Common Stocks and Uncommon Profits

Common Stocks and Uncommon Profits by Phil Fisher

In 1958 Philip A. Fisher published Common Stocks and Uncommon Profits in the hope of giving investors a systematic process to follow when seeking out great companies. Widely respected and admired, the book creates a process for an investing philosophy focused on growth.

Our team shares some variant of Buffett’s quip that Berkshire Hathaway is “85% Graham and 15% Fisher.” 85% of Buffett’s investment process comes from Benjamin Graham’s timeless book “The Intelligent Investor” with its emphasis on value and safety. The other 15% comes from Mr. Fisher’s book which emphasizes sustainable growth.

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Much of the froth that remains in today’s stock market is characterized by “growth” stocks that lose money. The securities analyst today is often left with little more than sales as a metric for valuation. We hope our notes remind today’s growth investors that profit margins are valuable when building an intelligent investment process!

Common Stocks and Uncommon Profits Summary

Published in 1958, we found re-reading the book to be an extraordinary experience. We are well-served to take a moment to revisit the work of one of history’s most influential investors of all time. The book is a reminder of the tremendous economic and political range this country has experienced.

Mr. Fisher discusses how the scars of the post 1929 crash will no longer be tolerated by either our people or politicians. He observes that the government will “…not hesitate to lower taxes or make whatever other deficit-producing moves were necessary to restore prosperity and eliminate unemployment. This is a far cry from the doctrines that prevailed prior to the big depression.”^[1]

Fisher’s conclusions from this political and economic bias are that bonds are actually the speculative asset class while equities are the only ones to combat currency depreciation. There is an eerie resonance here with our work on the Great Inflation of 1969 – 1984. We framed that analysis with quotes from Warren Buffett’s letters to shareholders which emphasized stocks over bonds.

Our team does not make macro forecasts. Yet we believe dollar devaluation and persistent inflation are as plausible today as in 1958 or 1969. Regardless of your macro views, we think the investment community is still wholly unprepared for any sort of persistent inflation. The market appears to believe we will soon revisit an investment environment similar to 2017-2021. This speculative environment was characterized by cheap money, weak lending covenants and relentless multiple expansion.

The following quote from Mr. Fisher’s book is worth reprinting in light of today’s circumstances:

In its letter of December 1956, the First National City Bank of New York furnished a table showing the worldwide nature of the depreciation in the purchasing power of money that occurred in the ten years from 1946 to 1956. Sixteen of the major nations of the free world were included in this table. In every one of them the value of money significantly declined. These declines ranged from a minimum in Switzerland, where at the end of the ten-year period money would buy 85 per cent of what could be purchased ten years before, to the other extreme in Chile, where in ten years it had lost 95 per cent of its former value. In the United States this decline amounted to 29 per cent and in Canada to 35 per cent. This means that in the United States the annual rate of monetary depreciation during the period was 3.4 per cent, and in Canada it was 4.2 per cent. In contrast, the yield offered by the United States Government bonds bought at the beginning of the period … was only 2.19 per cent. This means that the holder of this type of high-grade, fixed-income security actually received negative interest (or loss) of better than 1 per cent per annum if the real value of his money is considered.^[2]

Later, in Chapter 8, we quote another piece from the book which discusses the incredibly high tax rates on inheritance and wealth that we think will be of interest today. We bring up these items because the movements which are often described as “socialist” today would merely be history repeating itself. This nation has experienced cyclical flows from massive wealth accumulation to distribution.

What feels new to us today is actually just a perfect repeat of a period in our nation’s past. Regardless of how you feel about such policies, it is crucial that you realize they have historical precedent.

Common Stocks Uncommon Profits Chapter Notes

Preface:

Quote: Here I had a ringside seat at the incredible financial orgy that culminated in the autumn of 1929 as well as the period of adversity that followed. My observations led me to believe that there was a magnificent opportunity … for a specialized counseling firm that would make itself the direct antithesis of that ancient but uncomplimentary description of certain stockbrokers – men who know the price of everything and the value of nothing –page 31

• To make big money in stocks, you must be patient
• The desire to follow the herd is a compulsive human behavior that you must avoid

Chapter 1: Clues from the Past

Quote: …the definite intention of reversing any unfavorable business trend by cutting taxes, building more public works, and lending money to various hard-pressed business groups, and it becomes increasingly plain that if a real depression were to occur the federal deficit…would produce further inflation in much the same way that the deficits resulting from wartime expenditures produced the major price spirals of the postwar period. –page 39

• Buying great firms and holding on is a terrific way to help reduce the risk of inflation and grow wealth
• R&D is an incredible source of competitive advantage for companies
• Even when bond yields are higher than the dividends equities pay, they create taxable income and expose investors to a decline in the dollar

Chapter 2: What “Scuttlebutt” Can Do

Quote: It is equally astonishing how much can be learned from both the vendors and customers about the real nature of the people with whom they deal. –page 45

• Talking to people who buy from and sell to a company can offer investors valuable information
• Investors should not underestimate the value of the “grapevine” when researching a firm
• While simple in nature, this task can be time-consuming

Chapter 3: What to Buy, the 15 Points to Look for in a Common Stock

We are omitting a quote here as this chapter holds the 15 points Mr. Fisher felt critical to finding a sound investment. Instead, we will provide summaries of each bullet below.

1. Buy companies with products that can allow them to grow revenues for many years to come
2. Make sure the management is determined to continue innovating and creating new paths to grow
3. R&D is crucial – do your best to make sure the money spent there is done so efficiently
4. Make sure the company has a great sales culture
5. Sales growth without profits is not valuable – make sure the company has healthy margins on new revenues – investors should be very careful about investing in firms with low margins on sales
6. Make sure a company has clear paths and plans to maintain or expand margins
7. Make sure the company has terrific relationships with its employees – a company is only as good as its people
8. Make sure the company’s management has aligned with the corporation’s goals and promotes from within
9. Companies, where the success is tied to a visionary without executive continuity, should be avoided
10. Ensure that a company has solid accounting and systems in place – must be able to track expenses
11. If the company is in an industry that requires specific knowledge and skills, make sure they have top-flight staff in that area
12. Invest in companies that are willing to give up margins to maintain strong relationships with suppliers as these firms will prove more profitable over the long term
13. Avoid firms that depend on investors for capital as growth should be funded by cash flows or debt
14. Bad news is inevitable; invest with management teams that are candid and honest about both the good and the bad
15. Management that is honest and committed to the wellbeing of all stakeholders is of critical importance. Beware executives that have business deals with family, related parties or engage in nepotism.

Chapter 4: What to Buy, Applying This to Your Own Needs

Quote: …the only funds [you] should consider using for common stock investment are funds that are truly surplus. –page 86

• Being a great investor does not require genius, only hard work and avoiding fads
• You should hire a financial advisor that is entirely honest – do not settle for anything less
• Investment advisors that point to track records based on forecasting are confusing luck with skill

Chapter 5: When to Buy

Quote: I believe that the economics which deal with forecasting business trends may be considered to be about as far along as was the science of chemistry during the days of alchemy in the Middle Ages. –page 90

• Forecasting future macroeconomic trends is as appealing as it is impossible to get right consistently
• Often even great companies will stumble and be quickly written off by most short-term investors causing prices to fall. Once you verify that management is working diligently to rectify the mistake, these can be great buying opportunities.
• Stagger the timing of your investment program to avoid buying a large piece of stock before a cyclical downturn. Spacing your purchases out helps you stay the course over the long haul.

Chapter 6: When to Sell, And When Not To

Quote: I believe there are three reasons, and three reasons only, for the sale of any common stock which has been originally selected according to the investment principles discussed. –page 105

• Reason 1: If your facts are wrong then be honest and act accordingly

“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.” –page 106

• Reason 2: If a great investment has changed in such a way that it no longer meets the 15 points outlined above, an investor should sell
• Reason 3: There are times when the investment landscape is priced so that truly great investments are scarce or Following the principle of staggering your investments, you put money to work in the best opportunity you can find. Later on, conditions may change making a far better firm now available for purchase. This is in no way an excuse to try and time markets.

If the job has been correctly done when a common stock is purchased… the time to sell it is – almost never. –page 113

Chapter 7: The Hullabaloo About Dividends

Quote: The managements whose dividend policies win the widest approval among discerning investors are those who hold that a dividend should be raised with the greatest caution and only when there is a great probability that it can be maintained. –page 121

• Investors understanding of dividends is highly flawed and filled with misconceptions
• If management is failing to invest internally, dividends are actually a misallocation of capital
• If you stick to the 15 points when picking stocks, you will often end up owning companies with the healthiest and most stable dividends

Chapter 8: Five Don’ts for Investors

Quote: Many things have happened to change these colorful markets of the past. High income and inheritance tax rates are one. A more important influence is the levelling of incomes that continues year after year in every section of the United States. The very rich and the very poor each year grow smaller in number. Each year the middle groups grow larger. –Page 125

1. Never buy IPOs – the deck is stacked against you in almost every way
2. Do not let the nature of the listing discourage you from buying a great company – he was discussing the “over the counter” market. We believe the corollary might be that low turnover should not discourage the purchase of a great company.
3. Do not buy a stock because its leadership tells a great story – don’t confuse great investor relations and PR to mean that the firm has a great future!
4. Do not let a higher multiple of earnings discourage you from buying great companies – it is ok to “pay up” within reason for a great company that can compound and grow
5. Do not let emotions around current price levels stop you from investing – if you identify a great company at a reasonable price, setting an arbitrary limit based on current market prices is not helpful

Chapter 9: Five More Don’ts for Investors

Quote: For some reason, the first thing many investors want to see when they are considering buying a particular stock is a chart giving the highest and lowest price at which that stock has sold in each of the past five or ten years. They go through a sort of mental mumbo-jumbo and come up with a nice round figure which is the price they are willing to pay for the particular stock. –Page 147

Without a disciplined process, investors will spend most of their time looking at fairly valued securities

1. Don’t overstress diversification – it is far better to own a smaller number of stocks that are of high quality and that you understand than a big basket of stocks you know little about
2. Don’t be afraid of buying on a war scare – more broadly speaking, when there are big macro-based panics and everyone is fearful, you should be greedy; time passes, and things get better
3. Don’t pay attention to price charts – the attention investors pay to price action is dangerous for two reasons. First, the patterns you see really don’t exist. Second, that distracts you from doing the work on fundamentals necessary to find great investments.
4. Don’t let short-term overvaluation keep you out of a great investment – a great company based on future expectations that is expensive based on existing information should be purchased over time
5. Don’t follow the crowd – market fads are common recurring features of markets – following fads is a great way to lose a lot of money. While fads can affect the whole market, they are more common in overhyped industries.

Chapter 10: How I Go about Finding a Growth Stock

Quote: This about sums up how I go about finding growth stocks. Possibly one-fifth of my first investigations start from ideas gleaned from friends in industry and four-fifths from culling what I believe are the more attractive selections of a small number of able investment men. –Page 170

• One of the best ways to find great companies is to look at what other proven investors with very long track records are doing
• The task of finding a great growth stock requires a fair bit of work, but anyone can do it if they put the time and effort into the process laid out by Mr. Fisher
• A great growth stock will compound over many years making the research effort quite modest relative to the pay-off

For those interested in digging into the heavier empirical research behind the validity of growth, dividend or value investing, please feel free to reach out to us. Our knowledgeable team can help locate and deliver material specific to your interests.

For investors interested in compounding capital using the industry’s best investment tools, you can find them on our website or by contacting us here. To learn about the following investment research tools:

• Click here for our paper explaining our Stock Ranking Tools
• Click here for our research explaining how to identify firms manipulating earnings to fool investors
• Click here for our research on some of the pitfalls faced by investors in index funds

We are grateful for any and all interest!