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Phil Fisher's Rules for Buying Stocks
In his legendary book "Common Stocks and Uncommon Profits", Fisher came up with a list of rules for buying and selling stocks. Let's take a look!
Some background on Phil Fisher:
Phil Fisher is known to be one of the first investors in high-quality companies with the idea of letting them compound over a long period of time.
A strategy that is often attributed to Buffett or Munger nowadays. But Fisher was the pioneer of this investing style and had a great impact on Buffett’s investing approach.
In Berkshire’s Annual Meeting of 2004, Buffett said that just as with Graham’s book The Intelligent Investor, Fisher’s Common Stocks and Uncommon Profits contains everything an investor would need to master the investment approach.
That’s why we’re taking a closer look into the book now. Precisely, we will look at Fisher’s List on the subject of buying stocks.
The List contains 15 points. We’ll take a look at eight of them which I consider to be the most important ones, but you can find the whole List at the bottom and a PDF here.
The first point is quite obvious. You want to invest in companies that can market their products into sizable and profitable markets.
There are two ways to do that:
You sell a product that already has a huge market
You sell a product in a currently small but rapidly growing market
To establish yourself in the already existing market you either need some form of regulatory edge or an innovative product that is better than the already existing ones.
Since having a regulatory edge as a small entrant (a company that just entered the market) is rather unlikely, a more innovative product is mostly the way in.
The second way, a small but rapidly growing market, however, is the more likely alternative and something that we’ve seen with most of the big tech forms of today.
They sold products into markets that either didn’t exist yet or were very small. Of course, sometimes it’s a mix of both strategies. Think of Amazon which used an existing market (the book market) but changed it by addressing a new customer. A customer who buys books online.
The vast majority of products have a life cycle that eventually ends. Some sooner than others. Only a few products are timeless and not subject to innovation and thus offer stable or growing profits for decades.
In order to be a great compounder, companies must be able to develop new products that ensure ongoing demand and profits when old products go out of business.
Apple is an excellent example of that. Starting (globally) with the iPod or early iPhone models, they kept introducing new products, besides improving the old ones, and advanced into fields like headphones, streaming, VR, and so on.
A modern term for companies constantly investing in new ventures alongside their main operation is “Spawners.”
The best product doesn’t get a company far if the management sucks at selling it. This is one of the most important aspects of a business’s success. However, very few investors pay attention to this.
That’s because it’s not really clear how to figure out how capable a company is at selling its products in comparison to other firms. There are no reliable numbers or ratios that can help quantify this.
Fisher used what he called the “Scuttlebutt” method. This method is about getting first-hand information about a company from authentic market sources like customers, suppliers, competition, and employees.
Another easy but effective way to evaluate a company’s sales/marketing organization is to assess its brand strength. The brand name is one of the strongest pull factors and particularly important for a company's long-term success.
One of the best ways to determine whether a company has a strong brand is by looking at the profit margin. Profit margins vary widely between companies within the same industry.
Companies with strong brands can demand higher product prices and thus have higher margins.
That’s why almost all great compounders are companies that maintain consistently higher profit margins than the competition.
The only exception is companies that deliberately engineer low-profit margins or earnings, as Amazon did over many years.
This is a more general point since the aspects that differentiate one company from another will be very different depending on the industry they operate in.
Basically, the point is to work out competitive advantages that the company in question has that can produce long-term, sustainable outperformance over their peers.
In some industries, you might look for patents or other regulatory advantages, while in others, you look for network effects, brand strength, or cost advantages.
As a long-term investor, you want the company's management to have a long-term focus as well.
There are many small factors that an investor can look at to see if the management has such a long-term focus.
Mainly by looking at how they treat customers and suppliers. A company that wants to do good in the long run, won’t make the sharpest deal with suppliers and customers all the time. Instead, they will focus on a good relationship.
Founder-led companies also tend to have a longer-term focus than companies run by a management that wasn’t evolved in the founding process. Interestingly, founder-led companies also tend to outperform non-founder-led companies, as shown in this Harvard Business Review:
These two points are closely related, so we will address them together.
This is a crucial one and a minimum requirement for every long-term investment. You don’t want to invest alongside management that isn’t transparent or even honest with shareholders.
Of course, it’s not always possible to immediately verify if what the management stated is correct. However, a look into the past often shows if the management can be trusted.
Look at annual letters from recent years and compare promises or statements made with the results later on.
As promised, here’s the whole List:
In the next couple of days, we’ll look at Fisher’s other List dealing with the right reasons to sell a stock.
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That’s it for today!
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