Jun 28, 2010|
Lessons from Philip Fisher - IV
Many companies appear to have great growth prospects going forward. But in our pursuit of searching for stocks that can provide exceptional long-term profits, one fine distinction needs to be made about these growth prospects. Is this growth expected to come from new demand for the existing products the company offers? If the answer to that question is yes, Fisher opines that such a stock may very well provide a nice one time profit.
But for a company to see sustainable growth over a great number of years, one needs to arrive at the answer to another important question.
And that question is: Is the company's R&D devoted to aggressively developing new products having a close relationship to those already part of the company's offerings?
A company may have a number of divisions. And many of these divisions may have product lines completely different from each other. However, this does not preclude such a company from the above mentioned criteria. What is required is that the company should have individual research efforts centered around developing new but related products around each of these business divisions.
There is also another kind of a company. And it too has strong R&D efforts. In Philip Fisher's view though it will not prove to be as profitable to the long term investor. This is a company which focuses its R&D efforts on a number of unrelated new products. The success of these products will serve to land the company in several new industries unrelated to its existing business. Such a result, though not all that bad, will not let the company exploit all such new products with the kind of profitability that shrewd investors look for. The goal of high profitability will be better achieved if the new products have some synergies with the company existing business expertise. Only in this manner can the highest profitability be achieved.
The point we are discussing may at first glance seem more to do with the operational aspect of a company. This is not so. It is a matter of management attitude more than anything else. For a company to move in the above discussed direction, one essential thing needs to be in place. It should have a management that recognises that the market for all products eventually get saturated. That's when growth tapers off. To continue to grow at a fast clip, a company has to further develop new markets. Only recognition of this aspect by management is not enough though. It also needs to have the determination to develop these new products and processes to keep the sales momentum going.
An investor can gauge the attitude of a company management on this count by parsing all communication received from it. The MD&A (management discussion and analysis) section in annual reports, management interviews, published reports, company presentations etc. are some of the sources an investor can refer to for this purpose. Also, one can learn a lot by just observing the management's past actions. US based company Apple Inc. is a fabulous example of the same. The company has been continually coming up with radically new products. Yet they've all been within the domain of the company's expertise. As soon as the market for an old product nears saturation point, the company has swiftly been ready with a new offering to take up the slack and push sales higher.
And that is one of the things it takes to separate the long-term multibaggers from the 'one hit wonders'.
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