FOOL SCHOOL
Stock Market Greats - Philip Fisher

September 28, 2005

You could say Philip Fisher was the stock market's first 'tech investor'. Originally published in 1958, his book, Common Stocks and Uncommon Profits, broke new ground in explaining how investors could judge fast growing, innovative companies. Fisher famously used his techniques to pinpoint the likes of Motorola (NYSE: MOT) and Texas Instruments (NYSE: TXN) in the mid-1950s, two stocks that registered substantial gains over the following decades.

When compared to many other stock market greats, Fisher's philosophy is notable for its near-total focus on qualitative matters. An ardent advocate of the long-term buy and hold, Fisher spent little time worrying about traditional valuation measures and in-depth number crunching.

Encapsulating his strategy, Fisher remarked: "Finding the really outstanding companies and staying with them through all the fluctuations of a gyrating market proved far more profitable to far more people than did the more colourful practice of trying to buy them cheap and sell them dear".

Indeed, the following quote, referring to a purchase of Motorola in 1955, sums up Fisher's philosophy well: "I became impressed both with the people [at Motorola] and with Motorola's position in the mobile communications business, where an enormous potential seemed to lie; whereas the financial community was valuing it as just another television and radio producer".

Scuttlebutt

The key to Fisher's philosophy was ensuring he was well ahead of the stock market with his research. Fisher wanted to latch onto great growth stories years before Wall Street got to hear about them. Thus he would investigate smaller companies whose technological merits were -- at the time -- generally labelled "highly speculative and beneath the notice of conservative investors or big institutions".

Of course, the field of long-term investment in technology-related companies is fraught with difficulty. Therefore, Fisher's ambition was to "distinguish the relatively few companies with outstanding investment possibilities from the much greater number whose future would vary all the way from the moderately successful to the complete failure."

To identify suitable companies, Fisher used his scuttlebutt approach. Whether they were employees, rivals, customers, suppliers, members of a trade association or involved in academic research, Fisher would speak to as many people that had some connection with a company or industry as possible.

As Fisher wrote: "The business grapevine is a remarkable thing. It is amazing what an accurate picture of the relative points of strength and weakness of each company in an industry can be obtained from a representative cross-section of the opinions of those who in one way or another are concerned with any particular company."

Fifteen points

Using the information from his scuttlebutt efforts, Fisher boiled down his stock picking approach into fifteen fundamental questions:

1. Does the company have products or services with sufficient market potential to make possible a sizeable increase in sales for at least several years?

2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?

3. How effective are the company's research and development efforts in relation to its size?

4. Does the company have an above average sales organization?

5. Does the company have a worthwhile profit margin?

6. What is the company doing to maintain or improve profit margins?

7. Does the company have outstanding labour and personnel relations?

8. Does the company have outstanding executive relations?

9. Does the company have depth to its management?

10. How good are the company's cost analysis and accounting controls?

11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?

12. Does the company have a short-range or a long-range outlook in regard to profits?

13. In the foreseeable future, will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders' benefit from this anticipated growth?

14. Does the management talk freely to investors about its affairs when things are going well, but 'clam up' when troubles and disappointments occur?

15. Does the company have a management of unquestionable integrity?

A casual glance at the questions clearly highlights Fisher's preference for assessing a company's products, people, industry position and growth potential, rather than getting heavily involved with the numbers. As Fisher writes: "Few of these matters are largely determined by cloistered mathematical calculation"

Such an attitude also allowed Fisher to disregard precise forecasting and traditionally high valuations, two common arguments often made against "growth investing": "The investor cannot pinpoint just how much per share a particular company will earn two years from now... [but] he should come pretty close in judging whether a sizeable increase in average earnings is likely to occur a few years from now. But just how much increase, or the exact year in which it will occur, usually involves guessing on enough variables to make precise predictions impossible.

Under such circumstances, how can anyone say with even moderate precision just what is overpriced for an outstanding company with an unusually rapid growth rate? If the growth rate is so good that in another ten years the company might well have quadrupled, is it really of such great concern whether at the moment the stock might or might not be 35 percent overpriced? That which really matters is not to disturb a position that is going to be worth a great deal more later".

Basics

Away from the specific stock picking advice, Fisher gives healthy guidance on general investment topics. His comments on diversification ("In the field of common stocks, a little bit of the great many can never be more than a poor substitute for a few of the outstanding") reputedly influenced the (then) young Warren Buffett. Other sound Fisher advice warns of the perils of following the crowd ("the ability to see through some majority opinions to find what facts are really there is a trait that can bring rich rewards"), and (appropriately, given recent events) of not being afraid of buying on a war scare ("The investor should ignore the scare psychology of the moment and definitely begin buying").

Furthermore, Fisher also laid down what have since become the definitive principles of selling an investment, a topic often overlooked by many investment writers:

1. When it becomes increasingly clear that the factual background of the particular company is less favourable than originally believed;

2. When the company no longer passes the fifteen tests to the same degree it qualified at the time of purchase, and;

3. When an alternative company with seemingly much better prospects is discovered.

Indeed, Fisher condensed his whole 'sustainable growth' strategy in the following opinion: "If the job has been correctly done when a common stock is purchased, the time to sell it is - almost never."

Although long-term investing in technology shares is considered akin to reckless gambling in the current stock market climate, Fisher's work still remains essential reading. In fact, given the current attitude towards Fisher's favoured industries, Common Stocks and Uncommon Profits may even prove profitable reading, too.

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