Common Stocks and Uncommon Profits and Other Writings (Wiley Investment Classics)

by Philip A. Fisher

a reverse “ten bagger”: it fell from ten to one.

“What are you doing that your competitors aren't doing yet?” implies

This is to find someone who is sufficiently skilled in the various facets of management to examine each subdivision of a company's organization and by detailed investigation of its executive personnel, its production, its sales organization, its research, and each of its other major functions, form a worthwhile conclusion as to whether the particular company has outstanding potentialities for growth and development.

Scuttlbutt. Talk to competitors, investors, ex employees, vendors

This group consists of former employees. Such people frequently have a real inside view in regard to their former employer's strengths and weaknesses. Equally important, they will usually talk freely about them. But enough such former employees may, rightly or wrongly, feel they were fired without good cause or left because of a justified grievance that it is always important to check carefully into why employees left the company being studied.

POINT 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?

I will attempt to show why the normal intricacies of commercial research and the problems of marketing new products tend to cause such sales increases to come in an irregular series of uneven spurts rather than in a smooth year-by-year progression. The vagaries of the business cycle will also have a major influence on year-to-year comparisons. Therefore growth should not be judged on an annual basis but, say, by taking units of several years each.

In either case the investor must be alert as to whether the management is and continues to be of the highest order of ability; without this, the sales growth will not continue.

POINT 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?

POINT 3. How effective are the company's research and development efforts in relation to its size?

companies vary enormously in what they include or exclude as research and development expense. One company will include a type of engineering expense that most authorities would not consider genuine research at all, since it is really tailoring an existing product to a particular order—in other words, sales engineering.

an outstanding technical college quietly advised its graduating class to avoid employment with a certain oil company. This was because top management of that company had a tendency to hire highly skilled people for what would normally be about five-year projects. Then in about three years the company would lose interest in the particular project and abandon it, thereby not only wasting their own money but preventing those employed from gaining the technical reputation for accomplishment that otherwise might have come to them.

The profit margin on defense contracts is smaller than that of nongovernment business, and the nature of the work is often such that the contract for a new weapon is subject to competitive bidding from government blueprints.

This means that it is sometimes impossible to build up steady repeat business for a product developed by government-sponsored research in a way that can be done with privately sponsored research, where both patents and customer goodwill can frequently be brought into play.

simpler and often worthwhile method is to make a close study of how much in dollar sales or net profits has been contributed to a company by the results of its research organization during a particular span, such as the prior ten years.

An organization which in relation to the size of its activities has produced a good flow of profitable new products during such a period will probably be equally productive in the future as long as it continues to operate under the same general methods.

POINT 4. Does the company have an above-average sa...

“scuttlebutt” technique. Of all the phases of a company's activity, none is easier to learn about from sources outside the company than the relative efficiency of a sales organization. Both competitors and customers know the answers.

POINT 5. Does the company have a worthwhile profit margin?

POINT 6. What is the company doing to maintain or improve profit margins?

The success of a stock purchase does not depend on what is generally known about a company at the time the purchase is made. Rather it depends upon what gets to be known about it after the stock has been bought. Therefore it is not the profit margins of the past but those of the future that are basically important to the investor.

Some companies are in the seemingly fortunate position that they can maintain profit margins simply by raising prices. This is usually because they are in industries in which the demand for their products is abnormally strong or because the selling prices of competitive products have gone up even more than their own. In our economy, however, maintaining or improving profit margins in this way usually proves a relatively temporary matter. This is because additional competitive production capacity is created. This new capacity sufficiently outbalances the increased gain so that, in time, cost increases can no longer be passed on as price increases. Profit margins then start to shrink.

POINT 7. Does the company have outstanding labor and personnel relations?

companies having an abnormally long list of personnel seeking to enter their employ are usually companies that are desirable for investment from the standpoint of good labor and personnel relations.

POINT 8. Does the company have outstanding executive relations?

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. A ruling family is not promoted over the heads of more able men. Salary adjustments are reviewed regularly so that executives feel that merited increases will come without having to be demanded.

POINT 9. Does the company have depth to its management?

But such management will not develop unless certain additional policies are in effect as well. Most important of these is the delegation of authority. If from the very top on down, each level of executives is not given real authority to carry out assigned duties in as ingenious and efficient a manner as each individual's ability will permit, good executive material becomes much like healthy young animals so caged in that they cannot exercise.

POINT 10. How good are the company's cost analysis and accounting controls?

POINT 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?

Influences such as manufacturing know-how, sales and service organization, customer good will, and knowledge of customer problems are depended on far more than patents to maintain a competitive position.

In fact, when large companies depend chiefly on patent protection for the maintenance of their profit margin, it is usually more a sign of investment weakness than strength.

For small companies in the early years of marketing unique products or services, the investor should therefore closely scrutinize the patent position.

POINT 12. Does the company have a short-range or long-range outlook in regard to profits?

POINT 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?

Since the investor should never be interested in small gains of 10 to 20 per cent, but rather in gains which over a period of years will be closer to ten or a hundred times this amount, the conversion price can usually be ignored and the dilution calculated upon the basis of complete conversion of the new senior issue. In other words, it is well to consider that all senior convertible issues have been converted and that all warrants, options, etc., have been exercised when calculating the real number of common shares outstanding.

POINT 14. Does the management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur?

POINT 15. Does the company have a management of unquestionable integrity?

Even among some of the so-called authorities on investment, there is still enough lack of agreement on the basic principles involved that it is as yet impossible to have schools for training investment experts comparable to the recognized schools for teaching law or medicine.

The growth stocks, over a five- or ten-year span, have proven spectacularly better so far as their increase in capital value is concerned.

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 factual background of the particular company is, by a significant margin, less favorable than originally believed.

Sales should always be made of the stock of a company which, because of changes resulting from the passage of time, no longer qualifies in regard to the fifteen points

after growing spectacularly for many years, a company will reach a stage where the growth prospects of its markets are exhausted. From this time on it will only do about as well as industry as a whole. It will only progress at about the same rate as the national economy does.

The company that can show an average annual increase of 12 per cent for a long period of years should be a source of considerable financial satisfaction to its owners. However, the difference between these results and those that could occur from a company showing a 20 per cent average annual gain would be well worth the additional trouble and capital gains taxes that might be involved.

If the job has been correctly done when a common stock is purchased, the time to sell it is—almost never.

so-called assets which in no sense increase the volume of business, but which would cause a loss of business if the expenditure had not been made. A retail store installing an expensive air conditioning system is a classic example of this sort of thing. After each competitive store has installed such equipment, no net increase in business will occur, yet any store which had not met the competitive move might find very few customers on a hot summer day.

Worthy of repetition here is that over a span of five to ten years, the best dividend results will come not from the high-yield stocks but from those with the relatively low yield. So profitable are the results of the ventures opened up by exceptional managements that while they still continue the policy of paying out a low proportion of current earnings, the actual number of dollars paid out progressively exceed what could have been obtained from high-yield shares.

4. Don't assume that the high price at which a stock may be selling in relation to earnings is necessarily an indication that further growth in those earnings has largely been already discounted in the price.

It seems almost impossible for many investors to realize, in the case of a stock that in the past has not sold at a comparably high price-earnings ratio, that the price-earnings ratio at which it is now selling may be a reflection of its intrinsic quality and not an unreasonable discounting of further growth.

However, if the company is deliberately and consistently developing new sources of earning power, and if the industry is one promising to afford equal growth spurts in the future, the price-earnings ratio five or ten years in the future is rather sure to be as much above that of the average stock as it is today.

Stocks of this type will frequently be found to be discounting the future much less than many investors believe. This is why some of the stocks that at first glance appear highest priced may, upon analysis, be the biggest bargains.