One Up On The Wall Street by Peter Lynch

2024-06-04

• See what institutional investors are doing, they are generally the laggards
• The bigger the equity fund, the harder it gets for it to outperform the competition
• Historically, stocks are embraced as investments or dismissed as gambles in routine and circular fashion, and usually at the wrong times. Stocks are most likely to be accepted as prudent at the moment they’re not.

Mirror Test

1. Buy a house: Use credit as leverage and tax advantages. No wonder people make money in the real estate market and lose money in the stock market. They spend months choosing their houses, and minutes choosing their stocks. In fact, they spend more time shopping for a good microwave oven than shopping for a good investment.
2. Only invest what you could afford to lose without that loss having any effect on your daily life in the foreseeable future.
3. Personal traits: Patience, self-reliance, common sense, a tolerance for pain, open-mindedness, detachment, persistence, humility, flexibility, a willingness to do independent research, an equal willingness to admit to mistakes, and the ability to ignore general panic. The true contrarian waits for things to cool down and buys stocks that nobody cares about, and especially those that make Wall Street yawn. Stand by your stocks as long as the fundamental story of the company hasn’t changed.

Market Timing

Don’t expect me to bet on the cocktail party theory. I don’t believe in predicting markets. I believe in buying great companies— especially companies that are undervalued, and/or underappreciated.
The way you’ll know when the market is overvalued is when you can’t find a single company that’s reasonably priced or that meets your other criteria for investment.

Part 1 Pointers

• Don’t overestimate the skill and wisdom of professionals.
• Take advantage of what you already know.
• Look for opportunities that haven’t yet been discovered and certified by Wall Street
• Invest in a house before you invest in a stock.
• Invest in companies, not in the stock market.
• Ignore short-term fluctuations.
• Large profits can be made in common stocks.
• Large losses can be made in common stocks.
• Predicting the economy is futile.
• Predicting the short-term direction of the stock market is futile.
• The long-term returns from stocks are both relatively predictable and also far superior to the long-term returns from bonds.
• Keeping up with a company in which you own stock is like playing an endless stud-poker hand.
• Common stocks aren’t for everyone, nor even for all phases of a person’s life.
• The average person is exposed to interesting local companies and products years before the professionals.
• Having an edge will help you make money in stocks.
• In the stock market, one in the hand is worth ten in the bush.

Picking stocks

News channels of Wall Street always get the news late. How can you get the news early?

• Professional's edge: Look at the sector you work for.
• Consumer's edge: Look at the companies that you interact in your daily life.
• Treat this information as if it was an anonymous tip. You have to study the company. For some reason, normally careful consumers invest their life savings on a whim.

Research

• All you have to do is put as much effort into picking your stocks as you do into buying your groceries. Even if you already own stocks, it’s useful to go through the exercise, because it’s possible that some of these stocks will not and cannot live up to your expectations for them.
• You will get your biggest moves in smaller companies
• Categories: slow growers, medium growers (stalwarts), fast growers, cyclicals, asset plays, and turnarounds
• If growth in earnings is what enriches a company, then what’s the sense of wasting time on sluggards?
• But for as long as they can keep it up, fast growers are the big winners in the stock market. I look for the ones that have good balance sheets and are making substantial profits. The trick is figuring out when they’ll stop growing, and how much to pay for the growth.
• The autos and the airlines, the tire companies, steel companies, and chemical companies are all cyclicals. Even defense companies behave like cyclicals, since their profits’ rise and fall depends on the policies of various administrations. You can lose more than fifty percent of your investment very quickly if you buy cyclicals in the wrong part of the cycle, and it may be years before you’ll see another upswing. Shaky companies in cyclical industries are not the ones you sleep on through recessions.
• Timing is everything in cyclicals, and you have to be able to detect the early signs that business is falling off or picking up. If you work in some profession that’s connected to steel, aluminum, airlines, automobiles, etc., then you’ve got your edge, and nowhere is it more important than in this kind of investment.
• Some companies have a lot of assets. consider owned land, subscribers, patents etc

Good Signs

• Insider buying is a good sign. When management owns stock, then rewarding the shareholders becomes a first priority, whereas when management simply collects a paycheck, then increasing salaries becomes a first priority
• In normal situations insider selling is not an automatic sign of trouble within a company. There are many reasons that officers might sell. But there’s only one reason that insiders buy: They think the stock price is undervalued and will eventually go up.
• Buying back shares is the simplest and best way a company can reward its investors. If a company has faith in its own future, then why shouldn’t it invest in itself, just as the shareholders do?

Bad Signs

• Avoid hottest stock in the hottest industry, the one that gets the most favorable publicity
• Beware any company that is touted as the next IBM, the next McDonald’s, the next Intel, or the next Disney etc.
• Avoid companies that often prefer to blow the money on foolish acquisitions instead of buying back shares or raising dividends. (Diworseifier) Some corporations, like some individuals, just can’t stand prosperity.
• That’s not to say it’s always foolish to make acquisitions. It’s a very good strategy in situations where the basic business is terrible. We would never have heard of Warren Buffett or his Berkshire Hathaway if Buffett had stuck to textiles.
• The synergy theory suggests, for example, that since Marriott already operates hotels and restaurants, it made sense for them to acquire the Big Boy restaurant chain, and also to acquire the subsidiary that provides meal service to prisons and colleges. But what would Marriott know about auto parts or video games?
• If a company must acquire something, I’d prefer it to be a related business, but acquisitions in general make me nervous. There’s a strong tendency for companies that are flush with cash and feeling powerful to overpay for acquisitions, expect too much from them, and then mismanage them. I’d rather see a vigorous buyback of shares, which is the purest synergy of all.
• Whisper stocks: Great story with no substance. What I try to remind myself (and obviously I’m not always successful) is that if the prospects are so phenomenal, then this will be a fine investment next year and the year after that. Why not put off buying the stock until later, when the company has established a record? Wait for the earnings.
• The company that sells 25 to 50 percent of its wares to a single customer is in a precarious situation. Short of cancellation, the big customer has incredible leverage in extracting price cuts and other concessions that will reduce the supplier’s profits. It’s rare that a great investment could result from such an arrangement.

Earnings

• what makes a company valuable, and why it will be more valuable tomorrow than it is today? it always comes down to earnings and assets
• Like the earnings line, the p/e ratio is often a useful measure of whether any stock is overpriced, fairly priced, or underpriced relative to a company’s money-making potential
• The fact that some stocks have p/e’s of 40 and others have p/e’s of 3 tells you that investors are willing to take substantial gambles on the improved future earnings of some companies, while they’re quite skeptical about the future of others
• You’ll also find that the p/e levels tend to be lowest for the slow growers and highest for the fast growers, with the cyclicals vacillating in between. We shouldn’t compare apples to oranges. What’s a bargain p/e for a fast grower isn’t necessarily the same as a bargain p/e for a cyclical.
• compare p/e in same industry and compare historic p/e of a company
• Interest rates have a large effect on the prevailing p/e ratios, since investors pay more for stocks when interest rates are low and bonds are less attractive.
• Future earnings: If you can’t predict future earnings, at least you can find out how a company plans to increase its earnings. Then you can check periodically to see if the plans are working out.
• There are five basic ways a company can increase earnings: reduce costs; raise prices; expand into new markets; sell more of its product in the old markets; or revitalize, close, or otherwise dispose of a losing operation

Two Minute Drill

• The next step is to learn as much as possible about what the company is doing to bring about the added prosperity, the growth spurt, or whatever happy event is expected to occur. This is known as the “story.”
• Before buying a stock, give a two-minute monologue that covers the reasons I’m interested in it, what has to happen for the company to succeed, and the pitfalls that stand in its path
• Topics to address: Dividend, business conditions, inventories, and prices, p/e ratio, where and how to fast growth, competition, does the idea work elsewhere? (for growth and expansions)
• It’s never too late not to invest in an unproven enterprise (IPOs)

Getting the Facts

• What you can’t get from the annual report you can get by asking your broker, by calling the company, by visiting the company, or by doing some grassroots research, also known as kicking the tires
• Annual report: Check cash position, long term debt. As often as not, it turns out that long-term debt exceeds cash, the cash has been shrinking and debt has been growing, and the company is in weak financial shape. Weak or strong is what you want to know in this short exercise
• Check 10 Year Financial Summary, shares outstanding, divide cash by shares to find net cash by each share

Some Famous Numbers

• Check percent of sales if you are interested in a company because of a particular stock
• If a company is fairly priced, p/e ratio will equal its growth rate. (dont forget p/e can be influenced by a lot of one off factors)
• A formula to compare growth rate to earnings: (Growth Rate + Dividend Yield / P/E) > 1.5 is okay > 2 is great
• Check net cash position per share, sometimes p/e ratio excluding cash position can be really cheap
• Check equity to debt ratio, 3-1 is normal. Among turnarounds and troubled companies, I pay special attention to the debt factor. More than anything else, it’s debt that determines which companies will survive and which will go bankrupt in a crisis. Young companies with heavy debts are always at risk.
• Check debt structure; bank debt vs funded debt. Banked debt is the worst.
• Check dividends and stock buybacks. We don't want diworseifications. Cyclicals are not always reliable dividend payers.
• Book value can be flawed. Book value often bears little relationship to the actual worth of the company. It often understates or overstates reality by a large margin. The closer you get to a finished product, the less predictable the resale value. So cotton is more valuable than textile. When you buy a stock for its book value, you have to have a detailed understanding of what those values really are.
• Cash flow is the amount of money a company takes in as a result of doing business. All companies take in cash, but some have to spend more than others to get it. This is a critical difference that makes a Philip Morris such a wonderfully reliable investment, and a steel company such a shaky one.
• if cash flow is ever mentioned as a reason you’re supposed to buy a stock, make sure that it’s free cash flow that they’re talking about.
• Check if inventories are piling up. With a manufacturer or a retailer, an inventory buildup is usually a bad sign. When inventories grow faster than sales, it’s a red flag.
• Growth rate: The key to it is that Philip Morris can increase earnings by lowering costs and especially by raising prices. That’s the only growth rate that really counts: earnings. If you find a business that can get away with raising prices year after year without losing customers (such as cigarettes), you’ve got a terrific investment.
• One more thing about growth rate: all else being equal, a 20-percent grower selling at 20 times earnings (a p/e of 20) is a much better buy than a 10-percent grower selling at 10 times earnings (a p/e of 10).
• Profit margin: The company with the highest profit margin is by definition the lowest-cost operator, and the low-cost operator has a better chance of surviving if business conditions deteriorate.
• This gets very tricky, because on the upswing, as business improves, the companies with the lowest profit margins are the biggest beneficiaries.
• What you want, then, is a relatively high profit-margin in a long-term stock that you plan to hold through good times and bad, and a relatively low profit-margin in a successful turnaround.

Final Checklist

General

• Check P/E ratio of company and industry
• Low Institutional ownership
• Insiders buying
• Earnings growth
• Balance sheet strength
• Cash position

Slow Growers

• Dividends are always paid and growing
• Dividend yield and cash position

Stalwarts

• Key issue is price, check P/E and buy low
• Check long term growth rate

Cyclicals

• Check inventories and supply demand relationship. Watch for new entrants
• Anticipate shrinking P/E over time toward peak earnings

Fast Growers

• How big is the growth story compared to the company size?
• Earnings growth
• Whether the expansion is speeding up or slowing down
• Low Institutional ownership and analyts coverage

Turnarounds

• Debt structure
• Unprofitable divisions action
• Cost cutting

Part 2 Pointers

• Understand the nature of the companies you own and the specific reasons for holding the stock. (“It is really going up!” doesn’t count.)
• Put your stocks into categories
• Big companies have small moves, small companies have big moves.
• Consider the size of a company if you expect it to profit from a specific product.
• Look for small companies that are already profitable and have proven that their concept can be replicated.
• Be suspicious of companies with growth rates of 50 to 100 percent a year.
• Avoid hot stocks in hot industries.
• Distrust diversifications, which usually turn out to be diworseifications.
• Long shots almost never pay off.
• It’s better to miss the first move in a stock and wait to see if a company’s plans are working out.
• People get incredibly valuable fundamental information from their jobs that may not reach the professionals for months or even years.
• Separate all stock tips from the tipper, even if the tipper is very smart, very rich, and his or her last tip went up.
• Some stock tips, especially from an expert in the field, may turn out to be quite valuable. However, people in the paper industry normally give out tips on drug stocks, and people in the health care field never run out of tips on the coming takeovers in the paper industry.
• Invest in simple companies that appear dull, mundane, out of favor, and haven’t caught the fancy of Wall Street.
• Moderately fast growers (20 to 25 percent) in nongrowth industries are ideal investments.
• Look for companies with niches.
• When purchasing depressed stocks in troubled companies, seek out the ones with the superior financial positions and avoid the ones with loads of bank debt.
• Companies that have no debt can’t go bankrupt.
• Managerial ability may be important, but it’s quite difficult to assess. Base your purchases on the company’s prospects, not on the president’s resume or speaking ability.
• A lot of money can be made when a troubled company turns around.
• Carefully consider the price-earnings ratio. If the stock is grossly overpriced, even if everything else goes right, you won’t make any money.
• Find a story line to follow as a way of monitoring a company’s progress.
• Look for companies that consistently buy back their own shares.
• Study the dividend record of a company over the years and also how its earnings have fared in past recessions.
• Look for companies with little or no institutional ownership.
• All else being equal, favor companies in which management has a significant personal investment over companies run by people that benefit only from their salaries.
• Insider buying is a positive sign, especially when several individuals are buying at once.
• Devote at least an hour a week to investment research. Adding up your dividends and figuring out your gains and losses doesn’t count.
• Be patient. Watched stock never boils.
• Buying stocks based on stated book value alone is dangerous and illusory. It’s real value that counts.
• When in doubt, tune in later.
• Invest at least as much time and effort in choosing a new stock as you would in choosing a new refrigerator.

When to really sell

• I pay no attention to external economic conditions, except in the few obvious instances when I’m sure that a specific business will be affected in a specific way (oil prices, DXY strength affecting imports exports)
• Sell Slow Growers when fundamentals deteriorate, market share is lost 2 consecutive years, no new products developed, r&d spending reduced, recent acquisitions look like diworseification, balance sheet deteriorate from acquisitions, low dividend yield
• Sell Stalwarts when you can sell one for high p/e and buy another one for low p/e, new products are not successful, no insider buys, a major division that contributes 25 percent of earnings is vulnerable to an economic slump that’s taking place, growth rate has been slowing down, and though it’s been maintaining profits by cutting costs, future cost-cutting opportunities are limited
• Sell Cyclical at the end of the cycle :)) Cyclicals are tricky. Sell if you estimate earnings will fall, costs start to rise, plants running at full capacity and company begins to spend money to add capacity, inventoried build up, commodity prices fall, competition increases, final demand slows down. Whatever inspired you to buy XYZ between the last bust and latest boom ought to clue you in that the latest boom is over
• Sell Fast Growers when second phase of rapid growth ends, p/e gets very big, sales are down, new store results disappointing, top executives leave
• Sell Turnarounds after they turn around :))

Part 3 Pointers

• Sometime in the next month, year, or three years, the market will decline sharply.
• Market declines are great opportunities to buy stocks in companies you like. Corrections -Wall Street’s definition of going down a lot- push outstanding companies to bargain prices.
• Trying to predict the direction of the market over one year, or even two years, is impossible.
• To come out ahead you don’t have to be right all the time, or even a majority of the time.
• The biggest winners are surprises to me, and takeovers are even more surprising. It takes years, not months, to produce big results.
• Different categories of stocks have different risks and rewards.
• You can make serious money by compounding a series of 20–30 percent gains in stalwarts.
• Stock prices often move in opposite directions from the fundamentals but long term, the direction and sustainability of profits will prevail.
• Just because a company is doing poorly doesn’t mean it can’t do worse.
• Just because the price goes up doesn’t mean you’re right.
• Just because the price goes down doesn’t mean you’re wrong.
• Stalwarts with heavy institutional ownership and lots of Wall Street coverage that have outperformed the market and are overpriced are due for a rest or a decline.
• Buying a company with mediocre prospects just because the stock is cheap is a losing technique.
• Selling an outstanding fast grower because its stock seems slightly overpriced is a losing technique.
• Companies don’t grow for no reason, nor do fast growers stay that way forever.
• You don’t lose anything by not owning a successful stock, even if it’s a tenbagger.
• A stock does not know that you own it.
• Don’t become so attached to a winner that complacency sets in and you stop monitoring the story.
• If a stock goes to zero, you lose just as much money whether you bought it at $50, $25, $5, or $2—everything you invested.
• By careful pruning and rotation based on fundamentals, you can improve your results. When stocks are out of line with reality and better alternatives exist, sell them and switch into something else.
• When favorable cards turn up, add to your bet, and vice versa.
• You won’t improve results by pulling out the flowers and watering the weeds.
• If you don’t think you can beat the market, then buy a mutual fund and save yourself a lot of extra work and money.
• There is always something to worry about.
• Keep an open mind to new ideas.
• You don’t have to “kiss all the girls.” I’ve missed my share of tenbaggers and it hasn’t kept me from beating the market.

https://www.goodreads.com/book/show/762462.One_Up_On_Wall_Street

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