Terry Smith on Shareholder Orientation

game becomes exciting and the striker runs into the penalty area with the ball, the second row of spectators stands up to get a better view. This blocks the view of those in the third row who follow suit. Pretty soon all the spectators are standing but no one has a better view than before, but they are all less comfortable. So, I think we will suspend judgement of who, if anyone, will emerge as a winner in AI. The second event worthy of mention is the passing of Charlie Munger, Warren Buffett’s long time business partner, who passed away in December at the age of 99. Apart from offering a perspective on the perennial question about my retirement, Mr Munger’s demise has led to the inevitable repetition of quotations from him by commentators. However, none of the commentators has alighted upon the Charlie Munger quote which in my view encapsulates the current state of world affairs: “If you’re not a little confused about what’s going on, you don’t understand it.” Finally, once more I wish you a happy New Year and thank you for your continued support for our Fund. Yours sincerely, Terry Smith CEO Fundsmith LLP Disclaimer: A Key Investor Information Document and an English language prospectus for the Fundsmith Equity Fund are available via the Fundsmith website or on request and investors should consult these documents before purchasing shares in the fund. Past performance is not necessarily a guide to future performance.

Moreover, even when the value investor gets it right and this happens, they then need to sell the stock which has achieved this and find another undervalued stock and start again. This activity obviously incurs dealing costs but value investing is not something which can be pursued with a ‘buy and hold’ strategy. In investment you ‘become what you eat’ insofar as over the long term the returns on any portfolio which has such an approach will tend to gravitate to the returns generated by the companies themselves, which are low for most value stocks. As Charlie Munger, Warren Buffett’s business partner, said: ‘Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return — even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you’ll end up with one hell of a result.’ Our emphasis added. Mr Munger is not offering a theory or an opinion — what he is saying is a mathematical certainty. The only uncertainty concerns our ability to forecast returns far ahead, which is why we prefer to invest in relatively predictable businesses.

There is also the fact that the alternative of investing in cyclicals, financials and so- called ‘value’ stocks involves investing in companies, which over time do not create shareholder value by generating returns on capital above their cost of capital and growing by deploying more capital at such favourable returns. We seek to invest in companies which accomplish this. Quoting Warren Buffett, the ‘Sage of Omaha’ and arguably the best investor over the past fifty or so years has in my view become somewhat passé. It is frequently done by acolytes or imitators many of whom seem to have done only the most cursory study of what he actually does, if anything at all. So instead I am going to quote his business partner and Berkshire Hathaway’s Vice Chairman, Charlie Munger: ‘Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return— even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result’ (emphasis added). I have no idea why Mr. Munger chose those particular rates of return but what I do know is that he is not voicing an opinion. What he is describing is a mathematical certainty.