Philip Fisher: Finding Growth Stocks
- I sought out Phil Fisher after reading his Common Stocks and Uncommon Profits and Other Writings. When I met him, I was as impressed by the man as by his ideas. A thorough understanding of the business, obtained by using Phil’s techniques... enables one to make intelligent investment commitments. --Warren Buffett
After Phil Fisher published the original 1958 edition of Common Stocks and Uncommon Profits, he received letters from readers all over the world---most asking for more detailed information about what an investor should do to find stocks with the potential to offer spectacular gains, that is, how to identify growth stocks. In later editions of the classic text, Fisher included a chapter (Chapter 10 in the latest 2003 edition published by John Wiley & Sons) on ’How I Go about Finding a Growth Stock’. This article is a summary of Fishers comments on this topic.
Fisher begins by stressing that finding growth stocks is a tedious process that must take time and energy, as well as skill and alertness. Small part-time investors may feel it is not worth the effort. While it would be nice if some shortcut could be found, Fisher doubts one ever will be. Fisher concludes, ’How much time should be spent on these matters is, of course, something each investor must decide for himself in relation to the sums he has available for investment, his interests, and his capabilities.’
Fisher further acknowledges that his method for searching for high-growth stocks is not the only possible method--and perhaps not even the best method--but it is the best method he has found and has worked well over many decades. Fisher organizes his growth stock search into two stages--the first stage being to narrow the field of possible stocks to investigate, and the second stage making a decision to buy or not to buy. Perhaps surprisingly, Fisher finds the first stage the most challenging.
Fisher states, ’This is the problem that confronts anyone about to start on a quest for a major growth security: there are literally thousands of stocks in dozens of industries that could conceivably qualify as worthy of the most intensively study. You cannot be sure about many of them until considerable work has been done. However, no one could possibly have the time to investigate more than a tiny percentage of the available field. How do you select the one or the very few stocks to the investigation of which you will devote such time as you have to spare?’
When Fisher began to assess his own personal investment screening process he was surprised to find out that his original ideas found by discussing businesses with scientists and management first-hand had only supplied about one-fifth of his eventual purchases in his portfolio. The lion’s share, about 80% of his stock purchases and an even greater share of portfolio profits over time had come from an entirely different source if stock ideas--recommendations from a small number of trusted sources.
Fisher says, ’I might not agree at all with the conclusions of any of these men as to a stock they particularly liked... however, because in each case I knew their financial minds were keen and their records impressive, I would be disposed to listen eagerly to details they might furnish concerning any company within my range of interests that they considered unusually attractive for major appreciation. Furthermore, since they were trained investment men, I could usually get rather quickly their opinion upon the key matters most important to me in my decision as to whether it might be a good gamble to investigate the company in question.’
What were Fisher’s key questions to his knowledgeable and trusted friends within his investing network? First, he wanted to know if the business, in general, had the potential for very high growth rates. Then he wanted to know how easily second and third industry entrants could compete with the first mover and take sales share or erode profit margins. Fisher found his network of investing friends a far richer source of good ideas than brokerage houses or newspaper journalists. One other useful source of original growth stock ideas would be business consultants, but the problem here is they are often reluctant to discuss details for fear of breaching client confidentiality.
Once Fisher has narrowed his search to a few candidates, what does he do next? He begins by explaining what he does not do. He does not approach anyone in the management at this stage. He does not spend hours and hours going over old annual reports and making minute studies of minor year-by-year changes in the balance sheet. He does not ask a stockbroker what they think of the stock. He does, however, glance over the balance sheet to determine the general nature of the capitalization and financial position. He also looks into breakdowns of sales by product lines, competition, degree of management or other major stockholders, and all earnings statement figures throwing light on depreciation, profit margins, research activities, and abnormal or non-recurring costs in prior years.
Now Fisher really goes to work. He uses the ’scuttlebutt’ method described throughout his book--interviewing scientists, engineers, suppliers, customers, competitors, and anyone else who might have important information about the business that is not common knowledge among public or institutional investors. At this point, if Fisher is hitting dead ends and struggling to get the information he needs--he will often give up and move on to investigate another business.
Fisher says, ’To make big money on investments it is unnecessary to get some answer to every investment that might be considered. What is necessary is to get the right answer a large proportion of the very small number of times actually purchases are made. For this reason, if way too little background is forthcoming and the prospects for a great deal more is bleak, I believe the intelligent thing to do is to put the matter aside and go on to something else.’
When Fisher uncovers interesting scuttlebutt on a business of interest--he usually needs to talk to one or two key people to gain additional information. He does NOT just walk up to them off the street and start asking questions. As he says, ’Most people, interested as they may be in the industry in which they are engaged, are not inclined to tell to total strangers what they really think about the strong and weak points of a customer, a competitor, or a supplier.’ Instead, Fisher goes to their commercial banker and explains openly how he is trying to gain information necessary to make an investment decision. Bankers are surprisingly helpful in making important introductions to open doors.
Only after all scuttlebutt has been accomplished are you ready to approach management of the company in interest. Fisher believes this is critical. Fisher states, ’Good managements, those most suitable for outstanding investment, are nearly all quite frank in answering questions about the company’s weak points as fully as about its strong points. However, no matter how punctilious a management may be in this respect, no corporate officer in his own self-interest can be expected, unasked, to volunteer some of the most significant matters to you, the investor, to know.’
In short, you need to do a tremendous amount of legwork prior to meeting management so you are in a position to ask probing questions about the business--strengths and weaknesses must be known prior to the meeting or you will still not know them after the meeting. Scuttlebutt is the essence of Fisher’s method. As he says, ’When it comes to selecting growth stocks, the rewards for proper action are so huge and the penalty for poor judgment is so great that it is hard to see why anyone would want to select a growth stock on the basis of superficial knowledge. If an investor or financial man wants to go about finding a growth stock properly, I believe one rule he should always follow is this: he should never visit the management of any company he is considering for investment until he has first gathered together at least 50% of all the knowledge he would need to make the investment.’
Fisher was once asked the ratio between companies visited and companies added to his portfolio. The banker asking the question guessed it was 250:1. Fisher answered, ’Actually it runs somewhere between one to every two and one to every two and one-half! This is not because one out of every two and one-half companies I look at measures up to what I believe are my rather rigorous standards for purchase. If he had substituted ’companies looked at’ for ’companies visited’ perhaps one in forty or fifty might be about right. If he had substituted ’companies considered as possibilities for investigation’ (whether I actually investigated them or not) then the original estimate of one stock bought for every two hundred and fifty considered would be rather close to the mark.’
Fisher added, ’What he had overlooked was that I believe it is impossible to get much benefit from a plant visit until a great deal of pertinent ’scuttlebutt’ work has been done first, and that I have found that ’scuttlebutt’ so many times furnishes an accurate forecast of how well a company will measure up to my fifteen points, that usually by the time I am ready to visit the management there will be at least a fair chance that I will want to buy into the company.’
Fisher finishes up by briefly addressing those who object to his method of spending such an amount of time and effort on each single investment decision. He says, ’I would ask those with this reaction to look at the world around them. In what other line of activity could you put $10,000 in one year and ten years later (with only occasional checking in the meantime to be sure management continues of high caliber) be able to have an asset worth from $40,000 to $150,000? This is the kind of reward gained from selecting growth stocks successfully. Is it either logical or reasonable that anyone could do this with an effort no harder than reading a few simply worded brokers’ free circulars in the comfort of an armchair one evening a week?’
Growth stocks cannot be found without hard work, and they cannot be found every day!
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