Summary
This bible of growth investors provides a useful 15 point framework to qualitatively evaluate companies. Combined with a more quantitative value approach, you can get a more complete picture of a possible investment. But it’s not worth the 300 pages; a good summary gives 99% of the value.
Key Takeaways
- Figure out the right things to buy and selling becomes less important because you can hold the stocks you own longer.
- It is often easier to tell what will happen to the price of a stock than how much time will elapse before it happens.
- ‘Scuttlebutt’ – go to five companies in an industry, ask each of them intelligent questions about the points of strength and weakness of the other four, and nine times out of ten a surprisingly detailed and accurate picture of all five will emerge.
- Stocks to buy – 15 points to evaluate businesses on:
- Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?
- 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?
- How effective are the company’s research and development affairs in relation to its size?
- Does the company have an above-average sales organization?
- Does the company have a worthwhile profit margin?
- What is the company doing to maintain or improve profit margins?
- Does the company have outstanding labour and personnel relations?
- Does the company have outstanding executive relations?
- Does the company have depth to its management?
- How good are the company’s cost analysis and accounting controls?
- 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?
- Does the company have a short-range or long-range outlook in regard to profits?
- 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?
- Does the management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur?
- Does the company have a management of unquestionable integrity?
- Buy the stock as soon as you feel sure you have located an outstanding company. But don’t invest everything at once. Dollar-cost-average into the investment over a period of weeks, months or years.
- That which really matters is not to disturb a position that is going to be worth a great deal more later.
- Questions to ask when receiving investment ideas
- Is the company in, or being steered toward, lines of business affording opportunities of unusual growth in sales?
- Are these lines where, as the industry grows, it would be relatively simple for newcomers to start up and displace the leading units? (low barriers to entry)
- Rewards in any field come as a result of great effort combined with ability and enriched by both judgment and vision.
- Philip Fisher’s investment philosophy:
- Invest in companies with a high profit growth potential and a strong moat.
- Invest when they are out of favour.
- Hold them until (a) there is a fundamental change to the business and investment thesis, or (b) they have grown to the extent that they will no longer grow faster than the economy.
- Dividends are unimportant unless you desire cash flow.
- Diversify across 10-12 unrelated businesses.
- The best way to mute competition is to operate so efficiently that there is no incentive left for the potential entrant.
What I got out of it
The edition I read consists of 3 of Philip Fisher’s books:
- Common Stocks And Uncommon Profits
- Conservative Investors Sleep Well
- Developing An Investment Philosophy
While Common Stocks And Uncommon Profits was a great read, I think reading an extensive summary of the book (like this one!) provides 99% of the value in less than 5% of the time.
The other two books can be skipped: simply read the conclusion and appendix at the end of Developing An Investment Philosophy to get all the value…which I have added almost in its entirety in my summary notes below.
Regarding Fisher’s investment philosophy, I find merit in combining his qualitative 15 point framework with a more quantitative value approach. The desired investment outcome is the same for both approaches, after all: finding and investing in stocks below their intrinsic value and holding them for as long as makes sense.
The two approaches combined should provide a more complete picture of the business I’m looking to invest in than either one can achieve on its own. And who doesn’t want a larger margin of safety when investing?
One final note: as Common Stocks And Uncommon Profits was originally written in the 1950s, it is quite dated at times. Not just in examples, but also in philosophy (e.g. the heavy emphasis on production capability or R&D expenses). This, in my opinion, doesn’t diminish the effectiveness and value of Fisher’s 15 point framework. Just remember that some points require some modernization to be properly applied in today’s world.
Summary Notes
Introduction
Figure out the right things to buy and selling becomes a less important because you can hold the stocks you own longer.
As a business, to not become complacent, ask yourself: “What are you doing that your competitors aren’t doing yet?”
Emphasis on the word yet. It implies driving the product market, forcing others to follow, and dominating for the betterment of customers, employees, and shareholders.
There is a need for patience if big profits are made from an investment. It is often easier to tell what will happen to the price of a stock than how much time will elapse before it happens.
Clues From The Past
Investing over trading – Finding the really outstanding companies and staying with them through all the fluctuations of a gyrating market has proven far more profitable to far more people than has the more colourful practise of trying to buy them cheap and sell them dear.
What is required is the ability to distinguish these relatively few companies with outstanding investment possibilities from the much greater number whose future would vary all the way from the moderately successful to the complete failure.
What “Scuttlebutt” Can Do
Go to five companies in an industry, ask each of them intelligent questions about the points of strength and weakness of the other four, and nine times out of ten a surprisingly detailed and accurate picture of all five will emerge.
Vendors, customers, former employees, research scientists in universities and government, and executives of trade associations are also great resources of information to further flesh out the strengths and weaknesses of the companies you’re researching.
What To Buy – Philip Fisher’s 15 Point Framework
- Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?
- Growth should not be judged on an annual basis but by taking units of several years each.
- ‘Fortunate and able’ vs ‘fortunate because it is able’
- If a company’s management is outstanding and the industry is subject to technological change and development research, the shrewd investor should stay alert to the possibility that management might handle company affairs so as to produce in the future exactly the type of sales curve that is the first step to consider in choosing an outstanding business.
- 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?
- The investor usually obtains the best results in companies whose engineering or research is to a considerable extent devoted to products having some business relationship with those already within the scope of company activities.
- How effective are the company’s research and development affairs in relation to its size?
- R&D / sales metrics can be misleading.
- Companies vary enormously in what they include or exclude as R&D expenses.
- Optimal results depend not just on headcount or talent, but also on the coordination of the human resources, teams and departments. Coordination with top management is crucial for maximum efficiency.
- Percentage of R&D focused on government contracts vs non-government contracts – government contracts offer small profit margins. Also, does the R&D for government research yield benefits outside of the research itself (competitive manufacturing capability, new principles and techniques that can be applied to non-government products)?
- Market research spending and capability to determine the potential market size and upside prior to R&D investments. The larger the market and more accurate the market research, the more potentially rewarding R&D decisions can be made.
- In no other subdivision of business activity are to be found such great variations from one company to another between what goes in as an expense and what comes out in benefits as occurs in research. Even among the best-managed companies, this variation seems to run in a ratio of as much as two to one.
- The essence of successful commercial research is that only tasks be selected that promise to give dollar rewards of many times the cost of the research.
- Avoid companies focused on ‘crash programs’: important elements of the research personnel are suddenly pulled from the projects on which they have been working and concentrated on some new task which may have great importance at the moment but which is often not worth all the disruption it causes.
- R&D / sales metrics can be misleading.
- Does the company have an above-average sales organization?
- Of all the phases of a company’s activity, none is easier to learn about from sources outside the company than the relative efficiency of a sales organization.
- Outstanding production, sales and research may be considered the three main columns upon which success is based.
- For steady long-term growth, a strong sales arm is vital.
- Does the company have a worthwhile profit margin?
- Young, low-margin companies: ensure that low profit margins are used to accelerate growth, not to simply sustain growth.
- What is the company doing to maintain or improve profit margins?
- When profit margins of a whole industry rise because of repeated price increases, the indication is not a good one for the long-range investor.
- Focus on companies that manage to improve profit margins by more ingenious means than just raising prices.
- Does the company have outstanding labour and personnel relations?
- Avoid high labour turnover. It’s an unnecessary expense.
- Many people wanting to work there is often a good sign.
- How are wages in relation to profit margins AND in relation to other companies in the area and industry? Above-average wages are often a good sign.
- What’s the attitude of top management toward lower-level staff?
- Does the company have outstanding executive relations?
- Slightly unrelated, but good to keep in mind: what are the incentives for executives?
- Does the company have depth to its management?
- Companies can grow via acquisition but at some point, they need to be able to recruit and/or develop capable management in-house.
- An appropriate amount of delegation of authority at every level is essential to growing a business. All humans are finite, so avoid executives too focused on day-to-day operations.
- Do executives welcome all suggestions – positive and negative – from staff and external sources?
- How good are the company’s cost analysis and accounting controls?
- 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?
- Which aspects are important differ per industry.
- Patents may provide a competitive advantage (moat) or may simply be a bonus. They are more valuable for smaller companies than for larger ones.
- Patents do not last forever.
- The content of the patent is equally important: does it involve a static product or an ongoing process?
- It is the constant leadership in engineering, not patents, that is a fundamental source of protection.
- Does the company have a short-range or long-range outlook in regard to profits?
- A company that will go to special trouble and expense to take care of the needs of a regular customer caught in an unexpected jam may show lower profits on the particular transaction, but far greater profits over the years.
- Favour companies with long-term outlooks over short-term ones.
- 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?
- Does the management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur?
- Companies into which the investor should be buying if the greatest gains are to occur are companies which over the years will constantly, through the efforts of technical research, be trying to produce and sell new products and new processes. By the law of averages, some of these are bound to be costly failures. How management reacts to such matters can be a valuable clue to the investor.
- Does the company have a management of unquestionable integrity?
- Regardless of how high the rating may be in all other matters, if there is a serious question of the lack of a strong management sense of trusteeship for stockholders, the investor should never seriously consider participating in such an enterprise.
When To Buy
- Take investment action when matters you know about a specific company appear to warrant such an action. Be undeterred by fears or hopes based on conjectures, or conclusions based on surmises.
- Corporate troubles, ask: permanent or temporary?
- The company into which the investor should be buying is the company which is doing things under the guidance of exceptionally able management. A few of these things are bound to fail. Others will from time to time produce unexpected troubles before they succeed. The investor should be thoroughly sure in his own mind that these troubles are temporary rather than permanent. Then if these troubles have produced a significant decline in the price of the affected stock and give promise of being solved in a matter of months rather than years, he will probably be on safe ground considering that this is a time when the stock may be bought.
- Large capital expenditures with relatively sure positive upside but aren’t priced in yet.
If the project is large enough to affect the company’s earnings as a whole, buying the company’s shares just before this improvement in earning power has been reflected in the market price for these shares can similarly mean a chance to get into the right sort of company at the right time.
The common denominator: a worthwhile improvement in earnings is coming in the right sort of company, but this particular increase in earnings has not yet produced an upward move in the price of that company’s shares.
Buy the stock as soon as you feel sure you have located an outstanding company. But don’t invest everything at once. Dollar-cost-average into the investment over a period of weeks, months or years.
When To Sell
3 reasons to sell a stock
- A mistake has been made in the original purchase and it becomes increasingly clear that the factual background of the particular company is, by a significant margin, less favourable than originally believed. The proper handling of this situation is largely a matter of emotional self-control.
- Companies which, because of changes resulting from the passage of time, no longer qualify in regard to the fifteen points outlined above to about the same degree it qualified at the time of purchase.
Deterioration commonly happens for two reasons:- Deterioration of management: complacency, inertia, new (worse) management
- The prospect of increasing the markets for its product has diminished. It’ll reverse to the mean of the market.
- Seldom arises if proper due diligence was done before: switch into a situation with seemingly better prospects. Only do this when you are very sure of your ground as the future is not guaranteed and there are (hidden) costs with switching (handling fees, taxation, etc).
When feeling “a stock has become overpriced and therefore should be sold…” ask yourself: What is overpriced? What am I trying to accomplish?
When we say that the stock is overpriced, we may mean that it is selling at an even higher ratio in relation to this expected earning power than we believe it should be. Possibly we may mean that it is selling at an even higher ratio than are other comparable stocks with similar prospects of materially increasing their future earnings.
All of this is trying to measure something with a greater degree of precision than is possible.
How can anyone say with even moderate precision just what is overpriced for an outstanding company with an unusually rapid growth rate?
That which really matters is not to disturb a position that is going to be worth a great deal more later.
The Hullabaloo About Dividends
When do stockholders get no benefit from retained earnings?
- When management piles up cash and liquid assets far beyond any present or prospective needs of the business.
- When substandard management can get only a sub-normal return on the capital already in the business, yet use the retained earnings merely to enlarge the inefficient operation rather than to make it better.
The management whose dividend policies win the widest approval among discerning investors is those who hold that a dividend should be raised with the greatest caution and only when there is a great probability that it can be maintained.
As long as dividend policy is consistent so that investors can plan ahead with some assurance, this whole matter of dividends is a far less important part of the investment picture than might be judged from the endless arguments frequently heard about the relative desirability of this dividend policy or that.
Comparing (un)stable dividend policies to running a restaurant:
A good restaurant man might build up a splendid business with a high-priced venture.
He might also build up a splendid business with an attractive place selling the best possible meals at the lowest possible prices.
Or he could make a success of Hungarian, Chinese, or Italian cuisine.
Each would attract a following.
People would come there expecting a certain kind of meal.
However, with all his skill, he could not possibly build up a clientele if one day he served the costliest meal, the next day low-priced ones, and then without warning served nothing but exotic dishes.
Don’ts For Investors
- Don’t buy into promotional companies.
- Don’t buy a stock just because you like the “tone” of its annual report.
- Don’t assume that the high price at which a stock may be selling in relation to earnings is necessarily an indication that further growth in those earnings has largely been already discounted in the price.
- Don’t overstress diversification.
- Minimum diversification needs
- Large stocks: no stock accounts for more than 20 percent of your portfolio
- Companies you invest in should have little overlap (in terms of industry or product lines). In other words: low correlation.
- Medium-sized, up-and-coming stocks: each stock accounts for a maximum of 10 percent of your portfolio
- Minimum diversification needs
- Don’t be afraid of buying on a war scare.
- War is always bearish on money. This is the time to buy at a discount.
- Buy, but buy slowly, so as to dollar cost average in.
- If war occurs, increase the tempo of buying.
- Be sure to buy into companies with products or services the demand for which will continue in wartime.
- Don’t fail to consider time as well as price in buying a true growth stock.
- If we feel the stock is close to as low a price as we can get, isn’t it safer to decide to buy at a certain date rather than a certain price?
- There is no guarantee of a further drop in price.
- Don’t follow the crowd.
- A different appraisal is often given not due to a different set of facts but a different appraisal of the same facts.
- To purchase shares to his greatest advantage, an investor must examine factually and analytically the prevailing financial sentiment about both the industry and the specific company of which he is considering buying shares. If he can find an industry or a company where the prevailing style or mode of financial thinking is considerably less favourable than the actual facts warrant, he may reap himself an extra harvest by not following the crowd.
How To Find Growth Stocks
Questions to ask when receiving investment ideas
- Is the company in, or being steered toward, lines of business affording opportunities of unusual growth in sales?
- Are these lines where, as the industry grows, it would be relatively simple for newcomers to start up and displace the leading units? (low barriers to entry)
Philip Fisher’s investment evaluation process
- Receive an investment idea
- The highest quality ideas come from a small number of other (outstanding) investors; occasionally from scientists, researchers or business executives. Rarely from media sources (as everyone reads those).
- 3 things I don’t do
- I do not yet approach anyone in management.
- I do not spend hours and hours going over old annual reports
- I do not ask every stockbroker I know what he thinks of the stock
- I will glance over the balance sheet to determine the general nature of the capitalization and financial position.
If there is an SEC prospectus I will read with care those parts covering the breakdown of total sales by product lines, competition, degree of officer or other major ownership of common stock, and all earning statement figures throwing light on depreciation, profit margins, the extent of research activity, and abnormal or non-recurring costs in prior years’ operations. - Whatever seems attractive: use the ‘scuttlebutt’ method. This is where the impressions and opinions of others become valuable. Work toward the 15 points outlined above.
- If I am not even close to getting much of the information I need (because I don’t have access to the necessary stakeholders, for example), I will give up the investigation and move on to something else.
- To make big money on investments it is unnecessary to get some answer to every investment that might be considered. What is necessary is to get the right answer a large proportion of the very small number of times actual purchases are made.
- After you’ve done your research and have answered most of the questions to the 15 points above with ‘scuttlebutt’, there is value in approaching management. Only by having what ‘scuttlebutt’ can give you, can you know what you should attempt to learn from management.
In almost any field nothing is worth doing unless it is worth doing right.
Rewards in any field come as a result of great effort combined with ability and enriched by both judgment and vision.
Philip Fisher’s Research Ratios
- 250 investment ideas (rough analysis of financial statements – step 3 above)
- 40~50 ideas researched (scuttlebutt + in-depth analysis of financial statements – step 4 above)
- 2~2.5 visits to management (step 5 above)
- 1 investment
Conservative Investing
A conservative investment is one most likely to conserve purchasing power at a minimum of risk.
Conservative investing is understanding what a conservative investment consists of and then, in regard to specific investments, following a procedural course of action needed properly to determine whether specific investment vehicles are, in fact, conservative investments.
How to be a conservative investor
- The qualities desired in a conservative investment must be understood
- A course of inquiry must be made to see if a particular investment so qualifies
Philip Fisher’s Investment Philosophy
- Buy into companies that have disciplined plans for achieving dramatic long-range growth in profits and that have inherent qualities making it difficult for newcomers to share in that growth.
- Focus on buying these companies when they are out of favour; that is, when, either because of general market conditions or because the financial community at the moment has misconceptions of its true worth, the stock is selling at prices well under what it will be when its true merit is better understood.
- Hold the stock until either (a) there has been a fundamental change in its nature (such as a weakening of management through changed personnel), or (b) it has grown to a point where it no longer will be growing faster than the economy as a whole.
Only in the most exceptional circumstances, if ever, sell because of forecasts as to what the economy or the stock market is going to do because these changes are too difficult to predict.
Never sell the most attractive stocks you own for short-term reasons. However, as companies grow, remember that many companies that are quite efficiently run when they are small fail to change management style to meet the different requirements of skill big companies need. When management fails to grow as companies grow, shares should be sold. - De-emphasize the importance of dividends, unless you desire cash flow.
- Making some mistakes is as much an inherent cost of investing for major gains as making some bad loans is inevitable in even the best run and most profitable lending institution. The most important thing is to recognize them as soon as possible, understand their causes, and learn how to keep from repeating the mistakes. A profit should never be taken just for the satisfaction of taking it.
- There are a relatively small number of truly outstanding companies. Their shares frequently can’t be bought at attractive prices. Therefore, when favourable prices exist, full advantage should be taken of the situation. Funds should be concentrated on the most desirable opportunities.
- 10 or 12 holdings is enough diversification when investing in the stock market.
- A basic ingredient of great stock management is the ability neither to accept blindly whatever may be the dominant opinion in the financial community nor to reject the prevailing view just to be contrary for the sake of being contrary. Rather, it is to have more knowledge and to apply better judgment, in a thorough evaluation of specific situations, and the moral courage to act “in opposition to the crowd” when your judgment tells you you are right.
- Success greatly depends on a combination of hard work, intelligence, and honesty.
Key Factors In Evaluating Promising Firms
Functional Factors
- The firm must be one of the lowest-cost producers of its products or services relative to its competition and must promise to remain so.
- A comparatively low breakeven will enable this firm to survive depressed market conditions and to strengthen its market and pricing position when weaker competitors are driven out of the market.
- A higher than average profit margin enables the firm to generate more funds internally to sustain growth without as much dilution caused by equity sales or strain caused by overdependence on fixed-income financing.
- A firm must have a strong enough customer orientation to recognize changes in customer needs and interests and then react promptly to those changes in an appropriate manner. This capability should lead to generating a flow of new products that more than offset lines maturing or becoming obsolete.
- Effective marketing requires not only understanding what customers want but also explaining to them in terms the customer will understand.
- Even non-technical firms require a strong and well-directed research capability to (a) produce newer and better products and (b) perform services in a more effective or efficient way.
- There are wide differences in the effectiveness of research. Two important elements of more productive research are (a) market/profit consciousness and (b) the ability to pool necessary talent into an effective working team.
- A firm with a strong financial team has several important advantages:
- Good cost information enables management to direct its energies toward those products with the highest potential for profit contribution.
- The cost system should pinpoint where production, marketing and research costs are inefficient even in sub-parts of the operation.
- Capital conservation through tight control of fixed and working capital investments.
- A critical finance function is to provide an early warning system to identify influences that could threaten the profit plan sufficiently ahead of time to devise remedial plans to minimize adverse surprises.
People Factors
- To become more successful, a firm needs a leader with a determined entrepreneurial personality combining the drive, the original ideas, and the skills necessary to build the fortunes of the firm.
- A growth-oriented CEO must surround himself with an extremely competent team and delegate considerable authority to them to run the activities of the firm. Teamwork, as distinct from dysfunctional struggles for power, is critical.
- Attention must be paid to attracting competent managers at lower levels and training them for larger responsibilities. Succession should largely be from the available talent pool. The need to recruit the CEO from outside is a particularly dangerous sign.
- The entrepreneurial spirit must permeate the organization.
- More successful firms usually have some unique personality traits – some special ways of doing things that are particularly effective for their management team. This is a positive, not a negative sign.
- Management must recognize and be attuned to the fact that the world in which they are operating is changing at an ever-increasing rate.
- Every accepted way of doing things must be reexamined periodically, and new, better ways sought.
- Changes in managerial approaches involve necessary risks, which must be recognized, minimized and taken.
- There must be a genuine, realistic, conscious and continuous effort to have employees at every level, including the blue-collar workers, believe that their company is really a good place to work.
- Employees must be treated with reasonable dignity and decency.
- The firm’s work environment and benefits programs should be supportive of motivation.
- People must feel they can express grievances without fear and with a reasonable expectation of appropriate attention and action.
- Participatory programs seem to work well and be an important source of good ideas.
- Management must be willing to submit to the disciplines required for sound growth. Growth requires some sacrifice of current profits to lay the foundation for worthwhile future improvement.
Business Characteristics
- Although managers rely heavily on return of assets in considering new investments, investors must recognize that historic assets stated at historic costs distort comparisons of firms’ performance. Favourable profit to sales ratios, notwithstanding differences in turnover ratios, may be a better indicator of the safety of an investment, particularly in an inflationary environment.
- High margins attract competition, and competition erodes profit opportunities. The best way to mute competition is to operate so efficiently that there is no incentive left for the potential entrant.
- Efficiencies of scale are often counterbalanced by the inefficiencies of bureaucratic layers of middle management. In a well-run firm, however, the industry leadership position creates a strong competitive advantage that should be attractive to investors.
- Getting there first in a new product market is a long step toward becoming first. Some firms are better geared to be there first.
- Products are not islands. There is indirect competition, for example, for consumers’ dollars. As prices change, some products may lose attractiveness even in well-run, low-cost companies.
- It is hard to introduce new, superior products in market arenas where established competitors already have a strong position. While the new entrant is building the production, marketing power, and reputation to be competitive, existing competitors can take strong defensive actions to regain the market threatened. Innovators have a better chance of success if they combine technology disciplines, e.g., electronics and nucleonics, in a way that is novel relative to existing competitive competencies.
- Technology is just one avenue to industry leadership. Developing a consumer “franchise” is another. Service excellence is still another. Whatever the case, a strong ability to defend established markets against new competitors is essential for a sound investment.