Terry Smith has added software company Adobe and weighing equipment manufacturer Mettler Toledo to Fundsmith Equity, according to the fund’s latest factsheet.
Smith previously had some exposure to Adobe via his Fundsmith Long/Short Master fund, which was set up to run a portion of his own personal wealth, but which he does not manage himself.
Yet this is the first time he has announced holding a position in either stock in his Fundsmith Equity fund, which has been popular for investors for the best part of a decade thanks to strong performance.
It has made 496.4% since launch in November 2010, compared with gains of 265.3% from the MSCI World index and 187.9% from its average IA Global peer, putting it second out of 212 funds in the sector over this time. The strong returns have also meant investors have backed the £25.5bn fund despite a relatively high ongoing charges figure of 1.04%.
Performance of fund vs sector and index since launch
Source: FE Analytics
In an interview with interactive investor in March last year, Smith named Adobe and Mettler Toledo when asked what companies he felt he had missed out on in the Fundsmith Equity fund, suggesting he has had his eye on them for some time.
However, he added: “We probably won’t fail as a strategy for investors if we don’t own the best companies in the world.
“We probably will fail if we start to own bad ones. And so, if in doubt, do nowt. We don’t go out there and do things unless we’ve got a high degree of certainty about it.”
Adobe announced record revenue of $4.3bn (£3.4bn) in the first quarter of 2022, representing 9% year-over-year growth, or 17% adjusted year-over-year growth.
Yet despite the strong figures, its shares have fallen 42% since their peak in November last year after the surge in inflation and interest rate expectations led investors to shun growth stocks in favour of their value counterparts.
In a note to investors in February, Richard de Lisle of the value-focused VT De Lisle America fund explained why a quality company such as Adobe looked susceptible to a further re-rating, even though its fundamentals looked “fantastic”.
“It has grown earnings at 19% on average for a decade and no doubt will keep going forever,” he explained.
“The stock is off from $700 to $500 [now $400], so it’s all priced in, right? Nope, it’s still on 50x trailing P/E [price-to-earnings], and in the 1980s you could get a 19% grower for 20x trailing. But the 1980s is where we’ve just referenced a 7.5% inflation rate.
“Sounds like a lot more P/E multiple falling still to be done here for the next few years. Earnings of more than 19% a year is a double every four years, so in four years’ time Adobe could be at the same price but on a trailing P/E of 25x if it can keep the good times rolling on.
“Not a bad outcome, but maybe not where you want to be?”
Performance of Adobe stock over 5yrs
Source: Google Finance
However, de Lisle’s hypothesis relies on a sustained period of inflation, and many managers expect the high rate of price increases to dissipate by the end of the year.
In addition, David Older, head of equities at Carmignac, recently said that most software companies were over the worst in terms of the multiple re-rating, with many of these now trading close to five-year averages.
He also said these will continue to benefit from secular growth trends that should increase their sales growth and profitability.
“These are structurally better businesses now with better visibility of earnings, because these are moving to long-dated subscription models – with higher structural margins and better cashflow generation because of the move to the cloud,” the head of equities explained.
“This is exactly the type of company you want to own with a backdrop of slowing growth.
He added: “Software also has pricing power: we have done rigorous survey work with corporates about their spending intentions, and software is top of the stack in terms of where they want to invest – it’s not an area that they want to be cutting.”
Data from FE Analytics shows 45 funds in the IA universe hold Adobe in their top-10, including LF Blue Whale Growth, whose manager Stephen Yiu recently said: “Financial commentators often talk about inflation, but disregard pricing power. In our view, the best hedge for inflation is a high-quality growing business that’s providing so much value to customers that it is able to sustainably raise prices by more than inflation each year. Adobe fits this description.”
Like Adobe, Mettler Toledo’s most recent results, for the fourth quarter, were also strong, with an 11% increase in sales compared with the same time the prior year, and a 14% increase in earnings per share (EPS). Again though, it is down 24% from its peak last year.
Just four funds hold Mettler Toledo in their top 10, three of which have a sustainable tilt.