Book To Read: ‘One Up On Wall Street’ By Peter Lynch
INVESTOPAPER
‘One Up On Wall Street’ is a best-selling book by the legendary mutual fund manager Peter Lynch. Through this book, Lynch explains that one can be successful in investing as long as s/he does proper research on his investment decision making. He assures that an average investor can generate good returns on his/her investments through his sense of understanding of the businesses operating around him/her.
Here we have compiled some of the important investing ideas from the book. Hope it is useful.
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Important Excerpts From ‘One Up On Wall Street’
The basic story remains simple and never-ending. 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. Corporate profits are up fifty-five-fold since World War II, and the stock market is up sixtyfold. Four wars, nine recessions, eight presidents, and one impeachment didn’t change that.
It’s best to define your objectives and clarify your attitudes (do I really think stocks are riskier than bonds?) beforehand, because if you are undecided and lack conviction, then you are a potential market victim, who abandons all hope and reason at the worst moment and sells out at hope and reason at the worst moment and sells out at a loss. It is personal preparation, as much as knowledge and research, that distinguishes the successful stockpicker from the chronic loser. Ultimately it is not the stock market nor even the companies themselves that determine an investor’s fate. It is the investor.
Most great investors I know (Warren Buffett, for starters) are technophobes. They don’t own what they don’t understand, and neither do I. I understand Dunkin’ Donuts and Chrysler, which is why both inhabited my portfolio. I understand banks, savings and loans, and their close relative, Fannie Mae.
At that low point, demoralized investors had to remind themselves that bear markets don’t last forever, and those with patience held on to their stocks and mutual funds for the fifteen years it took the Dow and other averages to regain the prices reached in the mid-1960s. Today it’s worth reminding ourselves that bull markets don’t last forever and that patience is required in both directions.
I’ve continued to invest the old-fashioned way. I own stocks where results depend on ancient fundamentals: a successful company enters new markets, its earnings rise, and the share price follows along. Or a flawed company turns itself around.
Owning to the lack of earnings in dot.com land, most dot.com’s can’t be rated using the standard price/earnings yardstick. In other words, there’s no “e” in the all-important “p/e” ratio. Without a “p/e” ratio to track, investors focus on the one bit of data that shows up everywhere: the stock price! To my mind, the stock price is the least useful information you can track, and it’s the most widely tracked.
The price tag of stocks sends the wrong message. If my favorite Internet company sells for $30 a share, and yours sells for $10, then people who focus on price would say that mine is the superior company. This is a dangerous delusion. What Mr. Market pays for a stock today or next week doesn’t tell you which company has the best chance to succeed two or three years down the information superhighway. If you can follow only one bit of data, follow the earnings.
Microsoft went public in 1986 at 15 cents a share. Three years later you could buy a share for under $1, and from there it advanced eightyfold. If you took the Missouri “show me” approach and waited to buy Microsoft until it triumphed with Windows 95, you still made seven times your money. You didn’t have to be a programmer to notice Microsoft everywhere you looked. Except in the Apple orchard, all new computers came equipped with the Microsoft operating system and Microsoft Windows.
An amateur investor can pick tomorrow’s big winners by paying attention to new developments at the workplace, the mall, the auto showrooms, the restaurants, or anywhere a promising new enterprise makes its debut.
Peter Lynch doesn’t advise you to buy stock in your favorite store just because you like shopping in the store, nor should you buy stock in a manufacturer because it makes your favorite product or a restaurant because you like the food. Liking a store, a product, or a restaurant is a good reason to get interested in a company and put it on your research list, but it’s not enough of a reason to own the stock! 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.
You don’t need to make money on every stock you pick. In my experience, six out of ten winners in a portfolio can produce a satisfying result. Why is this? Your losses are limited to the amount you invest in each stock (it can’t go lower than zero), while your gains have no absolute limit. Invest $1000 in a clunker and in the worst case, maybe you lose $1000. Invest $1000 in a high achiever, and you could make $10000, $15000, $20000, and beyond over several years. All you need for a lifetime of successful investing is a few big winners, and the pluses from those will overwhelm the minutes from the stocks that don’t work out.
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 ar racetracks, blackjack tables, or video poker. In fact, I think of day trading as at-home casino care.
History tells us that corrections (declines of 10 percent or more) occur every couple of years, and bear markets (declines of 20 percent or more) occur every six years. Severe bear markets (declines of 30 percent or more) have materialized five times since 1929-32.
It’s foolish to bet we’ve seen the last of the bears, which is why it’s important not to buy stocks or stock mutual funds with money you’ll need to spend in the next twelve months to pay college bills, wedding bills, or whatever. You don’t want to be forced to sell in a losing market to raise cash. When you’re a long-term investor, time is on your side.
“Stocks are overpriced,” has been the bears’ rallying cry for several years. To some, stocks looked too expensive in 1989, at Dow 2600. To others, they looked extravagant in 1992, above Dow 3000. A chorus of naysayers surfaced in 1995, above Dow 4000. Someday we’ll see another severe bear market, but even a brutal 40 percent sell-off would leave prices far above the point at which various pundits called for investors to abandon their portfolios. As I’ve noted on prior occasions: “That’s not to say there’s no such thing as an overvalued market, but there’s no point worrying about it.”
It’s when you’ve decided to invest on your own that you ought to try going it alone. That means ignoring the hot tips, the recommendations from brokerage houses, and the latest “can’t miss” suggestion from your favorite newsletter- in favor of your own research. It means ignoring the stocks that you hear Peter Lynch, or some similar authority, is buying.
There are a least three good reasons to ignore what Peter Lynch is buying: (1) he might be wrong! (A long list of losers from my own portfolio constantly reminds me that the so-called smart money is exceedingly dumb about 40 percent of the time); (2) even if he’s right, you’ll never know when he’s changed his mind about stock and sold; and (3) you’ve got better sources, and they’re all around you. What makes them better is that you can keep tabs on them, just as I keep tabs on mine.
During a lifetime of buying cars or cameras, you develop a sense of what’s good and what’s bad, what sells and what doesn’t. If it’s not cars and know something about, you know something about something else, and the most important part is, you know it better Wall Street knows it. Why wait for the Merrill Lynch restaurant expert to recommend Dunkin’ Donuts when you’ve already seen eight new franchises opening up in your area? The Merrill Lynch restaurant analyst isn’t going to notice Dunkin’ Donuts (for reasons I’ll soon explain) until the stock has quintupled from $2 to $10, and you noticed it when the stock was at $2.
Finding a promising company is only the first step. The next step is doing the research. The research is what helps you to sort out Toys “R” Us from Coleco, Apple Computer from Televideo, or Piedmont Airlines from People Express.
It’s obvious that studying history and philosophy was much better preparation for the stock market than, say, studying statistics. Investing in stocks is an art, not a science, and people who’ve been trained to rigidly quantify everything have a big disadvantage.
Mister Johnson believed that you invest in stocks not to preserve capital, but to make money. Then you take your profits invest in more stocks and make even more money. “Stocks you trade, it’s wives you’re stuck with,” said the always quotable Mister Johnson.
If a stock is down but the fundamentals are positive, it’s best to hold on and even better to buy more.
The point is that fortunes change, there’s no assurance that major companies won’t become minor, and there’s no such thing as a can’t miss blue chip.
To me, an investment is simply a gamble in which you’ve managed to tilt the odds in your favor.
Consistent winners raise their bet as their position strengthens, and they exit the game when the odds are against them, while consistent losers hang on to the bitter end of every expensive pot, hoping for miracles to happen just often enough to keep the losers losing.
You’re a good investor in houses because you know how to poke around from the attic to the basement and ask the right questions. The skill of poking around houses is handed down. You grow up watching how your parents checked into the public services, the schools, the drainage, the septic perk test, and the taxes. You remember rules such as “Don’t buy the highest-priced property on the block.” You can spot neighborhoods on the way up and neighborhoods on the way down. You can drive through an area and see what’s being fixed up, what’s run-down, how many houses, you hire experts to search for termites, roof leaks, dry not, rusty pipes, faulty wiring, and cracks in the foundation.
No wonder people make money in the real estate market and lose money in the stock market. They spend months choosing their houses, and minutes choosing their stocks. In fact, they spend more time shopping for a good microwave oven than shopping for a good investment.
Absent a lot of surprises, stocks are relatively predictable over ten to twenty years. As to whether they’re going to be higher or lower in two or three years, you might as well flip a coin to decide.
Only invest what you could afford to lose without that loss having any effect on your daily life in the foreseeable future.
It’s also important to be able to make decisions without complete or perfect information. Things are almost never clear on Wall Street, or when they are, then it’s too late to profit from them.
Some have fancied themselves “long-term investors,” but only until the next big drop (or tiny gain), at which point they quickly become short-term investors and sell out for huge losses or the occasional minuscule profit.
Obviously, you don’t have to be able to predict the stock market to make money in stocks, or else I wouldn’t have made any money. I don’t believe in predicting markets. I believe in buying great companies-especially companies that are undervalued, and/ or underappreciated.
Since the stock market is in some way related to the general economy, one way that people try to outguess the market is to predict inflations and recessions, booms and busts, and the direction of interest rates. True, there is a wonderful correlation between interest rates and the stock market, but who can foretell interest rates with any bankable regularity?
Let’s say you could predict the next economic boom with absolute certainty, and you wanted to profit from your foresight by picking a few high-flying stocks. You still have to pick the right stocks, just the same as if you had no foresight.
Perhaps some people make money in stocks without doing any of the research, but why take unnecessary chances? Investing without research is like playing stud poker and never looking at the cards.
The size of a company has a great deal to do with what you can expect to get out of the stock. Specific products aside, big companies don’t have big stock moves. In certain markets, they perform well, but you’ll get your biggest moves in smaller companies.
Sooner or later every popular fast-growing industry becomes a slow-growing industry. There’s always a tendency to think that things will never change, but inevitably they do.
A fast-growing company doesn’t to belong to a fast-growing industry. All it needs is the room to expand within a slow-growing industry. Beer is a slow-growing industry, but Anheuser-Busch has been a fast grower by talking over market share, and enticing drinkers of rival brands to switch to theirs. The hotel business grows at only 2 percent a year, but Marriott was able to grow 20 percent by capturing a larger segment of that market over the last decade.
Consistent winners accept their fate and go on to the next hand, confident that their basic method will reward them over time. People who succeed in the stock market also accept periodic losses, setbacks, and unexpected occurrences. Calamitous drops do not scare them out of the game. They realize the stock market is not pure science, and not like chess, where the superior position always wins. If seven out of ten of my stocks perform as expected, then I’m delighted. If six out of ten of my stocks perform as expected, then I’m thankful.
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.
When management owns stock, then rewarding the shareholders becomes the first priority, whereas when management simply collects a paycheck, then increasing salaries becomes the first priority.
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 carpool or on the commuter train- and succumbing to the social pressure, often buys.
What you’re asking here is what makes a company valuable, and why it will be more valuable tomorrow than it is today. There are many theories, but to me, it always comes down to earnings and assets. Especially earnings. Sometimes it takes years for the stock price to catch up to a company’s value, and the down periods last so long that investors begin to doubt that will ever happen. But value always wins out-or at least in enough cases that it’s worthwhile to believe it.
The fact that some stocks have p/e’s of 40 and others have p/e’s of 3 tells you that investors are willing to take substantial gambles on the improved future earnings of some companies, while they’re quite skeptical about the future of others.
If you remember nothing else about p/e ratios, remember to avoid stocks with excessively high ones. You’ll save yourself a lot of grief and a lot of money if you do. With few exceptions, an extremely high p/e ratio is a handicap to a stock.
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. These are the factors to investigate as you develop the story.
Stocks that pay dividends are often favored over stocks that don’t pay dividends. The dividend affects the value of a company and the price of its stock over time.
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.
The company with the highest profit margin is by definition the lowest-cost operator, and the low-cost operator has a better chance of surviving if business conditions deteriorate.
The more stocks you own, the more flexibility you have to rotate funds between them. This is an important part of my strategy. 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.
It’s a real tragedy when you buy a stock that’s overpriced, the company is a big success, and still, you don’t make any money.
Younger investors with a lifetime of wage-earning ahead of them can afford to take more chances on ten baggers than can older investors who must live off the income from their investments. Younger investors have more years in which they can experiment and make mistakes before they find the great stocks that make investing careers.
I’m constantly rechecking stocks and rechecking stories, adding and subtracting to my investments as things change. But I don’t go into cash. Going into cash would be getting out of the market. 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.
A price drop in a good stock is only a tragedy if you sell at that price and never buy more. To me, a price drop is an opportunity to load up on bargains from among your worst performers and your laggards that show promise.
If you can’t convince yourself “When I’m down 25 percent, I’ma 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.
Trying to catch the bottom on a falling stock is like trying to catch a falling knife. It’s normally a good idea to wait until the knife hits the ground and sticks, then vibrates for a while and settles down before you try to grab it. Grabbing rapidly falling stock results in painful surprises, because inevitably you grab it in the wrong place.
A stock’s going up or down after you buy it only tells you that there was somebody who was willing to pay more or less for the identical merchandise.
If you know why you bought a stock in the first place, you’ll automatically have a better idea of when to say goodbye to it.
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