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Saj Karsan
Saj Karsan
Articles (5983) 

Common Stocks And Uncommon Profits: Chapter 6-7

January 17, 2010
Warren Buffett has called himself "85% Graham and 15% Fisher". While the works of Graham are often cited, Fisher's book "Common Stocks and Uncommon Profits" is not. Here follows a summary of this work by Philip Fisher, known as one of the greatest investors of all time.

Chapter 6

Now that Fisher has discussed when a stock should be bought, he now discusses when it should be sold. There can be good personal reasons for selling a stock (purchasing a home, financing a business etc.), but Fisher focuses on the financial reasons for selling, of which he claims there are but three.

First, an investor should sell if he has made a mistake. Unfortunately, it is difficult for the investor to admit a mistake to himself. Furthermore, the investor is often willing to sell a mistake at a small gain, but he is loathe to do so even for the smallest of losses. Illogical behaviour of this sort can cost the investor dearly, for small losses remove little from a portfolio which should gain hundreds of percent over many years, but they can prevent an investor from allocating his capital to the stocks which will perform best in the future.

The second reason an investor should sell is if the company no longer exhibits the factors that made it a buy in the first place - namely, the fifteen items listed in Chapter 3. This can happen because management has become complacent, management has changed (and the new management no longer or is incapable of following the policies of the previous management), or the company is so large that it has run out of growth prospects. No matter how large the capital gain tax may be or how great the outlook for the company is, Fisher advises the investor to sell in such a circumstance.

The final reason the investor should sell is if there is a better opportunity in which to invest. A company that will grow earnings 15% annually for several years is great, but pales in comparison to the potential returns from a company that will grow earnings 20% annually for several years, even after taking into account the capital gains tax.

Fisher also warns investors not to sell simply because the price has advanced, or because it appears overvalued (when a company its growing earnings quickly, why pay the tax when its earnings will catch up to its premium in just a couple of years?), or because a bear market is expected (as these are impossible to predict).

Chapter 7

In this chapter, Fisher discusses whether dividends are important in stock selection. Fisher believes the public's thinking to be a little twisted and contain a number of half-truths when confronting the topic of dividends.

If managements are building up excess liquidity or generate sub-optimal returns on investment, Fisher absolutely believes that shareholders are better off if dividends are paid. However, the focus of the book has been on investing in the type of company that is generating excellent returns and with competent management; therefore, for the companies under consideration, these would not be issues.

Continuing with the assumption that this discussion is meant for holders of stocks which pass the 15 items listed in Chapter 3, for investors who are currently net buyers of common stock, Fisher finds it bewildering that they would find the idea of a dividend appealing. Presumably, they have invested in a great company, so it is strange that they would be willing to pay a tax, and then re-invest the lower proceeds, whether with the same company or elsewhere. Even pension funds, who do not pay tax, have to pay for the effort and transaction costs of investing the proceeds, when the funds could be utilized by the company with high rates of return.

Fisher recommends that management pay out a percentage of earnings, and stick to that, slowly and consistently raising it as earnings increase. In that way, they will attract the investors that are interested in that dividend rate and who can count on the income they require. For investors, however, Fisher believes that the dividend policy should be the least of their concerns.

Saj Karsan


About the author:

Saj Karsan
Saj Karsan founded an investment and research firm that is based on the principles of value investing. He has an MBA from the Richard Ivey School of Business, and an undergraduate engineering degree from McGill University.

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