Phil Fisher’s 15 Points to Look For In Common Stock | Rentals and Realtors
One of the most common questions when choosing investments in the stock market is, “How do I know if a company is a good choice for growth?” Many people get distracted with charts, misinformation, and other sources on Wall Street.
Others listen to their elders, elders like Philip Fisher.
Philip Fisher is one of the world’s renowned stock investors, surviving the Great Depression along with Black Monday, and had a portfolio worth $71M at the time of his death.
After writing his book, Common Stocks and Uncommon Profits in 1957, it has since been revised multiple times, and even praised from stock market moguls like Warren Buffett. For those who are interested in what the Oracle of Omaha has to say, he said this:
“I sought out Phil Fisher after reading his Common Stocks and Uncommon Profits…A thorough understanding of the business, obtained by using Phil’s techniques…enables one to make intelligent investment commitments.”
The Fifteen Points to Look For In Common Stock
In his book, Fisher details the qualitative process that any investors should go through when identifying a potential investment, and the questions to ask of a company before considering them.
One of the most memorable chapters from the book are the Fifteen Points to Look for in a Common Stock. Let’s review them, and then go in-depth through each step.
- Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?
- 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 have largely been exploited?
- How effective are the company’s research and development efforts in relation to its size?
- Does the company have an above-average sales organization?
- Does the company have a worthwhile profit margin?
- What is the company doing to maintain or improve profit margins?
- Does the company have outstanding labor and personnel relations?
- Does the company have outstanding executive relations?
- Does the company have depth to its management?
- How good are the company’s cost analysis and accounting controls?
- 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?
- Does the company have a short-range or long-range outlook in regard to profits?
- 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?
- Does the management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur?
- Does the company have a management of unquestionable integrity?
Point Breakdown
- Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?
Takeaways from Fisher’s book depict that:
- If a company stops making increases in sales and remains the same, they will lose to competition.
- Growth shouldn’t be judged on an annual basis, but instead by a several-year unit.
- There are two groups that have maintained growth by a several-year unit.
If a company stops making increases in sales and remains the same, then it is only a matter of time before they are thrown off of the top. Companies are constantly innovating, constantly trying to improve on all fronts: Marketing, sales, and innovation.
A lack of innovation will eventually lead to a lack of sales. Eventually a lack of sales leads to being overthrown by competition.
Fisher also says that growth shouldn’t be judged on an annual basis. This is because that business cycles can last longer than a one-year period. If a business cycle begins to downtrend for a couple years while your are evaluating, it can appear that a good investment is actually bad, or a bad investment is actually good, if you only look at it by an annual basis.
Then, the most important description of his first point is the difference between two solid groups:
- Fortunate and Able
- Fortunate because they are Able
Companies that are fortunate and able are able to capitalize on opportunity within their industry.
Take AMD for example. In the beginning, they were good in their industry. But as CPU’s and other equipment began to grow in popularity, the industry improved. When the industry began more popular, AMD was prepared to rise along with it, and is now one of the top technology stocks.
Companies that are fortunate because they are able are able to capitalize on opportunity beyond their industry.
Take Amazon for example. Jeff Bezos wants to build an online bookstore, but when he saw an opportunity to become an eCommerce giant, selling anything and everything you can think of, he jumped on it. Bezos and Amazon were able to move quick and capitalize on the opportunities that were shown to them.
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 have largely been exploited?
This point is a matter of management attitude. When a company’s management gets comfortable, or forgets their original goals, they stop innovating, leading to a decline in sales, and then failure.
The most successful companies have engineering and research facilities in each of their divisions.
3. How effective are the company’s research and developmental efforts in relation to its size?
Company spending on research and development is a good reflection of the company’s innovation.
It is easy to say that Amazon, Apple, Intel, and other large tech companies are extremely successful because of their innovation and hustle, right?
Right.
These are the top 5 research and development spenders in the tech industry. All of them are at the top of their field, and they invest the most money into their research and development division.
How do you calculate the percentage that a company spends on research and development?
Research / Total Sales = Percentage of sales dedicated to research
Compare the percentage of sales dedicated to research to the company’s competitors, and to the rest of the industry. If the number is quite low, then the company you’re evaluating is probably not innovating as much as a competing company should.
However: The numbers can be misleading, because companies may label different things as a research and development expense. Sometimes when it should go under production expense, a company may consider it a research and development expense.
Market research is just as important as developmental research. Fisher calls market research “the bridge between developmental research and sales.” And what good is a business if there’s no sales?
To check a company’s market research, all you need to do is ensure that the company is researching profitable things.
4. Does the company have an above-average sales organization?
It is also important for employees to receive sales training. In Robert Kiyosaki’s book, Rich Dad Poor Dad, Kiyosaki details an interview he had with a journalist in Singapore.
A journalist who interviewed Robert was concerned that her work doesn’t go anywhere.
Robert asks her to go back to college and learn how to sell.
She snaps and says,”I have a master’s degree in English Literature. I’m a professional. Why would I want to learn how to sell? I hate salespeople. All they want is money.”
Robert pointed to her interview notes and said,
“Robert Kiyosaki, best-selling author. It says best-selling author, not best-writing author”
Top companies invest in teaching their employees sales techniques, and ensure that their company is talented in sales.
5. Does the company have a worthwhile profit margin?
A profit margin is the amount of profits the company keeps relative to every dollar they get in sales.
In order to determine the profit margin of a company, simply divide the operating profit by the sales dollar.
Once again, this is not a study that should be done on an annual basis, but a several-year period.
Look for broad profit margins, but if you find a company that is profiting much more than competitors, but has less spending in research and development, that could be a bad sign.
This is because if a company is focused on profit rather than innovation, it is doubtful that they will remain at the top for the long-term.
6. What is the company doing to maintain or improve its profit margins?
It is important to improve profit margins, because as inflation rises, and wages increase, and more competitors come into play, eventually a company’s stagnant profit margin will go into the negative, eventually leading to either a buyout or bankruptcy.
Strong demand gives certain companies the power to raise prices, which helps increase the profit margin.
-However, if profit margins rise in a whole industry rise from repeated price increases, it may not be good for a long-term investor.
Some companies design lower-cost equipment to offset the higher wages.
7. Does the company have outstanding labor and personnel relations?
-If workers feel that they are being treated fairly, then naturally, productivity will rise.
If a company does not have any affiliation with a union, it is a great sign. However, if a company is affiliate with a union, that is not necessarily a bad sign.
Evaluate the labor turnover of the company compared to similar companies in the area, and watch for union strikes.
Companies with good labor relations typically settle grievances quickly.
8. Does the company have outsanding executive relations?
Executive relations is vital if you want good labor relations, this goes hand-in-hand.
If executive are continually pressured to produce good numbers and show signs of doing immoral things to obtain those numbers, then the company is not a good long-term hold. This is what happened with Salomon Brothers.
Executives drive the workers, so if they don’t have good relations, it will reflect within the company.
9. Does the company have depth to its management?
If a company relies solely on one or two people for innovation and ingenuity, then that company is at great risk for a long-term investor. If something happened to the upper management, the company would have to find a solution to not only maintain, but improve the current situation.
If a company has the inability to replace upper management with quality people, then it is a major weakness.
10. How good are the company’s cost analysis and accounting controls?
It is tough to tell if a company has good cost analysis and accounting controls, but if you have confidence in a company’s management, then you shouldn’t need to worry about a company’s ability to deal with the numbers.
11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how the company may be doing in relation to its competition?
Warren Buffett loves companies that have a moat, a massive advantage over competition.
“We’re trying to find a business with a wide and long-lasting moat around it, surround — protecting a terrific economic castle with an honest lord in charge of the castle.” -Warren Buffett
When we want to search for something, we don’t say, “Check your search engine,” we say “Google it.” When we want to order something, we don’t say “order it from your favorite store,” we say “order it on Amazon”. These companies have moats, and a massive competitive advantage over other companies that are trying to enter the market.
In order to find if your company has a competitive advantage, naturally, compare them to other competitors. But remember, when companies rely too heavily on patent protection for their competitive advantage, it is a sign of weakness.
12. Does the company have a short-range or long-range outlook in regards to profits?
Many companies focus on profits, and make that their priority. You see it all the time: Companies begin getting rid of their engineering management, and replace them with financial guys. This turns companies away from their initial intention, and focuses more on profits.
Many managers have a very good year, and then begin sacrificing other things in order to maintain that growth. This is not a good long-term strategy, and will eventually crumble.
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 shareholders benefit from this anticipated growth?
Increasing the amount of outstanding shares can dilute the value of the shares that stockholders already held, but it gives a company access to more money for different things, such as:
- Acquire a Company
- Build a New Facility
- Expand Production
- Pay Down Debt
Increasing the amount of equity financing can lead to a selloff, but it may not depending on the intention behind the financing.
14. Does the management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur?
It is inevitable, all companies will fail at some point. But the best managements show complete transparency through the tough times, and give investors confidence that they are receiving the correct information, and truly know what is going on within the company.
This allows shareholders to also know the problem, and what the company plans to do to fix it,
If a company “clams up”, that could mean that they either don’t have a solution to the problem, or they may not feel that they have a responsibility to their shareholders, and may not feel that they owe an explanation.
15. Does the company have a management of unquestionable integrity?
Going through the other fourteen points should give you a decent idea about answering this question.
Read annual reports, listen in on the earnings calls, listen to the CEO. Read about the CEO, and his staff. Integrity is the most important thing that a business can have, because liars don’t last long in business.
As Phil Fisher would say, “In evaluating a common stock, the management is 90 per cent, the industry is 9 per cent, and all other factors are 1 per cent.”
Philip Fisher’s 15 Points To Look For In Common Stock
This article was about the 15 points to look for in common stock, and these points will be the foundation when analyzing a company. Obviously there is more to do after, but these 15 points are vital when understanding a potential long-term hold.
