Suppose you are saving for a house in a few years. Leaving the money in cash feels wasteful when prices keep rising. Shares in a growing company seem to offer a way out. But the house purchase may arrive while those shares are down. The business could eventually fulfill every promise, too late for the purchase you planned.
Writing around nineteen sixty, Philip Fisher favored cash for approaching expenses under the relatively gradual inflation he saw. He separated having money available on time from preserving its buying power over many years. Long-term money could take business risks that money for a particular bill could not. Even then, the risk had to fit the owner's capacity to lose.
What the assets can earn
Fear of inflation can make almost any physical asset look reassuring. Fisher tests that reassurance with an imaginary warehouse in Germany during the currency collapse of the early nineteen twenties. It is full of bustles, the supports once used to shape women's dresses. These had been valuable goods. Fashion had moved on. Rising prices could not make people want them again.
A warehouse full of things is useful only if someone wants those things. Fisher applies the same reasoning to a company's assets. Except when a business is being liquidated, their value to its owners rests on what they can earn. He looks for management that can keep increasing earnings per share, the profit attributable to each share an investor owns. Buying a weak business, or paying too much for a good one, can defeat the intended protection.
Inflation also consumes capital inside a business. The same quantity of inventory costs more. Customers buying on credit owe larger amounts, tying up more company money until they pay. Worn-out equipment costs more to replace. Under the accounting rules Fisher describes, allowances based on the equipment's original cost may leave replacement costs uncovered. Before expanding, the company must finance these demands just to maintain its existing operations.
Better products and production methods can help. Machinery that makes goods more cheaply, or a product that lasts longer at the same price, can reduce effective costs. But an inflation forecast cannot tell you which management will deliver those improvements. Fisher would direct more effort toward investigating the business than toward predicting the next recession. A forecast often feels convincing because it agrees with the investor's temperament.
Nor did he think gradual inflation had to become runaway inflation. Buying goods ahead brings costs of its own, including storage, interest and possible obsolescence. Those costs can exceed the anticipated price rise. His argument leaves room for severe inflation, while rejecting the panic that makes an indiscriminate stock purchase feel urgent. With modest inflation, a patient search can be worth the buying power lost while waiting.
The loss has an owner
Two people can face the same investment and sensibly choose differently. Fisher compares someone whose small fund is a family reserve with someone who has ample resources elsewhere. A speculative venture might promise extraordinary gains to both. Only one can afford to lose the money without threatening the family's security. A longer-term reserve invested in shares also remains different from cash for an approaching bill.
The company itself changes the risk. A young business may depend on one manager, one technical approach and a loan arriving in time. A more established business can have a team able to learn new methods, enough money to finance the change, and another profitable operation to support it while it adjusts. The second company may offer less spectacular gains. It may also be much harder for one ordinary setback to destroy.
For people whose accumulated wealth supports their living standard, Fisher generally favors established growth businesses. Any unproven ventures should occupy a limited share suited to their ability to bear losses. The attraction of an enormous possible gain says nothing by itself about whether that gamble belongs in the owner's finances.
What a fund changes
A diversified fund can spread a small investor's money across businesses and provide a service when dependable individual advice is hard to obtain. Fisher expects this breadth to dilute exceptional gains as well as exceptional losses, bringing results closer to the market average. That is different from the resilience supplied by people and finances within one company.
Pooling does not remove every risk. In an open-end fund, investors can ask for their money back. Fisher wonders whether, in a prolonged bear market, withdrawals might force sales that depress prices and provoke further withdrawals. He presents an unresolved possibility; the bear markets of the nineteen fifties had not produced significant trouble of this kind.
Even a generous cash distribution needs interpretation. If a fund sells an appreciated holding and pays out the gain, the capital left inside may buy fewer shares of a replacement that has risen similarly. The payout belongs to shareholders; it has not vanished. But money received and earning capacity retained are separate measures.
Cash ready for the house purchase has done its job. Money intended to support years of future spending needs earning power that can grow, at a risk its owner can bear.
Three things to keep
Money needed soon must survive the spending date, even if cash loses buying power.
Inflation protection depends on growing earning power, not merely owning physical assets.
A smaller possible gain can be preferable when failure would damage your living standard.