WHAT TO BUY :Fifteen points to look for in a common stock:
Philip A. Fisher (Born: San Francisco, California in 1907; Died 2004 ), one of the greatest investors ever, explained his investment philosophy in one of the most popular investment books: ‘Common stocks and uncommon profits’. In this newsletter, we list some of the eye opening quotes from this book. In the next edition, we will list out the fifteen points used by him to select winning stocks. i) Scalability: Does the company have products/services with sufficient market potential to make possible a sizeable increase in sales for at least several years? This is important as just cost control can not be a sustainable lever for earnings growth in the long-term! Companies that are able to grow in the long-term are either ‘fortunate and able’ ( have some macro tail wind) or are ‘fortunate because they are able’ (ability to innovate and grow despite no particular tail wind). Good management is pre-requisite for long term growth in either of the cases.
ii) Innovation in the product pipeline: Does management have determination to develop products or processes that will further increase revenue potential even when growth potential of currently attractive product lines have largely been exploited.
iii) Research and development focus: Both, quantity as well as quality of R&D expenses important.
iv) Good quality sales team: Sales is the most basic single activity of any business. Making of repeat sales to satisfied customers is the first benchmark of success. Still, relative efficiency of sales, advertising and distribution receives much less investor attention than production, research, finance etc. This is likely because it’s relatively difficult to calculate sales efficiency of a company. A one-time profit can be made in a company which obtains worthwhile business because of its manufacturing or research skills without strong distribution. However such companies can be quite vulnerable. For steady long- term growth, a strong sales arm is vital.
v) High profit margin: Greatest long-range investment profits are never made by investing in marginal companies ( which make profit only during up cycles). Most of the really big investment gains have come from companies having relatively broad profit margins. Usually they have among the best margins in the industry.
vi) Efforts to improve profit margins: It is profit margin of the future and not of the past that is important for the investor. Increasing prices to is not the best way to improve margins as it invites competition to create new capacity which starts to put margins under pressure. Best way to improve margins is by capital improvement and product engineering department (automation and efficiency improvement).
vii) Outstanding labor and personnel relations: Company should have low labor turnover, saving training cost as well as driving better worker productivity if workers are not leaving and feel they are fairly treated. The company that makes above average profits while paying above average wages is likely to have good labor relations.
viii) Outstanding executive relations: Executive should have confidence in board/chairman. Promotions based on ability. Salaries at least in-line with industry with regular salary reviews. Preference to internal candidates over external in case of a vacancy at higher level.
ix) Depth in management: Growing companies will reach a size where one-man management will not be able to scale up. Delegation of authority is important. Organisations where top brass personally interfere with and try to handle day- to- day operating matters seldom turn out to be most attractive investments.
x) Cost analysis and accounting control: Understanding of true cost of each product category is important in order to know which one to promote.
xi) Excellence in important business activities: For example, handling real-estate matters in case of a retail company.
xii) Long-range profit outlook: Deliberately curtail maximum immediate profits to build up goodwill and thereby gain greater over-all profits over a period of years. Treatment of customers and vendors gives frequent examples of this. Red flag if company is making sharpest possible deals with suppliers or not caring enough to take care of trouble of a regular customer.
xiii) No near-term equity dilutions: Earnings growth should translate into EPS growth. Debt and internal accruals should be enough to take care of capital requirement for next several years. This will ensure that any equity dilution, if required, will happen at a much higher price. If this is not the case, careful analysis is required.
xiv) Management accessibility during downturns: During times of temporary failures, management should be forthright. Investor will do well to exclude from investment any company that with holds or tries to hide bad news.
xv) Unquestionable management integrity: Management is always far closer to company assets than shareholders. Without breaking any laws, the number of ways in which those in control can benefit themselves and their families at the expense of ordinary shareholders is almost infinite. Some Ways in which managements can benefit: taking high salaries for self/relatives, sell / rent properties or other items to the company at above market rates, distribution margin being collected by a promoter company, issue ofstock options.