Peter Lynch One Up on Wall Street Summary | Ultimate Guide
3 February 2020
Peter Lynch’s one up on wall street book was one of the first investing books that I read.
I probably first read the book when I was about the age of 20 or 21, and now, after about five years in the market, I can tell you that the lessons hold.
Who is Peter Lynch?
Peter Lynch is a legendary value investor that has one of the best investing track records ever. He managed the Magellan Fund at Fidelity Investments between 1977 and 1990 and returned an average of 29.2% per year in those times.
Peter Lynch One Up on Wall Street Key Takeaways:
In Peter Lynch’s one up on wall street, he views investments in the stock market based on six types of companies.
1. Fast growers
The first type of company is called fast growers.
Fast growers are companies that have proven to be able to grow their earnings per share by about 25% a year on average.
The key to investing in this type of company is to be wary and exit when the growth rate slows down.
The best kind of stock for fast growers are those that not owned by many institutions and are rarely heard – and they do not have a lot of analyst coverage yet. These kinds of companies tend to be underappreciated.
From my experience, fast growers tend to sell at a premium. One thing that I look out for when analyzing fast growers is the PEG ratio. I use it when I look at a fast-growing company with a high PE (price to earnings ratio).
Peter Lynch is also the one that I learned PEG ratio from.
Simply put, PEG ratio is the PE ratio of a company over its EPS growth rate.
So if a company has a PE ratio of 30, but its growth rate is 60%, its PEG ratio is less than one, which may show that the company is undervalued relative to its growth rate. Meaning, the valuation of the company may still seem ok even though its PE ratio is high – relative to its growth rate.
2. Slow growers
The opposite of fast growers is slow growers.
Slow growers are companies that usually pays dividends. The best kind of dividend-paying companies are those that pay dividends, and the dividend grows consistently year by year.
With this kind of dividend-paying company, we should look at its payout ratio, which shows the percentage of its earnings paid out as dividends. More than 100% is a warning signal as it will not be sustainable; anything below 60% is conservative and more sustainable, in my opinion.
Slow growers may be considered for income investors seeking stable dividend-paying investments.
But for slow growers, we also have to be wary it is not in a sunset industry if it is, the earnings may be on a perpetual decline, and the dividends will eventually be cut.
Stalwarts are somewhere in the middle of fast growers and slow growers.
They no longer grow as fast as a fast grower but also not as slow as a slow grower. Peter Lynch says that they are likely recession-proof companies. That means companies that possibly sell necessities like Unilever or P&G.
Dollar discount shops might also be recession-proof too because, in a recession, people tend to be more budget-conscious and shop more at discount stores.
Cyclical companies are companies with their profits moving up and down in cycles.
It could be companies in the oil industry as oil prices generally move up and down according to the supply and demand at the time. Memory prices are another example of a commodity that usually moves up and down in cycles. With cyclical companies, the trick is to know when to buy during the down cycle and exit during the upcycle.
Personally, I made good money buying Micron – a cyclical memory company’s stock – some at $34 in 2019. When the cycle turns up, the stock price also goes up pretty fast. In the last memory cycle, Micron went up from about $10 in 2016 swiftly to about $60 in 2018. But when it goes down, it also goes down fast; it went down from about $60 to $30 in less than six months after that. As of 1st February 2020, it is about $50.
Turnarounds are investment opportunity for companies that we think are currently in a bad position and is able to turn itself around.
I think one such example of a company is Apple before Steve Jobs went back and took over as CEO – after his return, he introduced the legendary iPhone and many other innovative products like the iPod.
For turnaround companies, the strength of the balance sheet is very important because they need to be able to get through the rough situation if there is any possibility of a turnaround.
6. Asset plays
Peter Lynch says to look for assets of the company that are underappreciated by the market.
The assets can be tangible or intangible assets. It is important to look at the strength of the balance sheet and whether the company is taking on too much debt that could potentially erode the value of the assets in the future.
Disney, a long time ago, could be considered as an asset play type of situation because back then, Marvel – even though they own it – are still not monetized as well yet at that point in time.
Other One Up on Wall Street Lessons That I Took Away
Put in the effort to learn as much as we can about the company before investing a dime. I think that this is very common sense advice. And yet, not many people do it.
Peter Lynch mentioned an example in the book that says something along the line of people spending more time researching what fridge to buy as compared to what stock to buy. I think that this is sadly true.
I have heard of friends putting their life savings on a stock, which in the end did not do well, and when I asked them the reason why they bought it, it is mostly based on a rumor that the company is going to do well. I think more can be done.
One way to put in more effort is to attend courses and read books before putting a dime in the stock market. The money we are going to save from all the painful beginners’ mistakes in the stock market can be worth the money and time we invested initially.
Put in at least one hour of investment research every week. This is an important bare minimum routine that every investor ought to have. Being a good investor is not easy; we need to read up a lot and do a lot of research on companies.
Putting in at least one hour is a good starting practice for every aspiring investor to have. But the truth is, one hour is barely enough, four hours a week is better, in my opinion.
But hopefully, by doing this, we will be able to make better decisions. Personally, for me, I put in minimally four hours a day to just read up on companies and find potential investments.
Look for underappreciated companies that do not have a lot of analyst coverage yet. I think this is solid advice and it is one of the advantages of being a retail investor – we can invest in smaller companies that do not have a lot of analyst coverage yet.
If we are able to invest in underappreciated companies with not much analyst coverage yet, by the time it is appreciated, the stock price will move up dramatically. And these companies tend to have a better valuation because they are usually not trading at a premium – due to a lack of analyst coverage.
One example is a stock I used to own called Care.com, which I purchased at an average price of $10. Within six months of owning it, I made a 50% return because they are bought over by a bigger company called IAC (which also happens to be the majority owner of Match [owner of Tinder and many other dating companies]) at $15.
None of my friends I talk to heard of care.com before. That stock investment drives my outperformance that particular year – which was 2019 – when my portfolio was up 50% because care.com happened to be one of my largest holdings back then with about 30% weightage.
Do not invest in hot stocks in hot industries. I think the reason why Peter Lynch mentioned this point is that hot stocks in hot industries tend to be overvalued.
I agree that euphoria usually happens for hot stocks in hot industries, this is usually because of the over-optimism for the future growth of the company and the sector it is in – which results in people overpaying.
The dot-com bubble crash is an example of such a situation happening. In recent times, I think Zoom video and Beyond Meat is an example of hot stocks in hot industries just right after its IPO.
Companies with no debt cannot go bankrupt. This is true, but also, it doesn’t mean that by investing in companies with no debt, we cannot incur an irreversible capital loss. An example is a company with no debt but decreasing revenue and earnings due to the fact that it is in a sunset industry.
Companies with significant insider ownership is always a plus point. I agree with this point. It boils down to this: skin in the game. Companies with significant insider ownership tend to have better alignment with the shareholders.
It is always a plus point if the CEO has big ownership in the company; they will tend to want the company to do well over time. An example of a company that I own in which the founder has huge stake in the company is Mark Zuckerberg, with about 20% ownership of Facebook.
Good profits can be made by investing in the right turnaround company. Starting from the baseline that we know turnaround rarely turns, if we can invest in the right turnaround company at the right time, good profits are bound to be made.
This is because turn around companies tend to be selling at a depressed price because they are usually in a bad situation. Once the bad situation turns into a good situation, the stock price tends to rally.
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