5 ideas
Investing is reduced to three sequential rules. First, own only businesses that earn high returns on capital in cash and can reinvest at those rates. Second, pay a price that doesn't wipe out that advantage. Third, then hold with minimal trading, because turnover adds cost and cuts compounding short.
Smith's analysis looked back at L'Oréal from 1973 onward. The case is his evidence that conventional valuation fear badly underprices durable quality.
Over long holding periods, a shareholder's return converges on the company's return on capital employed and how much of its cash it can reinvest at that rate. The multiple paid at entry fades in importance. A cheap stock with low returns compounds poorly, while a seemingly expensive one with high, cash-backed returns keeps compounding.
Standard fund charge measures such as the TER or OCF leave out dealing commissions, spreads and stamp duty generated by portfolio turnover. Those costs can rival the headline fee. Fundsmith publishes a Total Cost of Investment that adds transaction costs back in, exposing high-turnover funds whose true cost is concealed by industry convention.
Metrics like EBITDA and 'adjusted' profits strip out real costs such as capital expenditure, restructuring and share-based pay. Pay schemes tied to earnings per share also reward buybacks at any price and value-destroying acquisitions. Judge management by cash returns on capital instead, because the flattering metrics are the ones executives chose.