Saturday, December 26, 2009

Common Stocks And Uncommon Profits: Chapter 3, Part 1

Warren Buffett has called himself "85% Graham and 15% Fisher". While the works of Graham are often cited, Fisher's book "Common Stocks and Uncommon Profits" is not. Here follows a summary of this work by Philip Fisher, known as one of the greatest investors of all time.

In this chapter, Fisher tells the reader how to determine if a company is one which will produce the outstanding returns alluded to in the previous two chapters. There are fifteen questions about each company under consideration that must be answered. If the answer is yes for most of them, the stock could very well be a super-performer. On the other hand, if the answer is no for many of them, Fisher considers it unlikely that the stock can generate the outstanding returns required. The idea is to separate the companies that are "able" from those that are fortunate, as the ones that are able will continue to prosper long after the ones that are fortunate have seen their growth stall.

The first three criteria are covered in this post, with the remaining twelve covered in subsequent posts:

1) Does the company have the market potential to grow sales for at least several years?

Here, Fisher is not interested in market conditions which offer the potential for a large surge in sales, even for years at a time. While he acknowledges that profits can be made from investing in such companies, these are not the home-run type companies he is looking for. For this to be possible, management must be skilled, and is always growing markets and product lines such that sales continue to increase even as its industries mature. An example of such a stock Fisher picked out in the 1950s is Motorola; he goes on to describe why Motorola fit this description and turned out to be the winner that it did.

2) Does management institute policies that that result in newly developed products?

Fisher stresses that this is not the same question as the one above. While the previous question has a factual answer, this question is related to management attitude. In other words, does management recognize that existing products will eventually reach their market potential?

3) How effective is the company's research and development?

Does management make the investments in R&D necessary to keep the company's growth trajectory high? Here, Fisher notes that it is not just the amount of R&D that is important (as a percentage of sales), but how well the processes are managed, how well the teams are motivated, and how well the research processes are integrated with the sales team. Fisher also believes that companies with research efforts in areas where the company already has a successful product have the most promise for future returns, as opposed to research in areas in which the company has no existing expertise. Furthermore, stability in funding research products is also important; companies that cut R&D at the bottom of the business cycle pay far more in the end than those who stay committed throughout, even if they need to use a business cash advance.

1 comment:

Anonymous said...

i think if you look at buffet style from early 80s till now,i think he would say i am 80% fisher and 15% graham.

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