If you follow Warren Buffett’s Q&A session at the Berkshire Hathaway shareholder meetings, you have probably heard the Berkshire Hathaway CEO describe himself as as 85% Benjamin Graham and 15% Phil Fisher. The useful examination that follows is: In what regard is Buffett 15% Phil Fisher, and would it be wise for us to emulate likewise?
My view is that Phil Fisher’s appeal comes from plugging in answers to the limitations of Benjamin Graham’s philosophy and offering one superior edge.
The two limitations of Graham’s philosophy are that the types of bargains he found during the days of “Security Analysis” do not exist any more. Warren Buffett found an insurance operation in the 1950s trading in the $30s that was worth over triple the amount that he paid. The percent of publicly traded stock trading at a 70% to 90% discount is dramatically less than what Graham could find when he was scouring the detritus of The Great Depression.
Secondly, Graham made his money by purchasing undervalued stocks and then selling them at fair value within a few years. The extent of undervaluation must be so steep that it covers the taxability of the event. With a 23.8% tax being applied every time you switch investments, you must overcome this capital-cutting that the buy-and-hold investor does not have to endure.
Aside from the fact that following Graham’s strategy subjects you to more taxable events, you must also recognize that value investing is not nearly as self-propelling as buy-and-holding growth stocks.
In Common Stock and Uncommon Profits, Phil Fisher described this difference as follows:
“The reason why the growth stocks do so much better is that they seem to show gains in value in the hundreds of percent each decade. In contrast, it is an unusual bargain that is as much as 50 percent undervalued. The cumulative effect of this simple arithmetic should be obvious. In what other line of activity could you put $10,000 in one year and ten years later (with only occasional checking in the meantime to be sure management continues of high caliber) be able to have an asset worth from $40,000 to $150,000?”
If you choose an investment that you believe is worth x but is trading at 0.5x, the question is: What does the subsequent performance look like once x is achieved? But if a business is worth x and trading at 1.25x, and is growing at 15% for the next decade, you can see why the passivity of the latter is rewarded because the enormity of the growth overcompensates for any valuation that needs to get burned off when you overpay by a little bit.
When I try to look for value investments, I am willing to accept less on the value side if I get more on the growth side. In other words, I’d prefer the stock trading at 0.6x its value rather than 0.4x its value if I think the former stock is going to grow at 6% once it gets its act together. That is why I have liked IBM. It has probably traded at a discount between 20% to 30% discount during the time I covered it, but that discount intermingles with mid single digit earnings growth. In Buffett-like terms, I’d like to see the intrinsic value increasing during the same time I’m waiting for the market price to shift from undervaluation to fair valuation. I call it Fisherifying your Graham stocks.
If I had to get specific and reconcile these different philosophies into a coherent investment philosophy, I’ll offer this. I’d put 75% of assets into higher growth buy-and-hold-forever stocks like Brown Forman, Colgate-Palmolive, Hershey, and Nike, and then the remaining 25% into Fisherified value stocks like DineEquity during the 2010 through 2015 stretch when it was cheap at the beginning of the period while simultaneously increasing its intrinsic value due to the receipt of significant one-time franchise fees. I’m not sure there is much of a place for a strict Graham value stock, which I define as a stock trading at the sharpest discount to fair value X with no heed to whether the intrinsic value of X is expected to grow.