Kapil Lehar

The 15 point Checklist of Phil Phisher

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You might have probably heard of Philip Phisher. He was one of the biggest investors of his time. Warrant Buffet is often quoted saying that he was influenced by 2 investors:  Benjamin Graham and Philip Phisher.  Mr. Phisher was more inclined towards growth investing rather than value investing. He wanted a stock that could be brought at a reasonable price but never be sold. He always focused on the fundamentals and saw a great opportunity in upgrading his stocks when the market was bearish. His book Common Stocks and Uncommon Profits is worth reading and is recommended by non-other than Warren Buffet.

While “The intelligent investor” is said to be a bible on Value Investment philosophy, I strongly recommend reading Phil Phisher’s “Common Stocks and Uncommon Profits” as it is easier to begin with and covers a lot of ground that can help you come up with your own Investment Ideas.

In his book, Phil Phisher talks about the 15 fundamental business features that can’t be faked and are time tested. This means his principles would work even today and would obviously work in the Indian market as well. Below are those 15 points with explanations that are relevant to the Indian stock market.

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

A product or service is what makes or breaks a company. If the customers are satisfied with the quality of the product that the company produces and are at competitive prices, it is likely that it would have repeat customers. This creates a moat for business as competitors would have to strive hard to achieve both, the quality of the product and naming a competitive price.

Consider the case of Infosys, an IT service company. I have worked for this company in the past and can give reasonable comments about its most famous product, ‘Finacle’. It is a core banking system that is used by banks to process various banking tasks like interest calculation, standing instruction, recurring payment, etc. When Narayan Murthy had developed this software with his team, he was confident it would revolutionize the banking industry. He had a product with a strong competitive advantage. As per sources, Finacle is used by banks across 100 countries to serve over 1 billion customers. Mr. Murthy new he had a product that would dominate the market and would lead to a sale for years to come. 

This is why Phil phisher emphasizes a product or service so radical, that it can lead to a sizeable increase in sales.

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?

There have been companies in the past that had a product but failed to capitalize on the existing success. This may be due to multiple reasons. E.g. failing to understand the requirements of a consumer, failing to adapt to the market needs, lack of R&D, etc.

One example that comes to my mind is Nokia. It was a very successful Mobile manufacturing company at least in India. 4/5 people walking on the street would have a Nokia phone in the pocket. Later, the introduction of android phones changed the market completely. Nokia failed to adapt to the android market and continued with its own Symbian OS.  As Andrew Grove says in his book, ‘Only the paranoid survive’.

On the other hand, companies like Samsung continued to capitalize on the market at that time because they adapted to the Android open-source system. In recent years, even Samsung couldn’t stay ahead in the market due to cost issues. New phone manufacturers like Oppo, Vivo, and One Plus took over the market with the same set of features that Samsung had to offer but with more competitive pricing.

Phil phisher also talks about the determination of an organization to develop new products once the existing products have already been capitalized. A positive example of this would be Reliance Industries limited. Mukesh Ambani had made sure that the company continues to provide value to shareholders. He has very successful in using his Cash cow from Jamnagar to enter into a new market of telecommunication. We very well know how Jio has revolutionized the industry.

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

Who doesn’t know the importance of R&D in the long-term success of an organization? Lack of R&D means the company would be in deep water soon. One must also remember that there are companies that require more R&D than others, like pharmaceuticals who rely primarily on R&D. The amount of money spent on R&D sometimes directly correlated with the Revenue. Irrespective of the sector, it is important that Research and Development are given primary focus without which no product or service can boom.

Another important point that Phisher quotes about R&D is “The essence of commercial research is that only tasks be selected which promise to give dollar rewards of many times the cost of research.”

Management often takes wrong decisions with respect to R&D when there is self-interest involved. Other times the management simply switches to other R&D projects leaving behind the existing once without an outcome.

Does the company have an above-average sales organization?

It is the making of a sale that is the most basic single activity of any business. Without sales survival is impossible. MNC usually deploy tons of resources into sales because they know that a product well developed may not be a product well sold. Even a poorly developed product can be sold if the sales team of the organization is capable enough to sell it. However, the opposite is not true. It is Afterall the repeat sales to a satisfied customer that is the first benchmark of success. Phisher quotes, “A one time profit can be made in the company which because of manufacturing or research skill obtains some worthwhile business without a strong distribution organization. However, such companies can be quite vulnerable. For steady long term growth, a strong sales arm is vital.”

Does the company have a worthwhile profit margin?

Finally, we have something that financial people would find as the backbone of sound investment decisions. A matrix that is more quantitative than qualitative. The best way to study profit margin would be to determine, for each Rs 100 spent on sales how much is brought down to operating profit. The wider variation between the same group of companies would become apparent.

This matrix should be compared in relative terms and not absolute terms. This means, a profit margin should be compared in 2 ways, one is to compare it with other companies of the same sector and second would be to compare the profit margin with the same company’s past years.

What is the company doing to maintain or improve profit margins?

In an age where wages and salary go sky high year by year, it is important to grow or at least maintain profit margins. When the profit margins of a whole industry rise because of repeated price increases, the indication is not a good one for the long-range investor. Who would want to invest in companies with falling profit margins? Maintaining the margins is the least of expectations. Designing products or services that would decrease the cost of production or labor and increase the value for the customer is the safest way to increase profit margins. On the surface, this might look easy but no all companies are able to achieve this feat. May companies are always on the toe to figure out methods to see where economies can be brought about.

Consider Apple Inc. They have been able to increase the cost of their products without a decrease in sales or affecting profit margins.  It is this quality of product and services that an organization needs to maintain

Does the company have outstanding labor and personnel relations?

There is no specific method to measure personal relations. The best way would be to go on social media pages and see what people are commenting about the company. Another way would be to go on review sites like glassdoor.com. 90% of the time you would see genuine reviews. Its only about 10% of the time when the employee had a bad time with the company and now wants to demean its employer. One also needs to keep in mind that unionization is by no means a sign of bad labor relations.  Some of the companies with the very best labor relations are completely unionized but have learned to get along with their unions with a reasonable degree of mutual respect and trust.

A company with a long list of personnel seeking to enter their employ are usually companies that are desirable for investment from the standpoint of good labor and personnel relations.

Companies with good labor relations are also the ones that settle grievances quickly. A company must make the employee feel wanted and part of the business picture

  • Does the company have outstanding executive relations?

This one is the easiest to talk about. Top executive teams cannot afford to have friction. The company offering greatest investment would be the one with a good executive climate, where promotions are based on ability and not factionalism and salaries of executives should be in line with the standard of the industry.

Does the company have the depth to its management?

Ever wondered why some people invest in TATA companies even without doing a thorough fundamental analysis? If Ratan Tata comes to your mind, then you are right. The top man who is an owner investor and who has skin in the game, his own money on the line is likely to take the company forward in good terms. On the other hand, management who is measured just by the acquisitions would turn out to be a bad investment.

Since all humans are finite, an investor must know what can be done to prevent corporate disaster if the key man is no longer available.

There should be a delegation of authority in any organization. Each level of the pyramid should be given authority to carry out duties in an ingenious and efficient manner. Micromanagement must stop and executives must not try to handle day to day operations of employees.

Depth in true terms may also mean that the management should come from the same sector they are operating in and should be well qualified to run the show. Not only this, but the independent directors should keep an arms-length distance from the management and protect the interest of the shareholders first.

How good are the company’s cost analysis and accounting controls?

Imagine you have thought of putting a tea business in a mall. You decide to cost the Tea at Rs 5. You sell a lot of tea but at the end of the day, you realize that you are still in a loss. Why? Because you didn’t do your homework on pricing, you did not perform break-even analysis of your fixed and variable costs. This is what happens to companies that are multi-million dollars based and have no control over cost and accounting.  If the management does not have the true knowledge of the cost of each product in relation to others, it is under an extreme handicap. Every company that operate in its sector will have measures that can tell you whether they are in good shape or not. Apart from that it is important for an organization to manage its accounts and deploy cost control mechanisms.

Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?

Long story short, if a company is able to throw clues that the investment is going to turn out sound, one must not miss that opportunity. For eg if the company is about to launch a new product that you think can revolutionize the sector, then such companies are the once that should be sought. Maruti Suzuki for many years have been popular in the Indian market for 2 reasons. One, they offer cars at completive prices compared to Hyundai’s and Toyota’s. Although fair prices come with a cost but that’s a story for another day. Another reason it is popular is because of mileage. We are people obsessed with mileage. We don’t mind spending one-time money on the car but we want to make sure that it is low maintained and consumes less fuel. Maruti Suzuki has therefore been very successful so far in understanding the market sentiment of automobiles in India.

Having patents is yet another sign of strong moat. For large companies, a strong patent is a sign of strength. Only thing one needs to keep in mind is, it is one thing to get a patent on a product and it may be quite another to get the protection that will prevent others from making it in a slightly different way.

Does the company have a short-range or long-range outlook in regard to profits?

Some companies would conduct their affairs to gain the greatest possible profits now. This is done to please the analysts, journalists and to please the wall street/Dalal street big shot investors.

Amazon’s Jeff Bezos always focused on long term profits and never on the next quarter earnings.  His business model was sustainable in the long run. This helped the company survive in the most difficult times

In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders’ benefit from this anticipated growth?

The idea is simple. The more shares a company distributes the more investors or owners are present in the company making its profits less distributable. It is for the same reason why management with sound leadership would buy back its shares when the market is slow or the stock has failed to show a good return with respect to the profit it is throwing out. It signifies that the management is very confident in its business and is expecting its share value to rise in the near future. This in turn also helps increase the ROE of a business.

Sometimes when borrowing power is not sufficient, equity financing becomes necessary. In this case, the attractiveness of the investment depends on careful calculation as to how much dilution resulting from the greater number of shares to be outstanding will cut into benefits to the present stockholder that will result from the increased earnings this financing makes possible.

It is also advisable that one should always consider that all senior convertible issues are converted and that all warrants options etc.  have ben exercised when calculating the real number of common shares outstanding.

Does the management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur?

This point basically talks about Candor. The best person who has shown truly demonstrated candor in his annual letters is Warrant Buffet. He is a person who would not sensationalize a good quarter and yet talk upfront about bad decisions of the past . Mrs. Rittenhouse in her book: “Investing between the lines” has talked in detailed about Candor and Capital stewardship.

In any event, an investor must try to avoid investing in any company that withholds or tries to hide bad news. If there is a problem, it should be mentioned upfront. Once the problem statement is mentioned, there should be a strategy and an action plan to overcome the problem. This is what the shareholders expect from the management.

  1. Does the company have a management of unquestionable integrity?

You would agree that it all comes down to the integrity of the management. When Satyam was in the limelight of being such a profitable company and was on a succession of receiving industry awards, its scam was out in the open.

The management of the company is this the closest to its assets than the stockholder is. There are accounting gimmicks that can help the company bend the law without breaking it. The ways the management can benefit themselves and their families at the expense of the ordinary stockholder are almost infinite.

Phisher quotes, “Regardless of how high the rating may be in all other matters, however, if there is a serious question of the lack of strong management sense of trusteeship for stockholders, the investor should never seriously consider participating in such an enterprise.

To read more on books written by Phil Phisher and other famous investors, check out the Value Investing Section of our Bookshelf here.

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