Boganmeldelse af Phil Fishers "Common Stocks and Uncommon Profits"

Book Summary

Common Stocks and Uncommon Profits

July 9, 2017

This post is also available in: Dansk

Abstract

  • Warren Buffett claims that his investment philosophy is 85% Benjamin Graham, and 15% Phil Fisher – the author behind this book. Phil’s focus is on spotting longterm growth stocks that can manyfold in value. Below you’ll find Phil’s 15 questions, which investors should answer in order to find such growth rockets.
  • The questions mainly deal with management, profitability, growth potential in current product lines as well as willingness to allocate capital to new ventures once the current offerings’ potentials are exhausted.

Warren Buffett is famous for claiming that his intellectual genetics are composed of 85% Benjamin Graham (the author of The Intelligent Investor and Security Analysis), and 15% Phil Fisher – the author of Common Stocks and Uncommon Profits. I was thus ‘forced’ to read this book when one of my personal heroes praised the work so highly. Chapter 3 is the corner stone in my opinion, which is why I have dedicated this post to outline it.

The 15 questions that’ll aid you in spotting growth rockets
As mentioned, chapter 3 outlines the 15 questions one should address in the quest for growth rockets that have the potential to manyfold in value. You don’t necessarily have to set a checkmark for every single question, but if you can only convincingly answer a few of them in a positive light, chances are that the idea should go into the ‘no thanks’-pile. Please note that Phil’s focus is exclusively on longterm investments that’ll keep growing indefinitely. Hence, this list is not for the speculator looking for a quick buck. It’s for the patient investor who’s on the lookout for true compounding machines.

1) Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years? In length of the previous paragraph, Phil recommends that you disregard businesses that only have a few years of growth prospects. You should evaluate whether there will be a demand for the company’s products/services decades into the future now. A good starting point is looking at the earnings stability over the previous 10 years or more.

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? Phil is on the lookout for evidence that management is willing to allocate capital to R&D ventures in an attempt to improve and renew existing products as well as developing new ones. Such a mangement team recognizes that the company’s products’ growth potential will be exhausted in the long run, and knows that the development of new business areas is a necessity for longterm shareholder value.

3) How effective are the company’s research-and-development efforts in relation to its size? Phil discusses the difficulty of assessing the R&D efforts from the annual reports, since accounting practices are ‘fluffy’ in this domain. Instead, Phil recommends that you look at it from a more qualitative perspective. He suggests that analysts take a look at how many new products the company introduces each year and how much these contribute to the total sales and earnings volume. A company, which have successfully introduced profitable products relative to its size over e.g. a 10 year period, could be expected to continue doing so into the future.

4) Does the company have an above-average sales organization? Phil explains that a well-functioning sales department is the most vital organ in any company. Once again, Phil takes a more qualitative approach when recommending that the analyst should look “behind the numbers”. He uses IBM as a prime example, since its sales personel uses 1/3 of its time on training and education on IBM’s own institutes. A company that constantly focuses on sales growth and development of its sales force is a company that focuses on longterm shareholder value.

5) Does the company have a worthwhile profit margin? In length of question 4), Phil reminds the reader that sales growth only adds value as so forth the company is able to increase its operational profits accordingly. You have to consider whether revenue dollars turn into earnings dollars.

6) What is the company doing to maintain or improve profit margins? Phil points out that investment success does not rest on what the past has taught us about the company, but what the future will teach us. In conjunction with point 5), the analyst has to evaluate if the past’s profit margin can be expected to continue or improve into the future. Usually, the threats against a company’s profit margin are many. How’s the outlooks in terms of employee salary increases? Are there price increases on raw materials and equipment in the wakening? Does the company possess a pricing power that enables it to increase its prices? Answer these and other relevant questions when assessing whether the company’s profitability might be under pressure.

7) Does the company have outstanding labor and personnel relations? Phil stresses the importance of a company’s relations to its employees. The profitability of businesses with strong employee relations often significantly exceed those companies with only mediocre ones. A neat starting point may be to look at the turnover rate of the company’s personel, job satisfaction surveys as well as the number of applications for positions.

8) Does the company have outstanding executive relations? Phil exclaims that good relations with ‘lower ranking’ employees are important, but solid relations on the executive level is crucial. It’s the ingenuity and team-work of the top management team that’ll define whether the business will “break it or make it”. There hence has to be an excellent climate in the top ranks, e.g. proven by a high level of confidence between the CEO and the board.

9) Does the company have depth to its management? A business can not be reliant on a single person, e.g. a CEO. Companies that are able to grow indefinitely are those who focus on cultivating capabilities in individuals in an attempt to prepare each employee for a top position. The most important policy in this regard is to provide each individual the authority and freedom to perform tasks in an efficient and innovative manner.

10) How good are the company’s cost analysis and accounting controls? Phil explains that a company should have a clear overview of what their costs per product line are, hence empowering the management team to focus on cutting, optimizing and outsourcing where it adds most value. Ironically, investors’ chances of evaluating such are poor. Phil explains that one can only fall back to the general conclusion that a company, which is above-average in other aspects, will probably perform better than average in this regard as well.

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? This question is kind of a ‘catch all’-bucket that can be used to evaluate whether the company in question does something extraordinary in some regard. Phil mentions e.g. handling of leases, its ability to obtain patents, production know-how, customer relations, etc.

12) Does the company have a short-range or long-range outlook in regard to profits? Some companies focus on here-and-now profits, which may cause them to burn bridges to suppliers or customers to twist the last few dollars out of a relationship before the next quarterly report. Other companies have a longterm focus, which is why those businesses are willing to pamper their suppliers, give customers a discount etc. in order to establish goodwill that can be capitalized on in the long run.

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? Phil underscores the importance of acquiring stakes in companies with a strong financial foundation that warrants additional borrowing for e.g. expansion rather than issuing/selling shares. These methods are inexpedient ways to raise capital, as it cuts directly into the EPS of the outstanding shares.

14) Does management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur? Profit disappointments, shifts in demand for one’s products, failed product launches etc. are the unavoidable reality for even the most succesful companies. The key is transparency; the management team has to be open about such matters. Companies that ‘clam up’ are companies to avoid, Phil advises.

15) Does the company have a management of unquestionable integrity? All other points are completely irrelevant if the answer to this question is anything but a resounding “YES!” The company’s management team is closer to the business’ assets than the shareholders. If you can’t trust that the executives manage these assets to the best of their abilities on behalf of the shareholders, there can be no discussion: the idea must be placed in the ‘no thanks’-pile.

In my view, this book vary from other value investing books. Most books’ main focus is on acquiring assets cheaply. That’s not the focus of Common Stocks and Uncommon Profits, which Phil describes something along the lines of: “The intelligent investor should not buy stocks just because they are cheap, but because they promise him a huge return.” It’s all about spotting longterm growth stocks that can increase their value manyfold – the above points are the recipe for doing so.

This post is also available in: Dansk

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