Book-review: Investing for Growth by Terry Smith

I consumed a lot of Terry’s content before. Now a blog reader gave me this book and I was happy to finally read it …

Not the best investment book. Investing for Growth is mostly a concatenation of annual shareholder letters and newspaper contributions. This results in a less than ideal book structure. Howard Marks recycled much of his invaluable memos in The Most Important Thing, but he used snippets, not complete memos, and used those within a well structured book. I am greatly interested in the topic of ETFs, but did not want to read about structural ETF problems in this book, in several chapters. Anyway, the book offers a powerful message besides very good content (within a sea of rather useless content). Below are the content snippets I liked the most:

Useless P/E ratios. Terry states the obvious about the rather useless valuation measure, but what many of us value investors tend to forget and thus it is worth to repeat:
– lowly rated does not equal good value
– highly rated doesn’t not equal expensive.

Other stocks may outperform high-quality businesses in any period (over a short time period). In a strong bull market, especially in a recovery from an economic downturn, companies of this sort are apt to outperform the shares of the high-quality businesses we own. After all, the high-quality companies have nothing to recover from. If this worries you then Fundsmith’s approach is not for you.

High-quality is structurally undervalued. In Return-free risk – why boring is best, Terry provides explanations why high-quality companies are usually undervalued: We humans are gullible of a lot of biases. We do not pay up linearly for an improvement of certainty (reduction of uncertainty), i.e. we tend to pay a lot to get rid of the last increments of uncertainty (bonds), thus investments with a bit of uncertainty left (stocks of high quality companies) are structurally underpriced.

Straight talking management. I loved this section. We investors should be wary of a bunch of words and phrases

  • misusing words: leveraging a subsidiaries operational set-up, instead of copying it.
  • using words beyond their original meaning: key objectives, without relating to a lock but goals, footprint without relating to foot wear but talking about number of stores, roadmap instead of plan
  • Profound words instead of existing simple words: granularity instead of detail.
  • Sentences that begin with ‘To be honest’ beg the question of whether the speaker are normally dishonest.
  • Steering committees are not used on boats and should probabaly neither in companies
  • Be wary of management or commentators who engage in hyperbole. “Global” is a common example of hyperbole, mostly ‘international’ is closer to the truth

Smith’s Law: you should never use an expression if its opposite is so nonsensical that you would never say it. Examples are: select acquisitions, forward guidance, group together.

Companies publishing harsh criticism from their customers is a very good sign. Managers communicating openly sush ‘weakness’ in their operations are usually truly motivated to improve operations.

Various chapters are about companies, as Microsoft, Tesco or IBM, or specific investment themes as BRICs or banks. Terry does not invest in banks for various reasons, including their high leverage and fragility. An excerpt:

The fragility of banks is illustrated by a story from the 1980s, when there was a wave of nervousness in Hong Kong following the signing of the joint declaration regarding the colony’s handover to China. Property prices began to collapse and banks ran up bad debts as a result.
During this febrile period, a queue of people waited for a bus. It started to rain, and the queue moved across the pavement to shelter under the cover of a canopy on a building, which happened to house a branch of a local family-controlled bank. Passers-by, seeing the queue, concluded that there was a problem with the bank. Rumours of a run spread rapidly and by the following day, the bank was besieged by depositors demanding to withdraw their savings.

The desire of people to rely on forecasting despite its obvious drawbacks is illustrated by an anecdote from the Nobel laureate and retired Stanford University economist Kenneth Arrow. Arrow did a tour of duty as a weather forecaster for the US Army Air Forces during the Second World War. Ordered to evaluate mathematical models for predicting the weather one month ahead, he found that they were worthless. Informed of this, his superiors sent back another order:
(copied from the book)

The Commanding General is well aware that the forecasts are no good. However, he needs them for planning purposes.

Fundsmith’s investment process is the highlight of the book and are well presented in his videos:

  1. invest in good companies
    1. which create value for its shareholders by
    2. earning high returns on capital significantly above its cost of capital
    3. across the business and economic cycle
  2. don’t overpay
  3. do nothing

About good companies. The other route is to invest in a portfolio of equities in good companies which can be relied upon to compound in value over time. Such companies have been around for decades or longer, have good financial results (high returns on capital, high margins, good cash conversion of profits and moderate debt levels) even at the bottom of the economic cycle. They also have identifiable competitive advantages which should enable those returns to persist despite their obvious attraction to competitors. Whichever of these routes you choose, buy them, forget them and enjoy the results.

My favorite videos from Terry:


3 thoughts on “Book-review: Investing for Growth by Terry Smith

  1. Great write-up as always! Thanks for this. Specifically the discussion of management is often really interesting.

    If you want the negative example, just look at Northern Data management and at Wirecard’s Marsalek. Many buzzwords in the publications but no videos, no real critical work with customer complains, all sunshine….

    The opposite is for example Interactive Brokers billionaire founder who is sometimes quite outspoken. Or also Volkswagen management with its praise of Tesla or of Hyundai.

    Liked by 1 person

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