Warren Buffett once described himself as being 85% Ben Graham and 15% Phil Fisher. If Ben Graham is the father of value investing, Phil Fisher is the father of growth investing. The primary difference between the two philosophies is clear. Ben Graham’s investments tend to benefit from a one-time profit. However, Phil Fisher’s investments enjoy an increase in their intrinsic value over time as the companies develop new product lines and enter new markets.
If you have read the previous two book reviews, you may notice a common pattern emerging. The common pattern is hard work. Phil Fisher is no different and he begins his analysis with a technique he calls “scuttlebutt”.
Scuttlebutt is the process by which information about a company is unearthed. Scuttlebutt involves speaking with employees, competitors, management, and trade association executives etc. Phil notes the amazing picture one can build by speaking with these contacts. For example, employees may be able to identify key products or services before they are commercialised. Competitors’ may be able to identify changes to the industry structure before it happens. Generally, these contacts are prepared to tell you a lot more if they know they will not be quoted in the media. Using mosaic theory, a detailed assessment of the company is revealed. This information is critical to understanding a business in detail and is widely used by professional investors.
What to buy
Phil sets out a 15-point plan allowing the average investor to identify companies that can increase several hundred percent. He approaches investments in the same way insurance companies approach risk, identifying key qualities. I have chosen not to detail each of the fifteen characteristics he looks for, however, if you are interested, I recommend reading the book in its entirety. For the sake of brevity, I will focus on the characteristics that resonated with me.
Does the company have products or services with sufficient market potential to make possible a sizeable increase in sales for at least several years?
Sales are the lifeblood of any business. Obviously, it makes perfect sense to invest in businesses that can grow their sales over time. Preferably, these sales will fall in the company’s core competence.
Consider Blackmores to illustrate this point. In 2008, Blackmores was the leading health supplements business in Australia. At the time, they were expanding their line of health supplements by introducing several new categories. The categories were varied and included Women’s health and Children’s health. This unlocked another opportunity helping sales expand. The enterprising investor may have noticed the opportunity to export these supplements too, providing another lever of sales growth over time. Phil believes this to be an important characteristic of successful investing.
Does the company have a worthwhile profit margin?
Phil instructs us to question how many cents flows through to the bottom line from each $1 of sales. All companies are not created equal. Some companies enjoy large and sustainable profit margins, others scrape by on wafer thin margins. There would not be a small business owner on the planet who doesn’t understand this concept. However, thousands of investors may be unable to answer this simple question. Phil highlights that the greatest long term investment opportunities are made in companies with a sustainable profit margin.
What is the company doing to maintain profit margins?
This is an important question to consider. Phil points out that business costs tend to increase every year. Wages, for example, increase each year based on an award or enterprise bargaining agreement. The best businesses can sustain their profit margin in the face of cost inflation.
Take Blackmores for example, in 2008, category growth was around 5%. As the industry grew strongly, the industry participants did not need to cut their prices to grow sales. However, as industries mature, competition may begin to bite, and margins often come under pressure. Therefore, it is important to invest in companies operating in favourable industries. This ensures that the inevitable squeeze on margin from a mature industry is postponed.
Does the company have depth in its management team?
Phil identifies management depth as a key factor aiding successful growth investing. High quality management teams establish a successful culture and have good relations with employees and unions etc. Company culture is vitally important to successful investing. A healthy relationship between management and their employees is critical to the long term sustainability of the business model.
Management should not lose sight of the fact that they run the company for shareholders. A red flag is waived when management pay themselves exorbitant salaries and/or throw around company stock like confetti. Phil focuses on management with unquestionable integrity. By identifying companies with integrity, one can invest safely over the long term. This is one of the most important qualities of wonderful companies.
When to sell
There is no harder investment decision than deciding when to sell a wonderful company. Phil provides three reasons to help investors with this decision.
1. When a mistake has been made
This requires a degree of honesty with oneself. The proper handling of this requires emotional self-control. There is a well-known behavioural bias known as ‘regret aversion’. Basically, it means we tend to prefer avoiding losses to postpone acknowledging a mistake. Accordingly, we defer the sell decision, creating more problems. By recognising this bias, we can make more informed decision about investments. It is better to acknowledge a mistake when it is small, rather than when it is big.
2. The stock no longer meets the original investment criteria
Businesses are always in a state of flux. Therefore, what was true yesterday, may not be true today. Phil encourages us to stay on top of our investments at all times, so we can identify when something changes in the business.
3. You have found new and more attractive investment opportunities
Unfortunately, we live in a finite world. We have finite time and finite resources. Therefore, it makes sense to use our limited resources in the most profitable way. This may involve selling one under-priced stock for another under-priced stock.
Price as a reason to sell
Phil devotes significant attention to price as a reason to sell a wonderful company. Warren Buffett has been quoted as saying, “the time to sell a wonderful business is never”, Phil agrees. His rationale being that valuation is not a precise science. Therefore, when a company meets the valuation, we should have some discretion around selling. Great companies constantly innovate, developing new products or services that may expand future sales. Alternatively, they may have an opportunity to expand into new geographies e.g. Blackmores entry into China.
Wonderful companies have a habit of surprising to the upside. Therefore, Phil recommends holding wonderful companies even if they become overvalued in the short term.
I hope you enjoyed this book review.
About the Author
The Education of a Value Investor by Guy Spier
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