Phil Fisher: The 15 Points, Part 2

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- By Robert Abbott

When Philip Fisher published his 1958 book, "Common Stocks and Uncommon Profits and Other Writings," it gained attention for its 15 points. That is, 15 issues to watch for when buying stocks; the list has influenced many value investors in the 60 years since its publication, including Warren Buffett (Trades, Portfolio).


In a previous article, we reviewed the first three points he made about businesses: (1) Products or services with enough market potential to significantly increase sales for at least several years, (2) management is determined to keep developing products or processes that will further increase total sales, when the growth potential of currently attractive product lines has subsided and (3) the company's research and development is effective in relation to its size.

We now follow up with the remaining 12 points (some of which were covered lightly by the author):

The company has an above-average sales organization

Fisher lead into this subject by noting:


"It is the making of a sale that is the most basic single activity of any business. Without sales, survival is impossible. It is the making of repeat sales to satisfied customers that is the first benchmark of success. Yet, strange as it seems, the relative efficiency of a company's sales, advertising, and distributive organizations receives far less attention from most investors, even the careful ones, than do production, research, finance, or other major subdivisions of corporate activity."



One example of a business that was meeting this need in his day was the Dow Chemical Co., which is now DowDuPont (DWDP); the author said the company recruited and trained its sales people as carefully as it did with its research chemists.

The company has a worthwhile profit margin

This point is readily quantified by studying the profit margin over a series of years. A lack of consistency in the margins indicates a lower-quality company, and this type is rarely a good investment. Look first among the older and larger companies for strong profit margins and then for companies with the best margins in their industry.

The company is maintaining or improving its profit margins

Once investors have bought their stocks, their attention should shift from profit margins in the past to margins in the future. In Fisher's time, there were constant threats to profit margins, including rising labor costs, additional expenses for raw materials and supplies and in tax rates.

Many companies, in Fisher's experience, had addressed profit margin erosion by raising prices, but he had more admiration for companies that use "far more ingenious means." This includes designing new equipment that will reduce costs or improve productivity.

The company has outstanding labor and personnel relations

Here, Fisher looked at the profitability made possible by good labor relations. That allows companies to avoid the costs of frequent and/or prolonged strikes. In addition, satisfied workers are more likely to deliver productivity gains for their employers, and reduced turnover reduces the cost of hiring and training new workers.

One area of quantification for this subject is the relative labor turnover in one company compared with another. The author also warns against companies that depend on below-standard wages and encourages investors to determine the attitude of top management toward rank-and-file employees. Look for management that make employees feel they are wanted, needed and an important part of the business.

Members of the management team work well together

Fisher looked for what he called a "good executive climate," one in which executives have confidence in in their president (CEO in modern parlance) and chairman. There is confidence among them that promotions are based on ability, that merited increases will be received without asking and salaries are in line with the industry and geographic area.

There is an appropriate depth of management

While a small corporation may get by, or even thrive, under one-person management, larger corporations need depth. That depth is a form of insurance, enabling the company to carry on as usual if the top person is taken away. But as investors, we want more than just survival, we want continued growth. In turn, that demands a bigger management team to take advantage of new opportunities.

The company has strong cost analyses and accounting controls

Such oversight and control are needed so management knows what areas need its attention and if it is solving the problems being addressed. That is magnified when a company makes many different products.

Fisher acknowledged there is not much an individual investor can do to find out if these systems are functional and effective. As broad generalization, though, a company that is well above average in other areas will likely do well in this field as well (it might also be argued a company needs good oversight and control to function at high levels in those other areas).

There are unique aspects of the business that indicate how effective the company will be when compared with its competition

Think of this point as an early example of what we now call competitive advantages or moats. As an example of this point, Fisher pointed to the importance of real estate management within the field of retailing. While a retailer's main business may be selling products to consumers, its profitability can be affected by the quality of its leases. Not many years after Fisher's book was published, McDonalds (MCD) famously saved itself from oblivion by purchasing real estate and leasing the properties to franchisees. It was literally a turning point for the company's survival.

Similarly, insurance and patents may be that unique aspect of other companies. A company that can negotiate better insurance terms than its competitors could have an edge, for example. Fisher also mentions patents as a unique advantage, but warned that "constant leadership in engineering, not patents" was the fundamental source of protection.

A long-range, rather than short-term, focus on profitability

This point is developed in terms of a willingness to forego short-term profits to build up good will and thus reap greater profits in the long term. Companies that treat their suppliers and customers with respect will enjoy a competitive advantage.

The company has enough capital to avoid diluting shareholders' interests

Does the company have enough cash plus borrowing ability to finance prospects that could come up in the next few years? If there is not enough, then the company will need to do another equity financing, which could lead to dilution as more shares come onto the market. The same issue may arise if the financing involves securities with conversion features.

Ultimately, this depends on the quality of management. A team that has good financial acumen will raise earnings enough to compensate for the additional shares or structure the offering to match up with forecast earnings.

The company does not withdraw into silence when problems emerge

It is important for companies to report as freely during tough times as good times. Companies that "clam up" may do so for several reasons--none of them good. Silence suggests a company has not developed a solution to the current problem; it may be panicky; or it may not have "an adequate sense of responsibility to its stockholders." Simply put, investors should avoid companies that withhold or try to hide bad news.

Management has unquestionable integrity

There are several ways managers, or a management team, can enrich themselves at the expense of regular shareholders (what is formally known as the "agency problem" or "principle-agent problem"). The best protection against this problem is the integrity of managers, what Fisher calls "a highly developed sense of trusteeship and moral responsibility to their stockholders."

Fisher wound up by noting that few companies will ever get top scores on all 15 points, but this last one is critical. He wrote, "Regardless of how high the rating may be in all other matters, however, if there is a serious question of the lack of a strong management sense of trusteeship for stockholders, the investor should never seriously consider participating in such an enterprise."

(This article is one in a series of chapter-by-chapter digests. To read more, and digests of other important investing books, go to this page.)

Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.

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This article first appeared on GuruFocus.


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