One thing that stuck out reading Common Stocks and Uncommon Profits again was how ahead of his time Fisher’s ideas were. Not many on Wall Street thought like Phil Fisher.
Today, many argue Fisher’s ideas were antithetical to Ben Graham’s in The Intelligent Investor. Lots of what’s led to that conclusion is grounded by the modern-day finance’s obsession with categorizing investment styles into value investing, growth investing, quality investing (what’s even that?), and whatnot.
What’s funny is that while Wall Street has been dubbing Ben Graham the father of value investing and Phil Fisher the father of growth investing, neither of them explicitly uses such terms as definitions of philosophies. Fisher never claimed an investor should favor “growth stocks”, as per the modern perception, trading at high earnings multiples over “value” stocks trading at low earnings multiples. It’s that misunderstanding that has led many to reject Fisher’s ideas on the empirical evidence that low P/E stocks outperform high P/E stocks. Conflictingly, Fisher’s point is that outstanding growth companies are few and far between in his sense of the term and are not to be found in the vast majority of high-multiple stocks. Equally so, Fisher’s at-the-time profound claims that dividends don’t matter as much as most believe are widely rejected due to several charts showing the long-term dominance of dividend-paying stocks over non-dividend-paying stocks. Being a concentrated investor (his portfolio never held more than 17 companies, typically held <10, and three holdings often made up 75%/AUM), Fisher never cared for the average company in which a dividend in hand might be worth more than earnings retained.
Fisher emphasized that no growth company is worth an infinite price. He was interested in finding companies where their growth runway was substantially longer than the short-termist market would assume. For a company that grows and creates value on its way, the majority of the present value lies in the outyears. Fisher always sought to buy them on temporary setbacks or when future growth prospects weren’t yet widely recognized.
And because finding an outstanding growth company is rare, Fisher gave leeway to the companies fulfilling his 15 points (listed at the end) — especially the ones already owned. Many times during his career, he held onto a stock that even he thought was overpriced. And some of those companies, like Texas Instruments, would go on to decline 80% top to bottom under Fisher’s ownership, only to rise to new heights after a long dose of patience and never-sell optimism.
Why wasn’t Fisher tempted to sell at these high points to potentially buy back at a prospective lower price? For one, Fisher recognized the psychological bias that after every sharp advance in stock price, a stock nearly always looks too high at first glance. And he saw time and again that the clients he advised would sell a stock for a good gain when it appeared temporarily overpriced, only to never buy back at higher prices when they were wrong and lose further gains of dramatic proportions. As he put it, since you could be correct about short-term movements of a stock no more than 60% of the time, why should you step out of a position where you have a 90% probability of being right? Both the odds and the risk/reward favored holding since if you sell and don’t buy back, you’ll have missed long-term profits many times the short-term reversal.
When I originally acquired Texas Instruments shares in the summer of 1955, they were bought for the longest type of long-range investment. […] About a year later, the stock had doubled. […] at that time I had one relatively new account owned by people who, in their own business, were used to building up inventory when markets were low and cutting it back sharply when they were high. Now that Texas Instruments had doubled, they brought strong pressure to sell, which for a time I was able to resist. When the stock rose an additional 25 percent to give them a profit of 125 percent of their cost, the pressure to sell became even stronger. They explained, “We agree with you. We like the company, but can always buy it back at a better price on a decline.” I finally compromised with them by persuading them to keep part of their holding and sell the rest. Yet when the big drop occurred several years later and the shares fell 80 percent from their peak, this new bottom was still almost 40 percent higher than the price at which this particular holder was eager to sell!
The pillar of Common Stocks and Uncommon Profits, Fisher’s 15 points, are almost the reverse of what most people on Wall Street focus on. Fisher’s 15 points are ill-structured domains, contrasting the inherent beauty of the quantitative financial statement approach — analyzing liquidity, solvency, and cash flows — to uncovering undervalued assets. His intense focus on researching management, the sales organization, research arm, and people relations may seem so arbitrary for the model builder that one may think they’d add little value.
Granted, while logical, Fisher’s 15 points contain checklist items that aren’t easy to practice. Sometimes, they’re impossible to find the answer to. Some may say that they’re short of real insight. That’s because the points are so logical and qualitative by nature that using them appropriately requires a certain practice and pattern recognition. And they’re not checklist points more than they are Fisher’s way of saying, “These are the factors that truly drive decade-long growth and profitability of a company, and they might not show up in financial statements today.”
Even The Intelligent Investor acknowledges that Fisher’s approach is for the exceptional analyst. Footnote 3 to chapter 11 says:
On forecasting growth, stock selection can not be done dependably. At least not by the great body of security analysts and investors. Exceptional analysts, who can tell in advance what companies are likely to deserve intensive study and have the facilities and capability to make it, may have continued success with this work. For details of such an approach see Philip Fisher, Common Stocks and Uncommon Profits.
So, given its difficulty, how does one become such an exceptional analyst? Fisher argues that to find the answers to his 15 points, scuttlebutt research, i.e., talking to people in the company and industry, including competitors and former employees, is necessary. Essentially, scuttlebutt means digging up any information outside of the standard channels of due diligence.
The business “grapevine” is a remarkable thing. It is amazing what an accurate picture of the relative points of strength and weakness of each company in an industry can be obtained from a representative cross-section of the opinions of those who in one way or another are concerned with any particular company.
Fisher developed his Scuttlebutt method early in life as a first-year student in Stanford University’s then-fledgling Graduate School of Business. Every week, Professor Boris Emmett led a day-long tour of some of the major corporations in the San Francisco Bay region. The visits were not just a chance for students to view the facilities and machinery, but also to hear in-depth discussions between Professor Emmett and company executives and managers about the strengths, weaknesses, and potential of the business. Fisher saw the value of these visits as a learning experience and made sure to maximize his participation. That’s when he found its secret sauce to due diligence. As he recounts:
In that day … when the ratio of automobiles to people was tremendously lower than it is today, Professor Emmett did not have a car. I did. I offered to drive him to these various plants. I did not learn much from him on the way over. However, each week on the way back to Stanford, I would hear comments of what he really thought of that particular company. This provided me with the most valuable learning experiences I have ever been privileged to enjoy.
Phil Fisher’s Common Stocks and Uncommon Profits is not your typical quant-based investment book. It doesn’t show a single piece of financial statement. It unteaches you the things you’ve learned about being an Excel wiz to reap spectacular gains in the stock market — the ones you get by catching on and surfing a company for decades. Despite his simplicity, Fisher never claimed it was easy. He mentions a couple of times when he ventured out of his circle of competence within industrials and leading-edge technology companies and found that his methods of research didn’t work for him due to a lack of experience. He was a practitioner of seeking rationality and pursuing self-control, traits that require lifelong hard work and determination. In his 1980 book, Developing an Investment Philosophy, he mentions that his took 40 years to develop.
Fisher’s 15 Points
1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?
Fisher didn’t rely upon extrapolating sales growth trends but sought to comprehend and verify that such growth could be sustained into the future.
2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?
Companies that show promising growth potential shortly due to increased demand for current products, but lack plans for future growth beyond that, may offer a one-time profit opportunity. However, they are unlikely to provide consistent long-term financial success throughout 10-25 years.
3. How effective are the company’s research and development efforts in relation to its size?
According to Fisher, “If quantitative measurements — such as the annual expenditures on research or the number of employees holding scientific degrees — are only a rough guide and not the final answer to whether a company has an outstanding research organization, how does the careful investor obtain this information? Once again, it is surprising what the “scuttlebutt” method will produce.”
4. Does the company have an above-average sales organization?
Although the sale of goods and services is the fundamental operation of a business, the efficiency of a company’s sales, advertising, and distribution is, according to Fisher, not given enough consideration by investors.
5. Does the company have a worthwhile profit margin?
Fisher looked for companies with the largest possible operating margins, as they serve as a valuable buffer during periods of decline, even if they do not necessarily increase over time.
6. What is the company doing to maintain or improve profit margins?
At its core, companies can either raise their prices or decrease their expenses. Fisher was wary of companies that solely rely on raising prices to maintain or improve margins and instead looked for those that reduce costs through production and marketing efficiency, capital investments, and other innovative methods.
7. Does the company have outstanding labor and personnel relations?
Fisher’s interest in technology and innovation inclined him towards companies whose workers were not typically unionized because they already treated their people well.
8. Does the company have outstanding executive relations?
Compensation and promotion should be determined by merit and performance and the farther a corporation deviated from these principles, the less likely it was to be a top-performing investment.
9. Does the company have depth to its management?
According to Fisher, “‘The organizations where top brass personally interferes with and try to handle routine day-to-day operating matters seldom turn out to be the most attractive type of investments. Cutting across the lines of authority which they themselves have set up frequently results in well-meaning executives significantly detracting from the investment caliber of the companies they run.”
10. How good are the company’s cost analysis and accounting controls?
A company cannot achieve or sustain long-term success if it lacks a detailed understanding of its costs, and opportunity costs, on a micro-level.
11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?
Fisher writes that in retail, the management of factors such as leases and location is crucial. In technology, the level of patents and other protection for innovations, as well as the innovations themselves, play a crucial role.
12. Does the company have a short-range or long-range outlook in regard to profits?
Some companies prioritize maximizing current profits, while others prioritize long-term growth over immediate gains. Fisher looks for companies that practice delayed gratification to the benefit of long-term shareholders.
13. In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders’ benefit from this anticipated growth?
Fisher looked for companies that primarily grow through existing resources and retained earnings.
14. Does the management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur?
According to Fisher, “The investor will do well to exclude from investment any company that withholds or tries to hide bad news.”
15. Does the company have a management of unquestionable integrity?
Management is usually more knowledgeable about the company’s operations than its shareholders and there are “infinite” ways in which it can benefit itself at the expense of the shareholders. The only protection shareholders have against management abuses of position is to invest in companies whose managers have unquestioned integrity.