Part 4: A Summary of the Fisher Approach to Investing in Quality Growth Stocks
Philip Fisher is a strong believer thatthe market is not efficient. Occasional fads and styles in the market may producedistortions in the relationship of existing prices to real values. With the same set offacts, the market may reach different conclusions depending upon its physiology of themoment. Realities not only terminate these distortions, but also often cause the emotionto swing to the opposite extreme.
To succeed you must be able to see through the market opinion and discover the actualfacts. Do not blindly accept or reject the market opinion. You must be knowledgeable,exhibit good judgment, and have enough courage to act based upon your conviction.
As the saying goes, nothing is worth doing unless it is worth doing it right. While therewards of investing in growth stocks are tremendous, the penalties for making judgmentsbased upon only a superficial analysis are equally large. Fisher felt that making somemistakes is an inherent cost of investing for major gains. He said that the key tolong-term success is to do your homework, recognize mistakes as soon as possible, andlearn how to keep from repeating your mistakes Luck tends to even out in the long run.
The Fisher Growth Approach in Brief
Philosophy and style
Investment in "outstanding" companies that over the years can grow in sales andprofits more than its industry as a whole. The best opportunity for extraordinary profitscomes from buying "outstanding" companies at undervalued levels. The keyfeatures of "outstanding" companies are: strong management that has adisciplined approach designed to achieve dramatic long-term growth in profits, withproducts or services that have the potential for sizable sales long term, and with otherinherent qualities that would make it difficult for competitors and newcomers to share inthat potential growth.
Universe of stocks
No restrictions on universe of stocks from which to select. Over-the-counter stocks shouldnot be overlooked, but "outstanding" companies are not necessarily young andsmall.
Criteria for initial consideration
Prospective companies should pass most of the following 15 points, which can be dividedinto three main dimensions:
Functional factors:
- Products or services with sufficient market potential for sizable increase in sales for several years. Major sales growth, judged over series of years.
- Superiority in productionlowest-cost production (for manufacturing firms) or lowest-cost operation (for service firms or retailers).
- Strong marketing organizationefficiency of sales, advertising, and distributive organizations.
- Outstanding research and development effortsamount expended relative to its size, effectiveness of effort as indicated by ability to bring research ideas to production and to market and by how much research contributed to net profits.
- Effectiveness of company's cost analysis and accounting controls, and choice of capital investments that will bring the highest return.
- Financial strength or cash positionsufficient capital to take care of needs to exploit prospects for next several years without the need to raise equity capital.
Excellence in management
- Attitude of management to continue to develop products or services that will further increase sales. Development of good in-house management and teamwork.
- Management depth.
- Good labor and personnel relations: Affiliation with an international union may be an indication of bad relations; labor turnover relative to competitors.
- Long-range outlook by management even at the expense of short-term profits.
- Good investor relations, and willingness to talk freely about problems.
- Management of unquestionable integritysalaries and perks in line with those of other managers.
Business characteristics
- Above-average profitability: Compare profit margins per dollar of salescompare within industry and examine for several years, not just single years. Older and larger firms are usually the best in their industry. Younger firms may elect to speed up growth by spending all or a large part of profits on research or sales; for these, make sure a narrow profit margin is due to spending in these areas alone.
- Ability to maintain good profit margins: Good position relative to competitionfor instance, skill in a particular line of business, or patent protection for a small business.
Secondary factors
Once an "outstanding" company is found, purchase stock when it is out-of-favoreither because the market has temporarily misjudged the true value of the company, orbecause of general market conditions. "Outstanding" companies can also bepurchased at fair value, but investor should expect a lower (but respectable) return.
Stock monitoring and when to sell
- Use a three-year rule for judging results if a stock is underperforming but no fundamental changes have occurred.
- Hold stock until there is a fundamental change in its nature or it has grown to a point where it will no longer be growing faster than the overall economy.
- Don't sell for short-term reasons.
- Sell mistakes quickly, once they are recognized.
- Don't overdiversify10 or 12 larger companies is sufficient, investing in a variety of industries with different characteristics.