Recently I have been reading 2 great books from Peter Lynch. One up on wall street and Beating the street. Both are great books and packed with advice for investors and examples of investments that went well and the ones that did you turn out good. There is not so much difference between the books, but for the beginner I would recommend to begin with one up on wall street. It’s more general, while beating the street has more specific examples of investment cases.
Peter Lynch is one of the greatest investors of all time and his track record is impressive. I noticed that there is much overlap and commonality between Warren Buffets investing wisdom and Peter Lynch’ wisdom and a lot of it is common sense in investing.
The books are fun to read with plenty of humour in them. There are no investing secrets in these books. To earn beat the market in the long-term, you need to do your homework and really understand the companies you are buying. Peter Lynch was known to work his ass off.
Here are some of my notes and keywords from the 2 books:
-Ignore the market, focus on business, not the general economy, politics and macro issues. You can’t predict the macro too much degree, and there are too many people analysing this, so there is very difficult to earn a good return on having some special insight on the macro economy. In contrast you can be able to have an edge looking at a small micro cap business that not so many is knowing about. You need to hunt for value in areas of the market where there is less competition!
– Develop a stock thesis/story for each stock you buy. Write it down. Follow the story of the stock as the time go. Does the story turns out like you expect? You need to know the reasons why you bought the stock and what you expect will happen in the future. This can be easy to forget so you should write it down. If the story does not turn out like you predicted you might want to sell the stock and learn from your mistake and avoid to to that mistake again.
-Put the stock in the correct category: Slow grower, stalwart, fast grower, cyclicals, assets plays, turnarounds. Knowing the type of stocks you are analysing and buying makes you know what to put weight on in your analysis (ratios) and also what you can expect the stock to behave like in the future.
-Invest only in simple business that it’s for you to understand. You need to understand how the company earns money and the factors affecting it. If not you will not be able to be confident in the long-term about the stock, you will also not know if it is smart to add more to a position if the stock price goes down, vs a person that understand the company. If you don’t understand the company you will be too affected by the “market” and the markets pricing of the stocks, since that will be your measurement of the success of your investment.
– Choose stocks with boring/dull names. Stocks with boring names gets more easily ignored by the market. Stocks with hot names these days like element, bio, crypto, tech etc.. draws more attention and are more likely to be overpriced.
– Choose companies that do something dull. Most investors gets exited about new technologies and things that might revolutionize the world. However these stocks usually does not provide the best returns unless you are very lucky with your picks. Companies that deals with garbage, pest, waste, dry cleaning, funeral service etc.. is drawing much less attention but still can be fantastic business to invest in.
– Consider choosing companies that does something disagreeable. Like cigarettes, addictive products. It’s usually less investors investing in these.
-Spinoffs can be great investments. Usually investors and funds will sell these spinoffs when they come into their account because of funds mandates or because investors just get another company into their account and the just sell off without considering the company. This can create opportunities for the diligent investor.
– Choose good stocks in non-growth industries. Again less competition from other investors and also less new startup business that will disrupt the industry.
– Look for niche companies. Companies that do something very specific that not many other companies do. Where they are the leading company with the biggest market share. Like for example Tandy leather factory
-Look for companies that sells a service or product that people MUST have and that they will buy again and again. (Cola, cigarettes, shaving blades)
-Invest in companies that will benefit from technological advancements, not companies that will get disrupted by improved technology.
-Look for insider buying in a company. That is usually a very strong sign that the company is doing well and that the management believes in the future of the company.
-Share buyback. Companies that is buying back shares when the stock price is low is doing good capital allocation, because the value of your stake in the company will increase. However companies that buyback at high prices is destroying shareholder value.
-Invest in stocks that has a history of positive earnings! Don’t bet on the long shots and lottery ticket stocks.
-When cash exceeds debt it’s very favourable.
-Look at historical P/E values for the company you consider investing in. Are the current P/E high or low compared to historical P/E?
-If you underperform the S&P 500 index for more than 5 years or more, consider throwing in the towel and just put your money in an index fund instead and save yourself the work of investing.
-A portfolio for the private investor should consist of 3-10 stocks. You don’t want more because you need to know a lot about the stocks you own and keep updated on they story. If you keep 20-100 stocks you have not chance to know all of them very well and your returns will be too similar to an index fund.
-Don’t sell a stock too soon. Typical investor mistake. Cut the weeds and water the grass! Track the fundamentals, not the stock price.
-Sell a stock when your stocks story has played out or is no longer valid.
-Better to buy a 20% grower at 20 p/3 than a 10% grower at 10 p/e (because of the compounding effect)
– Compare business in the same industry with EBIT margins
-You want a relatively high profit margin company to its competitors in a long-term holding. In a shorter term turnarounds, a low profit margin gives a higher % stock price/profit increase than a higher margin competitor.
-Review your portfolio companies story every few months.
-Fast grower stocks: Growth rate of 20-25% is ideal. Higher than 25% is not preferred.
-Look for companies where the EPS growth is higher than the P/E ratio. A sustained EPS growth rate twice the current P/E is ideal.
– Look for hidden assets in stocks. Understated value on the balance sheet, operating loss carryforwards, companies that owns shares of other companies, goodwill that has been written down to 0, but is still valuable.
-Look for companies that can raise their prices year after year without loosing customers. Like for example Phillip Morris (PM)
Stocks to avoid:
– The hottest stocks in the hottest industry. Usually insanely overpriced.
– Beware the next “something”
-Avoid companies that acquires unrelated business
-Beware of “whisper” stocks. Stocks with promising technology that is going to save the world. That is usually stocks with no substance.
-Beware of stocks with only one customer. Things can turn bad if they lose that one customer.
-Beware of stocks with exciting and cryptic names.
-Avoid stocks with very high P/E’s
-Be aware of capex insensitive businesses.
-Be aware of inventory buildup in retail companies.
-Be aware of companies with pension plans, especially in turnarounds.
Peter Lynch checklist:
– Can the company expand successfully? To other states? To other countries? Is there more room for expansion?
-How does the companies headquarter looks like? The more simple and mundane their HQ looks like the more promising the company is. Companies that “waste” a huge amount of money on an impressive building is usually not a good stock, because they will probably spend money on themselves instead of the shareholders.
Turnaround checklist:
-How much cash does the company have?
-How much debt?
-What is the debt structure?
-How are they going to turn around? (Cost cutting, selling of unprofitable business)
If you want to do fundamental analysis of stocks and determine the quality and intrinsic value of stocks you can check out the Warren Buffett Spreadsheet