One Up On Wall Street: How To Use What You Already Know To Make Money In

by Peter Lynch

When you traffic in stalwarts, you’re more or less in the foothills: 10 to 12 percent annual growth in earnings.

Fifty percent in two years is what you’d be delighted to get from Colgate-Palmolive in most normal situations. With the stalwarts you have to consider taking profits more readily than you would with a Shoney’s, or a Service Corporation International. Stalwarts are stocks that I generally buy for a 30 to 50 percent gain, then sell and repeat the process with similar issues that haven’t yet appreciated.

I always keep some stalwarts in my portfolio because they offer pretty good protection during recessions and hard times.

People don’t buy less dog food during recessions

THE FAST GROWERS

These are among my favorite investments: small, aggressive new enterprises that grow at 20 to 25 percent a year. If you choose wisely, this is the land of the 10- to 40-baggers, and even the 200-baggers. With a small portfolio, one or two of these can make a career.

A fast-growing company doesn’t necessarily have to belong to a fast-growing industry. As a matter of fact, I’d rather it didn’t, as you’ll see in Chapter 8. All it needs is th...

There’s plenty of risk in fast growers, especially in the younger companies that tend to be overzealous and underfinanced. When an underfinanced company has headaches, it usually ends up in Chapter 11. Also, Wall Street does not look kindly on fast growers that run out of stamina and turn into slow growers, and when that happens, the stocks are beaten down accordingly.

So while the smaller fast growers risk extinction, the larger fast growers risk a rapid devaluation when they begin to falter. Once a fast grower gets too big, it faces the same dilemma as Gulliver in Lilliput. There’s simply no place for it to stretch out.

But for as long as they can keep it up, fast growers are the big winners in the stock market. I look for the ones that have good balance sheets and are making substantial profits. The trick is figuring out when they’ll stop growing, and how much to pay for the growth.

THE CYC...

A cyclical is a company whose sales and profits rise and fall in regular if not completely predictable fashion. In a growth industry, business just keeps expanding, but in a cyclical industry it ex...

The autos and the airlines, the tire companies, steel companies, and chemical companies are all cyclicals. Even defense companies behave like cyclicals, since their profits’ rise and fall ...

Charts of the cyclicals look like the polygraphs of liars, or the maps of the Alps, as opposed to the maps of Delaware you get with the slow growers.

Coming out of a recession and into a vigorous economy, the cyclicals flourish, and their stock prices tend to rise much faster than the prices of the stalwarts. This is understandable, since people buy new cars and take more airplane trips in a vigorous economy, and there’s greater demand for steel, chemicals, etc. But going the other direction, the cyclicals suffer, and so do the pocketbooks of the shareholders.

Cyclicals are the most misunderstood of all the types of stocks. It is here that the unwary stockpicker is most easily parted from his money, and in stocks that he considers safe.

Since Ford is a blue chip, one might assume that it will behave the same as Bristol-Myers, another blue chip (see charts). But this is far from the truth. Ford’s stock fluctuates wildly as the company alternately loses billions of dollars in recessions and makes billions of dollars in prosperous stretches.

Timing is everything in cyclicals, and you have to be able to detect the early signs that business is falling off or picking up. If you work in some profession that’s connected to steel, aluminum, airlines, automobiles, etc., then you’ve got your edge, and nowhere is it more important than in this kind of investment.

TURNAROUNDS

Turnaround candidates have been battered, depressed, and often can barely drag themselves into Chapter 11. These aren’t slow growers; these are no growers. These aren’t cyclicals that reboun...

I could attempt to reconstruct the rather long list of the failed turnarounds I wish I hadn’t bought, except the mere idea of it gives me a headache. In spite of this, the occasional major success makes the turnaround business very exciting, and very rewarding overall.

There are several different types of turnarounds,

There’s the bail-us-out-or-else kind of turnaround such as Chrysler or Lockheed, where the whole thing depended on a government loan guarantee.

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There’s the who-would-have-thunk-it kind of turnaround, such as Con Edison. Who would ever have believed you could lose this much money in a utility, as the stock price fell from $10 to $3 by 1974; and who would have believed you could make this much, as the price rebounded from $3 to $52 by 1987?

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There’s the little-problem-we-didn’t-anticipate kind of turnaround, such as Three Mile Island. This was a minor tragedy perceived to be worse than it was, and in minor tragedy there’s major opportunity. I made a lot of money in General Public Utilities, the owner of Three Mile Island. Anybody could have. You just had to be patient, keep up with the news, and read it with dispassion.

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There’s the perfectly-good-company-inside-a-bankrupt-company kind of turnaround, such as Toys “R” Us. Once Toys “R” Us was spun out on its own, away from its less successful parent, Interstate Department Stores, the result was 57 bags.

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There’s the restructuring-to-maximize-shareholder-values kind of turnaround, such as Penn Central.

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THE ASSET PLAYS

An asset play is any company that’s sitting on something valuable that you know about, but that the Wall Street crowd has overlooked. With so many analysts and corporate raiders snooping around, it doesn’t seem possible that there are any assets that Wall Street hasn’t noticed, but believe me, there are.

The asset play is where the local edge can be used to greatest advantage. The asset may be as simple as a pile of ...

I once visited a mundane little Florida cattle company called Alico, run out of La Belle, a small town at the edge of the Everglades. All I saw there was scrub pine and palmetto brush, a few cows grazing around, and perhaps twenty Alico employees trying unsuccessfully to look busy. It wasn’t very exciting, until you figured out that you could have bought Alico for under $20 a share, and ten years later the land alone turned out to be worth more than $200 a share. A smart codger named Ben Hill Griffin, Jr., kept buying up the stock and waiting for Wall Street to notice Alico. He must have made a fortune by now.

Many of the publicly traded railroads such as Burlington Northern, Union Pacific, and Santa Fe Southern Pacific are land rich, dating back to the nineteenth century when the government gave away half the country as a sop to the railroad tycoons. These companies have the oil and gas rights, the mineral rights, and the timber rights as well.

There are asset plays in metals and in oil, in newspapers and in TV stations, in patented drugs and even s...

Penn Central might have been the ultimate asset play. The company had everything: tax-loss carryforward, cash, extensive land holdings in Florida, other land elsewhere, coal in West Virginia, and air rights in Manhattan. Anybody who had anything to do with Penn Central could have figured out that this was a stock worth buying. It went up eightfold.

Fifteen years ago, each cable subscriber was worth about $200 to the buyer of a cable franchise, then ten years ago it was $400, five years ago $1,000, and now it’s as high as $2,200. People in the industry keep up with these numbers, so it’s not exactly esoteric information. The millions of subscribers to Telecommunications, Inc., made it a huge asset.

Asset opportunities are everywhere. Sure they require a working knowledge of the company that owns the assets, but once that’s understood, all you need is patience.

Companies don’t stay in the same category forever. Over my years of watching stocks I’ve seen hundreds of them start out fitting one description and end up fitting another.

Fast growers can lead exciting lives, and then they burn out, just as humans can. They can’t maintain double-digit growth forever, and sooner or later they exhaust themselves and settle down into the comfortable single digits of sluggards and stalwarts.

From Dow Chemical to Tampa Electric, the highfliers of one decade become the groundhogs of the next. Stop & Shop went from being a slow grower to a fast grower, an unusual reversal.

Cyclicals with serious financial problems collapse and then reemerge as turnarounds.

Growth companies that can’t stand prosperity foolishly diworseify and fall out of favor, which makes them into turnarounds.

Companies such as Penn Central may fall into two categories at once, and Disney, over its lifetime, has been in every major category: years ago it had the momentum of a fast grower, which led to the size and financial strength of a stalwart, followed by a period when all those great assets in real estate, old movies, and cartoons were significant. Then, in the mid-1980s, when Disney was in a slump, you could have bought it as a turnaround.

SEPARATING THE DIGITALS FROM THE WAL-MARTS

If you can’t figure out what category your stocks are in, then ask your broker. If a broker recommended the stocks in the first place, then you definitely ought to ask, because how else are you to know what you’re looking for? Are you looking for slow growth, fast growth, recession protection, a turnaround, a cyclical bounce, or assets?

Basing a strategy on general maxims, such as “Sell when you double your money,” “Sell after two years,” or “Cut your losses by selling when the price falls ten percent,” is absolute folly. It’s simply impossible to find a generic form...

Unless it’s a turnaround, there’s no point in owning a utility and expecting it to do as well as Philip Morris.

Shaky companies in cyclical industries are not the ones you sleep on through recessions.

Putting stocks in categories is the first step in developing the story. Now at least you know what kind of story it’s supposed to be. The next step is filling in the details that will help you guess how the story is going to turn out.

If it’s a choice between owning stock in a fine company with excellent management in a highly competitive and complex industry, or a humdrum company with mediocre management in a simpleminded industry with no competition, I’d take the latter.

You never find the perfect company, but if you can imagine it, then you’ll know how to recognize favorable attributes, the most important thirteen of which are as follows: