Showing posts with label stalwarts. Show all posts
Showing posts with label stalwarts. Show all posts

Thursday 14 March 2024

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.

Wednesday 25 September 2013

The Growth Stocks of Peter Lynch

Peter Lynch

From 1977 through his retirement in 1990, Peter Lynch steered the Fidelity Magellan Fund to a total return of 2,510%, or five times the approximate 500% return of the Standard & Poor's 500 index. In his 1989 book One Up on Wall Street, Lynch described a variety of strategies that individual investors can use to duplicate his success. These strategies divide attractive stocks into different categories, each characterized by different criteria. Among those most easy to identify using quantitative research are fast growers, slow growers and stalwarts, with special criteria applied to cyclical and financial stocks. (The latter, for example, should have strong equity-to-assets ratios as a measure of financial solvency.)

Peter Lynch's Company Categories:

Fast Growers

These companies have little debt, are growing earnings at 20% to 50% a year, and have a stock price-to-earnings ratio below the company's earnings growth rate.

Investing in these types of stocks makes sense for investors who want to find solidly financed, fast-growing companies at reasonable prices.

Slow Growers

Here Lynch is looking for companies with high dividend payouts, since dividends are the main reason for investing in slow-growth companies.

Among other things, he also requires that such companies have sales in excess of $1 billion, sales that generally are growing faster than inventories, a low yield-adjusted price/earnings-to-growth ratio, and a reasonable debt-to-equity ratio.

Investing in these types of stocks makes sense for income-oriented investors.

Stalwarts

Stalwarts have only moderate earnings growth but hold the potential for 30%-to-50% stock price gains over a two-year period if they can be purchased at attractive prices. 

Characteristics include positive earnings; a debt to equity ratio of .33 or less; sales rates that generally are increasing in line with, or ahead of, inventories; and a low yield-adjusted price/earnings-to-growth ratio. 

Investing in these types of stocks makes sense for investors who aren't willing to pay up for high-growth companies but still want the chance to enjoy significant capital gains.



Read more: http://www.nasdaq.com/investing/guru/guru-bios.aspx?guru=lynch#ixzz2fsOsMVsc

Wednesday 18 September 2013

Summary of Peter Lynch’s “One up on Wall Street”

Peter Lynch ran the Fidelity Magellan between 1977 and 1990. During this time he created the most enviable US mutual fund track record by averaging returns of 29% per year. To give you an idea of the compounding effect, he would have turned $10,000 into just over $270,000 in 13 years.

General Market observations
• The advance versus decline number paint better picture then the performance
of the market than index movements.
• Do not make comparisons between current market trends and other points in
history.
• For five years after July 1st 1994, $100,000 would have turned into $341,722.
If you missed the best 30 days, would have been worth $153,792.
• "The bearish argument always sounds more intelligent"
• Superior companies succeed and mediocre companies will fail. Investors in
each will be rewarded accordingly.
• Investing in stocks is an art not a science.
• If seven out of ten stocks perform, then I am delighted, if six out of ten stocks
perform, I am thankful. Six out of ten stocks is all it takes to create an enviable
record on Wall Street.
• Stand by your stocks as long as the fundamental story of the company has not
changed.
• There was a 16 month recession between July 81 and Nov 82. This time was
the scariest in memory. Sensible professionals wondered if they should take
up hunting and fishing, because soon we'd all be living in the woods, gathering
acorns. Unemployment was 14% and inflation was 15 %. A lot people said
they were expecting this but nobody mentioned it before the fact. Then
moment of greatest pessimism, when 8 out of 10 swore we where heading
into the 1930s the stock market rebounded with a vengeance and suddenly all
was right with the world.
• No matter how we arrive at the latest financial conclusions, we always prepare
ourselves for the last thing that happened.
• The day after the market crashed on Oct 19th 1987 people started worrying
that the market was going to crash.
• The great joke is that the next time is never like the last time.
• Not long ago people were worried that oil would drop to $5 and we would have
a depression. Two years later the same people were worried that oil would
rise to $100 and we would have a depression.
• When ten people would rather talk to a dentist about plaque then to a fund
manager about stocks, then it is likely the market is about to go up.
• “The stock market doesn't exist, it is there as a reference to see of anybody is
offering to do anything foolish” - Warren Buffett
• If you rely on the market to drag your stock along, then u might as well go to
Atlantic City and bet on red or black.
• Investing without research is like playing stud poker without looking at the
cards.

Categorising stocks
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.
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.

Three phases of growth:
Start-up phase: during which it works out kinks in the business model.
Rapid expansion phase: moves into new locations and markets.
Mature phase: begins to prepare for the fact there's no easy to continue to
expand.
• Each of these phases may last several years. The first phase of the riskiest
for the investor, because the success of enterprise isn't yet established.
The second phase in safest, and also where the most money is made,
because the company is going to think about duplicating it's successful
formula. The third phase is when challenges arise, because of company
runs into its limitations. Other ways must be found to increase earnings.
• You can lose more than 50 percent of your investment quickly if you buy
cyclicals in the wrong part of the cycle.
• You just have to be patient, keep up with the news and read it with dispassion.
• After it came out of bankruptcy, Penn Central had a huge tax loss to carry
forward which meant when it had to start earning money it wouldn't have to
pay taxes. It was reborn with a 50% tax advantage.
• It's impossible to say anything about the value of personal experience in
analysing companies and trends.
• Companies don't stay in the same category forever. Things change. Things
are always changing.
• It's simply impossible to find a generic formula that sensibly applies to all the
different kinds of stocks.
• Understand what you are expecting from the stock given its categorisation. Is
it the sort of stock you let run, or do you sell for a 30-50% gain.
• Ask if any idiot can run this joint, because at some point an idiot will run it.
• If you discover an opportunity early enough, you will probably get a few dollars
off its price for its dull name.
• A company that does boring things with a boring name is even better.
• High growth and hot industries attract a very smart crowd that want to get into
the business. That inevitably creates competition which means an exciting
story could quickly change.
• Try summarise the stock story in 2 minutes.
• Ask if the company is able to clone the idea.
• For companies that are meant to be depressed you will find surprises in one
out of ten of these could be a turnaround situation. So it always pays to look
beyond the headlines of depressing companies to find out if there is any thing
potentially good about the stock.

Financial analysis
• When cash is increasing relative to debt that is an improving balance sheet.
The other way around is a deteriorating balance sheet.
• When cash exceeds debt it's very favourable.
• Peter Lynch ignores short-term debt in his calculations. He assumes the
company that other assets can cover short term debt.
• With turnarounds and troubled companies, I pay special attention to debt.
Debt determines which companies survive and which will go bankrupt in a
crisis. Young companies with heavy debts are always a risk.
• Bank debt is the worst kind is due on demand.
• Commercial paper is loaned from one company to another for short periods of
time. It's due very soon and sometimes due on call. Creditors strip the
company and there is nothing left for shareholders.
• Funded debt is the best kind from a shareholders point of view. It can never be
called no matter how bleak the situation is.
• Pay attention to the debt structure as well as amount of debt when looking at
turnarounds. Work if the company has room for maneuver.
• Inventory - The closer you get to a finished product the less predictable the
resale value.
• Overvalued assets on the left of the balance sheet are especially treacherous
when there is a lot of debt on the right. Assets can easily fall in value whilst
debt is fixed.
• Keep a careful eye on inventories and think about what the value of
inventories should be. Finished goods are more likely to be subject to
markdowns then raw materials. In the car industry new cars are not prone to
severe markdowns compared to say the clothes industry.
• Looks for situations where there is high cash flow and low earnings. This may
happen because the company is depreciating a piece of old equipment which
doesn't need to be replaced in the immediate future.

The final checklist
• P/E ratio. Is it high for this particular company other similar companies in the
same industry?
• The percentage of institutional ownership. The lower the better.
• The record of earnings to date and whether the earnings are sporadic or
consistent. The only category where earnings may not be important is in the
asset play.
• Whether the company has a strong balance sheet or a weak balance sheet
and how it's rated for financial strength

When to Sell
Slow Grower
• I try sell when there's been a 30 to 50% appreciation or when the
fundamentals have deteriorated, even if the stock has declined in price.
• The company has lost market share for two consecutive years and is hiring
another advertising agency.
• No new products are being developed, spending research and development is
curtailed, and the company appears to be resting on its laurels.
Stalwart
• These are the stocks that I frequently replace for others in the category. There
is no point expecting a quick tenbagger in stalwarts and if the stock price get
above the earnings line, or if the P/E strays to far beyond on the normal range,
you might think about selling it and waiting to buy back later at a lower price or
buying something else as I do.
Cyclicals
• Extended run in upturn means a downturn could be nearing.
• One of the sell signal is inventories are building up in the company and can't
get rid of them, which means low prices and low profits down the road.
Fast grower
• If the company falls apart and the earnings shrink, and so will the P/E multiple
that investors have bid up on the stock. This is a very expensive double
whammy for the loyal shareholders.
• The main thing to watch for is the end of the second phase of rapid growth.
Turnaround
• The best time to sell a turnaround is after its turned - around. All troubles are
over and everybody knows it. The company has become the old self that was
before it fell apart: growth companies or cyclical or whatever. you have to do
reclassified stock.
Asset Play
• When the stock price has risen to the estimated value of the assets.

Silliest things people say about stocks
• If it's gone down this much already it can't go much lower
• You can always tell when a stocks hit bottom
• If it's gone this high already, how can it possibly go higher?
• It's only three dollars a share: what can I lose?
• Eventually they always come back

Things I have seen and general advice
• Most of the money I make is in the third of fourth-year that I've held the stock.
• In most cases it is better to buy the original good company at the high-priced
than it is to jump on the next “Apple or Microsoft” at a bargain price.
• Trying to predict the direction of the market over one year, or even two years,
is impossible.
• You can make serious money by compounding a series of 20 to 30% gains in
stalwarts.
• Just because the price goes up doesn't mean you are right.
• Just because the price goes down doesn't mean you're wrong.
• Stalwarts with heavy institutional ownership and lots of Wall Street covered
that outperform the market are due for arrest or a decline.
• Buying a company with mediocre prospects just because the stock is cheap is
a losing technique.
• Selling an outstanding fast-growing because the stock seems slightly
overpriced is a losing technique.
• Don't become so attached to a winner that complacency sets in and you stop
monitoring the story.
• By careful pruning and rotation based on fundamentals, you can improve your
results. If stocks are out of line with reality and better alternatives exist, sell
and switch into something else
• There is always something to worry about.
• Stick around to see what happens – as long as the original story continues
make sense, or gets better – and you'll be amazed at the result in several
years.
• One of the biggest troubles with stock-market advice is that good or bad it
sticks in your brain. You can't get it out of there, and someday, sometime, you
may find yourself reacting to it.
• I almost didn't buy La Quinta because in important insider had been selling
shares. Not buying because an insider have started selling can be as big a
mistake as selling because an outsider had stopped buying. In La Quinta's
case I ignored the nonsense, and I'm glad I did.
• You don't have to "kiss all the girls". I've missed my share of 10 baggers and
hasn't kept me from beating the market.


http://twitdoc.com/upload/funalysis/summary-of-one-up-on-wall-street-peter-lynch.pdf

Thursday 25 March 2010

Peter Lynch's 6 categories of stocks: Summing it up

Summing it up

That wraps up our practical introduction to Peter Lynch's six stock categories;

  • slow growers (sluggards), 
  • medium growers (stalwarts), 
  • fast growers, 
  • cyclicals, 
  • turnarounds and 
  • asset plays. 
These are only a guide, as companies won't always fit neatly into a single category, and the same company may move through several categories over the course of its life.

The biggest risk for investors is mis-categorising a stock.Buying a stock which you think is a fast grower, for example, only to find out a couple of years down the track that it is really a cyclical, is a chastening experienceAnd your own life situation and risk tolerance should dictate the weightings of each category in your portfolio.

If you've found these distinctions helpful, you might find it worthwhile heading to the source, Lynch's easy-to-read One Up on Wall Street.


Click:




Peter Lynch's 6 categories of stocks: Sluggards and Stalwarts

Peter Lynch's 6 categories of stocks: Asset Plays

Asset plays the last piece in the puzzle

GREG HOFFMAN
February 26, 2010

Over the past two weeks we've been on a tour of the way legendary US investor Peter Lynch classified stocks in his classic book, One up on Wall Street. Now, like the end of a game of Trivial Pursuit, we'll fill in the last piece of pie: asset plays.

The idea with asset plays is to identify untapped or unappreciated assets. These situations can arise for several reasons. A good historical example was Woodside Petroleum in the early part of this decade.

At the time, Woodside's annual profits didn't fully reflect its long-term earnings power. On 5 September 2003 (Long Term Buy - $13.40) our resources analyst enthused: ''It's hard to contain our excitement about the sheer quality of Woodside's assets, and we find dissecting the latest set of entrails (accounts) far less revealing than thinking about how things may play out at Woodside over the next five to 10 years or more.''

He was right, and those who followed his advice have so far more than tripled their money. Yet there was no magic involved. Woodside's enormous reserves and long-term contracts were there for all to see. But you needed to look past the then rather meagre profits and make an investment in the future potential of these assets.

''Recency bias''

It's easy to fall victim to ''recency bias'' in the sharemarket; placing far too much emphasis on the most recent financial results and not focusing on where a business is heading long term. Sometimes an asset play is plain enough to see but investors, for whatever reason, choose to ignore it. In the case of bombed-out SecureNet it was because everyone had sworn off ``tech stocks''.

On 26 July 2002 (Buy - $0.81), we pointed out that, ''SecureNet has an estimated $90-$92m cash in the bank, very little debt and 76m shares on issue. That means that were the company to return this cash to shareholders, each share would entitle the holder to about $1.18. That's 46% above the current market price. So, as long as the company isn't burning too much cash and management doesn't waste the money, at these prices it looks like a no-brainer.''

The company was taken over 12 months later by American group beTRUSTed at more than $1.50 per share, fully valuing the group's cash plus its IT security business. SecureNet was a classic asset play in the tradition of Benjamin Graham (author of our company's namesake, The Intelligent Investor in 1949).

Graham was a legendary investor and teacher (his most famous student being Warren Buffett) and, among other strategies, advocated buying stocks when they were available at less than their ''net cash assets'' (their cash balance less all liabilities) as SecureNet was.

RHG is a more recent example. Having steered our members clear of what proved to be a disastrous float, we ran the numbers as the stock price plummeted during the credit crisis and a clear picture began to emerge.

With a healthy portion of the group's multi-billion dollar loan book financed in the boom times by income-hungry funds at fixed margins, RHG was set to make hundreds of millions in profit as these loans were repaid. By our calculations, these profits would bring the group's total value to somewhere close to $1 per share.

At the depths of despair in June 2008, RHG shares changed hands for less than 5 cents each (several of our members report being happy buyers on that very day). That valued the company at less than $20m; an astonishing figure for a group that not two months later, would report a full year profit of $125m.

The stock now trades north of 60 cents and was a wonderful holding to have through early 2009 as it soared while most other stocks sank. And that's the beauty of a well-selected asset play; under the right circumstances it can offer a degree of protection to your portfolio.

Summing it up

That wraps up our practical introduction to Peter Lynch's six stock categories;

  • slow growers, 
  • stalwarts, 
  • fast growers, 
  • cyclical, 
  • turnarounds and 
  • asset plays. 
These are only a guide, as companies won't always fit neatly into a single category, and the same company may move through several categories over the course of its life.

The biggest risk for investors is mis-categorising a stock. Buying a stock which you think is a fast grower, for example, only to find out a couple of years down the track that it is really a cyclical, is a chastening experience. And your own life situation and risk tolerance should dictate the weightings of each category in your portfolio.

If you've found these distinctions helpful, you might find it worthwhile heading to the source, Lynch's easy-to-read One Up on Wall Street, which is number two on the reading list we provide to members of The Intelligent Investor when they first join up.

Next week I'll take you through some of the other books on that list. They're a great education.

This article contains general investment advice only (under AFSL 282288).
Greg Hoffman is research director of The Intelligent Investor which provides independent advice to sharemarket investors

http://www.businessday.com.au/business/asset-plays-the-last-piece-in-the-puzzle-20100226-p7lc.html

Peter Lynch's 6 categories of stocks: Cyclical Stocks

The pitfalls and profits of cyclical stocks

GREG HOFFMAN
February 22, 2010

Famous American investor Peter Lynch, in his great book ‘‘One Up On Wall Street’’, described how he split stocks into six different categories. In my previous two columns we covered sluggards, stalwarts and fast growers.

Now it’s time to move on to cyclicals which, along with the two categories we’ll cover on Wednesday and Friday, can offer lucrative opportunities. But they can also deliver crushing financial blows if you get them wrong.

If the sharemarket were a sporting competition, these stocks would be reserved for "first grade" players only. The market, though, is not like that. Beginners can quite easily lose their life savings on a cyclical stock bought at its peak, or on a turnaround that doesn’t turn around.

Most companies have a cyclical element to their operations. Even so-called defensive businesses benefit to some degree from a booming economy and suffer when things turn sour. But those particularly exposed to the ebbs and flows of a business cycle are known as cyclicals.

Retailers, vulnerable to fluctuations in discretionary consumer spending, are a good example. When unemployment or interest rates rise and consumers tighten their purse strings, they are hit hard. Shares in David Jones more than halved in the 14 months between December 2007 and February 2009. Then, as consumer confidence returned, they doubled over the ensuing 12 months.

There are also industry-specific cycles. Steelmaking and air travel can be deeply affected by movements in the supply and demand of their international marketplaces. The same is true of mining and related services groups, whose fortunes are much more tied to global economic conditions than to the local scene.

So, how does one spot a cheap cyclical stock?

A low price-to-earnings ratio (PER) often catches our eye at The Intelligent Investor. Yet this isn’t necessarily an opportunity with cyclical; it could be a trap. The fluctuating nature of a cyclical stock’s profits means they can appear superficially cheap, just as their earnings are about to fall off a cliff.

BlueScope Steel provided a classic example in 2007. Back then one of The Intelligent Investor’s researchers summed up his analysis like this: "The PER of 11.3 and the dividend yield of 4.4 per cent are deceptive and the stock would need to be a lot cheaper to offer a margin of safety. SELL."

BlueScope’s share price has since fallen by more than 75 per cent. Low PERs are not reliable indicators of value, especially when it comes to cyclical stocks.

To profit from cyclicals, you should seek them out at the point of maximum pessimism, when you’ve noticed signs that the underlying cycle is improving but the share price is still wallowing. Cyclicals aren’t the type of stocks you want to hold forever, though. And bear in mind that selling cyclicals too early can be uncomfortable.

Take my "Buy" recommendation on Leighton Holdings (something of a mix between a cyclical and a fast grower) at a low of $7.83 in May 2004. Less than two years later the stock was trading at $17.70 and I called on our members to take their 126 per cent profit (plus dividends) and run. Yet the stock price continued to soar throughout the resources boom, making my sell call look far too conservative, if not foolish.

A strong cycle can carry profits and stock prices further than you might imagine. But we must guard against greed becoming the dominant factor in any investment decision. While exiting a cyclical too early can lead to ‘seller’s regret’, getting out too late can be extremely hazardous to your wealth.

So one needs an understanding not just of the cycles affecting a stock but also of the expectations built into its share price at any point in time. When it comes to predicting cyclical turning points, I'm reminded of the quip that economists have predicted seven of the last three recessions – so don’t believe everything you read.

This article contains general investment advice only (under AFSL 282288).

Greg Hoffman is research director of The Intelligent Investor which provides independent advice to sharemarket investors.

http://www.businessday.com.au/business/the-pitfalls-and-profits-of-cyclical-stocks-20100222-oqi4.html

Peter Lynch's 6 categories of stocks: Fast Growers

Stalking the ten-bagger

GREG HOFFMAN
February 19, 2010

In Wednesday's column, we looked at what are generally less risky stock categories - sluggards and stalwarts. But what about the potential ten-bagger - a stock that rises by 10 or more times the price you paid for it?

Peter Lynch, the famous 1980s American fund manager and author, terms such stocks fast growers. Naturally, they're notoriously difficult to pick, inhabiting a land of broken dreams and expensive investment lessons for those too quick to put their faith in a good but elusive story.

The traps are numerous and deep. There are plenty of fast-growing industries - airlines, for example - that have been graveyards for investors. So it's vital to ascertain whether the company you have in your sights really has a sustainable competitive advantage.

Many a blistering growth stock has been lifted on the back of a single, hot product. Ballistics company Metal Storm was a favourite a few years ago, as was animal-focused biotech Chemeq; both ended up crashing spectacularly.

So it's crucial that you understand the risks and allocate your portfolio accordingly. Don't place all your hopes on one hot product.

And always make sure the company is delivering growth in earnings per share as well as net profit. It's too easy to grow net profit by raising more money from shareholders; double the amount of money you have in a plain old savings account and you'll double its ``profits''. What counts is growth in earnings on a per share basis.

Time to bale

The time to bale out is when you think the business might be maturing or saturating its market and no-one else has noticed. And, yes, unfortunately that is as hard as it sounds.

You should also pay heed to the loss of any key executives. Ten-baggers are often driven by one key entrepreneur like Chris Morris at Computershare, or a small team of motivated individuals, as is the case at QBE Insurance. If they're jumping ship then you might consider joining them.

As for retailers - often fast growers when they initially list - it's crucial to keep an eye on the same-store sales figure. When this number drops off it can be a sign that the concept is getting tired or that competition is staring to bite, even as profitability continues to grow through new store rollouts.

Is this 'nuts'?

More positively, the prices of these stocks can sometimes get way ahead of themselves and that's a good time to think about taking some or all of your money off the table.

Good examples would include Harvey Norman, Flight Centre and Cochlear back in 2001. All are great companies and, generally speaking, I'd be a happy holder (if not a buyer) of them, but there comes a point where you just have to say ''this is nuts''.

What constitutes a ''nutty'' price? It's difficult to say, but as Justice Potter Stewart once opined in the US Supreme Court on the subject of pornography: ''I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it.''

Be warned though: Too many high valuations can make one blasé. In the boom years, investors routinely paid price/earnings ratios of 16, 18 and even 20 for fairly mediocre business. As with many aspects of investing, success is determined by the price you pay to buy in, more than the price at which you sell to get out.

Next on our agenda is a tour through the land of cyclicals, then turnarounds and, finally, asset plays. Each has the potential to provide exciting returns and excruciating losses, so stay tuned.

This article contains general investment advice only (under AFSL 282288).
Greg Hoffman is research director of The Intelligent Investor which provides independent advice to sharemarket investors.

http://www.businessday.com.au/business/stalking-the-tenbagger-20100219-okuj.html

Peter Lynch's 6 categories of stocks: Sluggards and Stalwarts

Which pigeon hole for Telstra?

GREG HOFFMAN
February 17, 2010

''If you don't know where you're going,'' said Austrian psychologist Alfred Adler, ''you'll end up somewhere else.'' Adler probably wasn't thinking of the stockmarket at the time but his quote alludes to a classic investing mistake.

Most investors spend much of their time looking for stocks to buy. Very little time is allocated to thinking about when to sell. Buying stocks warrants intense consideration, selling is often done on a whim.

The problem, as Adler suggests, is that it's easy to forget what you originally expected from an investment. As a result, you end up in a place you neither recognise nor expect.

What's the solution? One way is to write down what you expect from a stock when you're doing your initial research. Some of The Intelligent Investor's analysts talk about ''milestones'' and ''roadmaps'' but they're probably just overdue a holiday.

More famously, Peter Lynch, the American investor and author, places his stocks into six categories:

  • slow growers (or ''sluggards''), 
  • medium growers (or ''stalwarts''), 
  • fast growers, 
  • cyclicals, 
  • turnarounds and 
  • asset plays. 

Such terms capture one's expectations for a stock pretty well.

As Lynch explains in One Up on Wall Street: ''There are almost as many ways to classify stocks as there are stockbrokers - but I've found that these six categories cover all of the useful distinctions that any investor has to make.''

In this column and the four that follow, I'll run through Lynch's categories and draw out some important distinctions using my own experiences and those of The Intelligent Investor team over the years I've been leading it.

Sluggards

Slow growers, or ''sluggards'', are businesses growing at the same rate as the general economy, say 3-4% a year, or less not a place for ''tenbaggers'' (stocks that rise 10-fold from your buy price). But, purchased at the right price, they can be nice, steady providers of dividends.

When looking at sluggards you need to think about the nature of the business, how it's financed and the history of dividend stability and coverage (earnings per share divided by dividends per share - other things being equal, the higher, the better).

The time to think about selling these stocks is when they've enjoyed some kind of significant - and unwarranted - capital appreciation. You didn't buy them for spectacular gains so when you get some, it's often a good time to sell.

Operationally, it should catch your attention if they start losing market share or changing strategy away from their core business (through unrelated acquisitions or shifting into unfamiliar geographic territory, for example).

We aren't flush with these sorts of stocks in Australia but Telstra is probably a good example. It features a number of sluggard hallmarks including market share loss and very thin dividend coverage.

Stalwarts

Stalwarts grow faster than sluggards but at less than double-digit rates. Dividend yield is not as crucial as it is with sluggards as these companies are often still investing for growth. Stocks like Woolworths and Metcash are good stalwart examples.

When looking to buy them, paying a sensible price is paramount. Keep an eye on the price-to-earnings ratio (PER) and make sure the business's strategy is clear and consistent.

If the PER blows out relative to other stalwarts, then it could be an opportune time to consider a switch to ensure your money's working as hard as possible. Share sales by several directors can be another warning sign (www.directorstransactions.com.au can help your research in this regard).

Also, keep an eye on whether profit growth is a result of cost cutting rather than growing sales (Telstra again). This is not a way to sustainable profit growth and can indicate that a stalwart is turning into a sluggard.

On Friday, we'll turn our attention to arguably the most exciting category of stocks; fast growers, and provide a few examples.

This article contains general investment advice only (under AFSL 282288).

Greg Hoffman is research director of The Intelligent Investor which provides independent advice to sharemarket investors

http://www.businessday.com.au/business/which-pigeon-hole-for-telstra-20100217-ocap.html

Monday 1 September 2008

Peter Lynch's Classification of Companies

There are different ways of classifying shares. Here is Peter Lynch's classification of companies (and by derivation, shares).

Slow growers: Large and ageing companies that are expected to grow slightly faster than the gross national product.

Stalwarts: Giant companies that are faster than slow growers but are not agile climbers.

Fast growers: Small, aggressive new enterprises that grow at 10 to 25% a year.

Cyclicals: Companies whose sales and profit rise and fall in a regular, though not completely predicatable fashion.

Turnarounds: Companies which are steeped in accumuated losses but which show signs of recovery. Turnaround companies have the potential to make up lose ground quickly.