Terry Smith hates these Seven Sectors

Terry Smith, the well-known investor behind Fundsmith, is famous for picking businesses that are easy to understand and can grow over the long term. But just as important as what he invests in is what he avoids. Here are seven sectors Terry Smith tends to stay away from—and why he thinks they’re too risky or unpredictable for his style of investing.

1. Banks & Financial Institutions

Smith avoids banks and other financial companies for several reasons:

• Too Complicated to Understand: The financial statements of banks are often confusing and hard to read. This makes it difficult for investors to know what is really going on or spot hidden risks.

• High Debt Levels: Banks borrow a lot of money to make profits. This means they can lose big if the economy gets worse.

• Lots of Government Rules: The banking sector is highly regulated. New laws or regulations can quickly change how much money banks make.

• Depend on the Economy: Banks make money based on interest rates and the overall economy, not just how well they run their own business. This makes them unpredictable.

2. Pharmaceuticals & Biotechnology

The world of drugs and medical research might sound exciting, but Smith sees too many risks:

• Unpredictable Success: Drug companies constantly work on new medicines, but most projects fail or never reach the market. Even a promising drug can be stopped by testing or government rules.

• Very Expensive R&D: It costs billions of dollars to develop a new drug, and there’s no promise of a payoff.

• Patent Problems: When a drug’s patent runs out, other companies can make cheaper copies, causing profits to drop fast.

• Hard to Keep a Lead: Science moves quickly. Today’s winning drug could be replaced by something better tomorrow.

3. Utilities

Utilities provide things like electricity and water, but Smith doesn’t see them as good investments:

• Limited Growth: Governments often set the prices for utilities, making it hard for these companies to raise prices or grow fast.

• Expensive to Run: Utilities have to build and maintain things like power plants and pipes, which costs a lot and usually means taking on big debts.

• Low Returns: Even after spending lots of money, utilities often don’t make as much profit for each dollar invested as other businesses do.

• Sensitive to Rule Changes: New government rules can quickly change how utilities operate and how much money they can make.

4. Telecommunications

Phones and internet are everywhere, but investing in these companies isn’t as simple as it seems:

• Tough Competition: There are many big telecom companies fighting for the same customers, which leads to price wars and lower profits.

• Constant Upgrades Needed: Telecoms have to keep upgrading their networks and equipment, which costs a lot and cuts into profits.

• Hard to Stand Out: When one company offers something new, others copy it quickly. This makes it hard for any company to stay ahead.

• Similar Products: Phone calls and data plans are mostly the same no matter who you use, so companies can’t charge much more than their competitors.

5. Commodities & Extraction (Oil, Gas, Mining)

Digging up resources like oil, gas, and minerals may sound profitable, but it’s also very risky:

• Unpredictable Prices: The prices of oil, gas, and minerals can change a lot in a short time, making profits go up and down quickly.

• Little Control Over Costs or Prices: These companies can’t set their own prices and have to deal with rising costs for things like equipment and labor.

• Boom and Bust Cycles: Demand for resources can change suddenly because of world events, new technology, or even the weather.

• Environmental and Legal Risks: Strict rules about pollution and land use can lead to fines or sudden changes in profits.

6. Real Estate Investment Trusts (REITs)

REITs let people invest in property, but Smith prefers to stay away:

• Tied to Interest Rates: REITs usually pay out most of their profits as dividends, and their value often drops when interest rates go up.

• Lots of Debt: Many REITs borrow a lot to buy properties, which can be risky if times get tough or borrowing costs rise.

• Can’t Reinvest Much: By law, REITs must pay out most of their earnings, so they have little left to reinvest and grow their business.

• Vulnerable to Downturns: If the economy slows or the property market drops, REITs can lose value quickly.

7. Automotive Manufacturers

You might think cars are everywhere and always in demand, but Smith avoids car companies:

• Tough Industry: There are many car makers all trying to win customers, so profit margins are usually low.

• Very Expensive to Compete: Building cars and developing new technology costs billions of dollars, and there’s a big risk if sales slow down.

• Fast-Changing Trends: What people want in a car can change quickly, and new government rules about safety or the environment can force sudden changes.

• Hard to Stay Ahead: When one company invents a new feature, others quickly catch up, making it tough to keep a long-term advantage.

Final Thoughts

Terry Smith’s strategy is all about finding simple, strong businesses that can grow steadily for years. By avoiding these seven tricky sectors, he focuses on companies he can really understand and trust to deliver results. If you want to invest like Terry Smith, it’s not just about what you buy—it’s also about what you leave out.