Saturday, February 20, 2010

Conservative Investors Sleep Well: Chapter 6

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 the expanded version of this book, which includes 2 other works by Fisher including "Conservative Investors Sleep Well" and "Developing an Investment Philosophy".

The issue of an investment's price is so important that Fisher devotes a third chapter to its discussion. While in the previous chapter Fisher discussed how the financial community's appraisal of the industry can have a strong effect on the price of an issue, now he discusses how the community's appraisal of stocks in general can affect a company's price.

Fisher discusses a few extreme examples to illustrate his point on this issue. One example occurred from 1927 to 1929, where a so-called "new era" was upon us: earnings grew tremendously, a businessman was elected President, the future looked bright, and stock prices grew to ridiculous levels. At the opposite end of the spectrum, but just as spectacularly wrong, common stocks sold at high discounts from 1946-1949 despite strong company earnings. Fisher argues that determining whether the market is about to enter such a period is a good way to avoid buying at the wrong price, and the best way to ascertain the future of the financial community's outlook on stocks is by correctly estimating coming changes in interest rates.

Though the financial community's feeling toward the market and the company's industry both have an effect on a stock's price, the strongest influence of an issue's price is still the appraisal of company-specific fundamentals. Fisher reminds the investor to compare the company's P/E to the first three dimensions of a company (discussed in the first three chapters) to determine whether it is under- or over-valued. In other words, just because one company's P/E is 10 and another's is 20 does not mean the one with the lower P/E is cheaper. If the company with the higher P/E will still command a higher P/E in five years (due to strong performance against the first three dimensions) and will have grown earnings to a large extent within that period (again, for the same reasons), it is actually the more conservative investment.

1 comment:

Anonymous said...

how does one correctly estimate interest rates??????