Philip Fisher on ‘When to buy’

Recently, I was reading one of the best works of Philip Fisher — his book ‘Common Stocks and Uncommon Profits’ written more than half a century ago. His thought process happens to be simple but highly effective — a best known combination for success in the business of investing. Although as contradictory it may sound, just like Benjamin Graham, he had adopted throughout his career an owner-like attitude while evaluating stocks. And just like Buffett, his favourite holding period was near about forever! In fact, he continued to hold his investment in Motorola for about 21 years right till the day he died. It is rare to find people having this kind of temperament in investing — despite this being precisely the field where one cannot ask for anything less than this type of commitment at least while evaluating businesses.

In one of the chapters of the book discussing when to buy stocks, his owner like thinking shines beautifully. Reflecting upon his long experience in the markets he observes-

As word first gets out about a spectacular new product in the laboratory of a well-run company, eager buyers bid up the prices of that company’s shares. When the word comes of successful pilot-plant operation, the shares go still higher. Few think of the old analogy that operating a pilot plant is like driving an automobile over a winding country road at ten miles per hour. Running a commercial plant is like driving on that same road at 100 miles per hour.

Then when month after month difficulties crop up in getting the commercial plant started, these unexpected expenses causes per-share earnings to dip noticeably. Word spreads that the plant is in trouble. Nobody can guarantee when, if ever, the problems will be solved. The former eager buyers of the stock become discouraged sellers. Down goes the price of the stock. The longer the shake-down lasts the more the market quotations sag. At last comes the good news that the plant is finally running smoothly. A two-day rally occurs in the price of the stock. However, in the following quarter when special sales expenses have caused a still further sag in the net income, the stock falls to the lowest price in years. Word passes all through the financial community that the management has blundered.

Buffet has said long back that in investing risk lies in not knowing what one is doing. Although, this was a hypothetical example put up by Fisher, such cases are not entirely unheard of in the markets. Quarterly number focused members of the street are known to experience such vicissitudes & mood swings. An investor having owner-like attitude would have better navigated such turbulences which is the part and parcel of our profession. Having known that these near term setbacks are actually indicators of things actually panning out, he would have only added to his position at such bargain prices. It couldn’t have been a better time for him.

What is interesting is that this attitude of the street i.e. focusing on near term results has not much changed since last 60 years when Fisher wrote this. Nor do I think it would change over the next 60 years :)

Further, he continues –

At this point the stock might well prove a sensational buy. Once the extra sales effort has produced enough volume to make the first production scale plant pay, normal sales effort is frequently enough to continue the upward movement of the sales curve for many years. Since the same techniques are used, the placing in operation of a second, third, fourth, and fifth plant can nearly always be done without the delays and special expenses that occurred during the prolonged shake-down period of the first plant. By the time plant Number Five is running at (optimum) capacity, the company has grown so big and prosperous that the whole cycle can be repeated on another brand new product without the same drain on earnings percentage-wise or the same downward effect on the company’s shares. The investor has acquired at the right time an investment which can grow for him for many years.

Though he talks about timing in the end, what really created an impact on me was his ability to think through clearly about his stocks for years together. Usually, one might have sold his position, at a descent profit when commercial plant came into operations and market corrected itself and now starts pricing thing efficiently. But Fisher did not think so. He could see that, although stock is now fairly valued with respect to its current earnings, this business could actually go upon expanding its sales as well as its margins which could create a bigger impact on profits. He could see capacity going 5x after years of initial commissioning.

Obviously, lot of things have to go right for the company for this to happen but he was willing to wait and see it coming thereby selling in finally at an even higher profit. It was his owner-like approach, understanding of the business and long term thinking which would have earned him this.

He came in hunting for a bargain like a ‘value guy’ and left out earning profits which ‘growth investors’ would envy — if at all such stereotype distinction exists.

Idea is thinking about stocks not as mere pieces of paper but as businesses in their own right, as Graham would say.