4 key investment principles by Terry Smith to help wade through market volatility

Terry Smith stands out as a notable personality in the realm of investments, earning the moniker “Britain’s Warren Buffett” due to his dedication to value investing and remarkable performance over time. As the founder and Chief Investment Officer of Fundsmith, a United Kingdom-based investment management firm, he has built a reputation for prioritizing high-quality, globally listed companies.

At the core of Smith’s investment philosophy is the strategy of acquiring and retaining robust businesses for extended periods, diverging from the short-term trading strategies commonly used by numerous fund managers. His focus lies on extensive research and comprehension of the companies in which he invests, aiming to pinpoint those possessing enduring competitive advantages and effective management teams. This methodical and discerning approach has yielded significant benefits for Fundsmith investors, exemplified by the company’s flagship Equity Fund, which has maintained an average annual return of over 478 per cent since its establishment in 2010.

Examining Smith’s success highlights the importance of understanding his investment philosophy and what distinguishes him from the crowd. His stock-picking strategy revolves around three key principles: Investing in sound companies, avoiding overpayment, and maintaining a long-term holding approach.

Consider investing in reputable companies

Search for companies that consistently achieve a return on invested capital (ROIC) well above their cost of capital, demonstrating efficient and profitable resource deployment. Smith places importance on robust competitive advantages, often referred to as moats, which safeguard a company’s profitability against competition. These moats may stem from diverse sources like brand recognition, intellectual property, network effects, or cost leadership. However, merely focusing on companies with high ROIC is insufficient. Although some high-quality companies may exhibit high ROICs, their growth potential might be constrained or depend on unsustainable methods.

Furthermore, allocating investments to reputable companies reduces the dependence on market timing or predicting short-term fluctuations. Prioritizing the inherent quality of the business empowers investors to navigate market cycles with the assurance that sustained long-term value creation will persist.

Emphasize simplicity and clarity

Terry Smith’s focus on simplicity in investment appeals to individuals who perceive the financial realm as overly intricate and daunting. He advocates for straightforward business models that not only are comprehensible to individuals of any financial background but also operate with transparency and clarity.

But then, it is not so easy to be simple. Simplicity starts by focusing on the fundamentals. Smith places a higher emphasis on comprehending a company’s fundamental business, its competitive strengths, and its financial well-being rather than delving into intricate financial models or engaging in technical analysis.

Steering clear of unnecessary complexity is crucial. This accomplished investor avoids businesses with intricate structures, opaque accounting practices, or excessive debt. He contends that such complexities often conceal underlying issues and elevate the risk for investors.

The advantage of adopting a long-term perspective should not be underestimated. Through investing in straightforward and comprehensible businesses, Smith promotes a commitment to a long-term investment horizon. This strategy diminishes the lure of impulsive decisions driven by short-term market fluctuations.

Steer clear of overpaying for stocks

Smith holds a nuanced perspective on valuation and the creation of long-term value. While undervalued stocks may present short-term gains, depending solely on a “bargain price” might cause you to overlook the compounding potential of high-quality businesses that consistently deliver robust returns over the long haul. Additionally, inexpensive stocks can be discounted for valid reasons, such as poor management, declining markets, or unsustainable business models. Misinterpreting a value trap as a bargain could incur significant costs.

Exercise caution regarding fees and investment expenses

Terry Smith strongly supports the reduction of investment fees and vocally criticizes the industry’s inclination to impose excessive fees that diminish long-term returns for investors. He contends that even seemingly modest percentage-based fees can accumulate significantly over time, diminishing profits and impeding capital growth.

Each percentage point in fees acts as an obstacle that investment returns must surpass to yield positive net gains. Smith underscores that elevated fees can substantially diminish the compounding potential of long-term investments.

He scrutinizes the value proposition of costly actively managed funds, often delivering subpar performance compared to the market while imposing substantial fees. Smith encourages a focus on low-cost index funds or passive strategies that mirror broader market indices, providing comparable or superior returns at a fraction of the cost.

Advocating for investment structures aligned with the interests of fund managers and investors, Smith suggests that performance-based fees or direct ownership in underlying assets can motivate managers to prioritize genuine value creation for investors.

Although Smith’s accomplishments are undeniable, it’s crucial to bear in mind that past performance does not guarantee future results. Blindly following Smith with the expectation of replicating his success would be imprudent. Investing in any financial instrument comes with inherent risks, and it’s essential to conduct comprehensive research and thoughtfully evaluate your investment objectives before making any decisions.