Atarashii consulting

Common Stocks and Uncommon Profits

By Philip A Fisher
Chapter 1 - Clues from the past

The book beings by Fisher stating that people buy common stocks for a number of
reasons, but at the end of the day, the primary reason is in order to make money. He continues
on to explain that the best place to start is to look at history. Historically speaking money has
been made two different ways. One of these great methods, was betting on the business cycle.
Although risky, this method proved to be very fruitful for a number of investors. In contrast to
this technique it has been found that finding the really outstanding companies and sticking with
them throughout the ups and downs is far more profitable in the long term, that is the main
focus of this book.

Chapter 2 – What the Scuttlebutt can do

Fisher highlights Scuttlebutt as searching for information about a company by asking the
people involved. This means employees, former employees, management, other investors,
competitors of the company in the same industry, etc. One great technique and place to start is
by going to five companies in the industry, ask them intelligent questions about their business
and the strengths and weaknesses of the other four. This has a very high probability of giving
you a good idea of who is the strongest of the five. One more point worth noting, earlier in the
paragraph I stated that former employees are a good place to gather information, this is true.
However, it is very important to note that information from this group needs to be cross
checked, for obvious reasons data gathered from previous employees can be bias.

Chapter 3 – what to buy

Chapter 3 is critical chapter in this book, as it directly lays out what Fisher believes and has
tested are the most important 15 points that need to be considered when searching for an
outstanding investment. The 15 points referred to are as follows.

1. Does the company have products or services with sufficient market potential to make a
possible sizable increase in the sales for at least several years?

2. Does the management have a determination to continue to develop products or

processes that will still further increase total sales potential when the growth potential
of currently attractive product lines has largely been exploited?
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3. How efficient are the companies research and development efforts in relation to its
size?

4. Does the company have an above average sales organization?

5. Does the company have a worthwhile profit margin?

6. What is the company doing to maintain or improve profit margin?

7. Does the company have outstanding labor and personal relations?

8. Does the company have outstanding executive relations?

9. Does the company have depth to its management?

10. How good are the company’s cost analysis and accounting controls?

11. Are there other aspects of the business, somewhat peculiar to the industry involved,
which will give the investor important clues as to how outstanding the company may be
in relation to its competition?

12. Does the company have a short-range or long-rang outlook in regards, to profits?

13. In the foreseeable future will the growth of the company require sufficient equity
financing so that the larger number of shares then outstanding will largely cancel the
existing stockholders benefit from this anticipated growth?

14. Does the management talk freely to investors about its affairs when things are going
well but “clam up” when troubles and disappointments occur?

15. Does the company have a management of unquestionable integrity?

Chapter 4 – What to Buy (Applying this to your own needs)

In this chapter, Fisher explains that it is fairly common for the average person to think
that the best investors are those that sit in solitude pouring over financial statements. He then
continues on to say that this is most often times not the case. The reason this is not the case is
the best investors are usually those individuals who have an interest in business problems, one
of the main reasons for this is it allows that individual to have an interest in digging deeper into
a company and its interworks.
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This chapter continues by going into deeper detail about how to select a financial
advisor. Fisher explains that financial advisors should be selected with caution. There is no
reason to not have them show you their record for the last 5 years so you can analyze it. It is
also important to select an advisor that has the same or similar investment philosophy to your
own.

Chapter 5 – when to buy

In the opening statement, Fisher states that if the right stocks are purchased over time
they will produce a profit, but in order to get the maximum profit, some timing must be taken
into consideration. The book then goes into detail about the struggles of trying to judge your
purchase by the current economic condition. The economy is always something to consider, but
predicting what is going to happen in the future regardless of whether the economy is in a bear
or bull market is insanely difficult. Even though history is a great indication of what will happen
in the future, the world is constantly entering uncharted territory, and if there is one thing that
is consistent, it is that people are irrational. This is the point that Fisher is trying to make, he
instead uses an example of a possible alternative, one that Warren Buffet is very fond of. The
example can be summarized as follows:

A company builds a new plant, they are a publically traded company and therefore the
building of the new plant effects their debt in a noticeable way. The shareholders take notice
and watch closely. After the plant is built production begins, but it takes a good 6 months for
this large of a factory to get up to speed, a lot of the bugs need to be worked out. The new
expenses start to take a toll on the earnings per share which cause many investors to panic.
Meanwhile, the factory is sorting out its issues and before long, it is at full capacity, finally the
factory is running smoothly! However, it is not long before the financial reports come out and
the net income has taken a big hit because of the increased expenses to get the factory
running, the stock price falls substantially, in some cases to the 52 week low.

This is a situation when Buffett and other value investors would become extremely
excited. If after doing your homework and noticing that the company has in fact created a
highly efficient factory, then buying the dip in such a situation could prove to be highly
profitable. The moral of the story here is that the company took a small financial hit in order to
build up its new investment, but the philosophy of the company and its effective processes for
operating never changed. It is situation like these, that value investors look out for.

Said more simply by Fisher, and in a broader sense “In short, the company in to which
the investor should be buying is the company which is doing things under the guidance of
exceptionally able management. A few of these things are bound to fail. Others will from time
to time produce unexpected troubles before they succeed. The investor should be thoroughly
sure in his own mind that these troubles are temporary rather than permanent. Then if these
troubles have produced a significant decline in the price of the affected stock and give promise
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of being solved in a matter of months rather than years, he will probably be on pretty safe
ground in considering that this is a time when the stock may be bought”.

Chapter 6 – When to sell

1. When a mistake has been made in the original purchase and it becomes increasingly
clear that factual background of a particular company is, by a significant margin less
favorable that originally believed.

2. If the company purchased no longer qualifies under all 15 points.

3. The third reason to sell a common stock is when the investor believes he has found a
more profitable investment, and wishes to capitalize on it.

Chapter 7 – The Hullabaloo about dividends

In this chapter Fisher talks a lot about what dividends can do for the large and small
shareholder. One common miss conception is that if a company chooses not to raise its
dividend when they are in a position to do so, they are favoring the larger shareholders. Fisher
explains that in many instances this is the wrong way of thinking, because the smaller
shareholder many times will take out a small portion of this income each year to use for other
investment. When this is the case, the company has to pay taxes on the dividend and so does
the investor. This double taxation causes dividends to be a poor use of funds when the
company has more worthwhile opportunities available. The key here is that in most cases some
sort of a divided is acceptable and necessary, but a large dividend in general should not be the
primary reason that an investor chooses to purchase a stock.

Finally, Fisher states that more often than not many investors fall into the trap of putting
too much emphasis on the size of the dividend, in most cases the big returns are found in the
low yield stocks, not the high yield stocks. The reason for this is that the lower yield dividend
stocks with good management, have the potential to open new ventures that pay more back to
the shareholders through earnings growth, and an increased value of the company, than would
be paid to an investor who owns high yielding shares.

Chapter 8 - Five Don’ts for investors

- Don’t number 1: Don’t buy into promotional companies. With an established company
investors can observe the management, the team work, all the accounting, sales, and
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the operations. Contrary to this, with promotional companies, all investors can do is
guess as to what the strength and weaknesses are. Guessing where the company may
go makes it near impossible to have the same level of track record and return of
investors who purchasing good established companies.

- Don’t number 2: Don’t ignore a good stock just because it is traded over the counter.
Trading over the counter can provide significant benefit to investors if the dealer is
selected with extreme care, just like any one individual security. Many individual
investors do not have the time to buy and sell individual securities having a dealer is a
very inexpensive form of adviser.

- Don’t number 3: Don’t buy a stock just because you like the “tone” of its annual report.
Annual reports are extremely important when researching company’s, the problem in
lies that some people put too much emphasis on them. Annual reports do not really
show if there are any true underlying issues with the company, or the communication
between the management on the true difficulties the company may be facing.

- Don’t number 4: Don’t assume that the high price at which a stock may be selling in
relation to earnings is necessarily an indication that further growth in those earnings has
largely been already discounted in the price. The easiest way to describe this is to
compare two companies. ABC company has earnings growth that is expected in the
years ahead, but it is a one-time thing, we know this because historically they have fully
exploited their new potential for earnings in the past, and then not replaced it
immediately with another new way, or ways to continue to grow earnings at the same
rate. If this is the case than it is safe to say that if the company is trading at twice the P/E
of the DOW then it is probably fairly priced, and the high price is already discounted for
future earnings. We know this because once the earnings surge is over then the stock
will settle back down to a P/E and price that is in line with regular shares.

On the flip side, if the company is constantly selling at twice the P/E of the DOW
and rather than going through spurts of large earning increases, continues to innovate
and come up with new ideas in a upward trending industry. Than it is much safer to say
that this company has not been discounted properly into the future and may prove to
be a bargain. This comparison is simply trying to note, at times stocks that are priced
high above the DOW may still be one of the cheapest stocks on the market.

- Don’t number 5: Don’t quibble over eighths and quarters. Many investors fall into the
trap of refusing to buy unless the stock they are interested in falls to an absolute price
just to save a dollar. I am talking about setting a limit order at $30 when the stock is
selling for $30.50 and then refusing to purchase the stock because it didn’t fall another
$.50. This is a dangerous way to invest because there are times when for one reason or
another, the stock will never fall to that price. In this case the investor would have
completely missed the boat, over a miniscule amount of money, this a extremely naive,
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all things considered if the investor truly believes he is purchasing a valuable company,
he SHOULD NOT, throw that opportunity away over a few cents.

Chapter 9 – Five more don’ts for investors.

- Don’t number 1: Don’t overstress diversification. Diversification is a very important part

of a successful portfolio. The problem is that experts and the media stress this idea so
much that the common individual investor at times will put far too little in companies he
knows well, because he puts an equal, or almost equal amount in a company he hardly
knows at all, just to be diversified, this is a mistake.

Another important factor to consider is that buying multiple stocks in the same
industry limits diversification, they are usually tied together in more than one way.
Purchasing 5 stocks in the same industry diversifies the investor’s portfolio far less than
purchasing 5 stocks across different industries. One method of diversification is to
purchase 5 wisely chosen growth stocks, putting 20 percent in each. This does not mean
however, that if over time one stock does really well and become 40% of his holding
that he should redistribute his earnings cross the others to hold a constant 20 percent
across all holdings. The investor may also choose to put 10% in 10 more established
stocks, with approximately 15-100 million a year in sales.

The final method Fisher mentions, is investing in smaller cap stocks. Here he
suggests no more than 5% of the investor’s portfolio. These are companies that have a
huge potential upside, but also the possibility of a total loss.

- Don’t number 2: Don’t be afraid of buying on a war scare. History has shown that
common stocks plummet in times of war, even the threat of war can have this effect.
History has also shown when the conflict is over, stocks always rebound to even higher
levels. Philip explains that investors should buy slowly on the threat of war and then
increase that buying significantly if war actually breaks out. Ideally, investors should
purchase companies that manufacture products that will remain in demand during war,
or even increase in demand.

- Don’t number 3: Don’t forget your Gilbert and Sullivan. Many investors make the
mistake of looking at the per share earnings over the past 5 or 10 years, without looking
at the context of why they were priced where they were priced. Past stock price and
earnings are irrelevant if there is no context for why they were what they were. What is
important is understanding why, as well as where the company is headed over the next
several years. One example fisher uses of this is Texas instruments. In this scenario,
many of the executives had made substantial gains since they began acquiring share as
part of their compensation. Historically they had pretty steady growth but it wasn’t
anything outstanding. Earnings per share for the prior 4 years were $.39, $.40, $.48 and
$.50. When the executives decided to sell in order to pocket some of their earnings and
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diversify into other securities, the media took this as sign to sell and followed suit. The
result was a large decline in the share price. Meanwhile, their military electronics
business as well as transistor business boomed! The lesson here is that things are not
always as they appear. All that being said, the other important thing to remember about
this is that the mistake is not in looking at past earnings, but in putting too much
emphasis on them. Past earnings are important, but they should not be as heavily
weighted as many believe.

- Don’t number 4: Don’t fail to consider time as well as price in buying a true growth
stock. For this one, the best explanation is through an example, I will use the one Fisher
uses in his book.

Suppose Company ABC is selling at a price of $32, due to a lot of attention in the
media because of previous ventures. After valuing the company, you see it as worth
about $20. Do to these past influences and the new announcements that have been
made, you believe the company is going to be worth about $75 in the next 5 years. The
question is, do you hold out to buy the stock to see if it falls in order to get a higher gain,
or do you pay the higher price, and possibly receive a smaller overall gain? Very tough
indeed…. Fisher explains that one way around this is to use time as your guide, instead
of price. If you know the company will receive a new pilot in 6 months, why not set a
time frame of 5 months and purchase one month before it’s unveiling? Fisher
justification is that ideally you would like to get as low of a price as possible, but if there
is no guarantee that it will go as low as you expect and you can’t predict if the price will
go up or down on the announcement. Then picking a date may be easier, because at
least then you will be able to purchase the stock, and not miss out all together on a
company that you know has potential, just because it did not fall another few points to
your desired price.

- Don’t number 5: Don’t follow the crowd. This don’t is one of my favorites, because it
speaks to the essence of value investing. Fisher explains that the financial crowd can
have a huge effect on the price of a stock, the opportunity here is that often times the
value of a company can be either inflated or deflated significantly. One recent example
of this is Tesla. Tesla may still be of good value because of its potential to be such a
dominant force, but looking strictly at its numbers, it is grossly overvalued. The
important point here is that on the flip side of this, sometimes companies are also
grossly undervalued for one reason or another. This can happen for a number of
reasons, one is political drama or some bad luck with a new product. At any rate, what is
important here is as an investor this dramatic decrease in share price, can present an
opportunity if there is little to no decease in the overall strength or potential of the
company.

Chapter 10 – How I go about finding a growth stock

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- Fisher states that there are key matters to consider when selecting the correct growth
stock. This in essence is looking at how the company measures up to the fifteen points
already discussed. One difference is that with selecting a growth stock there is special
emphasis placed on two things. The first is, is the company on a path towards a business
that can provide an unusually high growth in sales? Second does the company have a
moat with this increase in sales? How difficult would it be for other companies to enter
into that market? Fisher tells the reader that after the company has been evaluated
against the fifteen points, the next step is to gain as much inside knowledge as possible.
This can be done by talking to other investors, or ideally by talking to people close to the
company. After sufficient research is done, the next step is to talk to the management.
This conversation can be difficult, but the key here is to try and get as much insight into
the company beforehand as possible, so that you can ask intelligent questions.
Management will be much more inclined to answer your questions if they sense that
you already know something about their business.

As stated in the book, an important fact to consider is this, “an investor should
never visit the management of any company he is considering for investment until he
has first gathered together at least 50 percent of all the knowledge he would need to
make the investment.”

Fisher is thorough, but this is precisely why he has done so well over his
investment career. To give you an idea of how thorough, Fisher explains his ratio of
visits to management. For perhaps every 150-250 stocks researched, Fisher visits 1 and
of all the companies he has visited, Fisher has usually invested about 50% of the time.
At the end of the chapter Fisher makes a statement that I find very interesting, as well
as entertaining! As you may expect, Fisher has received quite a bit of criticism for his
technique because of how labor intensive it is. He proceeds to remind the reader, “In
what other line of activity can you put $10,000 in one year and ten years later with only
occasionally checking, be able to have an asset worth from $40,000 to $150,000”? A
valid statement indeed!

Part two: Conservative Investors Sleep Well

Chapter 1 – The First Dimension of a Conservative Investment, “Superiority in Production,

Marketing, Research, and Financial Skills”

The four major divisions of the conservative investment.

1. Low-Cost Production. It is important that the company in question is one of the, if
not the lowest cost producer in the industry. Margins need to stay high in order to
assure the company remains above the breakeven point even in a down turn. Lower
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cost and higher margin are also conducive to greater retained earnings, allowing the
company to finance its self. This eliminates the delusion of common shares when
more are issued to raise capital, as well as eliminates the potential for the company
to have to borrow excessively in order to expand its operations.

2. Strong Marketing Organization. Marketing needs to stay relevant and in touch with
what the consumer wants. It is important to be able to adjust your company to cater
to your audience as they evolve. The world is constantly changing; a strong
marketing team is instrumental in maintaining relevance.

3. Outstanding Research and Technical Effort. Just like with marketing, research and
development is on the front lines for a company to stay relevant. In order to keep
moving the machine forward, new ideas, products and procedures, etc. must be
continually cultivated.

4. Financial Skill. Companies who have a good grasp of their finances can utilize their
energy the most efficiently towards the products that benefit them most. They can
also use this knowledge to reduce costs where they see there is the biggest issue, or
opportunity for improvement. A strong understanding of the company’s finances, is
also a key element in catching early warning signs of a potential problem.

Chapter 2 – The Second Dimension, “The People Factor”

It’s about the people, the number one factor that has the biggest driving factor for any
company is the people that work there. Attitude and culture are everything. The most
successful companies in the world generally share one very important trait, and this is the
practice of promoting from within. Well run companies should have tiers of management,
where the more senior employees teach and mentor the people right below them. Promoting
from within cultivates a culture of loyalty, dedication and motivation. If employees feel they
have opportunities at the company they work for, they are much more inclined to push
themselves or shoot for more responsibility.

When it comes to the CEO’s, the best CEO’s, are those which surround themselves with a group
of people whom they trust, and can delegate a large amount of responsibility to in each of their
areas of expertise.

“However much policies may differ among companies, there are three elements that must
always be present if a company shares are to be worthy of holding for conservative, long-range
investment.”

1. “The company must recognize that the world in which it is operating is changing at
an ever-increasing rate.” In a nut shell, “change and improvement arise from
innovative thinking to make a workable system better, not from a forced reaction to
a crisis.”
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2. “There must always be a conscious and continuous effort, based on fact, not
propaganda, to have employees at every level, from the mostly newly hired blue-
collar or white-collar worker to the highest levels of management, feel that their
company is a good place to work.”

3. “Management must be willing to submit itself to the disciplines required for sound
growth.” The big take away from this, is that growth oriented companies must focus
on making enough to expand their business, and then do just that with it. Rather
than taking every cent from the company and using it to grow the bottom line.”

Chapter 3 – The Third dimension, “Investment Characteristics of some businesses”

The third dimension can be stated as, does the company have the traits and enough of a
competitive advantage that it can produce significant profitability into the foreseeable future?
In a growth company, profitability is of the utmost importance, the cost of research, products,
buildings, failed investments, payroll, you name it, no company is starved as much for money as
a growth company.

Fisher states in his book that profitability can be expressed in two ways. Method one, is
the one most often used by management, ROA, or return on invested assets (Net income/total
assets) *for more valuation ratios visit (link to valuation tools page). Method two, is
comparing the profit margin per dollar of sales. For this method, method one also has to be
considered and kept in our minds, because they work in tandem. Inevitability, if the company in
question has both of these, chances are there is some heavy competition in that market. The
company can set its self apart by operating more efficiently than anyone else.

As an investor, it is important to know the market share of the company you are
researching. In very profitable industries it is common for there to be heavy competition, so
much so, that if your company is at the top with market share in an industry, even if they have
only 2-3 percent more in terms of percent of sales, you have great investment.

Chapter 4 – The Fourth Dimension, “Price of a conservative investment”

The fourth dimension involves the price earnings ratio (link valuation tools article).
The law of price changes can be stated in just a few words, but they are very powerful indeed.
“Every significant price move of any individual common stock in relation to stocks as a whole
occurs because of a changed appraisal of that stock by the financial community.”

Fisher makes another profound pricing statement a little further into the chapter. In a
few words, he explains exactly what happens to the pricing of common stocks on a day to day
basis. “Any individual stock does not rise or fall at any particular moment in time because of
what is happening and will happen to that company, it rises or falls according to the current
consensus of the financial community as to what is happening and what will happen, regardless
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of how far off the consensus might be”. In my eyes this is gold, in a short sentence we learn
how it is that stocks can be over or undervalued in the market.

In this next part Fisher explains a dilemma that many investor face and one I have
struggled with many times in my own experiences, the situation is whether to hold the tock or
not when the price is too high. This is always a tough choice, but if the fundamentals of the
company you purchased still remain in tacked, then the right choice is to hold. The reason for
this is that if you truly found a good company than eventually its valuation will be in line with its
worth. There may be some downside in this process, but over an extended period of time, the
value is there. Another reason, is the chances of selling and then trying to rebuy at a lower price
can be extremely difficult to time. Often times you end up selling at the bottom, but then don’t
know when to get back in until too late, consequently you miss out on a good portion of the
rally.

Chapter 5 – “More about the Fourth Dimension”

This was a very short chapter, and its focus is on going into greater detail about the
financial communities appraisal of a stock and how that can affect the price, the most critical
take away from this chapter can be summarized as follows: “The conservative investor must be
aware of the nature of the current financial community appraisal of any industry in which he is
interested.” The reason this is important is because the investor when trying to determine
when to purchase a security, should be comparing the market price to the fundamentals as
discussed earlier. This is how we as value investors find companies that are undervalued, and
potentially worth purchasing

Chapter 6 – “Still More about the Fourth Dimension”

The main focus of chapter six is that investors need to do the research themselves, in order
to make sure the value the financial community placed on the stock in question is actually 100%
valid, or if they are off in one way or another. Most of the time the financial communities view
of a particular company is reflected in the P/E ratio.

Another interesting factor that Fisher explains is that, “the further into the future profits
will continue to grow, the higher the price-earnings ratio an investor can afford to pay.” He
demonstrates this by illustrating that even if a company doubles its earnings year over year, but
then has flat forecasted earnings for the next 4-5 years, the price will undoubtedly remain
almost exactly the same, as before the earnings were doubled. The only caveat to the previous
rule is the P/E ratio is driven by the financial community. Therefore, it needs to be taken with a
grain of salt, they could perceive the situation wrong and still give the company a higher
valuation despite the bleak earnings forecast.

This whole concept of the financial community perceiving a stock’s price incorrectly as
previously discussed, is the main premise behind value investing. One great example of this is
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the Wells Fargo scandal that just happened in 2017. After this scandal, Wells Fargo’s stock price
had seen a significant draw down, the stock price fell to $44.23, a loss of about 10%, but for
what? Just bad publicity? Yes, they did break the law, but the quality of the company did not
change because of this, these are the types of bargains we are looking for.

Fisher reveals another genius concept in this chapter and it is one that even the most
sophisticated investors must be warry of. The concept is as follows. Suppose company X has
been trading at between $32-$35 per share for quite some time, as an investor it is easy to
assume that this must be the genuine value of the company. Therefore, if the price where to
then fall to say $22 a share, then the stock must be cheap right? The dangerous mistake here is
not actually valuing the company and taking the markets word for it, the reality is there is a
very real possibility that even $22 a share is too high a price. On the flip side of this concept, it
is easy to want to sell when a stock that has been purchased rises from say 60-70, 50-70, but
again, if $70 is still a low value for that stock, then the investor is making a mistake.

The last concept Fisher mentions is interest rates, in the most practical sense this is the 10-
year treasury note. As the 10-year interest rate increases money flows out of the stock market,
as the rate goes lower money will flow into the stock market. The reason for this, is that if an
investor can get a good rate purchasing government bonds at zero risk, why would he take his
chances with stocks, for only a couple more percentage points?

All that being said, the fourth dimension can be summarized as follows: The price of a stock
at a moment in time is determined by the financial community’s appraisal of the company, and
the industry which it is in and to some degree the general level of stock prices. Determining if
the stock is actually worth a given price and not under or overvalued, depends on how far off
these factors are from reality. To the extent that general market prices affect the total picture,
it depends on being able to somewhat estimate changes in financial factors, the most
important one of these is the interest rate.

Part three: Developing An Investment Philosophy

Conclusion- summary of Philips investment philosophy

1. Buy into companies that have disciplined plans for achieving dramatic long-rang growth
in profits and that have inherent qualities making it difficult for newcomers to share in
that growth.

2. Focus on buying these company’s when they are out of favor.

3. Hold the stock until either (a) there has been a fundamental change in its nature (such
as a weakening of management through changed personnel) or (b) it has grown to a
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point where it no longer will be growing faster than the economy as a whole. Only in the
most exceptional circumstances, if ever, sell because of forecasts as to what the
economy or the stock market is going to do, because these changes are too hard to
predict. Never sell the most attractive stocks you own for short term reasons. However,
as companies grow, remember that many companies that are quite efficiently run when
they are small fail to change management style to meet the different requirements or
skill big companies need. When management fails to grow as companies grow, share
should be sold.

4. For those primarily seeking major appreciation of their capital, de-emphasize the
importance of dividends. The most attractive opportunities are most likely to occur in
the profitable, but low or no dividend payout groups. Unusual opportunities are much
less likely to be found in situations where a high percentage of profits are paid to
stockholders in dividends.

5. Making some mistakes is as much an inherent cost of investing for major gains as
making some bad loans is inevitable in even the best run and most profitable lending
institution. The important thing is to recognize them as soon as possible, to understand
their causes, and to learn how to keep from repeating the mistakes. Willingness to take
small losses in some stocks and to let profits grow bigger and bigger in the most
promising stocks is a sign of good investment judgment. A profit should never be taken
just for the satisfaction of taking it.

6. There are a relatively small number of truly outstanding companies. Their shares
frequently cannot be bought at attractive prices. Therefore, when favorable prices exist,
full advantage should be taken of the situation. Funds should be concentrated in the
most desirable opportunities. For those involved in venture capital and quite small
companies, say with annual sales of under $25,000,000. More diversification may be
necessary. For larger companies, proper diversification requires investing in a variety of
industries with different economic characteristics. For individuals (in possible contrast to
institutions and certain types of funds), any holdings of over twenty different stocks is a
sign of financial incompetence. Ten or twelve is usually a better number sometimes the
costs of the capital gains tax may justify taking several years to complete a move
towards concentration. As an individual’s holdings climb towards as many as twenty
stocks, it nearly always is desirable to switch from the least attractive of these stocks to
more of the attractive. It should be remembered that ERISA stands for Emasculated
Results: Insufficient Sophisticated Actions.

7. A basic ingredient of outstanding common stock management is the ability neither to

accept blindly whatever may be the dominant option in the financial community at the
moment, nor to reject the prevailing view just to be contrary for the sake of being
contrary. Rather, it is to have more knowledge and to apply better judgement, through
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evaluation of specific situations and the moral courage to act “in opposition to the
crowd” when your judgment tells you, you are right.

8. In the handling of common stocks, as in most other fields of human activity, success
greatly depends on a combination of hard work, intelligence, and honestly.