Buying ‘superior’ companies
So far, we have reviewed the investing styles of Benjamin Graham, Peter Lynch and John Neff, three of the most successful money managers and investors of contemporary times.
Our next subject is Philip Fisher, another legendary master who, like the previous three, combined growth and value investment styles to their limits.
I must say, I have been under some pressure to go straight to Warren Buffet. He is the most-sought study in today’s troubled market with his continued record of success. However, I thought we should first take a look at Philip Fisher’s investment method for two reasons. First, Philip Fisher is one of two financial professionals named by Warren Buffet to have a significant influence in his investing style. Second, Warren Buffet is more complex than what he seems to be in simple stories told about him, that I thought the best way to present him and his investing style is to first sift through the methods of people in the investment community who had a profound impact on his professional practice.
Fisher wrote several books on stock investments. However, he is best known for the book titled “Common Stocks and Uncommon Profits.” This book, in addition to Benjamin Graham’s “The Intelligent Investor,” had a profound impact on Warren Buffet. It was reported that because Buffet was so impressed with the book, he even went to the extent of meeting Fisher personally to learn more.
When interviewed by “Forbes” in 1969, Buffet declared: “I’m 15 percent Fisher and 85 percent Benjamin Graham.”
Fisher strongly advocated buying what he called “superior” companies. These are companies “with the ability to grow sales and profits over the years at rates greater than their industry average”—revealing his predilection toward companies with high-growth potentials in combination with the principal norm of buying companies that give good value.
He further refined this norm with the added standard that he preferred companies that are not just “fortunate and able” but are “fortunate because they are able.”
These distinctions are very important, according to him. To make his point clearer, he describes a “fortunate and able company” as one that “has a good product right from the start, solid management and it benefits from factors beyond the company’s control such as an unforeseen use of its products.”
In contrast, he describes a company that is “fortunate because it is able” as one that “might have a mediocre product to begin with, but the management team is so clever that they adapt the product to the marketplace and diversify into other areas that offer opportunity.”
Thus, “fortunate-because-they-are-able” companies are “superior companies” that “have a high quality of people that direct the day-to-day operation and long-term planning of the business, endowed with high integrity such as honesty and personal decency, along with outstanding labor and personal relations and outstanding executive relations.”
To insure success, Fisher also demands that you invest in industries you are only familiar with. He calls this “your circle of competence.” To him, this requirement becomes all the more important as you “conduct thorough, unconventional research” to find superior companies.
According to Fisher, too, good and reliable information can be best obtained by interviewing “individuals who know the company, customers, suppliers, former and current employees, competitors, industry associations.” These people have tidbits of information, which he calls “scuttlebutt” (a Navy term describing gossip around a ship’s drinking fountain). The scuttlebutt is what he also calls “the business grapevine” in investing.
Fisher also recommends that one should have a “focused portfolio” only because of the extensive research effort needed to uncover superior companies. He said, “investors should not have more than what they could keep tract of.”
He, thus, seldom maintained 10 companies in one portfolio. Even at that, “the portfolio’s money is concentrated in three to four stocks” only. As he always emphasized, “a few superior companies are better than a slew of mediocre ones.”
Fisher particularly makes his moves to purchase companies when they are experiencing depressed earnings either because they are yet at the initial stage of construction of a new plant that will increase productivity or at the initial phase of introducing a sure-winner but new product.
He also likes to “buy when there is bad corporate news, such as when there is a strike, a marketing error or some temporary misfortune.” On capital intensive companies, he likes to “buy them after they had made unusually large capital investments” in which immediate profits—and consequently their stock price— will suffer.
He observed that after the capital investment and “the resultant product has been in production for a while, engineers figure out how to increase their output substantially by spending a relatively modest amount of additional capital. This may produce a significant improvement in the company’s profits.”
A familiar current strategy, Fisher also likes to “buy on a war scare.” He says that governments plunge into debt to pay for a war, resulting in debasing the currency.” And “prices of things go up, including stocks, which represent ownership of physical assets,” he adds.
Fisher only sells in the following situations: “When a mistake was made in the first place; the company or industry has changed and the stock no longer qualifies as a growth stock; a better prospect is available, and after three years, if the stock underperforms the market.”
Also, “Fisher does not sell just because a stock appears to be selling for a P/E ratio (PER) significantly above average, or because the stock price has risen.”
Other than the above said grounds, Fisher will almost never sell.
Bottom line spin
Last week, trading was suspended from Monday to Wednesday. When trading resumed on Thursday, we witnessed a repeat of the frightening drop the market suffered last June 13, right after the observance of Independence Day.
The market fell 389.22 points or 5.96 percent; a little less than the 442.57 points or 6.75 percent the market suffered then.
Like before, the market recovered the following day. However, the recovery was less vigorous, indicative of the less favorable status of the market—possibly—in the next two or three weeks.