Phil Fisher was a legendary investor with an outstanding record from the mid-1900s and the author of a best-selling and influential book: “Common Stocks and Uncommon Profits and Other Writings.” Published in 1958, it was praised for its practical yet profound recommendations on how to buy and sell stocks.
Not so well known is Fisher’s advice on the pitfalls that can trap unprepared investors. In chapter eight, he provided five warnings, and now, in chapter nine, he has provided five more. This chapter’s list or errors begins with the subject of diversification.
Too much diversification
Every investor has heard of the value of diversification, of putting all their eggs in one basket lest that basket fall. Fisher, though, wanted to draw attention to the other extreme, of having so many eggs that some do not end up in attractive baskets, and the individual eggs do not receive enough attention.
He claimed that a portfolio of a quarter- to a half-million dollars (in 1958) with 25 or more stocks would be “appalling.” Not in the number itself, but in having only a small percentage in attractive stocks about which the investor is very knowledgeable. Fisher went on to say that investors have been so oversold on diversification that they have some stocks about which they know nothing, and far too little about the others.
How, then, would investors choose a more appropriate number? Fisher did not have a specific number in mind because many individual companies were already diversified by products and other factors. He concedes that mistakes will happen from time to time, and sufficient diversification should take the sting out of them.
Finally, he remarked, “However, beyond this point he [the investor] should take extreme care to own not the most, but the best. In the field of common stocks, a little bit of a great many can never be more than a poor substitute for a few of the outstanding.”
Being put off by wars or fear of wars
In the mid-1950s, memories of World War II and the Korean War were fresh in the minds of everyone, and the Cold War was very hot, so it is not surprising that Fisher had a section that dealt with investing and war.
He observed that, with one exception, the stock market plunged whenever a war broke out during the first half of the 20th century. That one exception was the beginning of World War II, before Americans were pulled into it. Why, asked Fisher, did investors dump their stocks on the fear of war or the outbreak of hostilities? After all, stocks had always rebounded and gone higher by the ends of wars.
In answer to his own question, Fisher explained governments always spent far more than they brought in during wars, made up the difference by printing money and that led to inflation. Money becomes less valuable and, as a result, “It is just that money becomes even less desirable, so that stock prices, which are expressed in units of money, always go up.”
Falling for superficial financial statistics
Perhaps this section was broadly intended as an attack on technical analysis, or perhaps just the specific issue he cited, which was investors checking price ranges—the highs and lows of a stock over some period such as five or 10 years—before buying a stock. Fisher wrote that many investors apparently use the high and low over a period to come up with “a nice round figure which is the price they are willing to pay for the particular stock.”
The author argued that such practices are both illogical and financially dangerous because they put attention on things that do not matter and divert attention away from things that do matter. He followed up by questioning why a stock sells at the price it does; in answer, he reported it is the “composite estimate at that moment of what all those interested think the corrective value of the shares should be.” What really matters is that the price is based on the “current appraisal”.
Not considering time as well as price when buying a “true growth stock”
Fisher grappled here with a question that troubles many investors: At what price should shares be purchased? First, he said, “what is really important here is to find a way that we can buy the stock at a price close to the low point at which it will sell from here on in.”
Next, he argued there is a counterintuitive case to be made for buying at a certain date rather than a certain price. Fisher offered the example of buying a chemical company about one month before its new pilot plant opens, and goes on to say this approach is not ignoring the concept of value, even if it appears to do so. When information suggests that a bottom-line increase and/or share price increase is coming, it makes sense to buy according to date and time rather than price.
Following the herd
Fisher considered this a difficult investment concept because there are no precise words or mathematical formulae that would explain it. In the stock market, as well as many other institutions, there are fads and styles that come and go (in the years following Fisher's death, the science of behavioral finance would fill in that gap).
His example, timely for readers in 1958, was the widespread belief after World War II that the then-current boom was temporary and could not last. As Fisher put it, “for these three years, from 1947 to 1949, almost the whole financial community was indulging in a mass delusion.”
That delusion kept a cap on markets until a slight depression occurred in 1949; shortly after, the trend turned up sustainably. Many stocks subsequently doubled in value in the next few years. Again, one psychological mood had replaced another, while nothing essential about the companies changed.
(This article is one in a series of chapter-by-chapter digests. To read more, and digests of other important investing books, go to this page.)
Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.
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