"They think it’s all over.” Commentator Kenneth Wolstenholme’s remark at the end of the 1966 World Cup Final has passed into popular culture as a widely used expression. But I am amazed how little investors learn from the world of sport, which has a lot to teach us.
In managing the Fundsmith Equity fund we seek to invest in companies that have a long history of success in a few sectors such as consumer staples, medical equipment and franchising.
People often say to us: “Oh, you try to pick winners.” The reality is that we don’t seek to predict who will win, but rather to bet on a company that has already won.
To explain what we seek to do I would turn to the world of horse racing. As a professional gambler, Alex Bird made a fortune betting on photo finishes. You can read about it in his autobiography, Alex Bird: the Life and Secrets of a Professional Punter.
In Bird’s day, photo finishes were not digital and it took several minutes to develop the film and view the outcome, during which time bookmakers continued laying odds on the outcome.
Bird realised that they were breaking one of the fundamental rules of bookmaking – never make odds on an event that has already occurred, as someone who knows the outcome can take you to the cleaners.
Allegedly, bookmakers in the vicinity of St James’s Palace learnt this the hard way when they laid odds on the name of royal babies while the Queen Mother, who liked a bet, was still alive.
Bird noticed that when horses crossed the line together, the horse on the far side often appeared to have won. What he had figured out was “parallax”: the difference in the apparent position of an object viewed along two different lines of sight.
He discovered a simple technique to exploit this. By standing as near to the winning post as possible, closing one eye and creating an imaginary line across the track at the finishing line, he could tell which horse had actually won. Using this simple system for the next 20 years he made himself a fortune, with a reported 500 consecutive successful bets.
This can happen in the financial world. When Warren Buffett announced that after a career investing only in the US he had bought a British share for the first time, the bookmakers made odds on which share it was. This was dangerous given that a number of intermediaries, such as Berkshire Hathaway’s brokers, already knew.
What has all this got to do with investment? At Fundsmith we do not seek to pick winners in the sense that most punters do, which is studying form, viewing the horses in the ring and then betting.
We seek to emulate Alex Bird – we wait until we know who has won and then wait for the bookmakers to offer us odds against them winning. In our case there are not bookmakers in the sense of a racecourse, we are talking about the market mispricing shares.
There are some companies where we do not need to speculate on whether they have won in the sense of being successful and dominating certain product categories. Nestlé is the world’s largest food and beverage company and has been in business for 148 years with only one loss.
Colgate Palmolive has 45pc of the world market for toothpaste and 35pc for toothbrushes. It is also the leader in liquid soap and third in pet food. We simply need to wait until the market misprices these shares in order to get our chance to bet on a certain winner.
This can happen for many reasons, for example when a panic occurs such as the whole market experienced in 2008 2009. Or it can come about because investors sensing recovery dump known winners and turn to the shares that rise most in such circumstances, such as cyclicals, financials, recovery stocks and highly indebted companies.
It may entail particular concerns about the product, such as cola drinks or micro beads in toothpaste, or a milk powder safety scare. Or currency moves such as the recent rise in the Swiss franc, which sent Nestlé’s shares down by more than 10pc even though 98pc of its business is outside Switzerland.
Situations such as these can all provide chances to invest by betting on a certain winner if they drive the valuation to a level which does not reflect these companies’ sustainable returns.
Click here to view the article on Telegraph.com.