Developing An Investment Philosophy: Chapter 4

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".

This final chapter focuses on whether the market is efficient. Fisher is clearly in the "no" camp, though he notes that this philosophy has been gaining steam. He agrees that it is very difficult to make short-term profits and gain quickly from new, public information. However, for long-term investors he argues that the market is not even close to perfect.

To illustrate his point, Fisher points to the distribution of returns of various stock indexes. While the indexes themselves may move small amounts from day-to-day as the outlook for business conditions changes, individual stocks have far larger distributions of returns. Over five-year periods, the returns on an index may seem reasonable, but around 10% of stocks will show gains of thousands of percent. Fisher believes prudent investors can uncover at least some of these special stocks, leading to outsized profits in the long run.

As an example, Fisher takes the reader through a few years comparing the operations to the stock price of a company called Raychem Corporation. This was a company that only undertook projects if it could be the industry leader and if it possessed some knowledge or advantage that would make it difficult for competitors to copy. The company traded at 25 times forward earnings in 1975, as new products were expected to grow earnings in the years to come.

After a single major new product failure (resulting in a write-off that hurt earnings), followed by an unrelated restructuring meant to improve profitability, the stock dropped to one third of previous value over the course of a single year. Raychem management was upfront about both the positives and negatives facing the business, and yet the stock price stayed low, much to Fisher's bewilderment. Eventually, the price recovered. Fisher believes this to be a perfect example, though only one of many, of how the market is clearly inefficient.

Developing An Investment Philosophy: Chapter 3

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".

As Fisher's philosophy has matured, he has further refined his investment processes. In this chapter, Fisher takes the reader through his thought process, and recommended mode of action, on several points.

Following World War II, Fisher's research led him to believe that the chemical industry would do well in the coming decades. As such, he spent some time researching various businesses in this industry in order to find the one that offered the most promise for outstanding returns. In the end, he chose Dow Chemical as his investment choice, and he was greatly rewarded.

There were many reasons for his choice. Throughout the organization, Fisher was getting the impression that there was excitement from employees and the belief that greater growth lay ahead. Fisher was tremendously impressed with the CEO's response when asked the most important long-range problem facing his company (which is one of Fisher's favourite questions):

"It is to resist the strong pressures to become a more military-like organization as we grow very much larger, and to maintain the informal relationship whereby people at quite different levels and in various departments continue to communicate with each other in a completely unstructured way and, at the same time, not create administrative chaos."

Dow also limited its involvement to product lines wheer it was or had a reasonable chance of becoming the most efficient manufacturer. Research was a priority, and individuals of unusual ability were identified and elevated. Some of the sayings of Dow's late founder were also quoted to Fisher by a number of employees, two of which Fisher incorporated into his own investment business:

"Never promote someone who hasn't made some bad mistakes, because if you do, you are promoting someone who has never done anything."

"If you can't do a thing better than others are doing it, don't do it at all."

While Fisher was wildly successful with his investments in the ensuing decades, he did make a few mistakes. He spells out some of his errors, as these are often the most worthy experiences from which to learn. One problem is that success breeds complacency: on one particular occasion, Fisher only completed part of an analysis on a company before buying in. With more effort, he would have uncovered the problems that would cause the stock to subsequently drop in the coming year.

Fisher also states that he has been far more successful in industries which he knows well, which are manufacturing and high-tech companies that serve manufacturers. In other industries, he believes his methods can be applied, but believes investors with more knowledge of those particular industries are in the best position to thrive. Finally, Fisher recommends that investors not sell in anticipation of predicted market downturns, for predictions of this nature are extremely difficult to make.

Developing An Investment Philosophy: Chapter 2

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".

In this chapter, Fisher discusses how his investment philosophy has changed over time as he has learned from experience. Fisher shares some of his learnings, as well as some corollaries of those learnings which can be of use to investors.

First, Fisher has a three-year rule when it comes to selling investments. Unless he uncovers information which makes him doubt his original thesis, Fisher will not give up on a company before this time. However, if a company has not fulfilled its promise after three years, he will sell it immediately. Too often, he has seen companies underperform for a year or more, but when the gains do arrive, they come quickly and to a large extent. Rarely will it get to a point where Fisher has to sell after three years; this is not because all his investments pay off handsomely, but rather as a result of the fact that he will often uncover information that is not to his liking before that time is reached.

After a couple of early mistakes, Fisher vowed never to invest significantly in a company without getting to know its management first. There are two traits Fisher believes make for a top-notch management. The first is business skill. For superior business skill, management must not only be above-average handlers of the company's day-to-day tasks (e.g. finding more efficient ways to produce, managing receivables with sufficient diligence etc.), but must also have the ability to look ahead and make long-range plans that will produce future growth without taking huge financial risks. The second trait management must have is integrity, as they will always be closer to the business' affairs than stockholders.

Many are of the view that to make the most money in the market, one must be a contrarian, zigging when the market zags. However, this is not enough: the contrary opinion must also be correct. Simply going against the prevailing opinions will not result in outperformance, and can result in detriment. For example, as it became obvious that the automobile would replace the streetcar, shares in the latter sold at ever-lower P/E values; nevertheless, it would have been costly to buy these securities simply on the grounds that they were not favoured by the market. It is for this reason that Fisher came up with the three-year rule, as a quantitative check to stop him from continuing to be go against the market for too long.

Fisher has also played around with market timing. However, he found that the gains that were to be made (if there were any) were small relative to what could be made from trying to find the truly homerun stocks that are out there.

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

An investment philosophy (unless copied from someone else) does not develop in a day or even a year. Instead, it evolves over time using logical reasoning, experience and research. In this the first chapter, Fisher describes how his investing philosophy evolved by taking the reader through the major experiences that influenced his interaction with the stock market.

Fisher first gained interest in the market as a young boy who witnessed his grandmother's discussions with her nephew about her stock investments. As the roaring 1920s continued, Fisher dabbled in the market and made a few dollars himself, but he realizes now that at that time he learned nothing of value when it came to investing.

Fisher learned more about evaluating business potential while at Stanford's Graduate School of Business. He would have weekly discussions with one professor in particular about specific companies that the class would visit in order to evaluate.

As the stock market continued to ramp up, financial firms were looking for warm bodies to sell securities. Fisher took a job at an investment bank doing something he now calls "intellectually dishonest". As a Wall Street statistician (which analysts were called back then, until the market crash made statisticians so unpopular that a name change was required), Fisher would pump out reports, without doing any proper research, about new security issues that would allow salesmen to push the issues on their customers. It was here that Fisher realized that there must be a better way to do this.

Fisher began to study companies more thoroughly to test if this was true. In one of his first experiments, he spoke to retailers about some of their radio products. Much to his surprise, everyone he spoke to across a number of different firms all had similar things to say. As a result, Fisher was able to predict the demise of a popular company on the basis that it's products were not doing very well.

Furthermore, in August of 1929 Fisher's evaluation of the stock market was so bearish that he issued a report to the officers of his bank that the next six months would see the beginning of the greatest bear market in a quarter of a century. Nevertheless, Fisher did not put his money where his mouth was, and lost a lot of money in the ensuing stock market collapse.

Following the crash, jobs in the finance industry were hard to come by. Fisher realizes now that it was a great time to start his own firm, but back then he had little choice, as only menial jobs were available. Therefore, in a small office with expenses of $25/month, Fisher started his own advisory firm. In the first year, he made a profit of just $3/month, and in the following year it would grow to $30/month. This is the kind of money he could have made as a newsboy selling papers, but it laid the foundation for a business that would prove to be extremely profitable.