The Open Curriculum

The Market · Level 2

Common Stocks and Uncommon Profits

Philip A. Fisher · 1958

Thesis

The largest investment returns come not from buying cheap stocks or timing the market but from finding a few outstanding companies with long runways of growth, able management and unquestionable integrity, learning about them through the business grapevine, and holding them for many years, selling almost never.

The main ideas

Scuttlebutt

Philip Fisher, who founded the investment counseling firm Fisher & Co. in San Francisco in 1931 and ran it until 1999, published Common Stocks and Uncommon Profits in 1958. His method begins with what he called scuttlebutt, the business grapevine.

Financial statements, Fisher argues, reveal little of what makes a company outstanding. The rest can be learned from people who deal with it: competitors, customers, suppliers, former employees, research scientists in universities and government, and executives of trade associations. Each source is partial and some are biased, but together they produce a consistent picture.

His most striking claim concerns competitors. Ask intelligent questions of five companies in an industry about the strengths and weaknesses of the other four, he writes, and nine times out of ten a surprisingly detailed and accurate picture of all five will emerge.

The mechanism is that people who compete with or depend on a company know its real strengths and weaknesses better than its published reports reveal, and are often willing to discuss them.

Implication: before investing in a business, talk to the people who buy from it, sell to it and compete with it, and weight what they say above the company's own account.

The fifteen points

The book's central chapter lists fifteen points to look for in a common stock. The first asks whether the company has products or services with sufficient market potential to make possible a sizable increase in sales for at least several years. The second asks whether management is determined to develop new products or processes to keep sales growing once current lines have matured. Fisher's example for the first point is Motorola, which he had bought in 1955. Its disappointing television business obscured the promise of its two-way radio business, then used mainly by police and taxi fleets, which had a long runway of growth into other industries.

The others cover research effectiveness; the sales organization; profit margins and efforts to improve them; labor and executive relations; depth of management; cost and accounting controls; industry-specific signs of competitive strength; a long-range outlook on profits; whether growth will require so much new equity that existing shareholders' gains are diluted; whether management talks freely to investors when things go well but clams up when troubles occur; and whether management has unquestionable integrity.

Fisher does not require a company to pass every test. It can fall short on a few and still be an outstanding investment. But integrity is absolute: a company that fails the fifteenth point should be rejected whatever its other merits.

Implication: evaluate a company on the qualities that sustain growth over many years, and treat any doubt about management's honesty as disqualifying.

When to buy

Fisher rejects timing purchases on forecasts of the economy or interest rates, which he considers unreliable. Instead he looks for moments when an outstanding company's earnings and share price are temporarily depressed by problems that do not affect its long-term prospects.

His example is the start-up of a new plant, which often brings unexpected costs and delays that depress earnings for a time. Investors who sell on the disappointment create the opportunity; once the problems are solved, earnings rise and the stock with them.

The mechanism is that the market overreacts to short-term disappointments in companies whose long-term strength is intact, so temporary bad news creates entry points.

Implication: keep a list of outstanding companies, and buy when a temporary, solvable problem depresses their price, not when a forecast says the market will rise.

When to sell

Fisher gives three reasons to sell. The first is that the original purchase was a mistake: the facts turn out significantly less favorable than believed. The second is that the company no longer qualifies on the fifteen points, because management has deteriorated or its growth has run out. The third is that a clearly better opportunity appears, a bar he sets high.

Selling because the price has risen, or because the market seems likely to fall, is not among them. "If the job has been correctly done when a common stock is purchased, the time to sell it is—almost never."

The mechanism is that the gains from an outstanding company come from many years of compounding growth. Selling to lock in a gain, or to avoid a decline, risks missing far larger gains and replacing the company with a weaker one.

Implication: write down why you bought each holding, and sell only when one of those reasons is no longer true, not because the price has moved.

Dividends

In a chapter titled "The Hullabaloo about Dividends," Fisher argues that dividend considerations should be given the least, not the most, weight by investors selecting outstanding stocks.

His reasoning is that earnings retained by an excellent management and reinvested at high rates of return usually do more for shareholders than the same earnings paid out. He adds that over five to ten years, low-yielding growth stocks have tended to end up paying more in dividends than high-yielding stocks, because their earnings grow.

Implication: do not choose stocks for their current yield. Ask instead whether management can reinvest earnings at high returns.

Ten don'ts

Fisher closes with two chapters of warnings. Don't buy into promotional companies, new ventures without a record. Don't ignore a good stock just because it is traded over the counter. Don't buy a stock just because you like the tone of its annual report. Don't assume that a high price relative to earnings means that further growth has already been discounted. Don't quibble over eighths and quarters of a point when buying a stock you want to own.

Don't overstress diversification. Owning many companies you know little about is riskier, Fisher argues, than owning a few you know well. Don't be afraid of buying on a war scare. Don't forget your Gilbert and Sullivan: past price ranges and old per-share figures have nothing to do with the case. Don't fail to consider time as well as price in buying true growth stocks. And don't follow the crowd.

Implication: concentrate on a small number of companies you understand thoroughly, ignore irrelevant statistics and market fashions, and do not let small price differences keep you out of an outstanding company.

Limits

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