Saturday, March 14, 2015

Book Review #22: Common stocks and uncommon profits: Author: Philip A Fisher

Note: After reading this review, if you want to get into details of this book, please read the 'Chapter Summary''  by clicking on the Link

Philip Fisher (Phil Fisher to his friends) stands along with Mr.Benjamin Graham and Mr.Warren Buffets as one of the stalwarts in the area of Finance and Investments. 
The book 'Common Stocks and Uncommon Profits and Other Writings' by Mr. Fisher is a crisp volume detailing his principles on Investing for the long term. Mr.Fisher is focused on the long term and is heard telling that the 'best time to sell a stock is never'. He emphasizes buy and hold strategy.
The book is divided into three parts. Part 1 covering 11 chapters is titled 'Common Stocks and Uncommon Profits', This part discusses the points that are very close to every investor's heart vis, how do I identify and analyse companies, what should I buy and when should I buy or sell. Part 2 discusses the common tenets of Conservative Investment. The final part, Part 3 details the evolution of Mr.Fisher's investment philosophy and covers 4 chapters.
These three parts are written at different times and are consolidated. Due to this, you will find some of the points repeating in all the three parts.
The only way an investor can make significant wealth in stock market is to identify good companies with long-term potential and stay invested in them for the long haul. The good news is that a number of such companies exist in the market. These companies need not be young and small. Even big companies can offer returns to the investor. This book attempts to help investor identify great companies. 
Mr.Fisher is a proponent of the 'Growth Investing' school as against Mr.Graham who pioneered the 'Value Investing' school of thought when it comes to investing. Till I read this book, I was not clear of the differences between the two schools. 
Now I do. Value investing stresses on buying great companies with demonstrated earnings potential and management capability and which has fallen into short term difficulties. A value investor looks for low PE multiple and as a proof of continued earnings capability, the value investor gives importance to continuous dividend payments, preferably over the past 20 years or so. The longer, the better. The focus of Value Investor is on past performance and extrapolating the same to the future.
Growth investor, on the other hand, looks for potential growth. He knows that one has to pay high current prices, in terms of higher PE, to capture a stake in the potential growth of the company. Current earnings do not matter to a growth investor, all he wants to know is whether the future earnings growth will compensate for the higher current price that he is paying in relation to current earnings. 
Take Titan as an example for growth Investing. Back in 2004, the company was trading at a price of 50 and a PE (TTM) of about 250. This meant that at the current earnings, existing in 2004, the company would take 250 years to pay off 50 rupees. However, people who bought Titan at a PE of 250 were not buying it for the current earnings, they were buying it for the future potential. Titan had recently forayed into an unknown territory of Gold and Diamond Jewellery through its flagship brand 'Tanishq'. While the sales of Tanishq Jewellery was nothing to shout home about at that time, the investors were excited about the future potential of the first Jewellery player in the Organized Sector.
And Titan has handsomely rewarded its investors over the last 10 years. 50 Rupees invested in 2005 would be worth Rupees 8000 at the current market prices. 
There are three main aspects covered in part one of this book. First one is the 'Scuttlebutt' approach popularized by Mr.Fisher. Once you identify a company that you want to research, the first step is to use the Scuttlebutt approach. The investor need to meet the suppliers, the customers and the ex-employees of the company to understand their views about the strengths and weaknesses of the company. 
Only after completing the Scuttlebutt that an investor should meet the management of the company to tie up the loose ends and take a decision on whether to invest the money in buying the shares of the company.
Mr.Fisher is a Long-term investor. His minimum holding period is three years since he feels that it will take that much time for the earnings potential to materialize in the normal course of time. He, like Mr.Buffet, is not a fan of the pressure of 'Annual Earnings'. He is aware that earnings tend to ebb and rise over short periods of time and a relatively longer period of time is necessary for the true potential of the company to be demonstrated. 
The second aspect covered in the book is more practical.This is the operative part of the book and covers 15 questions that one should look for answers about a company before deciding to invest in it. The questions cover the 'what is what' of investing including Products, Approach to Research and Development, Effectiveness of the Sales Team, Management Integrity, Management Potential, Labour relations, Costing, Finance and Controls, Technology, Patents etc. 
The key point is that, as Warren Buffet mentions, when you are buying the stock of a company, you are buying into a business. It is important for you look at the investment through the eyes of a business owner and not through the eyes of a short term investor or speculator. To a business owner, the above 15 points, give a birds eye-view of the operational aspects of a business and give a fair idea about the long-term growth potential of their investment.
The third aspect covers timing of transactions. There are two parts to timing, when to buy and when to sell. One should buy a stock at the earliest part of a growth cycle. For example, one would get good buying opportunities just before a new product is being rolled out or a new factory is being put into production. The initial teething problems will beat down the stock and will provide a good entry point. One key lesson about timing is never to time the market. For example do not buy a stock expecting market to rise in the short term.
As per Mr.Fisher, once one invests in a company with long term growth potential, one should not think about selling at all. One should continuously review the company and sell only if the initial assumptions which were made at the time of purchase are invalidated. The discussion on when to sell is brought into sharp contrast by detailing when an investor should not sell a stock. 
With about 5000 listed stocks available to invest in, an average reader will wonder how Mr.Fisher identifies the stocks to focus on. One chapter is dedicated to this discussion. Unfortunately for a lay investor, Mr.Fisher almost never initiates research on a stock that has been recommended in the printed media. He feels that by the time the print media is aware of a stock, the smart investors would already have made money on those stocks.
Part 2 of the book, covering six chapters, covers conservative investment. A conservative investment conserves the purchasing power of the investor at minimum risk. A conservative investment will have low cost production, a good sales organization, has good finance and accounting controls, effective R&D processes and treats its people well. Once a conservative investment is identified, the investor should consider the views of the financial community (Mr.Market) to decide when (timing) of purchase. The financial community values a stock based on its view of the prospect of market and economy, of the industry in which the company operates and of the company itself.  Whatever may be the final decision a long term investor should not quibble about the 'eights and quarters' and miss out a good investment because the price did not reach your target price. 
The book rounds off by discussing the evolution of Mr.Fisher as an investor. Coming from a family which discouraged equity investing ('Gambling') the authors evolution to a world class investor makes fascinating and absorbing read. The lessons that he learned in his career are summarized in eight crisp points to end the part 3. 
The language of this book is 'prosey' and verbose. And it is written in the early 1900 style of long winded sentences and big paragraphs. For those of us who have got into the habit (thank you very much, Twitter !!) of reading short prose with more dialogues, this book can be a stretch. But focus on reading it and you will unearth a number of investment treasures. That is a promise...

Note: For details read the 'Chapter Summary'.

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