Library / Investment Classics

Date of review: May 2019
Book author: Philip A. Fisher
Вook published: 1975

Conservative Investors Sleep Well by Philip A. Fisher (first published 1975)

This is the second book out of three main ones written by a legendary investor Phil Fisher, who in my view is less known than some other authors considered to be the fathers of fundamental or value investing. I like the second book as not only it is quite short (just about 45 pages), but also very clearly structured.

Four core areas ('dimensions') of focus for an investor to pick solid investments that would preserve his capital and possibly grow it quite considerably.

The first one is Superiority in Production, Marketing, Research, and Financial Skills.

Fisher discusses what could be behind leadership in this area — low-cost production, strong marketing organisation, outstanding R&D, 'financial skill'. The last point is about management's ability to properly identify products that have the highest contribution to overall profits and cashflows.

The second dimension is 'The People Factor'.

Fisher quotes a pioneer venture capitalist, Edward Heller, who apparently said that behind every unusually successful corporation was this kind of determined entrepreneurial personality with the drive, the original ideas, and the skill to make such a company a truly worthwhile investment.

The third dimension is the 'Investment Characteristics of a Business'.

Fisher makes an interesting point that profit margin is more important than returns on capital in selecting conservative investments as business with low margins but high asset turnover (which could lead to the same ROIC as a high margin, low turnover combination) would be hit harder during downturn or cost inflation since lower margins would be more sensitive to even a small change in product costs or realised prices/volumes.

Fisher also discusses some factors that lead to better margins which Buffett refers to as the moat. They include monopolistic positions, efficiency especially coming from economies of scale. Interestingly, Fisher makes a point that it is safer to buy number one player in the sector even if number two theoretically has more growth potential because often the position in the industry allows to disproportionately collect sector profits (a company with 20% market share would often collect 60% of profits, while the second company with 10% market share would only capture 20% of profits and most other players in the sector would be working at break-even levels). Quite unexpectedly (given that the book was written over 50 years ago), Fisher discusses the impact of technology on company's competitive positions and how businesses can compete in technology sectors.

The fourth dimension is the 'Price of a Conservative Investment'.

Fisher makes an important point that a price move often occurs due to changes in general expectations for a stock, rather than actual changes in the business. However, with time the underlying fundamentals start getting reflected in the price which creates opportunities for patient investors.

Fisher also ranks investments by risk factors. His lowest risk category are well established businesses with strong long-term potential which are currently not fully appreciated by the market for some reason. The second least risky category are still strong companies that are generally adequately priced (as long-term growth will generate enough returns to compensate any fluctuations in PE ratio). Fisher's third category are slightly overpriced companies with great characteristics which are still fine to be part of a portfolio but probably should not be considered for fresh purchases. Companies with low valuation multiples but not strong in the first three dimensions (Product, People, Business) may be candidates for speculation, but not for conservative investments, according to Fisher.

In the last two chapters Fisher makes follow-up comments on the Fourth Dimension. Fisher breaks down factors that impact valuation multiples which include general market conditions (sentiment), sector views and stock specific valuation. He also makes the point that quality of the business / product is more important than the price paid today as over time a superior business will not only deliver better earnings growth but will likely retain its PE multiple, while another business may face operational challenges, deliver slower earnings growth and face de-rating.

Fisher makes an important point about picking great companies facing temporary challenges.

'The great growth that had been correctly discounted in the price-earnings ratio is likely to become "undiscounted" for a while, particularly if the company experiences the type of temporary setback that is not uncommon for even the best of companies. In times of general market pessimism, this kind of "undercounting" of some of the very finest investments can reach rather extreme levels. When it does, it affords the patient investor, with the ability to distinguish between current market image and true facts, some of the most attractive opportunities common stocks can offer for handsome long-term profits at relatively small risk'.

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