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Terry Smith: The British Fund Manager Beating Buffett

Technically speaking, Terry Smith is not a hedge fund manager. The UK based fund manager, founded and manages the Fundsmith Fund, which today manages more than $20 billion of assets for clients, which mostly include small UK-based investors.

Since its inception, Smith's fund has smashed all expectations. From launch in November 2010, his flagship fund has returned more than 300% for investors, nearly doubling the return of Warren Buffett's (Trades, Portfolio) Berkshire Hathaway (BRK.A) (BRK.B) over the same time frame. Between November 2010 and the time of writing Berkshire's B shares have returned 148%.

Buffett-style approach

Smith's investment approach is based on that of Buffett. He is looking for high quality, highly profitable companies that have a massive runway for growth in front of them.

He is also looking for businesses that have a tremendous competitive advantage over the rest of their sector or industry. He has never bought shares in a bank and says he never will. And he will only buy companies he knows and understands well. Smith avoids companies in the insurance, real estate, chemicals, heavy industry, construction, utilities and airline industries.

That blocks out a considerable percentage of the global investment universe, but Smith is quite happy sticking to what he knows. One of his greatest investments was buying Domino's (NYSE:DPZ) at around $15 per share when his fund first launched.

Even though it is a UK-based investment manager, Fundsmith is not constrained in where it can invest. Most of the portfolio is invested overseas, particularly in the US.

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US investments

At the end of the second quarter of 2019, around 10% of the portfolio was invested in PayPal (NASDAQ:PYPL), and 8.5% was invested in Microsoft (NASDAQ:MSFT) with another 6.5% invested in Facebook (FB).

These are some of the most popular companies on the market at the moment, but if we move down the list of owned stocks, some interesting ideas appear. For example, Smith has $1.2 billion invested in IDEXX Laboratories (NASDAQ:IDXX) and $1.2 billion invested in Estee Lauder (EL).

IDEXX designs and manufactures products for the vet and water testing markets as well as selling a line of portable electrolyte and blood gas analyzers for the human market. Sales have grown at a compound annual rate of 10% over the past six years, and net profit has more than doubled over the same period. The stock is currently trading at a relatively demanding forward P/E of 54.4, but with a return on capital invested of 48% and an operating margin of 23%, this is undoubtedly a high-quality business.

Other companies that also feature in the portfolio include the provider of business and financial management solutions for small businesses Intuit (NASDAQ:INTU).

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Once again, this is another high-quality business trading at a premium valuation. Last year the company reported a return on capital employed of 43% and an operating margin of 27%. In addition, the stock has net cash on the balance sheet of $2.3 billion. Net profit has grown at a compound annual rate of 15% for the past six years. At the time of writing, the stock is trading at a forward P/E of 37.7 and offers a token dividend yield of 0.7%.

Smith has $1.2 billion invested in Intuit, and he has put a similar amount into medical technology group Stryker Corp (NYSE:SYK).

This business follows the same pattern as the other companies list of above. It is a high-quality company with a profit margin of around 20% that has a unique operating business and niche in its sector.

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Net profit has grown at a compound annual rate of around 30% for the past six years, and it doesn't look as if growth is going to slow down anytime soon. The business invests a lot of money in research and development to continually improve its offering, as well as investing in select acquisitions for bolt-on growth.

Disclosure: The author owns shares in Berkshire Hathaway.

This article first appeared on GuruFocus.