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“One Up on Wall Street” by Peter Lynch

one_up_wall_street

Peter Lynch is famous for heading up the Fidelity Magellan fund during the eighties, when he averaged +29% annual returns.  Just lucky?  Maybe!  But in this book he shares his secrets of stock picking anyway.  He is a fundamentalist, long stock only investor – serious about buying pieces of good companies at deal prices, betting that the market will eventually realize what gems the companies really are.  The specific examples in the book are quite dated, but the principles hopefully are sound.

  • First, a knock against index funds.  Lynch says that the index funds’ gains are usually propped up by a small number of stocks in the index. I wonder if this is still true?  He says to look at the advance/decline numbers (number of stocks rising vs those falling) and you can see this.
  • “To me, an investment is simply a gamble in which you’ve managed to tilt the odds in your favor.”  Lynch puts his success ratio at around 60%, but some of these were “tenbaggers” (increased 10x in stock price) or better.  The trick is to realize companies which are in a good position before the market at large realizes it too.  Because when it does, that is when stocks shoot up.  He even goes as far as to recommend dull-sounding companies in dull industries, which have little or no institutional ownership or analyst coverage.
  • Be aware of companies growing – new products or entering new markets.  Put these companies on radar screen, then check fundamentals next.
  • Search for companies or industries with large earnings growth as % of market
  • Slow growers, medium growth, fast growth, cyclical (vulnerable in recession), turnaround, asset plays (holds assets land etc which aren’t yet reflected in share price).  Important for knowing how much profit to take.  Slow – moves @ GDP growth, medium – 25%/yr, fast – sky’s the limit.
  •  Simplicity is a virtue: “When somebody says, ‘Any idiot could run this joint,’ that’s a plus as far as I’m concerned, because sooner or later any idiot probably is going to be running it.”
  • Insider buying is a strong indicator that things are looking up.  Many reasons for selling but only one for buying – believe stock is going up
  • Prefer companies that buyback stock rather than make dubious acquisitions.  (“diworseification”)
  • Don’t buy anything without earnings.
  • Don’t buy company too dependent on a single customer
  • Use p/e to classify companies – higher p/e than average indicates sentiment of faster earnings growth
  • Increase Earnings – reduce costs, raise prices, expand to new markets, sell more in old markets, revitalize or sell losing operation
  • Balance sheet: (cash + marketable securities – long term debt) / total shares outstanding =  available cash per share.  If available cash per share is close to the share price, then the stock is probably a great deal.  (Don’t count other “assets” since their stated book value is probably much higher than they could ever be sold off for). Also check balance sheet for: decreasing debt, decreasing # of shares, increasing cash.  P/e should be roughly equal to earnings growth rate.  If lower p/e than % earnings growth, good.  Also compare long term debt to total stockholder equity.  Want equity >> debt to ensure low bankruptcy risk.
  • Three phases: startup, expansion, saturation.  Want to get stocks out of risky startup phase but still in expansion.
  • Make yourself write short paragraph on each buy decision – what is the compelling story that is making you buy this company?
  • Don’t sell when stock goes up or down some set percentage; sell if you think the company’s “story” has changed.  Simple sell test – “Would I buy this stock again right now?” (per all the rules) If not, sell.
  • Some typical “story-changers” that indicate it is time to sell: no insider buying during past year, slowing earnings growth rate, p/e much higher (50%) than industry average
  • “It can’t possibly go lower!”. Oh yes it can.  Beware stocks in free fall.
  • Don’t mess with options or futures.  Ought to be outlawed.  Very expensive since they expire; you don’t own the companies.