Peter Lynch was one of the greatest mutual fund investors of all time, achieving over a 29% annual rate of return with Fidelity’s Magellan Fund from 1977 to 1990. Lynch’s strategy focused on finding both smaller, high growth stock opportunities, as well as buying larger otherwise strong companies that were either coming out of a period of hard times or were simply being neglected by the market.
Peter Lynch Quit At The Top Of His Game – But Not Before Sharing His Knowledge With The World
While only in his 40’s, Lynch decided to call it quits and spend more time with his family. Before doing so however, he gave the investing world this gem of a book:
Lynch wrote two other books – namely Beating the Street as well as Learn to Earn. Though I have not read the latter yet (it was written for a younger audience) the former is excellent as well. That’s for another post though. What can we learn from One Up On Wall Street?
The Six Categories of Stocks
When examining stocks to select for potential purchase it is useful to be able to categorize them in a set way for better understanding. After all, our brains are essentially pattern recognition machines, so it helps to have a simple organizing framework for stock selection.
In the book, Lynch describes corporations as, in a way, having different personalities just like people. They are as follows:
- Slow Growers – These are your typical large corporations that grow earnings around 2-5% per year. They are usually very mature businesses, and only attractive most of the time because of their fat dividend yields.
- Stalwarts – These are the “blue chip” stocks of the market. They’re mature like slow growers but they grow faster, usually with earnings growth in the 10-12% range. Lynch says that it is always great to have a portion of your portfolio in stocks like these because they are high quality and tend to provide some protection from loss during recessions.
- Cyclicals – These are businesses that routinely move up and down with business cycles. Lynch notes that it is easy for amateurs to get caught up with these types of stocks and think that they are Stalwarts, when in fact, they are not. Think of stocks in the energy, materials, or travel sectors. There are periods when they are making money hand over fist, and others where they are struggling to make a profit or even losing lots of money.
- Fast Growers – This category of stock is where Lynch seemed to focus most of his energy and research. Companies in this group tend to grow their earnings at 20-25% annually. Investing in the right Fast Grower at the right time can yield phenomenal results, such as investing in an early Netflix or Amazon (both of which I missed by the way). Lynch wisely notes that in a small porfolio, one or two of these stocks can make a career.
- Asset Plays – Sometimes, companies have significant assets within their control that may or may not be listed on their balance sheet. Great opportunities can exist here for companies with under-appreciated assets.
- Turnarounds – Corporations that deal with significant trouble or hardship but are still surviving and have a shot at rebirth are considered turnarounds. Be careful with this type of stock though. As Warren Buffett has said, “Turnarounds rarely turn.” It is easy to be optimistic with a company’s future prospects when the data says otherwise.
Check out the podcast episode on this topic below:
Earnings and Other Key Indicators
Lynch goes on to discuss what is most important in analyzing a company, and not just considering each category but in general. For example, he discusses how important earnings are in a company and stock’s investment potential – the larger and more stable the potential future earnings, the greater the potential return on investment.
He also discusses many other aspects of research, such as how to understand basic financial terminology, how not to get carried away with hot or popular stocks that tend to be fads, and how finding a company with a boring sounding name can actually be exciting.
I also like how Lynch stresses throughout the book how great stock investments that he looks for are those that many others don’t look for. He concerned himself not just with finding great companies, but with finding great companies that haven’t been noticed by others yet for some reason or another.
Although I think this is arguably harder in today’s world because of improvements in data science and the systemization of stock selection at asset management firms, there is still room for the individual investor to have an edge – particularly with smaller stocks which are simply too small for many fund managers to buy (this is because putting up lots of money in a small stock would effectively “move the market” and the stock price of the company would rapidly shift up as its shares are bought up, negating any big gains).
If institutional investors don’t follow the stock, that may be a good sign. If the work the company does sounds dull or boring, even better. While everyone is focused on Amazon or Apple, you can focus on smaller players that might have a shot at being “the next big thing” within their particular line of business.
For example, Lynch gives an example of funeral home company Service Corporation International (SCI):
The best thing about this company is that it was shunned by most professional investors for years. Despite an incredible record, the SCI executives had to go out on cavalcades to beg people to listen to their story. That meant that amateurs in the know could buy stock in a proven winner with a record of solid growth in earnings, and at much lower prices than they’d have to pay for a hot stock in a popular industry. Here was the perfect opportunity – everything was working, you could see it happening, the earnings kept increasing, there was rapid growth with almost no debt – and Wall Street turned the other way.
Although the current SCI is probably not quite as attractive as it was when Lynch profiled it here, it still seems like a solid company and is an excellent example of looking for great stocks in unlikely places.
This Is A Practical Introductory Investment Book
Though the examples are naturally dated because of time, I appreciate that Lynch writes from his first-hand experience and doesn’t throw around too much confusing jargon (when he does, he explains what he means in simple terms). So many non-fiction authors fail to do this well, so I appreciate it as a reader and I certainly appreciated it several years ago when I had far less knowledge than I do now.
Looking back now at the book yet again I amazed by how much general material he was able to cover in one book, and do it in such a non-intimidating way. His style is conversational, so it’s easy to grasp. It also doesn’t hurt that sometimes there are pictures or tables throughout, which add some variety to the text:
Be sure to check out the book. It’s packed full of information, written for beginner investors, and is easy to understand. Let me know what you think of it!