An extraordinary teacher
If you ask any of the great investors they will tell you they got where they are standing on the shoulders of giants.
Warren Buffett readily credits Philip Fisher as the source of much of his investment philosophy. The key takeaway is that all investors can learn from those who have gone before. As they have done, so can we.
Looking for good companies
The following is taken from Warren Buffett’s Meeting with University of Maryland MBA Students – November 15, 2013, with notes taken by Professor David Kass.
“Q. – In the past you said you attribute 85% of your investing to Benjamin Graham and 15% to Philip Fisher. Has that percentage changed?
WB: I developed my investment strategy under Graham. I went to Columbia and learned from Graham. With Graham’s approach, you cannot lose money over time. It’s very quantitative in nature, and you have to do reasonably well. On the other hand, it has less and less application as you get into bigger and bigger companies with larger sums of money. It’s better to buy wonderful businesses at fair prices than so-so businesses at low prices.
With the “cigar approach”[Ben Graham’s approach], you can find a nasty cigar on the ground, with one puff left, can pick it up, light it and you get a free puff. You can keep doing this and get many free puffs. That’s one approach, that’s what I did. I looked for very cheap stocks quantitatively. After exposure to [Philip] Fisher and Charlie [Munger], I started looking for better companies. Previously I was doing both. Now we are looking for good companies, not just cheap companies.” (emphasis added)
I think the real percent is much higher than the questioner’s 15%. Readers can judge for themselves after reading this post.
Who was Philip Fisher?
In preparing to write his 1980 book, The Money Masters, John Train met Philip Fisher. Train described him, at that time as ‘the most famous of the older generation of investment counsellors in San Francisco’. (Train, The Money Masters – Nine Great Investors: Their Winning Strategies and How You Can Apply Them.1980) p56.
Train writes: “He set up shop as an investment counsellor almost fifty years ago [actually March 31, 1931], and has spent thirty- five years in his present office building. During that time neither he nor his office has changed much. His reputation as an original, profound, and remorselessly thorough investment thinker has continued to grow, as has the value of the handful of portfolios he manages.” (Train, 1980)
Hagstrom quotes from a 1987 Forbes article written by Buffett titled “What we can learn from Philip Fisher”. Buffett read Fisher’s 1958 book, Common Stocks and Uncommon Profits (Harper & Brothers) and sought out Fisher.
Buffett wrote in the article: “When I met him, I was as impressed by the man as by his ideas.” He went on: “Much like Ben Graham, Fisher was unassuming, generous in spirit and an extraordinary teacher.” Buffett added that even though Graham and Fisher’s investment approach differed, they “parallel in the investment world.” (Hagstrom, The Warren Buffett Way – Investment Strategies of the World’s Greatest Investor. 1994) p27.
Both Fisher and Buffett emphasize what Buffett calls a moat around the company’s business and Fisher calls freedom from ‘cutthroat competition’. Fisher articulates this as being “the degree to which there does or does not exist within the nature of the business itself certain inherent characteristics that make possible an above-average profitability for as long as can be foreseen into the future.”
Fisher placed a great deal of emphasis on profit margins. Fisher believed that “from the standpoint of safety of investment all the emphasis is on profit margin on sales.” (Fisher, Common Stocks and Uncommon Profits 1958,1996) p199.
High profit margins are a reflection not only of the strength of a company’s technological lead, its marketing and sales but also its position as a low cost producer. In words that Warren Buffett would warmly approve, Fisher writes: “Some companies are in the seemingly fortunate position that they can maintain profit margins simply by raising prices.
Buffett’s emphasis is more on return on invested capital which he felt resulted from strong franchises with freedom to price. Of course the business franchise and ROIC are connected. The company that has the power to raise prices to maintain profit margins and hence maintain a high ROIC and Owner Earnings is probably the one with a defensible moat.
Concentration and Seven Footers
Philip Fisher’s view was that there “are a relatively small number of truly outstanding companies. Their shares frequently can’t be bought at attractive prices. Therefore, when favorable prices exist, full advantage should be taken of the situation. Funds should be concentrated in the most desirable opportunities.” (Fisher, 1958,1996) p277. (emphasis added)
Sounds like Warren Buffett. Buffett wrote: “Over time you will find only a few companies that met these standards [superb companies] – so when you see one that qualifies, you should buy a meaningful amount of stock.” (Buffett W. E., The Essays of Warren Buffett: Lessons for Corporate America. 1998) p93. Buffett read his Fisher and learned from him.
Fisher wrote: “…among investors with common stock holding having a market value of a quarter to a half million dollars [in 1958 dollars], the percentage who own twenty-five or more different stocks is appalling. It is not this number of twenty-five or more which itself is appalling. Rather it is that in the great majority of instances only a small percentage of such holdings is in attractive stocks about which the investor or his advisor has a high degree of knowledge [sounds like Buffett]. Investors have been so oversold on diversification [more Buffett] 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.” (Fisher, 1958,1996)p.135. (emphasis added)
“Usually a very long list of securities is not a sign of the brilliant investor, but of one who is unsure of himself.” (Fisher, 1958,1996)p.144. This is vintage Buffett.
Buying companies at beaten down prices
Fisher: “In short, the company into which the investor should be buying is the company which is doing things under the guidance of exceptionally able management. A few of these things are bound to fail. Others will from time to time produce unexpected troubles before they succeed. The investor should be thoroughly sure in his own mind that these troubles are temporary rather than permanent. Then if these troubles have produced a significant decline in the price of the affected stock and give promise of being solved in a matter of months rather than years, he will probably be on pretty safe ground in considering that this is a time when the stock may be bought.” (Fisher, 1958,1996)p.101. (emphasis added)
This is classic Buffett, but is comes from Fisher. See my last post here.
Favorite holding period is forever
Philip Fisher summarizes his approach to selling: “If the job has been correctly done when a common stock is purchased, the time to sell it is – almost never.” (Fisher, 1958,1996)p.113. If the reader hears echoes of Warren Buffett it’s actually the other way round.
Fisher’s seemingly simple bit of advice highlights one of the most common of investor failures – that of buying and selling too much, also known as trading. Investors are fundamentally different creatures than traders. In fact, many people don’t know the difference. At meeting a number of years ago, I asked the group whether they were investors or traders. Remarkably, none seemed to distinguish between these two words.
Cutting the flowers and watering the weeds – Holding winners
In Warren Buffett’s 1988 chairman’s letter he said he is just the opposite of those who hurry to sell and book profits. Buffett likened this to what Peter Lynch has called cutting the flowers and watering the weeds.
Of course investors should be cutting weeds not watering them.
Philip Fisher put it this way: “Willingness to take small losses in some stocks and to let profits grow bigger and bigger in the more promising stocks is a sign of good investment management. Taking small profits in good investment and letting losses grow in bad ones is a sign of abominable investment judgment. A profit should never be taken just for the satisfaction of taking it.” (Fisher, 1958,1996) p277. (emphasis added)
Philip Fisher wrote in Common Stocks and Uncommon Profits that, “More money has probably been lost by investors holding a stock they really did not want until they could ‘at least come out even’ than from any other single reason.”
Wall Street’s fixation on price earnings ratios
Fisher wrote: “My approach to investing expanded as I learned from my 1929 mistakes. I learned that, while a stock could be attractive when it had a low price-earnings ratio, a low price-earnings ratio by itself guaranteed nothing and was apt to be a warning indicator of a degree of weakness in the company. I began realizing that, all the then current Wall Street opinion to the contrary, what really counts in determining whether a stock is cheap or overpriced is not its ratio to the current year’s earnings, but its ratio to the earnings a few years ahead. If I could build up in myself the ability to determine within fairly broad limits what those earnings might be a few years from now, I would have unlocked the key both to avoiding losses and to making magnificent profits!” (Fisher, 1958,1996) p234. (Emphasis added)
Buffett shared this aversion to p/e ratios. Buffett believed discounted cash flow (DCF) was the correct approach: “[Intrinsic value is] an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: it is the discounted value of the cash that can be taken out of a business during its remaining life.” (Buffett W. E., The Essays of Warren Buffett: Lessons for Corporate America. 1998) p187.
Except, that isn’t exactly how Buffett went about it!
The subject continued at the 2007 Berkshire Hathaway AGM, as quoted by the Value Investing World website July 24, 2019, when Warren Buffett commented:
“We don’t formally have discount rates. Every time I start talking about all this stuff, Charlie reminds me that I’ve never prepared a spreadsheet. But, in effect, in my mind I do. We are going to want to get a significantly higher return, obviously — in terms of cash produced relative to the amount we’re outlaying now — for a business than we are from a government bond. That has to be the yardstick at a base. And how much more do we want? Well, if government bond rates were 2 percent, we’re not going to buy a business to earn 3 or 3 1/2 percent expectancy over the years. We just don’t want to commit our money that way. We’d rather sit around and wait a little while. If they’re 4 3/4 percent, you know, what do we hope to get over time? Well, we want to get a fair amount more than that. But I can’t tell you that we sit down every morning and I call Charlie in Los Angeles and say, ‘What’s our hurdle rate today?’ I mean, we’ve never used the term. We want enough so that we feel very comfortable if they closed down on the stock market for a couple of years, if interest rates go up another hundred basis points or 200 basis points, we’re still happy with what we’ve bought. I know it sounds kind of fuzzy, but it is fuzzy.” 2007 AGM
Conservative vs conventional
Fisher’s book, Conservative Investors Sleep Well, written in 1974 at the depths of the bear market and published by Harper & Row in 1975 and republished by John Wiley & Sons, Inc. in 1996, notes that: “Unfortunately, often there is so much confusion between acting conservatively and acting conventionally that for those truly determined to conserve their assets, this whole subject need considerable untangling…” He points out that for investors able to think for themselves and act independently the investors’ approach can be conservative regardless of whether it is conventional or unconventional. (Fisher, 1958,1996) p178. (emphasis added)
Even investment advisors who are paid an annual fee regardless of trading activity are susceptible to herd like behavior. As experts, investment advisors are likely to be the source of very conventional advice. As John Maynard Keynes put it succinctly in The General Theory: “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.” (Keynes, The General Theory of Employment, Interest and Money. 1936,2007) p158.
Buffett commented on the failure of the average mutual fund to outperform the indexes. As reported by Roger Lowenstein: “Why was it, [Buffett] wondered, that “the high priests of Wall Street,” with their brains, training, and high pay, couldn’t top a portfolio managed by no brains at all? He found the culprit in the tendency of managers to confuse a conservative (i.e., reasonably priced) portfolio with one that was merely conventional.” Lowenstein elaborates, “It was a subtle distinction, and bears reflection. The common approach on owning a bag full of popular stocks – AT&T, General Electric, IBM, and so forth – regardless of price, qualified as the latter, but surely not as the former. Buffett blamed the committee process and group-think that was prevalent on Wall Street.” Quoting Buffett, “My perhaps jaundiced view is that it is close to impossible for outstanding investment management to come from a group of any size…” (Lowenstein, 1995,2008)p.85. (emphasis added)
Growth vs value
At risk of oversimplifying: – what Fisher was looking for was superbly managed growth companies, with emphasis on ‘growth’.
Buffett comes at growth differently. In essence Buffett emphasizes businesses that produces a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and places less emphasis on the achievement of gains in earnings per share. That said, Buffett makes clear that growth and value are joined at the hip and he does look for growth.
Buffett puts it this way: “Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards – so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.” (Lawrence A. Cunningham, The Essays of Warren Buffett: Lessons for Corporate America, 1998) p93 cited as (Buffett, 1998) (emphasis added) So, Buffett is also into growth.
As I noted last week, “value stocks” and “growth stocks” are an artificial construct from the investment industry designed to sell “investment products”.
I could go on. I’ve read a lot written by both Warren Buffett and Philip Fisher. It is clear that Buffett studied Fisher and adopted many of his ideas. We can do the same.
Readers wishing to dig deeper into Philip Fisher’s ideas on investing take a look at the following sections of the Motherlode:
4.17 Risks when markets are down
5.06 The biggest mistake in the history of finance
12.09 Cutting the flowers and watering the weeds – holding winners
19.01 Crowd mentality is nothing new
21.02 The bitterest way to learn
27. Sound Principles of Operation
31. General approach to choosing common stocks
33. Thoughts about the different sectors and groupings
35.35 Other measures of company performance – Profit margins
36. Diversification, balance and strategy
39. Use of ratios to value shares
40. Finding and studying companies to invest in
Readers might also check out this post which is based very much on Philip Fisher’s ideas:
19 Cardinal rules on selling stocks
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