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Steven Chen
Steven Chen
Articles (183)  | Author's Website |

Lessons on When to Sell From Terry Smith

Poor capital allocation, unsatisfactory growth and narrowing moat are sell signals

We at Urbem find it significantly beneficial to learn from the greatest investors' decisions to sell. A decision to sell could imply an elevated investment risk ahead. Meanwhile, selling at a good price can be harder than buying at a good price, as selling is exposed to unlimited risk of missed potential.

In this article, we will go through the records of Terry Smith, often called the "English Warren Buffett (Trades, Portfolio)," who claims that the most challenging part of his investment strategy is to "sit there and do nothing." The "sell" decision is a really big deal at Smith's firm, Fundsmith, as the firm has a low turnover rate.

Below is a summary of the voluntary sales (excluding impacts from acquisitions or spinoffs) at the Fundsmith Equity Fund since its inception, along with the reasons given for the sales:

Year

Company

Reason

2011

Kimberly-Clark (NYSE:KMB)

Incremental return on capital

2011

Domino's Pizza (NYSE:DPZ)

Valuation, leverage

2013

McDonald's (NYSE:MCD)

Valuation, growth

2013

Schindler (XSWX:SCHN)

Valuation

2013

Serco (LSE:SRP)

Capital allocation (acquisition)

2013

Sigma-Aldrich (SIAL)

Capital allocation (acquisition)

2013

Waters (NYSE:WAT)

Reinvestment opportunity

2014

Swedish Match (OSTO:SWMA)

Competitive threat

2015

Domino's Pizza

Valuation

2015

Choice Hotels (CHH)

Capital allocation (new investment)

2016

Procter & Gamble (PG)

Competitive threat

2017

JM Smucker (SJM)

Margin, return on capital

2017

Imperial Brands (LSE:IMB)

Growth potential

2018

Nestle (XSWX:NESN)

Capital allocation

2019

3M (MMM)

Capital allocation

2019

Colgate Palmolive (CL)

Growth

2020

Clorox (CLX)

Valuation

As we observe, most of Smith's sales were due to deteriorating fundamentals. Examples include poor capital allocation, unsatisfactory growth and a narrowing moat. In particular, Smith stays cautious about large acquisitions, as described below:

“Sigma-Aldrich attempted to acquire Life Technologies, a company which is much larger in every sense – revenues and market valuation. This worried us a lot. With our low portfolio turnover we are in effect leaving the allocation of capital generated by the wonderful returns earned by our portfolio companies to the management of those companies. When one of them looks likely to take a business with good, predictable returns and do something large, exciting and risky, we have a strong impulse to run away.”

- 2013 Shareholder Letter

Smith has also been keeping his eyes on the development of the competitive landscape, as indicated in the case of Swedish Match:

“We sold the latter [Swedish Match], which had also been our worst contributor in 2013, during 2014. We took the view that the ecigarette development, whilst not necessarily harmful to the cigarette companies, was a potentially disruptive change which could adversely impact its Snus smokeless product. We are sensitive to the possibility of permanent loss of value which disruptive change can cause and on the whole we seek to avoid investing in companies which could be affected by it.”

- 2014 Shareholder Letter

Quantitatively, Smith depends on metrics like margin, the total return on total capital, the incremental return on incremental capital, top-line growth and valuation (e.g., free cash flow yield) to facilitate his "sell" decision-making. The sales that Smith regrets the most appear to be Domino's Pizza in 2015, according to his annual letters. A high valuation here drove the decision. Hence, one key lesson can be learned: never sell a good company with good fundamentals and a profitable business model just because it seems overvalued.

Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of Domino's Pizza and Waters.

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About the author:

Steven Chen
Steven CHEN is a quality-focused investor (with bottom-up opportunistic approaches), an ex-hedge fund analyst on Wall Street, a serial entrepreneur, computer scientist, and free-market capitalist.

Steven is the Managing Partner of Urbem Partnership, a value/quality-focused investment partnership fund (www.urbem.capital), and Urbem Capital, the research boutique that focuses on the highest-quality 0.1% of all public companies worldwide.

Steven can be reached at [email protected] or through LinkedIn.

Visit Steven Chen's Website


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