In the summer of nineteen fifty-six, Philip Fisher could buy Texas Instruments shares from its principal officers for fourteen dollars each. That was about twenty times the seventy cents the company was expected to earn per share that year. Larger competitors threatened its transistor business. And why were the officers selling?
The objections were reasonable. Answering them required more than labeling the stock expensive. Fisher wanted to know what would increase its future earning power and how much of that improvement investors already recognized. A high valuation could be justified; a low one could conceal trouble. Neither number settled the purchase.
The officers, it turned out, were selling only a small fraction of holdings that represented much of their wealth. Diversification and possible estate taxes offered an explanation. Inside the company, growing geophysical and military electronics operations accompanied even faster transistor growth. Management was strengthening research, planning mechanization and building distribution. Those developments gave Fisher reasons to believe it could compete with larger rivals.
What a premium buys
The price-earnings ratio divides the share price by annual earnings per share. It tells you how much investors pay for each dollar of earnings. A share price can rise because earnings increase, because investors pay more for each dollar, or because both happen together.
By the following summer, Texas Instruments management estimated earnings at about one dollar ten cents per share. The stock had roughly doubled over the preceding year. The projected earnings increase was smaller: investors were also paying a higher multiple. This historical result illustrates how business improvement and changed expectations can reinforce each other. It cannot validate another expensive stock without investigating its circumstances.
A high ratio raises a further question. What comes after the next increase in profits? A company with one big earnings surge and little to follow it may deserve an ordinary valuation once the surge ends. Today's premium can have brought those gains forward. A company continually developing profitable products may still have another generation coming when the current one matures. Continuing opportunities can justify a continuing premium.
That requires evidence of the organization's abilities and room in its industry to grow. Popularity alone proves nothing; neither does being unfashionable. An old share-price high or low is equally inconclusive when products, managers or competition have changed. Past earnings are useful for understanding business cycles, rather than mechanically deciding what the company is worth now.
Fisher also recognizes uncertainty in the calculation. Nobody knows exact earnings years ahead. Modest apparent overpricing is therefore a weak reason to sell a well-understood business with strong continuing prospects. A new purchase still needs a reasonable price. Choosing the right company matters greatly, but paying too much reduces the return.
When weak profits need a closer look
Current earnings can fall while future earning power improves. Research consumes money before there is anything to sell. A process that works in a pilot plant can encounter expensive trouble at full scale. Once production works, sales and advertising expenses may rise before enough customers buy to make it profitable.
An investor who bought the promising announcement may lose patience during the bills that follow. Fisher looks for opportunities here, under demanding conditions: a sound underlying business, unusually capable management and a specific problem that plausibly can be resolved in months. Some projects fail. A declining share price does not turn management's promise into evidence.
The timing question becomes whether an identifiable improvement is approaching before the price reflects it. The same logic applies to expanding an already profitable operation. Study the development and when similar advances in that business previously attracted recognition. A lower price might arrive, but waiting for it can also miss the improvement entirely. An approaching pilot-plant milestone can give a purchase date more substance than an indefinite order at a favorite price. The project and the market's response can still disappoint.
Make a decision while uncertainty remains
Waiting for a reassuring economic forecast adds another uncertain judgment. Fisher identifies interacting forces: business conditions, interest rates, government policy, inflation and inventions. Getting one right leaves the others unresolved. He allows rare, conspicuous speculative extremes as exceptions, but they offer no routine buying method.
For someone adding to successful established holdings, he favors acting on a suitable company opportunity without waiting for the economy to look predictable. New earning power may help the shares during a downturn; it cannot prevent a fall. For a new investor, or someone moving into growth stocks after a long market rise, he suggests spreading purchases over years. Uncommitted funds remain available, while early results test the investor's judgment or the adviser's work.
The trade also needs care. Examine whether you could actually sell the holding when necessary; an exchange label alone cannot answer that. Use an able, conscientious intermediary. On a small order already judged reasonably priced, insisting on a tiny discount can lose the investment. A large order needs more discretion because the buying itself can push up the price.
The useful purchase decision rests on a company-specific change, a price that leaves the opportunity worthwhile and evidence strong enough to act on. None requires knowing where the whole market will go next.
Three things to keep
A lasting premium needs continuing earning opportunities to justify it.
Temporary weakness is attractive only when the business and its proposed recovery deserve confidence.
Operating evidence can guide a purchase while the market's direction remains uncertain.