Phillip Fisher - 15 Point Checklist
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In today’s review week look at the book Common Stocks and Uncommon Profits, by Phillip Fisher.
Fisher is widely labelled as the father of growth investing, and his work comes highly recommended by the likes of Warren Buffet.
Inventor of the word ‘Scuttlebutt’ Fisher describes how investors scramble everywhere, looking for pieces of information to establish the prospects of a company.
Fishers philosophy however centred around finding strong management teams, and excellent growth potential.
Fortunately the work of Fisher lives on, and thanks to his writings he discloses a 15-point checklist to discover common stocks and uncommon profits.
Let’s take a look at the key thoughts from one of the world’s best investors.
When I first read the book, it soon became clear to me that Fishers investing approach was rather subjective, relying on qualitative questions as opposed to using specific values or financial ratios often referred to by other investors.
Contrary to the beliefs of other investors like Benjamin Graham who was a pure value hunter, Fisher was not concerned about paying for a stock which was ‘perceived’ to be expensive.
Value investors like Graham look to determine the intrinsic value of a stock, whilst evaluating quantitative criteria to find undervalued opportunities, thereby buying stocks which offer a margin of safety.
Growth investors like Fisher, however, are happy to buy stocks which are considered overvalued, on the premise that the growth potential would more than justify the ‘expensive’ purchase price.
Considered as a long-term investor, Fisher said;-
“If the job has been correctly done when stock is purchased, the time to sell it is almost never.”
Although Fisher does suggest that any purchase which later fails his 15 questions (which we discuss shortly), consideration should be given to replacing the stock with a more attractive proposition.
A great example of Fisher not selling a stock was his purchase of Motorola in 1955. The evolution of its products driven by the research and development efforts, led to Fishers purchase to increase 20-fold.
Fisher accepted that his qualitative approach was not easy, and said:-
“Great stocks are extremely hard to find. If they weren’t, then everyone would own them.”
Let’s take a look at the 15-point checklist Fisher refers to in order to find these great growth stocks.
You will see that the checklist is not about analysing numbers, its about getting to the heart of the business, understanding what makes the business tick and ultimately what makes the company grow.
The convenience of finding the answers was often limited to attending Annual General Meetings. As such, Fisher did not look for diversification, he spent the time to search for the few stocks which passed his checklist criteria and made
The 15-point checklist is not exhaustive but many of the questions do not have a simple answer, leaving them open to a certain degree of interpretation.
Number one on the checklist relates to products and services.
Does the company have the products or services, with sufficient market potential, to make possible a sizable increase in sales for at least several years?
The company Heely’s was a prime example of not having sufficient market potential, the wheel in the shoe fad soon faded, along with its share price.
Number two on the checklist.
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?
The company Apple is a great example of determination. Under the leadership of Steve Jobs, Apple continued to develop new products. Year on year unveiling new products whilst promoting continual sales growth. The company Samsung would be another great example.
Next, we ask the question;
How effective are the company’s research and development efforts in relation to its size?
Typically, a company is either over-spending or under-spending. An established company may have a bigger moat and therefore spend less on R&D, whereas a younger company may need to overspend on research or on developing a product to provide an advantage over its competitors.
Warren Buffet believes a high R&D is often a negative and compromises the businesses profitability.
Next, Does the company have an above average sales organization?
“It is the making of repeat sales to satisfied customers that is the first benchmark of success”
After all, if you cant sell the product and keep the customer happy, there is only one way the business is heading..
Does the company have a worthwhile profit margin?
Clearly a company with good profit margins is often more favourable than one without.
An example is a company I’m considering called Pathfinder Bancorp, the operating margins are being reported between 15 and 20% consistently year on year. This is one of the many factors I look at prior to an investment decision.
Question 6 on Fisher’s checklist is;
What is the company doing to maintain or improve profit margins?
Again, another question which queries the intention and motivation of the management team. An annual report could be a key document to find the answer.
Does the company have outstanding labour and personnel relations?
“Companies with good labour relations usually are the ones making every effort to settle grievances quickly. The investor who buys into a situation in which a significant part of earnings comes from paying below standard wages for the area involved, may in time have serious trouble on his hands”.
Social media could be a good place to start or may be a website like Glassdoor to reveal insider reviews.
Number eight on the list asks;
Does the company have outstanding executive relations?
“The company offering greatest investment opportunities will be one in which there is a good executive climate. Executives will have confidence in their president and/or board chairman. This means, among other things, that from the lowest levels on up, there is a feeling that promotions are based on ability, not factionalism”.
Does the company have depth to its management?
The company Tesla would be a prime example here. Would the company still grow and have the same vision without Elon Musk?
Fisher’s ideal is for upper management to delegate to lower levels of management.
Warren Buffet made a great quote when he said;
“I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will”.
Question ten on the checklist asks;
How good are the company’s cost analysis and accounting controls?
As investors we are reliant on the information produced in the financial statements. We can then look at key ratios to make a more informed judgement.
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?
A very broad, subjective question.
Perhaps the strength of a patent could provide clues to the future of the company…
Does the company have a short range or long-range outlook regarding profits?
Many growth stocks are priced on their potential earnings rather than the intrinsic value. The company Amazon being a great example. Its valuation at the time of writing is 1.1 Trillion yet its revenue is lagging at 251 Billion, providing a PE ratio of 72.
Jeff Bezos is the visionary force behind Amazon, as a result the profit potential is likely to be in the longer-term horizon.
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?
In simple terms, this refers to share dilution. Share dilution is the issuance of new stock into the market to raise capital, which thereby reduces the shareholders proportional ownership of the company.
Personally, I look for strong balance sheets with a more self-sufficient means for growth, rather than companies showing a history of share dilution.
14th on the checklist asks;-
Does the management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur?
This is self-explanatory, transparent communication to investors is paramount for both trust and clarity, regardless if the message is positive or not.
Does the company have a management of unquestionable integrity?
Again, this speaks for itself, a company which falls short of moral responsibility should be left alone. The company Enron is another great example. Investors lost millions because of the historic scandal.
Evidently, finding answers to all these questions is not an easy task, but Fisher reminds us:-
“Buying a company without having sufficient knowledge of it may be even more dangerous than having inadequate diversification.”
To summarise Fisher’s checklist, we can categorise them into three main areas; -
Management, Scalability and Finances.
Does the management team offer integrity, direction, motivation and have depth beyond the CEO?
Does the company have a product or service aligned with a growing demand, and is there an advantage to be gained over a competitor?
Does the company have a good profit margin supported by a solid balance sheet?
If you can find the answers to these questions, it’s likely you have found a great company.
A non-believer of efficient market theory, Fisher summarises his philosophy when he says;-
"I do not believe that prices are efficient for the ‘diligent’, ‘knowledgeable’, ‘long-term’ investor".
In essence, Fisher’s approach relied on his Scuttlebutt method, expending the time and energy to gain as much knowledge as he could to make a long-term investment decision.
A unique approach, published into a great book which became the first of its kind to make the New York Times bestseller list.
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