So the fifth most important takeaway from Beating the Street, in my opinion, is that you should "Focus on the even bigger picture"
Imagine that you are living in Sweden, or some other country with seasonal weather conditions
One day in the winter, the temperature suddenly drops below zero degrees Celsius
People start to panic
It was 30 degrees just a couple of months ago, what is happening? Is it the beginning of the next Ice Age?
The media starts to produce daily headlines about how polar bears could die from the cold, how electricity will stop working and
how even hell may eventually freeze if this drop in temperature continues
A silly scenario, you say? Absolutely, but it's not much different from this one, which has happened on multiple occasions
Imagine that you are living in a country with a stock market, which price is determined by a group of emotional human beings
One day after a bull market, stocks suddenly drop ten percent from their previous high
People start to panic
The Dow Jones was
27,000 just a couple of months ago, What is happening? is at the beginning of the end of the financial system as we know it?
The media starts to produce daily headlines about how stocks may eventually become
worthless pieces of paper and how investors should switch to money in the bank and bonds if they don't want to risk personal bankruptcy
Equally silly, yet, this is a reoccurring thing, from which we don't seem to learn very fast
Just like with the weather, stocks go through numerous cycles
This is a natural thing, as the price of the market is determined by you,
me, and a bunch of other emotional characters that swing from optimistic to pessimistic and then back again
Peter Lynch says that the key to making money in stocks is not to get scared out of them
The stomach determines the fate of the stockpicker, not the head
Whenever Peter Lynch himself feels the itch to sell all his stocks and prepare for the worst
he likes to remind himself of "The even bigger picture"
The even bigger picture is that during the last 60 years
stocks have outperformed bonds by almost 3.5:1 per year and
let's not even discuss money in bank accounts here
Despite the
thousands of reasons that we've seen that the financial world may come to an end,
stocks have been returning, on average, 7.1% per year versus 2.1% per year for bonds, after inflation
Besides, if total disaster actually does strike, money in the bank will be just as useless as stock certificates
But if disaster doesn't strike (which is a much more likely scenario).
the stock picker will be the richer man in the long run
At number four we have that "Making money in stocks is a combination of science, art and legwork"
So it's no secret that Peter Lynch became such a successful fund manager at Fidelity Magellan by investing in stocks
But how did he do it?
He attributes his success to a combination of science, art and
legwork
Stock picking is partly a science, as great opportunities can be found by investigating the numbers that are presented in a company's financial statements
Peter Lynch has many such quantitative factors that he likes to see, and he presents some of them in Beating the street
- Growing sales and earnings
- A reasonable price
- Low debt
- Share buybacks etc
But if this was the only ingredients in picking great stocks,
mathematicians and accountants would be the richest people on the planet (which they aren't)
Successful investing is also partly an art
In the long run, a stock will be priced fairly relative to how its earnings are developing
The investor must understand what has been able to drive earnings in the past, and
triggers that can cause them to grow in the future too
A good way to make sure that you have a correct hunch is this:
"If you are prepared to invest in a company,
then you ought to be able to explain why in simple language that a fifth grade could understand, and quickly enough,
so the fifth-grader won't get bored"
The last factor is legwork: stay busy
Peter Lynch himself visited hundreds of companies per year and read even more annual reports
He assessed that for every ten companies you investigate you'll find one where the story is better than the market is currently expressing
He also emphasizes that when investigating an opportunity, you typically stumble across another one
Peter Lynch's favorite question when interviewing CEOs was this:
"Are there any other companies that you were impressed with?"
When the CEO of one company talks fondly of a competitor in the same industry, you've probably found yourself a good deal
Number three: Use the earnings line to identify buying opportunities
First: sales and earnings must be moving
Second: buy at a reasonable price
In Beating the street Peter Lynch gives an interesting tip on how to quickly evaluate if the price of a stock is fair or not
He says that one can identify an opportunity by looking at the "earnings line" of a company
In the long-run, the development of a stock will resemble the development of its earnings
Whenever we have reason to believe that the price of a stock is lower than what is fair compared to its earnings and
expected growth rate, we have a buying opportunity. And if the reverse is true, we should probably sell
Let's take Google as an example here. During the years 2008 to 2013,
Google's earnings increase from
$4.2 billion to $12.7 billion , which is equal to a yearly growth of 25%
Let's say that we had reason to believe that Google could continue this strong growth
As a rule of thumb:
Peter Lynch thinks that a stock should sell at a P/E below its yearly growth rate
So whenever the stock of Google drops below a P/E of 25, we consider it a buy
The earnings line represents what the value of the company should be if the stock was priced at 25 times, its earnings
As you can see, Google could have been considered a buy in mid 2015 when the price of the stock dropped below the line
In mid
2018 on the other hand, the stock was a sell, as the gap between the price and the earnings line had become very large
And interestingly enough, with these assumptions, Google should be a buy today
Please note that this is not in any way a recommendation to buy Google today. This is just a part of the analysis
There's more science art and legwork to be added before we can decide weather Google is worthy of our money or not!
Number 2: Search for overlooked stocks with strong owners
It pays to be a contrarian when it comes to investing
It can be very profitable to go to places where other fund managers and investors are afraid to invest
Look for companies that aren't followed by many analysts
In Beating the street Peter Lynch lists many of his investing principles and Peter's principle number 18 is:
"When even the analysts are bored, it's time to start buying"
This typically results in a lower price than warranted
Moreover, an overlooked company is usually favorable from other perspectives as well
For one thing, the largest share owners are usually still the founders of the company and the top management
This type of "skin in the game" is great for the investor
You can rest assured that your interest and that of the management are aligned
Furthermore, the owners of the business are typically more well educated about the industry with overlooked companies
What you want to see are owners that have succeeded with similar businesses before
What you don't want to see is that the largest five owners of the business are insurance companies or other large institutional players
These people rarely know much about the industry and they probably don't care much about the company either,
as it most likely will represent only a small fraction of their total capital on the management
So, look for companies that Wall Street has missed
and where the owners are well invested and capable of running such a business
And ranking in as the most important takeaway of Beating the street, we have: Buy Swedish
Okay, not really, but Peter Lynch speaks fondly about Sweden in Beating the street so of course, I had to bring this up
Actually, among Fidelity Magellan's top five performers under Peter Lynch's management,
the only stock that wasn't from the US was Swedish
And that's probably about it for my patriotic bragging ...
Number one: Look for great companies in lousy industries
I talked a little bit about this in my review of Peter Lynch's other, more famous book, One up on Wall Street
There, you can learn about the ten traits of the typical 10 bagger, which is a stock that increases a thousand percent or more
Check out that video after this one
Now, a quick quiz. here would you rather invest your money today?
One: Internet and direct marketing retail
Two: Software
Three: Life science
Four: Energy equipment and services
Five: Metals and mining
Six: Oil gas and consumable fuels
Which ones did you pick?
According to research from fidelity.com, 1-3 are the top three performing industries of the last five years
while 4-6 are the worst performing ones
Peter Lynch would probably shy away from the first group and instead focus his legwork on the second one. Why?
Because strong performance attracts competition
Everyone and his cousin would like to start a business in the first of the three industries,
while companies are dying like flies in the second three
Peter Lynch recommends, that you should buy the strongest company or companies in industries,
where the general opinion is that things have gone from bad to worse
As competitors fall the market share of these companies will increase as will their profitability
It won't take long before the stock price follows too
If you want to learn about the ten traits that Peter Lynch wants to see when he's looking for stocks that return more than 1,000%,
the so-called 10-baggers, click on my video of One up on Wall Street
Click the link now
See you soon