Why Good Management and R&D Matter - Phil Fisher Real World Examples

In engineering, we have a saying: good architecture survives bad code, but no amount of good code survives bad architecture. Same is true for businesses. Best product, cheapest factory, most favorable regulation – none of it matters if people running the company are mediocre. Six real stories that prove this point.

Two Kinds of Lucky Companies

Growth stocks fall into two categories. “Fortunate and able” – decent management plus lucky industry tailwinds. “Fortunate because they are able” – management brilliance creates its own luck. The distinction matters enormously.

Alcoa – Fortunate and Able

The Aluminum Company of America is the textbook example of the first category. Founders had genuine vision – they correctly saw commercial applications for aluminum when most considered it a laboratory curiosity.

But nobody, including Alcoa’s founders, predicted the full size of the aluminum market that would develop over seventy years. Airborne transportation opened markets that had nothing to do with the original business plan. Technical developments that Alcoa did not create multiplied demand far beyond initial projections.

Alcoa benefited enormously from forces beyond its control. That is the “fortunate” part. The “able” part is that management was skilled enough to capitalize on every external tailwind – encouraging trends, adapting production, expanding capacity at the right moments.

The results speak for themselves. Even people who bought Alcoa shares relatively late – at the median average price in 1947 – saw roughly 500 percent appreciation in just ten years. And that was measured at a point when the stock was already down 40 percent from its all-time high. Not the low price. The average price over the year.

Lucky, yes. But luck without ability is worthless.

Du Pont – Fortunate Because They Are Able

Du Pont is the opposite case. This company was not originally in nylon, cellophane, lucite, neoprene, or any of the glamorous products people associate with the name. For many years, Du Pont made blasting powder. In peacetime, growth would have roughly paralleled the mining industry. Nothing spectacular.

But brilliant business judgment combined with superb technical skill transformed a powder company into a two-billion-dollar chemical giant. They took knowledge from the explosives business and systematically launched product after product into adjacent markets.

A novice might think it a lucky coincidence that companies with the highest investment ratings also produce the most attractive growth products. This is like the tourist who returned from Europe remarking what a nice coincidence it was that wide rivers so often flowed through the hearts of large cities. Cause and effect, not coincidence. The rivers were there first. So was the management skill.

Motorola Under Paul Galvin – Management Creates Its Own Growth

Motorola started as a radio manufacturer. That is it. Radios. If management had been average, Motorola would have lived and died with the radio business.

Instead, here is what alert management did with technological change. They made Motorola a leader in two-way electronic communications – starting with police cars and taxicabs, then expanding into trucking, delivery fleets, utilities, construction, pipelines. After years of costly development, they built a profitable semiconductor division. They became a major factor in stereophonic phonographs, increased higher-priced television sales through a creative tie-in with furniture maker Drexel, and entered hearing aids through a small acquisition.

None of this was inevitable. The big television upgrade cycle that many expected had not materialized. Original radio-television lines were flat. A mediocre team would have reported declining revenue and blamed market conditions.

Motorola’s management did not wait for favorable conditions. They went and built new product lines using existing organizational resources and skills. The stock went from 45 to 122 in a few years. Those shares were held by the man who identified this pattern until he passed away in 2004. Nearly fifty years of compounding because management kept finding new ways to grow.

Useful R&D Versus Wasted R&D

Not all research spending is equal. Three defense projects can have identical importance for national security and completely different value for investors.

Project one: magnificent weapon, no commercial applications, government owns all rights, simple to manufacture. Any company could win the production contract. Investor value: zero.

Project two: same weapon, but manufacturing so complex only the researching company can produce it. Investor value: moderate – steady government contracts, thin margins.

Project three: same weapon, but the company learns principles directly applicable to its commercial product lines with higher profit margins. Investor value: enormous. Government-funded R&D feeds directly into profitable civilian products.

The most successful companies of the mid-twentieth century mastered this transfer. Texas Instruments rose nearly 500 percent in four years from its NYSE listing. Ampex rose 700 percent in the same period. Both excelled at converting defense R&D into commercial advantage.

The formula for useful R&D is three parts: create new products, develop manufacturing expertise that competitors cannot easily replicate, and ensure that expertise transfers to other business areas. R&D spending without this chain is just an expense line on the income statement.

How do you evaluate R&D quality from outside? Quantitative measures – annual spending, number of PhD employees – are rough guides at best. Better approach: talk to people. Ask research professionals inside the company, in competing firms, at universities. Even simpler: look at how much revenue new products have contributed over the past ten years. A company with a steady flow of profitable new products will probably continue under the same management approach.

Dow Chemical and IBM – Sales Forces That Win Wars

Great products are worthless without the ability to get them into customers’ hands. This is especially true for fast-growing companies where the market is expanding faster than any single sales team can cover.

Dow Chemical is famous for research. What is less known is that Dow selects and trains sales personnel with the same obsessive care it applies to research chemists. Before a college graduate becomes a Dow salesman, he may visit headquarters multiple times so both sides confirm the fit. Before he sees his first customer, specialized training can last from a few weeks to over a year depending on complexity. And that is just the beginning – significant effort goes into continuously improving how Dow solicits, services, and delivers.

IBM took it even further. The average IBM salesman spent a third of his entire working time in company-sponsored training schools. One-third. Partly this was to keep up with rapidly changing technology, but the underlying message is clear: the most successful companies invest relentlessly in their sales arm.

A company can make a one-time profit on manufacturing or research skill alone. But such companies are vulnerable. For steady long-term growth, a strong sales force is not optional. It is the delivery mechanism for everything else the company builds. Want to evaluate sales culture? Same approach as R&D – talk to people in your network. You will quickly learn whether a company invests seriously in its sales arm or treats salespeople as disposable.

American Cyanamid – Buying Trouble at a Discount

Sometimes the best growth investments are companies going through temporary difficulty while executing a growth plan.

American Cyanamid had a world-class pharmaceutical division called Lederle. But the larger industrial and agricultural chemical operations were viewed as a mess – inefficient plants thrown together during the merger mania of the 1920s. Wall Street priced the stock at a lower multiple than other major chemical companies.

What the market missed was new management quietly cutting costs, eliminating dead weight, restructuring. What the market noticed was a huge capital expenditure on a new organic chemical plant in Louisiana. When that plant fell months behind schedule, sentiment got even worse.

Smart money bought at about 46 dollars. Within three years, earnings grew 37 percent but the stock gained 85 percent – price-to-earnings ratio expanded as investors recognized the improvement. Five years later, earnings up 70 percent, stock up 163 percent.

The investment was eventually sold for about 110 percent profit. In retrospect, selling may have been premature – the Lederle pharmaceutical division had bright prospects in new antibiotics and oral polio vaccine becoming apparent after shares were sold.

Two lessons here. First, the best time to buy a growth company is during temporary operational trouble – when the stock drops but underlying strategy remains sound. Second, selling winners too soon is a common and expensive mistake. Nobody ever went broke taking a profit, but many people left enormous gains on the table.

Food Machinery and Chemical Corporation – Patience Rewarded

Before World War II, Food Machinery was a pure machinery company – spectacularly successful thanks to brilliant management and engineering. During the war, they diversified into chemicals to stabilize cyclical machinery revenue with consumable products that could grow through research.

By 1952, four acquired chemical companies made up roughly half of non-defense sales. Quality varied wildly – one division led a growing field with broad margins, another had obsolete plants and poor morale. Wall Street’s verdict was blunt: machinery divisions were excellent investments with 9 to 10 percent internal growth. Chemical divisions were a drag. Until chemicals proved themselves, institutions would not touch the combined enterprise.

Management attacked methodically. They built a top team through internal promotions and external recruitment, spent heavily on modernizing plants and expanding research – increasing R&D spending 50 percent in a single year.

Here is the critical detail: despite all restructuring costs, chemical earnings did not decline. They held steady. That was the signal. If earnings hold flat while absorbing massive restructuring costs, imagine what happens when those costs wind down and improved operations start contributing.

In 1958, a recession year when nearly all chemical and machinery companies reported declining profits, Food Machinery hit an all-time earnings peak of 2.39 dollars per share. The chemical divisions were finally performing alongside the machinery business.

Then came external validation. McGraw-Hill created an award for outstanding management in the chemical industry. A panel of ten experts from business schools, investment institutions, and consulting firms evaluated twenty-two nominees. The award went not to an industry giant but to the Chemical Divisions of Food Machinery – the company most institutional buyers still considered undesirable.

The stock went from about 25 dollars to 51 dollars – a 102 percent gain. Investors who recognized the restructuring pattern early captured both earnings growth and multiple expansion simultaneously. Double compounding.

Key Takeaways

Management quality is not a soft factor. It is the hardest factor. Alcoa rode external tailwinds but needed competent management to capitalize. Du Pont and Motorola created entire industries through management brilliance alone.

R&D spending means nothing unless it produces new products, builds hard-to-replicate manufacturing expertise, and transfers knowledge across business lines. Count results, not budgets.

Sales forces are the delivery mechanism for everything else. Dow Chemical and IBM invested relentlessly in training. One-time profits are possible without great sales – sustained growth is not.

The best buying opportunities in growth stocks come during temporary operational trouble. American Cyanamid and Food Machinery both delivered outsized returns because the market confused short-term restructuring costs with permanent weakness.

And the hardest lesson: once you find a company with management this good, think very carefully before selling. The next ten years of compounding might dwarf everything you have already gained.