Phil Fisher, the legendary professor and investor who authored "Common Stocks and Uncommon Profits" as well as "Conservative Investors Sleep Well," developed a reputation for finding a few very good investments, buying as many shares of them as he could afford, and then holding them indefinitely (often for decades on end), as they quietly compounded regardless of what turmoil was occurring in the United States. Fisher claimed that he at one point owned 30 stocks, but only 6-8 of them were "very serious investments." Fisher followed his six to eight investments very seriously—reading everything he could find on the companies—and holding them for as long as he did not believe the company’s competitive position/long-term profit generating ability was not compromised. In his book, "Common Stocks and Uncommon Profits," Fisher gave investors many warnings of types of investments to avoid, and I included a list of my favorite five below.
1. Don’t buy shares of a company just because you like the voice of the annual report. If a company puts obfuscating footnotes in its annual report that lists unclear expenses in size six print, that ought to send up red flags about management. But Phil Fisher cautions us against thinking that the opposite is necessarily a good sign—a company with an annual report that touts old-fashioned values and long-term planning is automatically a company that you should entrust with your investment dollars. I fell victim to this myself when I was reading the annual report of Realty Income (O), a real estate firm famous for paying out a dividend monthly. The annual report talks about working for a hypothetical 75 year-old retired female librarian who relies on the monthly dividend check from Realty Income to pay her mortgage and heat her home. The company claims to use this hypothetical construct as an incentive to encourage long-term thinking. This is a refreshing tone to find in annual reports, but I can’t let it become an overriding factor in my judgment—if I do think Realty Income is a worthwhile investment, I should not let the story of the little old lady waiting for the dividend check cloud rational analysis.
2. Never make a long-term investment in promotional/gimmicky companies. It was just a few years ago that Crocs (CROX) footwear became a hot craze—of course, the fad didn’t last, and the stock has plummeted from the upper $70s in 2008 to about $15 today. With hindsight, it’s easy to see that paying $70 for CROX was well, a crock of something, but it’s not quite as easy to be cool and rational during times of mania. After all, it’s a very human ambition to dream of getting in on the ground floor of the next Wal-Mart (WMT), Microsoft (MSFT), or Apple (AAPL). I would say as a general rule that companies that sell clothing/dress wear are more susceptible to being short-term fads, and it can’t hurt to keep in mind Warren Buffett’s rule that ‘there are no called strikes in investing.’ If you have an account with a few thousand dollars (or whatever the amount may be) for ‘funny money’ speculative investments, that’s one thing—but you’re probably going to be much better off ignoring the Beanie Babies of the world in your long-term portfolio.
3. Don’t quibble over eighths and quarters. Warren Buffett once discussed at one of the Berkshire Hathaway (BRK.A) shareholder meetings that he came close to making a very substantial investment in Wal-Mart Stores Co. in the late 1980s, but elected not to do so because he kept waiting for the share price to come down nine cents, and it never did. Buffett estimates that his refusal to budge has cost Berkshire investors $5-$6 billion dollars (granted, they have done quite all right otherwise). Once you identify a great company that could serve as a long-term holding, Fisher would not advise that you get bogged by a few cents. If you plan on buying General Electric (GE) and holding the stock for over the next ten years, it certainly will matter whether you pay $14 or $21 per share, but you could miss out on a good opportunity if you insist on getting in at $14 per share when the stock is trading at $14.12 and it never comes down.
4. Do not ever buy shares of a company that has a management team with questionable integrity. Phil Fisher could think Bank of America (BAC) was worth $25 per share, but he wouldn’t touch it at $5 per share if he felt that management wasn’t candid, honest, and forthright in its business dealings. The fact that Bank of America promised a dividend (then went back on it), promised not to raise capital (and then raised capital), promised not to sell its interest in a Chinese bank (and then began selling its interest in a Chinese bank) would be enough to deter Fisher from considering the bank as an investment. If you can’t trust the numbers on the balance sheet, the direction of the company, or the integrity of the balance sheets, how could you possibly have any confidence in the company?
5. Don’t assume that a high price-to-earnings ratio automatically assumes that future growth is discounted in the price. When Philip Fisher made his famed investment in Motorola (MSI) during the late 1950s, he paid in the vicinity of 20x earnings for the shares, which was almost twice as high as the average P/E of Dow stocks at the time. Fisher held onto those shares of Motorola for about fifty years—until his death in 2004—and that investment alone was enough to make him a millionaire. As an investor, you need to estimate the difference between the company’s growth and the growth that is baked into the price. If your research indicates that Microsoft will grow at 16% annually but Wall Street analysts are only pricing in 7% growth, then you may have found a bargain. If you calculate that a company will demonstrate earnings growth at a rate much higher than is built into the price, you may have found a bargain. Phil Fisher could have bought Bethlehem Steel for 3x earnings or Motorola for 20x earnings, and history revealed that Motorola at 20x earnings was a much better deal—while you want to buy assets on the cheap, don’t let the P/E be the ultimate arbiter of value.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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