Philip Fisher’s Common Stock Search

Warren Buffett credits Charlie Munger and Philip Fisher for guiding him away from investing in companies selling below book value and towards quality companies that grow slowly over time. Fisher describes the things he looks for in common stocks in his book Common Stocks and Uncommon Profits. Below is the list of 15 points to consider when evaluating a company before investing:

1. Does the company have a sufficient addressable market to realize large revenue growth over several years? This question may be difficult to answer, depending on the company. For example, a fast food business can fairly easily predict the total addressable market size by looking at mature businesses like McDonald’s or Domino’s. In contrast, it is hard to know how many people will buy an electric vehicle in the absence of regulations.
2. Does management continue to invest in new products? This is an important point, as new products can drive growth and protect a company from outside disruption. Technology companies are among the highest investors in R&D because products can quickly become obsolete. For example, Google parent Alphabet spent over $45 billion on R&D during 2023, almost 15% of their $307 billion in revenue. However, simply spending money on R&D isn’t enough, which leads to question number 3…
3. How effective are the company’s research efforts relative to its size? Fisher advocates for consistent R&D spend over time regardless of where a company is in the economic cycle to avoid wasteful spending. Given that complex research projects may take many years to come to completion, it is likely that many projects may span a recession and might never be commercialized if funding is cut off at a critical moment to conserve cash at the corporate level. Even with consistent funding, not all R&D projects will succeed. It is rumored that Apple spent over $10 billion on their car program before deciding to abandon the program. While this is a large amount of money, it is relatively small compared to the size of the company. Further, there were likely many learnings from the program that can be translated to other products in development.
4. Does the company have an above average sales organization? Check out the company’s website and social media to see how they promote their products. Is it clear what products they offer and what value it provides to the customer? Do they offer multiple ways for customers to reach them.
5. Does the company have a worthwhile profit margin? Companies with low profit margins don’t have pricing power and will struggle to differentiate their products and services from competitors. Low performing companies may see their margins expand faster than good companies in good times, but the trend can quickly reverse when the market slows down. The relative quality of competitors in an industry can be seen by comparing their margins over a period of several business cycles.
6. What is the company doing to maintain or improve profit margins? As Jeff Bezos is credited with saying, your margin is my opportunity. A large profit margin is a good indicator of a company with a competitive advantage at that instant in time, but it will also induce competitors to come after your business. Companies should constantly invest in the business to maintain their advantage, whether it is a technology company investing in the next innovation cycle or a consumer packaged goods business buying advertising. 3G Capital learned the hard way that advertising budgets aren’t just a good place to cut costs in the CPG (consumer packaged goods) industry. That being said, companies should always remain vigilant to make sure that SG&A (selling general & administrative) costs don’t grow faster than revenues.
7. Does the company have outstanding labor and personnel relations? Nothing can kill a business faster than bad employee relations. It is easy to see how a strike could ruin a business, but even worse might be the chronic under-performance of a workforce that is apathetic or holds hostile feelings towards the company.
8. Does the company have outstanding executive relations? Good leadership can make or break a company and constant turnover can cause a company to lose direction. Keeping quality managers requires a fair workplace where high performers feel like they are valued and have opportunities to grow.
9. Does the company have depth to its management?
10. How good are the company’s cost analysis and accounting controls? This one can be hard to gauge as an outside party, but generally it is good to avoid companies that frequently change the financial metrics that they tout in earnings calls and press releases. Also be wary of companies that rely heavily on non-GAAP financial measures like the dreaded adjusted-EBITDA to paint an optimistic picture of the future. As Warren Buffett says, “There’s never just one cockroach in the kitchen.”
11. Are there aspects of the business that give the investor important clues as to how outstanding the company is relative to competitors? Comparing companies within the same sector or industry is an important step in identifying the best long-term investments. Comparing margins among competitors is one metric, but other metrics can also be telling. For example, great investments like Costco and McDonald’s sometimes have negative working capital because they can sell their products before they have to pay their vendors. The idea is to understand the key performance indicators for the industry. Successful fast food chains like Chick-Fil-A can do 10x the amount of sales out of a single location that the typical Burger King does. Higher sales per location generally leads to higher margins and bottom line profits since fixed costs like rent and insurance become less significant in the overall profit and loss statement.
12. Does the company have short-range or long-range outlook on profits? Be on the lookout for companies that manipulate their earnings and cash flows to hit arbitrary guidance. General Electric was notorious for using a variety of schemes to always hitting their earnings guidance, only to have it all come apart during the Great Financial Crisis. Companies will work down inventories at the end of a quarter or year to inflate reported cash flow, but do they then lose out on potential sales when they can’t fill customer orders? Other companies might extend larger discounts to customers near the end of a reporting period to stuff the sales channel so they can hit a revenue target, only to have disappointing sales the following quarter because customers are carrying large inventories. Worse yet, those discounts drive down margins and habituate customers to expect discounts.
13. Will future growth require equity financing that will dilute out existing shareholders? This point is less important in today’s markets with debt financing being readily available, but investors must always be aware of dilution, whether it is coming from an additional funding round or generous stock grants to insiders.
14. Does management like to talk about positive results but avoid talking about troubles or disappointments? Management teams frequently talk about new initiatives to get analysts and investors excited about the stock, but do they take ownership of the problem when things go bad? For example, Boston Beer Company openly discussed their over investment in inventory in Truly Hard Seltzer when that category had explosive growth a couple of years ago. Conversely, look out for companies that talk up new products and initiatives and then never follow up in subsequent communications.
15. Does the company have management with unquestionable integrity? As Buffett has said many times, “look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you.” People who rise to a the highest levels of companies are generally smart enough to game the system to their advantage, so integrity is essential so they don’t enrich themselves ahead of shareholders. History is full of examples, like post-dating options, repricing options, and executive bonuses that are not tied to underlying performance. Aligning executive pay to metrics that reward long-term shareholders is the best way to harness intelligence and energy when you don’t have a way to determine integrity.