Peter Lynch’s One Up on Wall Street — The Six Categories of Stocks
As someone who wants to learn about investing (and has a lot of free time), I’ve spent my time reading through investing books. I wanted to keep a place where my thoughts, analysis and major takeaways are from these books. And as someone who firmly believes in the importance of fundamental analysis and in finding undervalued companies, I embarked on my learning journey by starting with Peter Lynch’s One Up on Wall Street.
You can get the book from Amazon here: https://www.amazon.com/One-Up-Wall-Street-Already/dp/0743200403
This is Part 1. Part 2 will be about the Final Checklist about deciding when to buy the stock and Part 3 will be about the best time to sell your stocks.
Edit 1: Part 2 is up here:
A bit about Peter Lynch
Peter Lynch was the fund manager of the Magellan fund at Fidelity Investments during the years of 1977 to 1990. During Lynch’s time, he averaged an annual return of 29%, making his fund the best-performing mutual fund in the whole world at the time. He is also a fierce advocate of value investing and made strong profits off companies like Phillip Morris, General Electric, Volvo and Lowe’s. His fund grew from US$ 18 million from 1977 to US$ 14 billion at the end of his tenure. To understand the scale, if you put in US$10,000 into his fund in 1977, you would have had a whopping US$ 280,000 at the end of his term. Impressive numbers. He is seen as a legend of value investing alongside Warren Buffett.
Without any further ado, I will get into Lynch’s Six Categories of Stocks
The Slow Growers
These are the companies that pay consistent dividends year-on-year, but do not have much in terms of returns from the actual stock price. These companies have a rate of growth that are slightly higher than the rate of growth of National GNP.
Below is the graph for General Motors (NYSE: GM), a company that was regarded as a slow-grower. We can see that the revenue is increasing, albeit very slightly year on year. The values on the left are in billions
Sooner or later, most popular industries become slow-growing industries, including metals like aluminium and steel, and utilities like the railroad and electric utilities.
The expectations of these stocks are:
- To give out generous and regular dividends. (GM has a 5% dividend yield rate)
- Have a flat chart for earnings (as we can see above)
These companies are not recommended by Lynch for 1 reason: If they have low potential for growth, you will not make money from it. Earnings enrich a company and reduced rate of earnings make a company much less attractive. If the company is going anywhere fast, neither will the stock.
The Cyclicals
The cyclicals are companies whose sales, profits and revenue are continuously increasing and decreasing. These companies are involved in industries like airlines, steel, aluminium, automobiles.
We can see this below with the changes in revenue of Ford Motors (NYSE:F), one of United States’ biggest automobile companies between 2010 and 2021. The revenue clearly increases and decreases in cycles. Ignoring the massive drops in 2020 due to the COVID-19 pandemic, we see that in the beginning of 2011 and 2012, revenue rises from 130 to 138 billion USD, but subsequently returns back to 130 billion before increasing. This trend is seen in years like 2015 and 2016 as well
The pattern is observable from the stock price as well. We see the price of Ford increasing and decreasing yearly. For example, the stock is at $6 in 2012 and increases to $12 in 2014 before falling to $7 in 2018.
The method of investing in cyclicals is finding out when the stock falls and knowing when the stock is able to pick up. Or, as Peter Lynch might put it:
Timing is everything in cyclicals, and you have to be able to detect the early signs that business is falling off or picking up
If invested correctly into (like in 2012 or 2020), then the gains from these cyclicals is very high. However, if invested in years like 2014, it takes much longer for you to realise your gains.
The Turnaround Plays
The turnaround plays are companies that are, simply put, doing horribly. These companies are potentially going to go out of business and are way down a depression during cycles. However, with competent management and investment, coupled with luck in economic activities and innovation in products, these companies can bounce back. And bounce back STRONG, with great upside.
In his book ‘One up on Wall Street’, Peter Lynch cites his play on Chrysler as a turnaround stock. According to him, Chrysler is a stock that most analysts did not back to pick up. However, in 1982, Lynch bought Chrysler for $6, and it became a fifteen-bagger. He invested 5% of the Magellan fund into the company at one point.
Another, more modern example of a turnaround play has to be the Bank Of America (NYSE: BAC). We can see the growth of the company below.
The 2008 Financial Crash was not kind to Bank of America, and in a matter of 2 years, the value of a stock pummelled to 1/10th of its original value to $5.57, one of its lowest point since its IPO. However, due to careful management post-recession, the stock was able to get to its current value of $47. This is a potential nine-bagger in a company that was very well-known. If the company can survive a raid from its creditors, and is not involved in a large-scale incident publicly, it can be a good turnaround play.
The Asset Plays
These are, in my opinion, the most interesting kind of plays. Very difficult to find, but if it pays off, it can pay off greatly. These are companies that are asset and resource-rich. They own land, minerals, oil or gas that is of utmost importance to the company. Alternatively, they may own Television rights, cable rights or internet rights in particular sections of the United States. These stocks own resources that larger companies may want, and would buy at a relatively higher price, allowing the stock price to increase. These companies, however, require immense patience and an understanding into how the company and its management manage the assets.
Now, moving to arguably the two biggest types of plays.
The Stalwarts
These companies are the ones that provide long-term protection in periods of recession. They do not offer explosive growth, but their level of growth is much higher than the slow growers that we previously saw. Some of the most famous stalwarts are Microsoft (NYSE: MSFT) or Alphabet Class A (NYSE: GOOGL).
Above, we can see Microsoft’s 5 year trend. The company has been going up consistently, and has tripled in the time period. These companies are established giants, with Microsoft having the largest market-cap in the world as of writing this article.
Below is the shares of Google’s parent company, Alphabet. The value of these Class A shares has almost quadrupled in the past 5 years, considering that the usage of Google and other Alphabet subsidiaries like Android and Youtube continues to increase. These companies are great protection come recession time, as seen in the minimal dip during the pandemic.
It is always great to have these companies as a part of your portfolio as they are relatively unlikely to go out of business even during recessions and their stock should increase steadily to provide your portfolio with security.
The Fast Growers
Finally, the fast growers. These are small, aggressive companies that become multi-baggers in their first few years, growing at a rate of 20–25% every year. These companies are the high-risk high-reward plays that can go the way of stalwarts, if successful, or can run out of stamina and expansion opportunities and become a slow grower, or even become bankrupt.
An example of a fast-grower is Square Inc, a fin-tech company that exploded onto the market, multiplying 20 times over a period of 5 years to the day.
These companies are the big winners in the stock market that can make an analyst’s career.
Some final notes
We saw the 6 types of companies according to Peter Lynch, but it is important to remember that companies never, as a rule, stay in the same category. Today’s fast-growers can easily be tomorrow’s stalwart. Sometimes, slow-growers can easily become fast-growers, or companies like AMD can become turnaround plays to fast-grower.
