What Morningstar.com REALLY Doesn’t Want You to Know

I’m sure you’ve heard people say that Wall Street never gives you the whole story. That it’s not in the Street’s best interests to tell you about the market’s biggest opportunities. That it keeps you in the dark about all the money over-the-counter and bulletin board stocks can deliver.

It might sound cliché…but I’ve found tangible proof that there’s some truth to those stories. At least one of Wall Street’s most trusted companies is pulling the wool over your eyes. It’s everything short of a deliberate attempt to steer you away from the stocks it doesn’t approve of.

I’ll explain in a second. But first, a little background is in order.

The story starts with a man named Philip Fisher.

A stock analyst who survived the market crash of 1929, Fisher made his mark with a landmark book, Common Stocks and Uncommon Profits. In fact, it was the first investment book ever to make The New York Times best-seller list. And while most people like to associate Warren Buffett’s investment style with Benjamin Graham’s, the Oracle of Omaha admits that Fisher inspired him, as well.

That’s partially because Fisher was a strong advocate of buying and holding. He once said the best time to sell was “almost never.” Of course, he didn’t mean you should blindly hold onto losing stocks…he meant that if you did your research right before you bought — and paid attention thereafter — you’d never have to worry about selling.

So it’s pretty amazing when you realize that Fisher was primarily a growth investor. He didn’t care about a company’s fundamentals…he cared about its business. He loved companies that were “highly speculative and beneath the notice of conservative investors or big institutions.” In fact, he famously bought Texas Instruments and Motorola long before they were household names — and even held Motorola until his death.

In Common Stocks and Uncommon Profits, Fisher spelled out 15 questions he used to evaluate a company. They were pretty open-ended and could be subject to interpretation. They were not, as he put it, “determined by cloistered mathematical calculation.” They were:

1.     “Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?”

2.     “Does the management have a determination to continue to develop products or processes that will further increase total sales potentials when the growth
potentials of currently attractive product lines have largely been exploited?”

3.     “How effective are the company’s research and development efforts in relation to its size?”

4.     “Does the company have an above-average sales organization?”

5.     “Does the company have a worthwhile profit margin?”

6.     “What is the company doing to maintain or improve profit margins?”

7.     “Does the company have outstanding labor and personnel relations?”

8.     “Does the company have outstanding executive relations?”

9.     “Does the company have depth to its management?”

10.  “How good are the company’s cost analysis and accounting controls?”

11.  “Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?”

12.  “Does the company have a short-range or long-range outlook in regard to profits?”

13.  “In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholder’s benefit from this anticipated growth?”

14.  “Does the management talk freely to investors about its affairs when things are going well but ‘clam up’ when troubles and disappointments occur?”

15.  “Does the company have a management of unquestionable integrity?”

Now, I’ll admit, there’s nothing groundbreaking here. Fisher’s 15 questions are fairly well known, and you can find them or slight variations all over the Internet. But I recently discovered that some of Fisher’s wisdom has been purposefully been withheld from investors. In fact, one of Wall Street’s most trusted Web sites glosses over some of what Fisher had to say.

You see, Fisher also listed five “don’ts for investors”:

1.     “Don’t buy into promotional companies.”

2.     “Don’t ignore a good stock just because it is traded ‘over-the-counter.’”

3.     “Don’t buy a stock just because you like the ‘tone’ of its annual report.”

4.     “Don’t assume that the high price at which a stock may be selling in relation to its earnings is necessarily an indication that further growth in those earnings has largely been already discounted in the price.” (Or put simply, price to earnings isn’t everything.)

5.     “Don’t quibble over eighths and quarters.” (That is, don’t stress over a few cents difference in price.)

Please pay attention to No. 2, in which a man hailed as one of the greatest investors says there’s nothing wrong with trading bulletin board and Pink Sheet stocks.

I ask you to pay attention, because the good folks at Morningstar.com think you shouldn’t know that rule.

It’s true. Its Web site has an Investor Classroom, which includes a profile of Philip Fisher. The article patiently explains his love of growth stocks. His 15 points are spelled out in detail. And then it goes on to paraphrase Fisher’s “don’ts” — all three of them. Not five…three.

Any bets on which ones are missing? Here’s a hint — they’re the ones that have nothing to do with fundamental analysis or exchange-traded stocks. See for yourself here.

Now, I know — Morningstar can easily claim it’s doing this for investors’ own good. That over-the-counter stocks can be risky…and discounting fundamental analysis may encourage bad research.

But whatever its reasons, one thing is clear — Morningstar.com is not giving you the whole story on Philip Fisher’s investment philosophy. Yet if it worked for him, why can’t it work for anyone else?


July 27, 2007

The Daily Reckoning