Phil Fisher’s Invesment Framework

The late Phil Fisher was one of the great investors of all time and the author of the classic book Common Stocks and Uncommon Profits. Fisher started his money management firm, Fisher & Co., in 1931 and over the next seven decades made tremendous amounts of money for his clients. For example, he was an early investor in semiconductor giant Texas Instruments , whose market capitalization recently stood at well over $40 billion. Fisher also purchased Motorola in 1955, and in a testament to long-term investing, held the stock until his death in 2004.

Phil Fisher wrote the first investment book ever to make The New York Times bestseller list, Common Stocks and Uncommon Profits. It also became required reading in the investments class at Stanford’s Graduate School of Business .

The book laid out senior Fisher’s 15-point strategy for finding great long-term growth stocks at a time when most investors and strategies swung with business cycles. His methods were so convincing that a young Warren Buffett went to visit Fisher and eventually incorporated a good deal of Fisher’s methods into his own stock selection process. Buffett later described his strategy as 15% Fisher and 85% Benjamin Graham.

Phil Fisher’s 15-point approach essentially attempts to determine whether a company is in a position to continue to grow sales for several years, has an innovative and visionary management, strong profit margins, effective sales organization and high-quality management. Fisher also argued against over-diversifying and, in his heyday, tended to hold only about 30 stocks. This is one of the Buffett strategies borrowed from Fisher as was his don’t follow the crowd approach.

Not insignificant in Fisher’s approach to growth stock investing was something he called “scuttlebutt.” This was the process of veering from printed financial stats or company disclosures. Fisher felt strongly that investors should “investigate” potential portfolio holdings by questioning customers, competitors, former employees and suppliers, as well as getting information from management itself. The art to this was not just in the answers Fisher got, but in asking the right questions.

15 Important Do’s for Investors

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? A company seeking a sustained period of spectacular growth must have products that address large and expanding markets.
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? All markets eventually mature, and to maintain above-average growth over a period of decades, a company must continually develop new products to either expand existing markets or enter new ones. If you look at all the businesses that died or currently suffering, their product lines were over exploited or they didn’t bother with development and adapting.

The problem was that Motorola got too comfortable and big headed about its success and didn’t bother to come up with new products.(Read more here).Then Apple and Samsung came along, and it was too late.

3. How effective are the company’s research-and-development efforts in relation to its size? To develop new products, a company’s research-and-development (R&D) effort must be both efficient and effective. One easy method you can use is to compare the R&D expense in relation to competitors.A company with a bigger moat can spend less on R&D and still have the same effectiveness. Whereas, a weaker competitor will have to outspend the #1 competitor to try and develop something better.

Ideally, you want a company’s R&D spending to be dedicated to creating or enhancing its economic moat. Firms that not only create new products but also create unique production methods will benefit more than companies that just create new products that can be quickly replicated by existing techniques in the industry.

4. Does the company have an above-average sales organization? Fisher wrote that in a competitive environment, few products or services are so compelling that they will sell to their maximum potential without expert merchandising. “It is the making of repeat sales to satisfied customers that is the first benchmark of success “This is an often overlooked area of research. The reason for this common oversight, as Fisher rightly notes, is that there’s no accounting measure or ratio — as there is for research and development, for example — that captures marketing spending and effectiveness.But the quality of a sales force matters. Think about it this way: Ever been to a restaurant with crappy service? Even if the food is good, because of a bad service experience you’re much less likely to go back or recommend the place to friends. The same thing occurs in business all the time.Analyzing the quality of a company’s sales force requires a more qualitative approach. If you can, ask customers, suppliers, competitors who has the best sales force in the industry. If you can get the company on the phone, ask them how their sales force is rewarded. If you don’t have access to those parties, a Google search may reveal something helpful.
5. Does the company have a worthwhile profit margin? Berkshire Hathaway’s  vice-chairman Charlie Munger is fond of saying that if something is not worth doing, it is not worth doing well. Similarly, a company can show tremendous growth, but the growth must bring worthwhile profits to reward investors.
6. What is the company doing to maintain or improve profit margins? Fisher stated, “It is not the profit margin of the past but those of the future that are basically important to the investor.” Because inflation increases a company’s expenses and competitors will pressure profit margins, you should pay attention to a company’s strategy for reducing costs and improving profit margins over the long haul.

The investing community often falls into the trap of extrapolating present trends. If a company’s margins have averaged 8% over the last five years, for example, many forecasts will assume about 8% margins over the next five years, too. As such, the market price for the stock has a good chance of implying about 8% margins going forward. So when a company is able to break away from historical trends and boost margins to, say 15%, that will have a profound impact on the stock price and investors who anticipated that move will be rewarded.

7. Does the company have outstanding labor and personnel relations? According to Fisher, a company with good labor relations tends to be more profitable than one with mediocre relations because happy employees are likely to be more productive. There is no single yardstick to measure the state of a company’s labor relations, but there are a few items investors should investigate. First, companies with good labor relations usually make every effort to settle employee grievances quickly. In addition, a company that makes above-average profits, even while paying above-average wages to its employees is likely to have good labor relations. Finally, investors should pay attention to the attitude of top management toward employees. LinkedIn, Glassdoor, and other websites may also provide some quality information about employee morale.
8. Does the company have outstanding executive relations? Just as having good employee relations is important, a company must also cultivate the right atmosphere in its executive suite. Fisher noted that in companies where the founding family retains control, family members should not be promoted ahead of more able executives. In addition, executive salaries should be at least in line with industry norms. Salaries should also be reviewed regularly so that merited pay increases are given without having to be demanded.
9. Does the company have depth to its management? As a company continues to grow over a span of decades, it is vital that a deep pool of management talent be properly developed. Fisher warned investors to avoid companies where top management is reluctant to delegate significant authority to lower-level managers.
10. How good are the company’s cost analysis and accounting controls? A company cannot deliver outstanding results over the long term if it is unable to closely track costs in each step of its operations. Fisher stated that getting a precise handle on a company’s cost analysis is difficult, but an investor can discern which companies are exceptionally deficient–these are the companies to avoid.

Also consider management incentives (found on the annual proxy statement) to see if executives have moving targets each year or lowered hurdles that have enabled management to earn a healthy bonus regardless of performance.

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? Fisher described this point as a catch-all because the “important clues” will vary widely among industries. The skill with which a retailer, like Wal-Mart WMT or Costco COST, handles its merchandising and inventory is of paramount importance. However, in an industry such as insurance, a completely different set of business factors is important. It is critical for an investor to understand which industry factors determine the success of a company and how that company stacks up in relation to its rivals.
12. Does the company have a short-range or long-range outlook in regard to profits? Fisher argued that investors should take a long-range view, and thus should favor companies that take a long-range view on profits. In addition, companies focused on meeting Stock market’s quarterly earnings estimates may forgo beneficial long-term actions if they cause a short-term hit to earnings. Even worse, management may be tempted to make aggressive accounting assumptions in order to report an acceptable quarterly profit number.
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 anticipated growth? As an investor, you should seek companies with sufficient cash or borrowing capacity to fund growth without diluting the interests of its current owners with follow-on equity offerings.

Basically, you want to find companies that are financially healthy enough to fund their growth investments with internally-generated cash or with reasonable amounts of debt. Firms that consistently need to issue equity (and dilute current shareholders’ stake in the process) should be avoided.

14. Does management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur? Every business, no matter how wonderful, will occasionally face disappointments. Investors should seek out management that reports candidly to shareholders all aspects of the business, good or bad.

Take a look through the company’s reports and conference call transcripts following a particularly poor quarter or year. Is management forthcoming about mistakes they’ve made or is everything sugar-coated or blamed on the economy/weather/markets? If management takes ownership for the company’s underperformance and thoroughly explains the steps they’re taking to improve the business, you might just have a winner.

15. Does the company have a management of unquestionable integrity? The accounting scandals that led to the bankruptcies of Enron and WorldCom should highlight the importance of investing only with management teams of unquestionable integrity. Investors will be well-served by following Fisher’s warning that regardless of how highly a company rates on the other 14 points, “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.”

In investing, the actions you don’t take are as important as the actions you do take. Here is some of Fisher’s advice on what you should not do.

5 Important Dont’s for Investors

1. Don’t overstress diversification.

Investment advisors and the financial media constantly expound the virtues of diversification with the help of a catchy cliche: “Don’t put all your eggs in one basket.” However, as Fisher noted, once you start putting your eggs in a multitude of baskets, not all of them end up in attractive places, and it becomes difficult to keep track of all your eggs.

Fisher, who owned at most only 30 stocks at any point in his career, had a better solution. Spend time thoroughly researching and understanding a company, and if it clearly meets the 15 points he set forth, you should make a meaningful investment. Fisher would agree with Mark Twain when he said, “Put all your eggs in one basket, and watch that basket!”

2, Don’t follow the crowd.
Following the crowds into investment fads, such as the “Nifty Fifty” in the early 1970s or tech stocks in the late 1990s, can be dangerous to your financial health. On the flip side, searching in areas the crowd has left behind can be extremely profitable. Sir Isaac Newton once lamented that he could calculate the motion of heavenly bodies, but not the madness of crowds. Fisher would heartily agree.

3. Don’t buy a stock just because you like the tone of its annual report. This is similar to promotional companies and don’t be suckered in by a great presentation which is all an annual report is. Read things critically and ask questions in your head and see if they answer them or hide the answer to them. If you don’t understand something move on!

4,Don’t assume that the high price at which a stock may be selling in relation to its earnings is necessarily an indication that further growth in those earnings has largely been already discounted in the price. Google and Apple were “expensive” P/E stocks greater than 25 in 2004 and they went up 1200% and 600% respectively since.

5, Don’t quibble over eighths and quarters.After extensive research, you’ve found a company that you think will prosper in the decades ahead, and the stock is currently selling at a reasonable price. Should you delay or forgo your investment to wait for a price a few pennies below the current price?

Fisher told the story of a skilled investor who wanted to purchase shares in a particular company whose stock closed that day at $35.50 per share. However, the investor refused to pay more than $35. The stock never again sold at $35 and over the next 25 years, increased in value to more than $500 per share. The investor missed out on a tremendous gain in a vain attempt to save 50 cents per share.

Even Warren Buffett is prone to this type of mental error. Buffett began purchasing Wal-Mart many years ago, but stopped buying when the price moved up a little. Buffett admits that this mistake cost Berkshire Hathaway shareholders about $10 billion. Even the Oracle of Omaha could have benefited from Fisher’s advice not to quibble over eighths and quarters.

Philip Fisher compiled a sterling record during his seven-decade career by investing in young companies with bright growth prospects. By applying Fisher’s methods, you, too, can uncover tomorrow’s dominant companies.Good luck 🙂