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Wednesday, 2 June 2010

Anatomy of a Growth Investor

Martinis in the Jacuzzi

The twentieth century gives us many examples of great investors but it’s an interesting fact that these are almost from the value side of the tracks. From Ben Graham to John Templeton and from Bill Ruane to Warren Buffett the men – and they’re all men – who’ve made extraordinary returns were all originally value investors.

With a single exception. Standing alone as a self-confessed, all-in growth style investor is Philip A. Fisher, who initially learned his investing skills during the downturn in the early 1930’s. Reading anything by Fisher is like sitting in a bubbling Jacuzzi sipping on a vodka martini and contemplating an evening of gentle debauchery with the Arts faculty: both a pleasure and an education.

Smart Beats Style

Fisher was a securities analyst before the profession was invented, being co-opted into Wall Street in 1928 just in time to both avoid serious losses and learn serious lessons. With little in the way of established practice to guide him Fisher developed his own, idiosyncratic, investing style. Yet despite his unique approach to investing what strikes you, when you read his beautifully simple prose, is how familiar the injunctions seem.

Dig into Fisher’s words and analyse his actions and what becomes clear is that he is the exception that proves the rule. It’s not whether you’re a value investor or a growth investor that makes the difference, it’s whether you’re smart enough to learn the lessons of your own mistakes.

The Lessons of Experience

In anecdote after anecdote he describes the errors he made and explains why he made them. In the beginning they were through a lack of experience and of understanding, in the end they were due to an occasional lack of psychological control. Always, though, there's the single important lesson:
“I have always believed that the chief difference between a fool and a wise man is that the wise man learns from his mistakes, while the fool never does. The corollary to this is that it behooved me to go over my mistakes pretty carefully and not to repeat them again”.
Used appropriately that could be a manifesto for every investor. Analyse every investment, particularly the mistakes, and figure out what you did right and wrong. Almost as importantly Fisher’s early experiences also taught him that being right without making money was a pointless, pyrrhic victory. The only investments that count are the ones that you make a profit from, preferably a munificent one.

Scuttlebutt

There are perhaps two nuggets that have entered the popular investing folklore through Philip Fisher – the Fifteen Points and the use of scuttlebutt. The former is a loose set of rules that Fisher proposed to analyse companies, the latter is the need to expend foot leather in a search for real information about a stock. Both of these ideas are replete with information that a smart investor should be willing to put to use. If you want to find out more about them look ‘em up on Google or read Common Stocks and Uncommon Profits, Fisher’s most popular book.

Yet it’s not just Fisher’s uniqueness that’s interesting, it’s also the ways in which he’s similar to the few other great investors of the last century that are remarkable, despite his vastly different approach. For Fisher’s main interest was in finding growth stocks, companies that had a technological edge on their competition which they could use to their advantage to compound their returns over the very long timescales he was prepared to hold for - over fifty years in some cases.

More Scuttlebutt

Generally he believed dividends were a distraction for such companies – any company of interest should be able to use its earnings vastly more effectively by re-investing them in itself than by distributing them to shareholders. It’s hard to imagine an approach less attractive to a value-style investor, yet the similarities persist.

Behind his approach was a willingness to put the effort in to understanding the companies he was investing in. The managers of the stocks Fisher invested in weren’t abstract ciphers in an annual report but flesh and blood people he spent time quizzing. Value investors generally – and, sadly, almost invariably correctly – take the approach that the managers of their investments can’t be trusted to use earnings wisely and are likely to do various stupid things like giving themselves unjustified bonuses or making unwise acquisitions. On this basis getting the earnings out in dividends makes sense. Fisher, on the other hand, spent his time finding managements he trusted, making the risk of letting them re-invest his earnings much lower.

Same problem, different solution.

The Lessons of '29

Fisher’s memories of the end of the 1920’s are instructive –
“As 1929 started to unfold I became more and more convinced of the unsoundness of the wild boom that seemed to be continuing. Stocks continued climbing to ever higher prices on the amazing theory that we were in a “new era”. Therefore, in the future, year after year if advancing per share earnings could be taken as a matter of course”.
As he relates he predicted the disastrous end to the boom – something, as we’ve seen, retrospective market analysis can’t do. Yet, with typical self-effacement, he goes on to explain how his prescience was rendered pointless because he was convinced he could outwit the market. His chosen investments were what we would now describe as deep value stocks. As he , wryly, puts it:
“... as the depression increased I learned rather vividly why these companies had been selling at such low price earnings multiples”.
PER, RIP

Fisher was particularly sceptical of current and forecast P/E ratios as predictors of future market returns. These ratios are based on two things – the ability of the company to increase its earnings and the willingness of investors to bid up the company’s price. In the short-term he felt that even if you could get the former correct, a difficult task given the problems of forecasting, it was impossible to judge the latter.

So he wanted, and went to great lengths to find, companies that could consistently meet and beat earnings forecasts. Yet even though he believed such companies were worth a higher price he also recognised that a great company doesn't make a great investment unless you can find an acceptable entry point. However, once he'd found companies he trusted at a price he thought acceptable he would often stick with them even when they became obviously overvalued:
“Even if the stock of a particular company seems at or near a temporary peak and that a sizeable decline may strike in the near future, I will not sell the firm’s shares provided I believe that its long term future is sufficiently attractive … It has been my observation that it is so difficult to correctly time the near-term price movements of an attractive stock that the profits made in the few instances when this stock is sold and subsequently replaced at significantly lower prices are dwarfed by the profits lost when timing goes wrong”.
Market Psychology

Above all Fisher describes how the mass psychology of the market can change imperceptibly and makes short-term forecasting a hopeless occupation: “the forecasting record of seers predicting changes in the business cycle has generally been abysmal”. He’s also gently scathing of efficient market theories: “I do not believe that prices are efficient for the diligent, knowledgeable, long-term investor”.

Reading Fisher is a refreshing tonic to all the day-to-day pointless excitement generated by commentators. It takes a proper view of history to be this foresighted:
“With the possible exception of the 1960’s there has not been a single decade in which there was not some period of time when the prevailing view was that external influences were so great and so much beyond the control of individual corporate managements that even the wisest common stock investments were foolhardy … Yet every one of these periods created investment opportunities that seemed almost incredible with all the advantages of hindsight”.
There you have it, the lessons of a growth investor. Buy good stocks, relatively cheaply, when no one else wants them and hold for a long time. Growth or value makes no difference if you can keep your head when all around others are losing theirs.

Footnote:

It's impossible to do justice to Fisher's simplicity of expression and clarity of thought in a short article, so the only real option is to read it for yourselves. His Common Stocks and Uncommon Profits is usually bundled with two other extended essays, Conservative Investors Sleep Well and Developing an Investment Philosophy (which all of the quotes above are taken from). I recommend reading them in reverse order to get the proper context.


Related Articles: Is Intrinsic Value Real?, The Rediscovered Ben Graham, Investing Like Berkshire Hathaway

3 comments:

  1. The idea of learning from one's mistakes is not emphasized nearly enough in the investment community. Along these lines I have to say that my mentor in the investment business many years ago taught me a valuable lesson. One Saturday, after we were on the wrong side of the bond market - we had positioned the portfolio for a drop in rates and they had risen - I found him at his desk with a stack of macroeconomic research materials. He told me that whenever he feels he doesn't understand why the market is doing what it is doing he reads until he feels he has a sense of the market. This ability to admit that one is wrong and "Mr. Market" is right served me well in my career. This reading activity is, of course, much easier today because everything is readily available.
    I look forward to reading the books you recommend.

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  2. Fisher, on the other hand, spent his time finding managements he trusted, making the risk of letting them re-invest his earnings much lower. Same problem, different solution.

    I view this as an extremely sharp comment. I like the protection from losses that is offered by dividends. But insight into the workings of the company being purchased is an effective substitute form of protection. Either way works.

    I believe that the payoff from developing insights is greater. But is is easier to find companies paying good dividends than it is to develop genuine insights.

    Rob

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  3. This is a great posting that provides a key to the growth versus value dynamic. As you note, most of the legends are value players; there aren't too many like Fisher who could be characterized as growth investors.

    You hit on an important differentiating factor between the two types: The reaction to mistakes.

    If you are in an investment manager's office and you see a wall devoted to "ten-baggers" or the like, you are visiting a growth investor. If such a display is of past mistakes, you are with a value investor. Those outward signs are indicators of one of common differences between the two classes (generally speaking): One tends to celebrate its big wins. The other pays more attention to its mistakes and tries to learn from them.

    No matter the investment style, you'll always be better off hitching your wagon to a manager who obsesses of his mistakes, not his successes.

    ReplyDelete