The fifth most important takeaway from Conservative Investors Sleep Well, by Philip Fisher, is the ability to identify:
What is a conservative investment?
In a world where we have central banks with
monetary policies never witnessed before and where global trade is constantly being threatened by protectionism,
it's quite tough to be an investor in the stock market
What if I lose it all?
What if there will be better buying opportunity in the future?
At times like these it's a good thing to study
legendary investors, such as Philip Fisher
Fisher was one of the two major inspirations of the world's greatest investor, Warren Buffett, and
Fisher argues that there's a type of investments that will perform well almost no matter what the economy hits them with:
It's the conservatively picked stocks
I thought that the term "conservative" was a bit boring, until I realized that Phillip Fisher thinks that offense is the best defense
Conservative stocks have four unique dimensions that you should look for:
1. Superiority in production marketing research and financial skills
2. Outstanding people
3. Protection of profits; and
4. A low price
The first dimension is pretty much just listing the most important activities for a company's profitability
Production, marketing, research and financial skills, are all vital for the survival and prosperity of a company
You can learn more about this in my summary of Philip Fisher's other book, Common Stocks and Uncommon Profits
The second dimension is about the quality of the people that are governing these activities
As we shall see, the process of identifying such top management is quite counterintuitive
In relation to the third characteristic, there are a few types of businesses that can maintain profits almost indefinitely,
thanks to for inherit company traits, but more on this later
Philip Fisher is one of the pioneers of growth investing, which means looking for companies with exceptional growth prospects
He always preferred quality business over cheap ones
So even though he thought of price as an important factor,
he found that the first three dimensions are more important, which we shall see next
Number 4: The conservative investment scale
Using these four dimensions, we can create a scale and rank which the most attractive stocks are for conservative investors
If you want to sleep well at night, while your investments create a passive income for you,
look for stocks in the leftmost part of the spectrum and avoid those to the right
The best option is of course to invest in a company that is superior in the first three dimensions, and,
which has a low price to earnings ratio when considering these factors
This is a quite uncommon situation though, which is why we also have to consider investments further down the scale for our portfolio
The second best option is to invest in a company that is, still superior in the first three dimensions,
but which is also priced relatively fairly
As we shall see in takeaway number three, such a company can still give wonderful returns over the long run
Next up, and this is where it shows that Philip Fisher truly preferred quality over price, is the company that is, once again,
superior in the first three dimensions, but that even taking this superiority into account, is too expensive
Fisher suggests that if you don't own one of these stocks previously, you should stay away
But if you have one of them in your portfolio already, stay put
There are two reasons for treating a stock that you already own differently:
The first one is that it's quite uncommon to find stocks that are superior in the first three dimensions
So the risk of switching into something that ranks lower on the conservative investment scale is very high
The second reason is due to tax purposes
Next up, which is a stock that Phillip Fisher does not suggest for the conservative investor,
but that many speculators (ie traders) seem to find attractive, is a company that is mediocre in the first three dimensions,
but that sells at a cheap price
In a fast moving world, the risk is just too high in this type of companies
Warren Buffett agrees, as he says that: "It's far better to buy a wonderful company at a fair price,
than a fair company at a wonderful price"
And finally, probably no surprise here, we have a company that is mediocre or even weak from the standpoint of the first three dimensions and
selling at a price that is too high - even for such mediocre prospects
Number three: The interplay: growth - PE - investment returns
Let's consider three hypothetical companies within the same industry
In this industry, a company without any growth prospects is valued by the market at a price to earnings ratio,
a P/E ratio, of 10
A company which seems likely to double its earnings in the next five years, on the other hand, is valued at a P/E ratio of 20
We have company A, B and C
Now, let's pretend that the market was correct in its observation and
five years later, company A still earns as much as it did five years ago. while B and C managed to double their earnings
Here's the interesting part.
What do you think that the returns of these companies will be?
Is it 0% for A and 100% each for B and C?
Not necessary
We must also consider if the valuations of the companies have changed at the end of year five
Let's pretend that the market still values and no growth company at P/E 10 and
one which seems likely to double its earnings in the next five years at a P/E of 20
Company A continues to have no growth prospects at all,
so it is still valued at a P/E of 10 by year 5
Therefore, the investment returns on the stock has been 0%, plus dividends of course, if the company is profitable
Company B is still regarded as a strong growth company, so it continues to hold a P/E ratio of 20
Therefore, the investment returns on the stock has been 100%
The earnings have doubled in five years and the valuation of the earnings remains the same
Company C is the interesting one
It is no longer considered a growth company, as,
there's been a lot of problems among employees and managers lately
Therefore, at the end of year 5, it holds a P/E ratio of just 10, down from previous 20
Even though it managed to fulfill the expectations of the market and double its earnings over the last five years,
the investment returns on the stock has been 0.
The earnings doubled, but the valuation was cut in half, so the net result for the investor is 0
Here, Fisher explains an important investment rule:
"The further into the future profits will continue to grow, the higher the price to earnings ratio an investor can afford to pay"
Number 2: Weaknesses in management that are easy to spot
People is the difference between an outstanding business and a mediocre one
As I mentioned earlier, this point is quite counterintuitive
To find great management, it's easier to look for weak management, and then avoid those companies, rather than go looking for the great ones straight-out
Here are 6 weaknesses in management that are easy to spot
A CEO from the outside
Promotions from within is something that Philip Fisher emphasizes
You want to invest in companies that are profitable and difficult to copy for competitors. If the company can hire a
CEO from the outside, that's able to operate the business well in just a couple of months,
it's not complex enough to hold a sustainable competitive advantage in this regard
An excessive CEO salary
If the CEO earns much more than the second or third man in the company, it is a red flag
Media complaints
Hello, Amazon?
While this is not enough to exclude a stock on its own, you want everyone in a company to feel that
It's a good place to work
In the long run, this creates motivation,
innovation and a competitive advantage
Unfulfilled promises
Compare the results of the company to what the CEO promised in previous shareholder letters
Promising results in itself is kind of like an orange flag, but promising them and then not delivering upon them,
definitely qualifies as a red one
A board with only the CEO
If the CEO of the company also holds a position among the board of directors,
you want at least another person from the executive management there with him
Otherwise, it may be a sign that the CEO doesn't want anyone to question him about the operations of the company in front of the
board, which is a poor trait in a leader
Engaged in unrelated activities
Especially if it's a smaller company, it should be focused on doing one thing only, and doing that thing very well
The jack-of-all-trades is the master of none
Number 1: Investment characteristics for indefinite growth
For a company to be able to grow, it needs profits
These profits can be reinvested in marketing efforts,
training programs for employees,
research on new products, better production, etc
Therefore, high profitability is a very desirable trait in conservative stocks
But ...
Imagine that you put out an open jar of honey, in the middle of the summer
What will happen to this jar? It will attract flies
High profitability in a business is just like that jar of honey, but instead of flies, it attracts competition
A company must protect its jar of honey, and there are four proven ways of doing this:
- Economies of scale
To produce in higher quantities, typically results in a lower cost per unit
This lower cost can protect the business from competitors that per definition must be small before they can become big
Think... Walmart
Brand name
A strong brand name gives pricing power
Pricing power gives higher profitability, which in turn can be invested in growth
Branding is more than just spending millions of dollars on Super Bowl ads,
which is why it's difficult to steal the honey from companies such as Coca-cola,
McDonald's and Disney
Combined scientific disciplines
You're investing Swede owned a company named Cellavision a couple of years ago,
which develops and sells solutions for analyzing blood in the healthcare industry
Without going into too much detail about the company, its solutions require
extensive knowledge within the scientific discipline of both machine learning and of hematology
According to Fisher,
it is much more difficult to organize and combine deep knowledge in multiple disciplines, which in this case
acts as a strong competitive advantage for Cellavision
Automatic reorders
Subscription models are much more common today than they were back when Philip Fisher wrote this book,
so companies seem to have snapped this up quite well
But ...
Subscription alone is not enough to protect your honey. It's all too easy for a customer to switch from Netflix to HBO to
Disney+ and then back again
The company must provide the customer with a product that is critical for its operations, yet,
the cost of the product can only be a small part of the customers budget
Also, the customers of the company must be many smaller ones, rather than a single large one, and
the company itself must be the dominant player in the market
Finally, the market must be specialized enough so that the only way to reach out to customers in an efficient way is through
targeted sales calls
Actually, I think that Cellavision fits these criteria quite well. Damn - I should never have sold that one ...
Warren Buffett, who is the richest investor in the world is Philip Fisher's most famous disciple
Learn how he took Fisher's growth investing to the next level by clicking on my playlist of Warren Buffett investing books
Cheers guys