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What stocks to buy: 15 points to look for

“What are the matters about which the investor should learn if he is to obtain the type of investment which in a few years might show a gain of several hundred per cent, or over a longer period of time might show a correspondingly greater increase?

” In other words, what attributes should a company have to give it the greatest likelihood of attaining this kind of results for its shareholders?”

Common Sense And Uncommon Profits by Philip A. Fisher, in answering these questions, gives the fifteen points to look for in a common stock:

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?

Companies which decade by decade have consistently shown spectacular growth might be divided into two groups:  “fortunate and able” and “fortunate because they are able”.  A high order of management ability is a must for both groups as no company grows for a long period of years just because it is lucky.

An example of the “fortunate and able” group is The Aluminium Company of America, says Philip Fisher.  The founders of this company were men with great vision. They correctly foresaw important commercial uses for their new product. However, neither they nor anyone else at that time could foresee anything like the future size of the market for aluminium products that was to develop over the next seventy years.

Du Pont is an example of the other group of growth stocks – the “fortunate because they are able” group –  says Philip Fisher.

This company was not originally in the business of making nylon,  cellophane, Lucite, neoprene, orlon, milar or any of the many other glamorous products with which it is frequently associated  in the public mind and which have proven so spectacularly profitable to the investor.

“Applying the skills and knowledge learned in its original powder business, the company has successfully launched product after product to make one of the great success stories of American stories,” says Common Stocks And Uncommon Profits.

 

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?

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, says Philip Fisher. “This does not mean that a desirable company may not have a number of divisions, some of which have product lines quite different from others.”

3. How effective are the company’s research and development (R&D) 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 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?

 

 

Philip Fisher’s five more don’ts for investors

1. Don’t overstress diversification
Investors have been so oversold on diversification that fear of having too many eggs in one basket has caused them to put far too little into companies they thoroughly know and far too much in others about which they know nothing at all. “It never seems to occur to them, and much less to their advisors, that buying a company without having sufficient knowledge of it may be even more dangerous than having inadequate diversification.
2. Don’t be afraid of buying on a war scare
War is always bearish on money. To sell stock at the threatened or actual outbreak of hostilities so as to get into cash is extreme financial lunacy. Actually just the opposite should be done. If an investor as about decided to buy a particular common stock and the arrival of a full-blown war scare starts knocking down the price, he should ignore the scare psychology of the moment and definitely begin buying. This is the time when having surplus cash for investment becomes least, not most, desirable…If war actually breaks out, the price would undoubtedly go still lower, perhaps a lot lower. Therefore the thing to do is to buy but buy slowly and at a scale down on just a threat of war. If war occurs, then increase the tempo of buying significantly. Just be sure to buy into companies with products or services the demand for which will continue in wartime, or which can convert their facilities to wartime operations.
3. Don’t forget your Gilbert and Sullivan
Gilbert and Sullivan are hardly considered authorities on the stock market. Nevertheless, we might keep in mind their “flowers that bloom in the spring, tra-la” which, they tell us, have “nothing to do with the case”.
Don’t be influenced by what doesn’t matter, says Philip Fisher. For some reason, the first thing that many investors want to see when they are considering buying a particular stock is a table giving the highest and lowest price at which the stock has sold in each of the past five or ten years. They go through a sort of mental mumbo-jumbo, and come up with a nice round figure which is the price they are willing to pay for the particular stock.
“Is this illogical? Is it financially dangerous?” asks Philip Fisher. His answer to both is an emphatic yes. It is dangerous because it puts the emphasis on what does not particularly matter, and diverts attention from what does matter. Another example is that many investors will give heavy weight to the per-share earnings of the past four or five years in trying to decide whether a stock should be bought. What counts is knowledge of background conditions. An understanding of what probably will happen over the next several years is of overriding importance.
4. Don’t fail to consider time as well as price in buying a true growth stock
5. Don’t follow the crowd

Five don’ts for Investors: Philip Fisher

Common Stocks and Uncommon Profits by Philip Fisher lists five don’ts for investors
1. Don’t buy into promotional companies
All too often, young promotional companies are dominated by one or two individuals who have great talent for certain phases of business procedure but are lacking in other equally essential talents. They may be superb salesmen but lack other types of business ability. More often they are inventors or production men, totally unaware that even the best products need skillful marketing as well as manufacture.
Their financing should be left to specialised groups. Ordinary individual investors should make it a rule never to buy into a promotional enterprise no matter how attractive it may appear to be.

2. Don’t ignore a good stock just because it is traded “over the counter”.
From the standpoint of marketability, a well-known, actively-traded stock on the New York Stock Exchange has advantage over the better over-the-counter stocks. But the better of the over-the-counter stocks are frequently more liquid than the shares of many of the companies listed on the American Stock Exchange and the various regional stock exchanges. “In short, so far as over-the-counter securities are concerned, the rules for the investor are not too different from those for listed securities. First, be very sure that you have picked the right security. Then be very sure that you have selected an able and conscientious broker. If an investor is on sound ground on both these respects, he need have no fear of purchasing stock just because it is traded ‘over the counter’ rather than on the exchange.”

3. Don’t just buy a stock because you like the “tone” of the annual report
Allowing the general wording and tone of an annual report to influence a decision to purchase a common stock is much like buying a product because of an appealing advertisement on the billboard.

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

Philip Fisher uses a fictitious company XYZ to highlight a costly error in investment reasoning. XYZ has qualified magnificiently for years in regard to Philip Fisher’s 15 points (Philip Fisher’s “Fifteen Points to Look for in a Common Stock”)). The stock has sold for years from 20 to 30 times current earnings as the financial community appreciated XYZ’s excellence in terms of constant growth in sales and profits. This is nearly twice as much for each dollar earned as the sale price of the average stock that has made up, say, the Dow Jones Industrial Averages.
Now XYZ has just issued a forecast indicating it expects to double earnings in the next five years. On this basis, some investors jump to the false conclusions that since XYZ is selling twice as high as stocks in general and since it will take five years for XYZ’s earnings to double, the present price of XYZ is discounting future earnings ahead and is therefore overpriced. The fallacy in the reasoning here lies in the assumption that five years from now XYX will be selling on the same price-earnings ratio as will the average Dow Jones stock.
If XYZ continues its same policies, five years from now its management will bring out still another group of new products that will swell earnings. If this happens, why shouldn’t this stock sell five years from now for twice the price-earnings ratio of the more ordinary stocks as it is doing for now and has done for many years past? This is why some of the stocks that at first glance appear highest priced may upon analysis, be the biggest bargain, said Philip Fisher.

5. Don’t quibble over eights and quarters
Here Philip Fisher uses a real example. A gentleman who has demonstrated a high order of investment ability wanted to buy 100 shares of a stock that was trading at 35.5. He put his order in at 35 as he wanted to save fifty dollars. The stock never sold again at 35. Twenty-five years later, it was selling at over 500. In an attempt to save fifty dollars, the investor failed to make at least $46,500.

Philip Fisher’s scuttlebutt method

For a man like Berkshire Hathaway chairman Warren Buffett who doesn’t personally own an iPhone, one wonders why he more than doubled Berkshire Hathaway’s holdings in Apple to about 2.5 per cent in January 2017. At that point, Mr Buffett owned US$17 billion worth of the tech giant’s stock

In a CNBC report on 27 February 2017 titled “Billionaire Warren Buffett more than doubled his holdings in Apple in 2017”, Mr Buffett, when asked why he raised the stake in Apple, was quoted as saying “because I liked it”. The legendary investor cited Apple’s
consumer-retaining power and CEO Tim Cook’s smart capital deployment strategy.

“Apple strikes me as having quite a sticky product, and an enormously useful product to people that use it,” Buffett said.

What was interesting is that Mr Buffett went on to say that the late investor Philip Fisher’s 1958 book “Common Stocks and Uncommon Profits” had inspired him to research how consumers felt about Apple products.
Mr Fisher talked about something called the “scuttlebutt method“, Mr Buffett said, adding that this method “made a big impression on me at the time, and I used it a lot”.

The “scuttlebutt method”, said Mr Buffett, is essentially going out and finding out as much as you can about how people feel about the products that they use.

Let’s look further into who Philip Fisher was and what his “scuttlebutt method” was all about.

American stock investor Philip Arthur Fisher (September 8, 1907 – March 11, 2004) was best known as the author of the investment guide book known as  Common Stocks and Uncommon Profits. The book has the reputation of staying in print since it  first published in 1958.

Phillip Fisher was referred to by Mr Buffett as “a respected investor and author” in a  letter to Berkshire Hathaway shareholders. Among his best-known  followers is Mr Buffett  who reportedly has said on some occasions that “he is 85% (Benjamin) Graham and 15% (Philip) Fisher”. Benjamin Graham (May 8, 1894 – September 21, 1976) is the father of value investing and Mr Buffett is his best known student.

Back to the “scuttlebutt method”, which provides clues that are needed to find really outstanding investments. Philip Fished said he called it “scuttlebutt method” for lack of a better term.

“The business ‘grapevine’ is a remarkable thing,” said Philip Fisher. “It is amazing what an accurate picture of the relative points of strength and weakness of each company in an industry can be obtained from a representative cross-section of the opinions of those who in one way or another are concerned with any particular company.”

“Most people, particularly if they feel sure there is no danger of their being quoted, like to talk about the field of work in which they are engaged and will talk rather freely about their competitors. 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,” said Mr Fisher.

According to Philip Fisher, competitors are only one and not necessarily the best source of informed opinion. Much also 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, according to Philip Fisher.

“The next step is to contact the officers of the company to try and fill out some of the gaps still existing in the investor’s picture of the situation being studied,” said Mr Fisher.

Benjamin Graham on dollar-cost averaging

In Chapter 5 (The Defensive Investor and Common Stocks) of The Intelligent Investor, Benjamin Graham, the father of value investing, touched on various aspects of defensive investment, among which was dollar-cost averaging, an application of a “formula investment”.

Elaborating, he said: “The New York Stock Exchange has put considerable effort into popularizing its ‘monthly purchase plan’, under which an investor devotes the same dollar amount each month to buying one or more common stocks.”

“During the predominantly rising-market experience since 1949 the results from such a procedure were certain to be highly satisfactory, especially since they prevented the practitioner from concentrating his buying at the wrong times,” added Benjamin Graham.

The father of value investing cited a comprehensive study of formula investment plans in which the author Lucile Tomlinson presented a calculation of the results of dollar-cost averaging in the group of stocks making up the Dow Jones industrial index. The average indicated profit at the end of 23 ten-year buying periods was 21.5 per cent, exclusive of dividends received. There were of course some instances of a substantial temporary depreciation at market value.

The author of the study said: “No one has yet discovered any other formula for investing which can be used with so much confidence of ultimate success, regardless of what may happen to security prices, as Dollar Cost Averaging.”

Seven stock investing mistakes to avoid: Pat Dorsey

It takes many great stock picks to make up for just a few big errors, says Pat Dorsey, author of The Five Rules for Successful Stock Investing. So even before one goes into any analysis process, care should be taken to avoid seven easily avoidable mistakes.
Here is Pat Dorsey’s list of seven mistakes to avoid:
1. Swinging for the fences.
2. Believing that it is different this time.
3. Falling in love with products.
4. Panicking when the market is down.
5. Trying to time the market.
6. Ignoring valuation.
7. Relying on earnings for the whole story.