Phil Fisher and Lessons from Depressions

I have started reading ‘Common Stocks and Uncommon Profits’, written by Phil Fisher, published way back in 1957. Almost all vintage investors say that this is the Bible for Growth Investing. Even Warren Buffett has this to say on Phil Fisher – ‘I am an eager reader of whatever Phil has to say, and I recommend him to you.’ Buffett has also indicated in the past that Fisher has influenced him in changing his mindset from a pure value to a somewhat growth investing perspective.

I probably should have read this much earlier. Especially in the collapse that we had 3 years back. The series of paragraphs below will tell you how prescient Phil Fisher was.

I was not too far into the book (page 38-40, in fact) when I stumbled on this gem (nothing to do with growth investing, everything to do with the big picture). I only wished I had come across this earlier. Simply outstanding. And remember, this book was written in 1957. What he says in the following paragraphs is probably an exact reflection of what has happened in all crisis since, across the world (1984 S&L, 1987 Black Monday, 1997 Asian crisis, 2000 crisis, 2008 crisis), including the great crisis we’ve had recently. Must read (emphasis all mine).

 

There is a greater advantage in owning certain types of common stocks, as a result of a basic policy change that has occurred within the framework of our federal government largely since 1932.

Both prior to and since that date, regardless of how little they had to do with bringing it about, both major parties took and usually received credit for any prosperity that might occur when they were in power. Similarly, they were usually blamed by both the opposition and the general public if a bad slump occurred. However, prior to 1932, there would have been serious question from the responsible leadership of either party as to whether there was any moral justification or even political wisdom in deliberately running a huge deficit in order to buttress ailing segments of business. Fighting unemployment by methods far more costly than the opening of bread lines and soup kitchens would not have been given serious consideration, regardless of which party might have been in office.

Since 1932, all that is reversed. The Democrats may or may not be less concerned with a balanced federal budget than the Republicans. However, from President Eisenhower on down, with the possible exception of former Secretary of the Treasury Humphrey, the responsible Republican leadership has said again and again that if business should really turn down, they would not hesitate to lower taxes or make whatever other deficit-producing moves were necessary to restore prosperity and eliminate unemployment. This is a far cry from the doctrines that prevailed prior to the big depression.

Even if this change in policy had not become generally accepted, certain other changes have occurred that would produce much the same results, though possibly not so quickly. The income tax only became legal during the Wilson administration. It was not a major influence on the economy until the 1930s. In earlier years, much of the federal revenue came from customs duties and similar excise sources. These fluctuated moderately with the level of prosperity but as a whole were fairly stable. Today, in contrast, about 80 per cent of the federal revenue comes from corporate and personal income taxes. This means that any sharp decline in the general level of business causes a corresponding decline in federal revenue.

Meanwhile, various devices such as farm price supports and unemployment compensation have become embedded in our laws. At just the time that a business decline would be greatly reducing the federal government’s income, expenditures in these fields made mandatory by legislation would cause governmental expenses to mount sharply. Add to this the definite intention of reversing any unfavorable business trend by cutting taxes, building more public works, and lending money to various hard-pressed business groups, and it becomes increasingly plain that if a real depression were to occur the federal deficit could easily run at a rate of $25 to $30 billion per annum. Deficits of this type would produce further inflation in much the same way that the deficits resulting from wartime expenditures produced the major price spirals of the postwar period.

This means that when a depression does occur, it is apt to be shorter than some of the great depressions of the past. It is almost bound to be followed by enough further inflation to produce the type of general price rise that in the past has helped certain industries and hurt others. With this general economic background, the menace of the business cycle may well be as great as it ever was for the stockholder in the financially weak or marginal company. But to the stockholder in the growth company with sufficient financial strength or borrowing ability to withstand a year or two of hard times, a business decline under today’s economic conditions represents a far more a temporary shrinking of market value of his holdings than the basic threat to the very existence of the investment itself that had to be reckoned with prior to 1932.

Another basic financial trend has resulted from this built-in inflationary bias having become embedded so deeply in both our laws and our accepted concepts of the economic duties of government. Bonds have become undesirable investments for the strictly long-term holdings of the average individual investor. The rise in interest rates that had been going on for several years gained major momentum in the fall of 1956. With high-grade bonds subsequently selling at the lowest prices in twenty five years, many voices in the financial community were raised to advocate switching from stocks which were selling at historically high levels into such fixed-income securities. The abnormally high-yield of bonds over dividend return on stocks – in relation to the ratio that normally prevails – would appear to have given strong support to the soundness of this policy. For the short term, such a policy sooner or later may prove profitable. As such, it might have great appeal for those making short or medium term investments – that is, for ‘traders’ with the acuteness and sense of timing to judge when to make the necessary buying and selling moves. This is because the coming of any significant business recession is almost certain to cause an easing of money rates and a corresponding rise in bond prices at a time when equity quotations are hardly likely to be buoyant. This leads us to the conclusion that high-grade bonds may be good for the speculator and bad for the long term investor. This seems to run directly counter to all normally accepted thinking on this subject. However, any understanding of the influences of inflation will show why this is likely to be the case.

 

Lessons learnt from just these couple of pages –

a) Depressions are likely to be shorter and shorter. As Buffett would say, volatility is your best friend. You can pick up great businesses at bargain prices during these periods.

b) Avoid companies with less than average financial strength who can’t tide through these short depressions. This especially means high debt firms, who have a low interest cover. Real estate firms usually come under this category (not infra though, I am beginning to like infra now– roads, irrigation and the like (not power sector)).

c) If you have a longer time frame (I do), avoid long term bonds. They are not wealth creators.

Outstanding stuff. As I said earlier, I only wish I could’ve read this in the middle of the depression. I would have picked up a lot more stocks than I did 🙂

 

P.S – An outstanding Credit Suisse study on Behavioral Finance (easily a must read) (It’s free, surprising for the quality of content in there) – https://infocus.credit-suisse.com/data/_product_documents/_shop/306486/global_investor_111_en.pdf

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  1. #1 by Abhishek Chaturvedi on May 19, 2011 - 4:33 PM

    Hi Kiran,

    Good post….i have also just started reading this classic material…let’s see if it helps me…

    another outstanding publication from Credit
    Suisse..

    https://infocus.credit-suisse.com/data/_product_documents/_shop/277189/cs_research_brand_investing.pdf

    Helps in understanding the “moats” attached to certain businesses….

  2. #2 by Dinesh on May 19, 2011 - 7:25 PM

    hi kiran
    good one… i also picked up this classic… should get around to reading it

  3. #3 by Kiran on May 24, 2011 - 5:02 PM

    @Abhishek – The book is slightly an involved read. It’s a classic because it helped a ton of investors. We are no different 🙂

    That is yet another fantastic report by Credit Suisse. Thanks for sharing.

    @Dinesh – Thanks. Yep, I guess we all should get around to read it, and imbibe its lessons. Let me know if you come across any important pages. I might have as well sleep-walked through some pages.

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