Growth Investing - Philip A. Fisher

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In one of his shareholder letters, Warren Buffett told his readers that the terms "value investing" and "growth investing" were really the same thing.  He felt that a value investor should be looking for companies whose business prospects and profits appear to be on an increasing trajectory for the foreseeable future.  Wall Street views growth stocks as those whose revenues and profits increase at annual rates which exceed, by a substantial amount, the average increases of those financial attributes for the general market.

Investing in stocks whose revenues and earnings are growing at a pace exceeding that of the market ("growth stocks") is a well respected investment philosophy.  The most famous proponent of growth investing was Philip A. Fisher, who wrote his classic, Common Stocks and Uncommon Profits in 1958.  Mr. Fisher was born in 1907 and started his own money management company in 1931.  He headed Fisher & Company until 1999, retiring at the age of 91.  He looked for companies which devoted a  large portion of their earnings to research and development of new products.  He was a long term investor.  His son, Kenneth Fisher, who has continued the family tradition of money management, reported that Mr. Fisher invested in Motorola in 1955 and held the stock until his death in 2004.

Philip Fisher listed 15 attributes to look for in a promising stock.  He indicated that a company should provide its customers with a product or service with a potential market large enough to provide significant sales increases in future years.  In addition to the product, the company also had to be able to improve on that product through continuous research and development in order to be ready to sell the new model (in today's parlance, its Version 2.0) when the current model had run its life cycle and to repeat this over and over again while also developing new products.   Mr. Fisher looked for a company with a significant percentage of its sales dollars devoted to research.  Not only must the product have a large market potential, but it also must be able to generate a significant profit margin for the company.  He also wanted to know what steps a company was taking to protect and increase its profit margin.

In addition to these financial characteristics, Mr. Fisher was interested in a company's labor relations, the depth of its management bench, its executive development program and the quality of its expense controls.  He wanted a company capable of financing its growth with earnings or debt.  Mr. Fisher recognized that if the company needed to raise additional capital through stock offerings, the existing shareholders' ownership percentage was going to be diluted by the issuance of additional shares to new investors.  If an investor owns 100 shares of a company which has issued 1,000 shares, he or she has a 10% interest in the company.  If that company issues an additional 1,000 shares and the shareholder does not buy any additional shares, then that 100 share percentage drops from 10% to 5%.

Three management traits were of also important to Mr. Fisher.  First, he wanted to find companies whose management was interested in the long term success of the company, not its next quarterly results.  Second, the management had to be honest with the shareholders in the bad times as well as the good ones.  He explained this as follows:

Furthermore, the companies into which the investor should be buying if greatest gains are to occur are companies which over the years will constantly, through the efforts or technical research, be trying to produce and sell new products and new processes.  By the law of averages, some of these are bound to be costly failures......How a management reacts to such matters can be a valuable clue to the investor.  The management that does not report as freely when things are going badly as when they are going well usually "clams up" in this way for one of several rather significant reasons.  It may not have a program worked out to solve the unanticipated difficulty.  It may have become panicky.  It may not have an adequate sense of responsibility to its stockholders seeing no reason why it should report more than what may seem expedient at the moment.  In any event, the investor will do well to exclude from investment any company that withholds or tries to hide bad news.

The third, and most important, management trait Mr. Fisher required was that the executives in charge have the utmost integrity and see themselves as stewards of the shareholders' business.

As with all forms of investing, relying solely on one concept can lead to trouble.  One of the more famous examples of growth investing gone wrong is the "Nifty Fifty."  This was the name given to 50 large cap stocks on the New York Stock Exchange which had consistent earnings growth during the bull market of the late 1960's and early 1970s.  Unfortunately, those companies became viewed as "one decision" stocks, i.e., buy and hold them with little or no thought to their financial condition or business prospects other than their earnings growth rates.  In that bull market, the P/E ratios paid for some of these stocks grew to as high as 50.  Even more troubling, the P/E ratios for the companies increased at a rate far in excess of the earnings increases of the companies.  As is usually the case, "Nifty Fifty" investors suffered large losses when the bottom fell out of the market later in the 1970s and prices crashed.

In order to get a full appreciation of the tenets of growth investing, an individual can do no better than to read this investment classic.  The above excerpt comes from Common Stocks and Uncommon Profits republished by John Wiley & Sons, Inc. under its Wiley Investment Classics series in 1997.

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