We are often asked for our outlook. Our answer tends to disappoint: we do not build our process around a forecast of where markets go next.
That is not evasion. A top-down view requires getting too many things right in sequence. It involves what we believe are very elusive steps – the macroeconomic path, its translation into markets and sectors and securities. Even a correct call at every step can still lose money if the market has already priced it in, or if the chosen company fails to deliver vis-à-vis the specific thematic we chose it to gain “exposure” to. We have never found this a reliable way to compound capital.
We instead acknowledge that there is considerable randomness in financial markets. Rather than pretending to know what we think cannot be known, we focus our analytical effort where we believe genuine insight is possible: individual businesses.
The market can be counterintuitive, fraught with inconsistencies and inefficiencies. Share prices can move dramatically because of sentiment, positioning, passive flows, momentum or changing expectations, without a corresponding change in the underlying economics of a company. A strong business does not become a bad business because its share price falls 20%. Equally, a mediocre business does not become attractive simply because its share price rises.
We find it easier to understand businesses, how they add value and the risk you take when owning them.
Our starting point is therefore different: rather than trying to determine where the market will be in a year’s time, we focus on what a business is worth today and whether that value can endure and compound over many years.
The investment discipline becomes much more a discovery process than a prediction game.
We study companies individually: their competitive advantages, management teams, capital allocation, balance sheets, cash flow, reinvestment opportunities and long-term earnings power. We then compare our assessment of intrinsic value with the price the market is asking us to pay.
At the end of the day, investing is about buying and owning assets that will throw off over time significantly more cash than the price you paid to acquire them.
A philosophy that is being tested
That gap between fair value and price also allows for a margin of error that makes our approach less risky. Such a conservative strategy works well over time but is handicapped during periods of excessive risk-taking and tends to underperform materially when markets are exuberant.
We live through such a period, courtesy of the massive AI infrastructure build-up currently under way. The behavior driving this is characteristic of a late-cycle market — and can, at its extreme, a bubble.
Even as some excesses have corrected last month, we see investment decisions mostly motivated by fear of missing out (FOMO) rather than careful long-term value appraisal. The appetite for compelling narratives is particularly evident in the IPO market, where investors have shown a willingness to embrace ambitious growth stories ahead of proven fundamentals. The flotation of SpaceX, the largest in history, is a striking example: a powerful vision and distant potential were sufficient to command a valuation close to US$2 trillion (roughly 100 times sales) for a business that loses money.[1]
When high valuations combine with optimistic future earnings assumptions, the risk compounds. This combination is now visible at market level: the US market’s cyclically adjusted P/E ratio stands close to 40, a level exceeded only once in more than 150 years of market history … at the peak of the dot-com bubble in early 2000.[2]
None of this tells us when the market configuration will reverse. Timing is unknowable. But markets driven by FOMO never end well. Eventually fundamentals reassert themselves.
Some choose to throw in the towel – we stay disciplined
Such periods of testing have occurred many times in history and generally end up creating soul-searching for some investors, including some of the most dedicated practitioners of the discipline.
A lot of us still have in mind the legendary investor Julian Robertson of Tiger Management Fund announcing that he would exit the game after “an irrational market, where earnings and price considerations take a back seat to mouse clicks and momentum”. That was in March 2000, right at the peak of the TMT bubble.[3]
We thought of Robertson again when we read the latest letter from Terry Smith, one of the managers we have long admired. In it, he signals that momentum will play a more prominent role in his decisions, and that he will be “much less willing” to buy quality companies when they stumble. Fundsmith’s portfolio turnover reached 51.8% in the first half of 2026, against a historic norm below 10%, for a fund built on a “do nothing” mantra.[4] [5]
We agree with him that market driven by passive flows and momentum can become increasingly distorted, that momentum sits at levels last seen in 1999, and that this will end badly.
Where we part ways is on the remedy. We believe that becoming more of a crowd follower, and setting aside time-tested investment principles, is not a solution we can get behind. Discipline is what keeps an investor rational when the crowd turns emotional. In our experience, it is the fortitude to stand apart that pays off.
We think that a fundamental investment approach focusing on earning power remains particularly relevant given the structural market changes that Smith describes.
Passive investing and index flows should increasingly expand the pool and the magnitude of the mispricing and therefore lead investment opportunities for the patient long-term shareholders. We are thrilled about that. That is the bread and butter we feed off to compound the wealth of our partners.
FEP aims to provide investors with exposure to companies that are of outstanding quality and underappreciated by the market.
Companies must have a long history of good financial performance and a strong balance sheet. They must maintain a high operating margin, consistently exhibit positive operating earnings, generate large free cash flow, and show robust returns on invested capital. The quality of the companies, the sustainability of their earnings power, and their development potential is also assessed through the analysis of 4 critical factors that Lloyd Capital defines as the 4 “M”s – Moat, Management, Market and Macro.
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[1] https://www.sjp.co.uk/individuals/news/does-spacex-have-a-moonshot-of-justifying-its-price
[2] https://www.multpl.com/shiller-pe
[3] https://www.theguardian.com/money/2000/mar/31/personalfinancenews.business1
[4] https://www.ii.co.uk/analysis-commentary/terry-smiths-massive-overhaul-underperformance-gap-widens-ii539599
[5] https://www.ii.co.uk/funds/fundsmith-equity-i-acc/B41YBW7
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