Table of Contents
During his Stanford days, Fisher used to accompany his professor to periodic visits to the companies in the San Francisco area. During these visits. There they learned about the operations involved in the business and helped them to solve immediate business problems. Fisher later described this experience as “That hour each week was the most useful training I ever received”.
From these experiences, Fisher learned that Superior profits could be made by:
1. Investing in companies with above-average potential, and
2. Aligning oneself with the most capable management
To find these exceptional companies, Fisher developed a point system, to weigh the characteristics of a company, that he used as a qualification:
Sales and Profits
The most important companies, Fisher identified, were those that could grow their sales and profits over the years at rates greater than the industry average. To achieve this, he believed that the company must possess products and services with market potential. He believed that such companies would grow over time by virtue of their potential. He also did not stress over the consistency of growth. Owing to changes in the business cycle some companies do face a temporary decline in growth, but if the fundamentals are strong, such companies provide good returns in the long term.
“The greatest investment reward comes to those who by good luck or good sense find the occasional company that over the years can grow in sales and profits far more than the industry as a whole.”
Philip Fisher
Research and Development efforts
Fisher identified that a company that puts efforts into research and development is more likely to show above-average growth over longer periods. Many successful companies would not have succeeded without commitment to Research and Development. While looking for investment, an investor must ensure that the dedication of the business towards R&D efforts matches at least its industry standard.
The Research & Development efforts could be for developing a new line of products, that allowed Coca Cola to survive for more than 100 years, or it could be to improve the existing products like Google does with its search engine (along with the new line of Google products).
Many of the dominating businesses went out of vogue due to their R&D dedicated competitors marching ahead with improved products and innovations.
Sales Organization
Fisher observed that even if a company develops superior products, no matter the investment in Research and Development, it does not translate into revenue and profits unless the products are expertly merchandised. It is the responsibility of the sales organization to help the customer understand the benefits of the offered products and services. The sales organization should also study the current trends, and buying habits of the customers and spot the customers’ needs. The learning from customer study would enable them to help address these needs by providing feedback to the other departments of the company. The sales organization thus becomes an invaluable link between the marketplace and the research and development unit.
Generate Profits
A company with above-average growth would be considered an inappropriate investment if it fails to generate a profit for the shareholders.
All the sales growth, research and development, and marketing efforts won’t produce the right investment vehicle if the profits do not grow correspondingly.
Fisher believed in investing in a company that not only produces the lowest cost products but is also dedicated to cost reduction. Such companies have lower break-even point, higher profit margins, and can withstand depressed economic times
Management Capabilities
According to Fisher, superior companies are directed by people with above-average management capabilities.
The managers are committed to developing new products and services that continue to spur sales and growth long after the current line of products or services is largely exploited.
Fisher notes that many companies have products and services to sustain them for many years, but not the correct policy. A company must have a viable policy for attaining the ends and long-term objectives with the willingness to subordinate immediate profits and gains if required. It does not mean sacrificing short-term possibilities. An able management can implement long-range plans while focusing on daily operations and willingness to make hard decisions.
Management and Employee working relations
According to Fisher, good management must ensure healthy working relations with all employees. Employees must feel that they are treated with respect and decency and can maintain a good work life balance. Promotions and rewards should be based on performance, and abilities and not favoritism.
Integrity and honesty of Top management
Fisher considered integrity and honesty as a very important trait required in the management of a superior company. One way to determine these traits in management is by observing how it communicates with the shareholders. All businesses, big or small, face difficulties. It is a tendency to talk freely when the business is good but during hard times, some managers start obscuring facts and details. How a management responds to business difficulties, and how openly it talks about the business during hard times goes a long way in gaining the trust of the shareholders and lends credibility to the management.
Accounting controls and Cost analysis
Fisher said that no company would be able to sustain its profitability unless it can break down the costs of doing business while simultaneously understanding the cost of each step in the manufacturing step. For this, a company must install adequate accounting controls and cost analysis. This enables a company to direct its resources to the products and services with the highest economic potential. Furthermore, accounting controls and cost analysis help identify snags in a company’s operations. These snags if addressed effectively help in improving the company’s profitability. High profitability helps a company in future growth without requiring equity financing. If the only way to grow a company is to sell its shares, then a higher number of outstanding shares will cancel out the benefits of higher growth and profits to the existing shareholders. A company with high profitability should be able to grow without diluting shareholder ownership.
Depth of management
The Chief Executive officer should have a talented team. The CEO should be able to delegate authority to run parts of the business to the other members of the team. This enables a company to survive in case something happens to the key person, as there are other capable people with the potential to take over the responsibilities.
Scuttlebutt
This is a qualitative method, originally discussed in Fisher’s book “Common Stocks and Uncommon Profits”. Scuttlebutt means discussing and understanding a company by personally talking to its stakeholders. The method revolves around gathering information from various stakeholders associated with a company – customers, suppliers, employees, and even competitors. By engaging with those directly involved in a company’s operations, the scuttlebutt method helps in a nuanced understanding of factors that might otherwise remain concealed.
If done well, the method can be a key to identifying companies with potential for growth and long-term value creation.