Phil Fisher, a seminal figure in investment strategy, revolutionized the field with his innovative Scuttlebutt analysis. This approach, grounded in thorough and meticulous research, seeks to unearth critical insights about potential investments by leveraging informal information sources. Fisher’s method, detailed in his landmark book “Common Stocks and Uncommon Profits,” offers a nuanced perspective on evaluating companies beyond the numbers, highlighting the importance of qualitative data in investment decision-making.
Phil Fisher’s approach to investment analysis seems more relevant than ever in today’s modern age. Powerful computer systems continually scour the market for quantitative anomalies to exploit through split-second trades. Screeners sift through vast amounts of data, seeking quantitative criteria that could indicate favorable outcomes. Additionally, most investment managers now have access to tools like Bloomberg terminals, providing ample information on virtually any publicly traded security worldwide at their fingertips. This raises the question: Is there still a competitive advantage in conducting individual due diligence on a company, or has the market become so omniscient and rapid that opportunities to outperform based on fundamental analysis alone no longer exist?
Due to the qualitative nature of Phil Fisher’s investment analysis, there still exists an opportunity to outperform through the old tried-and-true methods of stock selection and long-term ownership. It’s possible that certain areas of the market are more inefficient today due to the overemphasis on quantitative investing. Behind every operating business is a group of individuals working together toward a shared goal, ideally company success. By immersing oneself in the business and its people, one can discern insights that quantitative measurements may overlook.
Quantitative analysis undoubtedly has its merits, as it provides mathematical reasoning and helps us understand the world in measurable terms. However, this article argues that qualitative analysis, particularly based on Phil Fisher’s scuttlebutt approach, remains a rational and executable strategy for achieving outsized returns in the market.
Understanding Scuttlebutt Analysis
Scuttlebutt analysis is predicated on the idea that valuable information about a company can often be gleaned from those who interact with it regularly. This includes employees, customers, suppliers, and even competitors. Fisher believed that by engaging with these stakeholders, an investor could gain a holistic understanding of a company’s operations, culture, and competitive position.
The essence of Scuttlebutt analysis lies in its grassroots approach. Unlike traditional financial analysis, which relies heavily on quantitative data such as earnings reports and balance sheets, Scuttlebutt focuses on gathering qualitative insights. This method allows investors to see beyond the polished facade presented in official documents and uncover the underlying realities of a business.
Scuttlebutt is an important strategy for gaining knowledge that is not widely available. A key competitive advantage for an investor is being more involved in an industry than direct peers. Having contacts on the supply management side or maintaining relationships with certain industry professionals is crucial for judging the current climate of many industries or individual companies. If employees are complaining about work conditions and upper management, that is not a good sign. On the other hand, if employees are becoming more enthusiastic about their hours and changes in management, that could be an interesting sign. Remembering that we are in the real world and have the opportunity to make connections with individuals is a huge competitive advantage. Investing is by no means a popularity contest, and it is often the contrarian who ends up making the most rational decisions. However, having a large network of individuals who trust you can be a key advantage that, as of now, computers cannot compete with.
The Scuttlebutt Process
The process of Scuttlebutt analysis involves several key steps:
Identifying Information Sources
Fisher emphasized the importance of talking to a broad spectrum of individuals connected to the company. This includes current and former employees, customers, suppliers, and even industry experts. Each of these sources can provide unique perspectives and valuable information that might not be available through official channels.
Identification of individuals is key in making the most out of your efforts. Sometimes it is counterintuitive to spend your time with higher-up management, especially C-suite employees. The CEO is often the head salesman for the company, and you are less likely to get brutal truths or new insights about the company through them. Ideally, you want to talk to employees who are directly involved in the operations of the business. The individuals who are working 9 to 5, selling services or creating products, are the ones whose conversations can be the most meaningful. Even ex-employees are a great resource for understanding the ins and outs of a company, possibly from a negative perspective. When talking with ex-employees, you must keep in mind that they may obviously have some bias when it comes to opinions of upper management, but they often provide candid information that is great to follow up on to see where it may lead. Investment analysis through the scuttlebutt process is similar to detective work, and you have to get out there and identify possible leads wherever they may be.
Conducting Informal Interviews
Engaging in casual, open-ended conversations is crucial to Scuttlebutt analysis. These interviews should be conducted in a manner that encourages candidness and honesty. Fisher suggested asking specific questions about the company’s strengths, weaknesses, management quality, and competitive dynamics.
If you are going to execute the scuttlebutt process successfully, emotional intelligence is as desirable as intellectual superiority. The ability to be relatable, charming, and friendly can go a long way when it comes to getting the most out of your interviews. Rather than focusing on the reality of being an investor trying to learn more about the business, create an environment that makes the individual feel like this is a candid conversation with a friend. The more you connect with the individual, the more you will get out of the conversation. Little tricks like using their first name in conversation, body language, and the general tone of the conversation can change the environment into a more relaxed one. Once you feel a connection, then it is time to ask questions in a casual way. There is no reason not to be straightforward about the information you seek; lay it out for them and see where it goes. Many would be surprised at how willing individuals are to open up after a connection has been made.
Cross-Referencing Information
One of the strengths of Scuttlebutt analysis is its ability to cross-reference information from multiple sources. By comparing and contrasting different viewpoints, an investor can identify common themes and discrepancies, which can provide deeper insights into the company’s true state.
The ability to cross-reference the information gathered through conversations is key to the proper execution of the scuttlebutt strategy. Having a large network of contacts helps in uncovering the full picture. This is why it is always important, as an investor, to create new connections wherever they may be. You do not know why that individual might become an important part of your investment analysis process. They could end up being an employee of the company you are researching, an industry expert, or just a knowledgeable customer who could give you insights you were previously unaware of. Investment analysis is by nature a highly analytical process, but there is a significant advantage in embracing the most human aspects of the process.
The Qualitative Factors of Scuttlebutt Analysis
Phil Fisher’s Scuttlebutt analysis is underpinned by a comprehensive set of qualitative factors, each contributing to a holistic view of a company. These factors include:
- Large Market for Sizable Sales Increase
A large market for a sizable sales increase indicates the potential for significant growth. For example, consider a software business that, through new generative AI capabilities, can automate certain roles. This automation allows for greater scaling of the business, leading to more subscriptions and recurring revenue. With a largely untapped market of 3,000 customers, the company stands to experience considerable growth by leveraging these advanced technologies.
2. Determination for New Product Development
A determination for new product development shows a commitment to innovation and staying competitive. For example, consider a biotechnology company that is developing a new medicine currently undergoing trials. Once the trials are passed and the FDA approves the medicine, it can become a new product on the market, opening new revenue streams for the company. This demonstrates the company’s dedication to expanding its product line and enhancing its market presence.
3. Effective R&D Effort
Effective R&D effort ensures continuous improvement and development. For example, in the automotive industry, companies can incentivize engineers to create more efficient systems and produce advanced EV technology. This not only helps in reducing global emissions but also enhances safety procedures. Effective R&D involves smart expenditure, setting realistic goals, and properly incentivizing those involved. Transparent communication and well-structured incentives for productivity can drive innovation and ensure the company stays at the forefront of technological advancements.
4. Above Average Sales Organization
An above-average sales organization reflects the effectiveness of the sales and distribution teams. For example, financial institutions operate in a highly competitive environment where they differentiate based on investment product fees, compensation, and rates-based products. To compete effectively, they must have an above-average sales organization to inform and attract new clientele to their offerings. Since most financial products do not differ significantly in structure, the key difference lies in the sales organization that aids in client acquisition and the client onboarding process. Strong advertising and sales channels are crucial for these institutions to stand out and succeed in a crowded market.
5. Worthwhile Profit Margin
A worthwhile profit margin indicates financial health and operational efficiency. For example, a construction company needs to carefully analyze the contracts they take on. They must have a good understanding of the upfront costs and risks on their end, as well as the time that will be devoted to the project. Carefully selecting projects that are both on the lower risk end and provide a worthwhile profit margin is key to the sustainability of ongoing operations. Sustainable business models with low customer acquisition costs contribute to maintaining healthy profit margins and ensuring long-term success.
6. Actively Maintaining or Improving Margins
Actively maintaining or improving margins demonstrates ongoing efforts to optimize profitability. For example, semiconductor companies need to balance supply and demand, as well as implement efficient operating measures to avoid oversaturating the semiconductor market. They must also maintain pricing power to ensure profitability. By focusing on delivering value at a low cost, these companies can continue to improve their margins while remaining competitive in a rapidly evolving industry.
7. Excellent Labor and Personnel Relations
Excellent labor and personnel relations highlight the importance of employee satisfaction and retention. For example, in the airline industry, labor and personnel relations are crucial for success. Airlines are often known for having stressful relations with flight attendants and pilots, sometimes leading to strikes that disrupt operations and harm the company’s reputation. Positive feedback on platforms like Glassdoor can indicate good employee relations, but there is often a need for continuous improvement in facilities and benefits to ensure long-term employee satisfaction. Maintaining strong labor relations helps in creating a stable and motivated workforce, which is essential for the smooth functioning and success of any business.
8. Outstanding Executive Relations
Outstanding executive relations are essential for effective leadership and strategic direction. For example, healthy relationships among executives and the board are crucial for a company’s success, although occasional disagreements may exist. However, the corporate world has seen its fair share of proxy and interboard battles, which are famous for being expensive and sometimes leading to dramatic scenarios as tensions rise. These conflicts can disrupt company operations, damage reputations, and result in costly legal battles. Therefore, maintaining strong executive relations helps ensure smooth decision-making processes and a unified strategic vision, which are vital for long-term success.
9. Depth of Management
Depth of management indicates a robust and capable management team. For example, having technically skilled and experienced leaders with a background in the industry is crucial. It is important that these leaders possess knowledge about various areas of business operations rather than having a narrow view. Additionally, proper incentivization is key to ensuring that management makes the necessary long-term decisions for success rather than focusing on short-term goals due to improper incentives. A well-rounded and appropriately motivated management team is essential for the sustainable growth and success of a company.
10. Cost and Accounting Controls
Cost and accounting controls ensure financial discipline and accuracy. Ethical accounting practices are of utmost importance, as there is always room for accounting manipulation. It is crucial to maintain the highest ethical standards in accounting to prevent such malpractices. Financial discipline is essential because excessive leverage can lead to bankruptcy, while being overly conservative can hinder profit materialization. Therefore, a rational approach is warranted. Accounting fraud is like drug use—once it starts, it can be very painful to stop and extremely habit-forming. Additionally, it is illegal. This is why it is best to always take the high road in accounting, focusing on internal controls and accurate financial reporting to ensure the long-term health and integrity of the organization.
11. Peculiar Advantages Relative to Competition
Peculiar advantages relative to competition highlight unique strengths or market positions. For example, in marketing and advertising, distinctive elements such as a memorable mascot or a catchy jingle can significantly increase brand awareness. In industries like fashion, having sponsorships with individuals that customers admire, such as celebrities or athletes, can provide a huge advantage in differentiating a brand from the crowd. These unique advantages create a strong market position that competitors may lack, making them valuable assets for any company looking to stand out in a competitive landscape.
12. Long-term vs. Short Term Profit Outlook
Balancing long-term vs. short-term profit outlooks involves managing immediate gains while ensuring sustainable growth. For example, amusement parks need to balance cost-saving strategies with investment for the future. Navigating cost management while also investing in capital expenditures and not being stingy on maintenance expenses is crucial for keeping the park profitable and well-run. Long-term growth strategies and reinvestment plans are essential for sustaining the park’s operations, attracting visitors, and maintaining a high level of customer satisfaction. By prioritizing both immediate and future needs, amusement parks can achieve a stable and prosperous business model.
13. Aversion to Shareholder Dilution
Aversion to shareholder dilution protects shareholder value by limiting equity issuance. Shareholders are the owners of the company, and their interests should be safeguarded by the business. Over-reliance on share issuance to fund operations is a dangerous practice that can lead to dissatisfied equity holders. The best way to fund operations is through the company’s own revenue. However, if external financing is required, other options should be explored before resorting to share issuance. Fixed equity share counts and strategic financing options help maintain shareholder value and ensure that the company is not diluting its ownership unnecessarily, thereby preserving trust and satisfaction among shareholders.
14. Frankness Regarding Negative Developments
Frankness regarding negative developments emphasizes transparency and honesty in communication. Transparency is crucial for building trust within an organization, and distrust can sow the seeds of failure. Honesty must come from top management all the way to lower-level employees if a business is to survive. The way executives speak about negative developments is important to monitor. If they are candid and straightforward about challenges while offering solutions, there is hope. However, if they constantly downplay the situation, blame others for their actions, and play smoke-and-mirrors games about who is responsible for certain failures, it can cause serious distrust among employees, shareholders, and customers. A company must operate at the highest level of respect, which means being honest and open about problems they need to fix. Management’s willingness to discuss challenges openly is a key indicator of a healthy and trustworthy organization.
15. Management of Unquestionable Integrity
Management of unquestionable integrity ensures ethical practices and trustworthiness within a business. Corporate governance and management integrity are paramount for the success and longevity of any organization. Management must not overcompensate themselves and should prioritize the well-being of the business they are responsible for managing. Being a steward of a company is a significant responsibility, and there are always opportunities for abuse. By identifying management that consistently takes the high road and avoiding shady actors, one can set themselves up for investment success. An established ethos of integrity and honesty over decades reflects a commitment to ethical practices and builds trust among employees, shareholders, and customers. Such management is essential for creating a stable and reliable business environment.
Key Insights Gained from Scuttlebutt Analysis
Scuttlebutt analysis can reveal a wealth of information that might not be apparent from traditional financial analysis. Some of the critical insights include:
Understanding the competence and integrity of a company’s management team is vital for investors. Scuttlebutt analysis allows investors to gather firsthand accounts of how managers treat employees, handle challenges, and make strategic decisions. This provides a clearer picture of management quality and its impact on the company’s success.
A company’s culture can significantly influence its long-term performance. Through conversations with employees and other stakeholders, investors can gauge overall morale, values, and the work environment within the company. This insight helps assess whether the company fosters a positive culture that supports its strategic goals.
Customer satisfaction is another critical aspect that can provide valuable insights into the quality of a company’s products or services. High levels of customer satisfaction often indicate a strong competitive position and potential for sustained growth. Feedback from customers helps investors understand how well a company meets its market’s needs and expectations.
Suppliers can offer a unique perspective on a company’s operational efficiency and reliability. Good relationships with suppliers often translate to better terms and stability in the supply chain. By examining these relationships, investors can assess the company’s operational robustness and its ability to manage supply chain risks.
Competitors provide an external viewpoint on the company’s market position and strategic initiatives. Understanding how a company is perceived by its rivals can help investors assess its competitive advantages and potential risks. This information is crucial for evaluating the company’s strategic positioning and long-term viability.
While Scuttlebutt analysis offers numerous benefits, it is not without its challenges. One primary limitation is the potential for biased or incomplete information. Since Scuttlebutt relies heavily on informal sources, there is a risk of encountering subjective opinions or outdated data. Additionally, the process can be time-consuming and labor-intensive, requiring significant effort to gather and analyze information from multiple sources.
Despite these challenges, the insights gained from Scuttlebutt analysis can be invaluable. By complementing traditional financial analysis with qualitative data, investors can develop a more comprehensive understanding of a company and make more informed investment decisions.
In conclusion, Phil Fisher’s Scuttlebutt analysis remains a powerful tool for investors seeking to gain a deeper understanding of potential investments. By leveraging informal information sources and engaging in thorough qualitative research, investors can uncover valuable insights that might otherwise go unnoticed. While it requires diligence and a keen eye for detail, the rewards of Scuttlebutt analysis can be substantial, offering a unique edge in the competitive world of investing.
The information presented in this article is the opinion of Jacobs Investment Management and does not reflect the view of any other person or entity. The information provided is believed to be from reliable sources, but no liability is accepted for any inaccuracies. This is for information purposes and should not be construed as an investment recommendation. Past performance is no guarantee of future performance.