I recently re-read Phil A Fisher’s classic, “Common Stocks and Uncommon Profits.” After first speed-reading a book, I return to those I think worthwhile, and the second time through take notes. On subsequent times I refine my notes. Below are my refined notes after several re-reads. Most of the words are the authors. Any errors are mine. Any [brackets] are notes to myself… and now, to you.
[The book could be renamed, “How to secure fortune-producing growth stocks”]
[How?] Scuttlebutt = Research!
- Apply great effort,
- Combine effort with ability,
- and enrich effort and ability with judgement and vision.
Securing fortune-producing growth stocks is impossible without hard work, which is applied upfront, before purchase. And these situations cannot be found everyday. Patience is more important than intelligence.
“There is a tide in the affairs of men, which, taken at the flood, leads on to fortune.” – Shakespeare
[Mobs are tossed to and fro. Take action when they are extreme. Make the tide your asset.]
Below are sources of valuable information. They require work. But, they supply a great profit:
Competitors – Go to five companies in industry and ask intelligent questions about the other four.
Vendors & Customers – ask the 15 points.
University & Government Research Scientists – ask the 15 points.
Trade Association executives – ask the 15 points.
Past employees – ask the 15 points.
The 15 Points:
1. Market potential for sizable growth for years?
2. Does management desire new product development?
3. How effective are R&D efforts in relation to their size?
4. Does company have an above average sales organization?
5. Does company have worthwhile profit margin?
6. What is company doing to maintain or improve profit margin?
7. Does company have outstanding labor and personnel relations?
8. Does company have outstanding executive relations?
9. Does company have depth in its management?
10. How good are company cost and accounting controls?
11. Is company outstanding compared to competitors?
12. Does company have short range or long range outlook on profits?
13. Will growth be achievable without issuing addition stock?
14. Does management talk when things are going well but clam up when going poorly?
15. Does company have a management of unquestionable integrity?
Generally, Fisher writes about value AND growth. Value is mostly numerical but future growth is a critical estimate to determine intrinsic business value. Because precise intrinsic business value is unknowable, he advises dollar cost averaging or timed buying. Decide to buy and do not sweat petty savings when trying to make large profits. Either buy in your blocks over time (perhaps over a few years), or commit to buying by a particular date, with more emphasis on date than price. What date? Perhaps time your purchase within the fear surrounding the release of a new endeavor, but acquired close to the anticipated forward spring of the price.) [While no equation exists to assure this works, the concept is one to be mindful of.]
How does he find growth stocks? [Fisher updated original version with these instructions.]
1. Cull from other investors whom you respect. Expect 4:5 ideas to come this way.
2. Ask industry professionals. Prepare for about 1:5 to come this way. [where else does he get ideas?]
- Screen these ideas for broad criteria which you understand and which you find attractive.
- Then, perform a brief review of financial statements. Do not do complex calculations of precise nature, but rather scan and think. Make snap judgements to preserve your time. Discard many. Record some of the more promising ideas and begin to scuttlebutt the 15 questions above. Go for introduction to management on just 1:250 of these. Record your findings and try to learn.
- Then, you need an introduction. Try contacting the companies commercial bank or another large shareholder, explain your intention and ask for an introduction to someone at the company. Most will oblige so long as you appear prepared and do not over do it. Those whom make introductions often favor the concentrated investors. The concentrated investor applies a large portion of his net worth into a company and generally holds for a long time. [Referrals and company leaders desire a stable shareholder base. ]
[Ian Cassel recommends buying some at this point, then, as you contact management you can say, with sincerity, “I am a small shareholder and am considering making an increase.” I have incorporated this practice myself, and it lubricates the conversation.]
- During your meeting, inquire directly of specific weaknesses in marketing, operations, finance or leadership. You are likely to receive a diplomatic but helpful response. [The best managers will outline a framework by which they will make decisions. Other helpful (but disappointing) responses reveal incompetency.] From these responses you can begin to gauge the people in charge. There are often a handful at the top. So, be careful to avoid a snap judgement after the first one or two. You need a picture of the whole leadership team and a mental map of who plays what role, regardless of their titles.
- Be warned— you should acquire something like 50% of the information required to invest before contacting management. This aides you in asking intelligent questions and prevents you from wasting time. (Yours and theirs) Fisher says, “The time management allocates to a prospective investor will be proportionate not to the size of his investment but to the competency of the individual.” [I too, agree and have experienced good treatment.] At times, certain managers will ‘let down their guard’, and make side comments about challenges resolving certain problems, or manipulation procedures of their stock price, etc. You can also inspect other areas that may influence their actions (home lives and personal goals.) [If I lose trust in management, I don’t care how smart they are, or how good the numbers look, I’ll move to a safer distance. When I’ve failed to heed this instinct, I’ve lost money, and sleep. It’s not worth it.]
- Prepare to invest a significant sum in about 1:3 managements which you visit. This is not a light amount of work and you should either find them favorable or unsatisfactory. No great business will thrive under poor leadership. Survival is not enough for a long term growth position. [I believe that if you find really great situations, they are so rare, you ought to invest at least 10% of your net worth, and potentially as much as 30% right as you get started… but “getting started” might take 3 years. These really good situations can become 85% or more of an individual’s net worth. This is the way to wealth. As an asset manager you are expected to find more than one. Do the work. Earn it. Deserve it. As an individual you need not diversify further. Look through the ticker to the underlying company. How resilient is it? How able are they to gain marketshare when turmoil swirls? Be steadfast.]
- This about sums it up.
Phil Fisher says “diversification is like a speed limit.” [If you’re a good driver, controlling a suitable vehicle, you can travel faster (more concentrated).]
Here are “prudent” levels of diversification he recommends:
- Own 5 large, entrenched, properly selected, growth stocks. You could hold just these 5 in approximately 20% increments and do well.
- Or, own 10 medium sized growth stocks. A few may be smaller and have more significant growth potential. Having 10% of portfolio in each here makes sense.
- Or, own 20 small sized growth stocks. Small companies are higher risk (more dependent upon management), but they may have extremely great reward. Limit to 5% each.
Concentrate to a significant degree when you have done the work. Diversification is an oversold concept. And, if you had some of each “class” that would be just 35 companies. That is too many. It is completely irrational to hold more than 25 stocks in even proportion. [I totally agree.]
Remember, the ideal small company joins the medium size group, and the medium company becomes a large company. Over a long career a small company might even become a large company. This change does not mean you should sell, but rather you should evaluate them now on the basis of their new status/position. He compares it to owning a share of a classmate who has undergone many promotions in his career. Just because your classmate has already increased, does this mean he is done earning increases? No, it would be foolish to trade to a lessor classmate. Stay with him. The best will often get even better.
I love this book for numerous reasons. Foremost, I think he blends timeless principles with on-the-ground tips. And, while his primary aim is directed at marketable securities, the principles and tips are applicable to private companies as well. From this point onward to the end of this post, I will outline how I interpret and apply his principles and tips to private companies… and by chance and by discovered experience, I may lay forth a few of my own.
A conversation between business owners is fascinating. Regardless of the reason, there is always an abundance of uncertainty. They dwell and tame it. We always find something to talk about. Often it begins with their own business, but it very often moves about their community and to who is accomplishing much in their sphere. What is just under the surface? What is too over-the-top?
Private company owners are always 9/10th managers themselves. The absolute best expend just 1/10th of their time in this activity, because they have it so well-mastered. Time spent with them is brief but dense, like a diamond.
Exploration is in my bones. It is veiled in a cloak of learning. I’ve transformed it from a distraction and hobby to something of effort and reward. Each owner has much to teach. What hardened him or her? What would they redo? How does one company succeed and another fail? It does not feel like work to apply so much effort. It is an investigation, moving about in all directions.
If someone refers a business, I dive deeper more quickly. “Take a look” is the siren song. It draws you in. And by this, I think I am accidentally practicing Fisher’s 4:5’s rule. If left to my own purpose, I would only pursue those things that fascinate me most. I temper my ego and widen my viewpoint. I listen and act. I also return to center, thence to depart again elsewhere.
Prior to meeting with management, I direct my motive. I strive to seek their benefit. I see past the first order of the 15 questions above, and try to think deeply about what they might tell their spouses and colleagues. What friends might they have? Where might this new relationship go? Certainly, I sustain my desire to learn about their company, its people, and the uniqueness of their processes. But, I try to dig deeper. I don’t look for flaws to rub their faces in. I try to find compromises they’ve made, and understand why.
Ideally during, but often shortly after our meeting, I deliver some value in kind. The most helpful thing I can do is introduce them to prospective employees, customers, or vendors. I always appreciate this myself and it sparks a relationship which we can maintain with very little time. I have found this compounds significantly, makes my enterprise more anti-fragile, and endears me to people of influence.
When lacking sufficient energy or insight, my default is to recommend a book. On rare occasion, I might be asked for a tip. What do I see that could help them? It’s an open ended question that is more often a trap. I must be careful because I too am inclined to snap decisions. Besides “How does this work?” the next most common questions are some form of “Is my company sellable?” and “who else might like it?” and “what do you think?”
Selling a private company is a deeply personal thing. It is quite different than a faceless stock certificate offered on an electronic trading platform. The nuanced goals of the prospective seller are more complex than price alone. I have heard many say they intend to die at work. I actually respect this. The fool says I will sell this thing for a large profit to some sucker. The weak says, “I’ll take what I can get.” The wise says, I realize nothing will replace the role of this in my life. This confession is no sin. Only if their company is their idol does this unmoor them. Death at the helm does not negate their ability to plan. And, I have found that many who are comfortable to utter this to a near stranger, have well-formed plans. They are teasing me, to see if I ‘get it.’ And I do. In my desk is a letter to my wife and Mikel, to be opened upon my death. These folks never sell. And if they do, they regret it. I tell them, “don’t sell it.” They smile. A friendship is born.
Other managers ask me questions because they truly want help. I try to be realistic and helpful. This is a fine line. I don’t want to lead them on. Many have asked if I would pay a fair price. I tell them I am trying to deliver value, a portion is in cash, and the balance is more difficult to quantify. If price maximization is your only goal, I am not going to be able to deliver. But, if you want something more nuanced, then let’s continue the conversation.
When buying controlling interest in a small business, you want to try to break the deal early. Test the resolve of the seller. Warn them of the concerns we will both confront before the fat-lady sings. If they don’t want to hear an orchestra first, they will never hear her voice.
What I’ve found (outside of the 15 questions above), is that remaining in investigation mode, while remaining helpful, aides greatly in the discovery and introduction of even more private deals. Again, all the effort is up front. It is truly an investment in one’s time.
So people are liars. They trick and manipulate themselves and others. My worst offenses are when I lie to myself. And, as Fisher recommends, I am quick to make snap decisions. I say no. I say no, again. And, a good thing keeps coming back. Perhaps that’s foolish, subjective, or a lie I tell myself, but it’s probably the thing that confuses most of my colleagues. I will snap off a decision on a method or an entire company. I will also file the idea away (sometimes written down.) I’ll come back to it, or it comes back to me, and if it hits me just right, I’ll rethink it from a different point of view, and consider changing my mind. Many decisions are circumstantial. If the circumstances change, so do I. I just keep moving. (I don’t think you can do this with a large committee.)
Diving a bit deeper, I go right at the weaknesses. I try to avoid an attack posture, but instead, work to truly understand how they achieve. How do you hire? Are you drinking buddies with your top 3 customers? I watch what they do, not just what they say. Do they laugh, cry, agree, squirm, leave, lean in, etc? I can be perceived as a jerk sometimes. I’ve lost deals because I asked hard questions, or shared an uninvited opinion. I know I can be abrasive. I’m not trying to hurt. I’m trying to decide if we can work together. I’m trying to make sure we have agreeable overlap. If we don’t have overlap, don’t we both want to know? (I think many buyers are actually salesmen. They want to lure people in, and then switch the game on them. I think this hurts more than helps. And, it’s harder to scale. I often prick up front, and we heal together.)
I also want to know, when buying control of a private company, does this company have problems I know how to handle? All businesses have problems. I’d love to buy a company from a passionate owner who is willing to stick around indefinitely and merge his thinking with my thesis for the company. However, most small business owners cannot withstand an ownership change and staying in the company. It’s like extracting their heart, identity and friendships all at once, and then telling them it’ll be alright. They must be really mature to handle it.
Our ratio of closings to in-person meetings is a lot higher than people realize. Like Fisher, I think most people assume I go around taking meetings willy-nilly. Mikel knows I turn away most in-person meetings over the telephone, or via email. I do the dance by telephone and we both get a pulse on if this is worthwhile. Most times it is not, and I say so. I try to be helpful without being a jerk. Telling them upfront it’s unlikely is the kind thing to do.
Each prospective company has to past so many sniff tests before I go carving out hours or days of travel, thought, preparation and closure. I’d much prefer bumping into an owner five years before he wants to sell and simply staying in touch. That makes our transaction extremely smooth. We both know and respect each other. Our best purchases took years to develop rapport. I like this method, and I think the sellers do as well.
As for growth objectives, this is an extremely tough condition in private control purchases to gauge. Can the company survive a transplant of the founding owner to a new owner? No matter how well the previous owner has trained and developed his or her managers, the soul resides in the owner. The primary owner will change. This means the ethos is at risk. I have tried mightily to be the protector of the soul. The launch story is so, so critical. And not just the story, but the DNA of the company’s parents is implanted into the culture. Their fingerprints are in every nook and cranny.
On one hand you want to buy a company at a good price. On the other hand, you want a company with prospects for growth. If you transplant the owner, does the company survive?
I will begin to wrap this up now.
In my experience, there is a recovery period after the transplant. During this time the host body (team) must acclimate to the change. Are things safe? Are they fun? Did they move my cheese? Is it worth quitting? Leaving? Customers face the same questions.
In 11 of 12 acquisitions we have done, we have preserved the life and spirit of the acquired. We navigated these well enough because of the good faith of the seller. They wished us well, did their part, and walked into new phases of their lives, wishing their adolescent companies ado.
There were tears and hardships no doubt. But, we separately encounter fresh challenges and no longer weep over the scars. The patient heals. The customers adapt, often appreciatively. And we go onward and upward, one small step at a time.