My Takeaways from One Up on Wall Street by Peter Lynch
Over this past week, I read Peter Lynch’s One Up on Wall Street.
If you didn’t know, Peter Lynch was the manager of the Magellan Fund at Fidelity between 1977 and 1990. During this time, he was able to achieve an average return of 29.2%, which was consistently double that of the S&P 500. You might be wondering, how was he able to do this? This is what he shares in his book.
Peter Lynch believes professional investors face many challenges and obstacles, and the average investor can outperform the pros with a little research, patience, and resilience. Every day, we are surrounded by thousands of different products and services offered by companies. If we take the time to look into everyday companies, we can identify which companies will shine before Wall Street realizes it. This was how Peter Lynch could find big winners which could be 10-baggers, or stocks that would 10x in value.
In this post, I will talk about some of my main takeaways from One Up on Wall Street.
Invest in what you know
The average person can see trends happening in their normal life, way before it becomes popular on wall street. Lynch believes people can use these trends to their advantage, and find great, undervalued companies in their respective industries. A doctor can see changes taking place in biomedicine right before their eyes, and definitely earlier than the average Wall Street analyst. So, it makes sense if they buy into changes. On the other hand, it wouldn’t make sense for our doctor friend to predominantly invest in oil. What edge does he have in this field? Probably nothing. As a result, he will make less informed decisions and ultimately have less investing success.
Even if you aren’t a doctor, you can still see potential winners all around you. For example, Lynch told how housewives could have bought into Hanes after trying the company’s new underwear and seeing the amazing comfortability. With a little research, they would have bought a 10 bagger.
Keep an open eye around you, and you are very likely to stumble upon an underappreciated company. With a little bit of research and patience, this can result in massive gains.
Don’t get caught up in trends
There will always be a hot industry everyone is talking about. Sometimes, stocks in this industry can be 10x within a couple of months! Many times, however, these companies are grossly overvalued. A great example of this (not included in Lynch’s book) could be with the 2000 internet bubble. Leading up to this, tech companies seemed to be doubling overnight. But once reality caught back up, many of these companies severely reduced in market value. This is why Lynch says “most of the time, these companies fall as quickly as they rise.”
Even today, this statement still remains very true. This past year, many EV(electric vehicle) companies have risen like crazy to extremely unsustainable values. At around February 2021, this bubble somewhat popped, and many of these companies fell 50% or more from their all-time highs. While there are definitely some reasonably valued (or even undervalued) EV companies in terms of their future prospects, most are grossly overvalued.
Invest in what others overlook
Wall Street professionals face various hidden rules and regulations that prevent them from achieving high returns. Most notably, they are interested in maintaining a good reputation amongst others, and this often prevents them from investing in lesser-known, smaller-cap companies. For example, if someone invested in Apple and it went down 10%, no one would blame them for doing so. On the other hand, if someone invested in a lesser-known company which fell 10%, others would constantly question them about their decision and pester them into selling, even if the fundamentals of the business are still improving. This “hidden rule” results in numerous lesser-loved companies being grossly undervalued.
Lynch feels the individual investor can invest in these overlooked companies to make big gains. As long as the fundamentals are there, the company will eventually be realized by Wall Street, and at that point, it should approach its true value. Another notable investor who has made large profits through this “strategy” is none other than Warren Buffet
Make sure you are ready both financially and mentally to invest
There will ALWAYS be another bear market in the future. What matters is if you are ready to endure it. To ensure you won’t sell, you should be both financially and mentally ready for these difficult times. First, to be financially ready, you have to make sure you have debt and future expenses ready to be paid down. This way, if you lose major parts of your portfolio in the foreseeable future, then you won’t be forced to sell.
Secondly, you must make sure you are mentally ready to invest. This means you are patient, willing to make mistakes, and have a tolerance for pain. As long as someone has these 3 traits, Lynch believes they can successfully endure a bear market. You don’t even need to be particularly smart to invest. As long as you understand 5th-grade math and can understand the businesses you invest in, you should be all set.
Don’t worry about the market; worry about YOUR companies
The market is undeniably a predictable place. No matter what anyone does, no one can ensure 100% success in predicting it. However, Lynch feels you don’t have to predict the market to make money; you just need to find great undervalued companies with great fundamentals and future outlooks. As long as you do this, it does not matter if it is a “good market” or “bad market;” these companies WILL eventually realize their true values. So, as long as you invest in the right companies, everything will take care of itself, whether it be an overvalued or undervalued market.
Peter Lynch’s 6 categories of stocks
Peter Lynch likes to place his stocks into 6 categories: slow growers, stalwarts, fast growers, cyclical, asset plays, and turnarounds
Slow Growers
These are typically very large and mature companies that have expanded nearly to their max capacity. As a result, they grow at a relatively slow pace. Since these companies’ earnings aren’t going to grow anytime soon, neither will the share price. This is because earnings growth is what enriches companies.
Lynch feels there is no point in wasting time on a company that can’t grow. He feels the only reason one should invest here is if the company pays a generous dividend.
Stalwarts
These are still medium-to-large sized companies, but they still have room to grow. They have a relatively good 10–12% annual growth rate.
Lynch feels they won’t give aggressive returns(as shown with the fast growers), but they will perform pretty consistently and provide protection during recessions and hard times.
Fast Growers
These are small, aggressive growth companies that have ample room to grow and expand. They typically grow at an annual rate of 20–25%. Assuming these companies can keep up their growth (and they aren’t overvalued), then they can provide very high returns. Typically, aggressive growth stocks have bigger price movements since they carry more risk. However, finding winners here can pay very well.
Lynch feels the average investor can use their daily edges to find good, fast-growing companies. Fast growers are Lynch’s favorite type of stocks since they helped make up the majority of his fund’s returns.
Cyclicals
These companies are closely tied to the health of the economy. When the economy is expanding, these companies flourish; when the economy contracts, the stock price does as well. Timing and research is key for these companies because buying the wrong company at the wrong time can take years for it to recover. But if done correctly, they can provide lavish returns
Turnarounds
These are companies that have been shrinking because of new competition or issues in the underlying business. If poorly managed, these companies may not recover and go bankrupt. Most turnarounds fail, but those that can adapt and improve earnings can be very rewarding.
Asset Plays
These are companies that are sitting on valuable assets which have largely been unrecognized by others. When buying these, you want to see if it has more cash, property, machines, etc than what the stock is listed to be. Usually, buying asset plays should hypothetically have no risk associated with them. You are betting on others to eventually realize this value, but it could potentially be long periods of time before this happens.
Lynch’s philosophy
Lynch felt earnings were what mainly dictated stock movements. So, if earnings were up, then the stock price should be up as well.
As a result, Lynch liked to allocate 30–35% of his fund in stalwarts, 30–45% in growth stocks, and the rest in cyclical and asset plays. However, these amounts changed depending on the attractiveness of some categories.
Lynch liked buying “growth at a reasonable price,” meaning he liked companies that were relatively undervalued compared to their expected growth. He liked companies whose p/e ratios were less than its expected growth. The p/e ratio is a good indicator to show if a company is overpriced, fair priced, or underpriced. If it is too high, it can often serve as a handicap for the stock’s growth.
Lynch’s “undervalued growth” philosophy helped popularize the use of the PEG ratio. To calculate a company’s PEG ratio, you have to divide the P/E ratio by its expected growth. Typically, if it is less than 1, the company would be undervalued.
Buying a stock
Before Lynch bought a stock, he looked at a company’s story. This “story would” encompass the reasons why he is interested in a stock, why he thinks it will succeed, and some potential issues he might face along the way. This helped bring a more realistic sense of WHY he wanted to buy a stock. Lynch recommends that investors should give a 2-minute monologue on why they want to buy a stock. This can make sure you understand the business you are buying.
Lynch also looked at important fundamentals for the company. This includes the company’s expected growth, its past earnings, its balance sheet, its cash flows. This helps him to make informed buying decisions that can fit his criteria. It also provides insights into the financial strength of the company, and if it can successfully survive a recession.
If Lynch found an undervalued stock that fit his criteria and had a positive long-term outlook, then he would buy.
Selling a stock
Once Lynch found a great stock he liked, he would typically hold onto it for a long tie. Periodically, he would check back into the stock’s “story” and fundamentals to see if he still likes it. It didn’t matter to him if the share price went up or down. Whether it doubled in value or fell 30%, as long as he still saw the stock as attractive, he would hold. Holding because of these reasons is what prevented him from selling at unfavorable times, and ultimately let him get numerous 10 baggers. Ultimately, it was these 10-baggers that transformed his fund from an average one to a star performer
Conclusion
The average investor has much more in their favor compared to Wall Street professionals. Lynch believes that people can use everyday trends they see around them to beat the market. No matter how boring the company might seem, as long as you invest based on the company’s fundamentals, future prospects, and “story,” you should be able to profit in the long term. Overall these simple yet effective tips have allowed Lynch to double the S&P 500’s yearly returns for over a decade.
