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.

Philip A. Fisher part 10 about dividends

 Different dividend payout weights can confuse investors. Retaining profits in the company may make sense if they are used to launch new products, build factories, or purchase more cost-effective equipment, etc. Not all companies have the same need to invest in more efficient production. The investor's task is to assess how much capital the company needs to increase efficiency. The capital left in the company should maximize the returns received by the owners. Investors have different dividend needs.

Investors do not always get the full benefit of leaving capital in the company instead of paying dividends. The worst reason for this is that the company's management is of poor quality and does not get a return on the capital left in the company, but uses the capital to expand inefficient operations instead of making them more efficient. Top management may expand operations to justify increasing their salaries, which is directly out of the hands of the owners. Such companies do not meet Fisher's fifteen points. Companies that meet the conditions, on the other hand, find a use for the extra money in developing the company.

Management may also raise too much cash to increase their sense of security. This may happen unconsciously. Sometimes capital needs to be raised because customers or regulators want investments that do not have a positive impact on cash flow but will reduce it if not made. Such things include air conditioning and government-mandated investments such as ship scrubbers.

An investor should evaluate a company’s dividend policy at regular intervals because capital investment needs can change. This does not have to be done every year. Needs rarely change suddenly. The policy should be evaluated with long-term returns in mind, because that is the most useful. The most important thing for an investor in a dividend policy is its predictability. A rational investor plans ahead, so predictability is important. A company should tell investors its dividend policy and keep its word. According to Fisher, a company should tell investors what percentage of its annual profit it will pay out as dividends to its investors. The dividend rate can vary. Fisher used 25-40% of earnings as an example.

A percentage is most appropriate when it does not jeopardize long-term earnings growth but rather seeks to maximize it. Opportunities for earnings growth are rarely maximized by leaving all earnings in the company's capital. For Fisher, companies that offer high dividend yields do the investor a disservice in the long run because they rarely maximize earnings growth. By increasing earnings, dividends increase while the dividend yield remains the same, which increases the investor's income. Despite this, Fisher allowed a company to increase its dividend only when the company has enough income to grow the business, its profits, and has the ability to pay a higher dividend in the future. For Fisher, it was vital that a company not lower its dividend except in dire straits, because it affects the stock's valuation.

Philip Fisher part 9, on company visits

 A fifteen-item questionnaire prepared Fisher for the meeting with the company’s management. Without going through them, he would not have been able to ask the right questions. In addition, he would not have been able to ask follow-up questions to the answers he received. He prepared the question lists before the company visits. He wanted to be prepared for the meeting so that he could also provide added value to the respondents. In this way, he improved his chances of meeting the management again.

The company’s management meeting should provide the investor with detailed answers to two general questions. The first is how good the business practices are and the second is how well they are implemented. When answering the first question, the investor should focus on understanding, among other things, how well the company avoids basic mistakes, such as shortcomings that lead to a deterioration in the work atmosphere. The goal of such questions is to ensure that the company is not being managed poorly. Understanding exceptionally good management requires finding answers to more demanding questions, such as how well the employees in the sales organization are trained.

Many people talk better than they do. Good policies are not enough if they are poorly implemented. Understanding this and drawing the right conclusions is vital because managers learn to say the things investors want to hear. Many companies claim to take care of their employees while top management is on the warpath and workers are on strike. All statements by top management should be verified by those who have dealt with them.

According to Fisher, given the size of the investee’s business, an investor should focus on about five members of senior management. The qualifications of one or two members are not enough. The investor will probably not meet more than these members, so he must use his network to determine the quality of management. Adequate background information helps the investor better understand the people he meets and their abilities. It can help the investor confirm the assessments he has made about them before meeting them.

One of the best questions Fisher ever asked management was, “What are you doing now that your competitors aren’t doing yet?” The dynamic of this question centers on the word “yet” because most business leaders can’t answer it. Most companies don’t do anything that others aren’t doing, and most leaders have never asked themselves that question. The question refers to leadership in the business world, whether it’s about improving customer service, employees, products, or investor relations.

Philip Fisher part 8 and the Fisher method, Company research, points 11-15 /15

 12. Is the company focused on making a profit in the long term or the short term?

An investor should focus on companies that are focused on making a profit in the long term. Many companies focus on making a profit right now, others on making a profit in the future. The best evidence of this is for an investor to focus on understanding how the company treats its customers and subcontractors. Companies that invest in customer well-being are willing to invest in individual events to keep them coming back. Individual events may be more expensive, but the subsequent cash flows from customers make up for the effort.

Squeezing subcontractors to the limit by squeezing the cheapest possible parts or services from them can cause costs to increase in the future. Replacing one subcontractor with another can reduce the quality of the parts or services received, even if the price drops. This can lead to a deterioration in the quality of the final products and loss of sales. In addition, losing a subcontractor can lead to dangerous bottlenecks in production when demand for products suddenly increases faster than expected.

13. Does the company have enough capital to finance future growth?

The company must have enough capital to finance future growth in the near future, or it must have the ability to do so without the help of shareholders. The best opportunities for an investor come from companies that do not need their owners to finance their growth in the future. The investor does not have to worry about this beyond the near future. Many years from now, financing will likely be much more expensive for good companies, so it has no impact on the current investor.

14. Does management talk about the company's difficulties as much as it talks about its successes?

Even the best-managed companies experience unexpected difficulties, such as shrinking profits and falling product demand. The management's response to these situations provides the investor with valuable information. Management should immediately bring all the information to the investor. The investor should react immediately by selling the company's shares if he finds evidence to the contrary. A company that introduces new products and services to the market is bound to encounter failures. One place to look for evidence to the contrary is in the CEO’s reviews when presenting quarterly results or financial statements. The CEO should be able to tell investors where the company needs to improve.

15. Is the management completely honest?

The management has easier access to its assets than the owners. It should be completely honest with both the owners and the employees. Top management should not hire relatives by paying them more than other employees for the same job. Management should not buy real estate or production machinery from relatives or friends at market prices by paying more than the market price. An investor should never put their money in a company whose management’s sense of duty to the owners is in doubt.

Philip Fisher part 7 and the Fisher method, Company research, points 9-11 /15

 9. Is there depth in corporate management?

Small companies can do well when they have a capable person at the helm alone. Investors need to understand what happens to small companies if that person has to stop working. Sooner or later, a small, brilliant company grows so large that it cannot manage with one capable manager. At that point, the number of capable people in top management begins to affect success. A capable manager has to share responsibility because his or her time is not enough to handle all management tasks. The need for a large company to find a CEO from outside its ranks indicates that there is something wrong with the current management.

Top management is forced to share responsibility downwards or the company itself will not be able to develop future top managers. By sharing responsibility to lower management levels, top management does not turn its subordinates into incompetent decision-makers. Future leaders will develop if they are given enough opportunities to use their skills. A company is rarely a good long-term investment if top management interferes with the day-to-day operations of the company at lower levels. In addition, top management should welcome all suggestions for improvement, even if they criticize the way the company is run. Lower-level employees can provide a flood of useful ideas if their feedback is utilized.

10. How well does the company analyze its costs and manage its accounting?

No company will succeed in making investors high returns in the long term if it cannot examine its costs in sufficient detail in each of its operations. Only then will management know what requires the most attention. Successful companies do not rely on just one product. The success of companies suffers if their management does not know exactly the costs of individual products or services compared to others. The company will not be able to set the right prices to maximize profits if it does not know which products require special efforts in sales and marketing. In the worst case, the products with the greatest profit potential will make a loss.

Accounting management is important. The problem for investors is that if a company's accounting and cost analysis are inadequate, they will not receive enough information about the matter. Investors need to understand their limited ability to know when cost analysis is effective. Investors can consider it likely that a company is operating efficiently if its ability to manage its business is above average. The probability of this is significant as long as top management understands the importance of cost analysis and accounting management.

11. How well does the company manage the specific characteristics of its industry?

These characteristics include, for example, the locations of grocery retailers or the patent portfolios of technology companies. Finding good retail locations at low prices compared to the number of people moving around in the environment helps to increase the turnover of grocery retailers and thus also profits. Without good relationships with the bodies that decide on retail locations, it is difficult to succeed.

The patent portfolios of large technology companies improve their chances of success. They are rarely sources of large profits. Strong patent portfolios can give companies exclusive opportunities to make products more cheaply than others. Patents can usually prevent only a few ways to achieve the same result. An investor can foresee difficulties for a larger company that relies solely on its patent portfolio to achieve higher profit margins. An investor should pay special attention to the patent portfolios of small technology companies, because large companies can easily destroy them if their patent portfolios do not provide sufficient protection against large ones. Continuous product development is more important to companies than their patent portfolios. An investor should not give patents too much weight.

Philip Fisher part 6 and the Fisher method, Company research, points 6-8 /15

 6. What does a company do to maintain or increase its profit margins?

Past margins can be used as a guide, but they are not nearly as important as future margins. Costs tend to rise, so a company must strive to reduce costs by continuously improving its cost efficiency. A quality company must be the most cost-efficient company in its industry or close to it. It must also show evidence that it will remain so.

This gives it room to maneuver, since most competitors cannot compete on price for long in difficult times. Low costs also help it win the market when less cost-efficient companies are forced to abandon competing businesses. In addition, a higher-than-average margin helps finance most of the company's future growth internally. This reduces the company's need to draw on its owners' money to finance growth.

A company must strive to improve its operations by improving its products and services to be more cost-effective. An investor needs to understand how well a company is reducing its costs by improving its operating methods. It is likely that the companies that ared most ingenious in improving their cost efficiency will be the most successful investment targets in the long run. According to Fisher, business leaders talk about cost efficiency more enthusiastically than many other things to investors.

Improving cost efficiency is not the only way to improve margins. Companies can raise prices. Few companies can do this without increasing competitors. Prices can rise as demand increases. A company's margins can also rise when competitors raise their prices more, which promotes sales as customers switch vendors. These ways of increasing margins are rarely long-term. For a long-term investor, continuous price increases to increase margins for all players in a business sector offer a poor prognosis. Monopolies and other closely regulated businesses can be considered exceptions. Fisher also did not understand the concept of a sustainable competitive advantage that would arise, for example, from through psychological factors.

7. Does the company have great relationships with its employees?

One thing investors often neglect is to examine how good the work environment is in the company. A great atmosphere among employees leads to better profit margins. The difference in productivity between a great atmosphere and an average atmosphere is much greater than the direct effect of strikes. Effective management that makes employees feel well-treated improves productivity. Training new employees is expensive, so high staff turnover leads to unnecessary costs.

When management can convince all employees that it is serving their interests, it will be rewarded with lower costs and higher productivity. Management must treat its employees with respect and consideration and communicate well with them. Top management must know how employees at every level think. Management must deal with grievances quickly with employees. Whistleblowers cannot be punished, but must be rewarded. Employees should not just be told to do their jobs, but let them decide how to do their jobs. A high number of strikes indicates difficulties in the work environment. Their absence does not directly mean a great work environment.

In addition, a company should pay wages according to merit. A company that pays its employees better than average and has a better than average profit margin probably has a good work environment. Management should be prepared to improve employees' wages as productivity increases, even at lower levels, and not collect glory and euros only for itself. A company management that takes an unreasonable share of the profits rarely guarantees the best possible returns for investors in the long term.

8. Is the work environment among the company's management great?

The relationships among the top management also affect the company's success. They have the greatest responsibility and their decisions have the greatest impact. In companies that offer the best opportunities for investors, the relationships among the top management are great. Everyone in the top management trusts the CEO and the chairman of the board. This means, among other things, that all employees can rely on their own merits to reach the top management level. Relatives and friends are not favored in the career path. Top managers constantly review salaries according to qualifications and there is no need to ask for raises separately. Top management does not allow solo work but emphasizes working together. It also behaves that way. Investors can find information about these issues by asking employees at different levels of the hierarchy.