Common Stocks and Uncommon Profits - "Scuttlebutt" method might be of value in seeking to make investments in smaller, local companies.

Common Stocks and Uncommon Profits is one of the classic investment texts written for the lay person. The legendary investor, Warren Buffett, has credited Philip Fisher's investment strategy as strongly influencing him.

Rather than just seeking value, as the Ben Graham school of investment taught,Fisher realized that even a greatly "undervalued" company could prove a horrible investment. Sure, you might occasionally buy a stock for less than the company's cash-in-the-bank (back then, at least!). But what if the business is horribly run? It might not take long for the company to lose all that cash!

Even if the company returns to "fair" value, that ends the potential profit from investing in such a business. Holding an average company, because it was once undervalued, but is no more, makes little sense.
Fisher points out that the largest wealth via investing has been made in one of two ways. First, buying stocks when the markets crash and holding them until the markets recover. Secondly, with less risk and more potential return, you can also just invest in a small portfolio of companies which continue to strongly grow sales and earnings over the years. Then, if the company was correctly selected, you might never have to sell, while accruing a huge return on your initial investment.

Fisher pioneered the school of growth stock investing. In Common Stocks and Uncommon Profits, Fisher explains how he selects a growth company. He lists fifteen points which a company must have to be considered a superior investment.

Fisher's first point seems obvious: "Does the company have products or services with sufficient market potential to make possible a sizeable increase in sales for at least several years?"

Fisher shows that some companies might have potential substantial sales increases for only a few years, but after that have limited potential due to some factor, such as market saturation. For example, Fisher mentions the growth in sales of TV's until the U.S. market was saturated.

He also wisely suggests looking behind the products to seek other superior investments. While many TV manufacturers were competitive and it was difficult to tell which was best, Fisher points out that Corning Glass Works was, by far, the company most capable of producing the glass bulbs used in TVs.

Fisher tries to clearly distinguish between companies which are "fortunate and able" and those which are "fortunate because they are able." The second kind, the superior investments, are highly innovative and create new products which have growth potential. Fisher uses Dow Chemical as one example of a "fortunate because they are able" company.

The second point wants to know if management has the drive to innovate new products. A man ahead of his time, Fisher wonders about how much of a company's future sales might come from products not yet invented.

A constant theme of Common Stocks and Uncommon Profits is examiningwhat the company is doing to prepare for the future. Is the company spending wisely on Research and Development? Or, is the company just trying to maximize its current profit and reinvesting nothing for future growth?

Fisher explains why answering that question is difficult in practice. What different companies account for under R&D is one problem. Another is that some companies are more successful than others at turning money spent on R&D into future marketable products. Today, we must assume this question is far more difficult to answer!

In addition to questioning a company's R&D, Fisher wants to see a company with a strong sales organization and distribution efficiency. "It is the making of a sale that is the most basic single activity of any business," he writes.

Yet, why don't investors focus upon such key factors instrumental to a company's future growth? Fisher points out that certain issues are not quantifiable. That is why many investors tend to focus upon financial issues which can be expressed in a simple ratio.

How does the investor go about answering the "unquantifiable"? How does the investor know how well-managed the company is? Or, how does one evaluate the people factors, which Fisher says are the real strength of a superior growth company?

Fisher suggests the "scuttlebutt" method. This involves talking to suppliers, customers, company employees, and people knowledgeable in the industry, and, eventually, company management. From this information, an investor can get a good feel for the quality of the company as a growth investment. Fisher teaches us how to learn to ask the correct, company-specific questions.

Fisher acknowledges the "scuttlebutt" method is a lot of work. But, he asks,should it be easy to find such great companies, when finding only a few can easily lay the foundation for building huge future wealth?

I tend to think the average individual investor will not use the "scuttlebutt" method. And, for most investors and most companies, even if the investor had the desire to use this method, it would not be practical.
The average investor will not have access to all the people with whom Fisher suggests talking. Imagine trying to use this method on a larger company with tens of thousands of employees worldwide. What is said about the company in one area may differ greatly from what is believed about the company in another region. Applying such a method to evaluate a large, innovative company, such as 3M, for example, seems utterly impossible.

Yet, for investors seeking to make investments in smaller, local companies, the "scuttlebutt" method might be of value. For angel investors or mini-venture capitalists, reading Common Stocks and Uncommon Profits is probably also worthwhile. However, Fisher is quick to point out that such company evaluation is far more tenuous when the company hasn't any history behind it.

Entrepreneurs seeking to build companies should also give the book a quick read. The fifteen points are very important to company growth and success.And, encouraging these strengths from the perspective of a company's CEO trying to build the company is far easier than seeking to answer these questions from the perspective of an investor who is a company outsider!

Common Stocks and Uncommon Profits also has an excellent chapter titled, "Hullabaloo About Dividends" which tells us investing in growth stocks with smaller dividend payout ratios often leads to greater total future dividends because the dividends are growing, while high-yielding stock tends to grow far less, and hence, the dividends grow far less.

The book also has some excellent thoughts about buying-and-holding a stock and when to sell a stock. Fisher's thoughts on diversification are also well worth reading, although I would recommend more diversification than Fisher claims is adequate.

Overall, this is a great book for the individual investor. You will not be able to follow the "scuttlebutt" method in practice, for most investments, and, maybe, the complexity of today's companies and scientific research in many growth companies make Fisher's method less practical today than in the past, but there is much to learn about business and investing from this book.