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Terry Smith unshaken by investors' 'incredulity' over Facebook buy

Star fund manager faced questions over purchase of social media giant for Fundsmith Equity at annual general meeting

Terry Smith unshaken by investors' 'incredulity' over Facebook buy

Star fund manager Terry Smith has told Fundsmith Equity fund investors he’s not going to sell troubled Facebook (FB.O) and regrets not buying more during last year’s share price slump.

At the annual shareholder meeting for the £17.5 billion flagship fund last month, Smith defended his decision to buy shares in the US social media giant.

The purchase hasn't gone down well with some investors, who questioned Smith on why he had purchased the stock when Facebook was facing regulatory intervention, a drop-off in users, and scrutiny over its use of personal data.

Business journalist Jeff Randall who was interviewing Smith, said investors had expressed ‘widespread incredulity’ about the Facebook purchase in their questions for the star fund manager but it was summed up best by investor Paul Zimmerman.

He asked: ‘Terry, why are we still in Facebook? It feels like a company at risk of turning into a business under attack from regulators, governments, politicians, and its own customers. Management seems to be making a lot of mistakes. What am I missing? Can we get out please?’

Smith replied ‘we certainly can [get out] but we’re not going to’ unless he changed his mind.

‘We think it’s a very good business,’ said Smith.

Smith argued Facebook had a high return on capital, as well as high growth rate and although he expected the growth rate to ‘come down, and it has’, it would settle on a level that was still ‘very high’.

With so many opinions on the future of Facebook, Smith said ‘there is a danger of all of us working from personal anecdote rather than data’ and said that contrary to the idea that Facebook user numbers were sliding ‘users grew 10% last year outside the UK and America’.

He added there was still growth potential in ‘the one thing they make money from – advertising’.

‘Facebook has two billion users in round number terms but that’s not where money is made, it’s from online advertising where they are in a duopoly with Google,’ he said.

‘The number of advertisers they have is six million, which sounds large but isn’t.’

Smith said UK accounting software firm Sage (SGE) had six million users and was focused solely on the UK market whereas Facebook is ‘a nearly global social network and… only has six million advertisers and there is great potential for growth’.

The scrutiny that Facebook has come under from regulators and governments has made the market increasingly nervous about investing in the social media giant. But Smith (pictured) said the intervention would actually protect Facebook’s standing.

He likened the clampdown on social media sites to that of tobacco, where ‘incompetent’ regulation actually protected companies because it stopped new brands coming to market.

‘Something similar is happening with Facebook,’ said Smith. ‘[Regulation] is building a competitive moat that is insurmountable.’

He added that Facebook wasn’t ‘just going to disappear’ and people worried about competition should answer one question: ‘Who is the competition that will come past it? Because I can’t think of one.’

Smith said he ‘had a lot of remorse’ as ‘I wish I’d bought more after it fell’ and said it was one of the stocks he is ‘most excited about this year’, the other being tobacco stock Philip Morris International (PM.N). Both Philip Morris and Facebook performed badly last year.

Smith is also excited by a new position in McCormick (MKC.N), which he bought in February.

Smith said the seasonings maker was used in ‘any fast food or casual dining’ business and has ‘the highest return on capital of any food company we follow’.

The buy bolstered the fund’s consumer staples holding, an area of the market with which the manager had become synonymous, although his weighting to the sector has slid over recent years as his stake in technology firms has increased.

One investor at the meeting pointed out this shift in asset allocation and questioned whether the switch meant the fund was less well positioned for the next stage of the investment cycle.

‘You assume the next stage is a downturn and it may be further upturn,’ said Smith. ‘There is a danger in thinking you know what the next stage is.’

He said the decision to sell consumer brands like Proctor & Gamble (PG.N) and Colgate-Palmolive (CL.N) were based on the companies' performance, not a desire to sell down consumer staples in favour of technology.

Smith also argued the fund did not invest in the ‘sex and violence end of tech’ such as new apps with no profit or cashflow but sticks to technology that is ‘pretty mundane’ and established, such as payroll systems.

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