The Investing Checklist Of Legendary Growth Investor Phillip Fisher: Part 1

Many investors have heard of Warren Buffett, but perhaps less know is Phillip Fisher, and his rules on investing in the stock market. Fisher is one of the investment greats with a stellar track record of investing in well-managed, high-quality growth stocks for the long-term. In fact, Fisher is one of Buffett’s investing mentors.

Fisher’s most famous investment was that of Motorola – he bought the stock in 1955 and did not sell it for the remainder of his life (he passed away in 2004). In his book Common Stocks and Uncommon Profits, Fisher shared a checklist of 15 characteristics he looked out for when it comes to buying growth stocks. I want to discuss his checklist in a series of articles, and this article – Part 1 – shall look at the first three characteristics.

1. Does the company have the products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?

Here, Fisher is asking the investor to study the company’s products or services and to assess if they have the potential to command a significant market share, or if they are groundbreaking enough to beat the competition such that customers will choose the company’s products over its competitors’.

Sales growth is one of the key attributes to look for when assessing a growth stock, as there is only so much a company can do to grow profits by cutting expenses. The key here is to assess if a company’s products have “market potential”, which translates to whether the company’s offering has a unique selling proposition compared to its competitors. Would the company’s product pipeline also be able to enable the company to grow its sales over time, or would price competition erode whatever margins or advantage the company has?

This is not an easy question to start off the checklist with, but is absolutely essential to tackle if the investor wants to find out if a company has revenue-growth potential over the medium-term.

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 this second point, Fisher is talking about a company’s Research and Development (R&D) efforts. For most manufacturing companies, part of their budget will flow into R&D spending in order to ensure that they can develop products and/or services which remain in demand, and to replace older products over time.

The way to measure this is to review the company’s R&D expenditure in relation to its revenue, and to compare this percentage across similar companies. Generally, larger and more established companies need to spend less on R&D as a percentage of their sales; this gives larger companies an edge as it allows them to remain competitive while still spending significant sums of money on R&D, but may stunt other smaller companies which may not have the financial muscle.

Next is to assess if the new products which a company is developing have good sales potential when compared to existing products. The company will usually articulate this in its Management Discussion And Analysis (MD&A) section on the progress being made with new product development, and the market potential for these new products, as well as the timeline for completion and sampling/testing (if applicable). Investors can delve into these facts to get a clearer picture of how the company will fare in the future by looking at its R&D expenditure, product pipeline, and planned marketing strategies for these new products.

3. How effective are the company’s research and development efforts in relation to its size?

This follows-up from Point 2 and looks into the effectiveness of a company’s R&D efforts. The best way to measure this is to look at sales growth over the years and compare it against the R&D expense as a percentage of revenue. Do this for the company’s peers as well to get a clear picture of whether the company is efficient or inefficient.

For example, Company A may be spending just 3% of its revenue to enjoy 10% sales growth, while Company B may also be enjoying 10% sales growth but has to spend 10% of its revenue on R&D. Of course, another factor to consider is the absolute sales generated by each company, as companies with a larger sales base generally find it tougher to grow in percentage terms.

A second example would be Company C and D both spending 3% of their revenues, but Company C enjoys a strong 15% rise in revenue while Company D actually sees a decline of 5% in its revenue the following year. From this, we can conclude that, all factors being equal, Company C’s R&D efforts bore more fruit than those of Company D.

Part 2 of my series shall look at the next 3 points within Fisher’s 15-point checklist. Stay tuned! [Editor’s note: Parts 2, 3 and 4 have been published. They can be found herehere, and here.]

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