2 Things I Learned From Philip Fisher

Many of history's greatest figures stood on the shoulders of giants. This is also true of history's greatest investors. And within our business, few shoulders are as broad as those of Philip Fisher.

In fact, Fisher's 1958 book, Common Stocks and Uncommon Profits, essentially defines what it means to be a business-focused investor. The philosophies that Fisher advocates within have inspired legions over the years, from Warren Buffett to our own David Gardner.

Beyond numbers
Fisher was unlike almost any investor who came before him, which drove him to enter the private-client money management business in 1931. He explains in Common Stocks:

My observations [of the financial services industry] led me to believe that there was a magnificent opportunity ... for a specialized investment counseling firm that would make itself the direct antithesis of that ancient but uncomplimentary description of certain stockbrokers -- men who know the price of everything and the value of nothing.

In other words, Fisher saw the need for a firm dedicated to studying not just ratios and metrics, but the best businesses the stock market had to offer. This rebellious philosophy led Fisher to buy shares of Motorola in 1955, three years before Common Stocks and Uncommon Profits was published. Seeing no fatal weaknesses in the business as it grew, he never sold his shares -- multiplying his money many, many times over in the process.

Focus on the business
Like Philip Fisher, David Gardner and our team at Motley Fool Rule Breakers know that while stock prices are in constant motion, a business's prospects are much more predictable. Or as David wrote in our August issue:

If you want to win with your chosen Rule Breakers ... it's absolutely critical to be an information hound about the companies themselves. My own reflection is that too many investors get to know a stock's fluctuations better than the business behind them! Reverse this convention and you'll become a better investor.

While we'd all be fortunate to duplicate even a fraction of Fisher's success in our own investing, an understanding of the advice Fisher provides in Common Stocks and Uncommon Profits will help you get started. Two tips have proven especially fruitful in my own stock-picking education:

Lesson No. 1: Great stocks may look overpriced.
Fisher's goal in investing was to find those stocks that "in a few years might show a gain of several hundred percent." For Fisher, that meant more than combing through lists of companies selling for less than their book values. Instead, he was willing to study any business selling for any price. As he counsels investors in Common Stocks, "Don't assume that the high price at which a stock may be selling in relation to its earnings is necessarily an indication that further growth in those earnings has largely been already discounted in the price."

Even as information about stocks is more available today than ever before, many seemingly expensive stocks go on to crush the market's expectations. For example, each of the following has sold for, on average, more than 40 times earnings over the past five years:

Company

Five-Year
Average P/E

Five-Year
Return

The Knot (Nasdaq: KNOT  )

95.9

3,506.7%

Quality Systems (Nasdaq: QSII  )

41.6

1,003.0%

Urban Outfitters

42.0

988.1%

Apple Computer (Nasdaq: AAPL  )

41.9

579.7%

Research In Motion

65.8

542.0%

Red Hat (Nasdaq: RHAT  )

47.7

505.7%

Source: Capital IQ

Why have these stocks outperformed? I believe investors came to recognize that all of these were great business with excellent growth prospects and, accordingly, decided to pay up for quality.

Lesson No. 2: Hold management accountable.
Management teams across the board are excellent at answering questions right after they've posted a record quarter. You only learn what type of CEO you've invested in at times like these -- when things aren't going precisely to plan.

That's why it's so crucial to evaluate your company's management on an ongoing basis. Fisher asks in Common Stocks, for example, "Does the management talk freely to investors about its affairs when things are going well but "clam up" when troubles or disappointments occur?" If the answer to this question is "yes," then you may want to reconsider your investment.

Think of Hoku Scientific (Nasdaq: HOKU  ) and its press release hocus-pocus. Or of the palms greased by Law Enforcement Associates (AMEX: AID  ) to tout its stock.

The Foolish bottom line
My copy of Common Stocks and Uncommon Profits is lined with yellow highlighter ink -- and I've learned much more from it than simply the two lessons presented here. Reading that book was one of the most important steps I took toward developing a lucid growth investing strategy.

We use Fisher's tenets when searching for ultimate growth stocks at Rule Breakers (and we've found four multibagger stocks in two years). The newest issue of Rule Breakers -- with two brand-new stock picks -- releases at 4 p.m. ET today. Click here to check out today's picks (and the entire service) with a free 30-day trial.

Fool contributor Tim Beyers only breaks the rules in his portfolio. Wimp. Tim owns LEAP options in Apple. Get the skinny on all of Tim's stock holdings by checking his Fool profile. The Knot is a Rule Breakers selection. Quality Systems is a Stock Advisor pick. The Motley Fool has an ironclad disclosure policy.


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