I recently reread Common Stocks and Uncommon Profits by Phil Fisher, while I was flaneuring in Morocco. Fisher held stocks for years and even decades, and focused on situations where he could get a several hundred percent gain over his holding period. His process focused on “Fifteen Points” to look for in a common stock. Not every investment was positive on every point, but good long term investments would need to exhibit many of them.
Here are my notes on the Fifteen Points.
- Does the company have products or services with sufficient market potential to make a possible sizable increase in sales for at least several years?
Fisher didn’t spend time on “cigar butts”- he wasn’t interested in squeezing cash out of a dying business, even though it could be lucrative for certain investors. Likewise, he acknowledges that its possible to make a quick profit from one time cost cuts in an inefficient business, although that wasn’t his niche. Notably Buffett described himself as 85% Graham and 15% Fisher, and the Fisher component arguably made him more money over the long term.
It’s important to consider what the limits of growth might be- once every potential customer has purchased once, then what? During Fisher’s time he focused on a lot of high-tech product companies. In modern times, there are a lot more service focused companies which can potentially generate recurring revenue streams.
A company with massive long term growth potential may have lumpy sales growth. Annual comparisons generally don’t mean that much, instead investors should compare multiple years.
If management is decent and lucky they might find themselves with a long run growth opportunity. If their truly good and lucky, they’ll find a way to creat it.
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 to produce in the future exactly the type of sales curve that is the first step to consider in choosing an outstanding investment.
One of the key examples is Motorola.
- Does the management have a determination to continue to develop products or process that will still further increase total sales potentials when the growth potentials of currently attractive products have largely been exploited?
As a deep value dumpster diver by nature, I’ve many times ended up in companies where management sits back and overpays themselves off the proceeds from a good product, until it becomes obsolete without properly innovating. This is a point to heed more often in microcap land. At the very least, if a company only has a one time growth spurt, then the disciplined investor should sell as that nears its end, especially if the market is pricing in a continuation that is unlikely to occur.
- How effective are the company’s research and development efforts in relation to its size?
Note the key word is effective. More dollars invested could be wasted. Coordination between engineers and salespeople and executives is key. If executives cut long term projects during lean years, only to restart and overfund them in fat years, investors are likely to have a bad time over the long run.
- Does the company have an above average sales organization?
Production+sales+ research are the three pillars upon which success is based.
- Does the company have a worthwhile profit margin?
Relatively self explanatory- note an investor needs to determine what the actual expenses are. Companies may capitalize things that should be expensed or vice versa. A research company that appears to have poor margins on the surface may actually be an unusually attractive investment upon closer look.
- What is the company doing to maintain or improve profit margins?
Look for smart cost cutters, and companies with personell that find ways to drive higher profit margins. Here is where the “scuttlebutt” method comes into play, along with direct discussions with company personell.
- Does the company have outstanding labor and personnel relations?
This can be a hidden weakness in a company that employs a lot of low wage labor. Once relations sour they may be hard to fix. 10-Ks do usually disclose some basic info on labor relations(ie amount of unionization if any)
- Does the company have outstanding executive relations?
Promotions from inside based on merit. It seems like the executive class has become mercenary since Fisher’s time, so it may now be more critical to have owner operators, or at least executives with a lot of skin in the game.
- Does the company have depth to its management?
Investigate for signs of micromanagement- which can lead to a weak bench of executives, since younger employees won’t have the necessary experience.
- How good are the company’s cost analysis and accounting controls?
“It is not so much the existence of detailed figures as their relative accuracy which is important.”
Without this, management won’t be able to make the right investments in the business, or direct operations properly.
- 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 be in relation to its competition.
In order to “get” this point, an investor really needs to understand the industry. Some matters may be of great importance in one industry, but meaningless in another. These matters are not always obvious from the surface. This point is really about people and process, more than any product. A couple key quotes:
“In our era of widespread technical know-how it is seldom that large companies can enjoy more than a small part of their activities in areas sheltered by patent protection.”
“As has been true many times before and since, it is the constant leadership in engineering, not patents that is the fundamental source of protection. The investor must be at least as careful not to place too much importance on patent protection as to recognize its significance in those occasional place where it is a major factor in appraising the actractiveness of a desirable investment. “
- Does the company have a short-range or long-range outlook in regard to profits?
Its hard to find executives with a truly long range outlook, that can be immune to the vicissitudes of quarterly reporting but still intensely driven. When you find one invest and hold or the long term. Figuring this out usually takes a bit of investigation.
“The scuttlebutt method usually reflects these differences in policies quite clearly. The investor wanting maximum results should favor companies with a truly long range outlook concerning 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 stockholder’s benefit from this anticipated growth?
This is a topic that I have been contemplating a lot lately. The ideal company can self finance its growth. But often a company will need to raise more equity capital to pursue an opportunity. This happens all the time in venture capital.
At the same time, I’ve probably over prioritized excess capitalization as a strength in my investment process, and ended up with overly large positions in cash box type companies with minimal growth prospects and no imminent catalyst, while under prioritizing accretive growth opportunities with slightly more balance sheet risk. Fisher advises:
“Conversely , from the standpoint of making maximum profit over the years, the investor should never go into a situation with a poor score on any of the other fourteen points, merely because of great financial strength or cash position.”
- Does the management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur?
Fisher doesn’t go too much in to the dangerous psychology of people who can’t handle or admit failure. He points out that management that clams up when things are bad probably doesn’t have a good plan to solve unanticipated difficulties and/or doesn’t have an adequate sense of responsibility.
- Does the company have a management of unquestionable integrity?
Due to the information asymmetry, management always knows more than investors. Another huge challenge for microcap investors. There are numerous ways, without breaking any laws, that company insiders can enrich themselves at the expense of outside private minority investors. The scuttlebutt method can be helpful in verifying if management ha a sense of trusteeship. Fisher advises against investing in companies that have unethical management, even if everything lines up. I guess this is the growth investing versionof “there ain’t no such thing as halfway crooks.”