Saturday, January 23, 2010

Common Stocks And Uncommon Profits: Chapter 8

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.

This chapter contains 5 "don'ts" for investors:

1) Don't buy unestablished companies

The temptation is there to buy brand new companies with little operating history, since investors who wait for these companies to become established will have to pay several times the price. Fisher argues that there are too many potential points of weakness for companies without a few years of sales and without at least one full year of operating profits.

2) Don't ignore a stock just because it is "over the counter"

Fisher argues that the rules for over-the-counter stocks are not too different from those on the exchange. If a great company can be found, the investor should not disregard it simply because it is not traded on an exchange.

3) Don't buy a stock because of the "tone" of its annual report

A company's annual report can appear upbeat simply because of the skill of its investor relations group. Investors are encouraged to see the facts that are often hidden between the colourful pictures and rosy language. When reports fail to give information on matters of real significance to the investor, the stock should not be considered for investment.

4) Don't assume that a stock's price already discounts high future earnings growth

In some cases, a stock may trade for twice the P/E of the market because earnings are expected to increase relative to the market. In such a case, analysts will often say the stock price discounts the future earnings growth. Fisher cautions the investor from this line of thinking. Because the investor is seeking out companies (as per Chapter 3) that continue to bring new products to market or find new markets for products, these companies should continue to grow. As such, there is no reason why these companies should always have a P/E that is much higher than the average company.

5) Don't quibble over the ask price

In some cases, investors will be unwilling to pay the market's asking price, and will therefore issue limit orders. In order to save a few bucks, the investor may cost himself dearly over the long term. If a company is a great company suitable as a long-term holding, the potential gains far outweigh the few dollars potentially saved by holding out for a better price. It is best not to take the chance that the issue will never be purchased.

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