One Up On Wall Street – a book where Peter Lynch explains how he found so many „ten baggers “. „Ten baggers“ means holding a stock till it raises ten times its value from the time it was purchased.
In my opinion, it is one of the greatest books with many practical examples of where you should put your focus and how to analyze stocks. If you want to get your own copy visit Amazon.
About Peter Lynch
Peter Lynch was born in 1944 in America. In his career, he was an investor, mutual fund manager, and philanthropist. His most famous book is „One Up On Wall Street“ which sold over 1 million copies.
He managed the Magellan fund at Fidelity investments between 1977 and 1990 in which he had a 29.2% average annual return. This is twice as much as the famous S&P500 fund.
Before You Invest Go Through Peter Lynchs’ Checklist
As investing can be hard, especially, when a stock you have purchased is going down you can be tempted to sell and cut your losses. Though this might be a bad move according to Peter Lynch.
Also, you have to have some personal qualities to make money buying stocks. If you imagine yourself stressing out a lot about the money you might want to consider some safer options like index funds, real estate, bonds, and so on.
You Should Think About These Things Before Even Starting:
- Owning a house
Owning a house is one of the best investments. Though there were some crises in the past in the housing market in general this is a great investment.
FHFA House Price Index went from 180 to 392 in the last 10 years. Meaning the average house price in the US more than doubled in the last 10 years.
- Do you need the money?
Firstly, you should consider whether you have your 3-6 months’ safety money if anything were to happen. Also, do you have any planned expenses soon like a child‘s college education or buying a new car?
I have covered a lot of this in my previous article Money saving tips.
- Do you have self-constraint
To be a successful investor you must have patience and tolerance for the times when your investments will take a dip. I can assure you that it is not if, it is when. The good thing is that if you did your homework and follow investment principles a good company will rebound over the long term.
Also, you must not follow what everyone else is doing and resist your „gut feeling“. The facts are what you are looking for when evaluating an investment.
- Do not ask for a good time to invest
Nobody knows when the market will crash and start growing again. Even Warren Buffet starts selling everything he owns around 3 years before the market really crashes.
But what is better – to miss 10-30% growth or lose 30-80% of what your own?
You should consider what to look for in a company and evaluate if it will be profitable to purchase the stock. If the price seems cheap and the stock passes your checklist then it is a good time to invest.
- Evaluate where are your strengths
It is a good idea to start with companies that you have an advantage over the others. For example, I work in the electronics industry, I know the market, so, I have a bit more knowledge advantage in it.
It does not mean that you should avoid markets that you do not know, it simply means that you should research them more to feel more comfortable in analyzing them.
- Big companies cannot grow fast
If you are looking for companies like Peter Lynch that can grow 10 times and become a ten-bagger you have to evaluate if it is realistic or not.
For example, do you think that companies that have already matured like Microsoft, Apple, and Amazon could grow 10 times? Probably not.
Company Types by Peter Lynch
There are many criteria that you can classify stocks as, but Peter Lynch has developed the main 6.
- The slow growers
These are the companies that are old and large and they are not expected to grow as fast anymore. These companies are usually kept for dividends.
These companies on average grow 2-4 percent per year.
- The Stalwarts
These are also big companies. However, they usually grow at 10-12 percent per year. The companies are good when recessions hits. Peter Lynch recommends having at least some of them in your portfolio.
- The fast growers
The companies that a booming fast. They tend to grow 20-25 percent per year. The companies usually get their returns when they successfully expand to new regions and duplicate their success.
If you want high returns these are the companies that you should look into.
- The cyclicals
The companies that rise and fall regularly. You can find these companies in the auto, airline, tire, steel, and chemical companies.
In these kinds of companies, it really pays to have a knowledge advantage to know when the contracts are ending and what new contracts will be signed.
However, if you miss the entry point here it could a very long time till you get your money back.
- Turnarounds
The companies that face real problems. It might be companies that get a lot of public backlashes, are facing trials, or are on the brink of bankruptcy.
The market tends to overreact to the situation and the price fall more than it should. However, if you believe that the company will clear its name then it might be a good investment to make.
- The asset plays
These are the companies that have great assets that Wall Street does not know about. It can be real estate, some cheap stock that has been pilled up for years, and know it is worth more than the company is valued for.
What To Look For According To Peter Lynch
When you are trying to pick a stock try to tell a story about it. Think of it like a sales pitch for a company. Think about these points below.
- The name of the company sounds silly
This is great because the companies can be overlooked by the professionals and it does not get people excited. Therefore, the stock price should not be overvalued.
- The company does something dull
If the company is easy to understand and everyone could manage it then it does not matter as much who is managing it. It simply cannot fail.
- The company does something disagreeable
With the rise of eco-lifestyle companies that manufacture plastic utensils, plastic bags are great because people avoid buying them. However, the demand is still there.
- It‘s a spinoff
When the companies get too big they tend to create separate companies for easier management. The mother company in this case does not want any negative publicity so the new spinoff has to go by the same rules as the parent company.
- Stocks that are under the professional radar
There aren‘t many professionals following the company and the institutions do not own it. This means the price is not falsely overpriced.
- Associated with toxic waste or mafia
Industries like waste management are great because people automatically avoid these. This is another sign that the company is not overvalued.
- Something is depressing about it
This includes everything related to funerals. People do not like to think about this but the truth is that there are 8 billion people alive and the number is rising every year.
- It‘s a no-growth industry
In high-growth industries, there are a lot of competition and Asia companies always find a way to manufacture something cheaper. The no-growth industries do not get that as it is not as hot.
- It‘s got a niche
Companies that have a niche will survive bear markets. Even companies like rock companies have almost a monopoly because it is too expensive to get them from anywhere else. This means there is no way the company can be pushed out of the market.
- People have to keep buying it
Everyday product manufacturers will always be needed. Think about it this way – if there would be another great depression, where would your expenses go? To food, house cleaning supplies, and so on.
- It‘s a user of technology
Companies like Automatic Data Processing benefits when there are price wars between computer companies as they can get cheaper hardware. These kinds of situations can be found in other fields in the market.
- The insiders are buyers
This is a big one. If the insiders are buying they believe that the company will grow. Who has the biggest knowledge advantage? The insiders!
- The company is buying back shares
When a company is buying back its share it is also great because it is the best way company can award its investors. This means that this company sees that it is stock price is below what it should be.
Analytics To Go Through That Peter Lynch Uses
- P/E ratio
The P/E ratio shows the price-earning multiple. It helps to determine if a stock is undervalued or overpriced. It also shows the number of years it will take to earn back your initial investment.
The ratio average will be different for every industry. The highest being for technology
It usually does not tell much on its own so you also have to look into earning growth ratio. If the growth rate is higher than the P/E ratio this is a big indicator that this is a great investment.
- Growth rate
As well as you can check what was the growth rate over the last 10 years you can evaluate how the company can grow.
For example, a company can grow by selling more or selling the same thing at a higher price. Something like cigarettes is an example of that. Companies can charge more without losing their sales. This is a very good sign.
- P/E of the market
This ratio is a good indicator of whether the market is undervalued or overvalued as a whole. To make sense of it you must check what the P/E ratio was in previous years.
- Future earnings
This number is not exact as no one knows the future. Analysts try to predict these but you can check how the company is trying to justify future earnings and how they are planning to grow.
- Percent of sales
When you are interested in a company because of one of its products you should look into how much the company makes of it concerning all the sales. If the number is low it will not make much difference if only that one product makes a lot of sales.
- Cash position
When a company has a lot of cash compared to its long-term debt it is a very good sign.
- The debt factor
You should care about what is debt versus equity. By this, you can determine if the company has the potential to survive the next crisis.
- Dividends
If you buy a company for dividends what you want is to see the company paying them on time for at least 20-30 years without lowering them.
- Book value
This is not a very accurate measurement but if you find the book value is twice as expensive as the stock price then you may have found yourself a deal.
- More hidden assets
You should the what the company owns. Sometimes, company can own very expensive materials now that they got cheaply a few years ago. You cannot see this in the balance sheet. For example, land, timber, oil, or precious metals.
- Cash flow
You should look into what is the stock price relevant to per share cash flow. The higher it is the better.
My boss always tells me that companies go bankrupt not because they stop selling as well but because they do not have good cash flow.
- Inventories
Similar to hidden assets you should check what the company owns and what stock politics it has. However, in general, if the company cannot fit its inventories into its warehouse it is a bad sign.
What Peter Lynch Would Avoid
Peter Lynch also wrote about what things to avoid when you look for a new investment. Here is the full list.
- Hottest Stocks that everyone is talking about
When everyone is talking about a stock the price is definitely inflated. There is a saying that if your taxi driver tells you how he or she invested in a company it is already too late to invest. For example, I wouldn’t go near Tesla even with a 10-foot stick.
- Beware of the next something
If people are talking that the company will be something next chances are it won’t be.
- Avoid diworseifications
When a company has a lot of free money sometimes it does not know what to do with it and starts buying other companies that are not connected with the mother company in any way.
In the beginning, you might be interested in a company for what it does. However, if it buys another company it is a new industry for it and it is a lot harder to predict how the company will do.
- Beware the whisper stock
When people tell you that they found this great stock you should really avoid the advice and check for yourself if it is really worth investing in.
- Beware the middleman
Companies that everyone would do well without are not good investments. For example, in the supply chain, important parties are manufacturers and end clients. Everyone in between can be changed.
- Beware the stock with the exciting name
When a company has an exciting name people tent to fawor that company. However, if a lot of people gets excited then the stock prices gets inflated.
- Do not sell too soon
Never say that you will sell the company when it gets to X price. Usually, you want to buy a company to keep. You should check the companies’ stories every year and the fundamentals. If they have changed only then you should sell.
Peter Lynch would not have gotten 10x of some of his investments if he sold when companies doubled in value.
- Avoid options, futures, shorts
As it is hard to earn money in stocks Peter Lynch does not recommend buying options, futures, and shorts.
Do Not Listen To Professionals
On every investment page, there are always opinions from professionals that it is a great time to buy or sell. But in reality, they are just guesses.
For example, some companies can even try to use this scam where they tell 50 people to buy one stock, and others to short it. Then they split 50 lucky ones with another stock. After 4 times people would give all their money and lose it all to the next company.
Remember that brokers get money in both cases – when you win and when you lose. They do not have much interest in you winning.
- They have much pressure to perform
Mutual fund managers have a huge pressure to perform. Because of that, they cannot let themselves invest in small companies that the investors would not approve of. Also, they have to look into short-term investments where they would get money
- They might be wrong
I made this mistake myself. When I learned that Buffet bought stock in Alibaba. I checked the price then and it was already 30% cheaper than Warren Buffet had paid. I thought for myself that it was another 30% for me. It turned out the company lost 30% more in the next half a year.
- Nobody knows the future
The analytics in Wall Street does all kinds of analyses but the truth is nobody knows the future. I can tell you that the market will take a dip and I am 100% right. But neither you nor I know when this will happen, how long will it take, or how much the market will fall.
- They have to follow the rules
Investment managers have a lot of rules to follow that you do not have to. Peter Lynch emphasizes that all of us have an advantage here because we can look into smaller companies, buy them and not inflate the prices by ourselves as that investment fund would.
Conclusion
You have to evaluate If you have all the necessary qualities to be an investor first. If at any point you find that stock investing is not for you then you can follow Peter Lynch, Warren Buffet, and many more famous people that it might be a lot better to buy the S&P500 index fund.
It will be much better than giving money to fund managers.
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