Good evening, ladies and gentlemen, and welcome to the annual shareholders meeting of the Fundsmith Equity Fund. I'm King. I'm your MC for this evening. Lovely to see so many of you here. Thank you for turning up on a chilly February evening. Those of you who've been here before will know the ground rules, but I'll just set them out anyway. When Terry sends out his annual letter at the beginning of the year, you're invited to put questions for this meeting. Terry, Julian, and the team then go through the questions with me, and I choose the ones that I think I would like to hear answers to and that you would like to hear answers to. My interests are very much aligned with yours. All of my family are investors in the fund. So, I'm just as keen to hear what Terry and Julian have to say as you are. We have more than 200 questions this year. We only have time, understandably, for around 10 this evening. If your question hasn't been chosen, don't blame Terry and Julian, blame me. I'm the one that decides what questions are put up. And if your question hasn't been put to the guys tonight, Fundsmith will be getting back to you. You will get an answer. And I'm reliably informed that a lot of those answers may already be out and with you. So, you will get an answer even if your question hasn't been raised this evening. Without further ado, then I would like to welcome to the podium your chief investment officer, Terry Smith.
Nice to see so many of you as it always is. I'm going to run through the usual stuff that I run through and a few other things as well and then Ian's going to bowl the questions for us as you know. That's the format. We've had Ian, we've got me. That's a disclaimer. I won't make the usual joke about the disclaimer. You've all heard my joke on that one by now, I think. So I'll move straight on to this. What I'm going to talk about now, not in the questions but now is performance and the investment strategy. And I'll go straight into it. The one I would use to describe it for the last 12 months is poor. And I thought about a lot of words to use in relation to it and I came up with poor. Because it seemed to me if we keep going like that we will all become poor. We don't really want to do that do we? And the critical point that I make in relation to the slide is that it says people say five years of underperformance. I don't wish to split hairs. That's not the way to address this subject. But you know 5 years ago we did 22% for one year and if you do 22% who cares what the market does. I want to talk about the background to that and I want to do it because I think you should be informed about the background to that and performance. One of the many things that irks me is the commentariat who when we talk about the reason why our performance has diverged significantly from the index for the last few years say that we're making excuses or that we're trying to blame something. We're not making any excuses. We're not trying to blame anyone or anything. Blame me if you want to blame anyone. We're just trying to give you an explanation because I think that explanation is provided in order to try and do something that we've tried to do from the very beginning with Fundsmith, which is to give you the information to make an informed decision about what to do about this. That's what we're here for. Not trying to make excuses, trying to give you some information. The only other thing I would say about the actual performance on the slide I mean obviously I could point to the long term but you know I won't be doing that is the key words on the slide which I would emphasize are those words there so far because probably what will determine the outcome in terms of whether we're poor or not is not what's happened in the last 12 months but what we do in the next 12 years and I and the team are committed to doing that to carrying on in a manner which we'll describe as we try and deal with the issues that we're talking about now.
First of all, what worked and what didn't last year because this gives you some insight into what's happening, what we did and didn't do, right? Our top five performers and our top five detractors. The top five performers, the best performer was Alphabet, Google and old money as they say. This is a company which if you read the outpouring of commentary at the beginning of 2025 about AI you would see that people were saying that Gemini their large language model was a failure. It was disastrous wasn't working very well and by the time we got to the end of year it was all a success and that's all very good because we own them and I welcome that. But it does make me think how quickly things can change in this particular area of human endeavor which I don't like very much actually. IDEX our second best performer. This is our veterinary diagnostic equipment company that we've owned for a very long time. It had a great pandemic as pet adoption soared. It had a come down after the pandemic when vet visits trailed off as some of those pets were given back and it's now back on a growth trend again. I'm pleased to say. Philip Morris. This is our only remaining tobacco stock which we don't actually own because of the tobacco element. It's because they are the leader in reduced risk products, a heat not burn and more recently the nicotine pouch products and this has really been a great success for the company and we're very pleased that it's actually started to show through in the share price over time. Meta, the old Facebook and old money. This as you probably know from previous remarks was a very difficult share for us. We bought it and received a barrage of criticism and it's actually been a very strong performer and Microsoft last but not least if Microsoft is still in that position in 2026 it will be the 11th year.
What didn't work Novo Nordisk which has moved to a fast from a tragedy I think in terms of the company we bought it in I think 2016 we thought it was different to other drug companies in terms of the drug discovery process we proved to be right they came out with the first weight loss drug way actually when it was released as a diabetic drug a drug that's got any number of other indications some of them labeled now for conditions which it helps and they managed to snatch defeat from the jaws of victory in the core US market by playing it very badly against their competition Eli Lilly and their other competition in terms of people who compound the drugs often illegally and I think the thing that we it's important to learn things from mistakes it's making mistakes is something we absolutely all do the main question is what are you going to do about it and in this particular case if you went back to the beginning of fundsmith and any of the meetings that you attended where people often ask us things Why don't you own drug companies? You ought to own drug companies and so on. We always said we won't own a drug company. We really don't like the uncertainty of the drug discovery process. We don't like the fact that unlike branded goods, if somebody comes up with a more efficacious product, you're dead. That you're relying upon legal protections. The legal protections are often quite faulty in terms of protecting. You're not relying upon moats, competitive moats designed as a result of branding, marketing, distribution, and so on. You're relying upon legal protection and it doesn't work. So, I think the thing we've learned is we were right first off. Don't own drug companies. That's what we've learned from that one.
Automatic data processing, the world leader in payroll and HR processing through software. Obviously suffering a bit from what people have now called the SaaS apocalypse. So, people thinking that all the traditional software providers are going to be wrecked by AI. Maybe they are. I think one of the things that protects companies like this very probably is the fact that they have got an awful lot of our data which they use and I have been a user of ADP products in companies that I've run over time. And also that what they're providing is non-trivial. You know, it's pretty mission-critical and incredibly complex. If you take the United States of America, they're dealing with 50 different states in terms of employment legislation and taxation. And that's non-trivial.
Church and Dwight. Church and Dwight is a bit of a surprise entrant for us in here. This is a consumer goods company. It's the one that I always quote the joke on for the disclaimer where the chief executive said, 'If you believe me and buy my stock, it's your problem.' This is a consumer goods company. It makes brands which are secondary brands, discount brands and so on. Like Arm and Hammer toothpaste, for example, is one of their brands. OxiClean Detergent, which you probably never heard of, is one of their brands. Typically a company where you benefit from economically difficult circumstances was people trade down into the products. Guess what? They're not. And you probably heard this expression, the K-shaped economy, K-shaped like that. This I think is an exemplar of the K-shaped economy, which is people at the top of the K are doing very well and they don't buy it products. And people at the bottom of the K are doing very well and they're trading down to well, I don't know what own label, nothing at all. In some cases, it's actually illustrating, I think, what's going on with the bottom of the K in the economy. We're not selling it. It will come right. I mean, I think this is a company which is very well set up to handle the fact that people at the top of the K will probably be trading down at some point. But we will wait for that.
And there must be something in the water in Denmark, I think. And I apologize to anyone who's Danish in the audience by saying that because Coloplast, which is also one of our detractors, is a Danish medical company. It's a company which makes catheters, tubes that go into the human body. And then it's made a couple of acquisitions. One that provides devices that go in to deal with the aftermath of throat surgery, throat cancer in particular and wound care. They acquired a company that uses Codkin, would you believe, for advanced wound care, and that's not a joke. I mean, there they really do use it for that for a variety of reasons. Not the least one is there's never been a case of any transmission of any infection between a cold water fish and a human being. So you don't have to irradiate it before you use it and so on. Very clever. Nothing wrong with the two acquisitions. They forgot to apply for US approval for one of the products which is pretty silly but that was it. Nothing other than that wrong with the acquisitions. But what it does mean is they took their eye off the ball and the operating performance has become poor in the original business to a degree. They've got a change of chief executive. They've fired the chief executive as Novo Nordisk. And we're awaiting the new chief executive before we decide what we think about that.
And last but no least, Fortinet, maker of cyber security devices, routers which secure your network. They're in a two-way fight with a company called Palo Alto Networks in this area roughly. They again had a wonderful pandemic. A lot of us work from home. We needed a router so that we wouldn't actually compromise the security of our network. They sold twice as much as they normally do. After the pandemic, they came down from that high. The share price came down even more from that high and we bought our stake. And it's done very well for us actually overall, but last year a bit of a negative. I think what's driving that negative slightly is the view that there could be some form of replacement in terms of software that will replace the router. For what it's worth, and I just take my leave from people in the industry I talk to is having a separate physical device with its own software is an integral part of network security and is likely to remain. So, we're still there.
You if you read our annual letter, you'll have seen some of these slides, although we've got quite a few more in the questions. What's going on? So, we've got a strategy of investing in quality growth companies, which performed very well for 10 years and then has performed increasingly bad for the last four or five years. What's going on, folks? Is it just we've got it wrong? Is it that the strategy no longer works at all? I mean, it clearly hasn't worked during this period. That's not even a matter of debate. I think what's going on is a couple of things. This is about concentration of performance. This slide, the gray bars are the proportion of the S&P 500, which is in the market capitalization of the top 10 companies. So, the top 10 companies by market value, what proportion index are? You see they're 25% there and they're 34% by the time we get over there. And then and this is rather more important what percentage of the performance of the index they provide. You can see they're starting to provide two-thirds of the performance of the index. So it's very concentrated. If you don't own some or all of those companies, you're going to struggle basically in terms of performance.
You can see concentration of performance here. This is actually market value rather than contribution. But you can see here where we've got to the top 10 companies being 35% of the market there. You get a long-term perspective. This is the top three stocks over here and this is the top one stock here. But you can look back over a hundred years and see when was it last like that about there. That's about right about 1929 or something. That's Oh, what happened next? Yeah. Okay.
This is one of the things driving it, which is the switch into index funds. Increasingly money has been placed in index funds. They're called passive funds, but they're not really passive. Whether we're talking about an index fund, it's an open-ended fund or an ETF to track an index. And they're outperforming people like us, and therefore the money is flowing from people like us into the index. And when that happens, it has a very big effect. And you can see it here on this slide how it's happening. You know if you go back to roundabout the dotcom here you can see that the proportion of money in index funds was around about 10% I would guess something like that. Now in 2023 I think that is it went over 50%. And it's still going up still and it is a momentum strategy. It's not a passive strategy. There may not be a fund manager making choices for you but it's not a passive strategy.
When you go out of here tonight and decide that I've got this completely wrong and you sell your fundsmith units and you put it in the index, it will definitely give momentum to Nvidia. Why? We don't own any Nvidia. So, we won't be selling any Nvidia to fund the redemption and you will definitely be buying more of Nvidia than any other company in the index when you do that. This is a momentum strategy and momentum strategies can be very legitimate. Julian and I worked over the years with some very good analysts who analyzed things for momentum strategies and did very well with them. I've got to tell you it's a perfectly legitimate methodology. But the thing is this, if you're going to engage in it, do not become confused about what you're doing. That's would be my advice. So if you're going to run a momentum strategy, buy things because they're going up. And when they're not going up, sell them. That's it. Don't buy things because they're going up and then decide that you understand the market for GPU processors and so you're going to hold on to it even though it goes down. No, that's not a momentum strategy.
The best people we've worked with on momentum strategies were sometimes so good at it that they almost seem to be in league with the devil in predicting where prices were going to go and what they owned or didn't own. But their methodology was very particular and it illustrates that point. You could show them a chart of a price movement of a company, a commodity, whatever, a currency, and you needed to show them the volume figures. They always needed to see the volume for the movements because that told them how important the movement was. And they were very good. If you ever told them what the chart was, they weren't so very good. And that's what you're basically engaging in with passive funds. You are engaging in a momentum strategy with passive funds.
This paper which I would imagine not a lot of people here have read called the origins of financial fluctuations the inelastic markets hypothesis I wouldn't imagine too many people buy that before a long flight is quite interesting I think it's been largely overlooked because talking about the switch of funds between us and index funds and it's not just the percentage that's in index fund is the fact that for the percentage to be climbing there must be money switching from one to the other that's what's happening. Unsurprisingly, of course, the thesis of markets, if you like, the original sort of elastic markets or perfect markets combined thesis is if you take a dollar or a million dollars or a billion dollars out of one company's stock and you put it in another company's stock or you take it out of one fund and you put it in another fund or you take it out of bonds, you put it in equities or the reverse, whichever, whatever you want. It doesn't make any difference to the valuation. You know, if I go and sell Microsoft this evening and put it all into PepsiCo tomorrow, it doesn't affect the valuation of either Microsoft or PepsiCo. It's unaffected.
However, these people have looked at the data and discovered that the actual market impact for a dollar going from one security to another in recent years has been a multiplier of somewhere between three and eight times. So when you took your money out of us and the dollar went into Nvidia, the effect on the Nvidia price was somewhere between $3 and $8 on average $5 between those. That's a startling number. And the reason for it is, as I tried to explain in the title, the inelastic markets hypothesis, because if you take the dollar out of our fund and put it in the passive fund, it doesn't make any difference. That works providing there are people in a position to take the opposite view. So if you think that something is vastly overvalued it can by being driven by the momentum of index funds that will be bought down to earth by people who are running active funds who will sell it or even short it in the case of hedge funds. What they're pointing out is there are increasingly fewer of those people because of the rise of index funds. There are increasingly fewer active funds to do that. And even within those active funds, there are an awful lot of people who've become closet index trackers. They're running an active fund, but they stay pretty damn close to the index for survival reasons. And frankly, I can't blame them where I am at the moment. It feels quite an interesting thing to do from time to time to say, 'Well, the hell with it. Why don't we just buy what's in the index?'
Because that's almost the point that I would make about this is when people are talking about our performance and in the last few years and the rise of the magnificent 7 and then AI and index funds our differential in performance at the moment a negative differential clearly has not come about because we couldn't work out what to do right from somewhere around two around a bit years ago it was blindingly obvious that that bunch of companies there were going to go up and you really, you know, if you wanted to be anywhere near the index, you needed to own them. You may not like this very much, but we have quite deliberately stuck to what we said we're going to do. And it's being costly, and it may continue to be costly, but we're not proposing to change it. We're not not owning those companies because we couldn't quite figure out that they might go up. We're not owning those companies because we think they're actual problems and dangers in owning them, which in the long term we think will come to play. And we want to still be here running this money in the way that we said we would at the end of it coming into play.
You can see just by way of illustration as well the effect of this inelastic markets. These are some price movements from the last quarter of last year and first couple of months of this year of a range of companies and the size of movements is extraordinary. I mean we own some of these companies but not all Magnum Ice Cream spun out from Unilever down 16% in a day. These are movements in a day. Okay. We own Novo down 70%. It's done that twice, two times. We own IDEX up 15%. You know we own Essilor Luxottica the eyeglass company up 13%. These are big movements in a day for what are pretty big companies actually you know 145 billion euro company you know 215 billion dollar company. How about this one? Oracle goes up 36% in a day and becomes worth $933 billion nearly a trillion dollars company in a single day. When Julian and I were first working together in broking, a company that moved 20% in a year in share price terms was the subject of considerable interest. Wow, that's a lot, isn't it? Now we're talking about exceeding that in a day in trillion dollar companies. Something's not right, folks. Right. And there's something that's not right. Goes back to that paper. There isn't an elastic market out there. There's no one. When Oracle announced, which they did, that they had $400 billion of commitments to purchase hyperscale data center capacity over the coming years. By the way, from a company that hasn't got any money, OpenAI, when they announced that the share price went up 36% because there was just not enough people with the assets and the mandate on the other side to take the opposite bet and sell the shares. That's what it's telling you and it's not very healthy in my view.
I suspect by the way that the flows into ETFs in particular is not just driving the index funds performance in terms of the large companies out there which we don't own in some cases. It's driving other things as well. That's the Bitcoin price. So here's the SEC agreeing that you could own Bitcoin and ETF and there's the Bitcoin price, right? I suspect the ease with which people can own things makes a considerable difference to whether or not they will do so particularly when they get fear of missing out because they read about it going up. The thing I would put as a cautionary tale though bearing in mind our strategy and how it differs from what the index is doing is that this is something which does exactly the same in the opposite direction. The Bitcoin price has roughly halved once it started to turn. Momentum remember I've said as a strategy is legitimate but try and remember that you don't have a view fundamentally just when it starts going down you sell it. It's probably also partly behind gold as well I suspect that we see there the gold price and the ETF flows which way around this is is difficult to determine the ETF flows because the gold price goes up or gold price goes up because of the ETF flows I don't know but it is an interestingly highly correlated chart isn't it to look at.
Enough of performance. So that's what I wanted you to know about what we've done, where it came from, where we made mistakes, which we did. What's happening in the wider world out there and how we view it. Okay? And how we view it is with adjustment. We're going to stick to what we do. Investment strategy. We talk about this just for a few minutes if you would indulge me because I think you should know whether we're doing what we said we're going to do. Three steps. Only invest in good companies. Try not to overpay. Try and do nothing.
Only invest in good companies. There's the look through table. These are the companies in our portfolio over the years with five performance metrics down here to tell you how they're performing. You can see the return on capital employed ROC last year was 31%. Down very slightly but not very much. And as you can see very significantly higher than the 17% on the index. Good. Our companies are making 31 p or cents for every dollar pound that we own of their capital. Okay. Gross margin the difference between cost of sales and revenues. Our companies have got 62% again down very slightly. 45% 43% on the index. Our companies make stuff for four and sell it for 10. People in the index make stuff for about 5.5 and sell it for 10. That's what it's telling you in English. Take out the other costs, you get to operating margins, 28%, down slightly last year. Beginning to get a theme here, aren't we though? Nothing to write home about, but bit on the weak side there. Not just for us. I mean, it's not this is not particular to this group of companies. I'm just saying for corporations on the outside very particular as a whole. Maybe a little bit of a trend there. No. And you can see 28% compares with the index pretty well.
Cash conversion. You might recall that we always used to have sort of high 90s and we had a bit of a downturn here and here and this was caused by the pandemic. People when the supply chain started to seize up bought stuff when they could get their hands on it. They weren't worried about the size of their stocks. They were worried about whether or not they could get the components, the ingredients. And we thought that would recover and they started to recover and then we had a little bit of a downturn here starting with the amazing spending on capex by the large technology companies. It has recovered notwithstanding the fact that those large technology companies are still very big spenders and partly because we've cut our exposure to them over that period. And it has again we're a bit better than the index which is where we like to be on the whole. Interest cover 29 times. So the profits of these companies cover 29 times their annual interest. They are incredibly conservatively financed. They're going to see us through whatever kind of crisis we next have. Therefore, there will be one. And they're much better financed than the market which is on eight or nine times interest cover.
Don't overpay. So all right, we think we've got a bunch of companies which are financially very sound there. How about their valuation? Well, we use free cash flow yield. The cash the company generates divided by its market value to give you a yield like you get on a bond to measure it and you'll see that last year we closed with a free cash flow of about 3.7%. And I think the starting number which is number I'd have presented to you when I stand up last year was 3.1%. So the valuation improved, the yield went up, they got a lot cheaper. Not all that surprising when you consider they didn't perform very much. What's really interesting is this. They're now a lot cheaper than the S&P 500. I'm not worried about the Footsie. There are only a handful of companies in the Footsie that would qualify for our fund. But they are now cheaper than the S&P 500.
Before I move on to show you how that looks historically, the free cash flow grew 16% last year. That's a hell of a growth rate for these companies. Now, I think it's rather exceptional because they were recovering from the squeeze on cash flows I was talking about earlier. But nonetheless, that's a pretty interesting clip for these things. And if you look at the history on it, so there we are with our year that just closed with 3.1% 3.7%. I've stood up here in front of you for 15 years and have said we own a bunch of very good companies. They are more expensive the S&P 500 but they are justified by the quality which they bring in terms of returns on capital, profit margins, cash generation in that valuation. I can now tell you we own a bunch of companies which are better than the S&P 500 which is significantly cheaper. That's the first time I've been able to say that to you. Basically, the nearest I would have got would have been if you were an attendee at the first annual general meeting out here. Other than that, nope. We've been sitting here with our valuation this line here being below in terms of you. We're now above it. Now, doesn't mean they're cheap, but it does mean they're relatively cheap. And that may be quite interesting a bit later on when things develop.
Do nothing. We try to do nothing. It never works. There's always something to do, but we don't do a lot. We sold two stocks last year. We sold PepsiCo and Brown-Forman, PepsiCo, drinks and snacks. We'd had several years of worrying about lack of free cash flow growth at the company actually. And then on top of that, we have the whole weight loss drug phenomenon. Novo Nordisk may not actually be a great success, but I assure you the weight loss phenomenon is here to stay. And snacks are actually in the crosshairs of that. One of the products that's absolutely in the crosshairs of it. So we sold them and Brown-Forman you might recall we sold Diageo the year before. We hung on to our Brown-Forman. Partly because we wanted to make sure that the effects we were seeing were genuinely the case with regard to weight loss drugs and alcoholic drinks. But as time went on, we became more convinced that there are several factors impacting the drinks companies negatively, not just weight loss drugs, but also generation Z or Zed, depending on whether you're American, drinking habits or lack of drinking habits. And the legalization of marijuana is another one which is quite a big impact. And I'm shocked by this, the number of people in my generation who stop drinking, he said looking meaningfully over there. Shocking sobriety has called on. We hoped that Brown-Forman's family ownership would lead them to perhaps find a course through all this that a company which was subject to sort of quarterly earnings influences wouldn't be able to. But it's not. So I think the family is very focused on getting its dividend rather than doing something. We need for to own a drinks company again we need somebody to come along and say we accept that there's a problem with generation Z, weight loss drugs, marijuana and what we're going to do is this as a result we haven't heard that from anyone yet and that's what we need to hear.
What did we buy? We bought back into Intuit accounting and tax software company. You might recall we sold it a few years ago when they made an incredibly bad acquisition for a bank a marketing company called Mailchimp. Where we thought that they paid three times the right price and that it wasn't in their area of expertise. The shares, this is a sort of moral tale of our time went up initially because they were going to be an AI beneficiary. They've now cratered and we've started buying them. The acquisition is sufficiently bad that they've now started reporting numbers ex Mailchimp. That's how bad it is. Would like to believe they've learned their lesson. We started buying Zoetis. Zoetis is the biggest veterinary pharmaceutical company in the world. Quite an interesting complement if you like to IDEX. We like this area. A company has struggled a bit. The fact there were side effects of this drug. We asked our veterinary consultant who's here tonight what she thought about it. She said she knew about the side effects and would prescribe it and she's also my daughter's over there somewhere actually. And so we bought it.
Essilor Luxottica we started buying. We've followed it since inception. World's biggest maker of eyeglasses, that is frames and lenses. A consolidator within that industry. An industry which has got a secular tailwind in terms of people who don't have vision correction in the world who need it and will get it eventually. And people in the developed world who've got vision correction but continue to trade up in terms of designer frames or multiple pairs of glasses etc. And of course they've got a hit at the moment at least with the smart glasses that they've partnered with Meta to do. And it's a great leap forward I think in terms of product because up to now the glasses were the ones provided by Google which were made you look as though you're at the dentist having a wisdom tooth extracted and cost $1,000. These ones are a pair of Ray-Bans and cost $300. So it's like oh well hang on I know which one I'm going for. I think there's a chance that they are part of the development now of a new product that we haven't seen since the smartphone really in terms of how we will get and interact with computers. Yes, there will be competition. Apple has announced that they're going to do some smart glasses. You know, I'm amazed by the commentary in the stock market continually, which is, 'So, you thought there'd just be one company doing this, did you?' No, of course there'll be competition over time.
We just started buying Wolters Kluwer. Wolters Kluwer is a Dutch company which is basically got a database of publications which they supply to people things like medical papers legal and so on which are used for people in terms of doing work on precedents for legal cases and contracts people developing surgical procedures and drugs and so on. They are one of the companies which is slated as being wiped out by AI. I think it's unlikely. My current joke comparison is we've got this company here which has got all of this peer-reviewed genuine research on medical legal and other matters sitting there versus the former chief constable of the West Midlands who decided that he would ban an Israeli club coming to play in Birmingham because of a violence at a West Ham match with the Israeli team which he got from AI and of course it was hallucinating. There'd never even been a game. So I don't think I really want people to research medical procedures that they use on me by that method. I'd like them to go and have a look at a paper written by some actual doctors and I think the rest of us will see that as an advantage as well.
Last but not least Magnum Ice Cream. This was spun out from Unilever. It's pretty good business actually. I think it just didn't fit very well within Unilever. I see Nestle are contemplating something pretty similar. The supply chain for ice cream is completely different to the remainder of the food business. We're hanging on to it for the moment. I think it may have some mileage in terms of self-help to do some things that will improve its performance over the years. All of that activity didn't cost an awful lot. There was slightly higher turnover than usual as you'll see 12.7% is a lot highest in these periods, but that's still very very low by industry standards. And you'll see here the actual cost of it was 1.7 million pounds. So 0.009 of a percent basically. So not something to trouble the scorers or make the brokers rich in terms of dealing. So a slightly bigger turnover and I think that's kind of a reflection of the times and it may continue to be a reflection of time but it didn't cost us a lot of money.
Thanks Terry. On with the questions then we'll open up with one from Colin Simpson. Terry says in your letter that the seven major tech companies are not all good companies of the sort we seek to invest in. Can you explain the thinking behind this view?
Yeah, we'll have a go, won't we? Yeah. Good. There's the return on capital employed of the magnificent seven companies. I'll let Julian start on this one.
So, yeah, evening all. I should add that for those of you whose questions have not been answered, they will be answered by human as opposed to AI. Even though the human might use AI. So what we are looking for from these companies is basically or our companies is I think decent returns, predictable returns and growth. And we've got two slides on this. So if you'll go to I know there's a lot of numbers on this first slide, but if you go to the last two columns, you've got the average return on capital and the standard deviation, which is basically a measure of volatility. So with Alphabet you've got 22% return on capital employed which is a decent number. It's a little bit below our average and this the standard deviation is 6%. So these are predictable returns. Amazon you've got 11% returns which are low and the fact that the standard deviation is 5% unfortunately means they're predictably low. Apple returns are good. And I wouldn't worry too much about that 14% because they're sort of somewhat volatile around a very high number. Meta returns are good and they're quite predictable. Microsoft very good and they're quite predictable. Nvidia is obviously interesting because in the course of what's admittedly a long period of time we've gone as low as minus 4%. We've been at 13% as recently as 2016. 12% as recently as 2023 and we're currently at 126%. So the average looks great but these are obviously based on those numbers not particularly predictable. And Tesla the returns are as you can see either negative or extremely low with the exception of one year. So the average is negative and they're extremely unpredictable.
We I mean just to say one thing on the investable universe which is there is a fractional element at the moment where if we did not have Nvidia in the investable universe and people asked us about and we just said well it's not in our investable universe so we can't really comment. I think that would come across as slightly lame. So the other thing is there could be a moment when as there was in 2002 with some of the companies that fell sharply after the dotcom bubble burst. There could be a moment when there probably will be a moment when some of these companies look interesting or whether they get cheap enough that we don't need to be able to forecast them out decades. So that's another reason we cover them. If we just move to the next slide, this is basically the company's free cash flow going back to 2010. If you go back say to 2015, so 10 years, you can say that as well as Alphabet's decent returns and predictable returns over the period 2015 to 2025, they've gone up what that's four or fivefold. You can see that Amazon those numbers are all over the place. You might recall that we started we did have a brief dalliance with Amazon in 2021 and 2022 because we actually correctly thought that that number the 2023 number you see of 32 billion was actually quite interesting and was on its way to something quite attractive. Unfortunately AI then got in the way. Apple is interesting because it's a very big number 98 billion in 2025 but it was actually 70 billion 10 years ago. Meta during that period has gone from 6 to 46 and in the intervening period was 54. Microsoft's trebled from 23 to 71. Nvidia has gone up 600-fold. And Tesla is now positive but it's a pretty small number. So when I go back to what I said before, if we take decent returns, predictable returns and a measure of growth, we think we've got those in five of those companies. We own three. We've included Nvidia as well because of the reasons I said and we do not have Tesla in our investable universe.
Thanks, Julian. Next question is from Christian Croen and he asks, 'Is the attention economy a fundamental shift in how we define value, prioritizing liquidity and reach over cash flow, or is it just a modern justification for a classic bubble?'
Oh, by the way, I forgot to say I agree with him. I agree with him. Yes. Okay. We both lived through as some of you did I imagine as well but very directly through the dotcom bubble and were running a broking business at that time in which we were using a fundamental valuation tool which is still in existence today called Quest owned by Canaccord and the head of it is here today.
The head of Quest is here today.
Is he here? Jimmy Cotton's here.
Yes. Oh Jimmy, you out there.
Good. And it's got a lot of similarity to the way that we look at companies. Unsurprisingly since we developed it and so you might be unsurprised to know that we were incredibly skeptical during the dotcom boom and we did have an analyst Mustafa Omar who famously used to put out share price targets of zero on companies on occasions and proved to be right but did get an awful lot of flak in the meantime. These are some quotes from that period that I've put up on the screen. I wonder if it sort of rings a bell with anything that's going on now. 'Traditional valuation metrics like P/E ratios don't apply to internet companies. It's about market share and future potential.' That was expressed by serial analysts over the period. This is from we've actually managed to find the particular analyst for this one. Mr. Gilder, the author and tech prophet. 'The internet is not just a new technology. It's a new world. The old metrics of valuation are as obsolete as the horse and buggy.' Yeah. And Mary Meeker was very famous, Morgan Stanley's queen of the net. She was only in 1999. 'We are in a new era. The old rules of valuation are gone.' Well maybe I don't think that we've entered an era where the rules of valuation in terms of returns on capital and growth are not going to be applied anymore. At the moment, they've just been suspended because people are in increasingly uncertain about the outcome of AI investment. That's what's happened to them at the moment.
I was just going to add that one of the interesting things about the four I think most people wouldn't doubt beneficiaries of the attention economy are Google in search, Amazon in e-commerce or online shopping, Facebook, Meta in social media and Apple in providing the device that actually enabled you to interface with the internet all the time as opposed to just when you're at your desk. And if you think about sort of when those companies came in, Facebook obviously wasn't even invented during the dotcom bubble. You know, came into 2004, as you can see from those, don't go back to the numbers on that previous page, but obviously sort of still pretty small 10 years later. Amazon was going then, but was mainly, as I recall it then, still a book seller.
Yes, it was competing with Barnes & Noble.
Competing with Barnes & Noble. Google wasn't was started in 98 was absolutely tiny at the time of the dotcom bubble didn't go public until a few years after that and the iPhone didn't come in until 2007. So one of the lessons of all this is that the way that the people who actually benefited from what the dotcom bubble produced i.e. the internet were actually very very unclear at the time that this was all going on.
Yeah. I mean, even if this is a fundamental change in the way that we work and assimilate information and program and process information, taking that precedent, it seems to me unlikely that we know who the winners are right now.
Very good. Well, there's a bit of a theme developing here because a lot of the questions that we've had in have been on this sort of theme and we've put a couple together here from Graeme Hedel and Homit Shader and the question is this with 500 billion US dollars sunk into AI and profitability still theoretical. Is this the largest speculative craze in history? Specifically, at what point does the declining return on capital employed and margin pressure from this AI arms race disqualify even the tech giants from your high return investable universe?
Yeah. Okay. There have been lots of these episodes in economic history where there have been major developments. You know there's a few on here. Canals, railways. I particularly like the communications one, the telegraph. So, you know, put some wires up alongside a railway and use Morse code to communicate. The telephone, connect a telephone to the wire so you could speak, radio, so you could speak without wires or broadcast. Of course, TV and the internet if we stay down there.
Airplanes, and of course now AI, and speculative bubbles existed around all of these things, basically all of them. The radio boom of the 1920s was dominated by a company called RCA, Radio Corporation of America, which notwithstanding the universal take-up of radio which continued, lost 98% of its stock value there. All of these, you might say, to some degree or completely benefited us, changed the way that we work, changed the way that we live, and have benefits for us, but they don't always have benefits for investors, sometimes at all actually.
Airplanes is the classic. The Wright brothers took to the sky in Kitty Hawk in 1903 with the first powered controlled flight. And the great Warren Buffett said that the right thing for any investor who was present to do would have been to shoot them down because nobody's ever made any money out of operating airplanes in the meantime. And so there is an awful lot of precedent for these things existing in the past. What we're living through, we always have this great sort of recency bias, don't we? And live in the moment of the present increasingly. I suspect the fact is that history does have quite a lot to tell us.
The actual question was about is it the biggest though. So we're going to talk about scale a bit here. These are the capex, so the capital expenditure that's been declared by the so-called hyperscalers building data centers and putting processing units into them for 2026 as you can see here. What we've done is we compared the numbers that they've announced with their cash flow. You can see in the case of Microsoft it's 87%, case of Meta 91%, the case of Alphabet 97%. The case of Amazon where Julian's already highlighted the rather low free cash flow, it's more than 100% of their cash flow. So they're going into debt for that. The case of Oracle it's twice their free cash flow. So they are going significantly into debt to do this. And the winner on the number one on the podium is CoreWeave where the commitments that they've announced for 2026 are 567% of free cash flows, or as we call it in analytical terms, a lot.
And actually there are some things that scare me that are not blindingly obvious. One of them that does scare me is since we're clearly in an arms race here, is that some of these people have enough money to keep going. That's one of the problems here, is they will probably keep going unless they won't walk away because they're financially constrained. They'll have to have some demonstrable sign that they can't get the kind of return on capital from these products that they're funding.
Is it the largest speculative craze in history? We've tried to do some work for you here which we've looked at some numbers. These are the top five AI hyperscalers combined market value at the moment: 11.2 trillion. These are the top five semiconductor businesses: $8.8 trillion. So we'll call that sort of 20 trillion between those two, shall we? The dotcom bubble and the NASDAQ at its peak was a total capitalization of 12. So that's interesting. We've had to do some real work historically and with some inflation statistics which are totally imperfect, which I'm sure you'll appreciate, to say that the Dutch East India Company had a valuation of 8 trillion, having the major advantage of running India or most of it at the time. The Mississippi scheme was 6.5 trillion and the South Sea bubble was $4.3 trillion. And we put the AI data center spend at the bottom there by way of comparison, how much they're actually saying they're spending. The short answer to the first part of the question would seem to be yes.
It is the biggest. Here's some other evidence of it in market terms. These are statistics back as you can see here to 1964. So long sweep of history and they look at how the largest 50 stocks have compared with the Russell Midcap index. So how the biggest 50 stocks in the market, which as we know are now dominated by the tech stocks, compared with the Russell Midcap stocks. And you can see that the dotcom is there and there's where we are now.
And an awful lot of what people talk is they say, well you know, you've got to be wrong because all these companies are doing this and Satya Nadella is a very clever guy and Larry Ellison and Mark Zuckerberg and so on. Yet they are. There's absolutely no doubt. But you know, they're rather like us. They're not exempt from making mistakes. Right? So this is Larry Ellison talking about, who runs Oracle, talking about cloud computing. Now cloud computing, distributed computing as I'm sure you're aware, has been the big thing prior to the AI boom in terms of the development of technology, in terms of moving from having on-premise servers to putting your stuff into a cloud which is run in a communal space in a data center. When the cloud began, he said, what is it? It's complete gibberish, it's insane, when is this idiocy going to stop? Now as a result of that he completely missed out on the cloud. He is now number four in a two and a half horse race in the cloud, the others being clearly Amazon, Microsoft and Google in the cloud in terms of the provision of cloud services.
And I think as smart as he is, that's affected the way that he's approached it. That's why that earlier slide shows that he's spending 200% of his cash flow on this. He's going all in on this. He's not missing the cloud twice, I think, is the way he views it. But before we think, well, that's good, because he's judged this to be right, he's spending twice as much money as he's got on this, he does not always get things right. In 2022, they announced the acquisition for 28.3 billion, quite a lot of money that, of a company called Cerner. And Cerner was a transformational system to reduce the administrative burden on doctors and nurses by using AI to analyze patient data and eliminate data fragmentation. So different parties having different bits of data about our health and not being able to put the whole lot together. We've not heard anything since. Now I'll leave it to you to decide whether we've not heard anything since because it's such a wild success that he's embarrassed or because it hasn't actually worked. But I know which way I'm betting on that. Julian, do you want to say anything about this? I've been talking pretty long.
I was just going to say one thing, which is so when I was sort of looking at some facts for this, if you'd have seen the Wright brothers, I think it was their fourth attempt during the day, and it flew for 852 feet. If somebody had said to you it's going to change the world and you said well it can only fly for 852 feet for 12 seconds, I don't know, and it can only carry one person, and obviously 100 years later you'd have looked pretty stupid. But I've heard the phrase which has already come in about people being AI deniers. We're not AI deniers. We're just trying to say, I want you to make money out of it. How the hell do you make money out of it? Or not only how do we make money out of it, but who are the people who will make money over the long run, who are going to be the way that Meta and Amazon and Google? And we haven't got a clue. And in aerospace, it wasn't anyone called Wright. That's the total Oracle movement over the few days when they announced the $400 billion commitment that they got from OpenAI, who I can assure you have not got $400 billion right now. Maybe they will have, maybe they won't.
Yeah. And of course the answer I think is yes to the gentleman's question.
Next question comes from David Cox. He asks, when people withdraw money from the fund, how do you decide what companies to sell?
It depends really. Sometimes the decision is kind of made for us over time. In some respects, we're subject to a thing called the concentration rules which are hardwired into the OEIC regulations, the open-end investment company regulations, which means we can't have more than 10% of your fund in one company and we can't have more than 40% of your fund in companies which are over 5%. And as things move about from time to time, we do get close to those rules being breached. We don't breach them, but we do get close to them being breached. So quite often the thing that we're selling is something to prevent a breach in those rules and that provides a liquidity for redemption sometimes. In this regard, if we've got something to sell either because it's about to go over 5% and join the other companies and breach it, we might sell that, or we might have one that's about to go over 5%, we don't want to sell that one, so we'll sell something that's bigger and take them down. I did some today in fact, I'm selling on this basis. That's quite often where the liquidity comes from.
Outside of that, we think about things along the lines of valuation fairly obviously. If something's sitting on 40 to 50 times earnings and we've got other things on sub 20, it doesn't automatically mean that the higher valuation one is the one to sell. Because sometimes low valuations are not always an indicator. They're sometimes a trap, but it certainly starts us thinking about it in terms of which way we go. Sometimes it's about coming out of sectors because we just think they haven't got as good prospects as the remainder of which we retain. So we might sell things to come out of things like the drinks companies.
Very good. Right, we're back to AI and capex again. Another question that we've blended from two people who've written in, Steven Hall and Mark Weissberger, and they ask: Microsoft has recently dropped out of the fund's top 10 holdings. Can you confirm if this position was reduced due to concerns over rising AI capex and its impact on free cash flow? If so, what was the scale of the reduction?
Yeah, I mean we roughly halved the holding in Microsoft, Meta, and slightly less so in Alphabet. And yeah, we did so because of concerns about what we're seeing sitting there in terms of the spending. And we're seeing $600 billion, I know not exactly the same group of companies, but four companies, $600 billion per annum going out. If we're looking for a 30% return on capital say, those companies are going to need to generate $180 billion of new cash flow, not from the things that they've already got, not by cannibalizing what they already have, to justify that in terms of return on capital per annum. That's quite a lot actually. And at the moment we're not really paying for AI mostly. We're users of it and we are paying but not to anything like a degree that could possibly justify that. And we are probably unusual in paying because we're a business. Most consumers are probably not paying at all. I mean, as a consumer, I don't pay for using it. And so that's tricky.
And I know there have been models historically where people have given you things and got you hooked on them and then later on told you what the price is and started to make lots of money from it. But they're relatively unusual and they do usually involve the person who manages to accomplish that achieving a dominant position in the industry. So it's all that. And at the moment if you think you can spot somebody who's going to achieve a dominant position in the AI industry, please let us know who it is and why you think it is, because I just at the moment it looks to us like anybody's choice in terms of who might be the winners if any out there. Will it even be a company in the West? I don't know. I really don't know. So I don't see the justification coming from that at the moment from a dominant player or players emerging who are able to charge, able to get that incremental cash flow in order to build returns that would justify the kind of spend that we're seeing here.
The other way of doing it, which people have done historically a bit as well, is to get you hooked on something and then not charge you directly for it but to sell you something, advertising, your data, etc. Facebook, Google and so on. But again, in order to accomplish that, you need a dominant position. You can't do it if there are myriad competitors. And so taking all that into account, yes, we did become quite pessimistic about whether or not the big tech companies that we have owned that have been very successful, like Meta, like Microsoft, like Alphabet, can continue to be the kind of companies that we want to own. Because if you look at the businesses that they were, we're talking about companies with very high returns on capital and they were very capital-light businesses mainly. These are not going to be capital-light businesses. This is going to fundamentally change the characteristics of those companies in a way that we don't like. So yes, we sold them for that reason.
Are any of the leaders of these companies making a good fist of explaining to the market why they're making these investments?
I think at the moment they've had the luxury of really not having to. We obviously listen to analyst calls and read reports. They're not being asked mainly.
