Book: Common Stocks and Uncommon Profits
Author: Philip Fisher
I need to get this out of the way. This is a great great book, but the introduction by the author’s son, Ken Fisher, spoiled the taste in my mouth a little as the son Fisher took time to talk about his father in way so that he could talk much about himself. Anyway, that did nothing to dull the beauty of this book. This is easily one of the best books I have read on investing (big surprise, given that this is one of the classics). Here we go.
The biggest takeaway from the book is that one should buy stocks to hold them for the very long run (reminds you of Buffett’s philosophy?). Fisher’s take on it is that the one should continue to hold the stocks even if the stock appears overvalued at the moment as long as you can ascertain that its peak earning power hasn’t past, among other things. In the very first chapter, he talks about the era before 1913, when federal Reserve was established–the era when the business cycle was even more pronounced, and stock market gyrated even more. Fisher says that even in these time, people who bought and held stocks made more money than those who bet on the cycles. He says that the only times you should sell are (a) when a mistake has been made, or (b) when the next peak earning power adjusted for the business cycle activity will be less than what it is now/has been. He thinks its is not worth disturbing a position that could likely be a great deal worth more even if it is 35% overpriced because you risk losing the future returns and incur a capital gains tax liability.
He says that companies with truly unusual prospects for growth are hard to find because they’re so rare AND they can be differentiated from a run of the mill company 90% of the times. On the other hand, it is vastly more difficult to understand what the market or the business cycle will do in the next few months. Thus, it is much likely for one to be wrong when guessing the short-term changes for a stock than assessing long-term prospects of a company. This is why one should not be selling a position in anticipation of market downturns. He says that the EMH is true in the narrow sense that it is very hard to make money in and out of stocks by trading them, but as owners and investors, one can beat the theory.
The second biggest takeaway is the idea of ‘scuttlebut’–someone who gets information from industry contacts that one develops and speaks with a bunch of them to get a more colorful picture of the company so one can understand the competitive position of the industry and company better. I guess this is what we could call “channel checks” in today’s parlance.
Fisher provides fifteen points to look for in a common stock
This is a very well-curated list, but I don’t think that this is where the book pays for itself. Most investors already look for most of the items listed below, and the list is not as useful as it must have bee back in 1958. Nonetheless, it is a phenomenal checklist.
- Can the firm have potential for sizable increase in sales for years to come?
- Does the management strive to develop products that will compensate for stabilization decline of the sales of the existing products? (some large companies tend to interrupt regular R&D for pet projects, which is often not successful).
- How effective are firm’s R&D efforts? Also, need to better understand what companies mean by R&D. Sometimes market research, or simple sales engineering is bucketed under R&D, and doesn’t represent true developmental research.
- Does the company have an above-average sales organization? (Fisher says that this is the trait that is most difficult to evaluate)
- Does company have a decent profit margin or is it a marginal company?
- What is the company doing to improve margins? (this is something the management will freely talk about)
- Does the company have outstanding labor and personnel relations?
- … outstanding executive relations?
- … has depth in its management?
- How good is company’s cost analysis and accounting controls? (in most of the cases, if the company is good at most of the other things, it can be assumed that the company is good at this too).
- Are there any other aspects of the business (perhaps peculiar to the business) that will give a hint about the company’s standing vs. the competition?
- Does the company have a short-range or long-range outlook when it comes to profits?
- Will the foreseeable growth require equity financing?… if it is years ahead, it is not that important as it can be assumed that the prices will be at a much higher levels. (quite an assumption here)
- Does the management talk even when things are not going well?
- Does the company have management of unquestionable integrity?
Stocks vs bonds
Fisher makes a strong case for stocks over bonds using the following logic. He says that the way our laws are written, and our accepted beliefs about what to expect in a recession, makes one of the two things likely. One, either the business will remain good and stocks will outperform bonds, or a significant recession will happen, when for a while bonds will out-perform stocks, but the recessions will cause the Fed to intervene (causing inflation) and the Federal government to produce deficits that will together lower the value of fixed-income instruments. This, of course, does not apply in the 2008 recession, as that was brought by collapse of the financial system after an obscene amount of debt was built in the system, and the Fed very quickly hit the zero-bound line of interest rates, and banks made hardly many loans post-recovery, causing very little inflation.
When to buy?
Fisher says that people often rely too much on the business cycle to make this decision, but this is but one of forces; the others are (a) interest rates, (b) government attitude toward investment and private enterprise, (c) inflation trends, and (d) new inventions that affect existing industries–the most powerful force. He says that instead of relying on the business cycle and general stock market trend, people should buy when funds are available. He says that buying points do no necessarily come out of corporate troubles, but could be a case where significant capex has been spent to get a plant running and some incremental capex can improve the productivity by a lot, which would a very high ROIC when thought of as a project on its own.
What about dividends?
Fisher thinks that dividends are overhyped. The company should allocate assets to pursue maximum future cash flow growth. He says that the company in the end attracts the investor-base it wants to, as long it doesn’t change its dividend policy–more important than high dividends is a consistent dividend policy. He compares a company to restaurant. He says that a restaurant can’t succeed if it catered to different clientele every day; it must be somewhat consistent.
Some interesting tidbits from the book-
- Industrial organizations used to have small R&D departments. Research activity increased for military purposes at first due to fear of Adolph Hitler.
- Capex and D&A is an interesting area where accounting, which doesn’t account for time value of money, can confuse people. Capex is always spent in current $s but D&A is spent in old $s which have a higher value than the simple accounting rules shows them for. This needs to be kept in mind as one analyzes companies with long depreciation schedules. This is beneficial for growth companies as they’re spending capex so fast that the D&A is recent $s and hence they’re obfuscating less than what older slower-growth companies would have.
- Don’t over-stress diversification
- Fisher talks about one of the ways in which the leader always remains the leader. He talks about situations where the buyer comes back to leader because no one will criticize the purchasing manager for making a safe decision, unless there is a significant economic difference.