Philip A. Fisher and `Scuttlebutt'

Philip A. Fisher and `Scuttlebutt'

July 11, 2000

I first encountered the word `scuttlebutt' in the novel `Battle cry', story of a US Marine Corps battalion against the background of WW II, by Leon Uris. Almost twenty-five years later, I encountered it again in `Common stocks and Uncommon profits', a book on investment, by Philip A. Fisher. Some words remain stuck in your mind for reasons unknown. During the first encounter I had not bothered to find out the meaning but this time I opened my copy of COD and learned that `scuttlebutt' is a colloquial word, meaning `rumor or gossip'. 

Phil Fisher is a name to reckon with in the field of security investing. His book, mentioned above, first appeared in 1958 and has remained a `must read' since then for all those interested in the art and science of investing. The book carries a small chapter of three pages titled `What "Scuttlebutt" Can Do' and according to some, those three are amongst the most important pages of the book. 

Cold figures and dry notes in any company annual report do not tell the whole story. Every company has some very strong points and also some that are worth hiding. The research team may be on the verge of a breakthrough that may lead to huge profits for many years to come, or the union leaders may be plotting a strategy to trap the management, or some key officials may be planning a new company in direct competition. These events when actually happen will have far reaching effects on the performance but the annual report may not carry any clue to help the investor. Yet, these are of great interest to him because future is all he cares for. Now, if he can not get the information through official sources, he has to use some back channels and that is where scuttlebutt comes in. 

Fisher has explained the importance of scuttlebutt very well in the book. He says: 

"The business `grapevine' is a remarkable thing. It is amazing what an accurate picture of relative points of strength and weakness of each company in an industry can be obtained from a representative cross section of the opinions of those who in one way or another are concerned with any particular company. Most people, particularly if they feel sure there is no danger of their being quoted, like to talk about the field of work in which they are engaged and will talk rather freely about their competitors. Go to five companies in an industry, ask each of them intelligent questions about the points of strength and weakness of the other four, and nine times out of ten a surprisingly detailed and accurate picture of all five will emerge."

To get such a picture, one has to visit the company, talk to its customers, vendors, employees, ex-employees and dealers etc. The word `scuttlebutt' used by Fisher is very apt because all those mentioned do not provide any hard quantifiable data; they offer opinions that are subjective. Most of what they tell, falls under the category of `gossip' but if analyzed well, it never fails to give an insight. All investors have their own method of collecting scuttlebutt but most of them don't give it as much importance as it deserves. Analyzing a balance sheet is more cerebral and more satisfying. It gives a `high' of a different kind but the high does not get converted into success if the scuttlebutt is inferior. 

Having read so much about the scuttlebutt method, I decided to try it out. Since visiting companies and getting to talk to people there is difficult I chose the easier path of visiting several branches of banks, both private and nationalized. Currently all branch managers are eager to talk to you because all of them want your account and deposits. The information obtained was very interesting. Since it was all hearsay I will not take names but would like to give a sample. In one bank I was told "We are young and dynamic. They belong to the Middle Ages. Or "We have a wide shareholding pattern but they are really a family owned concern." At another place it was "We are very cosmopolitan and diversified, they have a typical south Indian maharashtrian mentality. Try getting a TOD from then and see how many forms you have to sign" About one bank I was told that the chairman and the managing director do not see eye to eye. Many such interesting bits of information came my way. All were pieces of gossip but they all added little extra sharpness to the picture in my mind. 

Employees, if they feel secure, give lots of helpful information. Inventory is a big issue in manufacturing companies, and its valuation is a complicated affair. If an employee tells me that the company has a lot of dead inventory, I change my discounting factor from 80% to 70%. If more than three persons from the materials division say the same thing I reduce it further. If four out of five employees make disparaging remarks about the management, I revalue long term prospects for the company. No company can go places if the work force is dissatisfied. I know of a company where a relatively simple product has been under design for more than five years. Can this company stand against competition? I doubt. 

More than employees, ex-employees prove more valuable because they are not scared of voicing their opinions. However, Fisher warns that though they may provide valuable insight, their opinions should not be accepted without ample verification because many of them have an axe to grind. Drivers and peons fall in the same category. They come to know many things before the rest of the crowd, but one has to take what they say with not a pinch but a sack of salt. 

In the ultimate sense, an investor chooses to become a partner with the promoters of the company when he purchases a stock. If I do not like a person and his ways of running his business, I will definitely hesitate before deciding to own a part of that business. Personal chemistry does play a role. Many investors like to know about the CEO before they invest and they do not trust the articles appearing in magazines but collect information through their own sources. Personality of the CEO does contribute in the decision making process, especially with women, though not to a great extent. "Ratan Tata looks like a gentleman and gives me confidence" or " So and so from the Birla family does not smoke, does not drink and is a vegetarian" or "The new CEO (of a multinational) is really using this assignment as a stepping stone and will do any thing to please his bosses back home", are not statements to be ignored. This information goes beyond the cold figures of the annual report but it helps in getting a sharper view.

Philip Fisher always took a very long-term view. His famous statement " If the job has been correctly done when a common stock is purchased, the time to sell it is -almost never!" is indicative of that policy. Fisher also believed in having few outstanding companies in his portfolio. He once told John Train, another investor and author " I don't want a lot of good investments, I want a few outstanding ones." To have a few outstanding ones, one has to study quite a few and study them well. 

In his book Fisher provided fifteen points for the investor for examining a given stock and interestingly use of scuttlebutt appears in four of them.  

1. He suggests use of scuttlebutt for learning about company's cost analysis,
2. and accounting controls. 
3. He again suggests use of it while finding out whether the company has short range or long range outlook in regard to profits. 
4. Finally when it comes to the integrity of the management group, he again depends upon scuttlebutt. He has this to say, " The management of a company is always far closer to its assets than is the stockholder. Without breaking any laws, the number of ways in which those in control can benefit themselves and their families at the expense of the ordinary stockholder is almost infinite." He then says, "There is only one real protection against abuses like these. This is to confine investments to companies, the managements of which have a highly developed sense of trusteeship and moral responsibility to their stockholders. This is a point concerning which the "scuttlebutt" method can be very helpful."

Fisher felt that there is no way of knowing management's integrity but through scuttlebutt. There is nothing wrong if some services are purchased from a relative of the director or CEO but only scuttlebutt will inform us whether those services are being purchased at an appropriate price. If amounts disproportionate to the services received are being paid, it is the shareholder that is getting robbed of his legitimate profit.

All said and done, it is very difficult for an individual investor to follow the scuttlebutt method, because he has neither the time nor the network, but those young men and women who wish to pursue a career in security investment can start building their network at a young age. By the time they mature they will have an intangible asset of infinite value.

The saying, `No smoke without a fire' works in security investing too. Experience teaches us to notice the smoke but scuttlebutt helps us to locate the fire and judge its intensity. 

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