One investment report I always read as part of my research is Fundsmith’s ‘Annual Letter to Shareholders.’ Fundsmith has delivered incredible returns for investors since its launch in 2010 (last year it beat the FTSE 100 by about 30%) and the annual letter is always an informative read. Additionally, this letter often contains some useful investment tips from portfolio manager Terry Smith. These tips can potentially make me a better investor.
Last week, Fundsmith published its annual letter for 2020. Here are five key takeaways from the report.
Fundsmith likes highly profitable companies
One of the secrets to Smith’s success as an investor is that, like Warren Buffett, he focuses on highly profitable companies. “Consistently high returns on capital are one sign we look for when seeking companies to invest in. Another is a source of growth – high returns are not much use if the business is not able to grow and deploy more capital at these high rates,” he writes in his latest report.
In 2020, Fundsmith’s holdings generated an average return on capital employed (ROCE) of 25%. This was lower than in previous years. However, what’s interesting is that this was still 150% higher than the average FTSE 100 company’s ROCE.
In relation to valuations, Smith notes that the Fundsmith portfolio consists of companies that have higher valuations than the average FTSE 100 company. However, this doesn’t concern him because he doesn’t believe they are actually ‘expensive’.
“It is wise to bear in mind that despite the rather sloppy shorthand used by many commentators, highly rated does not equate to expensive any more than lowly rated equates to cheap,” he writes.
A K-shaped recovery
Smith says in the annual letter that he became increasingly bemused last year hearing various commentators predict that the economic recovery would be ‘V-shaped’, or shaped like a ‘U’, an ‘L’, or a ‘W.’
However, he did like the idea of a ‘K-shaped’ recovery. This is a concept I discussed last year. A K-shaped recovery occurs when different sectors of the economy emerge from a downturn with sharply differing trajectories, like the arms of the letter K.
Why Smith sold Reckitt Benckiser
Smith also explains why Fundsmith sold its entire stake in FTSE 100 company Reckitt Benckiser in 2020.
Reckitt Benckiser shares traded strongly last year as consumers rushed out to purchase increased quantities of household cleaning products, personal cleaning products, and OTC medicines.
However, Smith and his team felt that the company’s rating did not reflect the pedestrian nature of the business in more normal circumstances or some of the issues it faces. So, they offloaded the stock. They could be wrong, of course, but it was an interesting move nonetheless.
Finally, Smith touched on the fact that some trends have been accelerated due to Covid-19. These include:
Online working from remote locations using the cloud or distributed computing
Home cooking and food delivery
Online schooling and medicine
Social media and communications
Automation and AI
It’s worth noting that many Fundsmith stocks are benefiting from these trends.
For those looking for investment ideas, I think these trends could be a good place to start. But, as always, lots of research is crucial.
The post 5 takeaways from Fundsmith’s 2020 annual letter appeared first on The Motley Fool UK.
Edward Sheldon owns shares in Reckitt Benckiser and has a position in Fundsmith Equity. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2021