Decoding Terry Smith’s Annual Letters: A Blueprint for Enduring Wealth

Unveiling the Art of Disciplined Investing from a Modern Master

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Terry Smith, the founder of Fundsmith Equity Fund, is often called the “English Warren Buffett” for his disciplined, no-nonsense approach to investing. Since launching Fundsmith in 2010, Smith has delivered an annualized return of over 15%, turning a £10,000 investment into more than £60,000 by 2024, compared to £28,000 for the MSCI World Index. His annual letters to shareholders are not just performance updates but a masterclass in rational investing, blending sharp wit with timeless principles. Having studied these letters, I’ve distilled four core lessons that reveal Smith’s philosophy and offer a roadmap for building lasting wealth.

Source: Website Fundsmith

1. Buy Good Companies, Don’t Overpay, Do Nothing
   Smith’s mantra—“Buy good companies, don’t overpay, do nothing”—is the cornerstone of his strategy. In his 2013 letter, he defines “good companies” as those with high returns on capital, predictable cash flows, and durable competitive advantages, often referred to as “moats.” He avoids cyclical businesses like airlines or commodities, favoring firms like Microsoft or Unilever that deliver consistent performance across economic cycles.

   The “don’t overpay” part is equally critical. Smith shuns speculative growth stocks with sky-high valuations, preferring to buy quality at a fair price. Once invested, he does “nothing,” meaning he holds for the long term, minimizing turnover to let compounding work. In 2022, he noted that Fundsmith’s portfolio turnover was just 2.2%, compared to 30-40% for many active funds. The takeaway? Focus on businesses with enduring quality, buy them sensibly, and resist the urge to tinker.

2. Ignore the Noise, Focus on Fundamentals
   Smith is famously dismissive of macroeconomic predictions and market timing. In his 2019 letter, he wrote, “I have no idea what the market will do next year, and neither does anyone else.” Instead, he zeros in on company fundamentals—cash flow, margins, and growth in book value. This approach insulated Fundsmith during volatile periods, like the 2020 COVID crash, when the fund outperformed by sticking to high-quality names like PayPal and Intuit.

   Smith also warns against being swayed by media hype or analyst chatter. In 2021, he criticized the obsession with ESG (Environmental, Social, Governance) metrics, arguing that many ESG-focused funds hold companies with weak fundamentals dressed up in “green” rhetoric. His lesson is clear: tune out the noise and anchor your decisions in measurable, long-term business performance.

3. Cash Flow Is King
   For Smith, free cash flow is the lifeblood of a great company. In his 2015 letter, he explained that Fundsmith prioritizes businesses that generate surplus cash after reinvesting in growth, as this cash can be used for dividends, buybacks, or further expansion. He contrasts this with companies that rely on debt or equity issuance to fund operations, which he sees as a red flag.

   Smith’s focus on cash flow helped Fundsmith avoid value traps—cheap stocks with deteriorating businesses. For instance, in 2018, he sold holdings in companies showing signs of cash flow strain, even if their share prices seemed attractive. The practical takeaway? When evaluating a company, dig into its cash flow statement to understand its true financial health, not just its earnings or stock price.

4. Simplicity Breeds Success
   Smith’s letters are a testament to the power of simplicity. He runs a concentrated portfolio of 20-30 stocks, avoiding the over-diversification that he believes dilutes returns. In his 2016 letter, he quipped, “If you own 100 stocks, you’re not investing—you’re collecting stamps.” This focus allows Fundsmith to deeply understand each holding, from L’Oréal’s brand strength to Stryker’s medical device innovation.

   He also keeps his process straightforward, avoiding complex financial models or leverage. In 2023, he reiterated that Fundsmith uses no debt, as borrowing amplifies losses in downturns. For investors, this underscores the value of a clear, repeatable strategy: own a few exceptional businesses, know them inside out, and avoid unnecessary complexity.

Living the Fundsmith Way

Terry Smith’s annual letters are a beacon for investors navigating a world of noise and speculation. His philosophy—buy quality, stay disciplined, and think long-term—may sound straightforward, but its execution requires conviction and patience. By focusing on cash-rich, high-quality companies and ignoring short-term distractions, Smith has built a track record that few can match.

For those eager to learn more, Fundsmith’s website hosts all of Smith’s annual letters, each packed with insights and his trademark candor. Whether you’re managing a portfolio or just starting out, these letters offer a blueprint for investing with clarity and purpose. As Smith often says, “The best time to plant a tree was 20 years ago. The second-best time is now.” Start planting!

If I had a time machine I would go back 20 years and plant a tree, but unfortunately I don’t have one. With Compound & Fire I do follow Smith’s focus of cash-rich, high-quality companies. Hopefully you have enjoyed this article. Feel free to share it with friends and don’t forget to join our free global quality investing community on Discord!