Phillip Fisher had a profound influence on both Warren Buffett and Peter Lynch in their capital allocation process and had first coined the “scuttlebutt” technique when he wrote Common Stocks and Uncommon Profits. The scuttlebutt technique is inquiring and asking questions to various people with mutual interest or are involved with a certain company or industry. Asking suppliers, vendors, customers, competition, trade association executives, research scientist from universities or in government and previous employees may all be intangible sources of qualitative information.
Phillip Fisher writes about the business grapevine being a wonderful thing, he says: “It is amazing what an accurate picture of the relative points of strength and weakness of each company in an industry can be obtained from a representative cross-section of the opinions of those who in one way or another are concerned with any particular company. Most people, particularly if they feel sure there is no danger of their being quoted, like to talk rather freely about their competitors. Go to five companies in an industry, ask each of them intelligent questions about the points of strength and weakness of the other four, and nine times out of ten a surprisingly detailed and accurate picture of all five will emerge. “
Phillip Fisher goes on to say that an investor must make it clear beyond a doubt that the source of your information will never be revealed and that the investor must live up to policy or otherwise run the risk of not having opinions passed along.
When using the scuttlebutt approach it is best to diversify and crosscheck information that is obtained from all parties. An investor must do this to check for validity, as well as reliability of the sources, possibly exploiting them or at the very least being aware of the limitations that may be present, influenced by prejudice, biases and hidden incentives.
He also provides in his book Common Stocks and Uncommon Profits a list of 15 different questions, some best asked and information obtained from outside sources while others will be best asked to direct company personnel, it is an art. I have provided them below in minor detail and would recommend reading the original work in the 1950s publication Common Stocks and Uncommon Profits.
1) Does the company have products or services with sufficient market potential to make possible a sizeable increase in sales for at least several years? Phil goes on to talk about the “sales curve” and the importance of it being divided up in annual segmented chunks of several years representing a business cycle. He goes on to explain some companies not only show these increasing sales prospects in the medium term but also further beyond that because they are either “fortunate and able" or “fortunate because they are able.”
2) Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have been exploited? Point one is similar to point two, but different in respect to the potential sales growth that now exists for the company versus management’s attitude to create future growth.
3) How effective are the company’s research and development efforts in relation to its size? Looking into the programs management is implementing, completion times, crash program history, an industry comparison and viewing R&D expenditures versus the sales they produce, will be beneficial to the intelligent investor. If a company has a proven track record of producing products or services through research that has become profitable, it is more likely than not that they will continue this in the future, provided that they adhere to the same principles.
4) Does the company have an above-average sales organization? A large sales force is a very important attribute of a successful business, as very few products or services are so amazing that they will sell at their maximum potential unless they are merchandised. How educated or informed is the sales force? How efficient is the distribution network? Some of these questions may be hard to find quantitative answers for but can be more accurately understood through the scuttlebutt technique.
5) Does the Company have a worthwhile profit margin? “The only reason for considering a long-range investment in a company with an abnormally low profit margin is that there may be strong indications that a fundamental change is occurring for reasons other than temporarily expanded volume of business.” This is more of a quantitative approach but should be used in combination with scuttlebutt to provide insight into future profit margins either expanding or compressing on business prospects.
6) What is the company doing to maintain or improve profit margins? “When profit margins of a whole industry rise because of repeated price increases, the indication is not a good one for the long-range investor.”
7) Does the company have outstanding labor and personnel relations? How is the company’s turnover? What is the wage structure like? Do most profits go to high level executives or management or are they evenly distributed to lower ranking staff? Are workers hired in masses and laid off as quickly based on the business outlook? If nothing is done to build up the dignity of the individual this may not be a desirable investment or place to work.
8) Does the company have outstanding executive relations? Does management hire from within? Are salaries regularly reviewed? Is their confidence in the president and/or the chairman? What are management’s views on teamwork, functionality and cooperation within the organization?
9) Does the company have depth to its management? Is management given the authority and responsibility to make real decisions in an efficient manner? All humans are infinite although some are exceptionally outstanding, there comes a time writes Phillip Fisher “Sooner or later a company will reach a size where it just will not be able to take advantage of further opportunities unless it starts developing executive talent in some depth. Good executive material becomes much like healthy young animals so caged in that they cannot exercise. They do not exercise their faculties because they do not have enough opportunities to use them.”
10) How good are the company’s cost analysis and accounting controls? Management should have precise knowledge of the true cost of each product in relation to others or it becomes almost impossible to correctly execute pricing policies. “The best that the careful investor usually can do in this field is to recognize both the importance of the subject and his own limitations in making a worthwhile appraisal of it.”
11) Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competitors? Now this question is very difficult to answer directly but the competitive durable advantages of a company may be apparent. It is not simply one advantage or efficiency but a cumulative total of them all that is important. “It is the constant leadership in engineering, not patents, that is the fundamental source of protection.”
12) Does the company have a short-range or long-range outlook to profits? How does the company treat suppliers and customers? Does the company continuously look for the cheapest way of securing its goods or does it build rapport, sometimes paying over the market price from suppliers?
13) In the foreseeable future will the growth of the company require sufficient equity financing so that the large number of shares that are outstanding will largely cancel the existing stockholder’ benefit from this anticipated growth? How does the company view buybacks versus dilution? What is the attractiveness of the borrowing capabilities of the company? Phil Fisher goes on to talk about conversion privileges being assumed as converted due to the horizon of the investment and explain how per-share earnings is impacted in the future due to dilution outstripping the growth gains.
14) Does the management talk freely to investors about its affairs when things are going well but “clam up” when troubles or disappointments occur? How transparent is management in regards to screw ups or problems? Disappointments are inevitable but it is key how management acts during the situations and how freely they report wrongdoing or mistakes. A prudent investor would avoid a company that tries to withhold bad news from the shareholders.
15) Does the company have a management of unquestionable integrity? “Without breaking any laws, the number of ways in which those in control can benefit themselves and their families at the expense of the ordinary shareholder is almost infinite.” Are their members of the family on the payroll above normal? It is very important to understand where the management of a company’s incentives are aligned and how they are influencing decisions. It is one of those things that is easier said than done. One of the more easily spotted abuses of power comes from management awarding excessive stock options.
While reading Phillip Fisher’s writing I directly see the emulation of Fisher within both Warren Buffet and Peter Lynch. This is by no means an easy route and an easy game; anyone who thinks so is very naïve and most likely stupid. It is a life long process and an art form, from the art of asking questions and using the answers to further ask more precise or valuable questions. It is an art, from the basic assumption you use when calculating future projects or using GAAP measurements, all the while knowing your and there limitations. It is an art analyzing the masses attitudes and behavior. It is an art timing the shots you take, while developing acute patience for the “go for the jugular” deals. It is the most complex game I have ever known and probably will ever know, that is what originally drew me to it; being told it was a losing game from almost everyone I knew. I decided to share these fifteen points to hopefully help spark the engine inside your head with provoking thoughts and questions. It is not meant to be easy, if it was everyone would be doing it.
Phillip Fisher said brilliantly “The investors work is so specialized and so intricate that there is no more reason why an individual should handle his own investments than that he should be his own lawyer, doctor, architect, or automobile mechanic. He should perform these functions if he has a special interest in and skill at the particular field.”
About the author:I am working towards the CPA & CFA designations, and would love to manage an investment partnership in the future. I am a self taught investor through Warren Buffett, Charlie Munger, Ben Graham, Peter Lynch, Joel Greenblatt, David Einhorn, Seth Klarman, Howard Marks, Phillip Fisher and Thornton O'Glove. My focus is a bottoms up Value-GARP strategy with a mix of top down contrarianism.
"When you find yourself on the side of the majority, it is time to pause and reflect." - Mark Twain