Philip Fisher is the pioneer of growth investing. Learn the fundamentals of his investing strategy in this course.
The Birth of Growth Investing
“He should take extreme care to own not the most, but the best.”
The name’s Fisher, Philip Fisher
Growth vs. Value Investing
When investors are asked to describe their investment philosophies, two approaches are usually referenced: growth investing and value investing. Value investors look for stocks that look cheap on a price-to-earnings basis. They favor stocks that deliver lots of bang for the buck, or the “station wagons” of stocks.
Growth investors, on the other hand, look for stocks with more VROOOM in their growth trajectories, and don’t mind paying a little more for them. These investors prefer the “sports sedans” of stocks. Obviously, price is still important, but it’s a secondary consideration after the company’s growth profile.
Philip the Pioneer
Philip Fisher is considered one of the forefathers of growth investing. Fisher actually started as a value investor, but evolved his style following lessons learned in the 1929 stock crash. Fisher reasoned that value stocks can appear deceptively cheap because not all of a company’s problems are reflected in the accounting metrics. On this basis, Fisher shifted his focus on a company’s growth factors instead.
In true wonder-boy fashion, Fisher dropped out of graduate school at the tender age of 21 and launched his own investment firm only 3 years later. Fittingly, Fisher’s growth-focused investment firm, Fisher Investments (surprise), took root in what would later become Silicon Valley. From this perch, Fisher and his analysts targeted companies that dumped money into R&D to develop innovative products, which then fuelled market beating revenue growth rates.
Fisher’s decision to invest in a company wasn’t just based on a favorable view of its product offerings. Rather, a decision to buy meant a vote of confidence in the company management’s vision and organizational culture. In fact, Fisher had a 15 point checklist he went through during his evaluation process. Imagine selling this guy a used car. In addition to being quite selective, Fisher also earned a reputation as a very long-term investor.
In 1958, Fisher published “Common Stocks and Uncommon Profits,” where he presented his investment principles and process for evaluating companies. The work went on to become a classic within the field and cited by other investment legends for its influence on their own styles. You know you made it big when your book is frequently quoted by Warren Buffet, who even described himself as “15% Fisher.”
Today, Fisher’s investment firm still thrives under the guiding hand of his son, Kenneth Fisher, who has become a legend in his own right.
Grow Baby Grow!
“The company that doesn’t pioneer, doesn’t take chances, and merely goes along with the crowd is liable to prove a rather mediocre investment in this highly competitive age.”
Phil’s Fundamentals
Fisher’s investment strategy is like running a marathon: it’s simple to understand but requires a bit more effort to execute. In a nutshell, his approach uses fundamental analysis to identify visionary companies with sustainable, above-average growth prospects. Companies that grow their profits faster than average should then have stock prices that perform better than average, he reasoned.
Fisher outlined this approach in a list of 15 factors an investor must examine in determining a stock’s worthiness. Here are the key ones:
SUPERIOR MANAGEMENT
SUPERIOR R&D
SUPERIOR GROWTH
MARGIN
Technology, Opportunities Abound
Because of this investment philosophy, Fisher frequently found himself scouring the technology sector (or what qualified as “technology” in those days).
Why tech? The pace of change in the sector creates an environment that’s ripe for disruptive innovations. A pioneering company can generate tremendous profits until its competitors are able to respond with a rival product. Remember how everyone had to buy a Nintendo when it was first released and there was nothing else like it? Nintendo was making a fortune! That continued for quite a while until Playstation and Xbox came along and made things a bit tougher.
Invest for the Long Haul
“If the job has been correctly done when a common stock is purchased, the time to sell it is – almost never.”
One tenet of investing that Fisher emphasized repeatedly throughout his career is the value of long term investing. Although slinging stocks around like a hot potato may make for some short-term excitement, it is generally a worse strategy in the long run than a buy-and-hold strategy. Here’s why:
- Fisher’s method calls for a qualitative assessment of the company that covers the company’s products, management, strategy, culture, and quality of earnings. These factors do not change overnight, and neither should your investment thesis.
- Short-term investors are more prone to make trades based on emotion or reactionary instincts, neither of which leads to good decisions.
- Trading isn’t free. Commissions accumulate and will become a drag on your returns if you maintain a happy trigger finger.
That said, investing for the long term doesn’t mean being married to your stocks. An investor should allow his opinion to change along with the company’s prospects, rather than rationalize that “things will probably get better soon.” In other words, it’s ok to leave the game early if the home team is down by 10 runs in the bottom of the 8th, but you may want to stay in your seat if they’re down by only a run with men on base. Sounds easy, but recognizing patience versus rationalization isn’t always easy to do. Carl Icahn, regarded as one of the investing legends, took a 97% loss on Blockbuster stock when he refused to cut his losses (he did recover the last 3%).
Another common mistake that Fisher warned against is to make the decision to sell, but not until the stock recovers to the original purchase price. Many investors have done this only to see a failing company hit zero first.
A Few Good Stocks Are Better Than Many Mediocre Ones
“The disadvantage of having eggs in so many baskets that a lot of eggs do not end up in really attractive baskets, and it is impossible to keep watching all the baskets after the eggs are put in.”
The concept of diversification calls for portfolio holdings to be split among as many stocks as possible, with the idea that one or two bad investments won’t be enough to sink the ship. Fisher called for restraint in following this principle, for the following reasons:
- In the pursuit for diversification, investors risk lowering their investment standards so that they can pack their portfolios with a variety of stocks. What’s better, a meal at a buffet or a 2 course meal at a Michelin star restaurant?
- Related to the first point, crowding your good investments with mediocre ones will water down the your portfolio returns (see picture above).
- Carrying too many stocks in your portfolio means your diligence will be spread too thinly across all of them. Unless you eliminate the need for sleep or train your children to be stock analysts, you will be unable to devote the time to adequately monitor one stock without neglecting the others.
To be clear, Fisher isn’t advocating that you throw all your cash into one, or even two, stocks. A balance needs to be struck where your risk is distributed, but not to a point where you sacrifice the quality of your investments or ability to monitor them.
So what’s the right amount of diversification? A good general rule of thumb is to not have more than 10-15% of your portfolio in one stock. 10% for a stock you really like, 15% for a stock you absolutely love. Ask yourself this question: If you wake up tomorrow and your biggest stock holding becomes worthless, would you be stung or crippled? If the answer is closer to yes, then you need to diversify more.
If you’re just starting your portfolio, don’t go for a shotgun approach where you invest your entire portfolio in all your target companies at once. Instead, invest in a few to start (again, with each stock not exceeding 10-15% of your total cash available), then slowly add more stocks as you grow comfortable with your ability to monitor your existing holdings. Lebron didn’t try dunking in his first game (ok maybe he did).
Get Comfortable With Management
“Confine investments to companies the managements of which have a highly developed sense of trusteeship and moral responsibility to their stockholders.”
Get to Know Him Better Before You Hand Over Your Cash
One of the key requisites in a good company is good management. In this regard, Fisher calls for an all-encompassing review of a company’s leadership. These are some things to look for in spotting good management (If you haven’t noticed already, Fisher liked lists):
- Vision: First and foremost, management should have a long term vision of the company and the ability to execute that vision.
- Sense of trusteeship: Management should manage the company for the benefit of shareholders, not themselves.
- Spending discipline: Even in times of aplenty, management should deploy excess cash judiciously, rather than partake in “empire-building” where they spends money recklessly to expand into unrelated businesses. If Microsoft announces that it’s using all its available cash to start its own clothing line, then an investor should be concerned. Trust me, you DO NOT want programmers in charge of fashion.
- A consistent dividend policy: A constantly shifting dividend policy reflects a management with no long-term plan for deploying its cash. Very high dividends may also suggest that the company is unable to identify attractive R&D opportunities. This can be a pre-cursor to slowing innovation.
Key Ratios
Revenue Growth % (Current Year Revenue/Previous Year Revenue): The most important ratio in growth investing. As the name implies, this shows the growth rate of the company. You should calculate this ratio for multiple years to spot potential deceleration.
Profit Margin % (Profit/Revenues): This reflects a company’s “take-home” after all expenses (production, salaries, marketing, administrative, etc..) are accounted for. For example, say you’re trying to decide between investing in 2 different ice cream stores with the following financials:
Both have the same sales amount, but which business is more attractive? Store A takes home significantly more income after all expenses are paid out, hence illustrating the importance of profit margins. The jackpot is a company with high growth rates AND high margins.
R&D Expenditure % (R&D Expenses/Revenues): Without adequate R&D spending, a company’s product line will quickly become obsolete and its growth will stall, or even reverse. Generally, a company’s R&D spending should grow proportionally with its revenues, so comparing R&D Expenditure percentages over time is more appropriate than comparing R&D Expenditure in dollars. A declining % may imply that management is sacrificing long term growth for cash today, or a lack of an attractive project to pursue. Both are bad.
Here’s an example of all 3 ratios using one of Phil’s Potential Picks: 3D Systems (DDD). The company’s financials are in blue, while the calculated ratios are in green.
Revenue Growth: Not only is the company’s year-to-year revenue growth impressive, it’s actually accelerating (42% from 2009-2010, 53% from 2011-12)
Profit Margin: The company had a meagre 1% profit margin in 2009. This means that for every $100 it receives from customers, only $1 becomes profit after all production costs and company expenses are accounted for. This rapidly expanded to double-digit % in the years that followed. It did decline in 2012 so a careful investor will do some research as to why that occurred.
R&D Spending: The company has held R&D spending % constant over time, a sign that it remains committed to developing new products to stay competitive.