Venture Capital Defined

Dutch Lady: Last 5 quarterly results

 Income Statement

Balance Sheet

Cash Flow Statement

Plantation stocks at a glance

 

RIMBUNAN SAWIT at a glance

 

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

Enduring multi-baggers and Transitory multi-baggers.

Stocks for the long run.

The power of compounding is truly remarkable, almost magical for those with the ability to identify these companies with earnings power over the long term.

Do you know that DLady was priced RM 1.60 per share, Nestle RM 6 to RM 8 per share and Petdag RM 2.00 per share in the 1990s?

Today, DLady is RM 23.00 per share, Nestle is RM 120.00 per share and Petdag is RM 22.00 per share.

The prices of these stocks have dropped from their highest.  DLady has dropped from its historical high price of RM 75.00 per share.  Nestle has dropped from its high of RM 160+ per share.  Similarly, Petdag has dropped from its high price of RM 30+ per share a few years ago.

DLady has dropped a lot and there are various reasons for these. 

How can you exploit any opportunities depend on how you approach your investing. 

Enduring multi-baggers and Transitory multi-baggers.

ENDURING multi-baggers are those companies whose wealth creation is long-lasting and correction from the peak valuation is limited.
In fact, they continue to exist as multi-baggers even after the correction.
The enduring multi-bagging companies are typically few and difficult to be spotted, and most of the time they appear to be expensive at the time of buying because of the lack of faith in their longevity and size of growth.


TRANSITORY multi-baggers, on the contrary, are easier to be spotted but they always end up giving nasty end results.
Corrections are typically almost 100 per cent.
Cyclicals broadly come under this category.
The tragedy with this class of companies is that if you cannot sell in time, nothing is left in your hand.
But as correction is inevitable, market as a whole is left high and dry with a bad experience.
These companies are plenty and easy to be found, and they attract a lot of crowd.

Ten-baggers operate in growth industries.

Ten-baggers are shares where you make 10 times your money (I believe the phrase is derived from baseball). Such opportunities are rare, but I have been fortunate enough over the years to be involved in a few such situations: DLady, Nestle, Petdag and others.

There tend to be some common characteristics among these winners. The businesses all operate in growth industries and the company in question must be able to grow the top line. No one ever made a tenfold return on a pure margin improvement, or cost-cutting story with no sales growth.

Turnarounds are, however, a rich source of 10-baggers. For these to work, one's timing has to be immaculate, and the underlying business has to be sound - just desperately unloved by the stock market.

Patience is needed.

Such returns need patience. A hedge fund that churns its holdings every few months will never enjoy a 10-bagger. And therein lies the greatest danger: selling too early to enjoy the 1,000 per cent gain.

When you have doubled or trebled your money, it is so tempting to cash in profits. It must have been tempting in the early 1950s to take profits on Glaxo shares, just a few years after their 1947 flotation. Or to have done the same for Tesco which floated in the same year. Or sell Racal in the late 1960s after its 1961 market debut, decades before it spun off Vodafone. Yet each of those shares rewarded patient investors with epic performances over many decades, all 20-baggers at least, not even allowing for dividend.

One of the advantages that private equity enjoys is that it is forced to take a reasonably long-term view, and so is usually unable to rush for the exit at the first opportunity. Venture capital's other edge over quoted investors is debt: gearing in successful situations always amplifies the return to equity-holders. Typically, buy-outs have structures where 70 per cent of the capital is borrowed.

Quoted companies probably have the reverse capitalisation, with equity providing three-quarters of the funding. And as ever in investing, those who regularly find 10-baggers say you should stick to your own sphere of competence: buy what you understand.

Usual rules apply:  Quality, Management & Valuation

But the usual rules apply: look for real companies with competent management and a proven business model.

You won't find a 10-bagger among much of the over-hyped, speculative froth. Search for the solid operation with strong fundamentals and a high quality of earnings.

Very few acquisitive vehicles are 10-baggers. Management in such firms focuses on doing deals rather than organically growing its core business. This can produce reasonable returns, but rarely delivers the stellar, long-run performance that can come from a strong business franchise in an attractive niche. 

And balance sheets matter: 10-baggers must be able to fund expansion internally or through debt. Companies that are forever issuing equity dilute their stock performance.

So good luck in your search for the next blockbuster. It may well be an obscure, neglected company now, but with the potential for greatness. The secret is to spot that potential.

JAYATIASA at a glance