Known as the ‘father of growth investing’, Philip A Fisher was one of the first investment philosophers to focus almost exclusively on qualitative factors while making an investment decision.
Fisher began his investment journey as a securities analyst in 1928. Three years later, he founded his own investment counseling firm, Fisher & Co, which he managed for nearly 70 years till his retirement in 1999.
At a time when many investors were trying to make money by betting on business cycles, Fisher followed a ‘buy and hold’ strategy and picked well-positioned stocks, which were expected to achieve long-term growth in sales and profits.
To find such good quality names, he focused on factors that were difficult to measure through valuation ratios and other mathematical formula. He used factors such as quality of management, potential for long-term sales growth, and the firm’s competitive edge.
Fisher narrated his investment philosophy in the book Common Stocks and Uncommon Profits, which was published in 1958.
In adopting a long-term investment strategy, Fisher always invested in high-quality growth stocks of firms run by strong management teams. A prime example of this was Motorola, whose stock he bought in 1955 and didn’t sell for the rest of his life.
“If the job has been done correctly when a common stock is purchased, the time to sell it almost never occurs,” he wrote in his book.
Warren Buffett, the Oracle of Omaha, is also a big admirer of Fisher’s investing strategy and considered the book as one of his all-time favourites.
“I sought out Phil Fisher after reading his Common Stocks and Uncommon Profits. When I met him, I was impressed by the man and his ideas. A thorough understanding of business, by using Phil’s techniques can enable one to make intelligent investment commitments,” Buffett once said.
In his book, Fisher came up with a 15-point checklist to look for in a common stock, which many growth investors still religious follow.
Fisher says a company must qualify on most of these 15 points to be considered a worthwhile investment. He said it’s highly unlikely that a company will meet all the 15 points in his checklist and said if a company fails to meet the majority of the points, then investors should definitely avoid such investments.
Here are the 15 points that Fisher used to evaluate the characteristics of a business and its management quality:-
1. Does the company have significant sales growth potential for next several years?
Investors should seek companies that have a continuous period of exceptional growth. Fisher said such companies must have the products that can cater to large and expanding markets.
To find such companies Fisher advised investors to look at management quality, industry trends and business cycles. He said one should focus on the quality of growth by looking at several years of growth, and not make year-on-year comparisons.
2. Does the management have the determination to continue development of products and processes to increase total sales when the existing growth potential has been exhausted?
Fisher believed that investors should look for companies having excellent managements that are willing to develop products and processes even after the growth potential gets exhausted.
All markets eventually mature, and to maintain exceptional growth over longer period, a company must develop new products continuously to either expand existing markets or enter new ones, which is not possible without an exceptional management team.
3. Does a company take a long-range view to profits?
Fisher says it is best for investors to invest in companies that have a long-range view on profits, as such companies are more likely to deliver sustainable results in the long run.
He says such companies have the will to forgo near-term profits to look after their customers or suppliers during uncertain or difficult circumstances to improve relationships and profits in the long run.
But he warned investors to avoid companies that were focused only on meeting quarterly earnings estimates by forgoing beneficial long-term measures if they caused a short-term hit to earnings.
4. Will future growth of company require new equity financing such that expected benefits to existing shareholders are offset by the dilution in their claim?
Investors should look to invest in companies with sufficient cash or borrowing capacity to fund growth without diluting the interests of its shareholders.
If that was not the case, the expected growth in earnings should be sufficiently large to make the cost of the equity dilution acceptable. “What really matters is whether a company’s cash plus further borrowing ability is sufficient to take care of the capital needed to exploit the prospects of next several years,” he said.
5. Does the company have an attractive profit margin?
Fisher says investors should look for companies that not only show fabulous growth, but also reward them with exceptional profits. He says investors should look for companies across a span of years having the best margins in their industry.
But he felt exceptions could be made for companies that gave up profits to accelerate growth over the next few years in order to improve the company’s future, and not just reinvest all profits to stay afloat.
6. What is the company undertaking to protect or grow profit margins?
It is important for investors to pay attention to a company’s strategy for reducing costs and improving profit margins before investing in them.
Fisher says companies that actively review their operations for improvement and growth opportunities are likely to boost their profit margins in the long run.
Fisher warned investors to be wary of companies whose profit margins rise only as a result of simple price increase, which is not necessarily an attractive indication to a long-term investor.
“The success of a stock purchase does not depend on what is generally known about a company at the time a purchase is made. Rather, it depends on what gets to be known about it after the stock has been bought,” he said.
7. Are there characteristics unique to the business and/or industry that provide useful clues on the position of the company relative to its competitors?
Fisher says it is important for investors to understand which industry factors influence the success of a company and how that company measures up in relation to its rivals.
He said such factors are important clues but they vary widely across industries. Giving an example he said, the skill with which a retailer handled its merchandising and inventory was of top importance. However, in an industry such as insurance, a completely different set of business factors are important.
8. Does the company have an above average sales team?
Fisher says in a competitive environment, a company’s survival is heavily dependent on sales without which the chances of success become slim. He says there are only a few products or services that are so compelling to customers that they got sold to their maximum potential without expert merchandising.
Investors often make the mistake of underestimating the impact of company sales, and advertising and don’t pay much attention to these important factors.
According to Fisher, outstanding research, production and sales are usually the key drivers of a company’s success.
So if a company has an above-average sales team, then it should be surely considered for investment. “The ability to make repeat sales to satisfied customers is the first benchmark of success.” he said.
9. Is the company’s research and development efforts effective relative to its size?
Investors should pick companies that have both an efficient and effective research-and-development (R&D) team that can develop new and innovative products frequently.
Fisher says it is essential to understand the flow in sales and net profits from new products or services that can be attributed to a company’s R&D. “While research and development (R&D) expenses to sales ratios can provide a crude comparison of company research relative to competitors, it is not always meaningful. Such figures are potentially misleading because companies can account for R&D and capital expenses in very different ways,” he said.
10. Does a company have good cost analysis and accounting controls?
Fisher says although it is difficult to get precise information about a company’s cost analysis, investors can get an idea about which companies are exceptionally deficient and should avoid them.
He said a company that closely tracks each step of its operations can deliver outstanding results in the long run and should be among investors’ top picks.
“To develop and prioritise good strategies, companies need a sufficiently accurate and detailed breakdown of their cost and revenue drivers. Otherwise, management may or may not be solving problems that need the most attention,” he said.
11. Does the company have outstanding labour and personnel relations?
Fisher says companies with good labour relations performed better than the others, as happy employees tend to be more productive. He says companies with poor personnel relations had to also bear the cost of potential workforce strikes and high workforce turnover leading to unnecessary expenses.
Fisher suggested investors to investigate the state of a company’s labor relations by looking at a few things like-
- Rate at which a company is settling employee grievances
- The attitude of top management towards employees
He said the absence of conflict in a company was not a guarantee of a healthy relationship as it may be a sign of a culture of fear. So he said investors should be sensitive to top management’s attitude to employees at all levels and should review executive communications to determine how important employee relations are to the company and management before investing.
“Companies with good labour relations usually are the ones making every effort to settle grievances quickly… Investors who buy into a situation in which a significant part of earnings comes from paying below standard wages for the area involved may in time have serious trouble on his hands,” he said.
12. Does the company have outstanding executive relations?
Fisher says having an able executive team is vital to the success of a business and it was the company’s prime responsibility to cultivate the right atmosphere for its executives. Hence, companies having good relationship with executives should always be on investors’ radar.
13. Does the company exhibit depth in its management?
Fisher says investors should avoid companies where the top management is reluctant to delegate significant authority to lower-level managers. He says it is vital for the success of a company to have a deep pool of management talent that could fill in the voids left by key leaders and talent so that the company doesn’t panic when important personnels leave an organisation.
“The investor should have some idea of what can be done to prevent corporate disaster if the key man should no longer be available,” he said.
14. Is the management candid with shareholders during good and bad news?
It was important for investors to seek companies with management that reported honestly to shareholders on both the good and bad aspects of the business. Fisher says every business is bound to have its own ups and downs and the management which hid facts during bad times indicated lack of accountability towards its shareholders.
15. Does the company have a management of unquestionable integrity?
Fisher says investors should pick such companies for investment which have managements that show a strong sense of trusteeship and moral responsibility to their shareholders. “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,” he said. He felt bad management always found many ways to derive benefits at the expense of shareholders.
Although there is no secret strategy or a single magic formula to pick quality stocks that can give solid returns, Fisher’s 15-point checklist has helped generations of investors in selecting quality stocks.
This checklist can also help both beginners and expert stock investors conduct in-depth research on the quality of a business and its management.
(Disclaimer: This article is based on Philip Fisher’s book Common Stocks and Uncommon Profits.)
Credit: Stocks-Markets-Economic Times