Bookworm: Look for Fisher’s ‘X factor’ in long-term holdings
And while you’re at it, avoid a relatively common situation that can result in rapid share price drawdowns.
Mentioned: Garmin Ltd (GRMN)
By all accounts, Phil Fisher was a remarkable man. I recently started re-reading his best-known book, Common Stocks and Uncommon Profits – a book that could just have easily been written in 2017 than in 1957, the year it was first published.
The main draw to this book is Fisher’s list of 15 points that he looks for in a company with best-in-class growth potential for the long-term. In a previous article, I ran ResMed through all fifteen. Today I’ll focus on just one of the points. One that, if we are being completely honest, is a bit of a mouthful:
“Point 2: Does the management have a determination 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?”
Why this matters
Apart from truly exceptional cases, demand for most products goes through a cycle of introduction, growth, maturity, decline and obsolescence. And those stages only really refer to the product category itself not to increasing competition within the category, which can be just as damaging.
If a company wants to keep growing its revenues, profits and value for many decades on end, this can make depending solely on your current product lines rather risky. The unaddressed opportunity in your current markets will shrink. Past growth rates will be harder to match. Changes in technology and consumer preferences could even kill the business completely.
What Fisher was looking for were, then, were companies with a knack for finding new avenues of growth beyond their current product range. Not just by constantly improving and extending their existing product lines, but by establishing new products and entering new markets.
The best results, he says, are most likely to come in areas “having some business relationship to those already within the scope of company activities”. I took this to mean markets, products and solutions where the company’s existing expertise, technology, brand and distribution power give the company a solid head-start in the new product line.
An extreme example
The story of Garmin (NYS: GRMN) shows what can happen when a product responsible for a huge percentage of your sales falls by the wayside. It is also a good example of the kind of culture and qualities you need to make it through the other side.
Figure 1: Garmin's 2006 annual report. Source: Garmin
Anyone that travelled by car in the late noughties will remember that satnavs were all the rage. AA maps (or printed directions from the AA Route Planner) were no longer needed. You just typed your destination into the satnav, stuck it to your dashboard or windshield, and hit the road.
“Now, for about the price of a premium MP3 player, drivers can have easy, reliable navigation for any vehicle they choose to drive” said Garmin’s 2005 annual report. It continues: “According to industry analysts, unit volumes within the PND (portable navigation device) category alone are expected to nearly double in 2006.”
And so it proved. By 2007, Garmin’s revenues had surpassed $3 billion and were more than three times bigger than in 2005. By 2008, sales in the auto segment had reached over 70% of the group’s overall revenues and represented around 60% of its pre-tax profits.
Fast forward to today and satnavs are no longer a hot product. In fact, they are essentially obsolete. Drivers either get directions from a car’s central console (some of which are supplied by Garmin) or from their smartphone.
Even before satnav demand fizzled out, Garmin’s profits from selling them were hit by lower average selling prices amid fierce competition. In the end, pre-tax profits in Garmin’s auto segment fell from a peak of $565 million in 2008 to several years of consecutive losses.
For most companies, this kind of hit to your most important profit centre would be a death sentence. Not so for Garmin.
Garmin's comeback
Sure, the fall off in satnav sales came with a long, painful hangover – Garmin’s overall sales took eleven years to surpass 2008’s high of $3.5 billion. By 2024, though, revenues had reached $5.3 billion and earnings per share had almost doubled versus 2008.
They are not massively impressive annual rates of growth over a sixteen year period. But they aren't bad when you consider that the business line responsible for over 60% of profits in 2008 was vaporized.
Garmin’s market value of around $40 billion today is also considerably higher than in the PND heyday. Why? Because the three segments overshadowed by satnavs in the late noughties – Outdoor & Fitness, Marine, and Aviation – are now home to four businesses doing at least $800 million in sales.
Garmin has done a great job of finding new avenues of growth by constantly improving its offerings for its existing customer bases and finding new markets to serve. From ever better navigation solutions for boats and planes, to high end watches for fitness and golf fanatics.
In doing so, Garmin offers a strong example of finding ways to parlay a core competency and brand (in this case, within premium GPS hardware and software) into an ever-increasing raft of related products, markets and profit centres.
I would say that Garmin is, and likely always was, a company with Fisher style DNA. It was certainly never a one-product or one-market business. It probably just looked that way for a while because one of those markets happened to go parabolic.
This DNA was visible in Garman’s track record – it already had a long list of successful product launches under its belt before the satnav came along – and in its communications with shareholders during the satnav craze.
Garmin’s shareholder reports at the time would often stress that it hadn’t lost focus on its other markets, comments that were backed up by the launch of dozens of new products for these markets each year. As Fisher might have put it, Garmin was very much looking beyond the “currently attractive product lines”.
How investors can use this insight
First of all, think very carefully before investing in a company where the current level of sales and profits are reliant on a ‘hot product’ that markets are very excited about. Even if the company does seem to be a great innovator.
Investors are prone to extrapolating the hot product’s recent growth and profitability for longer than is realistic in most cases. Any reversal in this narrative can be deadly, especially for those buying in at prices that assume lasting growth. Garmin’s 80% drawdown isn’t an isolated incident.
Understanding the difference between a ‘Fisher-style company’ like Garmin and a flash in the pan like Go-Pro could help you find opportunities after that kind of share price carnage has taken place.
If a company is widely seen as a one trick pony but is actually a Fisher-style innovator, investors might become so depressed by events in ‘that one product’ that they ignore good things happening elsewhere.
A classic example of this was the opportunity that Warren Buffett spotted in Apple, as recounted by Robert Hagstrom in his book The Warren Buffett Way. While the market was worried about flatlining iPhone revenues, Buffett looked deeper and saw Apple's growing (and far more profitable) services business ready to pick up the slack.
