One Up On Wall Street

Introduction

About the book

One Up On Wall Street is one of the best books on the stock market. In this book, Peter Lynch (author) teaches how an ordinary investor can achieve high returns from his investment if they follow a common-sense investing approach. If you are just getting started with the stock market, it helps you understand the basics of investing and how the market works.  

About the author

Peter Lynch is an American Investor, a philanthropist, a former fund manager at Fidelity Investments and the author of the best selling book on the stock market: One Up On Wall Street. He has also written and co-authored a number of other books and papers on investing strategies. His most famous investment principle is "invest in what you know". 

One of his famous quotes: "Invest in what you know. It leaves out the role of serious fundamental stock research. People buy a stock and they know nothing about it. That's gambling and it's not good" – Peter Lynch.

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The Advantages Of Dumb Money

The first rule of this book is that people should stop listening to professionals, because after spending twenty years in the market, any regular person who uses at least 3% of their brain's capacity, can understand and pick stocks efficiently just like an average expert on Wall Street. Investing is not rocket science, instead, it is about smart money. The author says that when a person picks a stock of their own, they should outperform the experts.

Lynch also talks about mutual funds. He says that it is a wonderful avenue for people who do not have sufficient time or inclination to 'test their wits against the stock market.' It is also fit for those who seek diversification and have small amounts of money to invest.

He mentions that there are three good reasons why people should ignore what Lynch himself is buying: These reasons basically apply to all those who blindly follow famous investors or analysts.

• He might be wrong
• Even if he is right, one doesn't know when he might change his mind about a stock
• One has better sources to refer to, and it is all around them.

Lynch writes that the more right a person is about one stock, the more wrong they can be on all others and still end up triumphing as an investor.

One may have thought that a ten-bagger can only happen with some stock in a weird company, which generally investors avoid. But that's not the case, and there are numerous multi-baggers in respectable companies like Dunkin Donuts, Stop & Shop, etc who have given handsome returns.

While discussing the power of shared knowledge, he explains that to get spectacular returns, one has to sell and buy at the right time. He explained with an example that his wife Carolyn is one of his best sources because she had discovered L’eggs which turned out to be one of the two most successful customer products of the 70’s. His wife didn't have to be a textile analyst to realize that the company was selling a superior product; all she had to do was to try the product after buying it.

He says that people are more comfortable in making investments in something about which they don't have full knowledge.

He says that finding a company that is promising is only the first step post that, conducting a thorough research is important which helps one to understand companies and their products better.

Lynch writes that he is confident that any investor can benefit from the same tactics. According to him, it does not take much to 'outsmart the smart money'.

The book One up on Wall Street is divided into three parts where the first one deals with how one can assess themselves as a stock picker, how they can size up the competition and how one can decide if stocks are riskier than bonds. This part also focuses on how one should examine their financial needs and also develop a successful stock-picking routine.

In the second part of this book, he writes about how one can find promising opportunities and can decide what to look for and what to avoid. It discusses in detail how one should use brokers, annual reports and other resources to their best advantage. It also deals with what one can make of the various numbers involved in the technical evaluation of stocks.

The third part of his book deals with how one can design a portfolio or keep track of companies in which one is interested. Apart from this, Lynch also writes about when one can buy or sell the follies of options and futures and also comprises some general observations about the health of Wall Street, the stock market and American enterprise, all of which Lynch has noticed in due course of twenty years of investing. 

The Making Of A Stock Picker

The first chapter of the book is all about Peter Lynch ensuring the investors that no individual is a born stock market professional. He himself was an amateur when he began in 1963 yet he is a successful US investor today with a net worth of $450 million.

If he can, you can too. In this chapter of this book Lynch highlights the following points: 

• An individual cannot help but wonder what investments in stocks can do for them after going through the entire review of the book. 
• Lynch and his family witnessed the Great Depression in the 1930s. His family thought it was best for him not to engage in the stock market. But such urging put him & his family in counter-arguments while he was in his teens. He was a golf club attendant at that time at a posh course that was in proximity to Boston. Lynch caddied for CEOs & presidents of renowned companies such as Polaroid, Fidelity investments that were privately held, Gillette, etc.

This shows that one can receive the best education on stocks from anywhere, and not necessarily a formal education is required always. For example: Lynch picked up most of his learnings from the golf course.

Though he had no funds to invest in stock tips, the happy stories he heard on the Golf course, made him rethink his family’s stand that the stock market was a place to lose money. 

The Wall Street Oxymorons

After talking about how nobody is a born professional in the field of stocks, the author explains in this chapter, why amateurs should look at professionals with a “skeptical eye.”

According to him, multiple factors count while picking a stock, concerning both professionals as well as amateur investors.

The concept of 'Street Lag,' explains that a stock is already a multi-bagger by the time it appears in the radar of the professionals. Sometimes professionals are unable to invest in a potential multibagger. The professional is duty-bound on specific industries, whereas an ordinary investor does not have this constraint and can have his own investment style.

Lynch has opined that professionals invest to avoid losses, and not to make big profits. He says that whoever imagines that the average Wall Street professional is looking for reasons to buy exciting stocks hasn’t spent much time on Wall Street. In his continual exposition of emphasising about professionals being beaten by amateurs, Lynch turns to the rules that constrain professionals.

The worst of the herd mentality takes place in the bank’s pension-fund departments and in the insurance companies. The fund managers buy and sell stocks from pre approved lists. Nine out of ten pension managers work from such lists.

Other constraints faced by a professional which aren't confronted by amateurs are the rules and regulations of the organization that they work for, after having to spend a considerable amount of time convincing potential customers about the logic behind their investment picks, the massive size of the assets to handle etc.

Lynch says that there are some exceptions to the professional investor oxymoron, and points to a few "maverick fund managers" and "innovative fund managers” who do as they please, and are also doing exceptionally well.

Then, he talks about some spectacular stocks that he found, which were potential multibaggers and were so appealing, that almost all the investors would buy them if they could, but unfortunately, they couldn't. Professionals don't find stocks attractive until and unless they've been acquired by institutions and many respected Wall Street analysts. 

In this chapter, he talks about the market cap limitations that have been imposed by some fund institutions and companies. Stocks which were below a certain market capitalisation couldn't be selected or purchased. He says that the stocks that he tries to buy are the ones which are overlooked by traditional fund managers and he says that he continues to think like an amateur as frequently as possible. 

He draws a few essential conclusions in his chapter, where he says that:

• One doesn't have to invest like an institution because if they do so, they will be doomed to perform like them, which doesn't pan out very well in many cases. He says that investors who are amateur need not report to a higher authority, and they also don't need to spend their time justifying why they bought what they bought, and the prices they paid for it. 
• One can find brilliant opportunities in their workplace or neighbourhood, years and months before the news reaches the analysts. 

Finally, he ends his chapter by preparing his readers with his final words, “The stock market demands conviction as surely as it victimizes the unconvinced.”

Is This Gambling, Or What?

The third chapter of One Up On Wall Street, looks at investments in debts which comprise of money markets, bonds or certificates of deposit (CDs). He provides a perspective on stocks and bonds from 1988, and these are the things he covered in this chapter: 

• According to him, some investors have taken refuge in bonds, after the significant upset such as the 'Hiccup of Last October' [Black Monday]. 
• He said that the issue concerning stocks and bonds is worthy of resolve upfront, but in a dignified manner. Otherwise, it will show up at the most distressed moments. When stocks are dropping, and people are rushing to banks, to sign up for CDs. 
• Based on his perspective, which was from the late 1980s, Peter Lynch looked at bonds as being attractive in the previous 20 years, but not in the 50 years before that. 
• Both bond mutual funds as well as bonds used to offer a very high rate of interest 20 years ago, especially when bills came due during the Vietnam war. Rates of bonds drove higher due to inflation, and this made them look attractive. Investors demanded more stocks at the same time because of the protection, which equity provided to them, against inflation.
• Peter Lynch also noted that stocks had an average annual return of 9.8% between 1927 and 1988. On the other hand, inflation averaged 3% per year.
• Lynch argued that stocks are by far the most effective securities for increasing wealth.
• Lynch considers investing as gambling but distinguishes it from speculating by working hard to tilt the odds in one's favour. 
• In Lynch’s eyes, there is no hard and fast line between safe and unsafe. According to him, historically, stocks were embraced as investments or dismissed as gambles, and the timing of one’s investments were mostly wrong. For years, stocks in large companies were considered “investments'' and stocks in small companies “speculations”

His conclusion is as follows:

• An understanding of the difference between investing in stocks and investing in debt is essential. 
• What's more important than one's security choices is the “skill, dedication and enterprise of the participant”.
• He says that investing in stocks is undeniably more profitable than investing in debt. Since 1927, common stocks have recorded gains of 9.8% a year on average. Investing in stock has unlimited upside because investors are regarded as partners in a prosperous and expanding business.
• Stocks are riskier than bonds in the sense that, if one buys the right stocks at the wrong time and price, then they will be subjected to huge losses. 
• Investing in bonds is not risk-free. 
• People who succeed in the stock market also accept periodic losses, setbacks, and unexpected occurrences. They realize the stock market is not pure science, and not like chess, where the superior position always wins. 
• Lynch mentions that if seven out of ten of his stocks perform as expected, then he is delighted. If six out of ten of my stocks perform as expected, then he is thankful. It takes only six out of ten stock picks to be correct to produce an enviable record on Wall Street.

He concludes this chapter by saying, “To me, an investment is simply a gamble in which you’ve managed to tilt the odds in your favour.”

Passing The Mirror Test

In the 4th chapter, the author says that there is no point in studying the financial section until and unless one has passed the so-called “Mirror Test". He says that before one buys a share of a company, three personal issues have to be addressed.

• Does he/she own a house?
• Does the investor have the unique qualities that lead to success in investing?
• Investor’s monetary usages and needs.

Owning a House

• Peter Lynch says that before buying a stock, one should buy a house because it is a bigger and safer investment that almost everyone makes. However, there are exceptions to this rule, but a home would be financially rewarding for its owner in most of the cases. 
• He says that “It’s no accident that people who are geniuses in buying their houses are not efficient with their stock pickings. A house is entirely rigged in the homeowner’s favour. The banks let you acquire it for 20% down payment and even less in some cases, giving us the remarkable power of leverage.”
• Houses, like stocks, are most likely to be profitable when they’re held for a long period of time. 
• People make money in the real estate market and lose money in the stock market as they spend months choosing their houses, and minutes choosing their stocks. They spend more time shopping for a good microwave oven than shopping for a good investment. 

Need for Money

• The money that one wants to invest in stocks should be surplus, and if one is going to pay for their child's education in the next two or three years, the money should not be put into stocks. In other words, “Only invest what you could afford to lose without that loss having any effect on your daily life in the foreseeable future.”
• He also noted in his book that younger individuals who are living off inheritance and people who are living on a fixed income, especially ones who are old, should avoid investing in the stocks. 

Does one have the right qualities to succeed?

The third question asked by Lynch to potential investors was, in a way, created to discourage those who don't possess the right character traits for jumping and investing in the market. 

• According to the author there are a few absolute necessary qualities which are essential to be successful in creating wealth through stock investments. It  includes 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.
• It is 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.

Peter Lynch asks his potential investors to address the above three key issues. If one can answer 'Yes' to all of them, then they have successfully passed the mirror test and also possess the potential to become a good investor.

Is This A Good Market? Please Don’t Ask.

Peter Lynch believed that people should invest in companies and not in stock markets. In the 5th chapter of his book, he explains that one should never ask, "is this a good market to invest in?" because there are thousands of professionals who have tried to predict the market but have not been able to do so consistently. 

According to him, a person does not have to predict the stock market to make money in stocks. He wanted to convince people that the market is irrelevant.

The author didn’t believe in predicting markets; instead he thought about buying great companies, especially those that are undervalued. 

According to Lynch, every major up and down in the market has surprised him, and in no way is he a predictor of the market.

He believes that there is no market, such as an overvalued market, and there is no point in worrying about it either. A person will know when the market is overvalued, when they find a company that is reasonably priced and meets other criteria of an investment.

Key Learnings From Section 1

• Don’t overestimate the skill and wisdom of professionals.
• Take advantage of what you already know.
• Look for opportunities that haven’t  yet been discovered and certified by Wall Street—companies that are “off the radar scope.”
• Invest in a house before you invest in a stock
• Invest in companies, not in the stock market
• Ignore short-term fluctuations
• Large profits and Losses can be made in common stocks
• Predicting the economy and short term direction of the stock market is futile.
• The long-term returns from stocks are both relatively predictable and also far superior to the long-term returns from bonds.
• Keeping up with a company in which you own stock is like playing an endless stud-poker hand.
• Common stocks aren’t for everyone, nor even for all phases of a person’s life.
• The average person is exposed to interesting local companies and products years before the professionals.
• Having an edge will help you make money in stocks.
• In the stock market, one in the hand is worth ten in the bush.

Stalking The Ten-Bagger

In this chapter, the author talks about ten-baggers, which means that stocks will experience a ten-fold increase in the value over a period of time which is unspecific. 

The best place to begin looking for the ten-bagger is close to home—if not in the backyard then down at the shopping mall, and especially wherever you happen to work.

According to him, many of the ten baggers of his time includes Dunkin’ Donuts (NASDAQ: DNKN), L’eggs (NYSE: HBI) and Subaru (TSE:9778), who first manifested themselves as products which are relatively more significant than stocks.

According to him, one doesn't have to be the Vice President of a company to sense if the company is prospering or growing. One can be of any profession to understand the same.

There are several advantages listed by Lynch, which the non-professional investors have over the professional investors. According to him, there are 2 kinds of amateur investors: 

(1) ones who possess professional knowledge about industries, 
(2) a “grassroots observer’s” or amateur’s awareness of exceptional products.

One can pick winners, irrespective of what they enjoy, be it grassroots edge or professional: “Whichever edge applies, the exciting part is that you can develop your stock detection system outside the normal channels of Wall Street, where you’ll always get the news late.”

According to the author, one can find a ten-bagger when they go shopping. When a stock is about to rise quickly, there's a sign which people can look forward to: the warm reaction from customers. Working in a business offers an edge because one can get exposure to successful firms of that business. He suggests people understand the company's size as smaller companies can have a massive swing in value.

It is important for one to invest in companies that they can comprehend well, this can give them an edge. He believed that a person who has an advantage always has the place and the position to be above a person who doesn't have an edge.

I’ve Got It, I’ve Got It—What Is It?

Lynch propagates, in his book that the best place to start looking for the ten-bagger is close to one's own home. One needs to keep both their mind as well as their eyes open. There are several companies at shopping malls, workplace, etc., which we can come across.

According to him, people need to invest in companies that they have prior knowledge about because this will give them an edge. The primary aim of an investor should be to analyze the stocks after identifying them. Based on the timing of the business, companies can have six categories. Let us see what the author tells us about it. 

1. Slow Growers - When a popular growing industry slows down, most of the companies in that industry slowdown as well. Mr. Lynch elaborates that a company starts paying high dividends when they cannot think about new ways to expand their business. 

2. Stalwarts- Stalwarts are faster than slow growers, but are not the fastest in terms of growth. They are multi-billion dollar companies like Coca Cola, Procter and Gamble, etc. If we invest our money at the right time, we can make sizable profits from stalwarts. The author says that stalwarts have good protections during times of recessions

3. Fast Growers - These are the most aggressive investments an investor makes that can earn him up to 25% a year. A fast growing company might not necessarily belong to a fast growing industry. There are plenty of risks involved with fast growers as they might be a new company or under financed. An investor should look for good balance sheets and substantial profits when searching for these types of companies. 

4. Cyclicals - Cyclicals are the regular ups and downs in companies, and some of these cyclicals may be big companies and could be confused easily with Stalwarts. Companies like TISCO, banks, automakers, etc. fall into this category, and it is important to know when one should get into these stocks and when they should get out of them.

5. Asset Plays - Asset Plays are companies which hold significant and enough numbers of assets which are held in their books, and the market is not aware of this. Some of what is included in these assets consist of Carry forward losses which provide tax benefits to the company, real estate held at book value, huge customer base, investments in the shares of other companies, etc. 

6. Turnarounds - Turnarounds are companies that have very little to no growth. These companies go so down in their values because of their cyclical nature that people start thinking they will not be able to survive. For example, Ford, General Public Utilities, etc. Can be considered as turnarounds. There are several types of turnarounds which are: 

1. Bail-us-out-or-else 
2. Who-would-have-thought
3. Little-problem-we-didn't anticipate
4. Perfectly-good-company-inside-a-bankrupt-company
5. Restructuring-to-maximize-shareholder-value

1) Bail-us-out-or-else -  In these types of turnarounds, the company is on the verge of a bankruptcy and a government loan guarantee might be the only way they are saved. Examples include Lockheed or Chrysler. 

2) Who-would-have-thought - In this kind of turnaround, the author explains by giving an example of Con Edison. The stock prices fell from $10 to $3 in 1974, which is uncommon for a utility company, but by 1987, the stock prices rose from $3 to $57 in 1987. Such major turnarounds are generally predictable and an investor can gamble on it.

3) Little-problem - we-didn't anticipate - There are little problems that nobody anticipated with these kinds of turnarounds. For example, in General Public Utilities, there was a minor tragedy that people anticipated it to be worse than it actually was. We need to be patient and ignore the news about this stock with dispassion. The outcome of the tragedies should be measurable for the investor. Immeasurable tragedies like The Bhopal Disaster cannot be interpreted and should be left out.

4) Perfectly-good-company-inside-a-bankrupt-company - Toys “R” Us, is an example of such a turnaround. Where, Interstate Department, a subsidiary of Toys, was spun out of its parent, and did pretty well after that.

5) Restructuring-to-maximize-shareholder-value- Penn Central, can be an example of this kind of turnaround. Companies generally decide to restructure their entire structure, to maximize the shareholder value. Companies whose CEOs come out and announce this news to the public, are warmly applauded by the shareholders.

The Perfect Stock, What A Deal!

Peter Lynch says that it is easier to develop a company if its business is easy to understand. In this chapter of his book, he provides his readers with 13 attributes that can make it easier for them to find a company: 

 1. It sounds dull and boring: The author writes that a perfect stock will also be attached to an ideal company. These companies should engage in simple businesses and have a boring name because the more boring the name, the better it is. 

2. The work it does is also dull and boring:  It is exciting if the company with a boring name also has an equally dull function. Lynch says that both these factors can keep the oxymorons away until there is some good news which ‘compels them to buy in, thus sending the stock price even higher.’

3. It has a disagreeable function: According to Peter Lynch, a stock which is disgusting and boring at the same time, which will make people shrug in disgust, is ideal to invest in. 

4. It is a Spinoff: According to Lynch, “Spinoffs of divisions or parts of companies into separate, freestanding entities—such as Safety-Kleen out of Chicago Rawhide or Toys “R” Us out of Interstate Department Stores—often result in astoundingly lucrative investments.”

He says that a large parent company does not want to reflect a wrong impression of itself because its spin-off is in trouble. Thus, there is independence entrusted in the spin-offs, with a strong balance sheet, so that they can run their own show. 

5. The analysts don’t follow it, and the institutions don’t own it: If an individual finds a stock which has little or no institutional ownership, then they have found a potential winner. Next, they need to find a company that has never been visited by an analyst or is not very well known. This will make a person a double-winner. 

6. There are rumours about the company being involved with toxic waste or the Mafia: When such rumours surround a company, it usually trades at a steep discount as institutional investors as well as Wall Street, steer clear of it. Thus, these kinds of companies may present an excellent opportunity to the investors. 

7. It has an unfortunate aspect to it: Businesses like the mortuary are an excellent example because it is depressing. Lynch says that Wall Street would ignore mortality, aside from toxic waste.  

8. It is an industry with no growth: The author says that this is where the most significant winners evolve and rise. In a no-growth industry which is both boring as well as upsetting for people, there is no problem with competition. Thus, one does not have to protect their flanks from rivals who are potential, because nobody else will be interested. 

9. The company must have a niche: Peter Lynch wrote in his book that he always looked for niches and that the perfect company would have one. He said that chemical companies, as well as drug companies, have niches or products, which nobody else is allowed to make. He said that “Chemical companies have niches in pesticides and herbicides. It’s not any easier to get a poison approved than it is to get a cure approved.”

10. People have to keep buying it: Invest in companies that make drugs, soft drinks, etc., then in ones that sell toys because someone can make a doll that every child has to have, but can only have one each. Thus, there’s no point in taking chances on fickle purchases as there are several businesses around, which are stable. 

11. It uses technology: The author believed that we should invest in companies which benefit from a price war, rather than investing in computer companies which struggle to survive in an endless cycle of the price war. Thus, instead of investing in a company which makes an electronic product, it makes more sense to invest in supermarket companies which install these electronic products. 

12. The buyers are insiders: There is no better tip-off than the probability of success behind a stock than those people in the company who are putting their own money into it. The insiders who buy stocks, do it for only one reason, that is, they think that the stock price is undervalued and will go up eventually. 

13. The company is repurchasing shares: Buying back shares is the simplest and best way in which a company can reward its investors, according to Lynch. He also adds that if a company has faith in its owner, then why should it not invest in itself? 

After completing this chapter, he moves on to talk about what stocks one should avoid, in the next chapter.

Stocks I’d Avoid

In the 9th chapter, Peter Lynch talks about the stocks that one should avoid investing in. He gives several criteria:

1. People should avoid the hottest stock in the hottest industry because these stocks go up fast, and when the price falls, it falls too.

2. Another kind of stock which we should avoid is one, where the company has been tagged and labelled as the next IBM or the next McDonald’s, etc. because whenever a stock is tagged like this, it usually never becomes the next something.

3. According to Peter Lynch, the value of shareholders is lost when the acquisitions are beyond their understanding.

4. Lynch writes that people may from time to time, come and tell one about a company that they think is great for investment. People need to avoid these ‘whisper stocks’ as they are hypnotic and have an appeal to one's psychology.

5. Lynch says that “The company that sells 25 to 50 percent of its wares to a single customer is in a precarious situation meaning, that the company is failing to run efficiently. Thus, he adds that "If the loss of one customer would be catastrophic to a supplier, I’d be wary of investing in the supplier.”

6. He asks his readers to be wary of companies which have exciting and amusing names because they may often turn out to be mediocre while the companies with boring names that don’t attract investors may end up being valuable.

Earnings, Earnings, Earnings

2 factors, according to Lynch, which makes a company more valuable day by day, are earnings and assets. Sooner or later, value always wins because sometimes it takes a very long time for stock prices to catch up to the company's values. 

When talking about the stock prices and earnings of a company, Lynch says the following in his book: 

• A company's money-making potential is relative to the useful measures of whether any stock is reasonably priced, under-priced or is overpriced. 
• The P/E level tends to be the highest for fast growers and lowest for slow growers. According to him, the foray step towards looking at P/E ratios of various stocks that one owns is high, low or average, which are relative to the norms of industry norms. 
• Before buying a stock, the P/E ratio can tell a person if it is useful to know whether what one is paying for the earnings is in line with what others have paid for the same gains in the past. 
• A company which has a high P/E ratio must also have incredible growth in earnings to justify the high price, which is put on the stock.
• According to Lynch, when it comes to future earnings, the best way is a knowledgeable guess on which will be based upon the current earnings of a person. 
• For future earnings, a person needs to try and predict what is going to happen to the earnings in the next year, month or decade.

He writes that if one is unable to predict future earnings, at least they can find out how a company is planning to increase its earnings because then, one can periodically check to see if the plans are working out or not.

By adopting to five basic ways: like reducing cost, raising prices, expanding into new markets and by selling more of its products, a company can surely increase its earnings. 

The Two-Minute Drill

Peter Lynch, in the 11th chapter, writes that the 1st step is to know if one is dealing with a slow grower, fast grower, a cyclical, a turnaround, a stalwart or an asset play alongside the P/E ratio which gives one a rough idea of whether the stock is undervalued, currently priced or overvalued. 

The next step that follows is to learn about a company and about how it can bring an added prosperity.

He also says that before buying a stock one should be able to give a monologue of two minutes. This would cover the reasons which make a person interested in the company, what should be done for the company to succeed and the problems that stand in its path. 

He gave some examples of the two-minute monologue of different classes of Companies.  

1)Slow grower — Focus on the dividend. 

"This company has increased earnings every year for the last ten, it offers an attractive yield, it's never reduced or suspended a dividend, and in fact, it's raised the dividend during good times and bad, including the last three recessions. it's a telephone utility, and the new cellular operations may add a substantial kicker to the growth rate."

2)Cyclical — Focus is on business conditions, inventories and prices.

"There has been a three-year business slump in the auto industry, but this year things have turned around. I know that because car sales are up across the board for the first time in recent memory. I notice that GM's new models are selling well, and in the last eighteen months the company has closed five inefficient plants, cut twenty percent off labour costs, and earnings are about to turn sharply higher."

3)Stalwart — Focus is on the P/E ratio. This also focuses on if the stock has had a dramatic rise in price in recent months, and if anything, to accelerate the growth rate is being done. 

He writes, "Coca-Cola is selling at the low end of its P/E range. The stock hasn't gone anywhere for two years. The company has improved itself in several ways. It sold half its interest in Columbia Pictures to the public. Diet drinks have sped up the growth rate dramatically." 

According to him, "Last year the Japanese drank 36% more cokes than they did the year before, the Spanish upped their consumption by 26%. That's phenomenal progress. Foreign sales are excellent in general. Through a separate stock offering, Coca Cola Enterprises, the company has bought out many of its independent regional distributors. Now the company has better control over distribution and domestic sales. Because of these factors, Coca-Cola may do better than people think."

4)Fast Grower —Focus is on how and where it plans to continue growing fast. 

These are a few examples amongst many. Lastly, he concludes by saying that the more one knows, the better, and in several cases, one needs to devote a lot of time in developing and creating a script. 

Getting The Facts

Peter Lynch writes that as an investor one needs to focus on getting hold of facts though rumours are usually more exciting. He says that quarterly reports and annual reports are the best resources if one wants to find facts. 

An investor must get the most out of their brokers. If one's broker makes a recommendation about a stock, ask them about the category of the stock, expansion plans, insider buy, p/e ratio, etc. 

If a person has specific questions, then they can call the investor relations office for answers, and before calling one should always prepare their questions first. Lynch recommends investors to start with questions that show that they have thoroughly researched the topic.

Annual reports are the best resource, and every investor must thoroughly read them. 

According to Lynch, every investor must check marketable securities in the current situation of assets. If it has exceeded a long-term debt and liability section, it is favourable. This means that the company won't go out of business no matter what happens. 

On the other hand, it can be said that the financial condition of the company is in lousy shape if the cash has been shrinking and the debt has been growing. 

To conclude:

Peter Lynch asks all the investors to check whether the outstanding number of the share has reduced or increased in the last ten years. An increase in Earning per share occurs if one buys back shares.

Some Famous Numbers

Peter Lynch gives a list of various numbers which are worth noticing: 

• If you are interested in a company because of a particular product, the first thing you want to know is what that product means to the company. In other words, what percentage of the sales it accounts for that particular product.
• The P/E ratio of any company, which is priced moderately and has an equal growth rate of earnings, if it's less than the rate of growth, then it's a bargain because this is positive, whereas if it is twice the rate of growth, is negative. 
• A quick and easy way of determining if a company is financially strong is to compare its debt to equity. This includes questions like, how much the company owes, and owns. There's funded debt and bank debt where the former is the worst kind and is also due on demand.
• Companies which are fast-growing and young and don't pay dividends are likely to grow much faster as they are ploughing money into expansion. 
• Though book values are easier to find, one needs to have a detailed understanding of what they are. 
• One can find several companies who carry assets at a fraction of their real value and the companies which have natural resources as their assets are usually more valuable than others. 
• The amount of money a company takes while doing business is the cash flow of the company. Thus, a company that takes more cash is the one that is a better investment.
• A build-up in inventory is a bad sign, and if it grows faster than sales, then that is a worse sign. Thus, this is an aspect of a company that people must check.
• One must check if a company has an overwhelming pension obligation that they can't meet, especially in case of a turnaround
• Before investing, the investors must look at the ability possessed by a company to increase its earnings by raising prices and also by lowering costs. This is the growth rate which counts.

To conclude:

The author asks all the investors to have a focus on high profit-margins, in a stock which is long-term in nature and that one plans to hold through bad and good times as well, alongside a relatively low profit-margin in a successful turnaround.

Rechecking The Story

In every few months, it is worthwhile to recheck the story of the company:

1) To check if the earnings are growing as expected. 

2) To see if the merchandise is still attractive, and this may also involve checking the stores. 

3) In the case of fast growers, one must ask themselves what will keep them growing. 

It is essential to determine what phase the company is in, whether it is an expansion, start-up or maturity. 

The Final Checklist

The author mentions some final checklist on stocks before buying it. 

The P/E ratio. Is it high or low for the particular company and for similar companies in the same industry?

The percentage of institutional ownership. The lower the better.

Insider Buying: If insiders are buying or the company itself is buying back its own shares are positive for the company.

Growth in Earnings: Check on earnings growth to date and whether the earnings are sporadic or consistent. 

Balance Sheet: Whether the company has a strong balance sheet or a weak balance sheet, debt- to-equity ratio and the cash flow position and how it’s rated for financial strength.

The author also has beautifully explained specific pointers to check in different types of companies. 

SLOW GROWERS

In the case of slow growers, one buys dividends, and what percentage of the earnings are being paid out as dividends. If it’s a low percentage, then the company has a cushion in hard times. 

CYCLICALS

Lynch says that investors must keep a close watch on inventories and should watch out for new entries into the market. If one knows their cyclical, then they have the advantage of figuring out the cycles and thus makes it easier for them to predict an upturn in the cyclical industry than that of a downturn. Anticipate a shrinking P/E multiple over time as business recovers and investors look ahead to the end of the cycle, when peak earnings are achieved.

STALWARTS

One needs to check the P/E ratio of a company and must also check for unrelated acquisitions which have a chance of reducing future earnings. An investor must also check for a growth-rate which is long-term and has also maintained momentum in recent years. Lynch says that if someone is planning to hold the stock for a long time, then they must check how the company has performed during prior recessions. 

TURNAROUNDS

An investor needs to ask if the company can survive raids by creditors and how much cash the company has, alongside how much debt it has, as well. He says that if a company is bankrupt, then an investor needs to ask about what's left of it for shareholders. Lynch propagates that investors need to ask how a company is supposed to be turning around and if it has rid itself of unprofitable divisions. A few more questions that need to be addressed are, if the business is coming back or not, and if costs are cut and if so, what will be its impact. 

FAST GROWERS

Investors must investigate whether the product which is meant to enrich a company is a significant part of its business or not. They also need to see if the company has been able to duplicate its success in more than one place, as this proves that expansion is going to work. One should check whether the stock is selling at a P/E  ratio at or near the growth rate or not. 

ASSET PLAYS

Peter Lynch asks his investors to ask questions like what the value is, of the assets and if there are any hidden assets or not. He says that investors also need to ask how much debt there is to detract from these assets and if the company is taking on new debt and making its assets less valuable or not. 

Key Learnings From Section 2

• Understand the nature of the companies you own and the specific reasons for holding the stock.
• 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 di-worse-ifications.
• 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.
• Invest in simple companies that appear dull, mundane, out of favour, and haven’t caught the fancy of Wall Street.
• Moderately fast growers (20 to 25 percent) in nongrowth industries are ideal investments.
• Look for companies with niches.
• When purchasing depressed stocks in troubled companies, seek out the ones with the superior financial positions and avoid the ones with loads of bank debt.
• 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 storyline to follow as a way of monitoring a company’s progress.
• Look for companies that consistently buy back their own shares.
• 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, favour 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 an hour a week to investment research. Adding up your dividends and figuring out your gains and losses doesn’t count.
• Be patient. Watched stock never boils.
• Buying stocks based on stated book value alone is dangerous  and illusory. It's the real value that counts.
• When in doubt, tune in later.
• Invest at least as much time and effort in choosing a new stock as you would in choosing a new refrigerator.

Designing A Portfolio

In this chapter Lynch talks about how it is important to expect a reasonable return of at least 8-10% by making an investment in index funds, ETF etc. One can get a compounded interest of at least 12% over time. 

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

When discussing about how many stocks are too many in number to invest, he says that: 

• One can have as many stocks as long as they can understand a company better, and pass all tests of research. 
• He writes that if a person is looking for a ten-bagger then the more stocks they own, the more likely it is for one of them to become a ten-bagger.
• He also says that owning more stocks means more flexibility as one has to rotate funds between them. 
• Spreading one's money among several stock categories is another way to minimize downside risks.
• According to him, slow growers and stalwarts are low risk investments with a limited potential while asset plays and cyclicals have a great upside potential if one is able to make the right investment at the right time. Ten-baggers are likely to come from fast growers or turnaround. The key for smart investment is knowledgeable buying. 

Lastly, he concludes by saying that the key is to re-examine one's idea of a company from time to time as a lot of things depend on it. 

The Best Time To Buy And Sell

Peter Lynch says that, "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.”

The annual ritual of end-of-the-year tax selling, and institutional investors who like to dump the losers at the end of the year so that their portfolios are cleaned up for the upcoming evaluations present some opportunities. 

He writes that all the compound selling between the months of October and December enables in driving the stock prices down. Moreover, during collapses and hiccups also the stock prices are driven down every few years.

He asks his readers to stay away from stock market advice and tells them to avoid paying attention to external economic conditions like if the rate of interest is going up or down or if the company is heading into recession.

Peter Lynch points out the times when one should sell a slow grower 

1.When the company has lost market share for two consecutive years.

2.When no new products are being developed, and the spending on research is curtailed.

3.When there is a recent acquisition of two unrelated businesses and company 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.

4.He says that even at a lower stock price, the dividend yield will not be high enough to attract interest from investors. 

Peter Lynch points out the times when one should sell a Stalwart: 

1.If the P/E goes too far beyond the normal range, one might think about selling it and waiting to buy it back later at a lower price. One may also consider buying something else.

2.New products introduced in the last 2 years have had mixed results, and others still in the testing stage are a year away from the marketplace.

3.The P/E of the stock is 15 and when companies of a similar quality in the industry have a P/E of 11-12.

4.No shares have been bought by officers or directors last year.

5.The company’s growth rate has been slowing down. Though it’s been maintaining profits by cutting costs, future cost-cutting opportunities are limited.

Sell a Cyclical Company when:

1.The best time to sell it is towards the end of a cycle. But one should know when that time is.

2.According to him, an investor can get a signal when the future price of a commodity is lower than the current, or spot, price.

3.Lynch mentions that competitive businesses are bad for cyclicals but suggests that it is a good idea to sell them when the final demand for a product is slowing down. 

Sell a Fast Grower Company when:

1.One should watch for the 2nd phase of rapid growth or whether the company is entering a phase of maturity or not.

2.When the stock has high recommendation and is popular, it is time for selling.

3.When employees and executives leave a company to join another rival firm it seems like another good time for selling.

4.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

Sell a Turnaround Company when:

1.The best time to sell a turnaround is after it has turned around and is known by everyone.

2.When there is a debt that has been declining for five quarters and suddenly rises by at least $25 million in the latest quarterly report.

3.A rise in inventories at a rate which is twice the sales growth rate.

4.It can be sold when the P/E has increased with respect to prospects for earnings. 

Asset Play company should be sold when:

1.The shares sell at a discount value and the market has announced it will issue 10% more shares to help finance a diversification program.

2.There is a reduction in the corporate tax rate which considerably reduces the value of the company’s tax-loss carry forward.

3.Institutional ownership has risen from 25 percent five years ago to 60 percent today.

The 12 Silliest & Most Dangerous Things People Say About Stock Prices

In this chapter Lynch talks about twelve silliest things that he has heard people say about stock prices and thinks that one should dismiss them from their mind:

• If stock prices have gone down by this much already, it can’t go much lower.
• One can always tell when a stock’s hit bottom.
• If a stock has gone high already how can it possibly go higher? Lynch says that this is a terrible reason to snub a stock.
• There's not much to lose if it is only $3 a share—whether a stock costs $50 a share or $1 a share, if it goes to zero one will still lose everything.
• Prices always come back eventually, which is also not true because lots of stocks don't come back.
• There's a tendency to believe that there is always darkness before dawn—which means that if things have gotten a little bad it can't get worse.
• When a stock rebounds to higher levels – the investor plans to sell— no downtrodden stock ever returns to the level at which you've decided to sell.
• Why worry? Conservative stocks don’t fluctuate much—there is no stock that one should afford to ignore because companies are dynamic and prospects change over time.
• It’s taking too long for anything to ever happen—patience is the key to create wealth, so it is important to be patient.
• Look at all the money I’ve lost: I didn’t buy it! —one doesn't really lose anything by not owning a successful stock irrespective of it being a ten-bagger on Wall Street. Somebody else’s gains cannot be considered as your own personal losses. It is not a productive attitude for investing in the stock market
• I missed that one, I’ll catch the next one—there is no next Home Depot, no next Amazon, no next Costco. It’s better to buy the original good company at a high price than it is to jump on the similar or next one at a bargain price.
• The stock’s gone up, so I must be right, or, the stock’s gone down so I must be wrong—don’t confuse prices with prospects unless you are a short-term trader looking for 20-percent gain in the short-term.

Options, Future, And Shorts

Lynch writes in the 19th chapter of his book that unless one is a professional in trading it is nearly impossible for them to win bets.

He says that derivatives are leveraged products. It's great when used to hedge but extremely risky if used as a speculative tool. 

“In the multibillion-dollar futures and options market, not even a small percentage of money is put into constructive use. It doesn't finance anything, except the cars, planes and houses purchased by the brokers and the handful of winners. What we are witnessing here is a giant transfer payment from the unwary to the wary.”

Lynch tells his investors that they can't spend the proceeds from shoring stocks at other places unless they have paid the shares back to owners.

Key Learnings From Section 3

Peter Lynch lists of a few things which one can take from the last section from the book: 

• The market has a high chance of declining sometime in the future.
• The decline in markets offers a great opportunity to buy stocks in companies that one likes.
• Even if one tries, they cannot predict the market direction over a year or two. 
• There are different risks and rewards for different categories of stocks. 
• One is capable of making a lot of money by compounding a series of 20–30 percent gains in stalwarts.
• Just because a company is doing poorly doesn’t mean it can’t do worse.
• Just because the price goes up doesn’t mean one is always right.
• If a price goes down it doesn't always have to be that one is wrong. 
• One loses technique if they buy a company with mediocre prospects just because it is cheap. 
• Selling a fast grower which is outstanding just because it's stocks seem overpriced is a losing technique.
• Fast growers don't stay the same way forever and companies don't grow without reason.
• A stock doesn't know that one owns it.
• One doesn't lose anything by not owning a successful stock
• One can bet when it seems favourable.
• There is always something to worry about.
• An investor should not become attached to a winner in a way that one stops monitoring the story.
• One should keep an open mind to new ideas.
• If one isn't confident about beating the market then they should invest in mutual funds.

These are a few takeaways amidst many from the last section of his book.