This is a follow up reading from One Up Wall Street book summary where Lynch writes about how an ordinary person can also be ‘One Up’ the Wall Street professionals.
This book is akin to a diary that Lynch has written about his years spent investing in the markets working with Fidelity. In this book, he shared with readers the hits and misses and shared how he analyses the companies.
Herewith I have extracted the key points from this book.
1. A good company usually increases its dividend every year
2. You can lose money in a very short time but it takes a long time to make money
3. The stock market really isn’t a gamble, as long as you pick good companies that you think will do well, and not just because of the stock price.
4. You can make a lot of money from the stock market, but then again you can also lose money, as we proved.
5. You have to research the company before you put your money into it
6. When you invest in the stock market you should always diversify
7. You should invest in several stocks because out of every five you pick one will be very great, one will be really bad and three will be OK.
8. Never fall in love with a stock; always have an open mind.
9. You shouldn’t just pick a stock – you should do your homework.
10. Buying stocks in utility companies is good because it gives you a higher dividend, but you will make money in growth stocks.
11. Just because a stock goes down doesn’t mean it can’t go lower.
12. Over the long term, it is better to buy stocks in smaller companies.
13. You should not buy a stock because it is cheap but because you know a lot about it.
14. Hold no more stocks than you can remain informed on.
15. Invest regularly.
16. You want to see, first, that sales and earnings per share are moving forward at an acceptable rate and second, that you can buy the stock at a reasonable price.
17. It is well to consider the financial strength and debt structure to see if a few bad years would hinder the company’s long term progress.
18. Buy or do not buy the stock on the basis of whether or not the growth meets your objectives and whether the price is reasonable.
19. Understanding the reasons for past sales growth will help you form a good judgement as to the likelihood of past growth rates continuing.
20. Put as much of your money into stock funds as you can. Even if you need income, you will be better off in the long run to own dividend- paying stocks and to occasionally dip into capital as an income substitute.
21. If you must own government bonds, buy them outright from the Treasury and avoid the bond funds, in which you are paying management fees for nothing.
22. When you add money to your portfolio, put it into the fund that’s invested in the sector that has lagged the market for several years.
23. Trying to pick tomorrow’s winning fund based on yesterday’s performance is a difficult if not futile task. Concentrate on solid performers and stick with those. Constantly switching your money from one fund to another is an expensive habit that is harmful to your net worth.
24. Avoid the retailers that expand too fast, especially of they are doing it on borrowed money.
25 Any growth stock that sells for 40 times its earnings for the upcoming year is dangerously high priced. As a rule of thumb, a stock should sell at or below its growth rate.
26. In a retail company or a restaurant chain, the growth that propels earnings and the stock price comes mainly from expansion. As long as the same store sales are on the increase, the company is not crippled by excessive debt, and it is following its expansion plans as described to shareholders in its reports, it usually pays to stick with the stock.
27. Wait until the prevailing opinion about a certain industry is that things have gone from bad to worse, and then buy shares in the strongest companies in the group.
28. When insiders are buying, it is a good sign – unless they happen to be New England bankers.
29. To find the true ‘Book Value’ of any company, look at the Balance Sheet.
– if the inventory can have a decent resale value
– if there is too much merchandise inventory – it may mean that the management is deferring lose by not marking down them quickly. When inventories are allowed to build, this overstates a company’s earnings.
– A hefty accounts payable is OK – it means that the company its bills slowly and keeping the cash working in its favor until the last minute.
– goodwill or intangibles (a company’s acquisition of other companies) – the goodwill is the amount that has been paid for an acquisition above the book value of the actual assets.
– if too much a company’s total assets consisted of goodwill, I would have no confidence in its book value or in its shareholders’ equity.
– Debt equity ratio – if high, cause for concern.
– ideal Debt equity ratio – twice as much equity as debt, the more equity and the less debt the better.
– When is the Debt due? Are the debts owed to banks? Potential dangerous as the bank will ask for its money back.
30. Be on the lookout for great companies in lousy industries. A great industry that is growing too fast attracts too many competitors.
In a lousy industry, one that is growing slowly if at all, the weak drop out and the survivors get a bigger share of the market.
A company that can capture an ever increasing share of a stagnant market is a lot better off than on that to struggle to protect a dwindling share of an exciting market.
31. The greatest companies in lousy industries share certain characteristics.
– low cost operators
– penny pinchers in the executive suite
– avoid going into debt
– reject corporate caste systems that creates white collar Brahmins and the blue collar untouchables
– workers are well paid and have a stake in the companies’ future
– they find niches
32. What you need to know about an S&L (Savings and Loans)
(i) Initial Offering Price
– when the S&L is selling below the price at which it came public, it is a sign that the stock may be undervalued. Other signs must be considered.
(ii) Equity to Assets Ratio
– measures financial strength and ‘survivability’
– the higher the E/A, the better. Because of disaster protection and attractive takeover target.
– E/A of 5.5 to 6 is average. Below 5, dangerous.
– many of them pay better than average dividends
– when one meets all the other criteria and also has high yield, it is a plus
(iv) Book Value
– most of the assets of a bank are in its Loans
– once you ascertain that an S&L has avoided high risk lending, you can begin to have confidence that its book value as reported in the financial statement, is an accurate reflection of the institution’s real worth.
(v) High Risk Real Estate Assets
– be cautious when high risk assets (commercial loans and construction loans) exceed 5 to 10% of total outstanding loans
(vi) 90 Day Non-Performing Assets
– these are the loans that have already defaulted
– so it should be a very low number
(vii) Real Estate Owned (REO)
– the property on which the S&L has already foreclosed
– is an index of yesterday’s problems, because whatever that shows up here has been written off as a loss on the books
– not as worrisome as having a high percentage of Non- Performing Loans
– but it is worrisome when REO is on the rise. S&L are not in the real estate business and you have to assume that the S&L is having trouble getting rid of it.
33. With most stocks, a low P/E ratio is a good thing.
But Not with Cyclicals – it means they are at the end of the prosperous interlude.
Conversely, a high P/E ratio, which most stocks its regarded as a bad thing, may be good news for a Cyclical.
It means that a company is passing through the worst of its doldrums, and soon the business will improve.
34. Useful indicator to buy Auto Stocks is Used Car prices.
When Used Car Dealers lower their prices, it means they are having trouble selling cars, and a lousy market for them is even lousier for the new car dealers. But when used car prices are on the rise, it is a sign of good times ahead for the automakers.
Another useful indicator for Auto Stocks is “Units of Pent up Demand”
– actual car and truck sales vs trend –> the difference gives us the Units of Pent up Demand
– if actual car sales lagged the Trend, then it means to expect a boom in auto sales.
– after 4 or 5 years when sales are under the trend, it takes another 4 or 5 years of sales above the trend before the car market can catch up
35. Corporations, like people, change their names for one of two reasons; either they have gotten married, or they have been involved in some fiasco that they hope the public will forget.
36. Utilities are regulated by the government. A utility may declare bankruptcy and/or eliminate its dividend. But as long as people need electricity, a way must be found for the utility to function.
37. The four stages of a Utility.
– First stage:
– Disaster strikes – the utility is faced with a sudden loss of earnings – the stock suffers
– Second stage:
– “crisis management” – utility tries to survives by cutting capital spending and adopting an austerity budget (e.g cutting dividend)
– Third stage:
– “Financial stabilization” – the utility is not earning anything for its shareholders but survival is no longer in doubt
– the stock price has recovered somewhat
– Fourth stage:
– “recovery at last” – the utility is capable of earning something for the shareholders. Improvement of earnings and reinstatement of the dividend.
– Conclusion: Buy them when the dividend is omitted and hold on to them until the dividend is restored.
38. When the company is deeply indebted, you want it to be a debt that doesn’t have to be paid in full anytime soon.
39. The Six Month Checkup
– is the stock still attractively priced relatively to earnings?
– what is happening in the company to make the earnings go up?
– Conclusion – has the story gotten better? Gotten worse? Story is unchanged?
40. 25 Golden Rules
1. Investing is fun, exciting and dangerous if you don’t do any work
2. Your investor’s edge is not something you get from Wall Street experts. It’s something you already have. You can outperform the experts if you use your edge by investing in companies or industries you already understand.
3. You can beat the market by ignoring the herd.
4. Behind every stock is a company. Find out what it’s doing.
5. Often, there is not correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. In the long term, there is a 100% correlation between the success of the company and the success of its stock. This disparity is the key to making money; it pays to be patient, and to own successful companies.
6. You have to know what you own, and why you own it.
7. Long shots almost always miss the mark.
8. Owning stocks is like having children – don’t get involved with more than you can handle. The part time stock picker probably has time to follow 8 – 12 companies. If don’t have time, there don’t have to be more than 5 companies in the portfolio at any one time.
9. If you can’t find any companies that you think are attractive, put your money in the bank until you discover some.
10. Never invest in a company without understanding its finances. The biggest losses in stocks comes from companies with poor balance sheets. Always look at the balance sheet to see if a company is solvent before you risk your money on it.
11. Avoid hot stocks in hot industries. Great companies in cold, non growth industries are consistent big winners.
12. With small companies, you’re better off to wait until they turn a profit before you invest.
13. If you are thinking about investing in a troubled industry, buy the companies with staying power. Also, wait for industry to show signs of revival. Buggy whips and radio tubes were troubled industries that never came back.
14. If you invest $1000 in a stock, all you can lose is $1000, but you stand to gain $10,000 or even $50,000 if you are patient. The average person can concentrate on a few good companies, while the fund manager is forced to diversify. By owning too many stocks, you lose this advantage of concentration. It only takes a handful of big winners to make a lifetime of investing worthwhile.
15. In every industry and every region of the country, the observant amateur can find great growth companies long before the professional have discovered them.
16. A stock market decline is as routine as a January blizzard in Colorado. If you are prepared, it can’t hurt you. A decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm in panic.
17. Everyone has the brainpower to make money in stocks. Not everyone has the stomach. If you are susceptible to selling everything in a panic, you ought to avoid stocks and stock mutual funds altogether.
18. There is always something to worry about. Avoid weekend thinking and ignore the latest dire predictions of the newscasters. Sell a stock because the company’s fundamentals deteriorate, not because the sky is falling.
19. Nobody can predict the interest rates, the future direction of the economy, or the stock market. Dismiss all such forecasts and concentrate on what’s actually happening to the companies in which you have invested.
20. If you study 10 companies, you will find 1 for which the story is better than expected. If you study 50, you will find 5. There are always pleasant surprises to be found in the stock market – companies whose achievements are being overlooked on Wall Street.
21. If you don’t study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at the cards.
22. Time is on your side when you own shares of superior companies. You can afford to be patient – even if you missed Walmart in the first five years, it was a great stock to own in the next five years. Time is against you when you own options.
23. If you have the stomach for stocks, but neither the time nor the inclination to do the homework, invest in equity mutual funds. Here, it’s a good idea to diversify. You should own a few different kind of funds, with managers who pursue different styles of investing: growth, value, small companies, large companies, etc. Investing in six of the same kind of fund is not diversification.
The capital-gains tax penalizes those who do too much switching from one mutual fund to another. If you have invested in one fund or several funds that have done well, don’t abandon them capriciously. Stick with them.
24. Among the major stock markets of the world, the US market ranks eighth in total return over the past decade. You can take advantage of the faster growing economies by investing some portion of your assets in an overseas fund with a good record.
25. In the long run, a portfolio of well chosen stock and/or equity mutual funds will always outperform a portfolio of bonds or a money-market account. In the long run, a portfolio of poorly chosen stocks won’t outperform the money left under the mattress.