In 1975, Philip Fisher, the author of “Common Stocks and Uncommon Profits and Other Writings,” wrote and published another book titled “Conservative Investors Sleep Well.” The latter has now been incorporated into the first as “part two.”
The author said this book was written to help investors get through the slump that occurred after the 1973 oil embargo, and that it was heavily influenced by his son  Ken Fisher(Trades, Portfolio), who founded his own investment firm after briefly working for his father.
The first chapter of part two was a conservative investor’s guide to the advantages exhibited by quality—or conservative—companies.
To begin, though, he wanted readers to distinguish between acting conventionally and acting conservatively. So, he offered two definitions:
“1. A conservative investment is one most likely to conserve (i.e., maintain) purchasing power at a minimum of risk.
2. Conservative investing is understanding of what a conservative investment consists and then, in regard to specific investments, following a procedural course of action needed properly to determine whether specific investment vehicles are, in fact, conservative investments.”
With that in place, Fisher turned to what he called the “First Dimension” of conservative investment superiority: What businesses bring to the market. This dimension has four main subdivisions: low-cost production, strong marketing skills, outstanding research and development and financial skills.
Low-cost production
Fisher argued it was necessary to be the low-cost producer or as close to the low-cost producer as possible, to gain a large enough margin for at least survival. This would create two vital conditions. First, it would provide “sufficient leeway” between the breakeven points of most competitors. Second, the margins and subsequent retained earnings would be enough to finance new growth.
Acknowledging this point was made with manufacturing companies in mind. Fisher said the same principles held for service companies (everything from wholesaling to banking). In those cases, however, the word “operations” would be substituted for “production,” while referring to “high- or low-cost operators” rather than “low/high cost producers.”
Strong marketing company
Here, Fisher started with an example from early in the 20th century. It was of the marketing efforts of a company that manufactured horse-drawn buggies that had not been listening to its customers and, as a result, continued to make better and better buggies, rather than shifting to automobiles.
But that is only the opening stage. Beyond it, a company’s marketing team must make potential customers aware of the advantages it offers, and that can only be done well by understanding what potential buyers really want (even if the potential buyer doesn’t yet know).
Fisher called for “close control and constant managerial measurement of the cost effectiveness of whatever means are used” to make customers aware of the company’s advantages.
He also pointed out “An efficient producer or operator with weak marketing and selling may be compared to a powerful engine that, because of a loose pulley belt or badly adjusted differential, is producing only a fraction of the results it otherwise would have attained.”
Outstanding research and development
Research and technical development was a burgeoning field in the second half of the 20th century; during World War II, the combatants invested heavily in research in hopes of winning with the use of new tools such as radar. After the war, much of that research shifted from the military to commercial and industrial and gave an increasing number of companies what we would now call a competitive advantage.
Previously, only companies such as aerospace and pharmaceuticals might have had research and development operations, but by the 1970s it had worked its way into service industries as well. Fisher gave an example from banking: “Low-cost electronic input devices and minicomputers are enabling them to offer accounting and bookkeeping services to customers, thus creating a new product line for these institutions.”
Fisher also observed there is as much variation among companies as there is in marketing. The varying strengths of companies, therefore, can be tied back to the competence and ingenuity of research staff. New products often come from pooling the efforts of different groups of researchers (and connected to marketing, as he noted in another chapter).
To optimize corporate profits, these groups must develop and produce products for which there will be strong demand among consumers, can be sold by the existing marketing team and sold at a price with good margins. This demands a carefully coordinated effort among many internal groups and individuals, but without so much micromanagement that it smothers the innovation.
Financial skills
In this section, Fisher referred to the need among companies for above-average financial talent since they will have significant advantages. Such companies will know the precise product margin on each product in multiple product lines, so they can direct their best efforts toward the greatest profits—think of this as a version of the 80-20 rule.
To possess this knowledge means knowing not only the margins, but also the costs of everything from manufacturing to selling, and this is available only with “skillful budgeting and accounting.” This also leads to an early warning system that alerts management to potential problems and allows the application of remedial actions. No surprises for management or for shareholders.
Speaking of the latter, Fisher also wrote that superior financial skills also produce better capital investments or, put another way, better allocation of retained earnings.
The author wound up the chapter by addressing the seeming contradiction between being a conservative investor, with a focus on the safety of capital, and his discussion of growth stocks and their interest in new product lines. The answer, he wrote, is in the dynamism of business and markets, both stock markets and product/service markets:
“It should never be forgotten that, in a world where change is occurring at a faster and faster pace, nothing long remains the same. It is impossible to stand still. A company will either grow or shrink. A strong offense is the best defense. Only by growing better can a company be sure of not growing worse.”
(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.)
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