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

by Peter Lynch

you discover an opportunity early enough, you probably get a few dollars off the price just for the dull or odd name, which is why I’m always on the lookout for the Pep Boys or the Bob Evanses, or the occasional Consolidated Rock.

(2) IT DOES SOMETHING DULL

I get even more excited when a company with a boring name also does something boring.

(3) IT DOES SOMETHING DISAGREEABLE

Better than boring alone is a stock that’s boring and disgusting at the same time. Something that makes people shrug, retch, or turn away in disgust is ideal.

(4) IT’S A SPINOFF

Spinoffs of divisions or parts of companies into separate, freestanding entities—such as Safety-Kleen out of Chicago Rawhide or Toys “R” Us out of Interstate Department Stores—often result in astoundingly lucrative investments.

Large parent companies do not want to spin off divisions and then see those spinoffs get into trouble, because that would bring embarrassing publicity that would reflect back on the parents. Therefore, the spinoffs normally have strong balance sheets and are well-prepared to succeed as independent entities. And once these companies are granted their independence, the new management, free to run its own show, can cut costs and take creative measures that improve the near-term and long-term earnings.

If you hear about a spinoff, or if you’re sent a few fractions of shares in some newly created company, begin an immediate investigation into buying more. A month or two after the spinoff is completed, you can check to see if there is heavy insider buying among the new officers and directors. This will confirm that they, too, believe in the company’s prospects.

(5) THE INSTITUTIONS DON’T OWN IT, AND THE ANALYSTS DON’T FOLLOW IT

If you find a stock with little or no institutional ownership, you’ve found a potential winner. Find a company that no analyst has ever visited, or that no analyst would admit to knowing about, and you’ve got a double winner. When I talk to a company that tells me the last analyst showed up three years ago, I can hardly contain my enthusiasm. It frequently happens with banks, savings-and-loans, and insurance companies, since there are thousands of these and Wall Street only keeps up with fifty to one hundred.

I’m equally enthusiastic about once-popular stocks the professio...

Data on institutional ownership are available from the following sources: Vicker’s Institutional Holdings Guide, Nelson’s Directory of Investment Research, and the Spectrum Surveys, a publication of CDA Investment Technologies.

(6) THE RUMORS ABOUND: IT’S INVOLVED WITH TOXIC WASTE AND/OR THE MAFIA

(7) THERE’S SOMETHING DEPRESSING ABOUT IT

(8) IT’S A NO-GROWTH INDUSTRY

Many people prefer to invest in a high-growth industry, where there’s a lot of sound and fury. Not me. I prefer to invest in a low-growth industry like plastic knives and forks, but only if I can’t find a no-growth industry like funerals. That’s where the biggest winners are developed.

In a no-growth industry, especially one that’s boring and upsets people, there’s no problem with competition. You don’t have to protect your flanks from potential rivals because nobody else is going to be interested. This gives you the leeway to continue to grow, to gain market share, as SCI has done with burials.

(9) IT’S GOT A NICHE

Due to the weight of rocks, aggregates are an exclusive franchise. You don’t have to pay a dozen lawyers to protect it.

Once you’ve got an exclusive franchise in anything, you can raise prices.

(10) PEOPLE HAVE TO KEEP BUYING IT

I’d rather invest in a company that makes drugs, soft drinks, razor blades, or cigarettes than in a company that makes toys. In the toy industry somebody can make a wonderful doll that every child has to have, but every child gets only one each.

(11) IT’S A USER OF TECHNOLOGY

Instead of investing in computer companies that struggle to survive in an endless price war, why not invest in a company that benefits from the price war—such

(12) THE INSIDERS ARE BUYERS

When insiders are buying like crazy, you can be certain that, at a minimum, the company will not go bankrupt in the next six months. When insiders are buying, I’d bet there aren’t three companies in history that have gone bankrupt near term.

Long term, there’s another important benefit. When management owns stock, then rewarding the shareholders becomes a first priority, whereas when management simply collects a paycheck, then increasing salaries becomes a first priority.

(13) THE COMPANY IS BUYING BACK SHARES

Buying back shares is the simplest and best way a company can reward its investors. If a company has faith in its own future, then why shouldn’t it invest in itself, just as the shareholders do?

The common alternatives to buying back shares are (1) raising the dividend, (2) developing new products, (3) starting new operations, and (4) making acquisitions.

The reverse of buying back shares is adding more shares, also called diluting.

If I could avoid a single stock, it would be the hottest stock in the hottest industry, the one that gets the most favorable publicity, the one that every investor hears about in the car pool or on the commuter train—and succumbing to the social pressure, often buys.

High growth and hot industries attract a very smart crowd that wants to get into the business. Entrepreneurs and venture capitalists stay awake nights trying to figure out how to get into the act as quickly as possible. If you have a can’t-fail idea but no way of protecting it with a patent or a niche, as soon as you succeed, you’ll be warding off the imitators. In business, imitation is the sincerest form of battery.

BEWARE THE NEXT SOMETHING

Another stock I’d avoid is a stock in a company that’s been touted as the next IBM, the next McDonald’s, the next Intel, or the next Disney, etc. In my experience the next of something almost never is—on

AVOID DIWORSEIFICATIONS

Instead of buying back shares or raising dividends, profitable companies often prefer to blow the money on foolish acquisitions. The dedicated diworseifier seeks out merchandise that is (1) overpriced, and (2) completely beyond his or her realm of understanding. This ensures that losses will be maximized.

From an investor’s point of view, the only two good things about diworseification are owning shares in the company that’s being acquired, or in finding turnaround opportunities among the victims of diworseification that have decided to restructure.

Why did Melville succeed while Genesco failed? The answer has a lot to do with a concept called synergy. “Synergy” is a fancy name for the two-plus-two-equals-five theory of putting together related businesses and making the whole thing work.

The synergy theory suggests, for example, that since Marriott already operates hotels and restaurants, it made sense for them to acquire the Big Boy restaurant chain, and also to acquire the subsidiary that provides meal service to prisons and colleges.

If a company must acquire something, I’d prefer it to be a related business, but acquisitions in general make me nervous. There’s a strong tendency for companies that are flush with cash and feeling powerful to overpay for acquisitions, expect too much from them, and then mismanage them. I’d rather see a vigorous buyback of shares, which is the purest synergy of all.

BEWARE THE WHISPER STOCK

Often the whisper companies are on the brink of solving the latest national problem: the oil shortage, drug addiction, AIDS. The solution is either (a) very imaginative, or (b) impressively complicated.

Whisper stocks have a hypnotic effect, and usually the stories have emotional appeal. This is where the sizzle is so delectable that you forget to notice there’s no steak.

What I try to remind myself (and obviously I’m not always successful) is that if the prospects are so phenomenal, then this will be a fine investment next year and the year after that. Why not put off buying the stock until later, when the company has established a record? Wait for the earnings. You can get tenbaggers in companies that have already proven themselves. When in doubt, tune in later.

IPOs of brand-new enterprises are very risky because there’s so little to go on.

BEWARE THE MIDDLEMAN

The company that sells 25 to 50 percent of its wares to a single customer is in a precarious situation.

If the loss of one customer would be catastrophic to a supplier, I’d be wary of investing in the supplier.