Philip Fisher's 15 Rules For Picking Stocks
15 timeless rules from the book "Common stocks and uncommon profits"
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Dear investor,
I hope this message finds you well.
Warren Buffett is often described as a classic value investor in the tradition of his mentor, Benjamin Graham. However, another major influence on Buffett’s investment philosophy is Philip Fisher.
Fisher’s book, Common Stocks and Uncommon Profits, was the second investing book I read when I began my journey nearly 20 years ago, and its insights remain as relevant today as ever.
One of Fisher’s key contributions to investing is his 15-point checklist for evaluating a company's quality - not just through financial statements but by analyzing intangible factors like management effectiveness and corporate culture. These "soft factors" may not appear in the numbers immediately, but over time, they shape a company's financial performance.
Here are the 15 points Fisher considers before buying a stock:
1. Does the company produce goods or services whose sales are likely to increase substantially for at least the next several years?
A company’s stock price is heavily influenced by its ability to grow revenue (Wall Streets darling) and earnings over time. If a company’s products or services are in high demand and its sales are growing, it is more likely to deliver strong financial performance.
If sales are expected to grow, the company is more likely to generate higher cash flows, which can be reinvested in the business, returned to shareholders via dividends or buybacks, or used to pay down debt. (Assuming the company never gets recommended by Jim Cramer)
Check whether the company operates in a growing industry. For example, a company in the renewable energy sector might benefit from global decarbonization efforts, while a company in a declining industry (e.g., fossil fuels) may face headwinds.
Find out if the company’s offerings are meeting a growing or underserved need? For example, companies providing cloud computing services have benefited from the surge in remote work and digital transformation.
Can the company scale its operations to meet increasing demand without proportionally increasing costs? Scalable businesses (e.g., software companies) often have higher profit margins as they grow. Use the Capex-to-Cash Flow formula:
2. Is management determined to develop new goods or services?
Companies that continuously innovate are better positioned to adapt to changing market conditions, stay ahead of competitors, and capture new revenue streams.
Innovation can create a moat around the business, making it harder for competitors to replicate its offerings.
Companies that fail to innovate risk becoming obsolete. Think of Blockbuster vs. Netflix or Kodak vs. digital photography. A commitment to innovation ensures the company remains relevant over time.
Look at the company’s R&D spending as a percentage of revenue.
Review the company’s history of product launches. Have they successfully brought new goods or services to market?
Read management’s commentary in annual reports or earnings calls. Are they discussing future growth opportunities and innovation strategies?
Check for patents, partnerships, or acquisitions that indicate a focus on innovation.
3. How effective is a company’s research and development?
R&D is the engine of innovation for many companies, especially in technology, healthcare, and consumer goods. R&D is often a sign that a company is investing in its future. Without ongoing innovation, companies risk becoming obsolete as competitors introduce better products or technologies.
Effective R&D can lead to cost reductions (e.g., through process improvements) or premium pricing (e.g., through unique product features), both of which can boost profit margins.
Find out whether the company has a robust pipeline of new products or technologies. For instance, a pharmaceutical company with a deep pipeline of drugs in late-stage clinical trials is more likely to sustain growth.
Check out how much the company spends on R&D relative to its revenue. High spending may be justified if it leads to breakthrough innovations.
4. Does the company have an above-average sales organization?
A strong sales organization directly drives revenue growth by effectively converting leads into customers, upselling existing clients, and expanding into new markets. This is especially important in industries where long-term contracts or subscriptions are common.
Effective sales organizations leverage technology (e.g., CRM systems, data analytics, A.I. agents) to streamline processes, track performance, and identify opportunities.
Questions you should ask:
Is the company consistently growing its revenue at or above industry averages?
Does the company invest in training and tools to support its sales organization?
5. Does the company have a worthwhile profit margin?
Profit margin measures how much of each dollar of revenue translates into profit. Companies with strong profit margins often have pricing power, meaning they can raise prices without significantly losing customers. This is a sign of a strong brand, unique product offerings, or a lack of substitutes.
Companies with healthy profit margins are better equipped to withstand economic downturns, rising costs, or other challenges. They have more cushion to absorb shocks without jeopardizing profitability.
Profit margins vary widely by industry. For example, software companies often have high margins due to low variable costs, while grocery stores typically have low margins due to high competition and thin pricing. Comparing a company’s margins to industry peers provides context. (Lower margin companies can still benefit a well-rounded portfolio if their products have an inelastic demand like food)
6. What is the company doing to maintain or even improve its profit margin?
Simplified, companies can either raise their prices or reduce their costs. Fisher is somewhat skeptical of the company that maintains or improves its margins exclusively by increasing its prices, and looks for those that also maintain a keen eye towards production, marketing and other cost efficiencies.
Questions you should ask:
Does the company have a track record of successfully improving margins over time?
What specific initiatives (e.g., cost-cutting, pricing strategies, product innovation) is the company implementing to enhance profitability?
Earnings call transcripts are your friend.
7. Does the company boast outstanding labor and personnel relations?
Fisher’s focus on technological excellence and innovation led him to favor companies with strong labor relations, particularly those that paid above-average wages. He believed that such companies were better positioned to attract and retain skilled workers, foster innovation, and maintain operational stability.
His preference for companies with fewer unionized workers stems from his belief that such companies are often more innovative and agile. Unions can sometimes create rigid structures that hinder rapid decision-making or adaptation to technological changes.
Questions you should ask:
What is the company’s turnover rate, and how does it reflect employee satisfaction?
Does the company have a history of labor disputes or strikes? (car manufacturers come to mind)
How does the company invest in employee development and well-being?
Glassdoor ratings are your friend.
8. Does the company have outstanding executive relations?
Fisher believed that the quality of executive relations was a key determinant of a company’s investment potential. He argued that the best investment opportunities were found in companies with a positive executive climate, where:
Executives had confidence in the CEO and each other.
Compensation and promotions were based on merit and results.
There was a clear alignment between the leadership team and the company’s long-term goals.
Fisher warned that companies deviating from these standards were less likely to be outstanding investments. His focus on executive relations reflects his broader emphasis on management quality as a critical factor in investment decisions.
What you should find out:
Does the company have a succession plan in place for key leadership roles?
What is the turnover rate among top executives?
Is there a clear and fair process for evaluating executive performance and determining compensation?
9. Does the company have more than a handful of talented managers?
Fisher believed that the best investment opportunities were found in companies with strong, decentralized management structures. He emphasized:
The importance of having more than a handful of talented managers to ensure organizational resilience and scalability.
The dangers of top executives interfering in routine operations, which he saw as a red flag for poor investment potential.
The need for clear lines of authority and accountability, which enable managers to perform their roles effectively without unnecessary interference.
Questions you should ask:
Are there any signs of micromanagement or interference from top executives in routine operations?
What is the company’s track record of developing and promoting internal talent?
How does the company handle leadership transitions, and have there been any disruptions in the past?
10. How good are the company’s methods of cost analysis and accounting?
Fisher emphasized the importance of detailed cost analysis and accounting in driving a company’s success. He believed that no company could achieve or sustain outstanding success without a deep understanding of its costs. Specifically, Fisher highlighted:
The need to distinguish between profitable and unprofitable activities, allowing companies to focus on what drives value and eliminate what doesn’t.
The role of cost analysis in enabling continuous improvement and operational excellence.
The dangers of poor accounting practices, which can obscure a company’s true financial performance and lead to misguided decisions.
Questions you should ask:
Does the company have a history of improving margins through better cost management?
How transparent and reliable are the company’s financial statements?
Are there any red flags in the company’s accounting practices (e.g., frequent restatements, unusual adjustments)?
11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues about how outstanding the company may be compared with its competitors?
Every industry has unique dynamics and key success factors. Understanding these nuances allows investors to evaluate how well a company is positioned relative to its peers.
Fisher emphasized the importance of understanding industry-specific factors when evaluating a company. He believed that these factors often provided clues about a company’s competitive position and long-term potential. For example:
In retail, he highlighted the importance of lease management, as favorable lease terms could significantly enhance profitability.
In technology, he stressed the value of patent protection and other forms of IP, which could create barriers to entry.
What you should ask:
Does the company have a competitive advantage in industry-specific areas (e.g., prime locations in retail, strong IP in tech)?
How does the company manage industry-specific risks (e.g., regulatory changes, technological disruption)?
12. Does the company have a short- or a long-range outlook?
Companies with a long-term focus are more likely to invest in innovation, even if it means sacrificing short-term profits. For example, Amazon’s long-term focus on customer experience and infrastructure has driven its dominance in e-commerce and cloud computing.
Questions you should ask:
Does the company prioritize customer satisfaction and loyalty over short-term sales?
How does the company’s management communicate its long-term vision to shareholders? Do they have for example “5-year plans”?
Are there any red flags indicating a focus on short-term results at the expense of long-term value (e.g., aggressive cost-cutting, excessive stock buybacks)?
13. Will the company’s growth require so much equity finance that the much larger number of shares outstanding will largely cancel the benefit from this anticipated growth?
High-quality growth is often self-funded, as it reflects strong profitability and efficient operations. Companies that consistently require external financing may have weaker business models or less attractive growth prospects.
Fisher was wary of companies that relied heavily on external financing, particularly equity issuance, to fund their growth. He believed that the best investment opportunities were found in companies that could grow primarily through their own resources, such as retained earnings and cash flow.
Questions you should ask:
What is the company’s historical reliance on external financing, and how has it impacted shareholders?
Does the company have a strong track record of generating cash flow and retained earnings to fund its growth?
What is the company’s debt-to-equity ratio, and how does it compare to industry peers?
14. Does the management talk freely to investors about its affairs when things are going well but become mute when troubles occur?
How a company communicates during tough times is a strong indicator of its leadership quality. Companies that address challenges head-on and provide clear plans for resolution are more likely to navigate crises successfully.
On top of that transparent communication is not just a best practice - it’s often a legal requirement. Companies that fail to disclose material information risk regulatory penalties and legal action.
Questions you should ask:
How does the company’s management respond to difficult questions from analysts or shareholders?
Are there any red flags in the company’s communication practices (e.g., vague language, lack of detail, frequent restatements)?
Are there any examples of the company withholding or delaying bad news in the past?
For further reading, consider this article:
15. Does the company have a management of unquestionable integrity?
Management integrity ensures that the company’s financial statements and disclosures are accurate and transparent. Companies with unethical management are more prone to scandals, regulatory penalties, and reputational damage, all of which can destroy shareholder value.
Fisher was particularly critical of executives who used stock options to enrich themselves without creating commensurate value for shareholders. He saw this as a betrayal of their fiduciary duty.
He believed that the best protection against such abuses was to invest in companies where management viewed themselves as trustees of shareholder capital, with a strong sense of moral responsibility.
Questions you should ask:
How does the company handle executive compensation, particularly stock options and bonuses?
Have there been any past scandals or controversies?
How transparent is the company in its financial reporting and communication with shareholders?
An example for low integrity is SMCI which I previously wrote about:
Final thoughts
Much of the information needed to answer these 15 questions can be found in earnings call transcripts, as well as in the news and announcements section of a company’s website.
These sources provide direct insights into management’s priorities, growth strategies, and how they respond to challenges. By consistently reviewing these materials, investors can gain a deeper understanding of a company’s long-term prospects beyond the financial statements.
At the end of the day, investing isn’t just about numbers - it’s about understanding the story behind them.
Until the next issue. 🥂
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Disclaimer: This analysis is not advice to buy or sell this or any stock; it is just pointing out an objective observation of unique patterns that developed from my research. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice.