Fundsmith年度股东大会2023年——实录（稳健复利）

Ian King 00:47

Good evening, ladies and gentleman, everyone at Fundsmith is delighted to see you all. For those of you who don’t know me, I’m Ian King on the business presenter of Sky News, I have the pleasure of interviewing Terry and Julian, and hearing what they’ve got to say. Just a reminder for you all about what goes into this process. When the annual letter goes out, you’re all invited to submit questions to Terry and Julian. And then I sit down and decide which of them I’m going to put to them on this occasion. It’s a very independent process. It’s It’s my decision which questions get asked. So if yours hasn’t been asked today, blame me Don’t blame Terry and Julian, rest assured that if your question isn’t answered this evening, or doesn’t get asked, you will get a reply from Fundsmith. So everyone will will be will be dealt with in the in the fullness of time. And declaration for me, as some of you who’ve attended these events, or watch the online presentations in the past or No, I am invested in Fundsmith myself, so is so my kids, and so is Mrs. King, as well. So we are very, very much aligned with all of you. I’m just as interested to hear what Terry and Julian have to say, as all of you in this room. So without further ado, I’m going to hand over to Terry, to kick us off.

Terry Smith 02:12

Thank you. Here we are, again, after a three year break. And it’s very nice to be here and see you. As you probably know, last year, I managed to get COVID on the eve of the first attempt to do our physical meeting again. But I’ve survived intact while this far anyway, this year. As Ian said, I’m just going to take you through some slides, talk about all the usual things. If you’ve been here before that, you know that we talk about, and then hand back to you. And he’s going to feel to question your questions. Let’s take you on, there we go. There’s a disclaimer, as you know, you should read it, we always show it. And if you’ve been before, you’ll know my paraphrase of this, which is if you trust me and buy the units, then it’s your problem. Basically, that’s what that says, says it was slightly more legal sort of language. But that’s what it says. What I actually want to talk about is the performance of the fund, and the investment strategy.

That’s the two things that I want to cover here. And then we’ll cover other matters when we get to sit down and even put your questions to us performance. First, there’s the performance, not our finest hour last year, as you will know, we were down 13.8% About six points more than the market, which is disappointing. Those of you who’ve been here before or on other occasions, hopefully may recall that we’ve always said that there will come the day when we will either underperform or lose money or quite possibly both. Well, here it is we did it doesn’t make it feel any better does it? But it was inevitable. If you are seeking an investment that will outperform in every market condition and every reporting period, I would suggest that you watch on Netflix the rather fine four part docu-drama on Madoff, which I genuinely do recommend to you, I think I think it’s a very good series, by the way. But it’s the only way you’re ever going to get consistent performance in every period. Until suddenly you don’t. There isn’t anything else. I mean, I’ve known over the years of working in the industry, a number of people who’ve had some pretty good, what they call style rotation products, where they attempt to move from so called values, years to growth years, and so on, and cash and market time and so on. I’ve never seen one that worked. And this certainly isn’t one of them, as you probably gathered. What worked and what didn’t last year.

Let’s just go through some of the stocks by way of trying to illustrate what went on so you can see what the sort of fundamental causes of all this work last year. There’s our largest five contributors and our largest five detractors from performance. If you read the annual letter you probably know some of this already. But if you ask for one word to characterise the biggest contributors, the word that sprang to mind for me was defensive. As a drug company and two fast moving consumer goods companies out of those five defensive, that’s what worked last year. As an interesting sort of aside, I would point out that the consumer staples stocks, which were very good defensive stocks last year, on average now valued more highly than tech stocks. It’s worth thinking about that in light of circumstances. Now, what didn’t work? Well, if you look at the stocks on the right, I think the word that most people would would leap for is tech. They would say, well, meta platforms, the old Facebook, Pay Pal, some payment processor, but obviously uses technology, Microsoft, Amazon, I don’t actually think these labels are all that helpful, to be honest with you, you will have read probably in a number of places that we’ve become a tech fund, we haven’t, we’ve got less technology exposure now than we had a half a dozen years ago. And and I don’t think the biggest common denominator in here is necessarily technology, I think there are a number of things that led to this.

One of them is valuation, a couple of the shares were highly valued Pay Pal and IDEXX. In particular, IDEXX is the Veterinary Diagnostic equipment company that we are. And in periods when we have rising rates, like we had last year, highly rated stocks typically perform worse and lowly rated stocks, just like long dated bonds perform worse than short dated bonds, because you’re looking further into the future for the cash flows in valuing them. So I think valuation was was a factor in here. And I think that incident risk related to individual companies and the way that they were running their business or things that were happening to them extraneous to their business were quite important matter and Pay Pal in particular, I think we’re quite important in that regard. Just to illustrate that, I don’t think the technology label is really all that helpful in deciding what went on last year. If you have a look back to the contributors, you’ll see that automatic data processing is one of the top five contributors. It’s in the tech sector, basically. So I think there are other factors, not just technology at play here.

Terry Smith 07:08

Investment Strategy. Hopefully by now you’ve figured out that we’ve got a simple three step investment strategy, which we tried to stick to, we try to only invest in good companies, that is the most important thing that we do. We try not to overpay when buying or owning the shares. And then we do the really tricky bit, which is nothing, which is never quite possible. But we endeavour to do it. I’m going to take you through each of those, basically, to try and illustrate whether or not we’re doing what we said, we’re going to do start with investing in good companies. There’s what we call our look through table we every year, we give you this, we look at five of the main operating metrics or measures that our companies produce. We combine them for the whole portfolio using the weightings of the individual companies. And we compare them with two of the main indices, the s&p 500, and the footsie 100, you’ll see on the right hand side of the slide their return on capital employed or Roc II the top line, you’ll see last year, the return on capital employed in our portfolio was 32%. That’s an all time high. Basically, nothing fundamentally wrong with that.

If you look over at the index, you’ll see 18 16% Our companies are making close to twice what the index companies make in terms of return on capital employed nothing wrong. Gross Margin. This is I think, an often overlooked measure by analysts. This is the difference between company’s sales revenues and the cost of the inputs that they get to make their product or service, the components, the ingredients, and the services that go into the company so that they can do something with them and make a product or service and sell it to you at a markup 64%. Last year, in our portfolio, rock solid, basically, it’s been on the average really, for the last six or seven years, you’ll see that it’s significantly higher than the indices, which are 45 42%. To put it in English, our companies make things for 3.6 and seven for 10. That’s what they do.

Whereas companies in the index, on average, make things for 5.5 and seven for 10. It’s better to make things for 3.6 and seven for 10. That is meant for five point failures, I’m sure you can figure that out. This also tells you a couple of other things. However, this ratio, it tells you something about your defences against inflation, because clearly we’ve in a period of hot, much higher inflation than we’ve experienced for decades. And when you get inflation in input costs into companies, clearly, the smaller the percentage of sales that those input costs occupy, the easier it is for them to still remain profitable in those circumstances. The gross margin also tells you something about their pricing power. Basically they’re taking in these inputs a marking them up to sell them on. And essentially the high gross margin tells you that companies have got quite strong pricing power compared to people with low gross margins out there. And in fact, if you looked at our companies and what they did last year, you’ll find that particularly consumer companies it was a story about them, raising prices and maintaining sales revenue growth by raise In prices now, Julian and I don’t particularly like that as a way of growing a company. But it’s better than not being able to do it, it’s better than the alternative.

Take out all the other costs that companies incur, you get to the operating profit margin, which is the one that most people focus on. And you’ll see that it was 28% last year as high as it’s been in the last few years, compared to 18% on the index. So again, we’re much better than the index, cash conversion bit of a tricky one this last year, you’ll see that was just 88% Last year, which is the lowest that I think we’ve reported in line with the s&p still much higher than the footsie, I wouldn’t get too worked up about it. Cash flow is a very good acid test of a business. But it’s also much more volatile than reported profits. The whole thing about so called accrual profits is that they spread cash flows across reporting periods, you buy something, plant equipment, machinery, you spread the cost across periods and depreciate over time. For example, what we had was some very strange effects in companies last year, caused by the pandemic companies have had problems during the pandemic with their supply chain, they’d had stock outs, they couldn’t get the ingredients or manufacture things ranging from Bleach through to semiconductors. And as a result, when they could get some last year as the pandemic effects began to unwind in the supply chain, reverse back to normal, they bought everything that they possibly could basically, they they moved from just in time to just in case in terms of stock holding in their company.

So depressed cash flow last year, I think the probability is it will rebound quite sharply this year. So I’m not too worked up about it. Finally, interest cover, take the amount of the company’s paying interest and rent and compare it with their profitability. What’s the cover? How far would their profits have to fall before they weren’t able to pay the interest on the loans and the rent on the properties that they leased? And the answer is 20 times nearly as high as it’s ever been twice the index 10 or 11 times. These are very conservatively finance companies. Basically, they’re not making those great operating ratios by financial engineering. That’s not what they’re doing here. And look Taken as a whole. I think we got a portfolio of good companies, there are a couple of problems in there. There probably always are a couple of problems that just I don’t know which ones they are, that’s the only problem. I probably got the wrong ones now. Which ones especially. And I think we’ve tried to be very honest with you about those problems, whether they’re problems that we caused, or the company has caused and what we think about them and what we’re doing about them, ranging from engaging with the companies to flogging the shares. Basically, they’re always on problems, actually, you get more problems in circumstances such as we’ve now got because they it’s almost like putting penetrating oil in an engine. You find the klaxon cracks in the engine Brock, you know, certainly, that’s what circumstances like this are like they, they throw up more of the problems in companies. And we’ve got a couple. But it is a couple. It’s not more than a couple one taken as a whole.

This is still a very, very, very good group of companies, I would suggest. And hold that in mind now where he talks about the second point, which is don’t overpay This is often the most vexed part of the strategy, where people worry whether we’re overpaying or less to worry about now you’ll see the free cash flow yield. So the cash flows that the companies produce divided by their market value. Last year was 3.2%. Now, low is expensive and high is cheap in this is much more expensive or lower than the footsie. But frankly, forget the footsie I’m putting it in there for completeness. The type of companies that dominate the footsie are not the sort of companies that we’re ever going to own, they simply aren’t good enough. Basically, the real comparison is the s&p where but by the way, most of our companies are also quoted. So it’s a real comparison, you’ll see that we’re quite close to the same valuation as the s&p at the end of last year is slightly more expensive. But you know, when you get to do spot valuations at the end of the year, 3.2 versus 3.4 is well within the margin of error. And so I will suggest to you that at the moment, we’ve got a bunch of companies, which are very high quality, which are valued close to the average for the market, which is not a bad place to be.

The last thing to say is free cash flow growth last year was just 1%. And I mentioned this in my letter in a throwaway comment, I’m trying to learn not to make throwaway comments, because people take them a bit seriously. Sometimes I said, if you if you’re if you’re worried by 1%, which is the lowest growth we’ve ever seen, you might not want to read the coming years letter basically. Because of course I don’t know what’s going to happen in the in the economy any more than anybody else does. But actually, I’m not making a prediction here. I’m not predicting Armageddon, Julian and the team’s current guesstimate for what it’s worth on free cash flow growth is about 11% This year, basically, which by the way, corresponds quite neatly to the fact that the cash flow conversion, the amount of profits converted to cash was low last year, it probably will rebound. So I wasn’t making a prediction of Armageddon. I was just trying to be funny. Not gonna do that again. Do nothing. Again, this year, I think a more of x part of the strategy than normal, because we were a bit more active than normal, there’s the list of buys and sells last year looks like a hell of a lot, doesn’t it? There’s certainly a lot of names up there, it doesn’t amount to an awful lot of turnover, I’ll show you the turnover in a moment, it still actually is a very small percentage turnover, for the simple reason that quite a lot of the things that we sell, we are that haven’t been adding to for some time. And or they haven’t performed very well. And so when we sell them, they’re not a big part of the portfolio. And actually, when we buy things, we quite often don’t get a total weighting at the beginning, either because we’re being cautious, or simply because the share price moves away from us. So let me briefly take you through each of those. Just to explain the rationale. We sold our stake in Johnson and Johnson,

Terry Smith 15:49 the largest healthcare business in the world, basically, we bought this business, it’s got three parts. It’s got a drugs, business, a medical equipment and devices business and an over the counter metals, medicines business, basically. And we bought this business for the medical devices and equipment and an over the counter medicine business, which had performed terribly. And and what really bailed us out was the drugs business. Now, we don’t like that we don’t like owning businesses, even if they perform Okay? When the reasons wrong, you can get into a lot of trouble, I think good investment, convincing yourself that you really, you really were right in the first place, even when the reasons were wrong. And then add to that the fact that the drug portfolio which is performed well is facing quite an uphill, sort of run now in terms of drug expires. And it’s one of the problems with drugs is the patents expire, and they’ve got quite big patent expires Stelara being the one at the moment that’s coming up for expiry, which is a Crohn’s disease medication. And add to that the fact that the one of the two businesses that we really didn’t want to in the first place, the consumer business is being spun out. So it wasn’t really a good idea. We thought to stick around.

So we sold it. We sold our Starbucks very recent purchase. We purchased it at the bottom of the market roughly in the pandemic. It was okay for us. We did quite well. It rebounded, Mark, we bought it partly for the opportunity in China, its biggest growth markets China, China is a very big growth market potentially for coffee consumption versus tea. They had a bit of an open goal in front of them. We thought with the fact that their biggest competitor in China Luckin coffee was a fraud. And we thought, Well, that’s it and they managed to capitalise on that. Not one jot during the period. And the management descended into turmoil. We’re now got Howard Schultz back for his third spell as CEO, which in our view is not a good look at this company. Various other things have happened as well. We’re not a big fan of the incoming new CEO who will replace Howard for the third time. And also they one of the one of the points about the Starbucks experience was the the people who serve the coffee the partners as I would say, they I think because of the problems that they face. They ran into a unionisation drive in the staff which was handled very badly, essentially. So we sold them.

We sold Kone Finnish elevator and escalator business. We liked the elevator and escalator business. It’s an installed base of equipment that’s a team market for spares and service and so on. We still like the sector, we just took the opportunity to switch into Otis. Otis as the biggest manufacturer in the world of elevators and escalators. We didn’t want to own it in years gone by because it was part of a conglomerate called United technology, which did a lot of things that we don’t like, as well as elevators and escalators. But when it was spun out, we had the opportunity to own it on its own. So we just switched to Otis.

We sold Intuit, I wrote quite a lot in our annual letter about share based compensation intuits a accounting and tax software business. It’s been using a lot of share based compensation. But it’s not uncommon amongst technology based companies, we don’t mind that it adjusts its earnings from a GAAP generally accepted accounting principles basis to a non GAAP basis by taking out the costs from the p&l account of the share based compensation. We think that’s Baloney, frankly, this if it’s not a cost, what is it, basically, and then the market has accepted that and started to rate the company on these adjusted earnings. So it’s got to quite a big rating, compared to other companies, which we own like Microsoft, which also use share based compensation, but don’t adjust for it. These people have gone to quite a big rating on these adjusted earnings that we don’t like. And then finally, they’ve started to use this strange methodology of accounting as a yardstick for acquisitions. So they’ve been buying things they bought a couple of things, the most recent of which was an online marketing business called MailChimp. And we don’t like that acquisition for a number of reasons.

One, it’s not in their core business area. It’s not in the accounting tax software and we generally find when people people don’t normally have multiple good businesses, they usually have one at most two. Once they start investing outside those one or two It usually goes wrong. And this is outside their main area. And we reckon that based upon the brilliant share based compensation, adjusted earnings, and so on, they probably paid somewhere around three to four times the right price for this business, and when Julian and I and the team were having a conversation about this with them, the thing that they said when we said we think you paid too much for this much, much too much is it? Hey, it’s okay. Half of half of the price was in cat was in shares. Like so you think your shares are overvalued, that’s sorry.

Pay Pal. We sold I wrote a bit about this in the lecture as well. It’s an example of a company we think, snatching defeat from the jaws of victory. This was the number one company in online payments outside China. But through a combination of pie in the sky targets for for customer acquisition, based upon extrapolating the experience in the pandemic, they may came out with unrealistic client acquisition targets that about 300 million clients at the beginning of the pandemic, about 425 million at the end. And so they’re going to have 750 million, and then withdrew the target within one year, we’re not keen on people who withdraw targets within one year, but then thought about one very carefully, lack of engagement with the customers. Before the pandemic, the average customer dealt in their PayPal account 40 to 50 times a year, once a week.

By the end of the pandemic, they dealt with their PayPal account 40 or 50 times a year, once a week, you need to deal with your customers more if you’re going to grow a business rather light stores need to have more stores, same store sales, costs, we thought were out of control. And rather like Intuit, we then seemed seem to set off on a path of we think, Ill judged and expensive acquisitions buying things like Isetan, which is a point of sale, business for payments. So the whole point of this business was it was in the online digital payments space. And it’s now backing up into that which is the fastest growing part of it, versus the point of sale stuff where you pay for your car in a store or restaurant or whatever. They’re backing up into the slower growth part of it. And paying too much we thought so those are our sales.

What did we buy? We’ve already dealt with Otis, we bought Adobe, the leader in creative and graphic software in the world, you will most certainly all use Adobe products. It’s a very good business. We bought it very well on this occasion after the tech companies had had a rather bad spell. And then they announced the acquisition of a thing called Figma, which allows people to collaborate on the web in the use of creative software. This is problematic. They’re almost certainly paying too much. And it almost certainly reveals a view on their part of a competitive weakness in their business. At the moment, I can’t work out whether I’ll be happy or sad if they don’t get it because the competition authorities ruled it out. And you can imagine what happens to a share where I can’t figure out whether I’m happy or sad. If they if they fail with something. We’re not not very happy with that purchase at the moment. I’ve got to be honest with you.

Mettler Toledo, we bought we’ve waited several years where Mettler Toledo is a fine business. It’s the world leader in weighing equipment. Equipment that’s used to weigh things in food processing, drug development, drug put and bio processing, a mix other laboratory and manufacturing equipment as well multi pipetting equipment brilliantly one business in our view, you could set your watch by it. We were really impressed on a factory visit when one of our team went on a factory visit and found that the company had a methodology for monitoring the progress of projects. And it was a whiteboard with the project names at the top and some lines drawn down the board and a post it note that they moved across as the project progresses. That’s, that’s that kind of business. Otis, hopefully I’ve dealt with Apple we started to buy I’m pretty sure there’s a question later on Apple. So I’ll probably deal with it a little more then. But as you know, it’s something that we’ve shied away from buying, we started buying it towards the end of the year, we’ve got a tiny amount of stock and the share price ran away from us. We bought a little bit more in the new year during the weekdays that we’ve had in the market. And I think guided by Ian’s questioning will probably say a bit more about why we’ve had a change of opinion on that. At the moment, I said that there’s a lot of names on there, but it didn’t amount to an awful lot. There’s the actual portfolio turnover. You can see here our portfolio turnover last year was 7.4%. It’s a bit higher than their average obviously, although we have had higher turnover and some comparable figures. Compare that with the statistics last year we show that the average mutual fund manager in the UK turned over his or her portfolio 60% . Six zero, right. This is still very low turnover. We’re not very active and preferably wouldn’t do anything at all.

And you can see in terms of what we spent in terms of dealing costs last year, we spent point 003 of a percent we spent 777,000 pounds stealing on a 22 billion pound fund. And you can see in terms of our activity, nevermind the percentages, which are a formula we’re given and need to calculate on that which can sometimes produce slightly nonsensical things like negative turnover. Compare that number with these numbers over the year. This was not, in fact, a high turnover year, it was quite a low turnover year. And with that, I’m gonna hand you back to Ian, and let him questions.

Ian King 25:28

Thank you, Terry. So the first one, there are actually a couple here the wrong quarter related theme. So we’re gonna go with these from David pergola, who says, What is the best business you want to buy at the moment that you think the price is still too high? And associated question comes from Jane Patel. If you’re in the audience, thank you, Jay. Of all the stocks that the hold funds, have fun told, which is the one that you feel is the most undervalued,

Terry Smith 26:00

I’m having a glass of water so he could stop.

Julian Robins 26:04

Even though, so you get a lot of presentations in America where people give you their, which is where I live, which is where people give you their idea of their best stock, probably because they presumably own it. And they’re trying to give it a little bit of a path. So when I mentioned the stock I’m about to mention, which is the best stock that we’d like to buy, but we think it’s too expensive. I’m not giving it, we don’t own it, we genuinely would like to own it, but it’s still quite a ways off. And it is just an example. It’s not the example we’ve got quite a few stocks that we would like to buy at the best price of the stock is Adyen. It is a Dutch company, it’s got a market cap of 42 billion euros. It was doing in the year before. It’s a payments processor. So it basically enables companies to accept and process their payments. It does it both online and offline. So it does it for Nike, but it also does it for Domino’s, or McDonald’s. It is unlike PayPal, which we think has slightly gone off the reservation in terms of trying to focus on trying to move into other things like crypto trading and savings products and personal financial management. Adyen is laser focused on doing what I’m doing the payments situation well. It was doing 2.7 billion of turnover before COVID is now doing 8.9 billion. So that’s more than trebled in the space of three years, it was doing four euros of earnings, a bit over four euros of earnings before COVID is now doing 18. So it makes a 30% return on capital, everything we see about it is good. It operates in an area online payments, which we think is something which is likely to have a lot of natural growth, the only real barrier to entry is that it’s trading on on 60 times earnings. So this is an example of an even, you know, thinking fairly expansively, and even with sort of any kind of projections that, you know, we might put in the Terry probably wouldn’t believe anyway. But even with any projections that we might put in, it’s difficult to pay that price. And I think one one area or one one reason why we have sort of achieved what we what we have achieved is that we have been good at being patient with these expensive stocks, and waiting for glitches. So I think we waited four years to buy colour plants, which has been a fantastic stock for us. We waited five and in some cases six years to buy IDEXX, which has been a fantastic stock for us. So you know we It’s funny how we do get these opportunities, but you have to be patient and we’re going to still we’re going to try and stay patient in this case.

Terry Smith 28:59

I was hoping when Jr started speaking that he was going to answer that question. In a way that’s reminiscent of a story about Charlie Munger, Warren Buffett’s sidekick, there’s a story about somebody who was standing by an elevator and Charlie Munger was in there. And as the elevator door closed, that guy heard of Charlie Munger say there are only three things you need to know about the stock market. I was hoping he was going to tell you all the characteristics of the company and forget to mention the name.

Julian Robins 29:27

I did have this routine set up with actually another stock where I was going to say I was going to introduce it in terms of what it did, what the numbers were, what the attractions of the business and how it’s gonna go and you’re probably all wanting to know what the name of the stock is. And it’s people in the back. We’re gonna go Can’t hear that anyway.

Terry Smith 29:45

Anyway, did. So I’m on the second part. Okay, good. What’s the stock that we hold that we think is the most undervalued? This is going to be a shocker. And it I know it happens to sashet into another question or ten more out there, Meta platforms. I think it’s the cheapest stock that we own.

Ian King 30:06

And the reason?

Terry Smith 30:08

Well, it’s I don’t want to tread on too much. So I know you’ve got a question waiting for us on this. It’s on a PE of about 15. Notwithstanding all of the bad vibe that some people have got about this, it’s still one of the two leading digital advertising businesses in the world. It has 2 billion users, the users are still rising in number. I mean, I’ve lost count of the number of questions we get, including some tonight. But in general, for people who say, My children don’t use Facebook anymore, do children live in Indonesia, then? I mean, do you think it might be a wider world than Tunbridge Wells? So apologies to anybody from China? We need to think about in this regard. I mean, some of this is masked at the moment by the noise surrounding the metaverse and we probably should talk about the noise surrounding the metaverse because we can wax lyrical about that to a degree even though we don’t know the answer, but I almost feel we don’t need to know the answer. Because if they stopped spending on the metaverse today spent $13.7 billion on spending on the metaverse today, we would have a business on a single figure PE that’s one of the two top digital advertising businesses in the world. Now, I’m not sure that’s a really good thing for them to do, by the way. I’m uncertain about that. But I do know that they could just stop it. And I think if they just stopped that the share price would would roof it. Actually, I’m not sure it’s a good thing. But I think that’s what would happen.

Ian King 31:30

Well, I mean, that segues into the next question, which comes from Jack Newton, Nugent. Thank you, Jack. And he says, Do you regret buying meta?

Terry Smith 31:40

For suddenly regret buying it at the time I bought it? That’s for sure. Because we could have bought it a lot more cheaply. But let’s let’s just put it in context, shall we? And I regret buying it for the standpoint of it’s a pain in the ass to work, because people keep shouting out an awful lot about it, as predicted by Julian, who is now known on the team as the Nostradamus of Westport, which is a really, because he said it’s a different one. But it’s what I love. Yes, it’s where you live in. And, and he’s able to predict chief executives quitting to within the month, basically, it’s frozen for him. But he, he said, When we were debating whether to own it, it will be a difficult stock to own and then he came back after we bought it. So maybe it was too difficult to stop, too. It’s a real pain in the ass to own. And we could have bought it. But but let’s put it in context, I think we’re actually in profit at the moment.

I mean, it’s up over 40% year to date. So we’re not sitting here having lost you some large percentage of your money in major platforms, we’re actually very slightly in profit. It’s also a few sort of characteristics of it. If you look at the numbers up there, you will see what we’re trying to put in context for this is a business which in the last year had $116 billion of of revenues, it doesn’t get a single penny, of course, from the people that use the platforms from people use Facebook, Instagram, WhatsApp, it gets it from the advertisers, it’s got about 12 million advertisers, which by the way, in terms of growth, I’m since that’s where the revenue, I would say is not a particularly high number. Actually, you can see it’s got gross margins of 78%.

That’s the kind of business we like, you know, makes things for 22 sales and for 100. Basically, it comes down to operating margin at 25%. And return on capital employed, which admittedly has been going down as it’s been rolling in an awful lot of spending to 23% Return on capital employed. So that’s the past, not the future. But it is it’s a pretty strong business. As I said earlier on, it’s on a PE at the moment of 15.3. For what it’s worth, these are not our numbers, these are consensus numbers. So I’m 12.7 times. So it says For on Bloomberg, which is pretty cheap. Considering what it’s doing in terms of spending at the moment, you can see the S&P is on about 20 times. So there’s quite a lot of scope for things to go wrong here before this were to look expensive. And there’s the daily average active users on on the platform, you can see, it’s about 2 billion and still rising gently. I mean, just talk about things rising and rising gently in particular, in relation to things like this.

Most people seem to deal with it anecdotally and say, Well, I mean, it’s not great, because nobody uses it anymore, but demonstrably isn’t the case, then there’s a subset of that where people say but it’s only growing at 4% per annum when you’ve got 2 billion users and you’re not allowed to operate in China. So your your effective, your effective market is already a bit over 5 billion human beings. And you’ve got an x out the ones in Africa because quite a lot of member any access to broadband. You’ve probably got almost all the people in the world who can use your product on there. So isn’t gonna be growing at 20% per annum is it? So the fact that it’s still growing at all, I think is quite impressive.

Ian King 34:43

You don’t worry about the competitive landscape. I’m going to notice that Facebook and Google meta of Google, their share of the US online mall advertising market actually fell below 50% last month for the first time ever he don’t worry about the competition.

Terry Smith 34:59

We worry about everything else. Sure. I think they’re facing a couple of things in the advertising market, one of which you describe, which is the competitive landscape, which has moved against them, it’s moved against them with the iOS operating system change at Apple, where they can’t actually follow the, the data, as well as they used to in terms of the effectiveness of advertising. And it’s moved against them in terms of people who are coming up developing advertising. So people, like Amazon, for example, are moving into the advertising space quite effectively. But I still think they are actually a very, very big influence. And even though these two are only 50%, the ubiquity of the communications platform, and in Google, the search platform, I still think is an enormous grab, in terms of advertising for

Julian Robins 35:47 you probably want to make the point that the I mean, one thing we’re going to find is that is that these companies are now so big, that they’re just going to be a lot more cyclical than they were before.

Terry Smith 35:56

I think that’s an there’s an inevitability that if you look back in history, Tech was always relatively non cyclical. And relative because it was on a secular growth trend, although I think it’s still on a secular growth trend. I don’t think there’s any doubt about that. But it’s such a much bigger part of what we spend now that it can’t avoid being a bit cynical. Now, I don’t think that’s, that’s possible. I said, we’re talking about the metaverse, people, they’re spending a lot of money on it. What is it? Well, it’s obviously a form of enhanced stroke virtual reality product. Since we haven’t actually mostly seen it is difficult to tell you exactly what it is, how do we attempt to approach that then, we attempt to approach it by talking to people who we think might understand it in other companies, or might be users of it, people like Microsoft and Apple and Estee Lauder, and L’Oreal and so on. And what we get from that is a sense that as much as we find it difficult to envisage what this is, because we haven’t seen it, there is a reality behind it, and it will emerge, of course, so doesn’t mean that that Meta is going to be the leader or a leader in it. They may, they may emerge and they may fail. But I don’t think we should think that we’re talking about something which is science fiction, a pipe dream here.

I think it’s a lot more than that. I mean, to give you a couple of thoughts on that. I mean, the the people that we talked to in the consumer companies are absolutely clear. And things like cosmetics, that this is going to be a part of the future for it. The Koreans just announced for what it’s worth, that they think they’re going to create one and a half million jobs from it. Basically, people who’ve got some grasp of technology, in terms of national direction of their economy, and so on. So when when people poopoo it, it’s easy to do next, we don’t know what it is. But bear in mind the following, you can make big mistakes Pooh poohing these things. Larry Ellison, the founder of Oracle, I can’t remember which your dude is better on these things. And I said, the cloud cloud computing, what is it? That’s it’s gonna, nothing important is going to emerge from him. What is it within the last 10 years? Yeah, yeah. I mean, as a result of him taking that stance, they’re now number four in cloud computing, a distant fourth in cloud computing. And it’s a bit like the problems that we do have some of which do relate to technology stocks in our portfolio or thinking about things like the metaverse, it’s not a comfortable place to be. I’ll tell you that in terms of owning things like this, but the way I look at it is the other way up. Let’s imagine that we just ran our portfolio for so all time now with only consumer and medical stocks. And would you be happy? Would we be happy that we had no exposure to technology? Do we think that would work? Well? It didn’t work very well, last year, clearly. But do we think in most years in the market cycle, it’d be a really good idea not to have anything? I don’t think it would choose, you know, Okay.

Ian King 38:48

Very good. Right. So this next one, you’ve kind of headed it off at the passage from Maria Messerly. Thanks, Maria. Since the inception of value, 2022 years seems to be the most eventful in terms of stock rotation. I mean, you’ve kind of addressed that in the presentation. But she goes on to say, what can justify such a high flow of businesses in the portfolio? And here’s the key question, I think, is there any shift to a more frequent trading strategy? Long term?

Terry Smith 39:16

No, not a shift in strategy. And we’re still aiming to be very long term shareholders, ideally, forever if we get the opportunity to do so I, I wrote to a company this week, pointing out that we’ve owned them since inception, and have never sold a share. And that’s kind of a position we’d like to be in. Particularly, you know, if it’s a good business, and we think they’re doing things roughly right. What causes change is events, basically, you know, we have to sometimes react to events and that’s, that’s a fact of life. The other thing I would say is, this is not a change of strategy, but our, we’re going to talk about okay, you got a question about engagement with companies later on. One of the things that we’ve tried to operate on as a mantra over years, which we didn’t invent, because we didn’t actually invent anything. We tried to copy people who are quite clever with it, that’s the way forward is always invest in a business that can be run by an idiot, because sooner or later they all are. And, and the fact of the matter is, it’s an awful lot better to invest in certain businesses that are run by idiots than others.

And so, you know, things like consumer products companies, most it’s not ideal to have the media in charge, you’re probably going to survive, right? But when you get into certain areas, like technology, it’s a lot less easy to survive. It’s not impossible. It’s just less easy. I mean, some would say, and I don’t want to call anybody an idiot, for obvious reasons. So I know how boomerangs work. But I know, we bought our holding in Microsoft when it was run by Steve Ballmer, who lots of other people have certainly described in that manner. And I don’t have I don’t know Mr. Ballmer. And I try not to draw such conclusions on people I’ve never met. But certainly the Microsoft business survived that, that episode very well. But it’s equally true to say, the real impact of Microsoft was setting and Nadella coming on and grasping the business. So I think what I’m trying to say is, the difference between a very bad performance and a good performance is not as wide in in the more stable sectors that we invest in like food and consumer products, as it is in technology. And that’s that makes us I think, going forward a little more cautious from the experience that we’ve had about holding on sometimes.

Julian Robins 41:32

I’ve just added another couple of things, which is not withstanding the tremendous loyalty of the people in the room. We have had outflows over the last year. And and when you if you’ve got no inflows, and you have a stock you really want to buy, then the only way to raise money to buy it is to actually sell something else sell something else. So that’s certainly something that we’ve addressed. The other thing is that, I mean, I think that I mean, 2020, I thought was a fascinating year, because obviously, because of COVID, the market crashed, and there were lots of opportunities to buy things. Not a generational opportunity. But there were good opportunities. And I think that and we somewhat lucked out, because we own records since the start.

And we bought Clorox in 2019. And us we own the world’s two preeminent cleaning stocks at a time when demand for cleaning products was obviously very high. And we saw the stocks go up a lot, they doubled when a lot of other stocks had halved. And we were able to sell those and buy things which was significantly high quality. So I mean, that was a moment. And it was interesting that in the US companies publish what’s called sorry, fund managers published what’s called a 13 F, which gives their quarterly trades. And I was kind of mystified by how some of the big value funds were very, very inactive during that year. And I would have thought that a test of a fund manager or a value fund manager was that they would have been very active during 2020 because of the opportunities. And so I think, not as that I mean, we’re not trying to be more active or we don’t have any change in strategy. But there are moments when I think it’s right to be more active because rare opportunities present themselves.

Ian King 43:22

Good stuff. Thank you. This next one is from Paul adult, Paul. Frank, if you’re wondering, Paul is whether he’s actually a personal finance journalist, because this is a question I’ve seen thrown at various fund managers over the years such as Anthony Bolton at fidelity. Paul’s question is this does the size of the fund now effectively limits the investable universe for funds myth making it difficult to be as successful as the fund has been in the past?

Terry Smith 43:49

We’ve done your slide on this with some numbers on it. Just to give you an illustration, it’s it’s easy to, I think, fall into the trap. But it is a bit of a trap of thinking, Well, when you started fund Smith, you own Domino’s Pizza, and it did very well. And it was a $1.8 billion company. And you couldn’t own a $1.8 billion company today, could you? And the answer is no, we couldn’t not unless we wanted to own 25% or something. And we don’t want to own 25% of anything, basically. Because, you know, other people in the fund management industry have experimented with limited liquidity in open ended funds. And it’s a rather like, you know, playing with sort of fireworks does work for well, we’re not gonna do that. So the thing that people miss is the companies don’t stand still, you know, the fund has grown in size, yes, but quite a lot of the companies have performed pretty well as well. So we’ve given you a table here, which shows you the companies we just smallest by market capitalization that we either own or have owned, and we show you in there, what the size of the company is in terms of its market value.

In 2010, when we started, what the market value is today, and what percentage of the company we would have to own In order to get a 3% position in our fund 3% position would mean we’d have 30 stocks in round number terms. And I think you can see, but basically, even when we get to the very smallest of these, which are the bottom end of the footsie, these are not numbers where we say we’ll call them whenever that is terribly liquid seven or 8%. which funnily enough, I think the short answer is no, and it’s because the company is to a considerable degree, keep pace, because these are companies that are not just companies on average sitting out there, you know, so it’s not sort of take today’s example Accardo, where, you know, don’t blind when or if you own, you know, sort of 3% of your funding Accardo, five years ago, and you wanted 3%. Now, you know, most of the company, no, that’s not what we’re talking about here. We’re talking about our investable universe of companies where whether we own them or not, they’ve usually performed pretty well. Just out

Julian Robins 45:49 the simple point that that. I mean, it’s clearly obviously the case that, that there is more there is more percentage upside in, in smaller market cap companies as a general rule, but but one of the most successful companies that we’ve bought, where we’ve made 10 times our money as a company that you might have heard of called Microsoft. So it’s not only I mean, you know, we, I think the first price we bought Domino’s Pizza was $15. And at the peak, it was $500. So we might have made 30 times, you know, and you can see IDEXX was a $4 billion company there, and we’ve made six or seven times our money, but we’ve made 10 times our money in Microsoft. So again, if you’re patient, you do tend to get opportunities in in, in, in market caps of all sizes. Yeah.

Ian King 46:39

Great stuff. Right. This next one is on the investment process. So it’s a kind of related theme here from Peter Mitchell. Thanks for your question, Peter. And he asks, With the projected trends in ageing populations, what are the reasons behind there being no pure plays on eye care? Or hearing devices in the portfolio?

Terry Smith 46:59

You ever go? You ever got the point? Yes, that’s the point. I’m sorry.

Julian Robins 47:10

Right. So we have you probably heard us talk about our investable universe, which is 80 companies and within our investable universe, we actually do have two companies, which are pure plays on eye care and hearing devices. So the first one is the French company or French Italian company, EssilorLuxottica, we had originally SLR in the in the investable universe, French company, it’s the dominant player in the lenses that go into glasses, the big brands, big brands was Carrizal. And then it merged with Luxottica. And it started loading brands, and also retailers like Sunglass Hut, except you can see out there. It’s a $78 billion dollar company, we’ve we’ve had slo in the investable Universe since day one. One of the factoids that we used to produce quite often back in the day was that was that this was a good company, because there’s the question of said the wrong thing, or 4.2 billion people in the world who need corrective vision, only, and only about 1.8 billion have access to it. So it seems like a pretty good market. The it’s always been pretty expensive.

And then when they merged with Essilor, or when they merged with Luxottica, there was quite a lot of complications around the deal around who was gonna manage the business around other other acquisitions they were trying to do. And we’re gonna go on to a couple of slides time. Yeah, the other thing was that the return on capital, as you see was, was sort of slightly iffy to begin with and is now as a result of that deal gone down to a pretty small number. So it’s still in our investable universe. We’re still following it. Every set of results we still write up religiously was the model it we sort of we we listened to everything I’ve got to say but it’s on the watch list at the moment. And then the other company is a Swiss company called Sonova. As I said, It traces its origins back to a company called Electro acoustique. Founded in 1947. Some of you might notice Phonak ware which was renamed in 1977. And then it was renamed Sonova in 2007. Phone X is the best known brands. It is the world leader in hearing aids and in hearing implants. Again, if we go back to the slide again, used to have pretty good returns on capital. These are now still okay but less good. It’s had some problems with it had it had a history not hysterical is probably the wrong word. But it had a bizarre instance with insider trading and with back in the day and we follow it. It’s always been on our watch list. It, it’s never, it’s never grown quite as much as we thought it would.

Terry Smith 50:13

To the performance slide, yeah. This is the acid test.

Julian Robins 50:16

And I mean, I think I’d also I’d also use this point, although there’s not in the question wishes to say that these stocks are in our investable universe, but not in the portfolio, but even even the things which haven’t done as well in the investable universe, you know, it’s still done. Okay, so as long exhausting, there’s that 335% Since we started against the found that 486% and turnovers up 252%. So they still don’t, okay, we’ve done better. So I guess we’ve done well by not only them, but they are pretty decent businesses, and we continue to follow them.

Ian King 50:51

Right. This next one comes from Manish Gupta. Thank you, Manish for your question. Terry, your public comments on Unilever did create a lot of discussion. And I would believe did not go unnoticed by management’s. Would you take a similarly vocal approach on any other underperforming companies?

Terry Smith 51:12

Yes, if we had to. But frankly, it’s not our preferred route. Or even if we feel that we’ve got to engage with somebody, because we think things are not going right. By far our preferred route is to do it in private, we think most discussions where people are going to discuss something’s going to be difficult, because after all, you’re going to tell them, I don’t think you’re doing this very well. And not best performed with a megaphone in a public arena. So you know, we’re likely to start with just talking to them about it. And then if that doesn’t work, is to write them a letter I’m usually write them in and something saying what we think it’s not right and what we think should be done. And it’s only really when we think we’ve been completely ignored, that we reach for the lever and go public on the whole thing. And so I’m sure we could end up in exactly the same position, but it wouldn’t be our first or even our second stage of trying to alter what’s going on.

I mean, just one I’ve got the point. I mean, one of the things I would say is, a number of people have said to us look, if you don’t like Unilever, because after all, you keep talking about it, why don’t you sell the shares to which I reply, it’s not Unilever that we don’t like it’s the management, actually, within Unilever is fine. Unilever hasn’t changed that much. Unilever is still potentially a fine business. I mean, he’s got some very strong brands, it’s got things like dove and norlane got more than 4 billion euros in sales per brand powerful brands. It’s got arguably unparalleled distribution into the emerging world. I mean, it’s vice for being the largest, fast moving consumer, this company what it is in India, definitely. And also in Nigeria, and Indonesia. So we’re talking about three of the five most populous countries in the world, two of which will be amongst the three most populous countries of the world, in the middle of century by most people’s reckoning. That’s a powerful position. And we look back at the unilevel, we bought in 2010, which had 18 20%, or even in the low 20s percent return on capital. And now that’s 10%.

Less than that we think, Well, what’s changed? And I don’t think the answer is Unilever. And so, you know, it’s just to clarify a lot more, it’s not that we don’t like Unilever, we think Unilever still has the potential to be a very good business. But we think it needs to be managed in a manner that brings that out that doesn’t involve a lot of other things. And obviously, I’ve been extensively quoted on mayonnaise and soap and all kinds of things. But But let’s get back to something more basic than that, you know, they’ve sold the tea business, and they sold the spreads business, and they tried to buy the GlaxoSmithKline over the counter health business, we don’t think they should be doing things like that, mostly, we think what they should spend their time on doing is trying to make Unilever as good as it can possibly be in terms of how it compares with other really good businesses in cleaning products, and personal care products and food products. And, and once they’ve actually got the business to perform as well as it possibly can be the best example of it. So then we might ever think about doing something else. But until you get to that stage, I’m not quite sure why we’d let you out to play games with buying and selling.

Ian King 54:15

I mean, you’ll you’ll this is all addressed in the annual letter, of course, I mean, I was quite amazed by the table that you had in there about the number of acquisitions that they’ve done.

Terry Smith 54:22

But um, for some reason, it’s it’s regarded as a state secret, knowing how these things occurred. And I don’t you know, call me old fashioned. I don’t suppose that’s because they’ve done so well that they’re embarrassed by it, right. I mean, you know, the example I gave in the annual letter in particular of Carver, Korea, which they bought, I mean, they bought this business, from Goldman Sachs and Bain Capital, and with apologies to anyone in the room who works for either of those two organisations, this is a compliment by the way, buying things from them might not go well. They’re quite good at it. Another clue to what might happen is they bought it one year after Bain Capital and Goldman Sachs had invested for six times what they paid for it. This was built in the Korean press as a landmark in private equity in Korea, the steel. And then the final frontier is is we don’t think fast moving consumer goods companies like Unilever are all that good at the cosmetics business. We think it’s family controlled businesses, which only do cosmetics that are really good at cosmetics businesses, people like Estee Lauder and Lorell requires a completely different approach to the profitability and spending in terms of advertising promotion, packaging, then the consumer goods companies have got Procter and Gamble walked away from our soldiers cosmetics, Mr. Cote, they realise I can’t do this.

Ian King 55:40

You made clear in the shareholder letter in the annual letter that you were disappointed at the lack of communication have? Have you heard from them since it was announced that Alan job’s going yeah, we’re no good

Terry Smith 55:51 success. We aren’t yet we are talking to them. We had a chat with the chairman about the new CEO appointment. And I would say at the moment, we are kind of mildly encouraged. What are we mildly encouraged about? Well, first, we did talk to us, that’s quite a good start. But then secondly, you know, he said something that sounded a bit like what I said earlier, which is, he thinks the priority is to get the business to perform as well as it can perform. And the M&A is not really a focus for this at all. And assuming that they actually mean what they say, I think that’s exactly the right way to approach this, that they should be trying to benchmark Unilever against its peers out there against Nestle and in food and beverage against Procter and Gamble in household cleaning products, and personal care products, etc, etc, etc. And so right well, what sort of margins returns and growth rates are they able to generate? Why can’t we do the same. And then when you’ve actually had a go at that, then maybe we can have a chat about whether you’re capable of doing more exciting things.

Julian Robins 56:49

I just keep thinking back, some of you may remember the Henry Rude letters. Henry Rude was a fictional character who sent amusing letters to people. And he sent as I recall, a letter to Esther ransom, which was sort of mildly positive and nice. And he got what he what he thought was a bit of a brush off, you know, Dear Mr. Root, you know, thank you so much for your Lhasa, your kind letter, you know, Miss rounds and appreciates all the feedback from her sort of loyal followers. So having felt rather brushed off, he then sent her something utterly abusive, which I don’t think I can’t even repeat on this stage. And he got family show, family show. And he got a letter back saying, Dear Mr. Rude, thank you, for you so much for your kind comments, Miss Ramsey. Appreciate? And I think that that’s some sometimes what we feel

Terry Smith 57:40

Yeah, we do feel like that sometimes, we do feel that we might be talking to the weighing machine sometimes rather than speak your weight machine. Right. So

Ian King 57:51 as you rightly surmised, in your presentation, we do have an Apple related question. This comes from Joe Hadfield. Joe, thank you for your question. When asked about owning Apple during the 2014 annual shareholders meeting, Terry stated, we would never own a fashion business. And in our view, this is exactly what Apple has become. What shift in Apple’s business model over the last nine years, made you change your mind about the company.

Terry Smith 58:15

I really don’t like these people who can remember what I said it’s so it’s so distressing.

Ian King 58:21 on the internet. So

Terry Smith 58:23

I’d like to back up a bit, actually and explain why I think we took the stance we did and why we’ve now and then why we’ve now changed it to answer the question. Back in the dot com boom, when we were working in the in the broken pieces on the so called sell side of the industry, we used to market a product called Quest, which was a database system that had all the data on companies over about a billion dollars market value in the world, to institutions around the world. And looking at things it very much the same way as we look at them now, actually, in terms of whether companies great value or not, whether they’re good businesses. So we were asked for a presentation. And I was asked with Greg from here somewhere with us tonight. And we were asked for a presentation to a fund in Boston who had back to back presentations by yours truly. And and a gentleman called Michael Mobisoft, who’s a strategist. And they were puzzled about what to do about the dot com era. And Michael’s view was its quotes Columbus in the new world. Don’t worry about any of the normal metrics of cash flows and so on his eyeballs and clicks and buy everything roughly. I mean, I’ll paraphrase probably horribly. He’s a good guy. So don’t wonder. But yours truly said, Well, you don’t go to cash flow is not a business seller. And so by the end of this, they were even more confusing they were to begin with. So they said, Well, let’s talk about an individual stocks if we narrow down if they chose Nokia, and I using my cash flow system at the time, Nokia was trading at about 60 A share at the time. And my cash flow system that I presented it said it’s worth 12 Which of course people don’t normally do normally if people think something’s and silver says worth 50 Not 60 At 12, I was too bullish, by the way it went to three. Which was obviously a shock to people. The reason put forward on why we were wrong, why this consumer electronics products business making handsets basically wasn’t going to follow the path that we predicted in terms of cash returns and valuation was because it was an I hated this word ever since had an ecosystem.

People were tied into the Nokia ecosystem, and they couldn’t ever get out, they were always gonna have to buy new Nokia equipment. And so this proved to be absolute eyewash. And, of course, what’s happened over time is I’ve been so pumped up with my sagacity is result this, I’ve missed the Apple situation, I’m sorry. But anyway, one of the things we tried to do it because people have told us Apples, don’t worry about the devices business. Yes, you’re right, they’re on. They’re on a treadmill with regard to your iPhone in particular, which is obviously the biggest product by considerable margin. But it’s got an ecosystem. And the very use of that term and the way people talked about it led us to believe that we knew what we were doing. Our first mistake. And, but one thing we do, is we go back over things that we reject regularly, and blow the dust off. And metaphorically, they’re obviously an electronic file, so no real does and and see whether we’re right or wrong. And we try and get different members of the team to look at it each time to see whether anything new comes out of it. And when they did this, we noticed this, which is Apple’s revenues for the last few years, you’ll see up there. And the big orange bar is the iPhone sales, which as I said, is the largest segment of it. But this is the thing that was really striking, particularly once you started to get about here, this blue bar services over here, you know, the service part of this product is now about 25% of the revenues approximately, it encompasses things like music, TV, payments, so on, it’s clearly growing at about twice the rate of the handset business as well, which is interesting, and I think it is an ecosystem.

Julian Robins 1:02:04

And it’s extremely

Terry Smith 1:02:05 profitable. It’s twice, it’s got profitability, like a software business, whereas the handset business, the hardware business has got fairly, you know, not ordinary margins, good margins, but not like a software. But it’s got fantastic returns and margins as far as we can determine for it. And it’s a service business, which is being sold to a very good socio economic group, your investors in our fund, thank you very much. And I can tell you from statistics that we collect on you, that three out of every four of you is got an iPhone, and you’re quite well off, you’re not basically, you’re quite good to sell Pete things do for a simple reason, you’ve got money.

If you look at operating systems amongst the database of our investors, and this is pretty, pretty typical in the world. It’s three to one in terms of IRS systems, Apple systems versus Android systems, they basically got a very large, very good demographic and a fast growing services business. And that’s it basically, folks, we started buying at the end of last year, but got a tiny amount, because my target price was about $125. And it quickly went $250. So my reasoning was if I’m gonna $125 If you do the arithmetic, it’s about the same return as the s&p index. And this is a better business and the s&p index, in my view, of course, it quickly took off. And we bought a bit more now in the new year when it got back down towards our target price, but it’s taken off again. But as Julian’s said more than once in this, we will be patient. We don’t want to make compound previous errors by diving in. So we will be patient and you know, there’s a reasonable chance that the market will give us further opportunity to capitalise on that.

Ian King 1:03:51

Very good. Now, well, we’ve talked a lot in the past about market timing. I know it’s something that you’ve always set to your face against. And this next question is on that theme. It comes from Charles Douglas Charles, thank you. Do you have your in the room for your question? And he asks, Is there room for a portion of the portfolio to be more dynamic and responsive to market changes?

Terry Smith 1:04:13

I first of all, I’d like Mr. Douglas to meet Maria, whose question we answered earlier, who said we’re training too much or something like that they could meet let me know what they’ve what their combined opinion is on what we should do. It’d be good. You can’t please everybody is one of the things you find in here. Yeah, well, I think to some degree, we’ve hopefully answered this in what I’ve been saying so far, which is, there’s no massive change here. And and we’re certainly not going to market time. I don’t know anyone who can do it really. And I certainly know without any doubt that I can’t do it or we can’t do it. So we’re not going to do that. I think probably we’ve learned a little more, as I said about the necessity to not remain engaged in long term shareholders in businesses that can’t be run by the proverbial idiot that requires has slightly more of an itchy finger on the trigger than people who are selling soap and and household cleaning products. Basically, the capacity for damage is greater. So that’s that’s where I would have said the responsiveness will be.

Julian Robins 1:05:13

Also, forgive me if I’ve got this wrong, but I’ve a feeling that the word a portion of the portfolio means that means that we might be the meat of it because I think the question I’ve got here is, is there a room for a portion of the portfolio to be more dynamic? And I think that’s talking to some portfolios where they have their kind of the core element and then they have the kind of more tactical elements and I don’t think we don’t have one of those. No, we don’t want to lose no,

Terry Smith 1:05:39 no, that’s too complicated for us. We can’t do that.

Ian King 1:05:45

Right to two questions. Next on a related theme, they come from Aiden Mackay, and Gabrielle Jeffery or Gabriel. Jeffrey, thank you for those. First one, is actually a reference to feet, the funds with emerging equities Trust, which obviously you pulled down the shutters on that last year. And Aiden asks, why a feat companies had a better return on capital than the main Fund and the s&p 500, MSCI index, etc. Why did it not perform better or comparatively with funds with equity over a five year period? Another related emerging markets question comes from Gabriel. To what degree is the fund exposed to emerging markets through its companies? And to what degree do you see the success of emerging markets been crucial to such companies? Long term growth?

Terry Smith 1:06:35

Yeah, okay. Yes, feet? The answer is currency. Basically, if you own companies in something like the emerging markets fund, you can find very, very good consumer companies in for example, India, but they are in India. And they are subject therefore, in terms of what they produce for us in return in hard currency to the macroeconomics of India. And, and it’s and it and its currency movements. So that’s the Indian rupee from the Foundation have feet to the to when we left it, that’s, we were basically, in terms of the performance of the company is running up that down escalator. And before anybody thinks it, no, you can’t hedge the currency, it’s just not feasible. You can’t hedge for any kind of period ahead with any liquidity. And with an even if you do, it’s got massive cost associated with it. The emerging markets, currencies do not have the kind of liquidity that hard currencies have got, they don’t have the kind of hedging capability that currencies have got, you are basically locked into the currency risk of the country concerned. And that is not an atypical job. It’s also, of course, a bizarrely difficult area to try and predict, you know, we didn’t own anything in Russia. But if we were trying to predict what was happening in Russia as a result of the events of the Ukraine, the ruble has, of course, been very strong. It’s like I give up right on this, I’m not equipped to make these kinds of judgments is my view on it? And so we gave up basically, on the second part of the question, do we think that this is an important element?

Yes, most certainly, it is the breakdown of our country companies by listing on the on the left of the slide, you’ll see. But more importantly, there’s a breakdown by revenue. And you’ll see, whereas nearly 70% of our companies are listed in the United States of America, less than half of their revenues are actually from North America, taken as a whole. And in fact, we have one company that’s listed in the United States, which has zero revenue in America as we speak. Which is kind of interesting, though. It’s not when people talk about where’s the exposure, it certainly isn’t in America. It’s in other places. In fact, it’s in Indonesia, Turkey, and Philippines and places like that. And if you look down the table on the right, you’ll see Asia, Pacific Eurasia, Middle East Africa and Latin America there. If you sum those together, it’s about 30% of the revenues, the reality is clipping on towards a third of the revenues of our companies are from emerging markets, basically. And because they don’t suffer the same kind of things that we’re suffering in feet on the whole, which is quite a lot of what they do is made locally and sold locally. And they really only have translational effects to worry about in relation to that business. So they’ve not got the same kind of gross impacts that we had in there. They’re better able to manage it. They’re just better at it as well, frankly, than we were. And I think yes, this is an important part of it. If we to be overly simplistic.

I think if you look at the companies that we’ve got, selling more in the developed world is mainly about getting people to pay more and drink and eat better, and have things that relate to so called premiumization. Whereas in the developing world, it’s about developing utilisation is what Julian touched upon in terms of eye care and vision correction, which is most of the people he’s talking about who require the vision correction, don’t have it are in the developing world. So yes, I think it’s up very important part of what these companies do. I’ll come back to the Unilever comment, Unilever, we think about oh, yeah, he’s got very good brands. And so how about the distribution, the distribution capabilities is formidable in those areas.

Ian King 1:10:13

I always remember the chief executive, Diageo, Paul Walsh, when he was who was used to say that the US was his biggest emerging market, because there was emerging middle class buying and premium rising. Yeah,

Julian Robins 1:10:24 and I mean, this is, this is what I was gonna say was exactly the same point, which is emerging markets are different things to different people. So we own the three airline reservation companies or IT companies that between us and Smith’s and we follow, which is, so we own Amadeus, and then which is came out of the three, four European airlines, Iberia, and Lufthansa, Air France and somebody else. And so all their business historically was in Europe, and then they’ve moved to Asia. And then there are two companies called Travelport and Sabre, which are the US equivalent. So if you so they came out of united and American Airlines, and so Amadeus historically, did all of its revenues in the in Europe and Asia, and I think literally zero in the US, whereas now it’s starting to win business in the US. So it’s exactly the same point. Yeah.

Ian King 1:11:19

Very good. i For those of you gasping for drink, we’re, we’re into the home straight now. We haven’t really talked about macro this evening. And I’m afraid your luck’s just run out. This one comes from Peter bow. And like this one, Peter, thank you very much indeed for your question. And he asks, simply, has the Great Moderation gone for good?

Terry Smith 1:11:42

Yeah, probably the Great Moderation. So a period when we had low interest rates, but also low inflation, and the economy grew. Yeah, I mean, that was kind of sort of, if you think about it, it’s like one of those trick of the ice things where you’ve got some cricket stumps and, or castles where everything you walk up into Yeah, you can’t have that indefinitely, can you? And, of course, you know, the thing that helped us to have this rather strange confluence of low interest rates. Government spending more than they were fiscal stimulus, like government spending more than they were, they were getting in revenues. Debt being financed by Central Bank buying and not having inflation was a call to the great financial crisis, which helped with this, you know, the huge balance sheet recession that we had as a result of the damage to the banking system meant that we could operate for a period where all of those things could happen. Because we had very strong deflationary influences of what happened in the banking system and, and that was built on the back of other strong deflationary influences from the rise of China as a manufacturing power.

Probably that’s gone now, I think. But I was always taught when I was studying, to never if you want to pass an exam, don’t answer the question asked the question you wish they’d asked. I famously managed to have a famously however, I managed to answer a question on in my English history exam on the intellectual revolution of the early 17th century and its influence on the English to war by saying, well, there was no it was all caused by this, which I lecture after I said, brilliant, I’ve never seen anyone answer a question as well, when he clearly didn’t have any clue about the subject. I took it as a compliment. And the question, I guess, that I wish they’d asked. So I’m gonna answer anyway, is, how will we fare? How will fund Smith fair, right. And, I mean, obviously, your guest is at least as good as mine. But here’s a couple of clues. We’ve gone back. And we’ve done some work by looking at how the stocks of the salt we have performed versus the market in similar circumstances to the ones we’re now with. So with us, rates, just about four and a half percent, the short end. And in doing that work, my colleagues who did the work I congratulate because if you try and look this up on Bloomberg, you’ll find it’s hopeless, because the data only starts in the mid 1990s, which, of course, was the beginning of the Great Moderation. So working out what growth stocks versus growth, quality stocks did versus value, still absolutely hopeless, because you’re actually in the centre of the problem. So what we did is we went back and re recreated the data for the s&p, and for our own investable universe, and for the portfolio, back from the period from 1980 to 2001, when interest rates in the US averaged about four and a half percent. So the nearest comparator we can get, it’s not perfect. It’s not perfect either a number of stocks because not all of our stocks even existed back then, is not perfect in terms of data. But I can tell you the two things, which I find quite interesting in relation to it, fortunately, are one we are performed. If you look back on the stocks out, our investable years outperformed the s&p and our portfolio outperformed both of them. And the second thing was they managed to outperform both the falling and rising rate periods in that period in the in the rising rate periods. You’ll see that over here, and in the falling rate periods are clearly the falling rate periods produced bigger absolute returns because they do. The the valuation of things goes up more. But the good news, if there is any good news is if we are living through a repeat of that, and I don’t know whether we are, we should be alright. And strategic terms. I mean,

Ian King 1:15:13 obviously, you began your career when inflation was in the 20

Terry Smith 1:15:18 to 24.2% a year at my first full year in work, inflation, I think the all share index got to 108, or something like that my entire net worth was 132 pounds.

Julian Robins 1:15:29

And my first year in work was actually I think, the first year of the Great Moderation, which was 8485. Yeah. I thought when I read this question, this was a question about my drinking habits has the Great Moderation gone for good. But I also, one of the things I always sort of urge people to think about is, is that, you know, when we’re talking about inflation, and interest rates, and recessions, and growth rates and volatility, think about a great company, and then write down the top five or 10 reasons as to what made it a good company. And you know, you probably get great products, products that people love, great brands, great distribution, a succession of sort of decent managers who’ve done well, the company has tapped into a secular theme. If you’re looking for good companies, you shouldn’t be worried about this type of stuff.

Terry Smith 1:16:16

I mean, the likelihood they’re gonna sit there and describe interest rates has been the reason for their multi decade success is not high read, is it? I would have said, currency exchange rates it is it’s just not not very likely that that’s where they’re going to go in, in describing what this is. I haven’t got it with me now. So I’ll paraphrase. But there’s a wonderful quote, which says every year, profound fund managers and investors say they shouldn’t be investing in Coca Cola, because the the soft drinks market is pretty tapped out, the growth will be miserable. And, and consistently, they’ve been proved wrong. And of course, this is a quote in Berkshire Hathaway’s annual report from about 1994, I think. But he’s actually quoting Forbes from 1938. You know, people thinking that this stuff that’s really good is going to stop performing isn’t new, you know, they’ve been going at it since before World War Two, in fact, probably forever.

Ian King 1:17:09

We surprised at all, how in the US, in particular, at the beginning of this year, though, they the market got it wrong in terms of anticipating where the Fed would go. You have people even talking about the Fed cutting rates before the year end? Obviously the very thing that

Terry Smith 1:17:24 yes, yeah, I was a bit surprised. But I think an awful lot of people that we come up into contact with one sort or another in relation to these events that were going on, remind me if any of you have had young children had to go on a car journey. Right? What’s the phrase that you hear very early on in the journey? Yeah. Right. And it’s like, well, I don’t know whether we nearly got a clue, frankly. But, but I do know that keeping asking isn’t going to make it happen. And it isn’t going to make us all feel any better. Who knows whether we’re nearly there? Yeah. And I think that’s it was born of that we must be nearly there. After all, this has been horrible this year. So we must be we might be needed, then we might be not? I don’t know. I mean, you look at the history of bear markets, this would be a very unusual bear market, if it extended beyond two years. Very, very unusual indeed. And that means we’re, we’re probably looking at a long stop date of somewhere around November for these kinds of events out there. And, you know, the lots of people one could quote on this, I put in our, our annual letter, and one of the things that gives me comfort, one of the two things, one of them is if there is going to be macroeconomic difficulty, I think what we’ve got is relatively well placed relatively first thing, do you think anything else is not well placed? I hate to think what some of the so called Value stuffs gonna do. We’ll see what happens there. And the other thing is, there’s only one sort of market that ends in a recession. It’s a bear market. Market is a discounting mechanism. And it’s probably discounting something quite bad. And if something bad happens, then it will be relieved and we can get back to business, as it were, but I don’t know whether we’re there yet. And, and it’s you know, I think people should stop thinking like that. It doesn’t help.

Ian King 1:19:13

Pretty good job. Any anything to add to that note. I’d like to invite you all to show your appreciation for Terry and Julian. Thank you