Warren Buffett is a supporter of Fisher’s ideas of growth investing; enough said.
Book Summary:
An outstanding investment has to satisfy the following fifteen points:
1) Potential sales increment for several years
Investors should look at long term sales growth projection of a company and not make the judgement based on its performance year by year. This is due to the nature of business cycle which causes sales increment to come at different points of the cycle and each cycle is a several-year period. Short term or one time gain should be avoided as these gains are of much lesser degree in comparison with long term gains. Thus, to qualify for this point, the company must have a product or service that can capture the market share and has a potential to increase its sales for several years thereafter.
2) Willingness of management to develop new product/service to replace exploited ones
Investors should see the management willing to develop new products as the present ones are running out their potential. The management should not gloat over their successful product and not do anything to sustain the success. They should express eagerness to take the advantage of this success and further expand their market share through innovation of new products.
3) Research and Development efforts and effectiveness
Evaluating a company of its R&D efforts should not be solely judged by the amount of dollars spent, based on the figures on an accounting report. This is because there is no consistent rule that applies to all companies, as to how to justify money spent on research. Thus, companies can categorize certain expenditure to research expense which they are actually not. Besides the amount of research efforts, quality and effectiveness of the research must be evaluated too. How much benefits can the company gained from the outcome? How are the research carried out – Do researchers have good coordination with sales and production teams? Does management interrupt research projects easily?
4) Strong sales force
This would be another factor that is difficult to judge by numbers solely and does not have a mathematical formula for evaluation. Investors should look out for companies who spend resources and time to develop and maintain a high standard sales organization. For example, how much training a salesman from this company has to undergo?
5) Worthwhile profit margin
Operating profits should be examined and compared across several years. It would then be evident to seperate marginal companies from the better ones. During prosperous years for a particular industry, all companies would enjoy increased proffits but for marginal companies, they will enjoy higher profit growth than stronger companies. However, during downturns, earnings of marginal companies decline faster than the stronger ones. These marginal companies should be avoided unless one is certain that the reason for low profit margins is due to expenditure for the betterment of the company in the future (R&D for new products, develop sales force etc).
6) Actions to maintain or improve profit margin
A good management must be able to plan ahead and always strive to improve profit margin. With inflation which leads to rising costs, companies cannot merely increase prices to maintain profits. The management must constantly seek new ways to make operation efficient and cut costs.
7) Outstanding labor and personnel relations
A company with good labor relations as it would bring out good productivity rate from each employee. The cost of bad labor relations can be seen through strikes. One of the methods to evaluate labor relations is to compare labor turnover rate of one company with another of the same area and the same industry. In addition, one can also look at the number of job applications for the company. Another method is to see whether the company can achieve above average returns and yet paying above-standard salary to workers. In general, the management must show care and concern towards the lower echelon personnel.
Outstanding executive relations
Relation with lower echelon is important and relation with executives is vital. The management should create a good environment for executives to perform to their maximum ability and make them want to stay. Promotions in the company should be based on merits and not family ties. Salary should be paid at least at industry standard and adjustments should be reviewed regularly.
9) Management depth
As a company grows larger, a one-man management will no longer be able to handle all matters. Delegation of authority becomes a need and executives must be given the chance to carry out some certain duties as a form of training and development. Executive development usually begins when a company annual sales reach between fifteen to forty million dollars. Investors should also note how much does the top management welcome suggestions from personnel. In such a competitive era, ideas are valuable for improvement and change.
10) Good cost analysis and accounting controls
The management should have a good knowledge of cost breakdown of their products and operations. With this knowledge, they can divert attention to the relevant product or process that needs improvement.
11) Competitiveness edge
To generalize this selection criteria is to evaluate the competitiveness of a company in its industry. There are certain matters more important to one industry than another, or to a large corporation than a small one. For example, real estate matters (leasing of stores) are more important to retailers than web service companies. Patents are more important to smaller companies to protect their growth, while bigger companies cannot rely on patents alone to drive sales. The investor must be able to identify whether a company has valid competitive advantages.
12) Long term attitude
Evaluate the company’s policies in relation to how long term their attitude is. For example, their treatment towards suppliers – Is the company’s policy that the winning contract goes to the lowest cost supplier or it depends on the quality of supply? Towards customers – does the company incur higher cost now in customer relations department so as to build good will with customers for future businesses?
13) Dilution of gains due to share conversions
A good management should take care of existing shareholders’ benefits when carrying our equity financing. They must ensure all the convertibles (options, warrants, convertible bonds, etc) are not excessively issued such that it would dilute existing shareholder’s earnings to a great extent.
14) Honest with investors about bad news
Management should be forthright with shareholders about bad news as much as good news. Avoid companies who tries to hide the bad and amplify the good.
15) Management with integrity
There are some ways that management can abuse their authority for their own interests without breaking the law. The management can be bias towards family and relatives – pay them higher salaries, give them businesses and charge the company at unfair price. Management can also issue stock options more than they actually deserve.
Many of the above-mentioned criteria are difficult to find out from companies based on annual reports or company research data. Fisher came out with this term ‘scuttlebutt’ which is a method to dig out valuable information about a company of investment potential. The method is to go beyond reports and find out from employees, former employees and even competitors of this company.
The book consists of other writings by Philip Fisher – Conservative Investors Sleep Well and Developing an Investment Philosophy.
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