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The First Step To Doing Your Own Research

What can we learn from Phil Fisher?

Why understanding a business is important?
What you need to know about 'understanding a business'?
Understanding business models
Getting started
End note

What can we learn from Phil Fisher?

It would be a bit out of place to bring up Philip Fisher's name on a forum totally devoted to the Oracle of Omaha one would think. But not mentioning him would be a big injustice
to the field of value investing we believe.
His followers or people who've read his body of work would know what we are talking about. Just as Benjamin Graham, Fisher too would go down as a colossus in the art and
science of equity investing according to us.
An indication of his stature could be had from the proclamation that Warren Buffett so unabashedly makes. He calls himself 15% Philip Fisher and 85% Benjamin Graham. If
you ask us, the ratio could well be more given how Fisher's teachings have been instrumental in Buffett putting up such a strong performance during the latter part of his
investing career.
Of course, since Bufett calls himself a mixture of both Graham and Fisher, their investing styles certainly have to be different from each other. How different? Well, we had the
good fortune of having Fisher answer this question himself in a rare interview that the investing genius gave to Forbes way back in 1987.
The question was as straightforward as they come. What's the difference between Grahamism and Fisherism, he was asked.
He let it out that there are two fundamental approaches to investment. There's the Ben Graham approach. And this is nothing but finding something intrinsically so cheap that
there is little chance of it having a big decline. Such stocks have financial safeguards to them so that it doesn't go down much. And sooner or later, value comes into it.
And then there his approach he opines. Here, the idea is to find something so good that if one does not pay too much for it, it will have very, very large growth. What he is trying to
say is buy quality. In other words, buy companies with strong moats. And it doesn't matter if one is paying a slightly expensive looking price for it. For there is so much growth
ahead that eventually the expensive looking price will turn out to be a true blue value investment.
Isn't this exactly what we highlighted in our first lecture while discussing the difference between investment approaches of Buffett and Graham? Of course, Buffett seems to have
tweaked Philip Fisher's model a bit and their circle of competencies also differ. But at heart, what Buffett is doing now is a nice amalgamation of Fisherism and Grahamism
rather than Grahamism alone.
Some key differences between Fisherism and Grahamism

Fisherism

Grahamism
On intrinsic value

Intrinsic value keeps on growing with time

Intrinsic value remains nearly the same

On moats
Presence of moat a prerequisite

Presence of moat not a prerequisite

Portfolio allocation
Concentrated portfolio

Diversified portfolio

Investment universe
Well within circle of competence

Not so much emphasis on circle of competence

What price to pay?

Can pay a slightly expensive-looking price

Has to be bought at a huge discount to intrinsic

value

Why understanding a business is important?

Why do you invest in any asset or financial instrument? The answer is simple- to earn returns on your capital. When you invest in a bank fixed deposit, you know that you are
going to receive a certain interest rate over the life of the deposit. So in a fixed income security, both interest and capital repayment is assured.
In the case of a stock, neither the return on capital nor the return of capital is known or assured. It is upon the investor to estimate the intrinsic value of a stock. Now, estimating
the intrinsic value is essentially estimating the expected future earnings of a business. It is important to note here that it is practically impossible to predict future earnings
accurately. That is not even needed really.
What a value investor really tries to do is make an educated guess about the future earnings of a business. Remember, the keyword here is 'educated'. And that can only
happen if you understand a business. Investing without understanding a business is speculation.

What you need to know about 'understanding a business'?

An investor may think, "How can I understand a b usiness if I am not involved in running it?" So it is important to know what it really means to 'understand a business'?

"When I say understand--my definition of understand is that you have to have a pretty good idea of where it's going to b e in ten years. I just can't get that conviction with a lot of
b usinesses, whereas I can get them with relatively few." - Warren Buffett
"...we try to stick to b usinesses we b elieve we understand. That means they must b e relatively simple and stab le in character. If a b usiness is complex or sub ject to constant
change, we're not smart enough to predict future cash flows. Incidentally, that shortcoming doesn't b other us. What counts for most people in investing is not how much they
know, b ut rather how realistically they define what they don't know. An investor needs to do very few things right as long as he or she avoids b ig mistakes." Warren Buffett, Letter
to shareholders 1992
This explains why Buffett never invested in Microsoft despite being a close friend of Bill Gates. As investors, our interest must be to understand the economics of a business.
You need not know all the nitty-gritties and technicalities of a firm's products. Asking the right questions is the key.
"We have to understand the competitive position and dynamics of the b usiness and look out into the future. With some b usinesses, you can't." - Warren Buffett

Understanding business models

To begin with, get a grasp of the business profile of the company. Using the Porter's Five Force model, here is a broad questionnaire that could provide you a starting point to
understand a company. The below framework will come in handy when you make your future growth and earnings forecasts:
1 Understanding the company's position in an industry and identifying entry

What role does the company play in the industry value chain? An industry value chain includes all the steps and processes involved in the production
of goods. The value chain starts from raw materials and ends with the final end user product. Find out where in the value chain does the company
belong. Does it supply raw materials, or intermediate goods or value-added end user products? Is the business capital intensive? Does the business
involve a long gestation period? Is entry to the sector regulated? Is there high product differentiation? Is it easy to exit the industry?
2 Understanding the product and identifying the threat of substitute products

What are the characteristics of the product? Is it an industrial good? Is the product a consumer staple? Is a perishable good? Does it have a limited
shelf life? Is it a low value commodity? Is it a high value differentiated product? How often does it need to be replaced? Are there any substitutes to
this product? Are they cheaper or more expensive? What hinders customers from buying those substitutes, if at all? Does technological change
impact the company's product?
3 Does the company have bargaining power with suppliers?

What are the major costs involved? What are the main raw materials used in the production of the product? Which are the other major costs- power,
logistics, employees, etc? Who are the company's suppliers? Is the suppliers' market dominated by a few large firms? Does the company rely heavily
on any single supplier? Is the company a significant customer of the supplier? Can the company easily switch to another supplier?
4 Does the company have bargaining power with customers?

Who are the company's customers? Which are the main user industries of the product? Does the company rely on a few major customers? Which are
the major geographical markets where the company sells its products? Can customers delay purchases? Can customers easily and economically
switch to products offered by competitors?
5 How intense is the competitive rivalry in the industry?

Who are the main competitors? What is the structure of the industry- monopoly, duopoly, oligopoly, monopolistic competition? Are there several
similar-size firms in the market? What is the position of the company in the industry in terms of market share? Is there competition from the
unorganized market? Are the company's products different from those of the competitors? Is the industry growing at a brisk pace or sluggishly?

Getting started...
The best way to get started is to pick up the latest company annual report. Choose any company that you like. The annual reports are available on

most of the company websites. For beginners, we recommend choosing a relatively simpler business, say a single product company.
Read the Directors' Report and Management Discussion & Analysis. Here you will find a lot of useful information about the company, industry and the

economy. This could be a good starting point to build your understanding about a business.
We recommend reading historical annual reports. It will help understand how the industry dynamics have evolved over the years and how the company

has performed.
We recommend reading annual reports of competitors. It is beneficial to see how the competitors perceive the industry scenario and their business

strategies. In addition, reading annual reports of suppliers and customers (if they are listed companies) could provide valuable insights and help in
analyzing the overall industry scenario.
The other good sources of information are company websites. Some companies offer presentations of their businesses as well as also participate in

quarterly conference calls. The word transcripts or the audio recordings can be availed from the company's website or from free online portals such as
www.researchbytes.com. Getting to hear about the business and industry dynamics directly from the people who run the company can provide a very
good perspective to investors.

End note
In this maiden monthly E-letter, we have focussed on the theoretical framework of value investing and basic steps that can help investors get started with their own research.
We would like to emphasize here that value investing requires patience, discipline and regular study. It is the cumulative knowledge gained over time that will pay rich dividends
over the long term. So, do not look out for immediate results. Do not expect yourself to learn everything quickly.
"An investment in knowledge pays the b est interest." - Benjamin Franklin
We look forward to your views and suggestions on our first monthly E-letter, exclusively for our Equitymaster's Secrets subscribers. Please post your suggestions and feedback
in the forum.
Warm regards,
Equitymaster Research Team

Post A Query

Total Posts: 1

international fisher stocks

i can give only my examples, 3M at 22USD in 2008 was a typical graham proposition, now at 122usd it is now a fisher stock . so, valuation gap takes time to fill, but
any fisher type investment tests only ur conviction to hold despite profits. graham gives u statistical certainty of profit, fisher ENSURES lifelong richness. graham
provides margin of sfety while fisher enjoys the power of unrealized gains(compounding)
Posted by: MADHU V | 25th Jul '13 | All Replies

Total Replies: 1 | Report Abuse

Very commendable Excellent WORK BY EQUITYMASTER team

Dear team, i have found above maidan e newsletter for EM secrets V Subscribers very good informative. i congratute entire analytic and research team of equity
master.
please continue this and improve qualitaively hereon from next month newsletters.
also please despatch Best seller WARREN buffet Essays secrets to Me by 31.7.2013
Waiting for your return call
good work
Posted by: PRAMOD VERMA | 24th Jul '13

Total Replies: 0 | Report Abuse

intrinsic value as per Grahamism

'Intrinsic value remains nearly the same'. is that Graham insisting equity share investing for comparatively short terms over a time ,i.e. buy very low, sell at intrinsic or
above, again wait till it drop well below intrinsic to buy and so on?
Posted by: bharat shah | 24th Jul '13 | All Replies

Total Replies: 2 | Report Abuse

equitymaster team,
i think, Suresh Gujarati did not reply my query. he just put his views on your e-letter. please reply my query, if you think fit.
Posted by: bharat shah | 26th Jul '13

Like | Report Abuse

Dear Sirs,
It will take time to understand the working of both Giants, like me the beginner. I will have read some more time.
Regards
Suresh Gujarati
Posted by: suresh Gujarati | 24th Jul '13

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