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Below are my notes for the book: The Most Important Thing: Uncommon Sense for the Uncommon Investor. I tend to keep notes on things that I have not read in other investment books but if I find that there is an overlap and especially if it was not particularly useful, I will omit that addition into my notes.

Since other investors may be smart, well-informed and highly computerized, you must find an edge they don’t have. You must think of something they haven’t thought of, see things they miss or bring insight they don’t possess. You have to react differently and behave differently. In short, being right may be a necessary condition for investment success, but it won’t be sufficient.

Second-level thinking is deep, complex and convoluted. The second- level thinker takes a great many things into account:
* What is the range of likely future outcomes?
* Which outcome do I think will occur?
* What’s the probability I’m right?
* What does the consensus think?
* How does my expectation differ from the consensus?
* How does the current price for the asset comport with the consensus
view of the future, and with mine?
* Is the consensus psychology that’s incorporated in the price too bullish
or bearish?
* What will happen to the asset’s price if the consensus turns out to be
right, and what if I’m right?

To outperform the average investor, you have to be able to outthink the consensus. Are you capable of doing so? What makes you think so?
Second-level thinkers know that, to achieve superior results, they have to have an edge in either information or analysis, or both. ey are on the alert for instances of misperception.
* Why should a bargain exist despite the presence of thousands of inves- tors who stand ready and willing to bid up the price of anything that’s too cheap?
* If the return appears so generous in proportion to the risk, might you be overlooking some hidden risk?
* Why would the seller of the asset be willing to part with it at a price from which it will give you an excessive return?
* Do you really know more about the asset than the seller does?
* If it’s such a great proposition, why hasn’t someone else snapped it up?

Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity. At that point, all favorable facts and opinions are already factored into its price, and no new buyers are left to emerge.

The safest and most potentially profitable thing is to buy something when no one likes it. Given time, its popularity, and thus its price, can only go one way: up.

To sum up, I believe that an investment approach based on solid value is the most dependable. In contrast, counting on others to give you a profit regardless of value—relying on a bubble—is probably the least
Like opportunities to make money, the degree of risk present in a market derives from the behavior of the participants, not from securities, strategies and institutions. Regardless of what’s designed into market structures, risk will be low only if investors behave prudently.

I’m firmly convinced that investment risk resides most where it is least perceived, and vice versa:
When everyone believes something is risky , their unwillingness to buy usually reduces its price to the point where it’s not risky at all. Broadly negative opinion can make it the least risky thing, since all optimism has been driven out of its price.

This paradox exists because most investors think quality, as opposed to price, is the determinant of whether something’s risky. But high quality assets can be risky, and low quality assets can be safe. It’s just a matter of the price paid for them. . . . Elevated popular opinion, then, isn’t just the source of low return potential, but also of high risk.

Bottom line: risk control is invisible in good times but still essential, since good times can so easily turn into bad times.

Over a full career, most investors’ results will be determined more by how many losers they have, and how bad they are, than by the greatness of their winners. Skillful risk control is the mark of the superior investor.

Many people possess the intellect needed to analyze data, but far fewer are able to look more deeply into things and withstand the powerful influence of psychology. To say this another way, many people will reach similar cognitive conclusions from their analysis, but what they do with those conclusions varies all over the lot because psychology influences them differently. The biggest investing errors come not from factors that are informational or analytical, but from those that are psychological.

Time and time again, the combination of pressure to conform and the desire to get rich causes people to drop their independence and skepti- cism, overcome their innate risk aversion and believe things that don’t make sense. It happens so regularly that there must be something dependable at work, not a random influence.

The fifth psychological influence is envy. However negative the force of greed might be, always spurring people to strive for more and more, the impact is even stronger when they compare themselves to others. This is one of the most harmful aspects of what we call human nature.
There are two primary elements in superior investing:
• seeing some quality that others don’t see or appreciate (and that isn’t re ected in the price), and
• having it turn out to be true (or at least accepted by the market).

It should be clear from the first element that the process has to begin with investors who are unusually perceptive, unconventional, iconoclastic or early. That’s why successful investors are said to spend a lot of their time being lonely.

skepticism and pessimism aren’t synonymous. Skepticism calls for pessimism when optimism is excessive. But it also calls for optimism when pessimism is excessive.

That’s why the concept of intrinsic value is so important. If we hold a view of value that enables us to buy when everyone else is selling— and if our view turns out to be right—that’s the route to the greatest rewards earned with the least risk.

Since the efficient-market process of setting fair prices requires the involvement of people who are analytical and objective, bargains usually are based on irrationality or incomplete understanding. us, bargains are o en created when investors either fail to consider an asset fairly, or fail to look beneath the surface to understand it thoroughly, or fail to overcome some non-value-based tradition, bias or stricture.

To boil it all down to just one sentence, I’d say the necessary condition for the existence of bargains is that perception has to be considerably worse than reality. at means the best opportunities are usually found among things most others won’t do.

But one of the things I want to do in this chapter is to point out that there aren’t always great things to do, and sometimes we maximize our contribution by being discerning and relatively inactive. Patient opportunism—waiting for bargains—is o en your best strategy.

So here’s a tip: You’ll do better if you wait for investments to come to you rather than go chasing a er them. You tend to get better buys if you select from the list of things sellers are motivated to sell rather than start with a notion as to what you want to own.

The key during a crisis is to be (a) insulated from the forces that require selling and (b) positioned to be a buyer instead. To satisfy those criteria, an investor needs the following things: staunch reliance on value, little or no use of leverage, long-term capital and a strong stomach.

Investors who feel they know what the future holds will act assertively: making directional bets, concentrating positions, levering holdings and count- ing on future growth—in other words, doing things that in the absence of foreknowledge would increase risk. On the other hand, those who feel they don’t know what the future holds will act quite differently: diversifying, hedging, levering less (or not at all), emphasizing value today over growth tomorrow, staying high in the capital structure, and generally girding for a variety of possible outcomes.

Since the investors of the “I know” school, described in chapter 14, feel it’s possible to know the future, they decide what it will look like, build portfolios designed to maximize returns under that one scenario, and largely disregard the other possibilities. The suboptimizers of the “I don’t know” school, on the other hand, put their emphasis on constructing portfolios that will do well in the scenarios they consider likely and not too poorly in the rest.
* We have to practice defensive investing, since many of the outcomes are likely to go against us. It’s more important to ensure survival under negative outcomes than it is to guarantee maximum returns under favorable ones.
* To improve our chances of success, we have to emphasize acting contrary to the herd when it’s at extremes, being aggressive when the mar- ket is low and cautious when it’s high.

His views on market efficiency and the high cost of trading led him to conclude that the pursuit of winners in the mainstream stock markets is unlikely to pay off for the investor. Instead, you should try to avoid hitting losers. I found this view of investing absolutely compelling.

The choice between offense and defense investing should be based on how much the investor believes is within his or her control. In my view, investing entails a lot that isn’t.

I don’t think many investment managers’ careers end because they fail to hit home runs. Rather, they end up out of the game because they strike out too o en—not because they don’t have enough winners, but because they have too many losers. And yet, lots of managers keep swinging for the fences.

Thus, it’s important to return to Bruce Newberg’s pithy observation about the big difference between probability and outcome. Things that aren’t supposed to happen do happen. Short-run outcomes can diverge from the long-run probabilities, and occurrences can cluster.

One way to improve investment results—which we try hard to apply at Oaktree—is to think about what “today’s mistake” might be and try to avoid it.

Most investors think diversification consists of holding many different things; few understand that diversification is effective only if portfolio holdings can be counted on to respond differently to a given development in the environment.

Only investors with unusual insight can regularly divine the probability distribution that governs future events and sense when the potential re- turns compensate for the risks that lurk in the distribution’s negative left- hand tail.

This post lists my notes from reading the classic investment book: Common Stocks & Uncommon Profits. Written by the famous investment manager – Philip Fisher, the book espouses a growth investment philosophy. Growth investing involves identifying companies that will accelerate its overall market cap and net income much farther than is expected against current market expectations. The focus is not on identifying companies that are doing decently now but on companies that will be phenomenal in the future and would only require that you hold it through the journey.

The notes are split into the 15-point list that describes the attributes he’s identified for any well-run company and the second part are general comments that I found useful throughout the book.

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?

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 labor 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 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?

General Notes

Scuttlebutt means avoiding malarkey mills and seeking information from competitors, customers, and suppliers, all of whom have a vested interest in the target company, and few of whom have any reason to see the firm unrealistically.
Such a study indicates that the greatest investment reward comes to those who by good luck or good sense find the occasional company that over the years can grow in sales and profits far more than industry as a whole.

Go to five companies in an industry, ask each of them intelligent questions about the points of strength and weakness of the other four, and nine times out of ten a surprisingly detailed and accurate picture of all five will emerge.

It is equally astonishing how much can be learned from both vendors and customers about the real nature of the people with whom they deal. Research scientists in universities, in government, and in competitive companies are another fertile source of worthwhile data. So are executives of trade associations.

The investor usually obtains the best results in companies whose engineering or research is to a considerable extent devoted to products having some business relationship to those already within the scope of company activities.

Does the company now recognize that in time it will almost certainly have grown up to the potential of its pres- ent market and that to continue to grow it may have to develop further new markets at some future time?

[R&D] Figures of this sort can prove a crude yardstick that may give a worthwhile hint that one company is doing an abnormal amount of research or another not nearly enough. But unless a great deal of further knowledge is obtained, such figures can be misleading. One reason for this is that companies vary enormously in what they include or exclude as research and development expense.

A simpler and often worthwhile method is to make a close study of how much in dollar sales or net profits has been con- tributed to a company by the results of its research organization during a particular span, such as the prior ten years. An organization which inrelation to the size of its activities has produced a good flow of prof- itable new products during such a period will probably be equally pro- ductive in the future as long as it continues to operate under the same general methods.

Yet, strange as it seems, the relative efficiency of a company’s sales, advertising, and distributive organizations receives far less attention from most investors, even the careful ones, than do pro- duction, research, finance, or other major subdivisions of corporate activity

However, outstanding production, sales, and research may be considered the three main columns upon which such success is based.

If workers feel that they are fairly treated by their employer, a background has been laid wherein efficient leadership can accomplish much in increasing productivity per worker. Furthermore, there is always considerable cost in training each new worker.Those companies with an abnormal labor turnover have therefore an element of unnecessary expense avoided by better-managed enterprises.

Companies with good labor relations usually are ones making every effort to settle grievances quickly.

the investor should be sensitive to the attitude of top management toward the rank-and-file employees. Underneath all the fine-sounding generalities, some managements have little feeling of responsibility for, or interest in, their ordinary workers.

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

As has been true many times before and since, it is the constant leadership in engineering, not patents, that is the fundamental source of protection. The investor must be at least as careful not to place too much importance on patent protection as to recognize its significance in those occasional places where it is a major factor in appraising the attractiveness of a desirable investment.

In any event, the investor will do well to exclude from investment any company that withholds or tries to hide bad news.

There is only one real protection against abuses like these.This is to confine investments to companies the managements of which have a highly developed sense of trusteeship and moral responsibility to their stockholders.

Regardless of how high the rating may be in all other matters, however, if there is a serious question of the lack of a strong management sense of trusteeship for stockholders, the investor should never seriously consider participating in such an enterprise.

The successful investor is usually an individual who is inherently interested in business problems. This results in his discussing such matters in a way that will arouse the interest of those from whom he is seeking data

I believe there are three reasons, and three reasons only, for the sale of any common stock which has been originally selected according to the investment principles already discussed.The first of these reasons should be obvious to anyone. This is when a mistake has been made in the original purchase and it becomes increasingly clear that the fac- tual background of the particular company is, by a significant margin, less favorable than originally believed

More money has probably been lost by investors holding a stock they really did not want until they could “at least come out even” than from any other single reason.

Sales should always be made of the stock of a company which, because of changes resulting from the pas- sage of time, no longer qualifies in regard to the fifteen points outlined in Chapter Three to about the same degree it qualified at the time of purchase. This is why investors should be constantly on their guard. It explains why it is of such importance to keep at all times in close contact with the affairs of companies whose shares are held.

When companies deteriorate in this way they usually do so for one of two reasons. Either there has been a deterioration of management, or the company no longer has the prospect of increasing the markets for its product in the way it formerly did.

There is a good test as to whether companies no longer adequately qualify in regard to this matter of expected further growth.This is for the investor to ask himself whether at the next peak of a business cycle, regardless of what may happen in the meantime, the comparative per- share earnings (after allowances for stock dividends and stock splits but not for new shares issued for additional capital) will probably show at least as great an increase from present levels as the present levels show from the last known peak of general business activity. If the answer is in the affirmative, the stock probably should be held. If in the negative, it should probably be sold.

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 per cent overpriced? That which really matters is not to disturb a position that is going to be worth a great deal more later.

What is most important, however, is that stocks are not bought in companies where the dividend pay-out is so emphasized that it restricts realizable growth.

It never seems to occur to them, much less to their advisors, that buying a company without having sufficient knowledge of it may be even more dangerous than having inadequate diversification.

By giving heavy emphasis to the “stock that hasn’t gone up yet” they are unconsciously subscribing to the delusion that all stocks go up about the same amount and that the one that has already risen a lot will not climb further, while the one that has not yet gone up has something “due” it

To be a truly conservative investment a company—for a majority if not for all of its product lines—must be the lowest-cost producer or about as low a cost producer as any competitor. It must also give promise of continuing to be so in the future.

In the competitive world of commerce it is vital to make the potential customer aware of the advantages of a product or service.This awareness can be created only by understanding what the potential buyer really wants (sometimes when the customer himself doesn’t clearly recognize why these advantages appeal to him) and explaining it to him not in the seller’s terms but in his terms.

A conservative firm will have outstanding research and technical effort. A balance between cost-efficient operation and allowing for ingenuity

Companies with above-average financial talent have several significant advantages. Knowing accurately how much they make on each product, they can make their greatest efforts where these will produce maximum gains. Intimate knowledge of the extent of each element of costs, not just in manufacturing but in selling and research as well, spotlights in even minor phases of company activity the places where it is logical to make special efforts to reduce costs, either through technological innovations or by improving people’s specific assignments.

In a world where change is occurring at an ever-increasing pace, it is (1) a company capable of developing a flow of new and profitable products or product lines that will more than balance older lines that may become obsolete by the technological innovations of others; (2) a company able now and in the future to make these lines at costs sufficiently low so as to generate a profit stream that will grow at least as fast as sales and that even in the worst years of general business will not diminish to a point that threatens the safety of an investment in the business; and (3) a company able to sell its newer products and those which it may develop in the future at least as profitably as those with which it is involved today.

[Edward Heller] He said that behind every unusually successful corporation was this kind of determined entrepreneurial personality with the drive, the original ideas, and the skill to make such a company a truly worthwhile investment.

The force that causes such things to happen, that creates one company in an industry that is an outstanding investment vehicle and another that is average, mediocre, or worse, is essentially people.

In general, however, the company with real investment merit is the company that usually promotes from within.This is because all compa- nies of the highest investment order (these do not necessarily have to be the biggest and best-known companies) have developed a set of policies and ways of doing things peculiar to their own needs. If these special ways are truly worthwhile, it is always difficult and frequently impossi- ble to retrain those long accustomed to them to different ways of get- ting things done.The higher up in an organization the newcomer may be, the more costly the indoctrination can be.

A worthwhile clue is available to all investors as to whether a management is predominantly one man or a smoothly working team (this clue throws no light, however, on how good that team may be).The annual salaries of top management of all publicly owned companies are made public in the proxy statements. If the salary of the number-one man is very much larger than that of the next two or three, a warning flag is fly- ing. If the compensation scale goes down rather gradually, it isn’t.

However much policies may differ among companies, there are three elements that must always be present if a company’s shares are to be worthy of holding for conservative, long-range investment.

1. The company must recognize that the world in which it is operating is changing at an ever-increasing rate.

2. There must always be a conscious and continuous effort, based on fact, not propaganda, to have employees at every level, from the most newly hired blue-collar or white-collar worker to the highest levels of management, feel that their company is a good place to work.

3.Management must be willing to submit itself to the disciplines required for sound growth.

In all countries the morale effects appear striking when worker teams not only report directly to top management levels but also know their reports will be heeded and their accomplishments recognized and acknowledged.

Meanwhile, companies that do perfect advantageous people-oriented policies and techniques usually find more and more ways to benefit from them. For these companies, such policies and techniques—these special ways of approaching problems and of solving them—are in a sense proprietary.

Profitability can be expressed in two ways. The fundamental way, which is the yardstick used by most managements, is the return on invested assets.This is the factor that will cause a company to decide whether to go ahead with a new product or process. What percent return can the company expect on the part of its capital invested in this particular way in comparison to what the return might be if the same amount of its assets was employed in some other way? It is considerably more difficult for the investor to use this yardstick than it is for the corporate executive.What the investor usually sees is not the return on a specific amount of present-day dollars utilized in a specific subdivision of the business but the total earnings of the business as a percentage of its total assets.When the cost of capital equipment has risen as much as it has in the last forty years, comparisons of the return on total invested capital between one company and another may be so distorted by variations in the price levels at which different companies made major expenditures that the figures are highly misleading. For this reason, comparing the profit margins per dollar of sales may be more helpful as long as one other point is kept in mind.This is that a company that has a high rate of sales in relation to assets may be a more profitable company than one with a higher profit margin to sales but a slower rate of sales turnover.

However, while from the standpoint of profitability return on investment must be considered as well as profit margin on sales, from the standpoint of safety of investment all the emphasis is on profit margin on sales.

Now let us turn from this background discussion of relative profitability to the heart of the third dimension of conservative investing— namely, the specific characteristics that enable certain well-managed companies to maintain above-average profit margins more or less indefinitely. Possibly the most common characteristic is what businessmen call the“economies of scale.”

On the other hand, when a company clearly becomes the leader in its field, not just in dollar volume but in profitability, it seldom gets dis- placed from this position as long as its management remains highly competent.

What enables a company to obtain this advantage of scale in the first place? Usually getting there first with a new product or service that meets worthwhile demand and backing this up with good enough marketing, servicing, product improvement, and, at times, advertising to keep existing customers happy and coming back for more. This frequently establishes an atmosphere in which new customers will turn to the leader largely because that leader has established such a reputation for performance (or sound value) that no one is likely to criticize the buyer adversely for making this particular selection.

Another which we believe is of particular interest is the difficulty of competing with a highly successful, established producer in a technological area where the technology depends on not one scientific discipline but the interplay of two or preferably several quite different disciplines. I believe that some of these multidisciplinary technological companies, in not all of which is electronics a significant factor, have recently proven some of the finest opportunities for truly farsighted investing.

An example is a company that has created in its customers the habit of almost automatically specifying its products for reorder in a way that makes it rather uneconomical for a competitor to attempt to displace them.Two sets of conditions are necessary for this to happen. First, the company must build up a reputation for quality and reliability in a product (a) that the customer recognizes is very important for the proper conduct of his activities, (b) where an inferior or malfunctioning product would cause serious problems, (c) where no competitor is serving more than a minor segment of the market so that the dominant company is nearly synonymous in the public mind with the source of supply, and yet (d) the cost of the product is only a quite small part of the customer’s total cost of operations. Second, it must have a product sold to many small customers rather than a few large ones. These customers must be sufficiently specialized in their nature that it would be unlikely for a potential competitor to feel they could be reached through advertising media such as magazines or television.They constitute a market in which, as long as the dominant company maintains the quality of its product and the adequacy of its service, it can be displaced only by informed salesmen making individual calls.

The conservative investor must be aware of the nature of the current financial-community appraisal of any industry which he is interested

For a company to be a truly worthwhile investment, it must not only be able to sell its products, but also be able to appraise changing needs and desires of its customers; in other words, to master all that is implied in a true concept of marketing

I began realizing that, all the then current wall street opinion to the contrary, what really counts in determining whether a stock is cheap or overpriced is not its ratio to its current years earnings but its ratio to the earnings a few years ahead

Hope you found these notes useful. I use ideas like these within my own investment management philosophy.