ONE UP ON WALL STREET
PETER LYNCH
SUMMARY
Lynch opens the book with the contention that the average investor can perform as well as most experts. He dubs stocks that earn ten times of initial investment amount as "tenbaggers." Money for investing can be saved through minor lifestyle adjustments. Although the author attends many functions with high-level market professionals, he still finds many of his stock picks in his everyday life. The novel is divided into three portions: preparing to invest, picking winners, and long-term view. He states that there is no such thing as a born stockpicker, and that picking stocks is an art rather than a science, and as such cannot be quantified.
The author worked as a caddy in his youth and traded golfing advice for stock picks. He utilizes the term "street lag" to describe the amount of time between when consumers recognize a good product and when wall street recognizes the company. Some stock market professionals miss big winners because they do not want to defend unconventional stock picks to their superiors. Professionals are sometimes so restricted that they are given a list of stocks to choose from. Additionally, the SEC regulates what stocks certain funds may invest in. Consequently, individual investors are not as restricted as institutions.
Investing in bonds is essentially investing in debt. Before investing, the author asks the prospective investor if they own a house, if they need the money from the investment, and if they have a personality conducive to investing. Large losses and large gains may be had in the stock market, and attempting to predict the future is futile.
According to the author, many winning stocks are very obvious choices. Knowing stocks is not necessary to profit from stocks, but helps to avoid potential losses when tides turn. Professionals and consumers have different edges in the market. Professionals time the purchase of cyclical stocks with more success, and generally buy well-known companies at more opportune times. Additionally, professionals may have knowledge of assets which are not on balance sheet but may drive future earnings and expectations. Not all information is a buy signal, and investors should be conscientious of the source of information, and focus on bottom line effect.
The size of company affects expected returns, as a $10 million dollar revenue boost is greater to a company with a $5 billion market cap than it is to a $50 billion market cap company. Although big companies do not generally have big share price moves, they can have large swings downward. The author advises investors to allocate their funds in smaller companies.
Lynch groups stocks into 6 basic categories: slow growers, fast growers, stalwarts, cyclicals, asset plays, and turn-arounds. Slow growers grow at a slightly faster rate than the GDP, the author states. Fast growers are small, aggressive companies that advance at approximately 20-25% per year. Stalwarts are big companies that grow at approximately 10-12% per year. The author typically keeps stalwarts for a 30-50% gain prior to selling. Cyclicals such as auto stocks, steel, airlines, and chemicals, rise and fall in predictable fashion. Turnarounds are companies near bankruptcy that return to profitability. Asset plays are companies in possession of valuable assets that the investor knows about.
Companies can change categories based on internal modifications. In order to classify a stock, investors can consult with a broker. Categorizing stocks is the first step to creating a stock story. Developing a stock story takes only a few hours.
When formulating a stock story, Lynch looks for companies that do something against common practice, making them stand out, He looks for companies that are not followed by analysts, and have a depressing element to their company story. Companies built on a boring premise in a no-growth industry, with a boring name, a niche market, and a good buzz are ideal for the author. Lynch prefers spin-off stocks, with a guaranteed customer base, insider buying, company buybacks, and heavy company utilization of technology.
Rather than chasing the hottest names, Lynch prefers to avoid hot stocks in hot industries. He states that hot companies can fail by acquiring businesses that do not improve the company as a whole, instead of allocating the cash to buybacks or increased dividends. He avoids stocks that are rumored to be successful, but do not have verifiable success. Companies with sensational names get more initial attention from institutions. Bets are made on hourly fluctuations, but earnings drive long-term growth.
Price-to-earnings multiples vary based on sector and general market conditions, but can be a good metric to analyze valuation. Measuring the price against future earnings more effective than measuring stock against past earnings.
Companies increase earnings by cutting costs, raising prices, expanding, modifying a losing operation, and selling more in old markets. The author advises to watch a story develop for thesis confirmation prior to investing. In order to supplement information provided by the company, the investor can perform grassroots research, consult a broker, call, or visit a company. When speaking to a broker about a stock, Lynch advises to make the broker pitch the stock. When calling a company, Lynch advises to prepare questions, and display a high level of knowledge of the company. He states that companies are typically honest with investors, and qualifies his statement by adding that he obtains out of ordinary information only 10% of the time when consulting with the company itself. He states that companies give tours of headquarters to large investors. Lynch makes contacts who attend annual leadership meetings at companies, and states that he has learned a lot from personal contact with companies.
When analyzing a report, Lynch looks for debt, and a healthy balance sheet. A favorable sign to look for is the company having more cash than debt. In order to gauge long-term progress, he looks at the 10-year long term earnings reports. Assessing the percentage of sales of a company contributed by a particular product helps determine that product's value to the stock. He looks for companies with growth rates higher than price-to-earnings multiples. Looking at a company's cash position determines the ultimate value of the stock. At the time of writing the book, the average company had 75% equity and 25% debt.
Dividends can help abate the falling of a stock's price, and take cash away from expansion in smaller companies. When examining dividend stocks, it is important to track dividend history and a company's ability to pay dividend during times of hardship.
It is important to examine a company's assets beyond listed value, as some assets are not priced correctly. They may be underpriced on balance sheet or overpriced, depending on the tools the company is utilizing to determine asset worth. Cash flow measures how much money a company has to generate revenue. Free cash flow is the measure of cash available after normal spending. Another important consideration is that inventories should not exceed sales in growth rate.
Growth rate ultimately leads to the highest share price. Pretax profit important to assess growth rate. The author advises investors to re-check a company story each few months. There are 3 phases to a stock, according to the author: start-up, rapid expansion, and mature phase. As investors recheck stocks, they should try to determine what phase the company is in. During their mature phase, companies will sometimes try to cut costs, and sacrifice quality as a consequence.
He provides investors with a checklist to determine if a stock is worth investing in: contextual price-to-earnings multiple, institutional ownership, insider buying, consistency of earnings growth, balance sheet, and cash position. For slow-growing stocks, he advises to also check dividend history, and percentage of earnings paid as dividends. For stalwarts, he advises to examine acquisitions, and price history during recessions. For fast growers, he advises looking at product quality, and room for expansion. For turnarounds, he looks at ability to pay debt, what will be left for shareholders should the company go bankrupt, and the return of the business from any potential slump. For asset plays, he examines quality of assets, and ratio of assets to liabilities.
Lynch cautions to avoid long shots, companies with bad investments. He states that if an investor has a doubt about a company, they should pass, and return to the stock later. He advises to look for companies with low debt, because companies without debt can not go bankrupt. He cautions to separate the tipper from the stock tips, and to never neglect the potential value of a tip. Share buybacks, and companies with niches are attractive to Lynch. Companies with a moderate growth rate in a small industry are his preference. Investors are advised to be patient, devote an hour a week to research, and buy stocks based on real value rather than what he calls stated value.
At the time of the book, 9-10% was the average annual return. In order to make picking stocks worthwhile, investors should aim to get 12-15% annual return. While it's best to own as many stocks as you have an edge in or an exciting prospect for, Lynch states that buying stocks for the sake of diversity is ill-advised. When you own more stocks, you increase your probability of securing a tenbagger, and you increase your ability to rotate cash in and out of stocks. Spreading money into several categories that are outlined in the book such as stalwarts, and fast-growers minimizes downside risk. Buying during marketwide slumps can provide additional opportunity for profit. Sell slow growers when they begin to lose market share, make bad acquisitions, or a bad dividend yield. Sell a stalwart when it has overpriced contextual price-to-earnings, its products have mixed results, its major segments are vulnerable, or there is no insider buying. Sell cyclicals to internal weakness, rapid deterioration in share price, rising inventories, falling commodity prices, expiring contracts, slowing demand, high budget, and inability to compete by cutting costs. Sell fast-growing stocks as they become overpriced, performance becomes disappointing, governance leaves, or institutions buy shares rapidly. Sell asset plays that issue more shares than expected, their assets fail to realize predicted value, institutional ownership rises, or assets become overpriced.
There are 12 popular myths in stockpicking according to Lynch: 'It's gone down this much, it can't possibly go lower.' 'You can always tell when a stock has hit bottom.' 'It's gone this high, how can it go higher?' 'It's a cheap share price, what could I lose?' Gains and losses are made on percentages, not on share price. 'Eventually, they always come back.' 'It's always darkest before dawn.' 'When it hits a certain price, I'll sell.' 'Conservative stocks don't fluctuate much.' 'It's taking too long.' 'What if I bought at that price?' 'I missed that one, I'll catch the next one.' There is rarely a stock that exactly copies a similar company's success. 'Stock price going up or down determines if the investment is good.'
Because stocks are not commodities, Lynch believes that price insurance is unnecessary. At the time of the book reports estimated between 80-95% of amateur option trades lose. He declines to describe options and futures in full detail as it would require a large amount of exposition, the description may tempt an investor to purchase options, and he does not fully understand them, himself. In a hypothetical situation, an investor could buy options with the hope that a stock would rise, and while waiting for the stock to rise, the options would lose half their value. Then, they may become worthless at expiry date. The stock could make its move just after the options expire. Options are expensive, as brokers make commission on each trade, and charge premiums for the options themselves. Buying put options is not an effective tool to safeguard against decline, also, as one may lose 5-10% on put options to offset a 5-10% loss in the market.
The author compares shorting a stock to borrowing an item and selling it at a later date. Then, going out and buying a similar item for a lower cost, and returning it to the original owner. Shorting shares has drawbacks as you don't gain dividends, and don't realize a profit until you buy the shares back. Also, if the share price rises, the shorter loses the difference.
Stocks may move in the opposite direction of fundamentals in the short term. The value of merchandise determines the success of an investor in the long term, not short term swings. In 1988, 87% of shares changed hands, compared to 12% in the early 1960s. He contends that although the 1987-88 stock market is comparable to the 1929-1930 stock market, a depression would not have the same effect because of workforce distribution and the added cushion of having 2 earners rather than one.
Market declines are inevitable, impossible to predict, and can present great buying opportunities. Being right 100% of the time is not possible nor is it necessary, and some of the author's biggest winners surprised himself. Different categories of stocks have different risk profiles. Compounding 20-30% gains in stalwarts can lead to large stock gains. Companies can always do worse until they go bankrupt. The price rising is not necessarily a confirmation of thesis. Overpriced stalwarts with heavy institutional ownership are doomed to fall. Buying cheap stocks of mediocre companies is a bad tactic. Selling fast-growers because their stocks are slightly overpriced is a bad idea. Companies don't grow for no reason, and fast-growers can stop growing. A stock does not know that you own it, and you do not lose anything by missing out on a huge run in any stock. Don't become complacent in rechecking stock stories. If a stock goes to 0, you will lose all your money invested, no matter how much it was. By rotating stocks based on story rechecking, you can increase your gains. Maximize on all opportunity presented. You will not improve results by trying to invest more in bad performers. Buy a mutual fund if you don't think you can beat the market. Keep a sense of paranoia. Be open to new ideas, but don't be afraid to miss out on gains if you're not confident in the stock story.
No matter the buzz in the market, the author utilizes the same tactics. He has noted the market's reaction to enough different circumstances to reaffirm his confidence in his methodology, rather than in short-term swings. He states that winners in the stock market are prioritized correctly.
Lynch groups stocks into 6 basic categories: slow growers, fast growers, stalwarts, cyclicals, asset plays, and turn-arounds. Slow growers grow at a slightly faster rate than the GDP, the author states. Fast growers are small, aggressive companies that advance at approximately 20-25% per year. Stalwarts are big companies that grow at approximately 10-12% per year. The author typically keeps stalwarts for a 30-50% gain prior to selling. Cyclicals such as auto stocks, steel, airlines, and chemicals, rise and fall in predictable fashion. Turnarounds are companies near bankruptcy that return to profitability. Asset plays are companies in possession of valuable assets that the investor knows about.
Companies can change categories based on internal modifications. In order to classify a stock, investors can consult with a broker. Categorizing stocks is the first step to creating a stock story. Developing a stock story takes only a few hours.
When formulating a stock story, Lynch looks for companies that do something against common practice, making them stand out, He looks for companies that are not followed by analysts, and have a depressing element to their company story. Companies built on a boring premise in a no-growth industry, with a boring name, a niche market, and a good buzz are ideal for the author. Lynch prefers spin-off stocks, with a guaranteed customer base, insider buying, company buybacks, and heavy company utilization of technology.
Rather than chasing the hottest names, Lynch prefers to avoid hot stocks in hot industries. He states that hot companies can fail by acquiring businesses that do not improve the company as a whole, instead of allocating the cash to buybacks or increased dividends. He avoids stocks that are rumored to be successful, but do not have verifiable success. Companies with sensational names get more initial attention from institutions. Bets are made on hourly fluctuations, but earnings drive long-term growth.
Price-to-earnings multiples vary based on sector and general market conditions, but can be a good metric to analyze valuation. Measuring the price against future earnings more effective than measuring stock against past earnings.
Companies increase earnings by cutting costs, raising prices, expanding, modifying a losing operation, and selling more in old markets. The author advises to watch a story develop for thesis confirmation prior to investing. In order to supplement information provided by the company, the investor can perform grassroots research, consult a broker, call, or visit a company. When speaking to a broker about a stock, Lynch advises to make the broker pitch the stock. When calling a company, Lynch advises to prepare questions, and display a high level of knowledge of the company. He states that companies are typically honest with investors, and qualifies his statement by adding that he obtains out of ordinary information only 10% of the time when consulting with the company itself. He states that companies give tours of headquarters to large investors. Lynch makes contacts who attend annual leadership meetings at companies, and states that he has learned a lot from personal contact with companies.
When analyzing a report, Lynch looks for debt, and a healthy balance sheet. A favorable sign to look for is the company having more cash than debt. In order to gauge long-term progress, he looks at the 10-year long term earnings reports. Assessing the percentage of sales of a company contributed by a particular product helps determine that product's value to the stock. He looks for companies with growth rates higher than price-to-earnings multiples. Looking at a company's cash position determines the ultimate value of the stock. At the time of writing the book, the average company had 75% equity and 25% debt.
Dividends can help abate the falling of a stock's price, and take cash away from expansion in smaller companies. When examining dividend stocks, it is important to track dividend history and a company's ability to pay dividend during times of hardship.
It is important to examine a company's assets beyond listed value, as some assets are not priced correctly. They may be underpriced on balance sheet or overpriced, depending on the tools the company is utilizing to determine asset worth. Cash flow measures how much money a company has to generate revenue. Free cash flow is the measure of cash available after normal spending. Another important consideration is that inventories should not exceed sales in growth rate.
Growth rate ultimately leads to the highest share price. Pretax profit important to assess growth rate. The author advises investors to re-check a company story each few months. There are 3 phases to a stock, according to the author: start-up, rapid expansion, and mature phase. As investors recheck stocks, they should try to determine what phase the company is in. During their mature phase, companies will sometimes try to cut costs, and sacrifice quality as a consequence.
He provides investors with a checklist to determine if a stock is worth investing in: contextual price-to-earnings multiple, institutional ownership, insider buying, consistency of earnings growth, balance sheet, and cash position. For slow-growing stocks, he advises to also check dividend history, and percentage of earnings paid as dividends. For stalwarts, he advises to examine acquisitions, and price history during recessions. For fast growers, he advises looking at product quality, and room for expansion. For turnarounds, he looks at ability to pay debt, what will be left for shareholders should the company go bankrupt, and the return of the business from any potential slump. For asset plays, he examines quality of assets, and ratio of assets to liabilities.
Lynch cautions to avoid long shots, companies with bad investments. He states that if an investor has a doubt about a company, they should pass, and return to the stock later. He advises to look for companies with low debt, because companies without debt can not go bankrupt. He cautions to separate the tipper from the stock tips, and to never neglect the potential value of a tip. Share buybacks, and companies with niches are attractive to Lynch. Companies with a moderate growth rate in a small industry are his preference. Investors are advised to be patient, devote an hour a week to research, and buy stocks based on real value rather than what he calls stated value.
At the time of the book, 9-10% was the average annual return. In order to make picking stocks worthwhile, investors should aim to get 12-15% annual return. While it's best to own as many stocks as you have an edge in or an exciting prospect for, Lynch states that buying stocks for the sake of diversity is ill-advised. When you own more stocks, you increase your probability of securing a tenbagger, and you increase your ability to rotate cash in and out of stocks. Spreading money into several categories that are outlined in the book such as stalwarts, and fast-growers minimizes downside risk. Buying during marketwide slumps can provide additional opportunity for profit. Sell slow growers when they begin to lose market share, make bad acquisitions, or a bad dividend yield. Sell a stalwart when it has overpriced contextual price-to-earnings, its products have mixed results, its major segments are vulnerable, or there is no insider buying. Sell cyclicals to internal weakness, rapid deterioration in share price, rising inventories, falling commodity prices, expiring contracts, slowing demand, high budget, and inability to compete by cutting costs. Sell fast-growing stocks as they become overpriced, performance becomes disappointing, governance leaves, or institutions buy shares rapidly. Sell asset plays that issue more shares than expected, their assets fail to realize predicted value, institutional ownership rises, or assets become overpriced.
There are 12 popular myths in stockpicking according to Lynch: 'It's gone down this much, it can't possibly go lower.' 'You can always tell when a stock has hit bottom.' 'It's gone this high, how can it go higher?' 'It's a cheap share price, what could I lose?' Gains and losses are made on percentages, not on share price. 'Eventually, they always come back.' 'It's always darkest before dawn.' 'When it hits a certain price, I'll sell.' 'Conservative stocks don't fluctuate much.' 'It's taking too long.' 'What if I bought at that price?' 'I missed that one, I'll catch the next one.' There is rarely a stock that exactly copies a similar company's success. 'Stock price going up or down determines if the investment is good.'
Because stocks are not commodities, Lynch believes that price insurance is unnecessary. At the time of the book reports estimated between 80-95% of amateur option trades lose. He declines to describe options and futures in full detail as it would require a large amount of exposition, the description may tempt an investor to purchase options, and he does not fully understand them, himself. In a hypothetical situation, an investor could buy options with the hope that a stock would rise, and while waiting for the stock to rise, the options would lose half their value. Then, they may become worthless at expiry date. The stock could make its move just after the options expire. Options are expensive, as brokers make commission on each trade, and charge premiums for the options themselves. Buying put options is not an effective tool to safeguard against decline, also, as one may lose 5-10% on put options to offset a 5-10% loss in the market.
The author compares shorting a stock to borrowing an item and selling it at a later date. Then, going out and buying a similar item for a lower cost, and returning it to the original owner. Shorting shares has drawbacks as you don't gain dividends, and don't realize a profit until you buy the shares back. Also, if the share price rises, the shorter loses the difference.
Stocks may move in the opposite direction of fundamentals in the short term. The value of merchandise determines the success of an investor in the long term, not short term swings. In 1988, 87% of shares changed hands, compared to 12% in the early 1960s. He contends that although the 1987-88 stock market is comparable to the 1929-1930 stock market, a depression would not have the same effect because of workforce distribution and the added cushion of having 2 earners rather than one.
Market declines are inevitable, impossible to predict, and can present great buying opportunities. Being right 100% of the time is not possible nor is it necessary, and some of the author's biggest winners surprised himself. Different categories of stocks have different risk profiles. Compounding 20-30% gains in stalwarts can lead to large stock gains. Companies can always do worse until they go bankrupt. The price rising is not necessarily a confirmation of thesis. Overpriced stalwarts with heavy institutional ownership are doomed to fall. Buying cheap stocks of mediocre companies is a bad tactic. Selling fast-growers because their stocks are slightly overpriced is a bad idea. Companies don't grow for no reason, and fast-growers can stop growing. A stock does not know that you own it, and you do not lose anything by missing out on a huge run in any stock. Don't become complacent in rechecking stock stories. If a stock goes to 0, you will lose all your money invested, no matter how much it was. By rotating stocks based on story rechecking, you can increase your gains. Maximize on all opportunity presented. You will not improve results by trying to invest more in bad performers. Buy a mutual fund if you don't think you can beat the market. Keep a sense of paranoia. Be open to new ideas, but don't be afraid to miss out on gains if you're not confident in the stock story.
No matter the buzz in the market, the author utilizes the same tactics. He has noted the market's reaction to enough different circumstances to reaffirm his confidence in his methodology, rather than in short-term swings. He states that winners in the stock market are prioritized correctly.
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