FOOL ON THE HILL
Taking the Long View

In his 1979 book, Developing an Investment Philosophy, legendary investor and author Philip Fisher chronicles the maturation of his investment approach. Over the years, Fisher increasingly saw the merits of locating companies that, because of their business durability and management excellence, had the potential to be profitably held for a minimum of three years, if not many more than that. In his pursuit of such companies, Fisher boiled his investment philosophy to eight key points.

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By Phil Weiss (TMF Grape)
June 4, 2002

[At the recent Berkshire Hathaway annual meeting, Warren Buffett said, "I've seen nothing to improve on Graham and Fisher." With that in mind, today we present a review of Philip Fisher's 1979 investment classic, Developing an Investment Philosophy. For those of you not familiar with Fisher, he is a champion of long-term investing and one of the most influential investors of all time. His writings belong on every Foolish investor's bookshelf. This article was originally published on September 18, 1998.]

Fisher's overall philosophy revolves around being invested in a very small number of companies that, due to the characteristics of their management, should grow both sales and profits at a faster rate than their industry as a whole. This growth should be accomplished at a relatively small amount of risk to the investor.

The management of a company invested in by Fisher must have in place a policy that will enable it to meet Fisher's growth objectives and a willingness to forego short-term profits in exchange for greater long-term gains. Additionally, its management must be able to recognize if and when mistakes are made and take remedial action to correct such mistakes.

The majority of Fisher's investments are also concentrated among manufacturing companies that use leading-edge technology and superior business judgment to accomplish its goals. This was primarily because these were the businesses that Fisher believed he understood the best. He did, however, believe that his theories could be applied to other businesses as well.

Fisher devotes much of this book to explaining how his investment philosophy came into being. His interest in investing actually started when he was in grammar school. As a minor, Fisher was able to make some money during the roaring bull market of the middle 1920s.

Among the earliest lessons that Fisher learned was the importance of the marketing organization to the success of a business and the need to learn from those that had direct familiarity with the company and its affairs. Then, as the market began to recover from the crash of 1929, Fisher first learned that a company's current price earnings ratio was not nearly as important as the ratio of its price to earnings a few years into the future.

It was also in the early 1930s that Fisher came to realize that there are two "people" traits that are absolutely essential for successful investment. The first is business ability. The second is integrity, both in terms of the honesty and personal decency of the people that run the company. If the owners and managers of the business do not have a "genuine sense of trusteeship for the stockholders, sooner or later the stockholders may fail to receive a significant part of what is justly due to them."

When it comes to patience and performance, one thing that Fisher stressed to his clients was the importance of judging results based on a three-year period rather than a month or a year. His clients were told that if he had not produced worthwhile performance within three years (including all fees), then they should fire him. It's a shame that today's Wise analysts do not have such a stand-up philosophy.

Fisher applied a similar three-year rule to his stock holdings. Fisher sold very rarely due solely to his three-year rule. He said that he was unable to recall a single instance where the performance of a stock he'd sold after three years had made him wish he'd held on. Close scrutiny over a period of a few years made the qualities (and lack thereof) of the business plainly evident to him. On those occasions where he sold in less than three years, it was primarily due to obtaining highly worrisome insights into the way the company was being run.

It was at the end of World War II that Fisher gave up on the idea of market timing and decided to focus his efforts solely on making major gains over the long haul.

Fisher summarized his investment philosophy into eight points:

1. Buy stocks of companies that have disciplined plans for achieving dramatic long-term growth in both profits and revenues. Such companies must also have inherent qualities that make it difficult for new entrants into that business to share in such growth.

2. Fisher prefers to focus on such companies when they are out of favor; i.e., market conditions are not favorable or the financial community does not properly perceive the true worth of such companies.

3. Hold the stocks that you buy until there has been either a fundamental change in the company's nature or it has grown to a point where it will no longer be growing at a faster rate than the economy as a whole. He also says that one should never sell his most attractive stocks for short-term reasons.

4. If your primary investment goal is long-term appreciation of capital, then you should de-emphasize the importance of dividends.

5. Recognize that making mistakes is an inherent cost of investing. The important thing is that the investor must be able to recognize such mistakes as soon as possible, understand their causes, and learn from them so that they are not repeated. A willingness to take small losses in some stocks while letting profits grow bigger and bigger in your more promising stocks is a sign of good investment management. Don't just take profits for the satisfaction of taking them.

6. Realize that there are a relatively small number of truly outstanding companies. Your funds should be concentrated in the most desirable opportunities. "For individuals (in possible contrast to institutions and certain types of funds), any holding of over 20 different stocks is a sign of financial incompetence. Ten or 12 is usually a better number."

7. An important ingredient of successful investing is to have more knowledge and apply your judgment after thoroughly evaluating specific situations. You should also have the moral courage to act against the crowd when your judgment tells you that you are right.

8. One of the basic rules of life also applies to successful investing -- success is highly dependent upon a combination of hard work, intelligence, and honesty.

Fisher concludes this book with the following paragraph:

"While good fortune will always play some part in managing common stock portfolios, luck tends to even out. Sustained success requires skill and consistent application of sound principles. Within the framework of my eight guidelines, I believe that the future will largely belong to those who, through self-discipline, make the effort to achieve it."

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