Legendary investor Philip Fisher outlines his investment philosophy and process in his seminal book Common Stocks and Uncommon Profits. In our previous post, we focused on Fisher’s fifteen point checklist for finding promising companies. This time, we’ll look at his eight reflections on what not to do when investing.
What not to do:
- Do not follow the crowd
- Do not buy into promotional companies
- Do not buy a stock because we like the tone of the annual report
- Do not be afraid of buying during a war scare
- Do not forget your Gilbert and Sullivan
- Do not assume that the a company’s PE ratio is always indicative of its expected growth in earnings
- Do not Quibble over eights and quarters
- Do not over stress diversification
Do not follow the crowd
Investors should examine the current financial sentiment of the industry and company that he or she is buying into. It pays to not follow the crowd if the investor can identify an opportunity that the financial community perceives as less favourable than the facts admit. Likewise, the investor should be very careful to ensure that the price paid for a market darling or investment fad is justifiable.
Do not buy into promotional companies
Successful investing involves finding companies that develop new products or exploit new markets. While an investor can learn about the major functions of an established company (e.g. management, cost accounting, production, etc.), they can only make guesses about a company in the promotional stage.
It is difficult to achieve reliable returns from promotional companies. Analysis is therefore better confined to the identification of outstanding established companies. One should not feel compelled to buy into promotional enterprises to achieve exceptional returns since there are many exceptional opportunities across established companies and industries.
Do not buy a stock because you like the tone of its annual report
Companies that fail to reveal information on topics of material significance to investors are unlikely to make attractive investments. Annual reports are often too optimistic and reflect little more than the skill of the company’s public relations team. They rarely portray a truly balanced and complete discussion of a company’s problems and difficulties.
Do not be afraid of buying on a war scare
Investors that operate during such climates have tendencies to ignore or overlook fundamental economic consequences. History suggests that stocks dip and rise sharply on war scares and international crises. If actual hostilities or disasters unfold, scare psychology and price levels are likely to worsen. The plan is to buy slowly during a scale-down at the threat of war. During such events, governments tend to spend aggressively. The inflation that follows such spending means that more dollars are required to purchase the same number of shares of a stock.
Do not forget your Gilbert and Sullivan
The price at which a stock sells is based on the prevailing appraisal of the current situation. It is based on the weighted composite estimate of what buyers and sellers think the corrective value of the shares may be. Sometimes, events such as forced liquidation may produce moderate deviations from this value.
It is illogical and financially dangerous then to overemphasise historical statistics that divert attention from analysis that matters. The historical prices of stocks for instance may have little relationship to its prevailing price today.
However, per-share earnings across several years may reveal the cyclicality of a stock and how profits may vary with the business cycle. Analysis of PE ratio across these periods may provide an indication of future PE ratios. Ultimately, high quality appraisal requires good judgement. Investors should try to ignore information and noise that do not matter.
Do not assume that PE ratios are indicative of expectations
A high price to earnings ratio may indicate that expected earnings growth has been discounted in its price if such growth is believed to be temporary. However, investors may not always sufficiently discount companies with very strong five to ten-year growth prospects. Hence, some stocks that appear to be relatively highest priced may still be attractive bargains.
Do not quibble over eights and quarters
If the stock satisfies the principles of long term investing and is available at attractive prices, investors should purchase stocks ‘at-the-market’. On the assumption that a truly outstanding investment has been identified, the extra percentage or two paid is insignificant in comparison to the missed profits if the stock is not obtained. The stock should not be considered in the first place if minor price adjustments affect the long-term prospects of the investment.
Do not over stress diversification
The fear of having all their eggs in one basket has caused investors to put far too little in companies they thoroughly understand, and too many into companies that they know thing about.
Buying a stock without any knowledge about is potentially more dangerous than insufficient diversification. Of course, some minimum amount of diversification is needed to protect against catastrophic events.
Additional holdings should be added when they are equivalent to or exceed the attractiveness and expected growth of existing holdings with respect to risk. New holdings should also be equivalent with regards to an investor’s ability to follow and appraise his or her investments after it has been purchased.
A long list of securities may be a symptom of an investor who is unsure of him or herself. Investors should understand that mistakes are inevitable. Diversification helps to ensure that such occasional mistakes are not crippling. Beyond this, investors should make significant efforts to own the most outstanding stocks.
References
- Fisher, P. (1960). Common Stocks and Uncommon Profits, Harper & Brothers. Revised Edition.
- Fisher, P. (1975). Conservative Investors Sleep Well, Harper & Row. Chapters 1-3.