Smithson Investment Trust (LSE: SSON) has crushed the market’s performance over several years. And following the investment trust‘s strategy could help me beat the market as well. The method can be distilled into three simple steps (more on that below).
Between October 2018 and December 2021, the Smithson share price increased by about 97%. But the trust got caught in the recent bear market and the stock dropped by about 22% over the past year.
Nevertheless, Smithson beat the market. The company invests in small- and mid-cap companies with market capitalisations between £500m and £15bn. And as a comparison, the UK’s FTSE 250 index rose by roughly 20% while Smithson was outperforming. And over the same period, the FTSE AIM All-Share index gained around 22%. However, Smithson does invest in markets all over the world.
But Smithson left the UK’s mid-cap and small-cap indices in the dust. So how did it do this? Well, let’s first look at what the company doesn’t do. It doesn’t invest with borrowed money. It doesn’t hold more than between 25 and 40 stocks. It doesn’t use short-term trading strategies. And it doesn’t use derivatives. Smithson achieved its gains the old-fashioned way — by simply selecting, buying and holding stocks with money it already had.
Step 1 — a focus on compounding
It focuses on investing in businesses that can compound in value over many years. And that’s the first step I’d follow to try to beat the market. The trust looks for companies with an “established track record of success.” For example, an investee business might have already established a dominant market share for its products and services. Or it could have brands or patents that competitors would find difficult to replicate.
Smithson aims to identify businesses with “strong” profitability that’s sustainable over time. And it looks for “substantial” cash flow that businesses can reinvest into operations.
Step 2 — fair valuation
A key part of Smithson’s strategy is to seek a fair valuation before buying any stock it identifies as a candidate. So, the second step I’d follow is to focus on valuation. As part of this, it avoids businesses with lots of debt. And it shuns firms that rely on debt to provide an adequate return. It also skips past businesses in sectors and industries that innovate “very quickly and are rapidly changing”.
Instead, Smithson aims to pick enterprises that have demonstrated an ability to continue outperforming competitors. And that approach leads the trust to find value in companies that “rely heavily” on intangible assets. For example, in industries such as information technology, healthcare and consumer goods.
Step 3 — a long-term approach to investing
Having found great long-term compounding business selling at fair valuations, Smithson aims to hold their shares for years. And step three for me is to take a long-term approach to my investing. And that’s so that operational progress in each business can compound over time while the shares are in my portfolio.
There are no guarantees of a decent long-term investment outcome for me, even if I follow Smithson’s three-step strategy. However, just in case I can’t do it as well myself, I also have an investment in Smithson Investment Trust!