In this chapter, Fisher tells the reader how to determine if a company is one which will produce the outstanding returns alluded to in the previous two chapters. There are fifteen questions about each company under consideration that must be answered. If the answer is yes for most of them, the stock could very well be a super-performer. On the other hand, if the answer is no for many of them, Fisher considers it unlikely that the stock can generate the outstanding returns required. The idea is to separate the companies that are "able" from those that are fortunate, as the ones that are able will continue to prosper long after the ones that are fortunate have seen their growth stall.
The first three criteria are covered in this post, with the remaining twelve covered in subsequent posts:
1) Does the company have the market potential to grow sales for at least several years?
Here, Fisher is not interested in market conditions which offer the potential for a large surge in sales, even for years at a time. While he acknowledges that profits can be made from investing in such companies, these are not the home-run type companies he is looking for. For this to be possible, management must be skilled, and is always growing markets and product lines such that sales continue to increase even as its industries mature. An example of such a stock Fisher picked out in the 1950s is Motorola; he goes on to describe why Motorola fit this description and turned out to be the winner that it did.
2) Does management institute policies that that result in newly developed products?
Fisher stresses that this is not the same question as the one above. While the previous question has a factual answer, this question is related to management attitude. In other words, does management recognize that existing products will eventually reach their market potential?
3) How effective is the company's research and development?
Does management make the investments in R&D necessary to keep the company's growth trajectory high? Here, Fisher notes that it is not just the amount of R&D that is important (as a percentage of sales), but how well the processes are managed, how well the teams are motivated, and how well the research processes are integrated with the sales team. Fisher also believes that companies with research efforts in areas where the company already has a successful product have the most promise for future returns, as opposed to research in areas in which the company has no existing expertise. Furthermore, stability in funding research products is also important; companies that cut R&D at the bottom of the business cycle pay far more in the end than those who stay committed throughout.
Fisher continues to list off more of the 15 properties he believes investors should look for in order to identify the stocks with the potential for astronomical returns:
4) Does the company have an above-average sales organization?
Fisher calls the making of repeat sales to satisfied customers the first benchmark of success. But investors pay far less attention to whether a sales staff is efficient than they do to research, finance, production or other corporate activities. Fisher attributes the reason for this to the lack of financial ratios that can be applied in order to measure the quality of a sales staff. But the information is available in a qualitative sense using the "Scuttlebutt" method Fisher described earlier in the book. Competitors and customers know the efficiency of the sales staff, and they are often quite willing to express their views on the subject.
5) Does the company have a worthwhile profit margin?
Fisher believes that the greatest long-range investment profits are made by investing in the companies with the highest profit margins in the industry. There are some caveats to look out for though. Margins should be looked at over a period of many years, since temporary effects can abnormally lower or raise a company's margins. Furthermore, fundamental changes may be occurring in a company (new product, increase in efficiency) with low margins that will turn it into a company with high margins; these may be unusually attractive purchases. Finally, some companies have low margins because they plow a lot of their profits into research and sales, so they are actually building for the future. Investors counting on this to be the case must make absolutely certain that investing for the future is indeed the real reason for the low margins.
6) What is the company doing to improve margins?
Inflation will continue to increase the costs of most companies, but companies of different abilities will see varying results in their profit margins over time. Some companies have the ability to increase price in order to maintain or increase margins. Fisher argues that this only encourages new competitive capacity, and therefore only temporarily increases margins. But some companies use far more ingenious means to increase margins. Some corporations have departments whose sole function is to review procedures and methods in order to find savings. "Scuttlebutt" will not work as well as speaking to company personnel directly about the amount of work being done by the company in this area. Fisher argues that the investor is fortunate that most top executives are willing to talk in detail about such topics, however.
The first three criteria are covered in this post, with the remaining twelve covered in subsequent posts:
1) Does the company have the market potential to grow sales for at least several years?
Here, Fisher is not interested in market conditions which offer the potential for a large surge in sales, even for years at a time. While he acknowledges that profits can be made from investing in such companies, these are not the home-run type companies he is looking for. For this to be possible, management must be skilled, and is always growing markets and product lines such that sales continue to increase even as its industries mature. An example of such a stock Fisher picked out in the 1950s is Motorola; he goes on to describe why Motorola fit this description and turned out to be the winner that it did.
2) Does management institute policies that that result in newly developed products?
Fisher stresses that this is not the same question as the one above. While the previous question has a factual answer, this question is related to management attitude. In other words, does management recognize that existing products will eventually reach their market potential?
3) How effective is the company's research and development?
Does management make the investments in R&D necessary to keep the company's growth trajectory high? Here, Fisher notes that it is not just the amount of R&D that is important (as a percentage of sales), but how well the processes are managed, how well the teams are motivated, and how well the research processes are integrated with the sales team. Fisher also believes that companies with research efforts in areas where the company already has a successful product have the most promise for future returns, as opposed to research in areas in which the company has no existing expertise. Furthermore, stability in funding research products is also important; companies that cut R&D at the bottom of the business cycle pay far more in the end than those who stay committed throughout.
Fisher continues to list off more of the 15 properties he believes investors should look for in order to identify the stocks with the potential for astronomical returns:
4) Does the company have an above-average sales organization?
Fisher calls the making of repeat sales to satisfied customers the first benchmark of success. But investors pay far less attention to whether a sales staff is efficient than they do to research, finance, production or other corporate activities. Fisher attributes the reason for this to the lack of financial ratios that can be applied in order to measure the quality of a sales staff. But the information is available in a qualitative sense using the "Scuttlebutt" method Fisher described earlier in the book. Competitors and customers know the efficiency of the sales staff, and they are often quite willing to express their views on the subject.
5) Does the company have a worthwhile profit margin?
Fisher believes that the greatest long-range investment profits are made by investing in the companies with the highest profit margins in the industry. There are some caveats to look out for though. Margins should be looked at over a period of many years, since temporary effects can abnormally lower or raise a company's margins. Furthermore, fundamental changes may be occurring in a company (new product, increase in efficiency) with low margins that will turn it into a company with high margins; these may be unusually attractive purchases. Finally, some companies have low margins because they plow a lot of their profits into research and sales, so they are actually building for the future. Investors counting on this to be the case must make absolutely certain that investing for the future is indeed the real reason for the low margins.
6) What is the company doing to improve margins?
Inflation will continue to increase the costs of most companies, but companies of different abilities will see varying results in their profit margins over time. Some companies have the ability to increase price in order to maintain or increase margins. Fisher argues that this only encourages new competitive capacity, and therefore only temporarily increases margins. But some companies use far more ingenious means to increase margins. Some corporations have departments whose sole function is to review procedures and methods in order to find savings. "Scuttlebutt" will not work as well as speaking to company personnel directly about the amount of work being done by the company in this area. Fisher argues that the investor is fortunate that most top executives are willing to talk in detail about such topics, however.
