Super Stocks: A New Assessment Of Ken Fisher's Pioneering Book

Most of the criteria that Fisher identifies are unmeasurable. Five of the key criteria are (and I use his terminology here):

  • growth orientation,
  • marketing excellence,
  • an unfair competitive advantage,
  • creative personnel relations, and
  • the best in financial controls.

Of these, only the last is somewhat quantifiable. If the company has negative income or negative cash flow, there should be more than sufficient working capital to cover it, and the debt-to-assets ratio should be relatively low.

Fisher also places a good deal of emphasis on margins, but a super stock doesn’t have to have strong margins when one buys it. Instead, it has to have strong evidence that its margins will be good. Fisher believes that a company’s market share, along with the market share of its largest competitor and the growth of the industry, has a lot to do with its margin potential.

There are a few other quantifiable odds and ends in Fisher’s approach—he favors companies in industries without giants; he favors companies with few analysts. But these factors are not as important as his two value ratios, the five criteria above, and the possibility of strong future margins.

Creating and Backtesting a Screen for Super Stocks

Let’s first stick with Fisher’s two-rule system—low price-to-sales and low price-to-research (and research is best defined as R&D expenditures)—and use the minimum liquidity rules I gave above. Fisher is a long-term buy-and-hold investor, so let’s try a rolling backtest with a two-year holding period. If we assume slippage of 0.5% per round-trip transaction, the average two-year return per stock that passes this test since 1999 is 36.44%, compared to the S&P’s average two-year return of 15.55%. (I used Portfolio123 to perform this test, relying both on Compustat and FactSet data.) If we look at just the past ten years’ worth of two-year returns (which means starting twelve years ago, in January 2009), the average return goes up to 44.58%, compared to 30.09% for the S&P.

Fisher suggests that we should really focus on stocks with a price-to-sales ratio of less than 1.5 and a price-to-research ratio less than 10. Stocks with price-to-sales between 1.5 and 3 aren’t forbidden, but are not preferred; the same goes for stocks with a price-to-research ratio between 10 and 15. These two changes narrow our universe considerably: now we’re buying only about 100 stocks at a time. And now our results are even higher: the average stock since 1999 gets a two-year return of 45.65% and the average stock since 2009 gets a two-year return of 52.03%.

If we narrow our universe even more and just buy the ten stocks with the lowest price-to-sales and price-to-research ratios, we get even better returns. Because Fisher places more emphasis on the price-to-sales ratio than the price-to-research ratio, I’ve ranked these stocks according to the product of the square of the price-to-sales ratio and the price-to-research ratio, and chosen the lowest.

The average of these top-ten stocks goes up to 47.26% since 1999 and 79.43% since 2009. Moreover, the former per-stock results reflected the fact that you bought a lot more stocks during a down market than during an up market; this 10-stock backtest simulates an even portfolio, and therefore it’s harder to get good per-stock numbers from it.

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