Their approach to stock picking only aims to identify companies that can growtheir market capitalisationover time, irrespective of the market conditions.
Unsurprisingly, both managers have always stayed away from cyclical industries such as energy and banks. It means that their company analysis aims to unveil the structural drivers of growth for a company.
They tend to buy businesses dominating their industries, with high barriers to entry.
They also interact and meet the company management team to understand how they will protect the structural advantages of the business, their strategic plan to grow the margins and their use of capital.
These are the principles. But what about the practice? How many stocks do they have in common?
Using FE data over the past three years, we can only find one stock held by both: Imperial Tobacco (which was sold by Mr Smith at the end of 2017).
Although their investment mandates differ, with Mr Smith being a global equity investor, it does not fully explain the limited stock overlap.
Mr Smith has always allocated around 10 per cent of the assets to the UK equity market, while Mr Woodford has always invested 10 per cent of his assets overseas, but there isstill no crossover.
Macro awareness
Although their stock picking is mainly driven by a fundamental bottom-up analysis of a company, Mr Smith and Mr Woodford differ in their understanding of the macro environment.
Mr Woodford takes the macroeconomic environment into consideration when analysing the long-term prospects of a company, while Mr Smith simply ignores it.
Contrary to Mr Smith, Mr Woodford also has a stronger valuation discipline, as he aims not to overpay for a company.
The assessment of the macroeconomic environment also helps him to understand why the share price for a company trades at a discount to its intrinsic value.
This valuation awareness goes some way to explaining the differences in the industry allocation between Mr Smith and Mr Woodford.
Let us take the example of UK house builders. Mr Woodford has recently allocated to this industry as valuations for the sector have become distressed since the UK’s referendum to leave the EU.
Mr Woodford and his team analysed the free cash flow for those companies, and quickly concluded that the market has overreacted to that political event, thereby forecasting no growth in this industry, but he believes the UK’s leading housebuilding companies still benefit from a structural imbalance between supply and demand.
It also explains why these two managers have not out or under-performed their sector peers over the same time periods, but add value in different time periods.
