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Course 505
Great Investors: Philip Fisher


The late Phil Fisher was one of the great investors of all time and the author of the classic book Common Stocks and Uncommon Profits. Fisher started his money management firm, Fisher & Co., in 1931 and over the next seven decades made tremendous amounts of money for his clients. For example, he was an early investor in semiconductor giant Texas Instruments TXN, whose market capitalization recently stood at well over $40 billion. Fisher also purchased Motorola MOT in 1955, and in a testament to long-term investing, held the stock until his death in 2004.

Fisher's Investment Philosophy

Fisher's investment philosophy can be summarized in a single sentence: Purchase and hold for the long term a concentrated portfolio of outstanding companies with compelling growth prospects that you understand very well. This sentence is clear on its face, but let us parse it carefully to understand the advantages of Fisher's approach. The question that every investor faces is, of course, what to buy? Fisher's answer is to purchase the shares of superbly managed growth companies, and he devoted an entire chapter in Common Stocks and Uncommon Profits to this topic. The chapter begins with a comparison of "statistical bargains," or stocks that appear cheap based solely on accounting figures, and growth stocks, or stocks with excellent growth prospects based on an intelligent appraisal of the underlying business's characteristics.

The problem with statistical bargains, Fisher noted, is that while there may be some genuine bargains to be found, in many cases the businesses face daunting headwinds that cannot be discerned from accounting figures, such that in a few years the current "bargain" prices will have proved to be very high. Furthermore, Fisher stated that over a period of many years, a well-selected growth stock will substantially outperform a statistical bargain. The reason for this disparity, Fisher wrote, is that a growth stock, whose intrinsic value grows steadily over time, will tend to appreciate "hundreds of per cent each decade," while it is unusual for a statistical bargain to be "as much as 50 per cent undervalued."

Fisher divided the universe of growth stocks into large and small companies. On one end of the spectrum are large financially strong companies with solid growth prospects. At the time, these included IBM IBM, Dow Chemical DOW, and DuPont DD, all of which increased fivefold in the 10-year period from 1946 to 1956.

Although such returns are quite satisfactory, the real home runs are to be found in "small and frequently young companies… [with] products that might bring a sensational future." Of these companies, Fisher wrote, "the young growth stock offers by far the greatest possibility of gain. Sometimes this can mount up to several thousand per cent in a decade." Fisher's answer to the question of what to buy is clear: All else equal, investors with the time and inclination should concentrate their efforts on uncovering young companies with outstanding growth prospects.

Fisher's 15 Points

All good principles are timeless, and Fisher's famous "Fifteen Points to Look for in a Common Stock" from Common Stocks and Uncommon Profits remain as relevant today as when they were first published. The 15 points are a qualitative guide to finding superbly managed companies with excellent growth prospects. According to Fisher, a company must qualify on most of these 15 points to be considered a worthwhile investment:

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? A company seeking a sustained period of spectacular growth must have products that address large and expanding markets.

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? All markets eventually mature, and to maintain above-average growth over a period of decades, a company must continually develop new products to either expand existing markets or enter new ones.

3. How effective are the company's research-and-development efforts in relation to its size? To develop new products, a company's research-and-development (R&D) effort must be both efficient and effective.

4. Does the company have an above-average sales organization? Fisher wrote that in a competitive environment, few products or services are so compelling that they will sell to their maximum potential without expert merchandising.

5. Does the company have a worthwhile profit margin? Berkshire Hathaway's BRK.B vice-chairman Charlie Munger is fond of saying that if something is not worth doing, it is not worth doing well. Similarly, a company can show tremendous growth, but the growth must bring worthwhile profits to reward investors.

6. What is the company doing to maintain or improve profit margins? Fisher stated, "It is not the profit margin of the past but those of the future that are basically important to the investor." Because inflation increases a company's expenses and competitors will pressure profit margins, you should pay attention to a company's strategy for reducing costs and improving profit margins over the long haul. This is where the moat framework we've spoken about throughout the Investing Classroom series can be a big help.

7. Does the company have outstanding labor and personnel relations? According to Fisher, a company with good labor relations tends to be more profitable than one with mediocre relations because happy employees are likely to be more productive. There is no single yardstick to measure the state of a company's labor relations, but there are a few items investors should investigate. First, companies with good labor relations usually make every effort to settle employee grievances quickly. In addition, a company that makes above-average profits, even while paying above-average wages to its employees is likely to have good labor relations. Finally, investors should pay attention to the attitude of top management toward employees.

8. Does the company have outstanding executive relations? Just as having good employee relations is important, a company must also cultivate the right atmosphere in its executive suite. Fisher noted that in companies where the founding family retains control, family members should not be promoted ahead of more able executives. In addition, executive salaries should be at least in line with industry norms. Salaries should also be reviewed regularly so that merited pay increases are given without having to be demanded.

9. Does the company have depth to its management? As a company continues to grow over a span of decades, it is vital that a deep pool of management talent be properly developed. Fisher warned investors to avoid companies where top management is reluctant to delegate significant authority to lower-level managers.

10. How good are the company's cost analysis and accounting controls? A company cannot deliver outstanding results over the long term if it is unable to closely track costs in each step of its operations. Fisher stated that getting a precise handle on a company's cost analysis is difficult, but an investor can discern which companies are exceptionally deficient--these are the companies to avoid.

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 described this point as a catch-all because the "important clues" will vary widely among industries. The skill with which a retailer, like Wal-Mart WMT or Costco COST, handles its merchandising and inventory is of paramount importance. However, in an industry such as insurance, a completely different set of business factors is important. It is critical for an investor to understand which industry factors determine the success of a company and how that company stacks up in relation to its rivals.

12. Does the company have a short-range or long-range outlook in regard to profits? Fisher argued that investors should take a long-range view, and thus should favor companies that take a long-range view on profits. In addition, companies focused on meeting Wall Street's quarterly earnings estimates may forgo beneficial long-term actions if they cause a short-term hit to earnings. Even worse, management may be tempted to make aggressive accounting assumptions in order to report an acceptable quarterly profit number.

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? As an investor, you should seek companies with sufficient cash or borrowing capacity to fund growth without diluting the interests of its current owners with follow-on equity offerings.

14. Does management talk freely to investors about its affairs when things are going well but "clam up" when troubles and disappointments occur? Every business, no matter how wonderful, will occasionally face disappointments. Investors should seek out management that reports candidly to shareholders all aspects of the business, good or bad.

15. Does the company have a management of unquestionable integrity? The accounting scandals that led to the bankruptcies of Enron and WorldCom should highlight the importance of investing only with management teams of unquestionable integrity. Investors will be well-served by following Fisher's warning that regardless of how highly a company rates on the other 14 points, "If there is a serious question of the lack of a strong management sense of trusteeship for shareholders, the investor should never seriously consider participating in such an enterprise."

Important Don'ts for Investors

In investing, the actions you don't take are as important as the actions you do take. Here is some of Fisher's advice on what you should not do.

1. Don't overstress diversification.
Investment advisors and the financial media constantly expound the virtues of diversification with the help of a catchy cliche: "Don't put all your eggs in one basket." However, as Fisher noted, once you start putting your eggs in a multitude of baskets, not all of them end up in attractive places, and it becomes difficult to keep track of all your eggs.

Fisher, who owned at most only 30 stocks at any point in his career, had a better solution. Spend time thoroughly researching and understanding a company, and if it clearly meets the 15 points he set forth, you should make a meaningful investment. Fisher would agree with Mark Twain when he said, "Put all your eggs in one basket, and watch that basket!"

2. Don't follow the crowd.
Following the crowds into investment fads, such as the "Nifty Fifty" in the early 1970s or tech stocks in the late 1990s, can be dangerous to your financial health. On the flip side, searching in areas the crowd has left behind can be extremely profitable. Sir Isaac Newton once lamented that he could calculate the motion of heavenly bodies, but not the madness of crowds. Fisher would heartily agree.

3. Don't quibble over eighths and quarters.
After extensive research, you've found a company that you think will prosper in the decades ahead, and the stock is currently selling at a reasonable price. Should you delay or forgo your investment to wait for a price a few pennies below the current price?

Fisher told the story of a skilled investor who wanted to purchase shares in a particular company whose stock closed that day at $35.50 per share. However, the investor refused to pay more than $35. The stock never again sold at $35 and over the next 25 years, increased in value to more than $500 per share. The investor missed out on a tremendous gain in a vain attempt to save 50 cents per share.

Even Warren Buffett is prone to this type of mental error. Buffett began purchasing Wal-Mart many years ago, but stopped buying when the price moved up a little. Buffett admits that this mistake cost Berkshire Hathaway shareholders about $10 billion. Even the Oracle of Omaha could have benefited from Fisher's advice not to quibble over eighths and quarters.

The Bottom Line

Philip Fisher compiled a sterling record during his seven-decade career by investing in young companies with bright growth prospects. By applying Fisher's methods, you, too, can uncover tomorrow's dominant companies.

Quiz 505
There is only one correct answer to each question.

1 Fisher was the author of which classic investment book?
a. Security Analysis.
b. One Up on Wall Street.
c. Common Stocks and Uncommon Profits.
2 What sorts of companies did Fisher favor?
a. Young growth companies.
b. Companies with large dividends.
c. Companies in mature industries.
3 Fisher's time horizon for holding a well-selected stock can best be described as what?
a. Very long-term.
b. Short-term.
c. Three to five years.
4 Which statement would Fisher most agree with?
a. "I don't want a lot of good investments; I want a few outstanding ones."
b. "It is important to own a well-diversified portfolio of over 50 stocks to reduce risk."
c. "Large capitalization companies in mature and steady industries are the best investments."
5 According to Fisher, management quality:
a. Is irrelevent so long as the company is growing.
b. Should cause you to avoid a stock if there are serious stewardship issues.
c. Should not delegate to lower-level employees.
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