When the S&P 500 closed the year 2008 down 38.5 percent, it marked the second-worst year in history for the index. The worst year was 1931, during the Great Depression, when the index was down 43.3 percent, and Philip A. Fisher founded his investment counseling firm, Fisher & Company. By 1957, when Fisher published his now famous book Common Stocks and Uncommon Profits, a total of 10 out of his 24 years in the investment business were marked by negative S&P 500 returns. In 1974, the S&P 500 had its fourth-worst year in history (down 26.5 percent) and Fisher published his second piece, Conservative Investors Sleep Well.

There has never been a more urgent time to consider Fisher’s writings, given that our generation has only experienced four years of negative S&P 500 returns in the past 24 years, and that the S&P 500 is continuing its downward trend into 2009, at the time of writing of this article. Fisher’s experiences of volatile markets are implicit within his investment philosophy, which is focused upon the objective of capital appreciation through holding a few good-quality businesses with outstanding growth opportunities over the long term. Here are some of Fisher’s strategies for investing in bad (and good) market conditions.

1) Buy high-quality companies

With stock prices currently at historic lows, the challenge for the investor is to acquire high-quality companies that are temporarily undervalued by the market. According to Fisher, superior investment returns are only attained by buying excellent growth businesses and holding them for the long term.

In Common Stocks and Uncommon Profits, Fisher explains why it is simply not good enough to use quantitative models to look for bargains. One of the problems with relying on quantitative analysis is that “there may be such acute business troubles lying ahead, yet not discernible from a purely statistical study, that instead of being bargains they are actually selling at prices which in a few years will have proven to be very high.”¹ Furthermore, Fisher argues that even if one finds a “genuine bargain,” if the company is not a growth company then it could take a very long time for the stock to appreciate to its true value. As a consequence, “the most skilled statistical bargain hunter ends up with a profit which is a small part of the profit characteristics of superbly managed growth companies.”²

Fisher’s innovations were radical for his time. When he published his 15-point standard for assessing the quality of a business in 1957, most long-term investors were following the Benjamin Graham approach of buying companies at a discount to their intrinsic value. Warren Buffett didn’t apply Fisher’s ideas about quality until 15 years later, when he acquired See’s Candy Shops. As recounted in Buffett’s biography The Snowball, Buffett had to be convinced to pay for a brand name that had all the elements that Fisher looks for in a quality business: a smart manager in Chuck Huggins, a monopoly on “top quality” candy, a loyal customer base with recurring demand, and a reputation that was golden. This reputation was formed during World War II when, lacking large amounts of quality ingredients, See’s had to choose between compromising the quality of its recipes to generate sales, or shutting down. It chose the latter, and hung the sign “Sold out. Buy war bonds for Christmas,”³ over the storefront. Investing in See’s convinced Buffett of the value inherent in a quality business: “If we hadn’t bought See’s, we wouldn’t have bought Coke.”⁴

2) Use “scuttlebutt” in your investment decision-making process

When looking for investment opportunities, employ Fisher’s “scuttlebutt” methodology for narrowing down the investment universe to companies that meet the quality criterion. This approach involves gathering a cross-section of opinions from people who are associated with a company in order to paint a picture of that company’s strengths and weaknesses relative to others in the industry. According to Fisher, “scuttlebutt so many times furnishes an accurate forecast of how well a company will measure up to my 15 points, that usually by the time I am ready to visit the management there will at least be a fair chance that I will want to buy into the company.”⁵

Implicit behind the “scuttlebutt” methodology is the theory that problems within a company are systemic throughout. For example, problems at an upper managerial level may have cascading repercussions at much lower levels, even though it may not be immediately evident how the lower levels are related causally. Think about a company like Walmart, for example. Would interviewing employees who work the floor, and gauging their job satisfaction tell anything about the overall profitability or management of the company? Probably it would. At the very least it would inform us about whether the company has a robust philosophy or culture that informs all levels of practice.

Warren Buffett understood early in his career the value of investigating a company from all angles. In 1963, when a public scandal cut the price of American Express in half, Buffett needed to determine if customers had lost their trust in the American Express brand name. He employed Henry Brandt, a “born sleuth,” who “scouted Travelers Cheque users, bank tellers, bank officers, restaurants, hotels and credit card holders to gauge how American Express was doing versus its competitors, and whether the use of American Express Travelers Cheques and cards had dropped off.”⁶ Only when he was certain that the reputation of American Express was intact did he pour money into the stock, making it his largest investment at the time.

3) You only need to find a few growth companies

A practical outcome of Fisher’s investment process is the notion that the time and work spent investigating companies for quality necessarily means that an investor will only be able to sufficiently understand a few companies really well. In his view, it is far better for an investor to put money into a few well-known stocks, rather than spreading it across a wide range of stocks about which the investor knows very little. As Fisher put it, “to make big money on investments it is unnecessary to get some answer to every investment that might be considered. What is necessary is to get the right answer a large proportion of the very small number of times actual purchases are made.”⁷

Fisher uses a classmate analogy to explain the value of investing in only a few quality growth companies for the very long term.⁸ Suppose you are graduating from university and your classmates offer you a deal. Each proposes to give you one-quarter of their subsequent yearly earnings for the rest of their life in exchange for 10 times what they will earn over the next 12 months. You can only make the deal with three of your peers.

Your first step would be to analyze your classmates to determine how much money they might make. You would immediately discard most of your classmates because you don’t know them well enough to judge their potential earning power. Of the classmates you know well, you would select the best three.

In 10 years, one of the three has done extremely well, having been promoted several times, and he is now in a position to take the top job. This contract has been extremely profitable for you up until now, and someone offers to buy it at a 600 percent return on your original investment so that you can enter into a new contract with a classmate whose potential has not yet been unleashed (he is still earning the same amount as 10 years ago). Would you take the offer? Clearly, holding on to the single high-quality growth stock is better than selling!

4) Don’t sell high quality (unless you have a really good reason)

Fisher is adamant that selling outstanding companies in a bear market is the wrong action to take. He argues that an investor who sells a good company out of fear of the market “is ignoring a powerful influence about which he has positive knowledge through fear of a less powerful force about which… he and everyone else is largely guessing.”⁹ Moreover, he argues that there is a tremendous cost to investors who sell good companies in a bear market with the hope of buying them back. Not only is an investor unable to predict the market bottom, but in his experience investors usually also wait too long to reinvest: “When a bear market has come, I have not seen one time in 10 when the investor actually got back into the same shares before they had gone up above his selling price. Usually he either waited for them to go far lower than they actually dropped, or, when they were way down, fear of something else happening still prevented their reinstatement.”¹⁰

Given the current bear market, what are valid reasons in Fisher’s opinion to sell? Assuming the investor holds common stocks that were bought with an eye for quality, Fisher states that an investor should sell only if he realizes that a mistake has been made in the initial purchase, and/or if the business has changed such that it no longer fits the 15-point standard for quality. A third reason, which is particularly relevant to the current bear market, is that opportunities for attractive investment are magnified when prices are at historic lows, and investors should take advantage of the potential to upgrade their portfolios with companies that have seemingly better growth prospects.

In this era of deep uncertainty, when actual experience of real adversity in the capital markets is rare or nonexistent, we can be grateful that Phil Fisher left us a simple, sensible blueprint for investing our clients’ money.

¹ Phil Fisher, “Common Stocks and Uncommon Profits,” in Common Stocks and Uncommon Profits and Other Writings (Hoboken: John Wiley & Sons, 2003), 80.
² Ibid., 80.
³ Alice Schroeder, The Snowball: Warren Buffett and the Business of Life (New York: Bantam Books, 2008), 345.
⁴ Janet Lowe, Damn Right! Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger (New York: John Wiley, 2000), 133.
⁵ Fisher, 170.
⁶ Schroeder, 260.
⁷ Fisher, 167.
⁸ Ibid., 112.
⁹ Ibid., 109.
¹⁰ Ibid., 110.