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122 reviews for:
One Up on Wall Street: How to Use what You Already Know to Make Money in the Market
John Rothchild, Peter Lynch
4.06 AVERAGE
122 reviews for:
One Up on Wall Street: How to Use what You Already Know to Make Money in the Market
John Rothchild, Peter Lynch
4.06 AVERAGE
informative
slow-paced
More a funny take on markets and baby steps of looking at stocks rather than a die hard investment book.
informative
medium-paced
informative
inspiring
For anyone looking to start investing in the stock market, One Up On Wall Street is a great book to start with. Peter Lynch wrote in a way that made complex concepts relatable to the average reader. Although I had some knowledge of terms and concepts prior to starting the book, I feel that anyone who started reading would find it an easy read.
It is interesting to see how even though the book was published towards the end of the 1980s, most of the principles and concepts Lynch outlines are still mostly relevant in 2020.
It is interesting to see how even though the book was published towards the end of the 1980s, most of the principles and concepts Lynch outlines are still mostly relevant in 2020.
[Audiobook] Simple and straightforward. My annual book. I keep on coming back to his simple methodology whenever I'm overwhelmed with too much analysis.
I read this book a while ago, but I still use it for advice on investing. The book is old these days, and Lynch was lucky enough to live through one of best bull markets of the past 100 years, but his advice is still good because it's basic and simple. Look at the numbers, don't get carried away by fads or news, invest in what you know.
Peter Lynch’s One Up on Wall Street offers a contrarian view that by using an edge in your field and consumer habits along with fundamental analysis an individual has the freedom (unlike fund managers, etc.) to pick riskier, smaller companies that have a proven track record of good growth in mundane, out of fashion industries and good future prospects; in doing this one can beat both the market and professional traders and should aim for 12-15% annual returns for the work required.
To me, this barrage of price tags sends the wrong message. If my favorite Internet company sells for $30 a share, and yours sells for $10, then people who focus on price would say that mine is the superior company. This is a dangerous delusion. What Mr. Market pays for a stock today or next week doesn't tell you which company has the best chance to succeed two to three years down the information superhigh way. If you can follow only one bit of data, follow the earnings-assuming the company in question has earnings. As you'll see in this text, I subscribe to the crusty notion that sooner or later earnings make or break an investment in equities. What the stock price does today, to morrow, or next week is only a distraction.
My clunkers remind me of an important point: You don't need to make money on every stock you pick. In my experience, six out of ten winners in a portfolio can produce a satisfying result. Why is this? Your losses are limited to the amount you invest in each stock (it can't go lower than zero), while your gains have no absolute limit. In vest $1,000 in a clunker and in the worst case, maybe you lose $1,000. Invest $1,000 in a high achiever, and you could make $10,000, $15,000, $20,000, and beyond over several years. All you need for a lifetime of successful investing is a few big winners, and the pluses from those will overwhelm the minuses from the stocks that don't work out.
Whoever imagines that the average Wall Street professional is looking for reasons to buy exciting stocks hasn't spent much time on Wall Street. The fund manager most likely is looking for reasons not to buy exciting stocks, so that he can offer the proper excuses if those exciting stocks happen to go up. "It was too small for me to buy" heads a long list, followed by "there was no track record," "it was in a nongrowth industry," "unproven management," "the employees belong to a union,” and "the competition will kill them.” These may be reasonable concerns that merit investigation, but often they're used to fortify snap judgments and wholesale taboos.
In fact, between the chance of making an unusually large profit on an unknown company and the assurance of losing only a small amount on an established company, the normal mutual-fund manager, pension-fund manager, or corporate portfolio manager would jump at the latter. Success is one thing, but it's more important not to look bad if you fail. There's an unwritten rule on Wall Street: "You'll never lose your job losing your client's money in IBM."
If it's not the bank or the mutual fund making up rules, then it's the SEC. For instance, the SEC says a mutual fund such as mine cannot own more than ten percent of the shares in any given company, nor can we invest more than five percent of the fund's assets in any given stock. The various restrictions are well-intentioned, and they protect against a fund's putting all its eggs in one basket (more on this later) and also against a fund's taking over a company à la Carl Icahn (more on that later, too). The secondary result is that the bigger funds are forced to limit themselves to the top 90 to 100 companies, out of the 10,000 or so that are publicly traded. Let's say you manage a $1-billion pension fund, and to guard against diverse performance, you're required to choose from a list of 40 ap proved stocks, via the Inspected by 4 method. Since you're only al lowed to invest five percent of your total stake in each stock, you've got to buy at least 20 stocks, with $50 million in each. The most you can have is 40 stocks, with $25 million in each. In that case you have to find companies where $25 million will buy less than ten percent of the outstanding shares. That cuts out a lot of opportunities, especially in the small fast-growing enterprises that tend to be the tenbaggers.
The stocks I try to buy are the very stocks that traditional fund managers try to overlook. In other words, I continue to think like an amateur as frequently as possible.
By asking some basic questions about companies, you can learn which are likely to grow and prosper, which are unlikely to grow and prosper, and which are entirely mysterious. You can never be certain what will happen, but each new occurrence-a jump in earnings, the sale of an unprofitable subsidiary, the expansion into new markets-is like turning up another card. As long as the cards suggest favorable odds of success, you stay in the hand.
Anyone who plays regularly in a monthly stud poker game soon realizes that the same "lucky stiffs" always come out ahead. These are the players who undertake to maximize their return on investment by carefully calculating and recalculating their chances as the hand unfolds. Consistent winners raise their bet as their position strengthens, and they exit the game when the odds are against them, while consistent losers hang on to the bitter end of every expensive pot, hoping for mir acles and enjoying the thrill of defeat. In stud poker and on Wall Street, miracles happen just often enough to keep the losers losing.
There's no point in studying the financial section until you've looked into the nearest mirror. Before you buy a share of anything, there are three personal issues that ought to be addressed: (1) Do I own a house? (2) Do I need the money? and (3) Do I have the personal qualities that will bring me success in stocks? Whether stocks make good or bad investments depends more on your responses to these three questions than on anything you'll read in The Wall Street Journal.
It's no accident that people who are geniuses in their houses are idiots in their stocks. A house is entirely rigged in the homeowner's favor. The banks let you acquire it for 20 percent down and in some cases less, giving you the remarkable power of leverage. (True, you can buy stocks with 50 percent cash down, which is known in the trade as "buying on margin," but every time a stock bought on margin drops in price, you have to put up more cash. That doesn't happen with a house. You never have to put up more cash if the market value goes down, even if the house is located in the depressed oil patch. The real estate agent never calls at midnight to announce: "You'll have to come up with twenty thousand dollars by eleven A.M. tomorrow or else sell off two bedrooms," which frequently happens to stockholders forced to sell their shares bought on margin. This is another great advantage to owning a house.)
Because of leverage, if you buy a $100,000 house for 20 percent down and the value of the house increases by five percent a year, you are making a 25 percent return on your down payment, and the interest on the loan is tax-deductible. Do that well in the stock market and eventually you'd be worth more than Boone Pickens.
But this time it's to tell me what stocks I should buy. Even the dentist has three or four tips, and in the next few days I look up his recommendations in the newspaper and they've all gone up. When the neighbors tell me what to buy and then I wish I had taken their advice, it's a sure sign that the market has reached a top and is due for a tumble.
I could go on for the rest of the book about the edge that being in a business gives the average stockpicker. On top of that, there's the consumer's edge that's helpful in picking out the winners from the newer and smaller fast-growing companies, especially in the retail trades. Whichever edge applies, the exciting part is that you can develop your own stock detection system outside the normal channels of Wall Street, where you'll always get the news late.
However a stock has come to your attention, whether via the office, the shopping mall, something you ate, something you bought, or something you heard from your broker, your mother-in law, or even from Ivan Boesky's parole officer, the discovery is not a buy signal. Just because Dunkin' Donuts is always crowded or Reynolds Metals has more aluminum orders than it can handle doesn't mean you ought to own the stock. Not yet. What you've got so far is simply a lead to a story that has to be developed.
These are among my favorite investments: small, aggressive new enterprises that grow at 20 to 25 percent a year. If you choose wisely, this is the land of the 10- to 40-baggers, and even the 200-baggers. With a small portfolio, one or two of these can make a career. A fast-growing company doesn't necessarily have to belong to a fast growing industry. As a matter of fact, I'd rather it didn't, as you'll see in Chapter 8. All it needs is the room to expand within a slow-growing industry. Beer is a slow-growing industry, but Anheuser-Busch has been a fast grower by taking over market share, and enticing drinkers of rival brands to switch to theirs.
So while the smaller fast growers risk extinction, the larger fast growers risk a rapid devaluation when they begin to falter. Once a fast grower gets too big, it faces the same dilemma as Gulliver in Lilliput. There's simply no place for it to stretch out. But for as long as they can keep it up, fast growers are the big winners in the stock market. I look for the ones that have good balance sheets and are making substantial profits. The trick is figuring out when they'll stop growing, and how much to pay for the growth.
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 you work in some profession that's connected to steel, aluminum, airlines, automobiles, etc., then you've got your edge, and nowhere is it more impor tant than in this kind of investment.
Are you looking for slow growth, fast growth, recession protection, a turnaround, a cyclical bounce, or assets? Basing a strategy on general maxims, such as "Sell when you double your money," "Sell after two years," or "Cut your losses by selling when the price falls ten percent," is absolute folly. It's simply impossible to find a generic formula that sensibly applies to all the different kinds of stocks.
There's nothing thrilling about a thrilling high-growth industry, except watching the stocks go down. That's because for every single product in a hot industry, there are a thousand MIT graduates trying to figure out how to make it cheaper in Taiwan. As soon as a computer company designs the best word-processor in the world, ten other competitors are spending $100 million to design a better one, and it will be on the market in eight months. This doesn't happen with bottle caps, coupon clipping services, oil-drum retrieval, or motel chains.
If a company must acquire something, I'd prefer it to be a related business, but acquisitions in general make me nervous. There's a strong tendency for companies that are flush with cash and feeling powerful to overpay for acquisitions, expect too much from them, and then mismanage them. I'd rather see a vigorous buyback of shares, which is the purest synergy of all.
People may bet on the hourly wiggles in the market, but it's the earnings that waggle the wiggles, long term. Now and then you'll find an exception, but if you examine the charts of stocks you own, you'll likely see the relationship I'm describing.
Already you've found out whether you're dealing with a slow grower, a stalwart, a fast grower, a turnaround, an asset play, or a cyclical. The p/e ratio has given you a rough idea of whether the stock, as currently priced, is undervalued or overvalued relative to its immediate prospects. The next step is to learn as much as possible about what the company is doing to bring about the added prosperity the growth spurt, or whatever happy event is expected to occur. This is known as the "story."
I continue to eat sandwiches from Bildner's, and every time I take a bite of one it reminds me of what I did wrong. I didn't wait to see if this good idea from the neighborhood would actually succeed someplace else. Successful cloning is what turns a local taco joint into a Taco Bell or a local clothing store into The Limited, but there's no point buying the stock until the company has proven that the cloning works.
Although there are various drawbacks to being a fund manager, there's the advantage that companies will talk to us-several times a week if we'd like. Chair men, presidents, vice presidents, and analysts fill me in on capital spending, expansion plans, cost-cutting programs, and anything else that's relevant to future results. On the other hand, I can't imagine anything that's useful to know that the amateur investor can't find out. All the pertinent facts are just waiting to be picked up.
The p/e ratio of any company that's fairly priced will equal its growth rate. I'm talking about growth rate of earnings here. In general, a p/e ratio that's half the growth rate is very positive, and one that's twice the growth rate is very negative. We use this measure all the time in analyzing stocks for the mutual funds. (you can figure it out for yourself by taking the annual earnings from Value Line or an S&P report and calculating the percent increase in earnings from one year to the next.)
In a survey I once saw, college students and other young adults were asked to guess the average profit margin on the corporate dollar. Most guessed 20-40 percent. In the last few decades the actual answer has been closer to 5 percent.
What follows is a summary of the things you'd like to learn about stocks in each of the six categories: The p/e ratio. Is it high or low for this particular company and for similar companies in the same industry. • The percentage of institutional ownership. The lower the better. • Whether insiders are buying and whether the company itself is buying back its own shares. Both are positive signs.• The record of earnings growth to date and whether the earnings are sporadic or consistent. (The only category where earnings may not be important is in the asset play.) Whether the company has a strong balance sheet or a weak balance sheet (debt-to-equity ratio) and how it's rated for financial strength. The cash position. With $16 in net cash, I know Ford is unlikely to drop below $16 a share. That's the floor on the stock. What the growth rate in earnings has been in recent years. (My favorites are the ones in the 20 to 25 percent range. I'm wary of companies that seem to be growing faster than 25 percent. Those 50 per centers usually are found in hot industries, and you know what that means.) That the company has duplicated its successes in more than one city or town, to prove that expansion will work. • That the company still has room to grow. Distrust diversifications, which usually turn out to be diworseifications. Long shots almost never pay off. 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. Some stock tips, especially from an expert in the field, may turn out to be quite valuable. However, people in the paper industry normally give out tips on drug stocks, and people in the health care field never run out of tips on the coming takeovers in the paper industry. • Invest in simple companies that appear dull, mundane, out of favor, and haven't caught the fancy of Wall Street. Moderately fast growers (20 to 25 percent) in nongrowth industries are ideal investments.
That this return can be achieved without your having to do any homework or spending any extra money is a useful benchmark against which you can measure your own performance, and also the performance of the managed equity funds such as Magellan. Given all these convenient alternatives, to be able to say that picking your own stocks is worth the effort, you ought to be getting a 12-15 percent return, compounded over time.
In my view it's best to own as many stocks as there are situations in which: (a) you've got an edge; and (b) you've uncovered an exciting prospect that passes all the tests of research. Maybe that's a single stock, or maybe it's a dozen stocks.
Going into cash would be getting out of the market. My idea is to stay in the market forever, and to rotate stocks depending on the fundamental situations.
better strategy, it seems to me, is to rotate in and out of stocks de pending on what has happened to the price as it relates to the story. For instance, if a stalwart has gone up 40 percent-which is all I expected to get out of it-and nothing wonderful has happened with the company to make me think there are pleasant surprises ahead, I sell the stock and replace it with another stalwart
If you have a list of companies that you'd like to own if only the stock price were reduced, the end of the year is a likely time to find the deals you've been waiting for. The second is during the collapses, drops, burps, hiccups, and freefalls that occur in the stock market every few years.
The point is, there's no arbitrary limit to how high a stock can go, and if the story is still good, the earnings continue to improve, and the fundamentals haven't changed, "can't go much higher" is a terrible reason to snub a stock. Shame on all those experts who advise clients to sell automatically after they double their money. You'll never get a tenbagger doing that.
In most cases it's better to buy the original good company at a high price than it is to jump on the "next one" at a bargain price.
So when people say, "Look, in two months it's up 20 percent, so I re ally picked a winner," or "Terrible, in two months it's down 20 percent, so I really picked a loser," they're confusing prices with prospects. Un less they are short-term traders who are looking for 20-percent gains, the short-term fanfare means absolutely nothing. A stock's going up or down after you buy it only tells you that there was somebody who was willing to pay more or less for the identical merchandise.
Actually I do know a few things about options. I know that the large potential return is attractive to many small investors who are dissatisfied with getting rich slow. Instead, they opt for getting poor quick. That's because an option is a contract that's only good for a month or two, and unlike most stocks, it regularly expires worthless
To me, this barrage of price tags sends the wrong message. If my favorite Internet company sells for $30 a share, and yours sells for $10, then people who focus on price would say that mine is the superior company. This is a dangerous delusion. What Mr. Market pays for a stock today or next week doesn't tell you which company has the best chance to succeed two to three years down the information superhigh way. If you can follow only one bit of data, follow the earnings-assuming the company in question has earnings. As you'll see in this text, I subscribe to the crusty notion that sooner or later earnings make or break an investment in equities. What the stock price does today, to morrow, or next week is only a distraction.
My clunkers remind me of an important point: You don't need to make money on every stock you pick. In my experience, six out of ten winners in a portfolio can produce a satisfying result. Why is this? Your losses are limited to the amount you invest in each stock (it can't go lower than zero), while your gains have no absolute limit. In vest $1,000 in a clunker and in the worst case, maybe you lose $1,000. Invest $1,000 in a high achiever, and you could make $10,000, $15,000, $20,000, and beyond over several years. All you need for a lifetime of successful investing is a few big winners, and the pluses from those will overwhelm the minuses from the stocks that don't work out.
Whoever imagines that the average Wall Street professional is looking for reasons to buy exciting stocks hasn't spent much time on Wall Street. The fund manager most likely is looking for reasons not to buy exciting stocks, so that he can offer the proper excuses if those exciting stocks happen to go up. "It was too small for me to buy" heads a long list, followed by "there was no track record," "it was in a nongrowth industry," "unproven management," "the employees belong to a union,” and "the competition will kill them.” These may be reasonable concerns that merit investigation, but often they're used to fortify snap judgments and wholesale taboos.
In fact, between the chance of making an unusually large profit on an unknown company and the assurance of losing only a small amount on an established company, the normal mutual-fund manager, pension-fund manager, or corporate portfolio manager would jump at the latter. Success is one thing, but it's more important not to look bad if you fail. There's an unwritten rule on Wall Street: "You'll never lose your job losing your client's money in IBM."
If it's not the bank or the mutual fund making up rules, then it's the SEC. For instance, the SEC says a mutual fund such as mine cannot own more than ten percent of the shares in any given company, nor can we invest more than five percent of the fund's assets in any given stock. The various restrictions are well-intentioned, and they protect against a fund's putting all its eggs in one basket (more on this later) and also against a fund's taking over a company à la Carl Icahn (more on that later, too). The secondary result is that the bigger funds are forced to limit themselves to the top 90 to 100 companies, out of the 10,000 or so that are publicly traded. Let's say you manage a $1-billion pension fund, and to guard against diverse performance, you're required to choose from a list of 40 ap proved stocks, via the Inspected by 4 method. Since you're only al lowed to invest five percent of your total stake in each stock, you've got to buy at least 20 stocks, with $50 million in each. The most you can have is 40 stocks, with $25 million in each. In that case you have to find companies where $25 million will buy less than ten percent of the outstanding shares. That cuts out a lot of opportunities, especially in the small fast-growing enterprises that tend to be the tenbaggers.
The stocks I try to buy are the very stocks that traditional fund managers try to overlook. In other words, I continue to think like an amateur as frequently as possible.
By asking some basic questions about companies, you can learn which are likely to grow and prosper, which are unlikely to grow and prosper, and which are entirely mysterious. You can never be certain what will happen, but each new occurrence-a jump in earnings, the sale of an unprofitable subsidiary, the expansion into new markets-is like turning up another card. As long as the cards suggest favorable odds of success, you stay in the hand.
Anyone who plays regularly in a monthly stud poker game soon realizes that the same "lucky stiffs" always come out ahead. These are the players who undertake to maximize their return on investment by carefully calculating and recalculating their chances as the hand unfolds. Consistent winners raise their bet as their position strengthens, and they exit the game when the odds are against them, while consistent losers hang on to the bitter end of every expensive pot, hoping for mir acles and enjoying the thrill of defeat. In stud poker and on Wall Street, miracles happen just often enough to keep the losers losing.
There's no point in studying the financial section until you've looked into the nearest mirror. Before you buy a share of anything, there are three personal issues that ought to be addressed: (1) Do I own a house? (2) Do I need the money? and (3) Do I have the personal qualities that will bring me success in stocks? Whether stocks make good or bad investments depends more on your responses to these three questions than on anything you'll read in The Wall Street Journal.
It's no accident that people who are geniuses in their houses are idiots in their stocks. A house is entirely rigged in the homeowner's favor. The banks let you acquire it for 20 percent down and in some cases less, giving you the remarkable power of leverage. (True, you can buy stocks with 50 percent cash down, which is known in the trade as "buying on margin," but every time a stock bought on margin drops in price, you have to put up more cash. That doesn't happen with a house. You never have to put up more cash if the market value goes down, even if the house is located in the depressed oil patch. The real estate agent never calls at midnight to announce: "You'll have to come up with twenty thousand dollars by eleven A.M. tomorrow or else sell off two bedrooms," which frequently happens to stockholders forced to sell their shares bought on margin. This is another great advantage to owning a house.)
Because of leverage, if you buy a $100,000 house for 20 percent down and the value of the house increases by five percent a year, you are making a 25 percent return on your down payment, and the interest on the loan is tax-deductible. Do that well in the stock market and eventually you'd be worth more than Boone Pickens.
But this time it's to tell me what stocks I should buy. Even the dentist has three or four tips, and in the next few days I look up his recommendations in the newspaper and they've all gone up. When the neighbors tell me what to buy and then I wish I had taken their advice, it's a sure sign that the market has reached a top and is due for a tumble.
I could go on for the rest of the book about the edge that being in a business gives the average stockpicker. On top of that, there's the consumer's edge that's helpful in picking out the winners from the newer and smaller fast-growing companies, especially in the retail trades. Whichever edge applies, the exciting part is that you can develop your own stock detection system outside the normal channels of Wall Street, where you'll always get the news late.
However a stock has come to your attention, whether via the office, the shopping mall, something you ate, something you bought, or something you heard from your broker, your mother-in law, or even from Ivan Boesky's parole officer, the discovery is not a buy signal. Just because Dunkin' Donuts is always crowded or Reynolds Metals has more aluminum orders than it can handle doesn't mean you ought to own the stock. Not yet. What you've got so far is simply a lead to a story that has to be developed.
These are among my favorite investments: small, aggressive new enterprises that grow at 20 to 25 percent a year. If you choose wisely, this is the land of the 10- to 40-baggers, and even the 200-baggers. With a small portfolio, one or two of these can make a career. A fast-growing company doesn't necessarily have to belong to a fast growing industry. As a matter of fact, I'd rather it didn't, as you'll see in Chapter 8. All it needs is the room to expand within a slow-growing industry. Beer is a slow-growing industry, but Anheuser-Busch has been a fast grower by taking over market share, and enticing drinkers of rival brands to switch to theirs.
So while the smaller fast growers risk extinction, the larger fast growers risk a rapid devaluation when they begin to falter. Once a fast grower gets too big, it faces the same dilemma as Gulliver in Lilliput. There's simply no place for it to stretch out. But for as long as they can keep it up, fast growers are the big winners in the stock market. I look for the ones that have good balance sheets and are making substantial profits. The trick is figuring out when they'll stop growing, and how much to pay for the growth.
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 you work in some profession that's connected to steel, aluminum, airlines, automobiles, etc., then you've got your edge, and nowhere is it more impor tant than in this kind of investment.
Are you looking for slow growth, fast growth, recession protection, a turnaround, a cyclical bounce, or assets? Basing a strategy on general maxims, such as "Sell when you double your money," "Sell after two years," or "Cut your losses by selling when the price falls ten percent," is absolute folly. It's simply impossible to find a generic formula that sensibly applies to all the different kinds of stocks.
There's nothing thrilling about a thrilling high-growth industry, except watching the stocks go down. That's because for every single product in a hot industry, there are a thousand MIT graduates trying to figure out how to make it cheaper in Taiwan. As soon as a computer company designs the best word-processor in the world, ten other competitors are spending $100 million to design a better one, and it will be on the market in eight months. This doesn't happen with bottle caps, coupon clipping services, oil-drum retrieval, or motel chains.
If a company must acquire something, I'd prefer it to be a related business, but acquisitions in general make me nervous. There's a strong tendency for companies that are flush with cash and feeling powerful to overpay for acquisitions, expect too much from them, and then mismanage them. I'd rather see a vigorous buyback of shares, which is the purest synergy of all.
People may bet on the hourly wiggles in the market, but it's the earnings that waggle the wiggles, long term. Now and then you'll find an exception, but if you examine the charts of stocks you own, you'll likely see the relationship I'm describing.
Already you've found out whether you're dealing with a slow grower, a stalwart, a fast grower, a turnaround, an asset play, or a cyclical. The p/e ratio has given you a rough idea of whether the stock, as currently priced, is undervalued or overvalued relative to its immediate prospects. The next step is to learn as much as possible about what the company is doing to bring about the added prosperity the growth spurt, or whatever happy event is expected to occur. This is known as the "story."
I continue to eat sandwiches from Bildner's, and every time I take a bite of one it reminds me of what I did wrong. I didn't wait to see if this good idea from the neighborhood would actually succeed someplace else. Successful cloning is what turns a local taco joint into a Taco Bell or a local clothing store into The Limited, but there's no point buying the stock until the company has proven that the cloning works.
Although there are various drawbacks to being a fund manager, there's the advantage that companies will talk to us-several times a week if we'd like. Chair men, presidents, vice presidents, and analysts fill me in on capital spending, expansion plans, cost-cutting programs, and anything else that's relevant to future results. On the other hand, I can't imagine anything that's useful to know that the amateur investor can't find out. All the pertinent facts are just waiting to be picked up.
The p/e ratio of any company that's fairly priced will equal its growth rate. I'm talking about growth rate of earnings here. In general, a p/e ratio that's half the growth rate is very positive, and one that's twice the growth rate is very negative. We use this measure all the time in analyzing stocks for the mutual funds. (you can figure it out for yourself by taking the annual earnings from Value Line or an S&P report and calculating the percent increase in earnings from one year to the next.)
In a survey I once saw, college students and other young adults were asked to guess the average profit margin on the corporate dollar. Most guessed 20-40 percent. In the last few decades the actual answer has been closer to 5 percent.
What follows is a summary of the things you'd like to learn about stocks in each of the six categories: The p/e ratio. Is it high or low for this particular company and for similar companies in the same industry. • The percentage of institutional ownership. The lower the better. • Whether insiders are buying and whether the company itself is buying back its own shares. Both are positive signs.• The record of earnings growth to date and whether the earnings are sporadic or consistent. (The only category where earnings may not be important is in the asset play.) Whether the company has a strong balance sheet or a weak balance sheet (debt-to-equity ratio) and how it's rated for financial strength. The cash position. With $16 in net cash, I know Ford is unlikely to drop below $16 a share. That's the floor on the stock. What the growth rate in earnings has been in recent years. (My favorites are the ones in the 20 to 25 percent range. I'm wary of companies that seem to be growing faster than 25 percent. Those 50 per centers usually are found in hot industries, and you know what that means.) That the company has duplicated its successes in more than one city or town, to prove that expansion will work. • That the company still has room to grow. Distrust diversifications, which usually turn out to be diworseifications. Long shots almost never pay off. 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. Some stock tips, especially from an expert in the field, may turn out to be quite valuable. However, people in the paper industry normally give out tips on drug stocks, and people in the health care field never run out of tips on the coming takeovers in the paper industry. • Invest in simple companies that appear dull, mundane, out of favor, and haven't caught the fancy of Wall Street. Moderately fast growers (20 to 25 percent) in nongrowth industries are ideal investments.
That this return can be achieved without your having to do any homework or spending any extra money is a useful benchmark against which you can measure your own performance, and also the performance of the managed equity funds such as Magellan. Given all these convenient alternatives, to be able to say that picking your own stocks is worth the effort, you ought to be getting a 12-15 percent return, compounded over time.
In my view it's best to own as many stocks as there are situations in which: (a) you've got an edge; and (b) you've uncovered an exciting prospect that passes all the tests of research. Maybe that's a single stock, or maybe it's a dozen stocks.
Going into cash would be getting out of the market. My idea is to stay in the market forever, and to rotate stocks depending on the fundamental situations.
better strategy, it seems to me, is to rotate in and out of stocks de pending on what has happened to the price as it relates to the story. For instance, if a stalwart has gone up 40 percent-which is all I expected to get out of it-and nothing wonderful has happened with the company to make me think there are pleasant surprises ahead, I sell the stock and replace it with another stalwart
If you have a list of companies that you'd like to own if only the stock price were reduced, the end of the year is a likely time to find the deals you've been waiting for. The second is during the collapses, drops, burps, hiccups, and freefalls that occur in the stock market every few years.
The point is, there's no arbitrary limit to how high a stock can go, and if the story is still good, the earnings continue to improve, and the fundamentals haven't changed, "can't go much higher" is a terrible reason to snub a stock. Shame on all those experts who advise clients to sell automatically after they double their money. You'll never get a tenbagger doing that.
In most cases it's better to buy the original good company at a high price than it is to jump on the "next one" at a bargain price.
So when people say, "Look, in two months it's up 20 percent, so I re ally picked a winner," or "Terrible, in two months it's down 20 percent, so I really picked a loser," they're confusing prices with prospects. Un less they are short-term traders who are looking for 20-percent gains, the short-term fanfare means absolutely nothing. A stock's going up or down after you buy it only tells you that there was somebody who was willing to pay more or less for the identical merchandise.
Actually I do know a few things about options. I know that the large potential return is attractive to many small investors who are dissatisfied with getting rich slow. Instead, they opt for getting poor quick. That's because an option is a contract that's only good for a month or two, and unlike most stocks, it regularly expires worthless
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