Monday, November 30, 2020

Phil Fisher’s Scuttlebutt Approach to Company Research

Phil Fisher is one of the best investors in the world. He managed portfolios for a small group of clients over a period of several decades. He launched his investment firm at the depths of the Great Depression in 1931, and closed it near the end of his long-life in the 1990s. Sadly, he passed away at the age of 96. It looks like a lot of long-term investors tend to live for a long period of time – Buffett, Fisher, Munger, Kahn, Carrett, Walter Schloss, Ben Graham.

Phil Fisher popularized the concept of investing in promising companies that can grow over time, which can lead to very good long-term returns. He popularized the concept of growth investing in a nutshell.

For example, when he died in 2004, he still held shares of Motorola, that he had purchased many decades before that. The stock had done very well, as evidenced by this price only chart:


He also kept a fairly concentrated number of holdings in companies which he held for decades. Phil Fisher did an extensive research of companies, focusing on competitors, suppliers, employees, poring over records and filings, before investing in a company. That is a very time intensive task, but he was very good at it.

Warren Buffett has stated that his investing style has been influenced by Phil Fisher. He claims to be 85% Fisher/15% Ben Graham. As a result, a lot of investors are studying Phil Fisher as much as they can, in an effort to learn how to produce an outstanding investing effort.

There are a few books by Phil Fisher, which are great and very educational. I highly recommend them. For example, his book Common Stocks and Uncommon Profits convinced me to invest in defense contractors a few years ago.

His ideas to focus on future growth, and not just current yield, meshes well with my idea of dividend growth investing and buying companies to build up future yield on cost.

Phil Fisher believed that investors should focus on 15 criteria when deciding where to place their money. The more criteria a given company can meet, the better. he believed that if the job has been correctly done when a common stock was purchased, the time to sell it is almost never.

1. Does the company produce goods or services whose sales are likely to increase substantially for at least the next several years? 

Fisher was interested not in ‘one-off’ growth, nor necessarily in steady, year after-year increases in growth, but rather in ‘greater-than normal growth not only for the next several-year period, but for a considerable time beyond that.’ Fisher does not just extrapolate past sales growth: he seeks to understand how, and therefore to confirm that, past growth can continue into the future.

2. Is management determined to develop new goods or services? 

According to Fisher, ‘companies which have a significant growth prospect for the next few years because of new demand for existing lines, but which have neither policies nor plans to provide for further developments beyond this, may provide a vehicle for a nice one-time profit. [But] they are not apt to provide the means for the consistent gains over 10 or 25 years that are the surest route to financial success.’

3. How effective is a company’s research and development? 

‘If quantitative measurements—such as the annual expenditures on research or the number of employees holding scientific degrees—are only a rough guide and not the final answer to whether a company has an outstanding research organization, how does the careful investor obtain this information? Once again it is surprising what the “scuttlebutt “method will produce.’

4. Does the company have an above-average sales organization? 

The sale of goods and services is the most basic activity that a business undertakes; yet the effectiveness of a company’s sales, advertising and distribution receives far less attention from investors than it should. Here, too, Fisher relies heavily upon scuttlebutt: ‘of all the phases of a company’s activity, none is easier to learn about … Both competitors and customers know the answers. Equally important, they are seldom hesitant to express their views. The time spent by the careful investor n inquiring into this subject is usually richly rewarded.’

5. Does the company have a worthwhile profit margin? 

Although they need not necessarily rise over time, Fisher seeks companies with the largest possible operating margins. Accordingly, whether the company is large or small, new or well established, ‘investors desiring maximum gains over the years had best stay away from low profit-margin or marginal companies.’

6. What is the company doing to maintain or even improve its profit margin? 

Simplified drastically, companies can either raise their prices or reduce their costs. Fisher is somewhat skeptical of the company that maintains or improves its margins exclusively by increasing its prices, and looks for those that also maintain a keen eye towards production, marketing and other cost efficiencies, capital improvements and other innovations.

7. Does the company boast outstanding labor and personnel relations? 

Fisher’s interest in technological excellence and innovation led him towards companies whose employees tended not to be members of a trade union. Further, ‘the company that makes above average profits while paying above-average wages for the area in which it is located is likely to have good labor relations. The investor who buys into a situation in which a significant part of earnings comes from paying below average wages for the area involved may in time have serious trouble on his hands.’

8. Does the company have outstanding executive relations?

‘The company offering [the] greatest investment opportunities will be one in which there is a good executive climate.’ By this Fisher meant (among other things) that executives have confidence in their president and CEO, and that salary and promotion are based upon ability and results. ‘The further a corporation departs from these standards, the less likely it is to be a really outstanding investment.’

9. Does the company have more than a handful of talented managers? 

The less an organization’s survival and success depends on one or a small number of personalities, and the less one executive interferes with the job of another, the better. ‘The organizations where top brass personally interferes with and try to handle routine day-to-day operating matters seldom turn out to be the most attractive type of investments. Cutting across the lines of authority which they themselves have set up frequently results in well-meaning executives significantly detracting from the investment caliber of the companies they run.’

10. How good are the company’s methods of cost analysis and accounting?

No company will create outstanding success or continue it for any period of time if it does not know its costs in such detail that it is able to distinguish its most profitable activities (which it should continue and possibly expand) from its least profitable and unprofitable activities (which it should either improve or discontinue).

11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues about how outstanding the company may be compared with its competitors?

In retailing, for example, the way a company handles matters such as the location and duration of leases is very important. In the ‘tech’ field, it is not just the innovations themselves but also their degree of patent and other protection ‘which is a major factor in appraising the attractiveness of a desirable investment.’

12. Does the company have a short- or a long-range outlook?

Some companies conduct their affairs to gain the greatest possible profit today. Others deliberately don’t take jam today so that they can enjoy more jam tomorrow. Fisher seeks the latter and avoids the former type of company. If executives focus too much on the here and-now, for example in their treatment of customers and vendors, they might make poor long-term decisions.

13. Will the company’s growth require so much equity finance that the much larger number of shares outstanding will largely cancel the benefit from this anticipated growth?

Fisher seeks companies whose growth relies mostly upon their own existing resources (shareholders’ funds and retained earnings) and only incidentally upon external resources. In other words, he rejects companies that borrow heavily or issue large amounts of equity to finance their operations.

14. Does the management talk freely to investors about its affairs when things are going well but become mute when troubles occur?

The investor will do well to exclude from investment any company that withholds or tries to hide bad news.’

15. Does the company have a management of unquestionable integrity? 

Fisher noted that a company’s executives will almost always be much more familiar with a company’s affairs than its shareholders are. For this reason, managers can benefit themselves at the expense of shareholders in many ways. Decades before most others, Fisher recognized that ‘probably most costly of all to the investor is the abuse by insiders of their power of issuing common stock options.’ Fisher’s response? ‘There is only one real protection against abuses like these. This is to confine investments to companies [whose] managements have a highly developed sense of trusteeship and moral responsibility to their stockholders. This is a point concerning which the “scuttlebutt “method can be very helpful’.

Naturally, it is obvious that this is a super-investor that should be studied. A lot of people learn that to emulate their investment style, they need to spend a lot of time digging into every detail about a company, competitors and industry. All of this sounds like a lot of work. It is enough to get everyone discouraged.

I recently read the book "The Money Game" once, and then re-read it. The book discussed how Phil Fisher found his investment ideas:

“For years, Phil Fisher espoused what he called "scuttlebutt" as the way to zero in on a new investment, You know a company; you talk to their competitors. You talk to the people who sell them. things and to the people who buy things from them. An engineer, for example, might be enthusiastic about a new oscilloscope he was using, and that would lead you to the oscilloscope maker. People like to talk about their work. If you go to visit the plant of, say, the maker of peripheral computer equipment, it has been my experience that the people there will not only tell you all about peripheral computer equipment; they will tell you all the gossip about the major computer makers.

And not only that, they will tell you about the components within the computers because their friends, 'the computer engineers, have told them which components are exciting and every last one of these birds is in the stock market. and looking for sexy stocks just like you are. That fellow who has just taken you through the plant will tell you, in the company cafeteria, that he has just exercised his options, hocked his stock in his own company, and loaded up with Pazoomis Computer Machine Tool. You have only one problem, and that is, if you spend all of your time gossiping with computer engineers, when are you going to do whatever it is that you do? (You would have another problem if you did have the time to pursue all this scuttlebutt, and that is that engineers can be just as fanciful as stockbrokers, and a beautiful piece of equipment does not necessarily come from the most profitable company. And Pazoomis Computer Machine Tool may be just about to get swamped by Kearney and Trecker, and Giddings and Lewis, their competitors.)

Well, Phil Fisher is an honest man, and one day he sat down and made a study of where his successful ideas had come from. After many, many years in the business of scouting and evaluating. ideas, and after building up an incredible network of acquaintances and contacts throughout a variety of industries, he found that only one sixth of the good ideas had come from the scuttlebutt network. And the other five sixths? "Across the nation I had gradually come to know and respect a small number of men whom I had do outstanding work of their own in selecting common stocks for growth. . . . since they were trained investment men, I could usually get rather quickly their opinion upon the key matters .... I always try to find the time to listen once to any investment man .... " In other words, he found some smart people. That is one of the most important of the Irregular Rules, find smart people, because if you can do that, you can forget a lot of the other rules”

This was a very eye-opening quote for me. That’s because it explained to me why many of you are probably reading me. It also explains why you should read not just me, but perhaps others too. It also explains to me why other dividend bloggers follow me, and then I see my ideas on their articles a few weeks or months after I have posted it in the first place.

I have usually been against people blindly following others into investments. It strikes me as looking for investment tips and buying blindly on a hunch, which could turn out poorly and lead to investors not learning anything in the process. However, that quote made me see it in a new light.

Namely, if you develop your own process, you can still follow other investors that you respect. If they come up with investing ideas, you scrutinize them, analyze them, and check off the boxes on your investment checklist. If you learn about an investment from someone else, and it fits everything that you are looking for in your investment process, there is no shame in buying the investment. Of course, it makes sense to follow a few trusted investors that way, and be on the lookout for other good investors to follow. After looking at my investment journal, I am pretty sure that I invested in Visa a decade ago because I saw Buffett buying it, followed by a high dividend increase for the company. It also looked better than Mastercard to me at the time.

That being said, you should follow other investors, but you should still do your own analysis. Back in 2012 – 2013, I was also following Buffett into IBM. His words resonated with me, but I had more experience with Accenture. In the end I bought both companies, but in retrospect I should have bought Accenture over IBM.

Since this article is already getting too long, I would just stop right here. I hope you enjoyed it and have a further list for your education as an investor.

Relevant Articles:

These Books Shaped My Investing Strategy

The importance of pricing and valuation in dividend investing

How to Invest Like Warren Buffett


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