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Author: xerohype Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 8764  
Subject: Comparing Fisher to GG (very long) Date: 10/1/2000 2:44 PM
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Comparing Fisher's Principles to The Gorilla Game

by xerohype

A few weeks ago I had the pleasure to read Philip Fisher's Common Stocks and Uncommon Profits (heretofore referred to as CSUP). Fisher's investment philosophy fits very well with my philosophy of picking the very best companies and holding them for a long time. I think that as Gorilla Gamers we can use some of Fisher's principles as part of our arsenal for evaluating potential Gorillas. Fisher really studies the aspects of businesses that deal with good execution, especially analyzing the management of a company. A Gorilla such as PSFT that stumbles may have been recognized earlier through the application of Fisher's points. Microsoft has failed in some very key Fisher points, most notably when Bill Gates testified in the antitrust trial. A Gorilla that can't execute properly will be weakened, and a King that doesn't execute will be brought down in a big hurry by one or more Princes in its royalty game.

I recently posted a series of original articles in the KP board dealing with LTBH investing. In those articles I discuss LTBH elements from the Gorilla Game and also from Fisher's writings.

LTBH Series Introduction
http://boards.fool.com/Message.asp?mid=13372174

LTBH I: Why LTBH?
http://boards.fool.com/Message.asp?mid=13372291

LTBH II: Selecting LTBH stocks
http://boards.fool.com/Message.asp?mid=13372309

LTBH III: Jumping into the Market
http://boards.fool.com/Message.asp?mid=13372339

LTBH IV: Monitoring LTBH stocks
http://boards.fool.com/Message.asp?mid=13372374

LTBH V: When to sell
http://boards.fool.com/Message.asp?mid=13372399

There are many elements of Foolish investing that come from Fisher's philosophy:
Hold great companies for the long term
Invest for sustained growth and expanding possibilities.
Invest in companies with excellent management.

Let's take a look at Fisher's 15 Points:

The Fifteen Points to Look for Before Buying a Common Stock

1. Does the company have products or services with sufficient market potential to make possible a sizable increase in 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 potentials when the growth potentials of currently attractive product lines have largely been exploited?

3. How effective are the company's 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 margins?

7. Does the company have outstanding labor and personnel 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 competitors?

12. Does the company have a short-range or long-range outlook in regard 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 be "clam up" when troubles and disappointments occur?

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

Rubic in Grape's Fisher Kings board posts these points along with the first paragraph of their discussion:
http://boards.fool.com/Message.asp?mid=11610111

Mark (mlc11) does an outstanding job of summarizing Fisher's 15 points in these two great posts, that are part of an ongoing CSUP book club study by the graduates from the July RM Seminar:
http://boards.fool.com/Message.asp?mid=13268582
http://boards.fool.com/Message.asp?mid=13268605

Here are some examples of recent Fisher analyses of twosome companies we are familiar with:

JDSU by Phileo
http://www.tsrec.com/jdsu-fisher.html
http://www.tsrec.com/jdsu-fisher2.html
http://www.tsrec.com/jdsu-fisher3.html

NOK by TMFMycroft
http://boards.fool.com/Message.asp?mid=12780762


The whole Fisher philosophy comes down to researching the heck out of a company before you buy it, picking the very best and sticking with them for the long term (as long as those fundamentals hold) watching your gains compound to big returns.

That really jives with my personal philosophy. In page 7 of CSUP he writes: "These opportunities did not require purchasing on a particular day at the bottom of a great panic. The shares of these companies were available year after year at prices that were to make this kind of profit possible."

Fisher believes in sustainable growth, and also in companies that invest heavily in R&D to sustain that growth. These are my kind of companies, ones that look toward the future and improve all our lives with their products.

The other key subjective criteria with Fisher is that of excellent management, one that looks toward the future, not to short term earnings numbers.

We'll come back to Fisher as soon as we review some of the main concepts from The Gorilla Game.

+++++++++++++++++++++++
GG FAQ:
http://boards.fool.com/Message.asp?mid=13091110

GG criteria (from GG FAQ):

1. Discontinuous innovation
2. Proprietary open architecture
3. High barriers to entry
4. High switching costs
5. Strong value chain formation
6. Tornado market exists or foreseeable

Ten rules of GG (from the book by Geoffrey A. Moore, Paul Johnson and Tom Kippola):

1. If the category is application software, begin buying in the bowling alley.

2. If the category is enabling hardware or software, begin buying after the tornado has formed.

3. Buy a basket comprising of all the gorilla candidates-usually at least two, sometimes three, and normally no more than four companies.

4. Hold gorilla stocks for the long term. Sell only on proven substitution threat.

5. Hold application software chimp stocks as long as they exhibit potential for further market expansion. Do not hold enabling-technology chimps.

6. Hold kings and princes lightly, selling individual stocks on a marketplace stumble and the category upon deceleration of hypergrowth.

7. Once it becomes clear to you that a company will never become a gorilla, sell its stock.

8. Money taken out of non-gorilla stocks should immediately be reinvested in the remaining gorilla candidates.

9. In a gorilla collision, hold your gorilla candidates until there has been a definitive outcome.

10. Most news has nothing to do with the gorilla game. Learn to ignore it.

+++++++++++++++++++++

mlc11 posts a variation of Fisher's points here:
http://boards.fool.com/Message.asp?mid=13325367
This is from John Train's chapter on Fisher in The Money Masters:

Train feels that among Fisher's writings are probably about 20 points to examine, which can be grouped under 2 main categories:

Characteristics of an attractive business:

1. Growth from existing products and from new ones.
2. A high profit margin and return on capital, together with favorable trends for both.
3. Effective research.
4. A superior sales organization.
5. A leading industry position giving advantages of scale.
6. A valid "franchise"-proprietary products and services.

Qualities of management:

1. Integrity, implying conservative accounting
2. Accessibility
3. An orientation toward long-range results (if necessary at the expense of this quarter's bottom line) without equity dilution.
4. A recogntion of the pervasiveness of change
5. Excellent financial controls.
6. Multidisciplinary skills (where appropriate).
7. The special skills associated with particular industries.
8. Good personnel policies, including management training. He insists that a company must consciously and continually become a better place to work, from the executive level to union relations, and to be so perceived by its employees.

You may recognize a few of the attributes above in your favorite Gorillas. I'll just comment quickly on some of the similarities between the points above and GG.

The growth must be sustained, that means that the company has good growth from existing products and is looking for other markets in which to tornado in. High profit margins are a good measure of Gorilla power. Effective research to me means that you can take your products across the chasm to start new tornadoes (just like CSCO has done). Superior sales are key during the tornado phase of the technology product cycle, where the land grab for market share is key. Gorillas are known for having leading industry positions, they own that value chain through their proprietary architecture (their franchise so to speak) and the openness of that architecture makes it scalable. The qualities of management are key for great execution in all phases of the company's growth cycle.

++++++++++++++++++++++

Let me continue by discussing the similarities and differences between Fisher's points and GG by taking the Fifteen Points one by one. Let me caution that Fisher's points can apply to any company, while the GG is directed strictly towards technology. Of course, two of Fisher's favorite companies were Motorola (MOT) and Texas Instruments (TXN), leading technology companies to this day (though not Gorillas). The point of this exercise is not to meld the two philosophies, but to compare and contrast them in order to enhance our ability to find the best companies out there, the ones which will produce the outsized returns on our investment that we all crave and that Fisher was able to achieve during his long career as an investor.

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

This is the whole point of GG, to pick companies that have sustainable growth because they control the rights to an open proprietary architecture. A gorilla company entering its period of hypergrowth (tornado) will have many years of fat profits as it goes into Main Street.

2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?

This actually goes towards points that Moore addresses in his new book, Living on the Fault Line (LOTFL). Mature Gorillas and Kings must be ready to enter new markets with the possibility of new tornadoes, but this is made difficult by corporate inertia. Discontinuous innovation is usually suppressed in most corporate cultures, and then a new hot startup emerges that can usurp the mature gorilla. For example, IBM taken down by MSFT and INTC. That's one of the reasons that CSCO has been so successful, it acquires companies in the pre-chasm stage and assimilates their technology (can you say Borg-like) to enter new tornadoes.

3. How effective are the company's research and development efforts in relation to its size?

This point is very important for a technology company to maintain its lead. One can either develop technology in-house such as Lucent or buy it and integrate it like CSCO. In order to enter a tornado the R&D group must be very strong, and companies that invest a great deal in R&D have usually made great investments. Moore again makes some excellent points in LOTFL and Crossing the Chasm. It's not enough to have cool R&D products, you've got to have them cross the chasm. The way to do this is to apply a bowling pin strategy by going after niche markets that are all related each successive pin will then help convince the pragmatists in the herd that they should go with your product. R&D then serves to support the sales effort by making the product work and getting it out as quickly as possible to those with broken-systems that need it.

R&D to revenues is a good objective measure to look at raw spending, but for GGers you have to look under the hood of those revenues to make sure that the R&D products are crossing the chasm into the bowling alley.

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

This is critical for companies entering the tornado. The goal here is to grab as much market share as possible, thus making switching costs higher in the future. Once the market matures those customers are a lot easier to capture (they are already captive, especially for Gorilla companies). Once the tornado hits, the land grab is on, and your sales organization is critical.

5. Does the company have a worthwhile profit margin?

A telltale sign of a gorilla is high gross and net margins. They pick the sweet spot in the value chain and have all the other members take subservient spots with lower margins. Usually this translates into a light business model, heavily dependent on intellectual property.


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

A gorilla has a lock on that market, it goes with owning that proprietary open architecture. Companies like MSFT, INTC and CSCO, big gorillas all are always looking for ways to increase those already fat profit margins by squeezing efficiencies out of their manufacturing or contracting out low margin tasks.

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

8. Does the company have outstanding executive relations?

9. Does the company have depth to its management?

These are all important issues that have to do with management execution, a theme that is not explored by the Gorilla Game, but one that IMO is very important. You don't want any union strikes or personnel defections, so you must compensate your people very well. Also, you need to retain the best executive talent in order to execute and also have a clear plan for succession in your top executive team, that way Wall Street doesn't get nervous when your top man is set to retire. Moore makes the point in LOTFL that talent and time are your most scarce resources in this technology environment (money on the other hand is very available). Labor unrest and poor hiring practices can be fatal for a company trying to cross the chasm or come out ahead in a tornado market. No one can afford that kind of time loss or talent drain if they hope to compete well.

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

ORCL is a great example of a company that has really done wonders with its cost analysis and accounting controls, using its own software to save more than a Billion $ this year alone. This will definitely affect your GAP and make your company more effective. It all comes down to execution.

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 competitors?

Hmmm, let's see, how about having an open proprietary architecture, a strong value chain, high switching costs and high barriers to entry. Total domination of its industry sector may give us a clue. This is where the gorilla really shines.

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

This is key for companies aspiring to be gorillas or wanting to enter new tornadoes. Mature companies will squelch discontinuous innovation (DI) within their own R&D departments, and thus their startup competitors, the ones embracing DI will rise up and eat their lunch. Long range to me means that you fix your problems as soon as possible even if you take a short term hit in earnings (LU should be the poster child in how not to do this). LOTFL has some great points regarding how companies can nurture DI to help it cross the chasm. Mindless layoffs don't cut it, you need to shed context operations (ones that don't add to your ability to generate future profits by extending your CAP), and concentrate on the core operations.

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?

The real question here is whether you can fund future growth well with existing resources without diluting shareholders equity. As long as the capital is used to acquire R&D that leads to future tornadoes, this should not be a problem. Large increases in numbers of shares outstanding should be monitored by all investors. This is more of an issue for companies in Main Street. For companies in the tornado or trying to cross the chasm the survival of the company depends on getting the product to market first (early and ugly is fine), so that share dilution should not be the main concern, rather winning market share is of paramount importance.

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

That's a critical question, especially when a Gorilla Collision occurs or when a discontinuous innovation threatens an established Gorilla. The more information we get from management the more power we have as investors.

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

This is a key point that is not discussed in GG much. You may be able to attribute some of Microsoft's "caged gorilla" status by the way management has acted during the antitrust trial and even before that. I'm pretty sure that SEC investigations and DOJ suits can bring to their knees even the most powerful gorillas. Just contrast the way that INTC and MSFT have handled their antitrust problems.

The Gorilla Game does a great job explaining the way that technology companies come to dominate their markets (when they become gorillas), but Fisher's work can be used to gauge how well that gorilla will execute. Execution can affect both GAP and CAP, therefore market cap.

The strategies for handling buying stocks are a little different for both methods. Fisher is a big proponent of researching as much as possible a company, and then keeping it long term if it meets the fifteen points. For GG, one buys at the beginning of a tornado a basket of companies in that sector, consolidating into the Gorilla. Fisher will try to time the market, buying during corrections (such as with times of war) while with GG timing is not discussed much.

Selling rules are different for both methods as discussed in my LTBH selling article:
LTBH V: When to sell
http://boards.fool.com/Message.asp?mid=13372399

I believe that Fisher's principles can be used to help evaluate some of the subjective issues that might greatly affect management's execution abilities. You want to own the very best companies, and those are the ones that become Gorillas or strong Kings. The best of these will fit nicely with Fisher's points.

There is a lot more to Fisher than what I've covered above. Please feel free to challenge me on any of my flawed logic. Thanks for bearing with this long post.

-xerohype

Sources used:

GG FAQ version 1.2
http://boards.fool.com/Message.asp?mid=13091110

The Gorilla Game: Picking Winners in High Technology written by Geoffrey A. Moore, Paul Johnson and Tom Kippola.

Common Stocks and Uncommon Profits and other writings by Philip A. Fisher.

Forbes interview of Philip Fisher:
http://www.forbes.com/forbes/092396/5807222a.htm

Living on the Fault Line by Geoffrey A. Moore.

Appendix:

Helpful Links for Fisher Analysis

Taken from this post by mlc11:
http://boards.fool.com/Message.asp?mid=13288375

Business Ethics - 100 Best Corporate Citizens
http://www.business-ethics.com/the100.htm#100

Working Woman - 100 Best Companies for Working Mothers
http://www.workingwoman.com/wwn/wwn_driver.showpage?content=4337&area=30
& the 10 Best: http://preview.wwn.com/pvw/wwn_driver.showpage?content=4217&area=30

Fortune - 100 Best Companies to Work For:
http://www.fortune.com/fortune/bestcompanies/
& the 50 Best for Minorities: http://www.fortune.com/fortune/diversity/

Worth - Top 50 CEOs:
http://www.worth.com/articles/Z0005C01.html

Industry Week - Top 100 Managed Companies:
http://www.industryweek.com/iwinprint/BestManaged/2000/database/iw1000names00.asp

Job Circle - High Tech Snapshots:
http://www.jobcircle.com/career/profiles/

Council on Economic Priorities - Corporate Grades
http://www.cepnyc.org/qs/grades.wc?B1=Go+to+the+Free+Ratings+page

Electronic Business - 4000 Senior Execs in Electronics Industry respond to: "If you had to trust all your personal assets and finances to only 2 CEOs, who would they be..":
http://www.e-insite.net/e-insite/e2000/PDFs/peek1a.pdf

The key thing with a Fisher analysis is to analyze management's ability to execute. To this end you need to go through the industry trade magazines, and take in what they say about management.

Here are some online resources (from the GG FAQ) to help evaluate tech stocks:

Upside
http://www.upside.com/
Red Herring
http://www.redherring.com/
Techweb
http://www.techweb.com/
InformationWeek (some great links and in-depth stuff)
http://www.informationweek.com/
ComputerWorld
http://www.computerworld.com/
The Standard
http://www.thestandard.com
LightReading.com (the source for optical networking info)
http://www.lightreading.com
Google (an excellent search engine)
http://www.google.com

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