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

by Peter Lynch

Never invest in any company before you’ve done the homework on the company’s earnings prospects, financial condition, competitive position, plans for expansion, and so forth.

Long-term investing has gotten so popular, it’s easier to admit you’re a crack addict than to admit you’re a short-term investor.

By the way, the odds against making a living in the day-trading business are about the same as the odds against making a living at racetracks, blackjack tables, or video poker. In fact, I think of day trading as at-home casino care.

Stocks aren’t lottery tickets. There’s a company attached to every share. Companies do better or they do worse. If a company does worse than before, its stock will fall. If a company does better, its stock will rise. If you own good companies that continue to increase their earnings, you’ll do well.

Investing in stocks is an art, not a science, and people who’ve been trained to rigidly quantify everything have a big disadvantage.

if a stock is down but the fundamentals are positive, it’s best to hold on and even better to buy more.)

Most important, you can find terrific opportunities in the neighborhood or at the workplace, months or even years before the news has reached the analysts and the fund managers they advise.

Only invest what you could afford to lose without that loss having any effect on your daily life in the foreseeable future.

list of qualities ought to include patience, self-reliance, common sense, a tolerance for pain, open-mindedness, detachment, persistence, humility, flexibility, a willingness to do independent research, an equal willingness to admit to mistakes, and the ability to ignore general panic.

And finally, it’s crucial to be able to resist your human nature and your “gut feelings.”

Invest in things you know about.

Investing without research is like playing stud poker and never looking at the cards.

The autos and the airlines, the tire companies, steel companies, and chemical companies are all cyclicals.

Putting stocks in categories is the first step in developing the story.

“Any idiot can run this business” is one characteristic of the perfect company, the kind of stock I dream about.

IT SOUNDS DULL—OR, EVEN BETTER, RIDICULOUS The perfect stock would be attached to the perfect company, and the perfect company has to be engaged in a perfectly simple business, and the perfectly simple business ought to have a perfectly boring name. The more boring it is, the better.

(2) IT DOES SOMETHING DULL I get even more excited when a company with a boring name also does something boring.

If a company with terrific earnings and a strong balance sheet also does dull things, it gives you a lot of time to purchase the stock at a discount.

(3) IT DOES SOMETHING DISAGREEABLE Better than boring alone is a stock that’s boring and disgusting at the same time.

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.

(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.

(6) THE RUMORS ABOUND: IT’S INVOLVED WITH TOXIC WASTE AND/OR THE MAFIA It’s hard to think of a more perfect industry than waste management.

(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.

(9) IT’S GOT A NICHE I’d much rather own a local rock pit than own Twentieth Century-Fox, because a movie company competes with other movie companies, and the rock pit has a niche.

(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.

(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 There’s no better tip-off to the probable success of a stock than that people in the company are putting their own money into it.

there’s only one reason that insiders buy: They think the stock price is undervalued and will eventually go up.)

(13) THE COMPANY IS BUYING BACK SHARES Buying back shares is the simplest and best way a company can reward its investors.

Although it’s easy to forget sometimes, a share of stock is not a lottery ticket. It’s part ownership of a business.

There are five basic ways a company can increase earnings*: reduce costs; raise prices; expand into new markets; sell more of its product in the old markets; or revitalize, close, or otherwise dispose of a losing operation.

The p/e ratio of any company that’s fairly priced will equal its growth rate.

“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.” —John D. Rockefeller, 1901

If you find a business that can get away with raising prices year after year without losing customers (an addictive product such as cigarettes fills the bill), you’ve got a terrific investment.

There are three phases to a growth company’s life: the start-up phase, during which it works out the kinks in the basic business; the rapid expansion phase, during which it moves into new markets; and the mature phase, also known as the saturation phase, when it begins to prepare for the fact that there’s no easy way to continue to expand.

The first phase is the riskiest for the investor, because the success of the enterprise isn’t yet established. The second phase is the safest, and also where the most money is made, because the company is growing simply by duplicating its successful formula. The third phase is the most problematic, because the company runs into its limitations. Other ways must be found to increase earnings.

STOCKS IN GENERAL • The p/e ratio. Is it high or low for this particular company and for similar companies in the same industry. • The percentage of institutional ownership. The lower the better. • Whether insiders are buying and whether the company itself is buying back its own shares. Both are positive signs. • The record of earnings growth 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 (debt-to-equity ratio) and how it’s rated for financial strength. • The cash position. With $16 in net cash, I know Ford is unlikely to drop below $16 a share. That’s the floor on the stock.

Here are some pointers from this section: • Understand the nature of the companies you own and the specific reasons for holding the stock. (“It is really going up!” doesn’t count.) • By putting your stocks into categories you’ll have a better idea of what to expect from them. • Big companies have small moves, small companies have big moves. • Consider the size of a company if you expect it to profit from a specific product. • Look for small companies that are already profitable and have proven that their concept can be replicated. • Be suspicious of companies with growth rates of 50 to 100 percent a year. • Avoid hot stocks in hot industries. • Distrust diversifications, which usually turn out to be diworseifications. • Long shots almost never pay off. • It’s better to miss the first move in a stock and wait to see if a company’s plans are working out. • People get incredibly valuable fundamental information from their jobs that may not reach the professionals for months or even years. • Separate all stock tips from the tipper, even if the tipper is very smart, very rich, and his or her last tip went up. • Some stock tips, especially from an expert in the field, may turn out to be quite valuable. However, people in the paper industry normally give out tips on drug stocks, and people in the health care field never run out of tips on the coming takeovers in the paper industry. • Invest in simple companies that appear dull, mundane, out of favor, and haven’t caught the fancy ...

If you can’t convince yourself “When I’m down 25 percent, I’m a buyer” and banish forever the fatal thought “When I’m down 25 percent, I’m a seller,” then you’ll never make a decent profit in stocks.

The best time to buy stocks will always be the day you’ve convinced yourself you’ve found solid merchandise at a good price—the same as at the department store.

These are the Twelve Silliest Things People Say About Stock Prices, which I present in the hope that you can dismiss them from your mind. Some probably will sound familiar.

IF IT’S GONE DOWN THIS MUCH ALREADY, IT CAN’T GO MUCH LOWER

YOU CAN ALWAYS TELL WHEN A STOCK’S HIT BOTTOM

IF IT’S GONE THIS HIGH ALREADY, HOW CAN IT POSSIBLY GO HIGHER?

IT’S ONLY $3 A SHARE: WHAT CAN I LOSE?

EVENTUALLY THEY ALWAYS COME BACK

IT’S ALWAYS DARKEST BEFORE THE DAWN

WHEN IT REBOUNDS TO $10, I’LL SELL

WHAT ME WORRY? CONSERVATIVE STOCKS DON’T FLUCTUATE MUCH