Categorising stocks (Peter Lynch)

When you buy into stocks you need to understand why you are buying. In doing this, it helps to categorise the company in determining what sort of returns you can expect. Catergorising also enforces some discipline into your investment process and aids effective portfolio construction. 

Peter Lynch uses the six categories below;-

• Sluggards (Slow growers) – Usually large companies in mature industries with earnings growth below or around GDP growth. Such companies are usually held for dividend rather than significant price appreciation.

• Stalwarts (Medium growth) - High quality companies such as Coca-Cola, P&G and Colgate that can still churn out high single digit/low teens growth. Earnings patterns are not cyclical meaning that these stocks will protect you recession.

• Fast growers – Companies whose earnings are growing at 20%+ and have plenty of runway to attack e.g. think Google, Apple in their early days. It doesn’t have to be a company as “sexy” as those mentioned.

• Cyclicals – Companies whose fortunes are closely linked to the economic cycle e.g. automobiles, financials, airlines.

• Turn-arounds – Companies coming out of a depressed phase as a result of change in management, strategy or corporate restructuring. Successful turnarounds can deliver stunning returns.

• Asset plays – Firm has hidden assets which are undervalued or not recognized at all on the balance sheet or under appreciated by the market e.g. cash, land, property, holdings in other company.



Comment:
General observations about different types of stocks.

Wall Street does not look kindly on fast growers that run out of stamina and turn into slow growers and when that happens the stock is beaten down accordingly.

Fast Growers

 FAST GROWERS

Traits
• Small, aggressive new companies. Growing
at 20-25%.
• Land of the 10-40x, even 200x. 1-2 such
companies can make a career.
• Lousy Industry
o May not belong to fast growing industry.
Can expand in the room in a slow growth
industry by taking market share.
o Depressed industries are likely places to
find potential bargains. If business
improves from lousy to mediocre, you are
rewarded, rewarded again when mediocre
turns to good, and good to excellent.
o Moderately fast growers (20-25%) in slow
growth industries are ideal investments.
Look for companies with niches that can
capture market share without price
competition. In business, competition is
never as healthy as total domination.
o Growth ≠ Expansion, leading people to
overlook great companies like Phillip
Morris. Industry wide cigarette
consumption may decline, but company
can increase earnings by cost cuts and
price increases. Earnings growth is the
only growth that really counts. If costs
rise 4%, but prices rise 6%, and profit
margin is 10%, then extra 2% price rise
= 20% increase in earnings.
o Greatest companies in lousy industries
share certain characteristics:
i) low cost operators / penny pinchers
in the executive suite
ii) avoid leverage
iii) reject corporate hierarchies
iv) workers are well paid and have a
stake in the company’s future
v) they find niches, parts of the market
that bigger companies overlook. Zero
Growth Industry = Zero Competition.
• Hot Industry
o Hot Stocks + Hot Industry = Greater
Competition. Companies can thrive only
due to niche/moat/patents etc.
o Growth ≠ Expansion. In low growth
industries, companies expand by
capturing market share, cutting costs
and raising prices. When an industry
gets too popular, nobody makes money
there anymore.
• Life Phases of a Fast Grower: each may last
several years. Keep checking earnings,
growth, stores to check aura of prosperity.
Ask, what will keep earnings going?
i) Startup phase: companies work out
kinks in the basic business. Riskiest
phase for the investor because success is
not yet established.
ii) Rapid Expansion: company enters new
markets. Safest phase for investor where
most amount of money is made, because
growth is merely an act of duplication
across markets. Company reinvests all
FCF into expansion. No dividends help
faster expansion. IPO helps in expanding
without bank debt / leverage.
iii) Maturity / Saturation: company faces the
fact that there’s no easy way to continue
expansion. Most problematic phase
because company runs into its own
limitations. Other ways must be found to
increase earnings, possibly only, via
luring customers away from competitors.
If M&A / diworseification follows, then
you know management is confused.
• Find out growth plans and check if plan is
working?
i) Cost cuts – the proof is in decrease of
selling and administrative costs.
ii) Raise prices
iii) Entry into new markets
iv) Sell more volume in existing markets
v) Exit loss making operations
• What continues to triumph, vs, flop, is:
i) Capable management
ii) Adequate financing
iii) Methodical approach to expansion – slow
but steady wins this kind of race.
o When a company tries to open >100
stores/year, it’s likely to run into
problems. In its rush to glory, it can
pick the wrong sites or managers, pay
too much for real estate, and, fail to
properly train employees. It is easier
to add 35-40 stores / year.
• Re-classification away from Fast Grower
o A large fast growth company faces
devaluation risk, since growth may slow
down as it runs out of space for further
expansion.
o Inability to maintain double digit growth
may see a re-classification into a Slow
Grower, Cyclical or Stalwart. High fliers
of one decade are groundhogs of the next.
o Fast Growers like hotels/retail having
prime real estate turn into Asset Plays.
o There’s high risk, especially in younger
companies that are overzealous and
underfunded. The headache of
underfinancing may lead to bankruptcy.
o Fast Grower’s that can’t stand prosperity,
diworseify, fall out of favour, and, turn
into Turnaround candidates.
o Every Fast Grower turns into a Slow
Grower, fooling many people. People have
a tendency to think that things won’t
change, but eventually they do,
o Very few companies switch from being a
Slow Grower to a Fast Grower.
o Companies may fall into 2 categories at
the same time, or, pass through all
categories over time (Disney).
• During 1949-1995, an investment in the 50
growth stocks on Safian’s Growth Index
returned 230x, while the Safian Cyclical
Index only returned 19x.
• Growth companies were the star performers
during and after 2 corrections (1981-82 and
1987), and they held their own in the 1990
Saddam selloff. The only time you wished
you didn’t own them was 1973­74, when
growth stocks were grossly overpriced.

Buying and Holding Tips
• Fast Grower => 2x GNP growth rate.
Sustaining 30% growth rate is very difficult,
even for 3 years. 20-25% growth rate is more
sustainable (investing sweet spot).
• Best place to find a 10x stock is close to
home – if not the backyard, then in the
kitchen, mall, workplace etc. You’ll find a
likely prospect ~2/3 times a year. The
person with the edge is always in a position
to outguess the person without an edge.
• Long shots almost never pay off. Better to
miss the 1st stock move (during phase I), or
even the late stage of phase I, when the
company’s only reached 5-10% of market
saturation, and wait to see if it’s plans are
working. If you wait, you may never need to
buy, since failure would’ve become visible.
• Does the idea work elsewhere? Must prove
that cloning works in other markets, and
show its ability to survive early mistakes,
limited capital, find required skilled labour.
• The most fascinating part of long term, Fast
Growers is how much time you have to catch
them. Even a decade later and with stock
already up 20x, it’s not too late to capitalize
on an idea that has still not run its course.
• Emerging growth stocks are much more
volatile than larger companies, dropping and
soaring like sparrow hawks around the
stable flight of buzzards. After small caps
have taken one of these extended dives, they
eventually catch upto the buzzards.
• Small Company Index PE / S&P 500 PE:
Since small companies are expected to grow
faster than larger ones, they’re expected to
sell at higher PE’s, theoretically. In practice,
this isn’t always the case. During periods
when Emerging Growth is unpopular with
investors, these small caps get so cheap that
their PE = S&P 500 PE. When wildly popular
and bid up to unreasonably high levels, it is
= 2x S&P 500 PE.
• In such cases, small caps may get clobbered
for several years afterward. Best time to buy
is when Small PE / Large PE < 1.2x. To reap
the reward from this strategy, you’ve to be
patient. The rallies in small cap stocks can
take a couple of years to gather storm and
then several more years to develop.
• A similar pattern applies to the Growth vs
Value pots. Be patient. Watched stock never
boils. When in doubt, tune in later.
• Look for a good balance sheet and large
profits. Trick is in figuring out when the
growth stops and how much to pay for it?
• Recent price run-ups shouldn’t matter, so
long as PEG still makes it attractive.
• If PEG =1x, then 20% growth @ 20x PE is >
10% growth @ 10x PE. Higher compounded
earnings will compensate even for PE
multiple shrinkage.
• High PE leaves little room for error. Best way
to handle a situation where you love the
company but not the price (great company,
high growth, but high PE), is to make a
small commitment and then increase it in
the next selloff. One can never predict how
far the price may fall. Even if you buy after a
setback, be prepared for further declines
when you might consider buying even more
shares. If the story is still good, after review,
then you’re happy that the price fell.
• So, the important issue is why has the stock
fallen so much? If the long term story is still
intact and the growth will continue for a
long time, then buy more. If you can place
the company in its attractive, mid-life phase,
ex. 2nd decade of 30 years of growth, then
you shouldn’t mind paying 20x PE for a 20-
25% growth rate, especially if market PE =
18-20x with an 8-10% growth rate.
• If you sell at 2x, you won’t get 10x. As long
as same store sales are rising, company isn’t
crippled with excess debt, and is following
its stated expansion plans, stick around. If
the original story stays intact, you’ll be
amazed at the results in several years.
• Trick is to not lose a potential 10x, but know
that, if earnings shrink, then so will the PE
that’s been bid up high – double whammy.
• It’s harder to stick with a winning stock after
price increases, vs, continuing to believe in a
company after price falls. If you’re in danger
of being faked out into selling, revisit the
reasons / story, as to why you bought it in
the first place. There are 2 ways investors
can fake themselves out of the big returns
that come from great growth companies.
i) Waiting to buy the stock when it looks
cheap: Throughout its 27-year rise from
a split-adjusted 1.6 cents to $23, WalMart 

never looked cheap compared to
the market. Its PE rarely dropped <20x,
but earnings were growing at 25-30%
Any business that keeps up a 20-25%
growth rate for 20 years rewards its
owners with a massive return even if the
overall market is lower after 20 years.
ii) Underestimating how long a great
growth company can keep up the pace.
These "nowhere to grow" theories come
up often & should be viewed sceptically.
o Don't believe them until you check
for yourself. Look carefully at where
the company does business and at
how much growing room is left.
Whether or not it has growing room
may have nothing to do with its age.
o Wal-Mart IPO’d in 1970. By 1980 =
stock 20x, with 7x number of stores.
Was it time to sell, not be greedy, &
put money elsewhere? Stocks don’t
care who owns it and questions of
greed are best resolved in church,
not in brokerage accounts.
o The important issue to analyze was
not whether the Wal-Mart stock
would punish its holders, but
whether the company had saturated
the market. The answer was No.
Wal-Mart’s reach was only 15% of
USA. Over the next 11 years, the
stock went up another 50x.

Sell When
• Hold as long as earnings are growing,
expansion continues and no impediments
arise. Check the story every few months as if
you’re hearing it for the very first time.
• If a Fast Grower rises 50% and the story
starts sounding dubious, sell and rotate into
another, where the current price is <= your
purchase price, but the story sounds better.
• Main thing to watch is the end of phase II of
rapid expansion. Company has no new
stores, old stores are shabby, and the stock
is out of fashion.
• Wall Street covers the stock widely,
institutions hold 60%, and 3 national
magazines fawn over the CEO.
• Large companies with 50x PE!? Even at 40x,
and with wide, saturated presence, where
will the large company grow?
• Last quarter same-store sales are down 3%,
new store sales are disappointing, and the
company is telling positive stories, vs,
showing positive results.
• Top executives / employees leave to join a
rival.
• PE = 30x, but next 2 years’ growth rate =
15%. Therefore, PEG = 2x (very negative)

Examples
• Annheuser Busch, Marriott, Taco Bell,
Walmart, Gap, AMD, Texas Instruments,
Holiday Inn, carpets, plastics, retail,
calculators, disk drives, health maintenance,
computers, restaurants
• While it’s possible to make 2-5x in Cyclicals
and Undervalued situations (if all goes well),
payoffs in Fast Growers like restaurants and
retailers are bigger. Restaurants/retailers
can expand across the country and keep up
the growth rate at 20% for 10-15 years.
• Not only do they grow as fast as high tech
companies, but unlike an electronics or shoe
company, restaurants are protected from
competition. Competition is slower to arrive
and you can see it coming. A restaurant
chain takes a long time to work its way
across the country and no foreign company
can service local customers.
• Taste homogeneity helps scale in food,
drinks, entertainment, makeup, fashion etc.
Popularity in 1 mall = popularity in another.
Certain brands prosper at else’s expense.
• Ways to increase earnings (restaurants):
i) Add more locations
ii) Improve existing operations
iii) High turnover with low priced meals
iv) High priced meals with lower turnover
v) High OPM because of food made with
cheaper ingredients, or, due to low
operating costs
• To break even, a restaurants’ sales must =
Capital Employed. Restaurant group as a
whole may only grow slowly at 4%, but as
long as Americans eat >50% of their meals
out of home, there’ll be new 20x stocks.

People Examples
• Higher failure rate than Stalwarts, but if and
when one succeeds, it may boost income 10-
20-100x.
• Actors, real estate developers, musicians,
small businessmen, athletes, criminals

PE Ratio
• Highest for Fast Growers at 14-20x.
Company with a High PE must have
incredible growth (for next 2 years) to justify
its price. It’s a miracle for even a small
company to justify a 50x PE, as may so
happen during a bull market.
• 1 year forward PE of 40x = dangerously high
and in most cases extravagant. Even fastest
growing companies can rarely achieve 25%
growth, and 40% is a rarity. Such frenetic
growth isn’t sustainable for long & growing
too fast tends to lead to self destruction.
• 40x PE @ 30% growth isn’t attractive, but
not bad if S&P 500 = 23x PE & Coke PEG =
2x (PE = 30x @ 15% growth).
• Unlike Cyclical where the PE contracts near
the end of the cycle, Fast grower’s PE gets
bigger and may reach absurd, illogical levels.
• Earnings are not constant and PE of 40x vs
3x shows investor willingness to gamble on
higher earnings, vs, scepticism about the
cheaply priced company’s future.

PEG

2 Minute Drill
• Where and how can the company continue
to grow fast?
• La Quinta Motels started in Texas. Company
successfully duplicated its formula in
Arkansas & Louisiana. Last year it added
28% more units. Earnings have increased
every quarter. Plans rapid future expansion
& debt isn’t excessive. Motels are low growth
industry and very competitive but La Quinta
has found something of a niche. Long way to
go before it saturates the market.

Checklist
• Percentage of sales – is a new fast growing
product a large % of sales?
• Recent growth rate – favour 20-25% growth
rates. Be wary if growth is > 25%. Hot
industries show growth >50%.
• Proof – has company duplicated its success
in >1 city, for planned expansion to work?
• Runway – does it still have room to grow?
• PE – is it high or low, vs, growth rate?
• Δ Growth rate – is expansion speeding up or
slowing down? For companies doing sales
via large, single deals, vs, selling high
volume & low ticket items, growth slowdown
can be devastating because doing more
volume at bigger ticket sizes is difficult.
When growth slows, stock drops
dramatically.
• Institutional ownership / Analyst coverage –
no presence is a positive, as growth
expectations are still not captured in the
Price or PE.

Portfolio Allocation %
• 30-40% Allocation in Magellan. Magellan’s
allocation to Fast Growers was never >50%.
• 40% in Personal investor’s 10 stock portfolio
• If looking for 10x stocks, likelihood increases
as you hold more stocks. Among several, the
one that actually goes the farthest maybe a
surprise. The story may start at a certain
point, with specific expectations, and get
progressively better. There’s no way to
anticipate pleasant surprises.
• More stocks provide greater flexibility for
fund rotation. If something happens to a
secondary company, it may get promoted to
being a primary selection.

Risk/Reward
• High Risk – High Gain. Higher potential
upside = Greater potential downside.
• +10x / (-100%)
• Major bankruptcy risk for small fast grower’s
via underfinanced, overzealous expansion
• Major rapid devaluation risk for large fast
growers once growth falters, because there’s
no room left for future expansion

The Peter Lynch Playbook
Twitter@mjbaldbard 10 mayur.jain1@gmail.com

Stalwarts

STALWARTS

Traits
• Growth rate = 2x GNP growth rate
• Growth Rates: Slow Growers (1x GNP) <
Stalwarts (2x GNP) < Fast Growers (20-25%)
• Fairly large sized companies
• You can profit, based on time and price of
purchase. Long term return will be = bonds
• Good performers, but not stars – 50% return
in 2 years is a delightful result. Sell more
readily than Fast Growers.
• Good performers in good markets. Take 30-
50% returns, and then rotate money into
another Stalwart.
• Operating performance of such defensives
helps them survive recessions. No down
quarter for 20-30 years.
• Offer good protection in hard times. Won’t go
bankrupt, soon enough they’ll be
reassessed, and their value will be restored.
• Don’t hold after 2x, hoping for 10x. Can hold
for 20 years only if you bought a “Great”
company at a “Good” price.
• Can hardly go wrong by making a full
portfolio of companies that have raised
dividends for 10-20 years in a row.
• Hidden assets like brands & patents grow
larger, while the company punishes P&L
EPS via amortization, R&D, branding etc.
EPS will jump when these expenses stop, or,
the new product hits the market.
o Due to these hidden assets and low
maintenance capex, FCF > EPS.
o Possible to cut costs, raise prices and
also capture market share in slow growth
markets.
o If you can find a company that can raise
prices without losing customers, you’ve
found a terrific investment.

Examples
• Pharma, Tobacco, FMCG, Alcohol

People Examples
• Command good salaries and get predictable
raises – mid level employees

PE Ratio
• Average = 10-14x.
• PEG <0.5-1x is fine, but 2x is expensive.

2 Minute Drill
• Key issues are PE, recent price run-ups, and
what, if anything is happening to accentuate
growth rate?
• Coke is selling at the low end of its PE range.
Stock hasn’t gone anywhere for 2 years, even
though the company has improved in many
ways. Sold 50% of Columbia Pictures. Diet
drinks have dramatically sped up growth
rate. Foreign sales are excellent. Has better
control over sales & distribution after buying
out many independent, regional distributors.
Thus, it may do better than people think.

Checklist
• Price = key issue, since these are big
companies that aren’t likely to go out of
business
• Diworseification – capital misallocation may
reduce future earnings. Board of Directors’
is better off returning cash to shareholders.
• Long Term Growth Rate – has company kept
up with growth rate momentum in recent
years? Is it slowing/speeding?
• Long Term Holding – how did it fare during
previous recessions / market correction?

Portfolio Allocation %
• 10-20% Allocation, in order to moderate
risks in portfolio full of Fast Growers and
Turnarounds.
• Average 20% Allocation in a personal
investor’s 10 stock portfolio.

Risk/Reward
• Low Risk – Moderate Gain.
• 2 year hold may give 50% upside vs 20%
downside.
• 6 rotations of 25-30% CAGR Stalwarts = 4-
5x, or 1 big winner.

Sell When
• Stalwarts with heavy institutional ownership
and lots of Wall Street coverage, that have
outperformed the market and are overpriced,
are due for a rest or decline.
• 10x not possible. If P>E, or, PE>Normal, sell
and rotate. If Price gets ahead, but the story
is still the same, sell and rotate.
• New products of last 2 years have mixed
results & new testing products are >1 year
from market launch
• PE = 15x, vs similar quality company from
same industry at 11-12x PE
• No Executive/CXO/Director has bought
shares in last 1 year
• Large division (>25% of sales) is vulnerable
to an ongoing economic slump (housing, oil)
• Growth rate is slowing down and though
earnings have been maintained via cost
cuts, there’s no further room left.

Slow Growers

SLOW GROWERS

Traits
• Usually large and aging companies, whose
Growth rate = GNP Growth rate
• When industries slow down, most companies
lose momentum as well
• Easy to spot using stock charts
• Pay large and regular dividends
• Bladder theory of corporate finance: the
more cash that builds up in the treasury,
the greater the pressure to piss it away.
Companies that don’t pay dividends, have a
history of diworseification.
• Stocks that pay dividends are favoured vs
stocks that don’t. Presence of dividend
creates a floor price, keeping a stock from
falling away during market crashes. If
investors are certain that the high dividend
yield will hold up, then they’ll buy for the
dividend. This is one reason to buy Slow
Growers and Stalwarts, since people flock to
blue chips during panic.
• If a Slow Grower stops dividend, you’re
stuck with a sluggish company with little
going for it.

Examples
• GE, Alcoa, Utilities, Dow Chemical

People Examples
• Secure jobs + Low salary + Modest raises =
Librarians, Teachers, Policemen

PE Ratio
• Lowest levels, per PEG. Utilities = 7-9x
• Bargain hunting doesn’t make sense without
growth or other catalyst
• During bull market optimism, PE may
expand to Fast Growers’ PE of 14-20x
• Therefore, the only meaningful source of
return = PE re-rating

2 Minute Drill
• Reasons for interest?
• What must happen for the company to
succeed?
• Pitfalls that stand in the path?
• Dividend Play = “For the past 10 years the
company has increased earnings, offers an
attractive dividend yield, it’s never reduced/
suspended dividend, & has in fact raised it
during good and bad times, including the
last 3 recessions. As a phone utility, new
cellular division may aid growth.”

Checklist
• Dividends: Check if always paid and raised.
• Low dividend payout ratio creates cushion,
higher % is riskier.

Portfolio Allocation %
• 0% - NO Allocation, because without growth,
the earnings & price aren’t going to move.
Risk/Reward
• Low risk-Low gain, because Slow Growers
aren’t expected to do much and are priced
accordingly.

Sell When
• After 30-50% rise
• When fundamentals deteriorate, even if price
has fallen:
o Lost market share for 2 Quarters and
hires new advertising agency
o No new products/R&D, indicating that
the company is resting on its laurels
o Diworseification (>2 recent unrelated
M&A’s), excess leverage leaves no room
for buybacks/dividend increase
o Dividend yield isn’t high enough, even at
a lower price.

The Peter Lynch Playbook

Twitter@mjbaldbard 2 mayur.jain1@gmail.com

Turnarounds

TURNAROUNDS

Traits
• No growth, potential fatalities – a poorly
managed company is a candidate for trouble
• Make up lost ground very quickly and
performance isn’t related to market moves
• Can’t compile a list of failed Turnarounds,
since their records get deleted after collapse
• Turnaround types:
i) Bail Us Out Or Else: whole deal depends
on a government bailout.
ii) Who Would’ve Thought: can lose money
in utilities?
iii) Unanticipated Problem: minor tragedy
perceived to be worse, leading to major
opportunity. Be patient. Keep up with
news. Read it with dispassion. Stay away
from tragedies where the outcome is
immeasurable.
iv) Good Company Inside a Bad one:
possible bankruptcy spinoff. Look for
institutional selling and insider buying.
Did the parent strengthen the company’s
balance sheet pre-spinoff?
v) Restructuring: company diworseified
earlier, now the loss making business is
being sold off, costs cut etc.
• How will earnings change?
i) Lower costs
ii) Higher prices
iii) Expansion into new markets
iv) Higher volume sold in old markets
v) Changes in loss making operations
• Buy companies with superior financial
condition. Young company + Heavy Debt =
Higher Risk. Determine extent of leverage
and what kind is it? Long term funded debt
is preferable to Short/Medium term callable
bank debt, which may trigger bankruptcy.
• Inventory growth > Sales growth = Red flag,
& inventory growth is a bad sign. Depleting
inventory means things maybe turning
positive. High inventory build up overstates
earnings - may mean that management is
deferring losses by not marking down the
unsold items & getting rid of them quickly.
• Asset/inventory values maybe inflated. Raw
materials are liquidated better than finished
goods. Check for pension liabilities and
capitalized interest expense in asset values.
• Upswing favours Turnarounds > Normal
companies. So look for low margin
companies to succeed via operating leverage
/ high cost of production.
• If the industry is robust in general and the
company’s business doesn’t do well, then
one maybe pessimistic about its future.
• If the entire industry is in a slump & due for
a rebound, & the company has strengthened
its balance sheet and is close to the breakeven 
point, then it has the potential to do
jumbo sales when the industry picks up.
• Name changes may happen due to M&A or
some fiasco that they hope will be forgotten.
• Are Turnarounds obvious winners? In
hindsight, yes, but a company doesn’t tell
you to buy it. There’s always something to
worry about. There are always respected
investors who say that you’re wrong. You’ve
to know the story better than they do and
have faith in what you know.
• For a stock to do better than expected, it has
to be widely underestimated. Otherwise, it’d
sell for a higher price to begin with. When
the prevailing opinion is more negative than
yours, you’ve to constantly check & re-check
the facts, to assure yourself that you’re not
being foolishly optimistic. The story keeps
changing for better or worse, and you’ve to
follow these changes and act accordingly.
• With Turnarounds, Wall Street will ignore
changes. The Old company had made such a
powerful impression that people can’t see
the New one. Even if you don’t see it right
away, you can still profit more than enough.
• Cyclicals with serious financial problems
collapse into Turnarounds. Also, fast
growers that diworseify & fall out of favour.
• If Slow Grower = Turnaround, then it’s
performance maybe > Stalwart/Fast Grower
• Remind yourself of the Even Bigger Picture –
that stocks in good companies are worth
owning. What’s the worst that can happen?
Recession turns into depression? Then
interest rates will fall, competitors will falter
etc. if things go right, how much can I earn?
What’s the reward side of the equation? Take
the industry which is surrounded by the
most doom and gloom. If the fundamentals
are positive, you’ll find some big winners.

Examples
• Auto (Ford Chrysler), paper, airlines
(Lockheed), steel, electronics, non-ferrous
metals, real estate, oil & gas, retail, Penn
Central, General Utilities, Con Edison, Toys
R Us spinoff, Union Carbide, Goodyear.
• Record with troubled utilities is better than
troubled companies in general, because of
regulations. A utility may cancel dividends /
declare bankruptcy, but if people depend on
it, a way must be found to let it continue
functioning. Regulation determines prices,
profits, passing on costs to customers. Since
the government has a vested interest in its
survival, the odds are overwhelming that it
will be allowed to overcome its problems.
• Troubled Utility Cycle:
i) Disaster Strikes: some huge cost (fuel)
can’t be passed along, or, because a huge
asset is mothballed & removed from the
base rate. Stock drops 40-80% in 1-2
years, horrifying people who view utilities
as safe & stable investments. Soon, it
starts trading at 20-30% P/B. Wall Street
is worried about fatal damage – how long
it takes to reverse this impression varies.
30% P/B implies bankruptcy, emergence
from which may take upto 4 years.
ii) Crisis Management: utility attempts to
respond by cutting costs and capex.
Dividend maybe decreased / eliminated.
Begins to look as if the company will
survive, but price doesn’t reflect the
improved prospects.
iii) Financial Stabilization: cost cuts have
succeeded, allowing it to operate on
current revenues. Capital markets maybe
unwilling to lend money for new projects
& it’s still not earning money for owners,
but survival isn’t in doubt. Prices recover
to 60-70% P/B, 2x from stage (i), (ii)
iv) Recovery At Last: once again capable of
earning and Wall Street has reason to
expect improved earnings and the
reinstatement of dividends. P/B = 1x.
How things progress from here depends
on, (a) reception from capital markets,
because without capital, a utility cannot
increase its base rates, and, (b) support
from regulators’, ie, how many costs are
allowed to be passed on?
• One person’s distress is another man’s
opportunity. You don’t need to rush into
troubled utilities to make large profits. Can
wait until the crisis has abated, doomsayers
are proven wrong, and, still make 2-4x in
short term. Buy on the omission of dividend
& wait for the good news. Or buy when the
first good news has arrived in stage (ii).
• The problem that some people have is they
think they’ve missed it if the stock falls to
$4, then rebounds to $8. A troubled
company has a long way to go and you’ve to
forget that you’ve missed the bottom.

People Examples
• Guttersnipes, drifters, down and outers,
bankrupts, unemployed – if there’s energy
and enterprise left.

2 Minute Drill
• Has the company gone about improving its
fortunes and is the plan working?
• General Mills has made great progress on
diworseification. Cut down from 11 to 2
businesses that are key and the company
does best. Others were sold at good price
and the cash was used for buybacks. 1 key
business’ market share has improved from 7
to 25% and is coming up with new products.
Earnings are up sharply.

Checklist
• Plan – how will it turnaround? Sell loss
making subsidiaries? Cut costs? What’s the
impact of these actions? Is business coming
back? New products?
• Survival – can it survive a raid by short term
creditors? Check cash/debt position, capital
structure, can it sustain more losses?
• Bottom Fishing – if it’s bankrupt already,
then what’s left for owners?

Portfolio Allocation %
• 20-50% Allocation, based on where greater
value exists - Turnarounds or Fast Growers

Risk/Reward
• High Risk – High Gain.
• Higher potential upside (10x) vs higher
potential downside (100% loss).

Sell When
• After Turnaround is complete, trouble is
over, everyone is aware of changed situation,
& the company is re-classified as a Cyclical/
Fast/Slow Grower etc. Stockholders aren’t
embarrassed to own the shares anymore.
• Stock is judged to be a 2x, but not 5-10x
• PE is inflated vs Earnings prospects, sell and
rotate into juicier Turnaround opportunities,
where Fundamentals are better than Price.
• Debt, which has declined for 5 consecutive
quarters, rises again. Indicates increased
chances of relapse.
• Inventory rise > 2x Sales increase.
• >50% sales of the company’s strongest
division’ come from some customer whose
sales are slowing down.

The Peter Lynch Playbook

Twitter@mjbaldbard 5 mayur.jain1@gmail.com

Cyclicals

 CYCLICALS

Traits
• Sales and profits rise and fall in regular, if
not completely regular fashion, as business
expands and contracts.
• Timing is everything. Coming out of a
recession into a vigorous economy, they
flourish more than Stalwarts. In the opposite
direction, they can lose >50% very quickly
and may take years before another upswing.
• Most misunderstood type, and investors can
lose money in stocks considered safe. Large
Cyclicals are falsely classified as Stalwarts.
• If a defensive Stalwart loses 50% in a slump,
then Cyclicals may lose 80%.
• It’s much easier to predict upswing, vs, a
downturn, so one has to detect early signs of
business changes. You get a working edge if
you’re in the same industry – to be used to
your advantage. Most important in Cyclicals.
• Unreliable dividend payers. If they’ve
financial problems, then they become
potential Turnaround candidates.
• Inventory build-up = bad sign. Inventory
growth > Sales growth = red flag. Inventory
build-up with companies having fluctuating
end product pricing causes larger problems.
• Monitor inventory to figure out business
direction. If inventory is depleting in a
depressed company, it’s the first evidence of
a possible business turnaround.
• High Operating Profit Margin (OPM) = Lowest
Cost producer, who’s got a better chance of
survival if business conditions deteriorate.
• Upswing favours companies with Low
OPM’s. Therefore, what you want to do is to
Hold relatively High OPM companies for long
term and play relatively Low OPM companies
for successful Turnarounds / cycle turns.

• The best time to get involved with Cyclicals
is when the economy is at its weakest,
earnings are at their lowest, and public
sentiment is at its bleakest. Even though
Cyclicals have rebounded in the same way 8
times since WWII, buying them in the early
stages of an economic recovery is never easy.
• Every recession brings out sceptics who
doubt that we will ever come out of it, who
predict a depression and the country going
bankrupt. If there’s any time not to own
Cyclicals, it’s in a depression. “This one is
different,” is the doomsayer’s litany, and, in
fact, every recession is different, but that
doesn’t mean it’s going to ruin us.
• Whenever there was a recession, Lynch paid
attention to them. Since he always thought
positively and assumed that the economy
will improve, he was willing to invest in
Cyclicals at their nadir. Just when it seems
it can’t get any worse, things begin to get
better. A comeback of depressed Cyclicals
with strong balance sheets is inevitable.
• Cyclicals lead the market higher at the end
of a recession – how frequently today’s
mountains turn into tomorrow’s molehills,
and, vice versa.
• Cyclicals are like blackjack: stay in the game
too long and it’s bound to take back all your
profits. Things can go from good to worse
very quickly and it’s important to get out at
the right time.
• As business goes from lousy to mediocre,
investors in Cyclicals can make money; as it
goes from mediocre to good, they can make
money; from good to excellent, they may
make a little more money, though not as
much as before. It’s when business goes
from excellent back to good that investors
begin to lose; from good to mediocre, they
lose more; and from mediocre to lousy,
they’re back where they started.
• So, you have to know where we are in the
cycle. But it’s not quite as simple as it
sounds. Investing in Cyclicals has become a
game of anticipation, making it doubly hard
to make money. Large institutions try to get
a jump on competitors by buying Cyclicals
before they’ve shown any signs of recovery.
This can lead to false starts, when stock
prices run up and then fall back with each
contradictory statistic (we’re recovering,
we’re not recovering) that is released.
• The principal danger is that you buy too
early, then get discouraged, and, sell. To
succeed, you’ve to have some way of
tracking the fundamentals of the industry
and the company. It’s perilous to invest
without the working knowledge of the
industry and its rhythms.
• Timing the cycle is only half the battle.
Other half is picking companies that will
gain Most from an upturn. If Industry pick =
Right, but Company pick = Wrong, then you
can lose money just as easily as if you were
wrong about the industry.
• If investing in a troubled industry, buy
companies with staying power. Also, wait for
signs of revival. Some troubled industries
never came back.
• If you sell at 2x, you won’t get 10x. If the
original story is intact or improving, stick
around to see what happens and you’ll be
amazed at the results.

Examples
• Auto, airlines, steel, tyres, chemicals,
aerospace & defence, non-ferrous metals,
nursing, lodging, oil & gas
• Autos: 3-4 up years, after 3-4 down years.
Worse Slump = Better Recovery. An extra
bad year brings longer and more sustainable
upside. People will eventually replace their
cars, even if put off for 1-2 years.
o Units of pent up demand – compare
Actual Sales vs Trend, ie, estimate of
how many units should’ve been sold
based on demographics, previous year
sales, age of cars on road etc.
o 1980-83 = sluggish economy + people
saving up, therefore pent up demand =
7mm. 1984-89 boom, sales exceeded
trendline by 7.8mm.
o After 4-5 years below trend, it takes
another 4-5 years above trend, before
the car market can catch upto itself. If
you didn’t know this, you might sell your
auto stocks too soon. After 1983, sales
increased from 5mm to 12.3mm and you
might sell fearing the boom was over.
But if you follow the trend, you’d know
the pent up demand was 7mm, which
wasn’t exhausted until 1988, which was
the year to sell your auto stocks, since
pent up demand from early 80’s got used
up. Even though 1989 was a good year,
units sold fell by 1mm.
o If industry had 5 good years, it means
it’s somewhere in the middle of the cycle.
Can predict upturn, not downturn.
o Chrysler EPS for 1988, ’89, ’90 & ’91
was $4.7, $11.0, $0.3 & Loss,
respectively. When your best case is
worse than everyone’s worst case, worry
that the stock is floating on fantasy.
• At one point, high yield Utilities were 10% of
Magellan’s AUM. This usually happened
when interest rates were declining and the
economy was in a splutter. Therefore, treat
Utilities as interest rate Cyclicals and time
entry and exit accordingly. Can also treat
Fannie / NBFC’s as interest rate Cyclicals
benefitting from rate cuts.
• In the Gold Rush, people selling picks and
shovels did better than the miners. During
periods when mutual funds are popular,
investing in the fund companies is more
rewarding than putting money into their
funds. When interest rates are falling, bond
& equity funds attract most cash. Money
market funds prosper when rates rise.
• In US /Europe insurance companies, the
rates go up months before earnings show
any improvement. If you buy when the rates
first begin to rise, you can make a lot of
money. It’s not uncommon for a stock to
become 2x after a rate increase and another
2x on the higher earnings that result from a
rate increase.

People Examples
• Make all their money in short bursts, then
try to budget it through long, unprofitable
stretches. Farmers, resort employees, camp
operators, writers, actors. Some may also
become Fast Growers.

PE Ratio
• Slow Growers (7-9x) < Cyclicals (7-20x) <
Fast Growers (14-20x)
• Assigning PE’s: Peak EPS (3-4x) < Decent
EPS (5-8x) < Average EPS (8-10x)
• Stock Pattern: 1990 EPS = $6.5, Price Range
= $23 - $36, PE Range = 3.6-5.5x. 1991 EPS
= $3.9, Price drops to $26. PE = 6.7x, higher
than previous year PE, that had higher EPS.
• With most stocks, a Low PE is regarded as a
good thing, but not with Cyclicals. When
Low, it’s usually a sign that they are at the
end of a prosperous interlude.
• Unwary investors hold onto their shares
since business is still good & the company
continues to show higher earnings, but this
will change soon. Smart investors sell their
shares early to avoid the rush.
• When a large crowd begins to sell, the Price
and PE drops, making a Cyclical more
attractive to the uninitiated. This can be an
expensive misconception. Soon, the economy
will falter and earnings will decline at a
breathtaking speed. As more investors head
for the exit, price will plummet. Buying
Cyclicals after years of record earnings and
when PE has hit a low point is a proven
method to lose ~50% in a short time.
• Conversely, a High PE may be good news for
a Cyclical. Often, it means that a company is
passing through the worst of the doldrums
and soon its business will improve, earnings
will exceed expectations, and investors will
start buying the stock.

2 Minute Drill
• Script revolves around business conditions,
inventories and prices.
• There’s been a 3 year slump in autos but
this year things have turned around. I know
that because car sales are up across the
board for the first time in recent memory.
GM’s new models are selling well and in the
last 18 months GM closed down 5 inefficient
plants, cut 20% labour and earnings are
about to turn higher.

Checklist
• Inventories: keep a close eye on inventory
levels, changes, and, the supply & demand
relationship.
• Competition: new entrants / added supply =
dangerous development, because they may
cut prices to capture market share.
• Know your Cyclical: if you do, then you have
an advantage in figuring things out and
timing the cycles.
• Balance Sheet: strong enough to survive the
next downturn? Can it outlast competitors?
Is capex on upgradation / expansion a cause
for concern? How much of a drag is it on
FCF? Is CF > Capex, even in bad years? Are
plant & machinery in good shape?

Portfolio Allocation %
• 10-20% Allocation

Risk/Reward
• Low Risk – High Gain; or
High Risk – Low Gain, depending on
investor adeptness at anticipating cycles.
• +10x / (80-90% loss)
• Get out of situations where Price overtakes
Fundamentals and rotate into Fundamentals
> Price

Sell When
• Understand strange rules to play game
successfully, because Cyclicals are tricky.
Sell towards the end of the cycle, but who
knows when that is? Who even knows what
cycles they’re talking about? Sometimes, the
knowledgeable vanguard sells 1 year before
any signs of decline, so price falls for no
apparent reason.
• Whatever inspired you to buy after the last
bust, will help clue you in that the latest
boom is over. If you’d enough of an edge to
buy in the first place, then you’ll notice
changes in business and price.
• Company spends on new technological
expansion, instead of cheaper expenditures
on modernizing old plants.
• Sell when something has actually gone
wrong. Rising costs, 100% utilization but
spending on capacity expansion, labour asks
for increased wages, which were cut in the
previous bust etc.
• Final product demand slows down.
Inventory builds up and the company can’t
get rid of it. If storage is full of finished
goods, you may already be late in selling.
• Falling commodity prices, Futures < Spot
Price. Oil, steel prices turn lower much
earlier than EPS impact.
• Strong competition for market share leads to
price cuts. Company tries cost cuts but can’t
compete against cheap imports.

The Peter Lynch Playbook

Twitter@mjbaldbard 7 mayur.jain1@gmail.com

ASSET PLAYS

ASSET PLAYS

Traits
• Local edge is useful, since Wall Street 
ignores/overlooks valuable assets.

Examples
• Railroads, TV stations, minerals, oil &amp; gas,
timber, newspapers, real estate, depreciation
on assets that appreciate over time, patents,
cash, subsidiary valuations, foreign owner
priced cheaper than local subsidiary, tax
loss carry forwards, goodwill amortization,
brands, holding company / conglomerate
discount, depreciated assets that don’t need
maintenance capex but still produce FCF
(rental equipment EPS = 0, but FCF =3)

People Examples
• Never do wells, trust fund men, squires, bon
vivants
• Live off family fortunes but never labour –
issue is what will be left after payments for
travel, liquor, creditors etc.

PB Ratio
• If 2-5x is the expected return, then entry
point for P/NAV = 20-50%

2 Minute Drill
• What are the assets and what’s their worth?
• Stock = $8, but video cassette division = $4
and Real Estate = $7. That a bargain in itself
and the rest of the company = ($3). Insiders
are buying and the company has steady
earnings. There is no debt to speak of.

Checklist
• NAV? Any hidden assets?
• Debt – does leverage detract from asset
value? Is new debt being added?
• Catalyst – how will value get unlocked?
Raider / activist?

Portfolio Allocation %
• 0% - NO Allocation

Risk/Reward
• Low Risk – High Gain, IF you’re sure that
NAV = 2-5x current price
• If wrong, you probably don’t lose much

Hold
• If company isn’t going on a debt binge and
reducing NAV

Sell When
• Catalyst occurs – without raider/catalyst,
you may sit for ages
• Management dilutes/diworseifies
• Institutional ownership rises to 60% from 25
• Instead of a subsidiary selling for $100, it
sells for $60 - calculated NAV maybe inflated
• Tax rate deduction reduces value of tax loss
carry forwards

The Peter Lynch Playbook

Twitter@mjbaldbard 3 mayur.jain1@gmail.com

Growth Stocks: Searching for the Sprinters

Growth Stocks: Searching for the Sprinters

by Douglas Gerlach

Investors who focus on growth try to predict which companies will grow faster in the future -- faster than the rest of the stocks in the market, or faster than other stocks in the same industry. If you're successful in buying a company that does grow faster than other companies, then it's likely that the price of that company's stock will increase as well, and you can make a profit.
(My comment: Provided you did not pay too high a price to buy it.)

The stock of a company that grows its earnings and revenues faster than average is known as a growth stock. These companies usually pay few or no dividends, since they prefer to reinvest their profits in their business.

Peter Lynch primarily used a growth stock approach in managing the Magellan mutual fund. Individuals who invest in growth stocks often prefer it because their portfolio will be made up of established, well-managed companies that can be held onto for many years. Companies like Coca-Cola, IBM, and Microsoft have demonstrated great growth over the years, and are the cornerstones of many portfolios. Most investment clubs stick to growth stocks as well.

Learning From Peter Lynch: How to Survive a Market Correction

In the 1988 Barron's Roundtable, the guru gave some invaluable advice to investors
March 02, 2020

Peter Lynch’s track record at Fidelity Magellan shot him to fame, and to this day, many investors look up to him for advice on equity market investing. Over three decades, he has given many invaluable insights into markets and how they work.

Throughout his tenure at Fidelity, Lynch emphasized the importance of keeping the decision-making process simple. In his book "One Up On Wall Street," the guru revealed that he stumbled upon most of his best investment ideas at the mall when he was least expecting to shop for stocks.

As easy as this investment philosophy might sound, replicating Lynch’s performance can prove to be an impossible task. While there are many stock-picking lessons to learn from him, it seems especially appropriate in the current market correction to analyze how he survived significant market downturns during the period he led the fund, and the techniques he used to do so.



The 1987 market crash

On Oct. 22, 1987, the Dow fell by 508 points, or 23%. This day is now commonly known as Black Monday. This correction is the largest one-day drop in history and needless to say, there was fear and panic among both retail and institutional investors at that time. Peter Lynch was invited to the Barron’s Roundtable in 1988 while the market was still reeling from the massive losses the prior year. Some of the answers he gave the panelists are very relevant today and might help investors approach investing the right way.


Focus on company fundamentals, not on macroeconomic developments

When it comes to investing, it’s important to realize that there are a few variables that are out of the control of an investor. Global macroeconomic developments fall into this category, but investors spend both time and money on trying to be better forecasters of the next recession or the prospects for securing a better trade deal with the United Kingdom.

In 1998, Peter Lynch told Barron’s panelists:

“There’s always something to worry about. But it’s garbage to worry about these things. Philip Morris’s earnings went up about six-fold. in the last 10 years; the stock went up about six-fold. Merck’s earnings are up five-fold in the last 10 years; the stock is up four-fold. I don’t own any of these stocks; I can brag about them.”

He also listed a few stocks, including Avon Products, whose share price had declined drastically following a period of lower-than-expected earnings.

According to Lynch, the real focus of an investor should be on picking winning companies. Company fundamentals will rule over any other external factors in determining the value of an equity security in the long term. Understanding this important relationship could help generate alpha returns.

Today, the travel sector is getting hammered in the market as there’s a widespread fear of reduced travel and leisure activities on a global scale. This is true, but it’s very likely that leading companies in this sector, including Carnival Corporation (NYSE:CCL), will deliver stellar returns in the future. Carnival has very strong competitive advantages over its peers, including an economic moat, which will help it generate solid financial performance in the future, even though 2020 will be tough.

This applies to airline stocks as well. The falling stock prices do not reflect the economic reality that the demand for their services will pick up in the next decade along with the increasing disposable income in many countries across the world. According to Reuters data, business-related travel will also grow exponentially in the next five years, which is another driver of growth for the industry. Contrarian investors might want to research beaten stocks, which is the right decision according to Lynch.

A recession is coming, but there’s nothing to worry about

There’s no doubt that the U.S. economy will eventually reach a peak and report negative growth. This is called the business cycle effect, and there’s no outsmarting this. For centuries, the global economy has behaved this exact same way.



Source: Intelligent Economist

When Lynch was asked whether America was headed toward a recession in 1988, he said:

“Sure, but why should we worry about it? We had the worst recession since the Depression in 1982-’83. We had 14% unemployment, 15% inflation, and a 20% prime rate. But I never got a phone call a year before, saying we were going to have that. The stock market has a 100% record, in the last 50 years, of predicting upturns in the economy. It’s never been wrong. It’s less than 50-50 on a downturn. There will be a recession. But whether it’s going to in ’88 or ’89, I don’t know. Might be ’94. This theory that we have to have a recession every now and then — I’ve looked in the Constitution, stayed up late and read the Bill of Rights, and nowhere is it written that every fifth year we have a recession. People say, “Oh, it’s now so many months, plus a full moon, plus the election, and the Olympics, and therefore we have to have a recession.” It’s so crazy! You can have a good economy for three, four, five years”

He couldn’t have been any clearer about how fruitless it is to worry about the next crash. Nobody has ever been able to do this with any degree of certainty. However, it’s a given that markets will reward companies that are doing well. Whenever economic growth has been positive, broad markets have performed well, which is more than enough reason to trust that this will happen the next time as well. Things looked very gloomy in 2008, when fear was dictating investors’ decision-making processes. What followed was a decade-long bull run that is still intact.

Today, there’s no certainty of when the next recession is going to occur, or whether markets can continue to deliver acceptable returns in the next year. But, it’s a given that the U.S. economy will recover from a downturn regardless of how hard the fall is. With that in mind, investors should follow Lynch and continue their search for attractive investment opportunities.



Winning is almost certain in the long term when the strategy is correct

Many legendary investors, including Warren Buffett (Trades, Portfolio), have stressed the importance of thinking about the long term and not paying close attention to short term market fluctuations. When asked about the right way to approach markets, Lynch said:

“First, if you’re going to need money within 12 months to pay for a wedding or put a down payment on a house, the stock market is not the place to be. You can flip a coin over where the market is headed over the next year. I have no idea whether the next 1,000 points for the Dow or Nasdaq will be in positive or negative territory. But if you’re in the market for the long haul – 5, 10, or 20 years – then time is on your side and you should stick to your long-term investment plan. I would argue that the next 10,000 and 20,000 points for the market will be up. That’s been the long-term trend. The bottom line is to have a responsible plan for your investments and know what you own and why you own it. There’s too much at stake not to.”

This is invaluable advice for investors. The media, analysts and economists are talking about the impact of the new coronavirus and are in a never-ending race to predict how many points the Dow will drop before staging a comeback. This, however, will most likely end up being a futile task. Not a single analyst even remotely predicted that a virus would break out in the first half of 2020 and that economic growth would be challenged as a result. There was simply no way to do this, and the same is true for attempting to decipher the true economic impact of COVID-19. However, a few years down the line, it will be proven once again that corporate earnings have dictated the performance of markets, not the virus in and of itself.



Takeaway

The one thing that is in the control of an investor is his or her decision-making process. If there’s any liquidity, the best course of action is to invest such funds in the market. Selling when markets crash is not a wise thing to do, as empirical evidence suggests.

Peter Lynch emerged victorious in 1988 because he did not dispose of any of his holdings in 1987, even though markets crashed. Rather, he bought stocks, which went against the grain. Today, the markets are at a tipping point, and investors need to act as boldly as Lynch did to keep any hopes of generating positive returns in 2020.


https://www.gurufocus.com/news/1061797/learning-from-peter-lynch-how-to-survive-a-market-correction

About the author:

Dilantha De Silva

I am an investment professional with 5-years of experience in financial markets. I specialize in U.S. equities and incorporate a top-down approach to identify developing macro-level trends and the companies that would benefit from such trends. I am a strong believer that the best investment opportunities could be found in under-covered equities.

I currently work with leading financial publications including Refinitiv, Seeking Alpha, ValueWalk, GuruFocus, and TradeGrill to produce investment-related content.

I'm a CFA level 2 candidate and an Associate Member of the Chartered Institute for Securities and Investment (CISI, UK). During my free time, I enjoy reading.

Visit Dilantha De Silva's Website

THE 10 BEST INVESTORS IN THE WORLD

Warren Buffett
Charlie Munger
Joel Greenblatt
John Templeton
Benjamin Graham
Philip Fisher
Mohnish Pabrai
Walter Schloss
Peter Lynch
Seth Klarman



Warren Buffett (1930)

"Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down."

Warren Buffett, born on August 30, 1930 in Omaha, Nebraska, is known as the world's best investor of all time. He is among the top three richest people in the world for several years in a row now, thanks to the consistent, mind-boggling returns he managed to earn with his investment vehicle Berkshire Hathaway. The funny thing is that Buffett does not even care that much about money. Investing is simply something he enjoys doing. Buffett still owns the same house he bought back in 1958, hates expensive suits, and still drives his secondhand car.

Investment philosophy:
 Focuses on individual companies, rather than macro-economic factors
 Invests in companies with sustainable competitive advantages
 Prefers becoming an expert on a few companies over major diversification
 Does not believe in technical analysis
 Bases his investment decisions on the operational performance of the underlying businesses
 Holds on to stocks for an extremely long period, some stocks he never sells
 Uses price fluctuations to its advantage by buying when undervalued and selling when overvalued with respect to intrinsic value
 Puts much emphasis on the importance of shareholder friendly, capable management
 Beliefs margin of safety are the three most important words in investing


Charlie Munger (1924)

"All intelligent investing is value investing — acquiring more than you are paying for."

Charlie Munger is vice-chairman of Berkshire Hathaway, Warren Buffett's investment vehicle. Even though Buffett and Munger were born in Omaha, Nebraska, they did not meet until 1959. After graduating from Harvard Law School, Munger started a successful law firm which still exists today. In 1965 he started his own investment partnership, which returned 24.3% annually between 1965 and 1975, while the Dow Jones only returned 6.4% during the same period. In 1975 he joined forces with Warren Buffett, and ever since that moment Charlie Munger has played a massive role in the success of Berkshire Hathaway. While Buffett is extrovert and a pure investor, Munger is more introvert and a generalist with a broad range of interests. The fact that they differ so much from each other is probably why they complement each other so well.

Investment philosophy:
 Convinced Buffett that stocks trading at prices above their book value can still be interesting, as long as they trade below their intrinsic value
 Has a multidisciplinary approach to investing which he also applies to other parts of his life ("Know a little about a lot")
 Reads books continuously about varied topics like math, history, biology, physics, economy, psychology, you name it!
 Focuses on the strength and sustainability of competitive advantages
 Sticks to what he knows, in other words, companies within his "circle of competence"
 Beliefs it is better to hold on to cash than to invest it in mediocre opportunities
 Says it is better to be roughly right than precisely wrong with your predictions


Joel Greenblatt (1957)

“Choosing individual stocks without any idea of what you’re looking for is like running through a dynamite factory with a burning match. You may live, but you’re still an idiot.”

Joel Greenblatt definitely knows how to invest. In 1985 he started his investment fund Gotham Capital, ten years later, in 1995, he had earned an incredible average return of 50% per year for its investors. He decided to pay his investors their money back and continued investing purely with his own capital. Many people know Joel Greenblatt for his investment classic The Little Book That Beats The Market* and his website magicformulainvesting.com. Greenblatt is also an adjunct-professor at the Columbia Business School.

Investment philosophy:
 Buys good stocks when they are on sale
 Prefers highly profitable companies
 Uses the Normalized Earnings Yield to assess whether a company is cheap
 Beliefs thorough research does more to reduce risk than excessive diversification (he often has no more than 8 companies in his portfolio)
 Largely ignores macro-economical developments and short term price movements


John Templeton (1912 -2008) 

"If you want to have a better performance than the crowd, you must do things differently from the crowd."

The late billionaire and legendary investor, John Templeton, was born in 1912 as a member of a poor family in a small village in Tennessee. He was the first of his village to attend University, and he made them proud by finishing economics at Yale and later a law degree at Oxford. Just before WWII, Templeton was working at the predecessor of the now infamous Merrill Lynch investment bank. While everyone was highly pessimistic during these times, Templeton was one of the few who foresaw that the war would give an impulse to the economy, rather than grind it to a halt. He borrowed $10.000 from his boss and invested this money in each of the 104 companies on the US stock market which traded at a price below $1. Four years later he had an average return of 400%! In 1937, in times of the Great Depression, Templeton started his own investment fund and several decennia later he managed the funds of over a million people. In 2000 he shorted 84 technology companies for $200.000, he called it his "easiest profit ever". The beauty is that despite all his wealth, John Templeton had an extremely modest lifestyle and gave much of it away to charitable causes.

Investment philosophy:
 Contrarian, always going against the crowd and buying at the point of maximum pessimism
 Has a global investment approach and looks for interesting stocks in every country, but preferably countries with limited inflation, high economical growth, and a movement toward liberalization and privatization
 Has a long term approach, he holds on to stocks for 6 to 7 years on average
 Focuses on extremely cheap stocks, not necessarily on "good" stocks with a sustainable competitive advantage, like Warren Buffett
 Beliefs in patience, an open-mind, and a skeptical attitude against conventional wisdom
 Warns investors for popular stocks everyone is buying
 Focuses on absolute performance rather than relative performance
 A strong believer in the wealth creating power of the free market economy



Benjamin Graham (1894 - 1976) 

"Price is what you pay, value is what you get."

Columbia Business School professor Benjamin Graham is often called "The Father of Value Investing". He was also Warren Buffett's mentor and wrote the highly influential book The Intelligent Investor, which Buffett once described as the best book on investing ever written. Graham was born in England in 1894, but he and his family moved to the United States just one year later. His official name was Grossbaum, but the family decided to change this German sounding name to Graham during the time of the First World War. Graham was a brilliant student and got offered several teaching jobs on the University, but instead he decided to work for a trading firm and would later start his own investment fund. Due to the use of leverage, his fund lost a whopping 75% of its value between 1929 and 1932, but Graham managed to turn things around and managed to earn a 17% annualized return for the next 30 years. This was way higher than the average stock market return during that same period. In total, Graham taught economics for 28 years on Columbia Business School.

Investment philosophy:
 Focuses more on quantitative, rather than qualitative data
 First step is to look for stocks trading below 2/3rd of net current asset value (NCAV)*
 Prefers companies which pay dividends
 Looks for companies with a consistently profitable history
 Companies should not have too much long term debt
 Earnings should be growing
 Is willing to pay no more than 15 times the average earnings over the past three years
 Diversifies to spread the risk of individual positions
 Emphasizes the importance of a significant Margin of Safety
 Profits from irrational behavior caused by the manic-depressive "Mr. Market"
 Warns that emotions like fear and greed should play no role in your investment decisions

*NCAV = current assets - total liabilities



Philip Fisher (1907 - 2004) 

"I don't want a lot of good investments; I want a few outstanding ones."

Philip Fisher became famous for successfully investing in growth stocks. After studying economics degree at Stanford University, Fisher worked as an investment analyst before starting his own firm, Fisher & Co. This was in 1931, during the times of the Great Depression. Fisher's insights have had a significant influence on both Warren Buffett and Charlie Munger. Philip Fisher is also author of the powerful investment book Common Stocks and Uncommon Profits, which has a quote from Buffett on its cover which reads: "I am an eager reader of whatever Phil has to say, and I recommend him to you."

Investment philosophy:
 Dislikes technical analysis
 Does not belief in "market timing"
 Prefers a concentrated portfolio with around 10 to 12 stocks
 Emphasizes the importance of honest and able management
 Beliefs you should only invest in companies which you can understand
 Warns that you should not follow the masses, but instead have patience and think for yourself
 Companies should have a strong business model, be innovative, highly profitable, and preferably a market leader
 Has a focus on growth potential of both companies and industries
 Buys companies at "reasonable prices" but does not specify what "reasonable" is to him
 A true "buy & hold" investor who often holds on to stocks for decades
 Beliefs great companies purchased at reasonable prices and held for a long time are better investments than reasonable companies bought at great prices
 Has a "scuttlebutt" approach to doing research by asking questions to customers, employees, competitors, analysts, suppliers, and management to find out more about the competitive position of a company and its management
 Only sells when a company starts experiencing issues with its business model, competitive positioning, or management



Mohnish Pabrai (1964)

“Heads, I win; tails, I don’t lose much. “

Mohnish Pabrai has once been heralded as "the new Warren Buffett" by the prestigious American business magazine Forbes. While this seems like big words, you might start to understand why Forbes wrote this when you look at the performance of Pabrai's hedge funds, Pabrai Investment Funds, which have outperformed all of the major indices and 99% of managed funds. At least, that was before his funds suffered significant losses during the recent financial crisis because of their exposure to financial institutions and construction companies. Still, there is much we can learn from his low-risk, high-reward approach to investing, which he describes in his brilliant book The Dhandho Investor: The Low-Risk Value Method to High Returns.

Investment philosophy:
 Points out that there is a big difference between risk and uncertainty
 Looks for low-risk, high-uncertainty opportunities with a significant upside potential
 Only practices minor diversification and usually has around 10 stocks in his portfolio
 Beliefs stock prices are merely "noise"
 Used to buy reasonable companies at great prices, but now wants to focus more on quality companies with a sustainable competitive advantage and shareholder friendly management



Walter Schloss (1916 - 2012) 

"If a stock is cheap, I start buying." While Walter Schloss might not be the most well-known investor of all time, he was definitely one of the best investors of all time. Just like Buffett, Walter Schloss was a student of Benjamin Graham. Schloss is also mentioned as one of the "Super Investors" by Buffett in his must-read essay The Super Investors of Graham-And-Doddsville. An interesting fact about Walter Schloss is that he never went to college. Instead, he took classes taught by Benjamin Graham after which he started working for the Graham-Newton Partnership. In 1955 Schloss started his own value investing fund, which he ran until 2000. During his 45 years managing the fund, Schloss earned an impressive 15.3% return versus a return of 10% for the S&P500 during that same period. Just like Warren Buffett and John Templeton, Walter Schloss was known to be frugal. Schloss died of leukemia in 2012 at age 95.

Investment philosophy:
 Practiced the pure Benjamin Graham style of value investing based on purchasing companies below NCAV
 Generally buys "cigar-butt" companies, or in other words companies in distress which are therefore trading at bargain prices
 Regularly used the Value Line Investment Survey to find attractive stocks
 Minimizes risk by requiring a significant Margin of Safety before investing
 Focuses on cheap stocks, rather than on the performance of the underlying business
 Diversified significantly and has owned around 100 stocks at a time
 Keeps an open mind and even sometimes shorts stocks, like he did with Yahoo and Amazon just before the Dot-Com crash
 Likes stocks which have a high percentage of insider ownership and which pay a dividend
 Is not afraid to hold cash
 Prefers companies which have tangible assets and little or no long-term debt 10



Peter Lynch (1944)

"Everyone has the brain power to make money in stocks. Not everyone has the stomach."

Peter Lynch holds a degree in Finance as well as in Business Administration. After University, Lynch started working for Fidelity Investments as an investment analyst, where he eventually got promoted to director of research. In 1977, Peter Lynch was appointed as manager of the Magellan Fund, where he earned fabled returns until his retirement in 1990. Just before his retirement he published the bestseller One Up On Wall Street: How To Use What You Already Know To Make Money In The Market. Just as many of the other great investors mentioned in this document, Lynch took up philanthropy after he amassed his fortune.

Investment philosophy:
 You need to keep an open mind at all times, be willing to adapt, and learn from mistakes
 Leaves no stone unturned when it comes to doing due diligence and stock research
 Only invests in companies he understands
 Focuses on a company's fundamentals and pays little attention to market noise
 Has a long-term orientation
 Beliefs it is futile to predict interest rates and where the economy is heading
 Warns that you should avoid long shots
 Sees patience as a virtue when it comes to investing
 Emphasizes the importance of first-grade management
 Always formulates exactly why he wants to buy something before he actually buys something



Seth Klarman (1957) 

“Once you adopt a value-investment strategy, any other investment behavior starts to seem like gambling.“

Billionaire investor and founder of the Baupost Group partnership, Seth Klarman, grew up in Baltimore and graduated from both Cornell University (economics) and the Harvard Business School (MBA). In 2014 Forbes mentioned Seth Klarman as one of the 25 Highest-Earning hedge funds managers of 2013, a year in which he generated a whopping $350 million return. Klarman generally keeps a low profile, but in 1991 he wrote the wrote a book Margin of Safety: Risk Averse Investing Strategies for the Thoughtful Investor, which became an instant value investing classic. This book is now out of print, which has pushed the price up to over $1500 for a copy!

Investment philosophy:
 Is extremely risk-averse and focuses primarily on minimizing downside risk
 Does not just look for cheap stocks, but looks for the cheapest stocks of great companies
 Writes that conservative estimates, a significant margin of safety, and minor diversification allow investors to minimize risk despite imperfect information
 Warns that Wall Street, brokers, analysts, advisors, and even investment funds are not necessarily there to make you rich, but first and foremost to make themselves rich
 Often invests in "special situations", like stocks who filed for bankruptcy or risk-arbitrage situations
 Suggests to use several valuation methods simultaneously, since no method is perfect and since it is impossible to precisely calculate the intrinsic value of a company
 Is known for holding a big part of its portfolio in cash when no opportunities exist
 Beliefs investors should focus on absolute performance, rather than relative performance
 Emphasizes that you should find out not only if an asset is undervalued, but also why it is undervalued
 Is not afraid to bet against the crowd and oppose the prevailing investment winds
 Discourages investors to use stop-loss orders, because that way they can't buy more of a great thing when the price declines


Final words 

I hope you enjoyed reading how some the best investors in the world think about investing. You might have noticed some common themes, like buying companies for less than they are worth. And while they all practice this value investing approach, there are also notable differences between the strategies of these masters of investing. Where Warren Buffett runs a concentrated portfolio and focuses on "good" companies with a sustainable competitive advantage, Walter Schloss managed to earn impressive returns by simply buying a diverse set of extremely cheap companies. As Bruce Lee once said: "Adapt what is useful, reject what is useless, and add what is specifically your own.”


https://www.valuespreadsheet.com/best.pdf

Picking Stocks like Peter Lynch

Peter Lynch - One Up on Wallstreet (Book review)

Peter Lynch - Pearls on Investing for the Individual Investors *****

Published on Oct 16, 2012

In 1977, legendary fund manager Peter Lynch was named head of the then obscure Magellan Fund which had $18 million in assets. By the time Lynch resigned as a fund manager in 1990, the fund had grown to more than $14 billion in assets with more than 1,000 individual stock positions. From 1977 until 1990, the Magellan fund averaged a 29.2% return. This is exceptional considering how large the fund was. This video/audio is courtesy of Fedelity investments "The Stock Shop".

http://www.fidelity.com.au/

www.axiomax.com.au

The Science of Getting Rich - Secrets of Great Investors Peter Lynch

Peter Lynch's 25 Golden Rules of Investment

Peter Lynch on Fidelity Investments

Making Money in the Stock Market: Peter Lynch on Investing in the U.S. Economy (1994)

How Peter Lynch earned 29% a year for 13 years.

Focus on What is Knowable and Important

It is useful to think about the world in terms of a four-quadrant matrix where the horizontal dimension comprises what is knowable and unknowable and the vertical dimension comprises what is important and unimportant.

                             Knowable    Unknownable

Important

Unimportant

It should be obvious that you should not spend any time on what is unknowable and unimportant.

The trick is steering clear of the Unknowable/Important box and the Knowable/Unimportant box.

The trick is to focus on what is important and knowable. For example, it is very important to try to understand where a prospective business investment will be in ten years, even if it cannot be done with precision. It’s equally important to limit the time you invest thinking about investments to those businesses where this is actually possible. You can’t do this very often, but this is what you should be looking for.

Focus on spending your day in this quadrant. This is where meaningful decisions are made. This is where you can gain an edge over those who are unwittingly wasting time on the unknowable and the unimportant.



http://gregspeicher.com/?p=3299


Comment:  Peter Lynch - If you spent 13 seconds contemplating the macroeconomic factors affecting your investment prospect, you would have wasted 10 seconds of your time.  This time is better spent learning more of the company.