Philip Fisher Part 17, His Mistakes and Summary

 Mistakes are inevitable and no one avoids them. How you react to them is more important. Fisher made them. They were concentrated at the beginning and end of his investing career. Early mistakes are inevitable. Most investors learn nothing, but the best ones learn even more. They have learned more from mistakes than from success, and successful investors are no exception. Fisher's late-career mistakes, according to his son, were largely due to his poor health.

Fisher was also a victim of the great stock market crash that began in 1929. He thought stock prices were expensive, but he still put his money in three stocks that seemed cheap with low P/E ratios. He lost almost all of his investments by 1932. He put his money in a locomotive manufacturer, a roadside advertising company, and a taxi company. From this he learned that a seemingly cheap price does not guarantee a successful investment. It can be a sign of weakness. Fisher also tried market timing three times. Each time, he made profits, but found them too small for his time, so he stopped the business when it was unprofitable. In addition, he struggled in the early days to set a suitable purchase price. As a result, he often missed out on stocks that would have brought him big profits.

It is not easy to expose errors in thinking, but I think Fisher’s belief in the importance of top management in good investments is excessive. To quote Buffett, “when a company with a bad reputation meets a company with a good reputation, the company’s reputation is what remains.” I think Fisher never understood that human irrationality can lead to a lasting competitive advantage. This is one reason why he was not good at investing in companies that sell consumer goods. On the other hand, he was good at focusing on the companies that he understood best.

Constantly worrying about everything bad was a characteristic of Fisher. It made him feel more secure. Even small details could make him worry about the risks associated with an investment. This made him abandon many investments because he did not dare to take even small risks associated with them. His returns were lower due to this character trait. He did not dare to take as calculated risks as many other top investors.

Summary

Fisher was the father of qualitative thinking. His process was long and demanding. It is not for everyone. It is easier to implement if you are extroverted and ready to talk. For introverts, it is difficult and perhaps too demanding. I do not recommend it for them. Fisher succeeded well at it for one reason or another, so it is not impossible for those who do not care about other people. Fisher believed that luck equals in the long run, so for him, continued investment success depends on skill and sound principles. Fisher's book Developing An Investment Philosophy contains eight principles that he used, which crystallize his investment philosophy:

1. Buy stocks of companies that have disciplined plans for long-term profit growth and the inherent qualities to let others enjoy their profits.

2. Focus on the above-mentioned companies when they are not popular in the market.

3. Hold the shares until the company undergoes significant changes or has grown to a point where it cannot be expected to grow faster than the general economic situation.

4. Investors focused on appreciation should downplay the importance of dividends, because the best opportunities for returns are found in profitable companies that pay little or no dividends.

5. Making mistakes is a necessary price to pay for large investment profits.

6. There are a limited number of great companies. Their shares are usually not available at attractive prices, so the investments must be large when the opportunities arise. Investments should be concentrated only in the best targets. Owning more than 20 shares indicates incompetence.

7. The basic ingredient of investment management is not to directly accept the views of investors or to oppose them without understanding reality.

8. Success in stock investing depends on hard work, intelligence and honesty.

Philip A. Fisher part 16 Mergers and Acquisitions

Mergers and acquisitions can be seen as threats and opportunities. They are both. They can be a good way to grow both business and profits. They often contain more hopes than the above. The wrong acquisition or merger can weaken a company's operating opportunities for a long time. This is especially true in a situation where the sizes of the companies do not differ much from each other. In individual cases, buying or merging with much smaller companies does not have much impact on the success of the investment target. Too many small acquisitions too quickly can be a problem.

The biggest risks for buyers come from the fact that sellers know more about the weaknesses and strengths of their company. They are also better able to assess the value of the business they are selling. This applies to cases where the operating performance of the sold companies is not in a weak position. The risks for the buyer depend a lot on the competence of the top management, according to Fisher. Bad managers can destroy the investment target with one wrong acquisition. Every merger and acquisition is different. Fisher developed general guidelines for evaluating them.

There are three main sources of problems in mergers and acquisitions. The first is a fight for top management positions. This can cause internal tensions and inflamed relations, even though top management should be blowing out the coals. The second is a situation where top management dominates the business of an industry in which it has no experience. This can lead to a decrease in top management's efficiency. The third situation is the seller's advantage in pricing its business. The buyer may pay too high a price for the acquired company.

Mergers and acquisitions in which the buyer moves down the value chain rarely pose a high risk to the owners. This applies, for example, to a situation where a company that manufactures and sells a final product buys its subcontractors. This applies to situations where the buyer can improve its cost efficiency and quality by doing things itself. Usually, the buyer then knows in advance what he is getting. In addition, the three main sources of problems are usually conspicuous by their absence in these situations. These acquisitions rarely have any significance for the owners. The same principles can be applied to moving up the value chain as moving down. There is an exception to this when a company buys a business that competes with its customers. In this case, the end result is almost always unpleasant for Fisher.

When a company buys a company that is much smaller than itself, the risk to shareholders is small, as is the reward. There are a couple of exceptions to this. The first is the opportunity to develop a new and significant business for the buyer with the help of the acquired company. The second is to get top managers on the company's payroll through this. For Fisher, the best chances for a successful acquisition or merger arise between companies that operate in the same industry and know each other's business inside out, understanding the problems each other faces. The opposite situation, where companies do not know each other and whose business areas are different, is likely to produce a poor end result.

The most successful companies in M&A rarely do so. They do not actively seek opportunities and act when the timing is most favorable for all factors related to their own business. In addition, they focus on companies in industries that are closely related to their core business. Risks increase when a company is constantly looking for opportunities to grow through M&A. This is likely to lead to excessive diversification of business operations and expensive acquisitions. Operational risks increase when the CEO spends a significant amount of time on acquisitions or considers them to be one of his most important things.

Buying a not-so-attractive business may not be wise, even at a low price. The reason for the attractive price is likely that it has nothing to offer the buyer. Fisher considers attractive purchases to be those that are a perfect fit for the buyer. Their price may be high, but they will bring him the greatest benefits in the long run. Buying several weak companies can kill the management's ability to develop the business in the long run. This is usually justified by the idea of ​​diversifying the business, which should strengthen the business being owned, but it has the opposite effect. Excessive diversification creates unnecessary strain on top management. It is difficult to find a single rule of thumb for the amount of diversification, but its speed provides significant clues to the investor as to its wisdom.

Philip A. Fisher part 15 Top Management

 Fisher puts the weight of top management in the quality of an investment at around 90%. I see this as an exaggerated figure, as many companies can be managed by almost anyone, such as Coca Cola. Even exceptionally good management cannot work miracles if the company is in the wrong industry. Poor management can destroy any business if given the chance, so the ability of top management matters. A wrong assessment of management ability can lead to a wrong investment. At the time of investment, an investor using Fisher's fifteen points as a guide will likely have enough information about the abilities of top management, but assessing the successors of managers can be difficult. The departure of previous managers is the moment when an investor is most likely to make a wrong assessment of top management.

Top management can reward an investor in at least two ways. The first and less significant way is by significantly increasing the P/E ratio since the time of purchase. There are limits to the growth of the P/E ratio. A more significant way is the growth of the earnings per share received by the investor compared to the purchase price. With good management, the company grows its earnings much faster than the market average for a long time, which enables top returns. According to Fisher, few people on Wall Street in his time could justify the goodness of an investment by saying that “senior management has begun to demonstrate its ability to increase shareholder value without the market noticing.”

The CEO is the most important person in the company. He must strive to maximize shareholder value in the long term, not the short term. In addition, he must surround himself with competent people and give them areas of responsibility to handle without interfering in their actions. They must work together to achieve clearly defined goals without internal power struggles. One clue to whether a company revolves around the CEO is the salaries of other top executives. He should not have an unreasonable salary for the next managers in the pecking order. This is a warning sign for investors. Salaries should be reduced gradually.

Even the best members of the management team and teams have traits that are undesirable. The good traits of great management more than offset the bad ones. When an investor carefully examines a company, he can notice possible weaknesses in its management. Fisher listed four different weaknesses that are relatively easy to spot. They may not be the most important, but not requiring that much expertise from the investor to spot them.

The first sign of weakness that an investor may see is a company’s board of directors, which does not have enough people who are involved in the actual business. This is especially true of companies where the CEO also serves on the board. In this case, the CEO usually wants to be responsible for both managing the company’s actual operations and the board’s work. He either does not have enough faith in the other board members or believes that he is always right.

Another sign of weakness can be a member of senior management whose sole task is to grow the company’s business through mergers and acquisitions. Only a few mergers and acquisitions are profitable. The mindset of such individuals shifts to pursuing their own interests, because corporate restructuring is the only way to justify salary payments. Before long, corporate restructurings are done only for their own sake, without caring about the interests of shareholders.

The third sign of weakness is when one or more members are hired to the company's board of directors whose expertise is based on a narrow area of ​​board work. In board work, each member must be able to view the business strategy and its implementation with sufficient judgment. Each member must be able to warn the top operational management when the company is not performing according to expectations or strategy. Seeking narrow expertise for the board indicates that something has been done or is being done wrong in that area, or that weaknesses are being addressed in the wrong way.

The fourth sign of weakness mostly affects smaller companies. When a company operates in too many separate business areas for its size, it is a sign of difficulties or that top management does not know what it is doing. Fighting on too many fronts means that resources are dispersed, which makes it difficult for a company to operate. A mixed bag of tricks rarely produces maximum returns in the long run.

Philip A. Fisher part 14 Inflation

Inflation reduces real income, as Fisher sees it. He saw it moving with social trends. These trends primarily regulate government spending. He believed that government was the main culprit. He believed that increased government spending created a self-reinforcing inflationary spiral. The spiral produced temporarily high inflation. He saw the cure for inflation as increasing efficiency and achieving it through science and product development projects. He believed that mediocre companies’ stocks would not fare well in the fight against higher inflation, but that quality companies would even benefit from it. Inflation eats into returns as both costs and taxes paid on profits increase.

Fisher believed that most investors misunderstood the origin of inflation. He defined inflation as meaning that the amount of services and goods available for the same dollar is less than before. He believed that the more people saw the government's responsibility to increase or maintain the amount of services provided to citizens, the more likely inflation was to be inevitable. The worse times got, the more pressure the government felt to increase spending. This increased inflation. Many see increased spending as a necessary evil in bad times, but Fisher disagreed.

Increased spending can lead to an inflationary spiral, where far-sighted people begin to prepare for faster price increases when they see the first signs of inflation. They buy products they will need in the future before their prices increase. Demand causes the prices of these products to rise more than expected. Others wake up to it too, and the spiral continues, growing larger. Storing unnecessary products causes inefficiency because it is not free. Fisher also believes that high interest rates contribute to the inflationary spiral, because they limit businesses' investment in cost-effective development inputs. Only the best of them are implemented and the others are postponed or abandoned.

Price increases are rarely endless and inflation does not often run rampant. Investors need to see it impacting returns and think about it in the long term. Investments must be able to increase returns more than inflation and investors need to understand that buying the right investment at the right time is more important than quickly hedging against inflation. True top investments are never made because of short-term factors, such as higher inflation.

Investors want to increase their real purchasing power, so the impact of inflation must be reduced by buying shares. A company that can significantly increase its earnings with high profit margins acts as an excellent inflation hedge because it can finance its growth internally. Such companies best increase investors' real returns. Companies that do not require large investments also often act as better inflation hedges, but there are exceptions to this rule.

Companies that are able to operate more cost-effectively by increasing their machinery can use economies of scale to combat inflation. As unit costs decrease, they can quickly pay back their large investments, even if the machinery becomes more expensive. Companies that have to keep their capital tied up in fixed assets, such as land, can also benefit from inflation, because the real price of land usually does not fall. In addition, many companies that receive their payments in cash do not suffer as much. In particular, service companies that do not have to wait for their payments or those service companies that do not have to tie up their capital in inventories can cope during higher inflation.

Not all capital-intensive industries are as bad as investors think. Rapid technological development in a capital-intensive industry weakens a company's ability to hedge against inflation. This is especially true for industries whose demand is not affected by rising inflation, and industries that do not have a shortage of supply. Demand gaps improve the ability of even capital-intensive companies to price their products. The product portfolios of capital-intensive companies ultimately determine their ability to act as inflation hedges. Capital-intensive and price-regulated companies act as some of the worst inflation hedges because, during periods of higher inflation, regulation cannot keep up with price changes.

Companies that are able to control their prices have the best inflation hedges. Companies that are able to pass on their increased costs directly to prices and quickly to customers will fare best when inflation rises. Fierce competition, high supply relative to demand, and regulation pose the biggest problems for companies when inflation rises. An investor doesn't need to fear inflation when they understand how well a company adapts to it.

Philip Fisher part 13 On selling

If the purchases have been made correctly, there is little need to make sales. No one can be right all the time, and companies do not operate forever, as they did at the time of purchase, so selling is sometimes necessary. Fisher found three reasons to sell, from an investor's financial perspective:

1. Correcting a wrong decision

2. The company no longer meets the purchase criteria

3. Finding a better investment

An investor must sell their shares when they notice a clear difference in the negative between the company's facts and the assessment made at the time of purchase. Correcting such mistakes requires the investor to be able to control their emotions and be honest with themselves. Ego is an investor's biggest enemy, and no one wants to admit they were wrong. Small losses become large when ego prevents them from admitting the facts. According to Fisher, the biggest reason for investors' losses is hanging on to a stock that they do not actually want to own.

Fisher believes that recognizing reality and acting on it requires skill, understanding, and judgment. He sees achieving superior returns as a complex process. That's why investors make mistakes that they have to correct. By buying great stocks and holding them for a long time, an investor can make back the money they lost many times over. This is true when the investor is able to admit their mistakes quickly. By selling the wrong stocks, the investor frees up his money for better-performing investments.

An investor should sell his shares when a company's operations do not match the fifteen purchase criteria. Over time, business operations change, and the changes are not always for the better. An investor must stay on top of his holdings. A company's business and its growth potential usually decline for two reasons. Either the quality of the management or its future prospects have declined. Sometimes it's both.

Sometimes the quality of the management declines because one or more of its members has become complacent or incompetent. More often than not, the new managers do not perform as well as their predecessors. Either they do not operate according to the old corporate culture or they are not competent enough. When any of the above things happen, the investor should immediately sell the shares, regardless of the general state of the market or the high capital gains taxes.

The size of the company's business can also reach a level where it is not growing faster than the growth of its own industry or the industry as a whole is no longer growing. This usually happens after years of growth. When growth prospects disappear, there is not as much urgency to sell as when the quality of corporate management deteriorates. Fisher can hold on to some of the shares until a better investment is found. He suggests the following test for assessing growth prospects: the investor should ask himself whether the annual growth rate of the company's earnings per share from the current point in time to the peak of the current general business cycle is faster than from the peak of the previous business cycle to the present. If the answer is yes, the investment is worth holding, otherwise it should be sold.

The third reason for selling rarely occurs when an investor follows the right principles when making purchase decisions. An investor should sell his shares when a better purchase option comes along only when he is sure of the profitability of the decision. Attractive purchase options are difficult to find. They rarely come across to an investor when he has extra money. Therefore, selling is sometimes justified. High taxes alone can defeat a sensible change in investment, so the future prospects and growth rate of the new investment must be significantly higher than that of the investment whose shares are being sold.

Fisher urges great caution, because the risk of misunderstanding is high. An investor is very likely to misunderstand some fact when changing investment. In this case, the new investment will perform worse than expected and the switch will not be worthwhile. The business of both companies should be carefully reviewed using fifteen points before considering switching. The great advantage of old investments is that the investor is likely to know them better than the new ones.

The three reasons mentioned above are the only sensible financial reasons for selling stocks, according to Fisher. In addition, an investor may have personal reasons, such as buying a new home, etc. Sensible investors do not consider other reasons, such as bear markets. According to Fisher, only a maximum of one in ten investors buy back the stocks they have sold. If you have done your homework when buying, you do not need to consider selling often.

Philip Fisher part 12 Stock prices

 Investors determine the market price of a stock. The price depends on three things: The attractiveness of the company’s business, its industry, and the stock in general. The price does not always have anything to do with the true value of the business itself. The cheapness or expensiveness of a stock’s price is directly proportional to the future cash flows generated by the business. If the cash flows are greater than expected, the price is cheap. If the cash flows are less than expected, the price is expensive. Fisher never explained how he determined the true value.

All significant price changes in individual stocks relative to others occur when large numbers of investors change their perceptions of the company or its shares. Market prices change more because of what investors believe will happen than because of what actually happens. The market price fluctuates according to perceptions, and the true value of a stock can differ from reality for years. Sooner or later, false valuation levels will be broken and the price will correspond to true value, at least for a while. False prices arise from short-term psychological factors when investors become excited or depressed about a company, industry, or stock market.

A high P/E ratio does not directly indicate that the shares are expensive. Higher P/E ratios for companies that have increased their earnings and turnover over a long period of time can indicate their ability to increase earnings far into the future. An investor needs to understand the company and its future. This will allow them to draw conclusions about the correct value of the shares. A company's P/E ratio will likely be high in 5-10 years if the company is continuously developing new sources of income, its cost-efficiency, and its industry allows for positive earnings development. The shares of such companies take the future into account in their prices less than investors believe. Therefore, the prices of shares may seem high at first glance, even though they are inexpensive after valuation.

No one can determine the exact value. Conclusions can be drawn about companies that provide sufficient accuracy. Shares of companies that are rapidly growing their earnings and revenue can have high P/E ratios. Determining their true value is difficult because the current growth rate is less important than how long the growth will continue. The further you try to predict, the more likely you are to be wrong. Fisher offers investors excellent return opportunities, as shares of such companies can be purchased at a price that is no more than 25-30% of their true value.

Fisher defined the risk of stocks based on the quality of the companies' business and the general valuation level. He examined quality using his fifteen points and the general valuation level using market expectations, which was reflected in the shares' P/E ratio. He examined the latter using the last result. Fisher found the lowest risk and most sensible investment target in stocks that meet the quality criteria, but are undervalued by P/E ratios compared to the quality of the business. The second most sensible investment targets are found when the quality criteria are met and the valuation level reflects them.

The third group is companies that meet the quality criteria, but have become so attractive investment targets in the eyes of investors that they are willing to pay almost anything for them. Fisher recommends keeping these companies in the portfolio, but not buying them. In his opinion, if the business is truly high-quality, its development will soon prove that the current prices are reasonable.

Meeting the fifteen points is rare for companies, so it is difficult to find undervalued companies. The risk of changing such an investment to a lower quality one is high, so it is not worth taking the risk. Owners of temporarily overvalued but high-quality investments should be prepared for rapid price declines. According to Fisher's experience, most sellers of these shares do not return to their owners later, even if it would be reasonable to do so.

The fourth group is companies that are mediocre or poor in quality, but are either cheap or attractive in price. They may be suitable for speculators, but they are not sensible investments. The last group are stocks with high valuation levels compared to their quality and which the general public considers attractive investments. These stocks destroy the money and enthusiasm of many investors to invest. The investor has to ask himself whether the market's view is based on the correct valuation level, which is determined by the economic facts of the business?

Many investors base their view of a good time to buy on changes in the market prices of stocks. They can focus on analyzing historical price behavior, estimating the current price through historical highs and lows. They create an idea of ​​a reasonable price for themselves and end up with a nice-looking even sum. This price is illogical and dangerous.

This method is dangerous because it causes the investor to focus on things that are not important and forget about the important things. Staring at prices often causes the investor to reject stocks that would give the best returns. Investors forget that the current price is only the collective view of the price produced by a large group of investors, i.e. buyers and sellers. A stock is either correctly or incorrectly valued, and the investor must understand the true value regardless of the crowd. The value of a business changes when changes occur in it. These can be the result of new management, products, or other things that affect the business.

Some investors also focus on comparing the behavior of a company’s share price to the historical price changes of the entire market and form their purchase price based on this. This thinking also causes the investor to focus on the wrong things. It causes the investor to create an illusion in his subconscious that all stocks rise or fall by the same amount. Following historical price changes in the market and comparing them to individual stocks also makes the investor think that he knows more facts. The increase in the amount of work makes the investor believe that his investments are significant, which leads to wrong conclusions.

One of the unnecessary mistakes of the investor, which Fisher mentions, is fighting over cents. Small changes in purchase prices do not affect returns much in the long run. If the quality of the company's business is in order, the investor may miss out on significant sums of money while fighting over a few cents. This is especially true for small investors who buy such small amounts of shares that they do not have to fight over cents.

Philip A. Fisher part 11 Diversification

 Diversification should not be overestimated. The number of shares does not directly indicate the extent of diversification, if their number is not in the tens. The business operations of individual companies can also be diversified. Most of the business operations of companies listed on the Helsinki Stock Exchange take place around the world. The companies' customers can operate in different industries. One example of this is the chemical industry. In addition, the companies owned by an investor can operate in the same industry and fight against each other.

Fisher wrote: “Generally, high diversification does not indicate a brilliant investor but an insecure individual.” A large part of investments go to mediocre targets when an investor spreads his money across several stocks. In addition, it is difficult for an investor to follow a large number of companies. There is so much fuss about the dangers of concentrated portfolios that investors buy so many stocks that they do not know enough about their investment targets. Investments made with insufficient information are probably more dangerous than too little diversification.

The need for the number of different share classes depends on many things. An investor can get the same diversification by investing in five stocks as in fifty. Many companies have diversified businesses, while others have concentrated businesses. Buffett's Berkshire Hathaway is diversified. As the number of cyclical stocks increases, more diversification is also needed. Companies with one client or one top executive also need greater diversification than companies with several. Everyone's situation is different, and Fisher divides investment targets into three different types for diversification purposes.

A) Large companies that grow earnings and business. Individual companies should not account for more than 20% of the entire portfolio at the time of purchase. In this case, the investor should have at least five companies. The businesses of the companies should not overlap. If this is the case, diversification should be increased. Fisher points out that companies that grow earnings and business should not be sold for diversification reasons. Instead, the investor should be confident that the company's future will continue to be as bright.

B) medium-sized companies that grow earnings and business. The share of individual companies must not exceed 10% of the portfolio at the time of purchase, i.e. the portfolio must contain shares of at least ten different companies. These companies must have a good management team with several qualified members. Their business activities may overlap somewhat.

C) Small companies that can generate large profits and losses. The share of individual companies must not exceed 5% of the portfolio at the time of purchase, i.e. the portfolio must contain shares of at least twenty companies. Only money that can be safely lost should be invested in these companies. These companies usually either fail or develop into B-group companies, as long as the top management gains more depth, the business grows and competitiveness develops.