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.