort of problem, finding a company with very little competition where other threats, such as regulatory overreach, are low can be a winning play. Time is the friend of a wonderful business, and investing in such businesses can be well worth paying slightly more for quality.

    Terry Smith's Investment Insights and Cautionary Advice for Investors

    Investors should focus on the business fundamentals of a company instead of being swayed by biases and narratives. They should also be cautious while investing in dividend stocks and not solely focus on the dividend yield. Central banker's policies can result in inflation and currency depreciation over time. Terry Smith believes in investing in high-quality companies that have shown financial performance over many decades. The efficient market hypothesis does not necessarily hold in practice and taking on more risk does not always guarantee higher returns.

    Why Investing in High-Return Companies is Beneficial?

    Investing in companies that have consistently high returns on invested capital tend to outperform the market. Terry Smith emphasizes on the importance of investing in good companies that have high returns on capital relative to their cost of capital consistently over time. This creates value for shareholders who should want it to retain at least part of its profits to reinvest it at these attractive rates of return rather than handing them over as dividends or to be used for share buybacks. His investment rules also include minimizing fees, not over diversifying, and avoiding poor companies. An emphasis on certainty often leads to quality and boring stocks to be underappreciated by the market, allowing savvy investors to buy those companies that are underappreciated and outperform the market over time.

    Invest in Good Companies: Terry Smith's Investment Principles

    Invest in good companies with good products/services, strong market share, cash flow, and product development, rather than obsessing over factors and cheap shares. Stick to a set of investment principles and ignore public opinion. Owning shares in a good company is a larger determinant of long-term investment performance than buying cheap shares. Don't sell stakes in good companies, even if overvalued, as they tend to outperform over time. Reinvestment back into the business gives equities a unique advantage over other asset classes such as bonds or real estate. The returns of a stock tend to mirror the returns of the underlying business over the long term. Terry Smith's willingness to stand out and go against other money managers if he believes they're wrong is admirable.

    Investing in Successful, Ethical Businesses for Long-Term Growth

    The best investments are often the most obvious and involve running winners instead of cutting profits. Investing in franchisers like Domino's, which operate through franchises and have lower operating costs, can be especially profitable. However, value investing can be flawed as stocks with low valuations are often not good businesses, and waiting for the low valuation to be recognized can lead to a headwind. Terry Smith's portfolio is concentrated with top holdings like Microsoft, a great example of the power of buying a long-term compounder, and Philip Morris, a tobacco company with stable earnings but a questionable ethical standpoint. Overall, investing in successful, ethical businesses with strong long-term growth potential is key for successful investment strategies.

    Terry Smith's Investment Philosophy and Recent Purchases

    Terry Smith's investment philosophy involves investing in high quality companies with strong moats, high returns on capital, and consistent performance. He prefers companies with long histories and often looks at recent purchases rather than top holdings. He recently added sizable positions to Adobe, Amazon, and Alphabet. He also bought Otis Worldwide Corporation, an elevator and escalator manufacturing company and Church and Dwight, a household product manufacturer. While Otis has stable revenues and good return on capital, its lack of growth makes it less interesting. Adobe, on the other hand, has high margins, high return on invested capital, and is still growing rapidly. Its EV to EBIT is much lower than in years past, making it a quality compounder.

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    TIP626: Intelligent & Rational Long-Term Investing w/ François Rochon

    TIP626: Intelligent & Rational Long-Term Investing w/ François Rochon
    On today’s episode, Clay is joined by François Rochon to discuss how he’s managed to vastly outperform the market over the past 30 years. Since he started the Rochon Global Portfolio in 1993, his annual returns net of fees have been 13.6%, versus 9.2% for the benchmark. François’s investment approach is firmly rooted in three principles — patience, humility, and rationality — which are discussed in depth during this conversation. IN THIS EPISODE YOU’LL LEARN: 00:00 - Intro 02:17 - What led François to hiring Jean-Philippe Bouchard. 06:19 - The foundational investment principles of Giverny’s approach. 10:23 - How François realized so early in his career that you can’t predict the stock market. 19:53 - The tribal gene that sets 5% of investors apart from the rest. 29:29 - How we can be prepared for declines in the stock market. 35:37 - Why his biggest investment mistakes are mistakes of omission. 40:54 - How François views Berkshire Hathaway’s role in his portfolio. 45:27 - How François assesses the strength of a brand. 56:02 - His view on the valuation of today’s market. 68:15 - Why François is so passionate about investing. Disclaimer: Slight discrepancies in the timestamps may occur due to podcast platform differences. BOOKS AND RESOURCES Join the exclusive TIP Mastermind Community to engage in meaningful stock investing discussions with Stig, Clay, Kyle, and the other community members. Giverny Capital’s Letters. Learn more about the Giverny Capital. Books Mentioned: How to be Rich, Money Masters of our Time, The Craft of Investing. Related Episode: RWH016: The Best of the Best w/ François Rochon | YouTube Video. Follow François on LinkedIn.  Follow Clay on Twitter.  Check out all the books mentioned and discussed in our podcast episodes here. Enjoy ad-free episodes when you subscribe to our Premium Feed. NEW TO THE SHOW? Follow our official social media accounts: X (Twitter) | LinkedIn | Instagram | Facebook | TikTok. Check out our We Study Billionaires Starter Packs. Browse through all our episodes (complete with transcripts) here. Try our tool for picking stock winners and managing our portfolios: TIP Finance Tool. Enjoy exclusive perks from our favorite Apps and Services. Stay up-to-date on financial markets and investing strategies through our daily newsletter, We Study Markets. Learn how to better start, manage, and grow your business with the best business podcasts. SPONSORS Support our free podcast by supporting our sponsors: River Toyota Meyka AT&T Vacasa Fidelity Monarch Money Yahoo! Finance Long Angle Public USPS American Express Shopify HELP US OUT! Help us reach new listeners by leaving us a rating and review on Apple Podcasts! It takes less than 30 seconds, and really helps our show grow, which allows us to bring on even better guests for you all! Thank you – we really appreciate it! Support our show by becoming a premium member! https://theinvestorspodcastnetwork.supportingcast.fm Learn more about your ad choices. Visit megaphone.fm/adchoices Support our show by becoming a premium member! https://theinvestorspodcastnetwork.supportingcast.fm

    BTC179: The Business of Football and Bitcoin w/ Peter McCormack (Bitcoin Podcast)

    BTC179: The Business of Football and Bitcoin w/ Peter McCormack (Bitcoin Podcast)
    Join us as Peter McCormack shares insights on blending Bitcoin with football business. We delve into his club's dual promotions, strategic investor impacts from the Winklevoss twins, and the broader influence on Bedford, including a new Universal Studios park. Learn how Bitcoin plays a role in these developments and discover actionable strategies for integrating innovative concepts into local enterprises. IN THIS EPISODE YOU’LL LEARN: 00:00 - Intro 06:20 - The strategic role of Bitcoin in advancing the success of a local football club. 08:11 - The impact of high-profile investors like the Winklevoss twins on the club. 08:11 - Highlights from the "Cheat Code" Bitcoin conference and its integration with local business. 13:05 - How the club manages competitive growth and future challenges with spending caps. 17:53 - Insights into Peter McCormack's journey of owning and promoting his football team. 22:07 - The significant developments in Bedford, including plans for a Universal Studios theme park. 32:08 - Lessons on leveraging cryptocurrency in traditional businesses and community development. Disclaimer: Slight discrepancies in the timestamps may occur due to podcast platform differences. BOOKS AND RESOURCES Buy your Real Bedford sporting attire here. Peter’s podcast, What Bitcoin Did. Learn more about the Cheat Code Conference. Peter's Twitter. Check out all the books mentioned and discussed in our podcast episodes here. Enjoy ad-free episodes when you subscribe to our Premium Feed. NEW TO THE SHOW? Follow our official social media accounts: X (Twitter) | LinkedIn | | Instagram | Facebook | TikTok. Check out our Bitcoin Fundamentals Starter Packs. Browse through all our episodes (complete with transcripts) here. Try our tool for picking stock winners and managing our portfolios: TIP Finance Tool. Enjoy exclusive perks from our favorite Apps and Services. Stay up-to-date on financial markets and investing strategies through our daily newsletter, We Study Markets. Learn how to better start, manage, and grow your business with the best business podcasts. SPONSORS Support our free podcast by supporting our sponsors: River Toyota Meyka AT&T Vacasa Fidelity Monarch Money Yahoo! Finance Long Angle Public USPS American Express Shopify Learn more about your ad choices. Visit megaphone.fm/adchoices Support our show by becoming a premium member! https://theinvestorspodcastnetwork.supportingcast.fm

    TIP625: Berkshire Hathaway w/ Chris Bloomstran

    TIP625: Berkshire Hathaway w/ Chris Bloomstran
    Stig has invited legend investor Chris Bloomstran from Semper Augustus to teach us how to value Berkshire Hathaway on today's show. Semper Augustus has an outstanding track record with a compounded annual growth rate of 11.5% on equities since his fund's inception on 2/28/1999, compared to 7.6% for the S&P500.  IN THIS EPISODE YOU’LL LEARN: 00:00 - Intro 01:37 - The impact of holding cash on your portfolio returns.   24:07 - How to understand the five different components that make up stock market returns. 33:14 - How to estimate the expected return of being invested in the S&P500. 40:57 - What the intrinsic value of Berkshire Hathaway is. 45:51 - How Berkshire Hathaway has allocated capital since 2018. Disclaimer: Slight discrepancies in the timestamps may occur due to podcast platform differences. BOOKS AND RESOURCES Join the exclusive TIP Mastermind Community to engage in meaningful stock investing discussions with Stig, Clay, Kyle, and the other community members. Stig’s 2023 masterclass with Chris Bloomstran on valuing Berkshire Hathaway | YouTube Video. Stig’s 2022 masterclass with Chris Bloomstran on valuing Berkshire Hathaway | YouTube Video. Stig’s masterclass with Chris Bloomstran on equity valuations | YouTube Video. Chris Bloomstran’s website. Read Chris Bloomstran’s letters to his clients.  Buffett resource on CNBC. Check out all the books mentioned and discussed in our podcast episodes here. Enjoy ad-free episodes when you subscribe to our Premium Feed. NEW TO THE SHOW? Follow our official social media accounts: X (Twitter) | LinkedIn | Instagram | Facebook | TikTok. Check out our We Study Billionaires Starter Packs. Browse through all our episodes (complete with transcripts) here. Try our tool for picking stock winners and managing our portfolios: TIP Finance Tool. Enjoy exclusive perks from our favorite Apps and Services. Stay up-to-date on financial markets and investing strategies through our daily newsletter, We Study Markets. Learn how to better start, manage, and grow your business with the best business podcasts. SPONSORS Support our free podcast by supporting our sponsors: River Toyota CI Financial Meyka Fundrise Yahoo! Finance Long Angle iFlex Stretch Studios Public American Express Shopify HELP US OUT! Help us reach new listeners by leaving us a rating and review on Apple Podcasts! It takes less than 30 seconds, and really helps our show grow, which allows us to bring on even better guests for you all! Thank you – we really appreciate it! Learn more about your ad choices. Visit megaphone.fm/adchoices Support our show by becoming a premium member! https://theinvestorspodcastnetwork.supportingcast.fm