Connect with us

Investment

10 Investing Tips From Peter Lynch’s “One Up on Wall Street”

Pete Lynch

I had already written about Peter Lynch in some previous articles. Specifically, so far I’ve presented Lynch’s breakdown into the 6 business categories and also written about his final checklist for businesses in each category.

In this article, I would like to share with you 10 more helpful tips from his book One Up On Wall Street (still one of the best value investing books I would say). There may be overlaps with the checklist here and there, but what the heck…

1. Share = participation in the company

Many investors are quite naïve when it comes to investing in the stock market. They buy a stock because they see that it has performed very well recently… but without a sense of the intrinsic value, business model, or products and markets of the associated company.

In the long term, this type of investing in the stock market probably doesn’t work in most cases. In addition, such an approach contributes to the fact that we can regularly observe bubbles in the stock markets (or other asset classes).

On this point, Lynch says (and Buffett and other successful investors do, too): A stock represents a stake in a real company, and it’s important to understand what kind of company you’re investing in.

This “shareholder view” also helps immensely in identifying very specific reasons for buying shares. This tends to have more to do with how the business performs over the long term, rather than how the stock performs in the short term.

2. Whole company versus product

There are many companies that we just stumble across because they have a very attractive or innovative product in their portfolio… a product that we know well and maybe even use ourselves.

Invest in what you know.

– Peter Lynch

Investing in something that we understand well is one of the things we can learn from Peter Lynch’s books (and Lynch gives many examples of this, such as Taco Bell, L’Eggs / Hanes, etc.).

However – and this is just as important – always with the restriction that the product also plays an important role in the performance of the entire company.

Of course, thyssenkrupp, for example, also has hydrogen technology in its portfolio and Maggi is obviously manufactured and sold by Nestlé… but how relevant are these technologies or products in the overall context of the two companies?

Maggi’s share of Nestlé’s total sales, for example, is negligible and the product’s success is therefore in no way relevant to the company’s success.

“Good product = good company = good investment”… this causal connection does not always apply in reality and it is our job as investors to work out how important and relevant a great product or service actually is for the company.

If a product or service does not make a significant contribution to the company’s sales or profits, then it cannot and should not be the main reason for buying the corresponding stock.

3. Growth > 50% per year

Peter Lynch says we should be cautious about companies with growth rates above 50% or even 100%.

Growth for the sake of growth is the ideology of the cancer cell.

– Edward Abbey

Lynch gives us two reasons for this:

  • Such high growth typically cannot be sustained for long (among other things, other companies may also enter the market and want a piece of the pie)
  • In most cases, long-term growth also requires substantial investments

On the latter point: in the end, of course, it’s the incremental return on investment that matters. If this is too low, borrowing and capital increases will have a disproportionately negative effect on shareholders.

Another aspect is also psychological in nature: even a short-term “dip” in the growth rate can already shock the stock market and lead to a sharp and sustained drop in the share price of a once celebrated growth star… you know:

In the short run, a market is a voting machine but in the long run, it is a weighing machine.

– Benjamin Graham

4. DiWORSEification

I think it was Lynch himself who coined the term DiWORSEification .

What he means by that: Companies that take over other companies on the grounds that they want to make their own business “more secure” and “more stable” (that is, to diversify through growth) often do so in order to marginalize problems in their core business… or because of the CEO has a big ego and is dying to present a growth story.

In these cases – and this is the main point here – the acquisitions usually do not improve either the bottom line (i.e. the net profit… what is left over from the bottom line) or the return on investment (e.g. the ROCE or ROIC ) and it would actually be the better strategy, to return the capital to the shareholders, for example via share buybacks or dividends.

So we should be cautious about companies with a “diversification” strategy.

5. Advantage in knowledge

Because of their job, many private investors have a knowledge advantage in a certain area, which, however, they often do not use.

Anyone who works in a bank, for example, and therefore understands how the business model works and the structure of a bank’s balance sheet, should be better able to identify an attractive investment in the banking sector than most other investors.

However, instead of using their knowledge advantage to their advantage, many private investors are more likely to bet on the next biotech or digitization trend without understanding the industries, players, and business models in detail… and perhaps even triggered by a purchase agreement written by a “Robo-writer”. Recommendation on Wall Street Online or something.

Of course – and Peter Lynch agrees – there is nothing wrong with expanding your ” Circle of Competence ” over time and dealing with new industries and business models. On the contrary, there is even much to be said for it.

However, and this is the main point here: If you have a knowledge advantage in any area, then you should definitely make use of it when investing.

6. Tips from successful managers

The portfolios of the best-known and most successful fund managers can be viewed online by all of us. There are now many private investors who imitate the recommendations or reported purchases of their favorite fund manager… or follow a specific recommendation from the stock market media (TV, print).

Peter Lynch takes a rather critical view of this approach, particularly because in many cases neither the motives nor the risk taken (eg the size of the position in the manager’s portfolio) nor the purchase price actually realized are transparent from the outside.

So even if we hold a particular fund manager in high esteem for their track record and investment style, we should still conduct our own due diligence and form our own opinions on the investments made.

The investments of well-known investors are always a good source of inspiration. Of course, Lynch doesn’t deny that either.

7. Ugly Ducklings

This is one of Lynch’s best-known tips: Invest in simple companies… companies that seem dull and uninteresting, that isn’t trendy, and are more or less ignored by analysts.

Lynch even goes so far as to say that ideally, the companies should have an unattractive and catchy corporate name… perhaps along the lines of the dot-com busts of the late 1990s. 🙂

But joking aside: There is a whole range of small and profitable companies that do not appear on the radar of either investment banks or institutional investors and are therefore often available at low prices.

8. Debt-Free Businesses

A very important lesson from Peter Lynch is to correctly interpret a company’s debt situation.

In many cases, companies that are growing strongly are viewed as unreservedly attractive by the stock market.

Often, however, these companies are so focused on continuing the growth story that they end up ruining their balance sheets and wiping out much of the value generated in the early years of growth.

Or to put it in simple terms: Debt-financed growth into unattractive assets or business models will eventually take revenge. That’s why, per sé, Lynch looks for companies with strong and stable balance sheets :

What you want to see on a balance sheet is at least twice as much equity as debt, and the more equity and the less debt the better.

– Peter Lynch

9. Time investment

Lynch advises private investors to spend at least an hour a week on investment research (not counting dividends received and calculating portfolio appreciation).

The reason is simple: Lynch believes that having an independent view of the market or company is directly related to investing success.

In other words, there’s no justification for doing more research into buying a new refrigerator than into choosing a new investment.

10. “When in doubt leave it out”

There is also a good quote from Peter Lynch on the actual decision-making process (ie investment yes or no):

The key organ for investing is the stomach, not the brain.

– Peter Lynch

Most people would probably sign the statement directly… but the question is how it is actually meant…

One interpretation says that we should simply listen to our gut feeling when making the final decision. Another assumes that our feelings may be deceiving us and that we first have to steer ourselves in the right direction with a few appropriate questions.

So the guiding question would be this: What could prevent us from buying a stock even though we basically have a good gut feeling about it?

Here are a few more specific questions to illustrate or deepen the problem:

  • Are we perhaps biased because we’ve already spent ten days or more researching the company and don’t want to count that time as “wasted”?
  • In general, are we overconfident about understanding the industry and the company (ie, do we suffer from overconfidence bias )?
  • Is the CEO a very good communicator and perhaps only told us what we wanted to hear?
  • Basically, do we just like the stock because it has fallen in price and are afraid of missing out on what appears to be a good opportunity if we don’t act now?
  • Do we only like the stock because it was recommended to us by a contact we consider an expert (or maybe even an authority) and we don’t dare to question it?

Basically: If we should answer one or more of these questions with a “yes”, then that is an indication that we should perhaps reconsider the idea instead of making the purchase decision directly. There are investors who let an idea lie for months before making a final decision… just taking a step back for a few days or 1-2 weeks and reflecting again can also help.

Click to comment

Leave a Reply

Advertisement

Must See

Advertisement

More in Investment

[class^="wpforms-"]
[class^="wpforms-"]
%d bloggers like this: