At the Fundsmith Annual Shareholder Meeting this year, Terry Smith acknowledged that there had been more activities than usual. Throughout this article, I’ll discuss Fundsmith’s sales, purchases, the stock he wants most (but hasn’t yet owned), and the stock he believes is the cheapest in Fundsmith’s portfolio.
Fundsmith Sales
Why sell J&J?
Terry Smith’s investment firm, Fundsmith, bought J&J for its medical devices and equipment, as well as its over-the-counter medicine business. However, the over-the-counter medicine business underperformed, and the drugs business, which performed well, is now facing an uphill battle due to patent expirations. Additionally, J&J’s consumer business is being spun out. With these factors in mind, Terry Smith believed that it was not a good idea to stick around, and he sold his position in J&J.
Why sell Starbucks?
Fundsmith bought Starbucks partly for the opportunity in China, where the coffee market is growing rapidly. When Starbucks’ biggest competitor in China, Luckin Coffee, turned out to be a fraud, it was an opportunity for Starbucks. Despite this, Starbucks was not able to capitalise on the opportunity in China, and the management team descended into turmoil.
The incoming new CEO did not impress Terry Smith, and Starbucks also ran into a unionisation drive in the staff, which was handled poorly. All of these factors led Terry Smith to sell his position in Starbucks.
Why sell Kone?
Fundsmith liked Kone’s elevator and escalator business, which has an installed base of equipment that creates a team market for spares and service. However, when Otis, the biggest manufacturer in the world of elevators and escalators, was spun out from United Technology, Terry Smith saw an opportunity to switch into Otis.
Otis is the biggest manufacturer in the world of elevators and escalators. He didn’t own it previously because it was part of a conglomerate called United Technology, which has a whole suite of other businesses which Terry didn’t like. But when it was spun out, Terry jumped on the opportunity to own it and switched to Otis.
Why sell Intuit?
Intuit is an accounting and tax software business that has been using a lot of share-based compensation. While this is not uncommon among technology-based companies, Intuit adjusts its earnings from a generally accepted accounting principles (GAAP) basis to a non-GAAP basis by taking out the costs from the profit and loss (P&L) account of the share-based compensation.
Terry believes that this is baloney, but the market actually bought Intuit’s story, which has resulted in a big upward rerating compared to other companies that Fundsmith owns, like Microsoft, which also uses share-based compensation but does not adjust for it. In addition, Intuit has started to use this strange methodology of accounting as a yardstick for acquisitions, which Fundsmith does not like.
Intuit’s acquisition of MailChimp, an online marketing business outside its core business area, was particularly concerning to Terry Smith, who believes that it overpaid for the business.
Why sell PayPal?
PayPal was the number one company in online payments outside China, but it made unrealistic client acquisition targets based upon extrapolating the experience in the pandemic.
It aimed to acquire about 300 million clients at the beginning of the pandemic, about 425 million at the end, and have 750 million in total. However, it withdrew the target within one year, which concerned Terry Smith. As a result, he sold his position in PayPal.
Fundsmith purchases
Why buy Adobe?
Terry Smith purchased Adobe, a global leader in creative and graphic software, due to its strong business potential and the favorable timing of the purchase after tech companies experienced a downturn.
However, Adobe’s recent acquisition of Figma, a web-based creative software collaboration tool, is concerning to Smith as he believes they paid too much and it may indicate a competitive weakness. Smith is uncertain about the impact of the acquisition on Adobe’s share price and is currently not satisfied with the purchase.
Why buy Mettler-Toledo?
Terry Smith bought Mettler-Toledo after waiting several years. Mettler Toledo is a fine business and the world leader in weighing equipment, which is used in various industries including food processing, drug development, and bio processing. In Terry Smith’s view, it’s a brilliantly run business that can be relied upon.
During a factory visit, Terry Smith’s team was impressed by the company’s project monitoring methodology, which involved a whiteboard with project names at the top and post-it notes that were moved across the lines on the board to track project progress.
Why buy Apple?
Initially, Terry Smith and his team had shied away from buying Apple shares, but towards the end of the year, they started buying a small amount of stock. This hesitation may have been due to a past case study —Nokia—whose sky high valuation back during the dot com bubble was justified with its “ecosystem”, which ultimately proved to be false. They were highly sceptical of the strength of Apple’s ecosystem.
They discovered that Apple’s revenues were primarily driven by iPhone sales, but the services segment was growing at twice the rate of the hardware business. This service business, which included music, TV, and payments, had profitability like a software business and fantastic returns and margins. Furthermore, it was being sold to a good socio-economic group that was likely to continue buying Apple products due to their financial means. This led them to conclude that Apple truly has an ecosystem.
Meta: The cheapest company in Fundsmith’s portfolio
Terry Smith believes that Meta Platforms is the cheapest company in Fundsmith’s portfolio because it has a price-to-earnings ratio of around 15 and is one of the two leading digital advertising companies in the world with two billion users, which is still rising in number.
Despite negative perceptions, the company has generated $116 billion in revenue in the last year, all from advertisers. Furthermore, it has gross margins of 78%, an operating margin of 25%, and a return on capital employed of 23%.
Although Meta Platforms spends a significant amount of money on the metaverse, if it stopped spending on this today, it could still have a single-digit P/E ratio. Smith acknowledges that owning the stock can be challenging because of the noise surrounding it, but he states that the company is up over 40% year-to-date, and they are slightly in profit.
Considering the growth potential and the fact that the company is still growing even with a significant user base, Smith believes that Meta Platforms is an impressive business.
Adyen: The company Fundsmith wishes to own the most
Adyen is a Dutch payments processing company with a market cap of 42 billion euros that enables businesses to accept and process payments both online and offline. Unlike PayPal, which has diversified into other areas, Adyen is laser-focused on doing payments well.
Adyen’s turnover has more than tripled in three years, from 2.7 billion euros before COVID to 8.9 billion euros. Adyen operates in the online payments sector, which Terry Smith believes is likely to have a lot of natural growth. However, the stock is trading at 60 times earnings, making it difficult to justify buying at the current price.