Special Features Fisher's Investing Criteria

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By Peter Psaras and Chris Rugaber
January 18, 2001

Philip Fisher is the author of Common Stocks and Uncommon Profits, an investment classic that consistently appears on lists of the best investing books of all time, including our own. Despite being written in 1958, Common Stocks is as relevant as ever, since Fisher's lessons on analyzing individual businesses are timeless ones.

A tool that many investors take from Fisher's book is the list of 15 points he uses to evaluate individual companies (though the book includes much more than that). Whether you use each point in your own research or simply pick and choose, familiarity with all 15 should help anyone interested in learning more about what to consider when evaluating a potential investment.

Of course, the book delves into each point in greater detail than we can here, and is available at any library, bookstore, and in FoolMart. What follows is a survey of each of the 15 points, with Fisher's words in italics, and some real-world examples of how to apply them.

Fisher Point #1: The Pursuit of Growth
Does the company have products or services with sufficient market potential to make possible a sizeable increase in sales for at least several years?

When investing in individual stocks, an excellent place to start is to find industries whose prospects are above-average. Investors should consider companies and industries with potentially large, enduring markets, rather than chasing the latest hot stock. For example, mass consumer product companies such as Coca-Cola (NYSE: KO) or PepsiCo (NYSE: PEP) might not seem as exciting as the newest technology, but millions of soft drinks are sold around the world every day. Tom Gardner touched on this point in Rule Breakers, Rule Makers when he wrote, "For generations, wealth has been built out of what we all know."

Moreover, keep in mind that hot-selling products can soon reach saturation points. For example, investors interested in personal computer companies such as Dell Computer (Nasdaq: DELL) should consider whether that industry will be affected by slowing business information technology spending. Different businesses within each industry will handle these challenges differently, of course. Looking at several years' sales growth is one place to begin evaluating a company's performance on this point.

Fisher Point #2: Expansion and Innovation
Does the management have a determination to continue to develop products... that will... further increase total sales... when the growth potentials of currently attractive product lines have largely been exploited?

Following in the footprints of Fisher's Point #1, you need to know, "Is the company bent on expansion -- if need be, is it ready to reinvent or even entirely replace its current products with new and improved offerings?" Once you find a great company, determined to expand and innovate, consider yourself lucky.

Companies like Kellogg (NYSE: K) haven't been willing to adapt. They've had problems over the last decade because their Frosted Flakes can't be easily improved and marked up. And, unlike companies such as Coke, Kellogg's management hasn't driven forward with international expansion.

Examples of innovation include Corning's (NYSE: GLW) decision several years ago to expand beyond consumer glassware into fiber optic cable, and Charles Schwab's (NYSE: SCH) aggressive move into online trading, which threatened its brick-and-mortar business, but ultimately proved successful as the company became the leading online broker.

Fisher Point #3: Research and Development
How effective are the company's research and development efforts in relation to its size?

As a company continues to grow, a properly run research and development group (R&D) is critical. Fools, the only constant in the universe is change. That's a very real, yet very radical, concept. It is, therefore, a defining quality of superior management that they commit to staying one step ahead of that change.

Some industries require more R&D than others. Clearly, any biotech, software, pharmaceutical, or cutting-edge hardware company will need to have a substantial R&D budget. Investors should look at a company's R&D spending as a percentage of sales, and compare companies within similar industries. Another approach is to check for a growth rate in R&D that matches the growth rate in sales. There are more advanced methods of calculating the return a company receives on its R&D investment, which Fool writer Bill Mann discussed in a 1999 Rule Maker article. Finally, the Fool's Guide to Biotech Investing includes a detailed analysis of how to evaluate biotech companies' R&D spending.

Fisher Point #4: Rate the Sales Force
Does the company have an above-average sales organization?

Business is about selling -- the sale of research on Soapbox.com, the sale of soda at a ballpark, the sale of advertising on Seinfeld, and so on. But, how can you judge the sales organizations of a public company? One approach is to talk to their customers (using The Motley Fool discussion boards is a great armchair approach to this). Are they happy with the service they're receiving? Is the product or service effectively advertised, packaged, and delivered?

Other clues can be found while conducting basic research. For example, when TriQuint Semiconductor (Nasdaq: TQNT) recently announced that annual revenue would beat expectations, the company's senior management shaved their heads as a result of a bet they had with the company's sales force (as reported in the News to Go section of this Breakfast with the Fool piece). Any company's sales force that can get corporate executives to shave their heads may be worth a closer look.

Fisher Point #5: Margins of Profit
Does the company have worthwhile profit margins?

This is one of the few quantitative elements of Fisher's 15-Point Analysis. This and a high return on equity (ROE) are Fisher's desirables. Profit margin is simple. It's the amount of profit derived from every dollar of sales. Fisher likes to invest in companies with large profit margins, which can be important during tough economic times.

When a recession hits, low-margin companies start losing money, like so much sand through the fingertips. That happens because the high fixed costs of low-margin businesses are always there. Companies with higher profit margins have lower fixed costs and more room to maneuver during widespread economic hardship. While Fisher does not specify a particular level of profit margin, the Fool's Rule Maker Portfolio uses net margins of 10% as a criterion.

Fisher Point #6: Continuous Margin Improvement
What is the company doing to maintain or improve profit margins?

This is where superior management really differentiates itself from average and substandard leadership. Some examples of superior management teams improving profit margins are: 1) Citigroup (NYSE: C) moving their credit card operations to South Dakota and Nevada, both tax-free states;  2) Schering-Plough (NYSE: SGP) only building factories in certain countries if it's granted tax benefits; 3) Nokia (NYSE: NOK) making easily manufactured parts, like faceplates and headsets, in China; and 4) Coca-Cola revamping its entire distribution process to create a huge inventory-tracking system that improves communications with bottlers, production managers, and marketers. Each of these companies has high margins that have risen dramatically over the past decade, as have their share prices.

Fisher Point #7: Workforce Enthusiasm
Does the company have outstanding labor and personnel relations?

As an investor, you're an owner. As an owner, isn't it important that your employees are satisfied? The best products and services are created in the minds of superior thinkers. And, bright minds do their best thinking if they're motivated and happy.

If you're considering investing in an automaker, for example, keep in mind the rocky labor relations that companies such as General Motors (NYSE: GM) have experienced. Airlines have also had their share of labor troubles in recent years. This doesn't mean you shouldn't invest in those companies, but you should at least look into the current state of their labor relations. You wouldn't want to buy their shares right before a major strike.

Another approach is to talk to a few employees at a company you're researching. Their happiness is the source of their productivity, which is the source of all great investments.

Fisher Point # 8: Coherent Leadership
Does the company have outstanding executive relations?

If upper management is not communicating or is in a state of constant dispute, then nothing will ever get done. The leadership is tasked with developing the business plan. If they aren't working together, they can't design a vision that will inspire a growing workforce.

This may become a factor in the new AOL Time Warner (NYSE: AOL), for example. Like many mergers and acquisitions, the new company has upper management from both companies that are used to calling the shots on their own. Investors in this company will want to monitor how well all these executives work together.

An example of great executive relations can be found at Yahoo! (Nasdaq: YHOO). When CEO Tim Koogle was invited to join the company, he emphasized that his task was to support -- not replace or redirect -- the company's aims. The result has been an open-door style of management that reinforces the core culture and inspires every employee to take responsibility for the economic and service merits of their actions.

Next: Points 9-15