Common Stocks and Uncommon Profits

Philip Fisher

📚 GENRE: Business & Finance

📃 PAGES: 320

✅ COMPLETED: August 29, 2021

🧐 RATING: ⭐⭐⭐⭐⭐

Buy Book

Short Summary

Using his ’15-Point’ scale, Philip Fisher reveals the secrets to smart stock selection. Fisher explains what to look for in a company, when to sell stocks, and why you should avoid following the herd. 

Key Takeaways

1️⃣ Use the ’15 Points’ to Select Stocks — Fisher’s ’15-Point’ scale helped him big some big winners over the course of his career. Follow his lead when selecting stocks, specifically focusing on the company’s sales and net income growth rates, ability to expand into new markets, and quality of management.

2️⃣ Interest Rates Matters — Interest rates affect stock prices significantly. When interest rates are low, bonds aren’t competitive and people flee towards stocks. When interest rates are healthy, bond returns are competitive and some people pull their money out of stocks in favor of more conservative bond investments. When interest rates are low, companies are also able to borrow money at cheaper rates, which helps the bottom line. 

3️⃣ Stick With Your Good Stocks — Unless you absolutely have to sell them for some reason, try to hold your high-quality companies forever. Check in routinely to ensure the company is still growing and making good decisions. You should never sell your good companies just because the market is dipping. 

Favorite Quote

"When profit margins of a whole industry rise because of repeated price increases, the indication is not a good one for the long-range investor."

Book Notes 📑

*Did not take chapter-by-chapter notes on this one. Running list below.

  • What to look for when buying companies: The 15 Points:
    1. Increasing sales and net income and likelihood that it will continue. Growth opportunity.
    2. Is management committed to maximizing revenue from existing product lines AND developing new products/services?
      • A company’s R&D department play a big role here
    3. Efficient R&D department.
      • Looking to make good solid new products at lowest cost possible
      • Intelligent scientists/researchers
      • Management that doesn’t do “crash programs”, which is when they abandon a project in the middle stages 
    4. A strong marketing team
      • Nike and Apple are great at earning repeat customers through marketing
    5. Good Net Income/Profit margin
    6. What is the company doing to maintain or improve net income/profit margin,
      • Increasing wages and taxes pose a threat to net income
      • Is the company finding ways to reduce costs to offset growing wages and taxes?
    7. Does the company and its leadership treat employees well? Is it a desirable place to work?
    8. Does the company have strong executive relations? Are executives treated well? Are promotions fair and possible?
    9. Is there strong management depth?
    10. Is the company organized with its accounting so it knows exactly what it costs to produce each product or service?
    11. How does the company handle its leasing contracts and patents?
      • Tough to judge. 
      • This usually indicates how strong the company is as a whole. If it handles this stuff well, it probably handles everything well 
    12. Is the company focused on long term profits or short term?
      • Look at how the company treats customers and vendors as an example.
    13. Is the company constantly issuing more common stock and therefore diluting ownership stake for existing shareholders?
      • If so, this is a bad sign. They constantly need money and are diluting ownership stake to do it 
    14. How well does management communicate in good times and bad?
      • Difficulties will happen. How does management handle it?
      • Enron is a bad example
    15. Does the company have management team that is trustworthy and has great integrity?
  • Dividend stocks kind of stink unless you’re an old person needing income or you’re a very large money investor who will get huge dividend payments each quarter because you’ve invested a ton of $ in the company
    • Better off going with young growth stocks that will hopefully increase in capital appreciation significantly by reinvesting retained earnings back into the company/new products AND likely pay a nice dividend yield down the road based on your original investment.
  • Quote: “When profit margins of a whole industry rise because of repeated price increases, the indication is not a good one for the long-range investor.”
  • Invest in companies that are undergoing some changes/turbulence that will eventually increase their earnings and therefore their market price.
    • Their market price will be down currently because they are investing in a new plant, for example, and that extra expenditure and issues relating to it drives public sentiment and the share price down. This is the time to invest and then ride the market price up as the new plant helps the company increase earnings in the future 
  • Use dollar cost averaging if you’ve located a good company to invest in and the current market prices across the board are really high. That way, you will be investing when the share prices are high and you’ll be investing when the share price drops because the market drops 
  • P. 104: Drivers of stock prices/market:
    • Business/economic cycle
    • INTEREST RATES
    • Gov. Attitude towards business and the market
    • Inflation trend
    • New inventions 
  • When to Sell: 3 reasons:
    1. You messed up and picked a bad stock
      • Cut your losses quickly. Don’t wait and let your ego get in the way. Don’t “wait to get back to even.”
      • Over time, if you selected mostly good stocks, your losses will be easily covered and you’ll still end up with big gains. 
      • Don’t sweat bad picks. Everyone has makes bad picks. 
    2. The company no longer abides by the previously covered 15 points from earlier chapter
      • This may happen for 2 reasons:
        1. Management has become complacent and smug. Poor decisions are being made.
        2. The company has gotten so large and has expanded so well that it simply has no more growth left in it. It will only improve as much as the economy and the industry it is involved in. These are mega large cap stocks. Think General Electric. 
    3. If you can’t find any good deals in the market 
  • Overall, if you select a good company and buy at a good time, there is very little reason to ever sell.
    • Never get too concerned with market timing. Invest in good companies with good management. If you buy at a good time when shares are low, your gain will be bigger. But, if a good company is chosen, you will make a lot regardless
  • P. 113: Justin likes to buy/sell a lot using the three reasons scolded in this chapter:
    1. “The market is going to crash.”
    2. “The stock is overpriced.”
    3. “The stock had a huge gain. Time to get out.”
    • Market crash predictions are a guess at best 
    • If you buy good companies, you are much better off holding when the stock is “overpriced” because you are guessing that it’s overpriced by ___ amount. Plus you will be hit with capital gains tax for selling.
      • Better to lose some capital appreciation and still have your position in the company at a big gain than to sell, lose your position, and hope it comes back down so you can buy again 
  • P.116: Dividends:
    • There are two ways a company can use retained earnings: Pay a dividend or throw it back into the business to grow and increase future earnings (and therefore cause the stock price to rise if the funds are used well by management)
    • Due to taxes and the fact that you theoretically have to reinvest the $ and could make a bad decision, it is preferred if the company primarily uses the retained earnings to grow the company. This will help shareholders the most, ultimately 
  • P/E Ratio:
    • The stock is trading at ____ times earnings
    • P/E represents the dollar amount you are paying for every $1 of net income/earnings 
  • Diversification is not great
    • Because you’re fixated on putting eggs in many baskets, you choose bad companies that lose money. You also tend to invest in companies that you don’t know very well because you haven’t taken the time to research them
    • Also, it’s impossible to monitor all of these companies after you invest 
    • Instead, focus on choosing a tight number of great companies in different industries that you’ve researched thoroughly and can monitor over time 
  • P. 138: Nice example of little company reports I can start doing on the companies I invest in
  • Buy stocks on war/war scares
    • Stocks have always declined during war. Buy. 
    • Gov. Has to spend a ton to get through war. They print money. Inflation is huge, therefore do not get out of stocks to get into cash 
    • Historically, stocks have always risen to well above prewar prices after the war has been finished 
  • Past performance of the stock (EPS, P/E) matters, but not that much. What really matters is the direction the company is headed. How optimistic does the future look for the company?
  • P. 160: Don’t follow the crowd. Often the public appraises stocks based on human psychology and following the herd. Some stocks will go too high and others too low because of this. These prices have nothing to do with the facts of the company.
    • If you can find a good company with good management that is in the public’s dog house, you can win big over time 
    • We did that with Tesla. This was a hated company by the public and by most securities analysts. We bought at this time.
  • Christopher Columbus and his crew on the Santa Maria ship in 1492 were scared that their ship would fall off the face of the earth at any moment.
  • P. 166: How Fisher selects stocks
    • Look at financial statements
    • Read prospectus
    • Listen to quarterly calls
    • Look at breakdown of total sales by product line 
    • Look at competition in industry
    • Look at research and development activities (are new products being developed)?
    • How optimistic is the future outlook? 
    • How good is the management team? Are they making good decisions? 
  • Characteristics of a Conservative Stock
    • First Dimension: Superiority in production, marketing, research and financial skills
      • Low cost production: Allows the company to create strong profit margins, giving it the ability to survive down times in economy 
      • Gotta have a good margin between costs and selling price 
      • This also allows the company to avoid issuing new shares (diluting ownership) and issuing debt (bonds) so it therefore can support growth using its own profits
      • Strong marketing: Allows the company to sell more product. Target messages that show how the profit helps the customer. 
      • Without strong marketing, the product will never sell as well as it should 
      • Outstanding R&D: This is big. Must be able to identify new products that will sell at a great price AND create them. The R&D team plays a big role in that. 
      • Can’t just make any new product. Has to be able to sell and be in high demand. 
      • Excellent Financial Skills: Allows the company to know exactly how much it costs to produce products and therefore what to sell the products at. Allows the company to make good decisions about its direction and which projects it should or should not pursue.
    • Second Dimension: The People Factor
      • Culture is huge
      • You want companies that promote from within
      • Check company proxy statements to see how much each executive is making. You want salaries to be somewhat even. No one man running the show.
    • Third Dimension: Investment Characteristics of Some Businesses
      • High profit margins are like an open jar of honey – competition for these same margins will result in more competitors entering the space. More competitors = more competition for sales = profit margins will shrink because the average selling price will likely drop because the companies are competing for sales 
      • Well managed companies keep their profit margins healthy by using economies of scale – which allow them to build a large batch of units of inventory for lower average costs. 
      • Getting there first is a natural advantage that gives a company good profit margins. They grab most of the market share and command it. They have the advantage of being first. They establish customer trust.
        1. Ex. Apple 
      • For this third dimension, ask yourself, “What does this company do that other would not be able to do as well? What is the competitive advantage? 
    • The Fourth Dimension: The Price of a Conservative Investment:
      • Determining if a stock is valued correctly comes down to comparing how the financial community is appraising stocks at the industry, company, and market-wide levels. If the fundamentals of the company show that the true value of the stock is greater than what the community is appraising it at, it might be worth a buy
      • When P/E ratios are high across the board in the market, the community is overpricing most stocks. If P/E ratios are low across the board, the company is underpricing most stocks
        • In 2021, everything has a high P/E ratio. Stocks are overpriced.
      • When P/E ratios are drastically different between companies in the same industry, the community is appraising the individual companies differently based on various factors.
      • High interest rates = stocks suffer
      • Low interest rates = stocks thrive
        1. 2021: Interest rates are super low. Stocks are thriving. 
      • Low P/E = stock is underpriced 
      • High P/E = stock is overpriced because investors are willing to pay a high price for low earnings. They are anticipating that the company will grow earnings over the years to lower the P/E and justify the price. They are willing to pay this premium to get in on the company now while earnings are relatively low.
  • Stick with your good stocks even through downturns on the market.
    • The market is incredibly hard to time and predict, especially in the near term (6 months). It is far easier to predict the long term, so focus on finding good companies and buy their shares and hold for the long term. Don’t get too caught up in near term prices.
    • You can easily sell too early or sell and never be able to get the stock back at a good price if you try to time the market. 
  • Dividends: These are better for older people who need current income and aren’t as concerned with the long-term future of the stock price. Younger people who have a longer time horizon should prefer that the company either do a stock buyback or use the retained earnings to invest back in the company to develop new products, market the products to customers, create new plants to make more inventory, expand into new markets, etc.
    • The result of a company reinvesting retained earnings into the company is that the shareholder gets tax free gains in the form of a rising stock price. Dividends are taxed at the investor’s ordinary income (OI) tax bracket each year.