Terry Smith is a former UK analyst and banker who, in 2010, founded Fundsmith with a philosophy that is disarmingly simple: “Buy good companies. Don’t overpay. Avoid fiddling.”
It’s a straightforward but powerful approach that has allowed him to quietly outperform most professional investors.
He looks for companies with high returns on capital, strong competitive advantages and robust cash generation. He buys them at sensible prices, then holds them for a long time.
More simply: find excellence, don’t overpay, and get the hell out of its way.
Another unusual aspect of Terry’s thinking is his scepticism toward growth. Not growth in the sense of expanding a profitable core, but the kind executives chase when they have too much money, too much ambition or too much pressure to “do something.” Here lies one of the strangest paradoxes in business: growth can, and often does, destroy value.
Of course, growth is desirable and something investors should pursue. But it must be the right kind of growth. Growing market share, revenues, product range and market cap all sound positive, but none necessarily translate into higher per-share earnings, which ultimately drive returns.
In fact, a lot of growth is pure vanity and can end up destroying shareholder value.
A major culprit of counterproductive growth is acquisitions. Unless the target has superior economics, or can be bought cheaply enough to ensure an attractive return on capital, you’re effectively diluting the earnings power of the business. The merged entity might be bigger, but it’s rarely better, and that can hobble future growth potential.
And that’s assuming a smooth integration. Merging companies isn’t just a matter of plugging one spreadsheet into another. Cultures clash, systems don’t line up, and the promised synergies often fail to appear. On top of that, it’s a massive distraction for management, who end up firefighting rather than nurturing the parts of the business that create real value.
Another common growth misstep is geographic expansion. It’s easy to assume that success in one country can be replicated elsewhere, but that’s usually not the case. Competitive advantages are often local. A brand that commands pricing power in Australia might be just another name in Asia. A logistics network that hums here can easily buckle under different regulations abroad.
Smith points out that companies often enter new markets with lower margins, unfamiliar rules and no real edge. The result is headline revenue growth but declining returns on capital. Shareholders get the illusion of progress, but economically the business is often weaker, not stronger.
The next growth folly lies in product expansion. A company with a great offering assumes it can bring the same magic to other products, and then spends heavily on R&D and support structures. Small, calculated steps into adjacent areas can be smart, but a gung-ho push outside the core business often ends in wasted shareholder capital.
Much of this stems from the way executive incentives are structured. CEOs gain prestige running larger companies, and bigger firms can justify bigger pay packets.
But shareholders also share the blame if they constantly demand growth. Disciplined capital allocation and steady operational improvements rarely excite the market, so they take a back seat to bold moves that promise bigger, faster returns.
This pressure is greatest when a company is flush with cash or has easy access to funding. Few things are as dangerous as a CEO with ambition and a pile of cash burning a hole in their pocket.
As Terry says, if a company can’t reinvest its cash at high returns, it should return it to shareholders (either through dividends or buy-backs). Investors can then seek out other high-return opportunities, leaving only enough cash in the business to fund projects with clearly attractive prospects.
Ironically, the best growth strategy is often no strategy at all. If a company has found a profitable niche and can keep reinvesting there at high returns, it should stay put. When those opportunities dry up, the next best option is to return capital to shareholders.
It may look like a lack of ambition, but that focus is what best ensures attractive and sustainable growth. A company that grows revenue 20% a year by reinvesting at 25% ROIC is compounding real value. A company that grows revenue 20% a year by buying mediocre businesses at high prices is probably destroying value, even if it takes time to show up.
Terry Smith’s success comes from focusing on economic reality over optics, returns over revenue and discipline over drama. Growth isn’t bad, but it isn’t automatically good either. The question is whether a company can grow without lowering its returns.
If it can’t, the smartest move might be to do nothing at all.
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