Peter Lynch: One up on Wall Street Book Summary

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Peter Lynch argues how jokers like you and me could find hidden gems in the stock market much before the bigger jokers of Wall Street can if we keep our eyes open. He suggests that everyday information can be used to find spectacular growth stocks.

Peter used his skills at Fidelity to rake in huge profits from stocks that the market discovered much later than he did. Following are some of the gists taken from the book. Note the type of stocks he thinks we should be looking out for.

Types of companies

SLOW GROWERS

Since you buy these for dividends(why else would you own them?), you want to check to see if dividends have always been paid and whether they are routinely raised.
When possible, find out what percentage of the earnings are being paid out as dividends. If it’s a low percentage, then the company has a cushion in hard times. It can earn less money and still retain the dividend. If it’s a high %, then the dividend is riskier.

STALWARTS

These are big companies that aren’t likely to go out of business. The key issue is price and the P/E ratio will tell you whether you are paying too much.
Check for possible di–worseifications that may reduce future earnings.
Check the companies long-term growth rate and whether it has kept the same momentum in recent years.
If you plan to hold the stock forever, see how the company has fazed during previous recessions and market drops.

FAST GROWERS

Investigate whether the product that’s supposed to enrich the company is a major part of the company’s business.
What the growth rate in earnings has been in recent years (20-25% is great)
That the company has duplicated its successes in more than one city/town, to prove that expansion will work.
That the company has room to grow.
Whether the stock is selling at a P/E ratio at or near the growth rate.
Whether the expansion is speeding up (3 new motels last year and 5 this) or slowing down.
That few institutions own the stock and only a handful of analysts ever heard of it. With fast growers on the rise, this is a big plus.

CYCLICAL

Keep a close watch on inventories, and the supply demand relationship. Watch for new entrants into the market, which is usually a dangerous development.
Anticipate a shrinking P/E multiple over time as business recovers and investors look ahead to the end of the cycle, when peak earnings are achieved.
If you know your cyclical, you have an advantage in figuring out the cycles. Its easier to predict an upturn in a cyclical industry than it is to predict a downturn.

TURNAROUNDS

Most important, can the company survive a raid by its creditors ? How much cash and debt does it have ? What is the debt structure, and how long can it operate in the red while working out its problems without going bankrupt ?
If it’s bankrupt already, what’s left for the shareholders ?
How is the company supposed to be turning around ? Has it rid itself of unprofitable divisions ? This can make a big difference in earnings.
Is business coming back ?
Are costs being cut ? If so, what will the effect be.

ASSET-PLAYS

What’s the value of the assets ? Are there any hidden assets ?
How much debt is there to detract from these assets (Creditors are first in line)
Is the company taking on new debt, making the assets less valuable ?
Is there a raider in the wings to help shareholders reap the beneficiaries of the assets ?

Summary of One up on Wall Street by Peter Lynch – learnings

Understand the nature of the company you hold and the specific reason for holding the stock.
By putting your stock in categories, you’ll have a better idea of what to expect from them.
Big companies have small moves, small companies have big moves.
Consider the size of the 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 rate of 50 to 100% a year.
Avoid hot stocks in hot industries.
Distrust diversification, 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 plan 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, esp from an expert in the field, may turn out to be valuable
Invest in simple companies that appear dull, mundane, out of favour and haven’t caught the fancies of Wall Street.
Moderately fast growers (20-25%) in non growth 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 theCEO’s resume or speaking ability.
A lot of money can be made when a troubled company is turning around.
Carefully consider the P/E 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, favour companies in which management has a significant personal investment over companies run by people who benefit only from their salaries.
Insider buying is a positive sign, esp when several individuals are buying at once.
Devote at least an hour a week on investment research. Adding up your dividends and figuring out your gains and losses doesn’t count.
Be patient. Watched stock never boils.
Buying stocks 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.
Is the P/E ratio high or low in general as compared to the other companies in the same industry.
Lower the % of Institutional Ownership, the better.
If insiders are buying and if company is buying back its own shares, both are positive.
The earnings growth to date should be consistent, not sporadic (exception for asset play where earning growth is not important).
Company should have a strong balance sheet (debt to equity ratio) – how is it rated for financial strength.