Philip Fisher's classic tome, Common Stocks and Uncommon Profits, was published 45 years ago, yet today it offers investment advice as relevant as ever. This is surprising only because so many investment books are so awful, ignoring long-standing realities that make for good investing. But for those who want to look -- as Fisher did -- the clues to long-term success are there for the finding.
Fisher's book jumps right into the important topic of how to locate a good stock, naming -- in a chapter called "What to Buy" -- 15 points to seek in a common stock. Let's consider three of those points.
1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?
Clearly this is a great place to start, because without revenue growth a company can't grow, period. When considering this point, you need to consider not only market size in terms of potential sales, but in terms of competition -- both existing and likely. Dozens of software companies -- including Lotus, long since owned by IBM (NYSE:IBM) -- have launched products addressing sizable markets only to see Microsoft (NASDAQ:MSFT) steal away the potential.
2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?
In other words, will the company innovate in order to keep growing? Speaking of Microsoft, it faces this issue today -- how to grow more than 10% a year when it already owns most of the operating system (OS) market? Intuit (Nasdaq: INTU), meanwhile, is a good example of a software company that has found ways to keep growing under its popular tax and accounting software.
3. Does the company have a worthwhile profit margin?
This question must be asked in relation to total sales potential, not just on the basis of an absolute number. Wal-Mart's (NYSE:WMT) 2.8% profit margin looks more than worthwhile given its $250 billion in annual sales. In general, we at the Fool have considered any profit margin above 7% to be healthy, but there are always qualifiers.
If a firm has 7% profits margins but they're shrinking, we'd be leery. If margins are 4% and growing, we might be interested. Plus, in the case of Wal-Mart and other great retailers such as Costco (NASDAQ:COST) -- or Amazon (NASDAQ:AMZN) -- low margins might be acceptable because the company earns strong free cash flow on its high inventory turns and (though it sounds like an old joke, it isn't), they "make it up in volume."
So, investors should seek sufficient market potential, innovation that fuels continued growth, and significant profits for the effort -- now, is that too tough to find?
There are very few absolutes in investing, which is what makes it so interesting and challenging. If you'd like great new stock ideas delivered to you every month, and learning from those ideas, consider two of the Fool's market-beating newsletters,Motley Fool Stock AdvisorandMotley Fool Hidden Gems. And if you like lists, don't miss Rex Moore's recent 12 Investing Must-Knows and our own Fischer's -- Jeff Fischer's -- column on 5 Investing Don'ts.
