Peter Lynch's One up on Wall Street - notes - 1st halfby Tahmeed Ahmad
Review of Peter Lynch's first book: One up on Wall Street. Part I.
One point he does emphasis, however, is that most people should purchase a house before they invest in stocks since they tend to do more research. He also mentions that you have an edge in the industry you work at that you can exploit since you have access to information before the Wall Street analysts. He makes it a point to exploit edges, and I agree:
Lynch - 1st half "What makes a company valuable, and why it will be more valuable tomorrow than it is today... earnings and assets"
Earnings drive the stock price.
Compare P/E across companies within the same industry.
Track P/E ratio back across several years for a company.
High P/E of overall market during end of bull markets.
Low interest rates drives a stock's P/E up.
Predicting future earnings is tough, just get a rough estimate. More importantly, find out HOW a company plans to increase its earnings. Then you can check periodically if plans are working out.
Five ways a company can increase earnings:
1) Reduce costs
2) Raise prices - You can raise the price with an exclusive franchise.
3) Expand into new markets
4) Sell more of its product in old markets
5) Revitalize, close or otherwise dispose of a losing operation.
STOCKS TO AVOID
Avoid the hottest stock in the hottest industry - the one that gets the more favorable publicity.
Beware of the "next something" speculators. Avoid stocks that are being touted as the next IBM or next McDonalds or next Disney. ~
Avoid "diworseifications" - "Instead of buying back shares or raising dividends, profitable companies often prefer to blow the money on foolish acquisitions. The dedicated oiworseifier seeking out merchandise that is (1) overpriced and (2) complete beyond his or her realm of understanding. This ensures that losses will be maximized."
Beware of the whisper stock - the long shot stock that people tell you is a hot, but secret tip. something they are only telling you.
Beware of the middle man - "The company that sells 20 to 25 percent of its wares to a single customer is in a precarious situation.... short of cancellation, the big customer has incredible leverage in extracting price cuts and other concessions that will reduce the supplier's profits. it's rare that a great investment could result from such an arrangement."
Beware the stock with the exciting name - people will fall in love with it.
The Perfect Stock
Getting the story is easier if you understand the basic business. The simpler it is, the better. "An idiot could run this joint," because sooner or later any idiot probably is going to be running it.
"If it's a choice between owning stock in a fine company with excellent management in a highly competitive and complex industry, or a humdrum company with mediocre management in a simpleminded industry with no competition, I'd take the latter. For one thing, it's easier to follow."
"Any idiot can run this business" is one characteristic of the perfect company.
1) It sounds dull, or even better, ridiculous. The perfect stock ought to have a perfectly boring name.
2) It does something dull It does something boring, like make cans and bottle caps.
3) It does something disagreeable A stock that makes people shrug, retch or turn away in disgust is ideal.
4) It's a spin off
5) The institutions don't own it, and the analysts don't follow it "If you find a stock with little or no institutional ownerships, you've found a potential winner. Find a company that no analyst has ever visited, or that no analyst would admit to knowing about, and you've got a double winner... It frequently happens with banks, savings and loans, and insurance companies since there are thousands of these."
6) The rumors abound: It's involved with toxic waste and/or the mafia
7) There's something depressing about it
8) It's a no-growth indsutry no growth, like plastic knives, and forks. "For every single product in a hot industry, there are a thousand MIT graduates trying to figure out how to make it cheaper in Taiwan... This doesn't happen with bottle caps, coupon-clipping services, oil-drum retrieval, or motel chains."
9) It's got a niche Niche means there is little or no competition. People can buy jewelery from anywhere - internet, out of state, across the street. An asset play, no one can compete with. Exclusive franchises are a niche, they have value. You can raise the price with an exclusive franchise. Newspapers used to be niches. Drug companies and companies with patents have niches, since no one else can make their drug. Chemical companies have niches because getting a poison approved is as hard as a drug. Brand names are niches, like Robitussin, Coca-Cola, Tylenol, Marlboro.
10) People have to keep buying it - self explanatory
11) It's a user of technology - as technology is advanced and becomes cheaper, costs are reduces.
12) The insiders are buyers "In general, corporate insiders are net sellers, and they normally sell 2.3 shares to every one share that they buy... When insiders are buying like crazy, you can be certain that, at a minimum, the company will not go bankrupt in the next six months... Long term... when management owns stock, then rewarding shareholders becomes a first priority... it's more significant when employees at lower echelons add to their positions. if you see someone with a $45,000 annual salary buying $10,000 worth of stock, you can be sure it's a meaningful vote of confidence"
13) The company is buying back shares - you guys know this one already.