Sunday, January 3, 2010

Common Stocks And Uncommon Profits: Chapter 3, Part 5

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.

The following criteria conclude the list of items Fisher requires for stocks with outstanding returns:

13) Will substantial equity dilution be avoided to finance the business' growth?

A company that meets the tests of the other 14 criteria is one that will be able to borrow money to fund growth. However, debt levels will at some point hit a maximum level, which is determined by the type of business carried out. Therefore, if a company is already at a high debt level, equity financing might be employed. The investor should determine the attractiveness of the company after carefully calculating the results of dilution of the company's stock.

14) Does management continue to speak freely to investors when disappointments occur?

For even the best run companies, failures and disappointments occur. The firms showing the greatest gains are those which are always developing new products. Inevitably, some of these will not turn out as well as expected. How management reacts is what's important for the shareholder. If management "clams up" because it does not have a plan, or if management panics, the investor should exclude the company from investment.

15) Does management have unquestionable integrity?

Managements are always in a position such that they may enrich themselves at the expense of shareholders. They are closer to the assets than shareholders, and as a result are granted leeway that can be legally abused in an almost infinite number of ways. For example, they can put relatives on the payroll and pay them salaries above market value. Furthermore, they can lease assets to the corporation at above-market prices. Investors must confine investments to companies where managements are of the highest integrity. Fisher recommends the "scuttlebutt" technique (discussed in Chapter 2) for confirming that management has the necessary integrity.

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