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

by Peter Lynch

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 of Wall Street. • Moderately fast growers (20 to 25 percent) in nong...

seek out the ones with the superior financial positions and avoid the ones w...

Companies that have no debt can’t go bankrupt. • Managerial ability may be important, but it’s quite difficult to assess. Base your purchases on the company’s prospects, not on the president’s resume or speaking ability. • A lot of money can be made when a troubled company turns around. • Carefully consider the price-earnings ratio. If the stock is grossly overpriced, even if everything else goes right, you won’t make any money. • Find a story line to follo...

Study the dividend record of a company over the years and also how its earnings have fared in past recessions. • Look for companies with little or no institutional ownership. • All else being equal, favor companies in which management has a significant personal investment over companies run by people that benefit only from their salaries. • Insider buying is a positive sign, especially when several individuals are buying at once. • Devote at least ...

Be patient. Watched stock never boils. • Buying stocks based on stated book value alone is dangerous and illusory. It’s real value that counts. • When in doubt, tune in later. • Invest at least as much time and effort in choo...

In certain years you’ll make your 30 percent, but there will be other years when you’ll only make 2 percent, or perhaps you’ll lose 20. That’s just part of the scheme of things, and you have to accept it.

I never put more than 30–40 percent of my fund’s assets into growth stocks.

The rest I spread out among the other categories described in this book. Normally I keep about 10–20 percent or so in the stalwarts, another 10–20 percent or so in the cyclicals, and the rest in the turnarounds.

My idea is to stay in the market forever, and to rotate stocks depending on the fundamental situations. I think if you decide that a certain amount you’ve invested in the stock market will always be invested in the stock market, you’ll save yourself a lot of mistimed moves and general agony.

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.

If you have a list of companies that you’d like to own if only the stock price were reduced, the end of the year is a likely time to find the deals you’ve been waiting for.

But when you’ve found the right stock and bought it, all the evidence tells you it’s going higher, and everything is working in your direction, then it’s a shame if you sell. A fivefold gain turns $10,000 into $50,000, but the next five folds turn $10,000 into $250,000. Investing in a 25-bagger is not a regular occurrence even among fund managers, and for the individual it may happen only once or twice in a lifetime. When you’ve got one, you might as well enjoy the full benefit.

It’s normally harder to stick with a winning stock after the price goes up than it is to believe in it after the price goes down. These days if I feel there’s a danger of being faked out, I try to review the reasons why I bought in the first place.

Meanwhile the broker gets a commission from both sides of the transaction, so every “Congratulations” message represents a double payday.

When astrologers are interviewed alongside economists from Merrill Lynch, and both say contradictory things and yet sound equally convincing, no wonder we’re all confused.

preoccupation with money supply figures has been supplanted with intense fears over budget and trade deficits, and thousands more must have been drummed out of their stocks because of each.

As it turns out, if you know why you bought a stock in the first place, you’ll automatically have a better idea of when to say good-bye to it. Let’s review some of the sell signs, category by category.

WHEN TO SELL A SLOW GROWER

can’t really help you with this one, because I don’t own many slow growers in the first place. The ones I do buy, I sell when there’s been a 30–50 percent appreciation or when the fundamentals have deteriorated, even if ...

The company has lost market share for two consecutive years and is hiring another advertising agency. • No new products are being developed, spending on research and development is curtailed, and the company appears to be resting on its laurels. • Two recent acquisitions of unrelated businesses look like diworseifications, and the comp...

The company has paid so much for its acquisitions that the balance sheet has deteriorated from no debt and millions in cash to no cash and millions in debt. There are no surplus funds to buy back stock, even if the price falls sharply. • Even at a lower stock price the divide...

Costs have started to rise. Existing plants are operating at full capacity, and the company begins to spend money to add to capacity.

One obvious sell signal is that inventories are building up and the company can’t get rid of them, which means lower prices and lower profits down the road.

Competition businesses are also a bad sign for cyclicals. The outsider will have to win customers by cutting prices, which forces everyone else to cut prices and leads to lower earnings for all the producers. As

Two key union contracts expire in the next twelve months, and labor leaders are asking for a full restoration of the wages and benefits they gave up in the last contract. • Final demand for the product is slowing down.

The company has doubled its capital spending budget to build a fancy new plant, as opposed to modernizing the old plants at low cost. • The company has tried to cut costs but still can’t compete with foreign producers.

WHEN TO SELL A FA...

All the characteristics of the Stock You’d Avoid (see Chapter 9) are characteristics of the Stock You’d Want to Sell.

Unlike the cyclical where the p/e ratio gets smaller near the end, in a growth company the p/e usually gets bigger, and it may reach absurd and illogical dimensions.

The stock is selling at a p/e of 30, while the most optimistic projections of earnings growth are 15–20 percent for the next two years.

WHEN TO SELL A TURNAROUND

If the turnaround has been successful, you have to reclassify the stock.

Inventories are rising at twice the rate of sales growth.

The p/e is inflated relative to earnings prospects. • The company’s strongest division sells 50 percent of its output to one leading customer, and that leading customer is suffering from a slowdown in its own sales.

You don’t sell until the Bass brothers show up, and if it’s not the Bass brothers, then it’s certain to be Steinberg, Icahn, the Belzbergs, the Pritzkers, Irwin Jacobs, Sir James Goldsmith, Donald Trump, Boone Pickens, or maybe even Merv Griffin. After that, there could be a takeover, a bidding war, or a leveraged buyout to double, triple or quadruple the stock price.

Although the shares sell at a discount to real market value, management has announced it will issue 10 percent more shares to help finance a diversification program. • The division that was expected to be sold for $20 million only brings $12 million in the actual sale. • The reduction in the corporate tax rate considerably reduces the value of the company’s tax-loss carryforward. • Institutional ownership has risen from 25 percent five years ago to 60 percent today—with several Boston fund groups being major purchasers.

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?

Frankly, I’ve never been able to predict which stocks will go up tenfold, or which will go up fivefold. I try to stick with them as long as the story’s intact, hoping to be pleasantly surprised. The success of a company isn’t the surprise, but what the shares bring often is.

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

Whenever I’m tempted to fall for this one, I remind myself that unless I’m confident enough in the company to buy more shares, I ought to be selling immediately.

WHAT ME WORRY? CONSERVATIVE STOCKS DON’T FLUCTUATE MUCH

Companies are dynamic, and prospects change. There simply isn’t a stock you can own that you can afford to ignore.

IT’S TAKING TOO LONG FOR ANYTHINGTO EVER HAPPEN

This going nowhere for several years, which I call the “EKG of a rock,” is actually a favorable omen. Whenever I see the EKG of a rock on the chart of a stock to which I’m already attracted, I take it as a strong hint that the next major move may be up.