Common Stocks and Uncommon Profits

When Warren Buffet was asked for his top book recommendations, his list included the following four books (in no particular order of importance):

Buffet has admitted that his own investing style is a mix of teachings from Ben Graham and Philip Fisher. I have already read the Intelligent Investor and Security Analysis multiple times and I am sure to read these several more times in my investing journey. However, I have never read Philip Fisher. The book was first published in the 1950s, so before even picking up this book, I had a sense that some of the observations may be dated. But I wanted to take a look anyway.

Before we get into the book itself, I wanted to first explore a little more about Philip Fisher, the person behind the book.

Who is Philip Fisher?

Fisher made his humble beginnings as a dropout of the then newly created program/school Stanford School of Business Administration in 1928, to start working as a security analyst. He started his own investment firm called Fisher and Co. in 1931 and remained at the helm till his retirement in 1999. Immediately after starting his firm, due to the advent of World War II, he was forced to take up several desk jobs at the US Army Air Force. He used this opportunity to research and refine his own investment philosophy which he later put into practice after the end of the war.

I could not find a whole lot more information about him through the interweb beyond what he mentioned in his book and also what his son, Kenneth Fisher, has mentioned in the preface. He was known to a very private person, not known to give a lot of interviews. However, after publishing this book, he rose to prominence. Per what I have gathered reading around the internet, Fisher and Co. had a very small number of selected clients who were able to secure attractive returns using Phil Fisher’s approach. Today, he is widely regarded as a pioneer of growth investing and recognized by Morningstar as one of the greatest investors of all time.

Phil Fisher was one of the early proponents of the “buy and hold” strategy. To stress this point further, one of his most successful investments was a purchase of Motorola, which he bought in 1955 and held until his death in 2004. His other investments were Texas Instruments, a stock that I currently hold in my dividend portfolio, Dow Chemicals and so on.

During the later half of his life, he began suffering from dementia and/or Alzheimer’s disease and he ended up selling all of his holdings except for Motorola. Per his son Kenneth Fisher, he would never have sold his investments had he been of sound mind or his younger self and his investment returns would have looked much much better as a result. Fisher was known as a strong supporter of companies that would invest in research and development and a master at evaluating companies in the tech sector. This was a good 50 years before the advent of Silicon Valley.

Lets get into the book itself.

Book Dedication

The book starts of with a rather interesting dedication. Let me quote it here:

This book is dedicated to all investors, large and small, who do NOT adhere to the philosophy: “I have already made up my mind, don’t confuse me with facts.”

I paused after reading that statement because there is an interesting paradox. At times, as investors (and perhaps as individuals) we can be very closed-minded and not as receptive to opposing viewpoints. Maybe it is with the understanding that having a conflicted mind can impact our investing philosophy and mess with our heads. This trait can be good but it can also be bad as it stunts our learning process. It takes a strong mind to be open to counter viewpoints and somehow let that organically grow one’s own investing mindset.

Scuttlebutt technique

One of the strategies that Fisher repeatedly uses to evaluate businesses before deciding to buy them is coined as “scuttlebutt”. What does this mean?

Fisher recommends that in addition to studying a company’s financial statements, a wise investor can learn a lot more about any given company through the following avenues:

By going to five companies that are competitors and asking them intelligent questions about the strengths & weaknesses of the other four. Fisher claims that, more often than not, this approach will give the investor a surprisingly detailed and accurate picture of the overall landscape of the sector and the business itself.
By questioning vendors and customers that directly interact with the company.
By questioning research scientists who rely on products manufactured by this said company.
By questioning former employees of the company. Although, Fisher cautions about using this input with a pinch of salt as there could be bias in opinions here.

Fisher admits that while a typical retail investor may not (or cannot) have the leverage to go on such fact-finding missions, he/she can use these as a yardstick when choosing a professional advisor that can help them with such analysis.

With the scuttlebutt technique as the baseline, Fisher recommends the following 15 principles to look for in a stock before investing in them:

Does the company have products or services with sufficient market potential to make possible a sizeable increase in sales for atleast 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 efforts 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 margin?
Does the company have outstanding labor and personnel relations?
Does the company have outstanding executive relations?
Does the company have depth in 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 given 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 large 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 management of unquestionable integrity?

For a book that was published more than 60 years ago, I am amazed to see that so many of these principles are timeless and very much applicable even today. Fisher admits that it is unlikely that one would find a company that would meet all 15 of these principles, but he recommends to avoid companies that do not pass several of the above.

Selling Out of Positions

After going through all the research and investigation on what to buy and when to buy, an investor would naturally be curious about when to sell to gather profits. For this, Fisher states the following:

If the job has been correctly done when a common stock is purchased, the time to sell it is – almost never.

Evidently, Fisher is a supporter of the philosophy or buying and holding. He goes into several reasons why investors choose to incorrectly sell out of their positions. I particularly liked the discussion on selling out when the investor believes a stock is overvalued/overpriced:

This brings us to another line of reasoning so often used to cause well-intentioned but unsophisticated investors to miss huge future profits. This is the argument that an outstanding stock has become overpriced and therefore should be sold….Before reaching hasty conclusions, let us look a little below the surface. Just what is overpriced? What are we trying to accomplish? Any good stock will sell and should sell at a higher ratio to current earnings than a stock with a stable rather than an expanding earnings power…All of this is trying to measure something with a greater degree of preciseness than is possible. The investor cannot pinpoint just how much per share a particular company will earn two years from now…As a matter of fact, the company’s top management cannot come a great deal closer to this .. Under these circumstances, how can anyone say with even moderate precision just what is overpriced for an outstanding company with an unusually rapid growth rate?

I found this discussion particularly interesting and revealing. Valuing growth stocks, especially the ones that are early in their growth trajectories, is incredibly hard. Even top-investors like Warren Buffet, Mohnish Pabrai and the likes in various interviews have stated how they have tossed such opportunities in the “too hard” basket.

Dont’s for investors

Fisher goes into several dont’s for investors. I will cover some of the ones that I thought were interesting:

Don’t buy into promotional companies.
Don’t overstress diversification.
Don’t be afraid of buying on a war scare.
Don’t fail to consider time as well as price when buying a true growth stock.
Don’t follow the crowd.

Again, several of these dont’s are just as applicable today as they were when this book first came out. I wanted to expand on the second point regarding diversification here. Fisher states the following:

The horrors of what can happen to those who “put all their eggs in one basket” are too constantly being expounded. Too few people, however, give sufficient thought to the evils of the other extreme. This is the disadvantage of having eggs in so many baskets that a lot of eggs do not end up in really attractive baskets, and it is impossible to keep watching all the baskets after all eggs get put into them.

So clearly, Fisher believed in having a concentrated portfolio rather than diversifying among several sectors/industries. I have previously written about this subject stating why I disagree with this philosophy. There is a sea difference between the business acumen that the likes of Fischer, Buffet and Munger possess in comparison to an average retail investor such as myself. Diversification is a protection against this shortcoming and if performed as a part of a specific strategy, also provides a great defense in a various economic environments. A risk-averse investor would want to safeguard his invested capital and diversification is one way to achieve this.

Other writings

Part 1 of this book covers the subject of Common Stocks and Uncommon Profits. Parts 2 and 3 cover some of Philip Fisher’s other writings dealing with subjects regarding “Conservative Investment” and details on how Fisher went about developing his investment philosophy over the course of his life. I will cover the other two parts in greater detail in a future post on this blog as they are very important topics by themselves.

Overall thoughts regarding this book

Peter Lynch, another investing legend, once stated that investing needs to be a fine mix between science and art and that an astute investor will ensure that there is a proper balance maintained between both facets. If this balance is lop-sided in either direction, it could lead to a bad decision. I get a sense that while Buffet relies on Graham’s teachings for the “science” side of his investment philosophy, he chooses to rely on Fisher’s teaching for the “art” aspect of his investments.

In comparison to Graham’s books, I found the writing style in this book was very easy to follow. In that regard, I found the book to be more amenable to a beginner investor. Although the subject is mostly focused around picking growth stocks, I could see the same principles being used for evaluating dividend growth stocks and/or value stocks as well.

Some of the techniques mentioned in the book are just as well applicable to this day and age. I use an “indirect scuttlebutt” strategy in my analysis, where I look at the interviews of the CEOs (or other members of the board/management) for companies that I am interested in. If I can see consistency in responses and clarity of thought, that is usually a good sign. But if I detect BS in the responses, that is a massive red flag. I also read through forums, talk to technicians/consumers to see what they think of the products coming from a company which I am considering to invest in.

My only critic is that the writing at times appeared to be very dry. I could see some interesting parallels with the ideas discussed in Peter Lynch’s books, but in comparison Peter Lynch has a knack of keeping the reader engaged with his humor. I would have also liked to see more examples, potentially with graphs to accompany the discussion surrounding profit margins, cost of research vs size of the company etc. But some of these are very minor critics.

Overall, this is a great book and something I will re-read in the future.

Have you read this book? What were your takeaways? Please drop a comment below.