While his earlier book 'One up on wall street' focused on the concepts of Equity Investing, the focus of this book is on the application of those concepts for picking the right stock to invest.
In the introduction to the chapter, Mr.Lynch rues the fact that over a period of time Americans are investing less in equity and more in bonds. He demonstrates through data that over the decades from 1930 through 80's, Equity investments have outperformed all other asset classes. Author emphasizes that only way to make money is to invest consistently in equity over a period of time. As pointed out in One up on Wall Street retail invest. ors tend to enter and exit the market at precisely the wrong time.
One of the main points made in 'One up..' was that amateur investors have more opportunities to outperform the professionals provided they use their power of observation and common sense. In Chapter 1, 'Miracle at St.Agnes', author digs in to this point. He points the example of a group of school kids at St.Agnes school who followed fundamental rules of investing and over a two year period achieved a portfolio return of about 70%, the kind of returns that are the envy of professional investors.
Some of the rules followed by the children (7th Graders All !) are:
- A good company usually increases its dividend every year
- You can lose money in a very short time but it takes a long time to make money.
- You have to research the company before you put money into it.
- Never fall in love with a stock
- Just because a stock goes down doesn't mean it can't go lower
- Over the long-term it is better to buy stocks in small companies....
- Hold no more stocks than you can remain informed on
- Invest regularly
- You want to see that sales and earnings per share are moving forward at an acceptable rate and that you can buy the stock at a reasonable rate.
- It is well to consider the financial strength and debt structure to see how the company can withstand a few bad years
- Buy the stock based on whether if the growth meets your objectives and whether the price is reasonable
- Understanding the reasons for past sales growth will help you form a good judgement as to the likelihood of past growth rates continuing.
Chapter 2, 'Weekend Worrier', cautions the reader against making too much out of the negative news coming out in the news media. Through examples, the author convincingly proves the dichotomy between a stream of negative news that appeared in the news media and the significant out-performance of the market. The main message from this chapter for retail investors is to develop a dispassionate attitude to the negative news and to the occasional market downturns and continue investing in companies with strong fundamentals. Buying and selling stock is a game of the head while staying invested and having courage of your convictions is a mind game.
Being a book written by a Mutual Fund Manager, Chapter 3 focuses on investing in Mutual Funds. The chapter starts off by discussing that eternal investor's question, 'Stocks or Bonds?'. The book is very clear that Stocks are the way to go. Even for a retirement portfolio, the author suggests a full stock portfolio of companies with regular dividend payouts and dividend increases. The chapter also discusses various types of funds like Value Funds, Growth Funds, Income Funds, Special Situation Funds, Country Funds, Bond Funds and Sector Funds. The recommendation is to have equal allocation of your portfolio in Value, Growth, Special Situation and Bond funds. When it comes to sector funds, the recommendation is to invest in sectors that are down currently.
There is a tendency among investors to rotate their money among mutual funds which have produced high level of returns from a 3 year and 5 year perspective. The author disapproves this tendency. His recommendation is to identify some good funds and invest in them regularly.
Chapter 4, 5 and 6 cover author's stint at as the Fund Manager of Fidelity Magellan Fund. When he took over in 1977 the fund size was about 18 Million Dollars, which increased to 100 Million by 1981. Two points stick out while reviewing the fund performance during this period. One, there was a phenomenal turnover of stocks in the portfolio. Rather than sticking to a specific portfolio strategy, Mr.Lynch went about buying any stock that convinced him of its potential to be a multi-bagger. The second point was that in 1978 and 1979, the Dow Jones was at its lows and he was able to purchase some very good stocks at a P/E of about 5-6. As he mentions, you can't lose in any market if you get good companies at very low valuations.
Author mentions that he never invested in businesses that he never understood. That is a good lesson for all those Indian Investors who don't know the difference between 'ANDA (Abbreviated New Drug Application)' and 'Anda (Egg)' but still invest in companies in the Pharma sector!!
During the 'Middle Years', covering the period from 1981 to mid of 1983, the fund rose from 100 Million to 1 Billion. Some of the valuable points made in this Chapter 5 are about buying companies with Strong Balance Sheets and buying companies in Retail Chains and Restaurant Chains where the success in one market can be easily replicated in other markets. During the first half of 1982, markets were in doldrums and Interest Rates were at their highs. When he found that the Interest Rates on Bonds were over 6% higher than the dividend yield on Index Stocks, author moved out of stocks and invested in Bonds (probably his first and the last big purchase in Bonds).
Somewhere in the mid of 1982, author purchased Chrysler at a price of $2 per share. This was the beginning of his slow transition into buying shares in the auto sector during the later years from 1983 till 1990 when he retired. Till '83 through '88, his portfolio was stacked with Financials (Banks and Savings & Loans) and Autos. He played auto for about 5 years and in 1988 and made a lot of money for the customers of Magellan. The strategy was to identify potential growth sectors and buy good stocks in that sector, which paid off handsomely.
I observed two points while reading his earlier book (One up on Wall Street) and this book. The author has a thing against big companies like IBM and GM. Any mention of these stocks is to demonstrate his mistakes or to proclaim that he was constrained into buying these stocks since the public expected all the mutual funds to have exposure to these shares.
Mr.Lynch makes an interesting observation. Many individuals are smart enough to identify potential multi-baggers and initiate coverage on the same. However, where they fails is in continuing to track the stocks as it moves from $2 to $5 to $10 to $20 and so on...
By the time Mr.Lynch left Magellan, the fund size was 14 Billion Dollars !!!.
In Chapter 7 the author addresses the habit of some people to keep on buying new stocks all the time. Once they lose money in some stock, they go in search of new stocks. They never invest in the same company again. This habit do not find favour with the author. He feels that if an individual has invested in some stocks, he has gained some knowledge of the company, the industry, the growth drivers, business challenges etc. Once they have spent time collecting this information, they have an advantage with reference to these stocks and industries and hence should closely monitor these companies at a regular intervals and again buy the shares of these companies if their analysis shows these stocks to be worth buying. The author follows a good habit of documenting all his observations with reference to a specific stock and continuously updates the same.
That is a good habit that all investor should follow.
While reading this chapter, I was thinking as to how relevant this was for me. I can site countless times when I have bought good stocks, sold them off at a minor profit or loss and then never followed them again. Later I am surprised (unpleasantly) when I see that the stock that I sold at a 30% profit has ended up as a 10 Bagger. Then there are very few occasions when I see that the stock that I sold at a loss has dipped further, giving me the sense of being a savvy investor who cuts his losses !.
The rest of the book, starting Chapter 8 through Chapter 21 is a detailed description of Lynch process in action. He explains, lucidly and with a lot of wit, the process he followed while he went about investing in companies in different sectors. The sectors covered include Retail - focusing on 'The Body Shop', Real Estate - focusing on secondary sectors interior decoration (Pier 1) and gardening (Sunbelt Nursery), Consumption - 'Supercuts', Great companies in low growth industries, Savings & Loans (two boring Chapters -12 and 13 focus on S&Ls), Master Limited Partnerships (MLPs), Cyclicals, Energy, Government Owned Companies (Public Sector Companies), One entire chapter on Author's experience with Fannie Mae, Mutual Fund Industry and Restaurant Stocks (Chapter 20).
Chapter 21 completes this section by discussing how the investor should do a regular check and update his portfolio.
While reading the above section, I was fascinated by the amount of wisdom and experience that was packed in these chapters. While talking of investing in the Retail Sector (Chapter 8) author makes the following points. One, the companies in this sector should have expansion potential since they can only grow through expansion - by replicating in another market the lessons learned in the current market. Two, Debt is a strict no, no for retail. Three, the key parameter to look for is the growth in same store sales, which should grow by at least 5-6% year on year.
The key concept that one learns in Chapter 9 is about 'Quite Facts'. These are facts that are counter to the prevailing market thinking. For example, there are three quite facts that are relevant to Housing Market. One, price of a median house, Two, Affordability and Three, percentage of mortgage loans in default. Towards the end of a realty downturn, these Quite Facts begin to move in a positive direction and market takes some time to react to the reversal of the 'Quite Facts'. Another lesson that one learns is about 'year end anomalies', where the price of a stock could drop drastically in a short time and could rebound equally rapidly. To capitalize on this situation, speed is of essence (and liquidity, of course !).
When it comes to the financial analysis of companies, author recommends the following. Are the inventories increasing? If they are increasing, it may be a sign that management is trying to hide falling sales. Another check is about the book value. One has to analyse if the book value is 'Real'. Some times, unscrupulous companies will hide obsolete inventory and inflate the assets (like the story of the Software Seller who had room full of Windows 95 OS, when the technology had moved to NT) to make the book value look good. Another question to ask is whether the competition will be interested in buying out the company. If there is a strong case for competition to be interested in the company, it is a good sign for the investor. Other factors to consider are decrease in inventory (good). low Debt / Equity (good), type of debt - Bank debt (bad), funded debt (good), low goodwill (good) and good growth potential.
I was really frustrated while reading Chapter 15 on Cyclicals. Throughout this book and also in the previous book by the same author that I reviewed the key message was that one should buy companies with Low P/Es and with good earnings potential. This was an intuitive message that one could understand. Suddenly, while discussing Cyclicals, the author says that low P/E may be a 'Sell' signal when it comes to Cyclicals and high P/E may be a 'Buy' signal. The logic is that at the peak of the business cycles, the earnings would have run up and market will start selling the Cyclicals leading to lowering of P/E. While this could be applicable to stocks in other industry, the key difference between other industries and Cyclicals is that for other Industries the P/E will start falling when the 'Market' starts correcting, while for Cyclicals P/E will start falling when the Business Cycles start reversing, which could happen even when the market momentum is upwards.
While discussing the energy sector, the author talks of 'Troubled Utility Cycle'. In the first phase, disaster strikes and earnings take a severe downturn. Earning downturn could be due to high costs that cannot be passed on to customers or some huge assets that should be mothballed. In phase two, known as the 'Crisis Management', the Utility tries to respond to the disaster by cutting capital spending and by implementing austerity measures. In the third stage, 'Financial Stabilization', the costs are cut to the point where the Utility can operate on the cash that is received from the bill paying customers. In stage four, 'Recovery', the Utility is capable of earning for the shareholders. From here, the Utility will require the support from Capital Market and the Regulatory Agencies to progress.
Author is a big fan of Privatization initiatives undertaken by various governments. Every time it privatizes a business, government ensures that the shareholders benefit in a major way. Author advises the investors to follow suit and invest in all the government stock offerings.
Mutual funds and Restaurants are two industries with high cashflow potential that author covers towards the end of the book. He convincingly argues that these industries can significantly reward the investors, even doubling in two years, if invested wisely.
When it comes to the continuous monitoring, author suggests asking the following questions. One, is the stock attractively priced relating to the earnings and Two, How can the earnings grow? If the earnings are expected to grow, your decision is to stick with it and add more to your portfolio. If the earnings are expected to fall, the decision is to sell it off and buy other better opportunities.
What if the story is unchanged? In that case you could stick with the stock or sell it off and move into attractively priced options available in the market.
'One up on Wall Street' along with this book gives an excellent conceptual and process overview for the Amateur investor to venture into the Stock Market.
Chapter 4, 5 and 6 cover author's stint at as the Fund Manager of Fidelity Magellan Fund. When he took over in 1977 the fund size was about 18 Million Dollars, which increased to 100 Million by 1981. Two points stick out while reviewing the fund performance during this period. One, there was a phenomenal turnover of stocks in the portfolio. Rather than sticking to a specific portfolio strategy, Mr.Lynch went about buying any stock that convinced him of its potential to be a multi-bagger. The second point was that in 1978 and 1979, the Dow Jones was at its lows and he was able to purchase some very good stocks at a P/E of about 5-6. As he mentions, you can't lose in any market if you get good companies at very low valuations.
Author mentions that he never invested in businesses that he never understood. That is a good lesson for all those Indian Investors who don't know the difference between 'ANDA (Abbreviated New Drug Application)' and 'Anda (Egg)' but still invest in companies in the Pharma sector!!
During the 'Middle Years', covering the period from 1981 to mid of 1983, the fund rose from 100 Million to 1 Billion. Some of the valuable points made in this Chapter 5 are about buying companies with Strong Balance Sheets and buying companies in Retail Chains and Restaurant Chains where the success in one market can be easily replicated in other markets. During the first half of 1982, markets were in doldrums and Interest Rates were at their highs. When he found that the Interest Rates on Bonds were over 6% higher than the dividend yield on Index Stocks, author moved out of stocks and invested in Bonds (probably his first and the last big purchase in Bonds).
Somewhere in the mid of 1982, author purchased Chrysler at a price of $2 per share. This was the beginning of his slow transition into buying shares in the auto sector during the later years from 1983 till 1990 when he retired. Till '83 through '88, his portfolio was stacked with Financials (Banks and Savings & Loans) and Autos. He played auto for about 5 years and in 1988 and made a lot of money for the customers of Magellan. The strategy was to identify potential growth sectors and buy good stocks in that sector, which paid off handsomely.
I observed two points while reading his earlier book (One up on Wall Street) and this book. The author has a thing against big companies like IBM and GM. Any mention of these stocks is to demonstrate his mistakes or to proclaim that he was constrained into buying these stocks since the public expected all the mutual funds to have exposure to these shares.
Mr.Lynch makes an interesting observation. Many individuals are smart enough to identify potential multi-baggers and initiate coverage on the same. However, where they fails is in continuing to track the stocks as it moves from $2 to $5 to $10 to $20 and so on...
By the time Mr.Lynch left Magellan, the fund size was 14 Billion Dollars !!!.
In Chapter 7 the author addresses the habit of some people to keep on buying new stocks all the time. Once they lose money in some stock, they go in search of new stocks. They never invest in the same company again. This habit do not find favour with the author. He feels that if an individual has invested in some stocks, he has gained some knowledge of the company, the industry, the growth drivers, business challenges etc. Once they have spent time collecting this information, they have an advantage with reference to these stocks and industries and hence should closely monitor these companies at a regular intervals and again buy the shares of these companies if their analysis shows these stocks to be worth buying. The author follows a good habit of documenting all his observations with reference to a specific stock and continuously updates the same.
That is a good habit that all investor should follow.
While reading this chapter, I was thinking as to how relevant this was for me. I can site countless times when I have bought good stocks, sold them off at a minor profit or loss and then never followed them again. Later I am surprised (unpleasantly) when I see that the stock that I sold at a 30% profit has ended up as a 10 Bagger. Then there are very few occasions when I see that the stock that I sold at a loss has dipped further, giving me the sense of being a savvy investor who cuts his losses !.
The rest of the book, starting Chapter 8 through Chapter 21 is a detailed description of Lynch process in action. He explains, lucidly and with a lot of wit, the process he followed while he went about investing in companies in different sectors. The sectors covered include Retail - focusing on 'The Body Shop', Real Estate - focusing on secondary sectors interior decoration (Pier 1) and gardening (Sunbelt Nursery), Consumption - 'Supercuts', Great companies in low growth industries, Savings & Loans (two boring Chapters -12 and 13 focus on S&Ls), Master Limited Partnerships (MLPs), Cyclicals, Energy, Government Owned Companies (Public Sector Companies), One entire chapter on Author's experience with Fannie Mae, Mutual Fund Industry and Restaurant Stocks (Chapter 20).
Chapter 21 completes this section by discussing how the investor should do a regular check and update his portfolio.
While reading the above section, I was fascinated by the amount of wisdom and experience that was packed in these chapters. While talking of investing in the Retail Sector (Chapter 8) author makes the following points. One, the companies in this sector should have expansion potential since they can only grow through expansion - by replicating in another market the lessons learned in the current market. Two, Debt is a strict no, no for retail. Three, the key parameter to look for is the growth in same store sales, which should grow by at least 5-6% year on year.
The key concept that one learns in Chapter 9 is about 'Quite Facts'. These are facts that are counter to the prevailing market thinking. For example, there are three quite facts that are relevant to Housing Market. One, price of a median house, Two, Affordability and Three, percentage of mortgage loans in default. Towards the end of a realty downturn, these Quite Facts begin to move in a positive direction and market takes some time to react to the reversal of the 'Quite Facts'. Another lesson that one learns is about 'year end anomalies', where the price of a stock could drop drastically in a short time and could rebound equally rapidly. To capitalize on this situation, speed is of essence (and liquidity, of course !).
When it comes to the financial analysis of companies, author recommends the following. Are the inventories increasing? If they are increasing, it may be a sign that management is trying to hide falling sales. Another check is about the book value. One has to analyse if the book value is 'Real'. Some times, unscrupulous companies will hide obsolete inventory and inflate the assets (like the story of the Software Seller who had room full of Windows 95 OS, when the technology had moved to NT) to make the book value look good. Another question to ask is whether the competition will be interested in buying out the company. If there is a strong case for competition to be interested in the company, it is a good sign for the investor. Other factors to consider are decrease in inventory (good). low Debt / Equity (good), type of debt - Bank debt (bad), funded debt (good), low goodwill (good) and good growth potential.
I was really frustrated while reading Chapter 15 on Cyclicals. Throughout this book and also in the previous book by the same author that I reviewed the key message was that one should buy companies with Low P/Es and with good earnings potential. This was an intuitive message that one could understand. Suddenly, while discussing Cyclicals, the author says that low P/E may be a 'Sell' signal when it comes to Cyclicals and high P/E may be a 'Buy' signal. The logic is that at the peak of the business cycles, the earnings would have run up and market will start selling the Cyclicals leading to lowering of P/E. While this could be applicable to stocks in other industry, the key difference between other industries and Cyclicals is that for other Industries the P/E will start falling when the 'Market' starts correcting, while for Cyclicals P/E will start falling when the Business Cycles start reversing, which could happen even when the market momentum is upwards.
While discussing the energy sector, the author talks of 'Troubled Utility Cycle'. In the first phase, disaster strikes and earnings take a severe downturn. Earning downturn could be due to high costs that cannot be passed on to customers or some huge assets that should be mothballed. In phase two, known as the 'Crisis Management', the Utility tries to respond to the disaster by cutting capital spending and by implementing austerity measures. In the third stage, 'Financial Stabilization', the costs are cut to the point where the Utility can operate on the cash that is received from the bill paying customers. In stage four, 'Recovery', the Utility is capable of earning for the shareholders. From here, the Utility will require the support from Capital Market and the Regulatory Agencies to progress.
Author is a big fan of Privatization initiatives undertaken by various governments. Every time it privatizes a business, government ensures that the shareholders benefit in a major way. Author advises the investors to follow suit and invest in all the government stock offerings.
Mutual funds and Restaurants are two industries with high cashflow potential that author covers towards the end of the book. He convincingly argues that these industries can significantly reward the investors, even doubling in two years, if invested wisely.
When it comes to the continuous monitoring, author suggests asking the following questions. One, is the stock attractively priced relating to the earnings and Two, How can the earnings grow? If the earnings are expected to grow, your decision is to stick with it and add more to your portfolio. If the earnings are expected to fall, the decision is to sell it off and buy other better opportunities.
What if the story is unchanged? In that case you could stick with the stock or sell it off and move into attractively priced options available in the market.
'One up on Wall Street' along with this book gives an excellent conceptual and process overview for the Amateur investor to venture into the Stock Market.
