Every extra stock makes a claim on your attention as well as your savings. Owning more companies can spread risk, yet leave you knowing less about each one. Taking more cash out of a company can meet today's bills, yet leave less to finance its future. The right balance depends on how well you know the businesses and what you need from them.
Investor Philip Fisher preferred a small group of exceptional businesses and often favored small dividends. Those preferences came with demanding conditions. He needed to understand and monitor the companies, spread exposure to different economic forces, and trust management to invest retained profits productively. Shareholders also had to be able to afford the wait.
What you can know
Fisher understood manufacturers serving industrial customers and companies using technology to solve their problems. Fashion, advertising, shifting consumer tastes, and real estate required different judgments. Success in his own field did not supply those skills. His investments beyond his experience disappointed him. Someone else might know those businesses well, or cover more industries than he could. The boundary belonged to the investor's knowledge, not to a list of acceptable industries.
Knowledge also took work. Financial analysis and conversations with managers were only part of his investigation; he wanted independent accounts from people who knew the industry. Buying shares did not end that responsibility. Too many holdings could overwhelm his ability to follow them. He sought a manageable group whose sales, and especially profits, could grow faster than their industries while management controlled the risks that growth involved.
He still wanted larger-company holdings across industries with different economic characteristics. Several companies exposed to the same pressure offer less protection than businesses affected differently. Very small companies and venture investments could require a wider spread. Fewer names alone made nothing safer. The strength of the businesses, the quality of the research, and the connection between their risks mattered more than the count.
Fisher learned how position size could contain a research failure through a small drug company. A medical specialist enthused about a new family of drugs. Fisher spoke to a company officer and some similarly excited investment people, then bought shares. He skipped independent checks with competitors and other specialists. The drugs disappointed, and management problems emerged. When the company was eventually sold, his shares returned less than half what he had paid.
One cautious decision limited the damage. Because he barely knew management, he bought only a small position, intending to add as he learned more. Trouble appeared before he increased it. The small purchase did not repair his research. It kept weakly tested enthusiasm from committing too much of his capital.
Even making money could use his attention poorly. During the nineteen thirties, Fisher bought and sold the fruit and vegetable canner California Packing three times. Every trade was profitable. But the work and capital at risk produced much smaller rewards than long ownership of growing companies. Another timing attempt could go wrong. He eventually concentrated his practice on major long-term gains, giving up some profitable activity to spend his time where he expected it to accomplish more.
What the money must do
A company's earnings face a similar decision. A dividend pays some of them to shareholders now. Retaining them gives management money to reinvest. Fisher saw businesses with more promising research ideas than they could afford to develop. For an owner who did not need immediate income, leaving money with a capable company could produce more wealth than receiving it and finding somewhere else to invest.
The need for cash did not end at the laboratory door. Research led to development, then marketing costs. Successful sales could require additional plant capacity. More business also required more inventory and more money in accounts receivable, meaning customers' bills that had not yet been paid. Growth could consume cash before producing it. Retained earnings helped finance that whole sequence. Keeping the money was useful only if management had worthwhile opportunities and could turn them into profitable business.
The shareholder had bills too. Someone whose other income covered spending and left money to save could afford to let more earnings remain invested. Someone relying on investments for living expenses could reasonably prefer dividends. Fisher suggested looking for companies with less need for additional capital or fewer productive uses for it. Age alone did not resolve the choice; actual cash needs did.
Taxes and institutional policies complicated matters in Fisher's period. Some shareholders faced substantial dividend taxes, so internal reinvestment could avoid an immediate tax on the payout. Some pension and profit-sharing funds paid no income tax on dividends but would buy only companies paying one. Promising businesses sometimes introduced small payouts to attract those funds, despite having productive uses for the money. These historical arrangements explain incentives; they do not establish today's tax results.
Fisher's preference for low payouts still allowed attractive higher-dividend investments. The point was to understand what each use of earnings achieved. Keeping too much in an unproductive business could squander the owner's money. Keeping it in a productive one could still leave that owner short of cash. A company worth owning also had to fit the person who owned it.
Three things to keep
Fewer holdings help only when you can know them well and manage their risks.
Retained earnings need productive uses throughout the company's growth.
A promising business can still be a poor fit for your cash needs.