Phil Fisher on range-bound investing

I was first introduced to the idea of the "range-bound market" when I read reviews of "Active Value Investing". But when I read "Conservative Investors Sleep Well", I realized Phil Fisher had brought up the issue of "range-bound market" way before Vitaliy Katsenelson did.

The growth stock
Phil Fisher says that the price of any individual common stock is the result of the financial community's appraisal of that stock. The financial community is usually late to recognizing both the start and end of growth. When a company grows, the financial community may not realize its growth potential and the earnings growth are not reflected in the price, resulting in a low P/E. This is the best time to buy the stock.

The growing stock
As a company grows and the financial community realize its growth potential, the growth in P/E ratio and earnings will cause the stock price to grow far higher than that caused by either earnings growth or change in P/E alone. A high P/E, however, does not necessarily mean you should sell the stock because you can still enjoy earnings growth as the company grows - though you will not get to enjoy the P/E growth.

The maturing stock
As a company matures and approaches its limits to growth, however, you should sell. Eventually, the financial community will recognize the lack of future growth potential and adjust the P/E downwards, such that further earnings growth will not result in increased stock price. If you take into account secondary and tertiary effect of the financial community's appraisal of the stock's industry and sector and on common stocks in general, you will have a P/E and stock price that does not move in tandem with earnings growth.

A real-world stock
When I read what Phil wrote, I recalled one of Vitaliy's articles about Wal-Mart (WMT). For quite a while now, Wal-Mart grew its earnings but its price remained unchanged. The financial community had realized that Wal-Mart was approaching its limits to growth and adjusted its P/E accordingly. The earnings growth that did occur were already discounted into the price, so no further price increase occurred. For the financial community, unless Wal-Mart figures out a way to grow beyond its current limits, they will not price the stock for the same type of growth they experienced decades earlier.

References:
Conservative Investors Sleep Well (First published in 1975)
in Common Stocks and Uncommon Profits and Other Writings (Wiley Investment Classics)
by Philip A. Fisher

Active Value Investing
by Vitaliy N. Katsenelson


Disclosure: Long WMT.

P.S. This post was featured in The Festival of Stocks May 26, 2008 at Circle of Competence.