Sunday, January 24, 2010

Common Stocks And Uncommon Profits: Chapter 9

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 more "don'ts" for investors:

1) Don't be too diversified

The benefits of diversification are overstressed, in Fisher's opinion. However, the drawbacks are not. Fisher recommends that the investor know his companies well, and having too many companies can prevent this from occurring. Large companies operating in several business lines are already diversified, and therefore if a portfolio is made up of only these types of businesses, where no product lines between the companies overlap, Fisher recommends investors need only 5 stocks to be diversified. At the other end of the spectrum, if the investor has a portfolio of only small stocks in single product lines, Fisher recommends putting no more than 5% of one's portfolio in any one stock.

2) Don't be afraid to buy on a war scare

The threat of war causes investors to ignore fundamental economics in forming their stock quotations. As such, investors should take advantage of such opportunities in order to buy stocks during these temporary dips.

3) Don't be influenced by what doesn't matter

Investors will frequently be influenced by a company's past share price, and its past P/E ratio, and make assumptions about the company's future valuation based on the past. Fisher argues that past valuation levels are not relevant, and the investor should always be forward looking in order to determine what a company is worth.

4) Don't fail to consider the right time to buy a growth stock

Fisher admits that the practice he recommends in this section may be controversial, but he believes timing, and not just price, should be used when purchasing a stock that is trading at a rich value. If a stock passes the 15 tests of Chapter 3, it may be at a price that, while not unattractive, commands quite a premium to the market. Fisher suggests that in this case the investor wait in order to buy at a later date.

5) Don't follow the crowd

This is not easy for the investor, since we are all influenced by the world around us. However, Fisher urges the investor to see through the waves of optimism and pessimism that take turns over the market and over specific industries. These waves will inflate and deflate P/E ratios, offering investors opportunities for profit.

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