Philip A. Fisher: Art of Investing

Is investing a science or an art? This is a question that Kenneth L. Fisher addresses in his introduction to the book Common Stocks And Uncommon Profits written by his father, famed investor Philip A. Fisher:

The craft I described in my first book, Super Stocks (Dow Jones-Irwin 1984), including how to do it and several real-world examples. But again, this is all craft. Whenever you ask, you get answers. The art is to get more questions—and the right questions—flowing from the answers you receive. I’ve seen people who rigidly run down a standard question list, regardless of the responses they get. That isn’t art. You ask. He or she answers. What question best flows from the answer? And so on. When you can do that well on a real-time basis, you are a composer; an artist; a creative, investigative investor. I went with my father about a jillion times to visit companies between 1972 and 1982. I worked for him only for a year, but we did lots of things together after that. In looking at companies, he always prepared questions in advance, typed on yellow pages with space in between so he could scribble notes. He always wanted to be prepared, and he wanted the company to know he was prepared so they would appreciate him. And he used the questions as a sort of outline of topics to be covered. It was also a great backup in case the conversation went bad, and cold, which occasionally it did. Then he could get things back on course instantly with one of his prepared questions. But his very best questions always popped out of his mind, unprepared, never having been written down in advance because they were the angle he picked up on the fly, as he heard an answer to a lesser question. Those creative questions were the art. It is what, in my mind, made his querying great.

Before presenting his investment philosophy Philip, looks to the past and compares it to the present in search for investment clues, concluding that the present offers us just as many if not more opportunities to invest in growth companies:

Before going further, it might be well to summarize briefly the various investment clues that can be gleaned from a study of the past and from a comparison of the major differences, from an investment standpoint between the past and the present. Such a study indicates that the greatest investment reward comes to those who by good luck or good sense find the occasional company that over the years can grow in sales and profits far more than industry as a whole. It further shows that when we believe we have found such a company we had better stick with it for a long period of time. It gives us a strong hint that such companies need not necessarily be young and small. Instead, regardless of size, what really counts is a management having both a determination to attain further important growth and an ability to bring its plans to completion. The past gives us a further clue that this growth is often associated with knowing how to organize research in the various fields of the natural sciences so as to bring to market economically worthwhile and usually interrelated product lines. It makes clear to us that a general characteristic of such companies is a management that does not let its preoccupation with long-range planning prevent it from exerting constant vigilance in performing the day-to-day tasks of ordinary business outstandingly well. Finally, it furnishes considerable assurance that in spite of the very many spectacular investment opportunities that existed twenty-five or fifty years ago, there are probably even more such opportunities available today. 

From a practical guidance standpoint, Philip outlines his methodology for the sources from which one can gather intelligence on the companies to be considered for investment opportunities through his infamous “scuttlebutt method”:

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…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. However, competitors are only one and not necessarily the best source of informed opinion. It is equally astonishing how much can be learned from both vendors and customers about the real nature of the people with whom they deal. Research scientists in universities, in government, and in competitive companies are another fertile source of worthwhile data. So are executives of trade associations…There is still one further group which can be of immense help to the prospective investor in search of a bonanza company. This group, however, can be harmful rather than helpful if the investor does not use good judgment and does not do plenty of cross-checking: with others to verify his own judgment as to the reliability of what is told him. This group consists of former employees. Such people frequently have a real inside view in regard to their former employer’s strength and weakness…If enough different sources of information are sought about a company, there is no reason to believe that each bit of data obtained should agree with each other bit of data. Actually, there is not the slightest need for this to happen. In the case of really outstanding companies, the preponderant information is so crystal-clear that even a moderately experienced investor who knows what he is seeking will be able to tell which companies are likely to be of enough interest to him to warrant taking the next step in his investigation. This next step is to contact the officers of the company to try and fill out some of the gaps still existing in the investor’s picture of the situation being studied.

Having identified the sources, the Fifteen Points To Look For In A Common Stock are introduced, each to uncover a particular dimension of the organization being investigated as a potential investment opportunity:

POINT 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?

POINT 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?

POINT 3. How effective are the company’s research and development efforts in relation to its size?

POINT 4. Does the company have an above-average sales organization?

POINT 5. Does the company have a worthwhile profit margin?

POINT 6. What is the company doing to maintain or improve profit margins?

POINT 7. Does the company have outstanding labor and personnel relations?

POINT 8. Does the company have outstanding executive relations?

POINT 9. Does the company have depth to its management?

POINT 10. How good are the company’s cost analysis and accounting controls?

POINT 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?

POINT 12. Does the company have a short-range or long-range outlook in regard to profits?

POINT 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 s anticipated growth?

POINT 14. Does the management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur?

POINT 15. Does the company have a management of unquestionable integrity?

Fisher stresses the importance of the last point, integrity, as being foundational:

Any investment may still be considered interesting if it falls down in regard to almost any other one of the fifteen points which have now been covered, but rates an unusually high score in regard to all the rest. Regardless of how high the rating may be in all other matters, however, 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. 

On when to buy, the following guidance is provided:

I believe investors in this group should start buying the appropriate type of common stocks just as soon as they feel sure they have located one or more of them. However, having made a start in this type of purchasing, they should stagger the timing of further buying. They should plan to allow several years before the final part of their available funds will have become invested. By so doing, if the market has a severe decline somewhere in this period, they will still have purchasing power available to take advantage of such a decline. If no decline occurs and they have properly selected their earlier purchases, they should have at least a few substantial gains on such holdings. This would provide a cushion so that if a severe decline happened to occur at the worst possible time for them—which would be just after the final part of their funds had become fully invested—the gains on the earlier purchases should largely, if not entirely, offset the declines on the more recent ones. No severe loss of original capital would therefore be involved.

Fisher cautions us on trying to time the market, and miss out on buying opportunities:

So complex and diverse are these influences that the safest course to follow will be the one that at first glance appears to be the most risky. This is to take investment action when matters you know about a specific company appear to warrant such action. Be undeterred by fears or hopes based on conjectures, or conclusions based on surmises.

On when to sell, Fisher provides three drivers (besides personal emergency needs):

I believe there are three reasons, and three reasons only, for the sale of any common stock which has been originally selected according to the investment principles already discussed. The first of these reasons should be obvious to anyone. This is when 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 favorable than originally believed. The proper handling of this type of situation is largely a matter of emotional self-control. To some degree it also depends upon the investor’s ability to be honest with himself…We come now to the second reason why sale should be made of a common stock purchased under the investment principles already outlined in Chapters Two and Three. Sales should always be made of the Stock of a company which, because of changes resulting from the passage of time, no longer qualifies in regard to the fifteen points outlined in Chapter Three to about the same degree it qualified at the time of purchase. This is why investors should be constantly on their guard. It explains why it is of such importance to keep at all times in close contact with the affairs of companies whose shares are held. , When companies deteriorate in this way they usually do so for one of two reasons. Either there has been a deterioration of management, or the company no longer has the prospect of increasing the markets for its product in the way it formerly did…For those who follow the right principles in making their original purchases, the third reason why a stock might be sold seldom arises, and should be acted upon only if an investor is very sure of his ground. It arises from the fact that opportunities for attractive investment are extremely hard to find. From a timing standpoint, they are seldom found just when investment funds happen to be available. If an investor has had funds for investment for quite a period of time and found few attractive situations into which to place these funds, he may well place some or all of them in a well-run company which he believes has definite growth prospects. However, these growth prospects may be at a slower average annual rate than may appear to be the case for some other seemingly more attractive situation that is found later. The already-owned company may in some other important aspects appear to be less attractive as well.

He also reminds us, in concluding the chapter on when to sell, and when not to sell, that some of our holdings are worth keeping indefinitely:

Perhaps the thoughts behind this chapter might be put into a single sentence: If the job has been correctly done when a common stock is purchased, the time to sell it is—almost never.

Fisher is not a major proponent of dividends:

Actually dividend considerations should be given the least, not the most, weight by those desiring to select outstanding stocks. Perhaps the most peculiar aspect of this much-discussed subject of dividends is that those giving them the least consideration usually end up getting the best dividend return. Worthy of repetition here is that over a span of five to ten years, the best dividend results will come not from the high-yield stocks but from those with the relatively low yield. So profitable are the results of the ventures opened up by exceptional managements that while they still continue the policy of paying out a low proportion of current earnings, the actual number of dollars paid out progressively exceed what could have been obtained from high-yield shares. Why shouldn’t this logical and natural trend continue in the future?

Finally, he shares with us two lists of five don’ts for investing:

1- Don’t buy into promotional companies.

2- Don’t ignore a good stock just because it is traded “over the counter.”

3- Don’t buy a stock just because you like the “tone” of its annual report.

4- 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.

5- Don’t quibble over eighths and quarters.

6- Don’t over-stress diversification.

7- Don’t be afraid of buying on a war scare.

8- Don’t forget your Gilbert and Sullivan (There are certain superficial financial statistics which are frequently given an undeserved degree of attention by many investors).

9- Don’t fail to consider time as well as price in buying a true growth stock.

10- Don’t follow the crowd.

Besides being a very practical and applicable book on investing, particularly for those who subscribe to the value investing school of thought. Also, and although this is a book primarily targeted for investors it is just as applicable as a management book, outlining the foundations of a well run organization. Common Stocks and Uncommon Profits is a must read.

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