DR.
PETE'S HOME PAGE
Peter Lynch’s approach is strictly bottom-up, with selection from among companies with which the investor is familiar, and then
Courses through fundamental analysis that emphasizes a thorough understanding of the company, its prospects, its competitive
environment, and whether the stock can be purchased at a reasonable price. His basic strategy is detailed in his best-selling book
Business "One Up on Wall Street" [Penguin Books paperback, 1989], which provides individual investors with numerous guidelines for
Finance (300) adapting and implementing his approach. His most recent book, "Beating the Street" [Fireside/Simon & Schuster paperback,
1994], amplifies the theme of his first book, providing examples of his approach to specific companies and industries in which he
Investment has invested. These are the primary sources for this article.
Principles (350)
The Philosophy: Invest in What You Know
Security
Analysis (450) Lynch is a "story" investor. That is, each stock selection is based on a well-grounded expectation concerning the firm’s growth
prospects. The expectations are derived from the company’s "story"--what it is that the company is going to do, or what it is that
Seminar in is going to happen, to bring about the desired results.
Investments
(650) The more familiar you are with a company, and the better you understand its business and competitive environment, the better
your chances of finding a good "story" that will actually come true. For this reason, Lynch is a strong advocate of investing in
Student- companies with which one is familiar, or whose products or services are relatively easy to understand. Thus, Lynch says he
Managed would rather invest in "pantyhose rather than communications satellites," and "motel chains rather than fiber optics."
Investment
Fund (SMIF) Lynch does not believe in restricting investments to any one type of stock. His "story" approach, in fact, suggests the opposite,
with investments in firms with various reasons for favorable expectations. In general, however, he tends to favor small,
Virtual Stock moderately fast-growing companies that can be bought at a reasonable price.
Exchange
Selection Process
Philosophies of
Lynch’s bottom-up approach means that prospective stocks must be picked one-by-one and then thoroughly investigated--there is
some Master no formula or screen that will produce a list of prospective "good stories." Instead, Lynch suggests that investors keep alert for
Investors possibilities based on their own experiences--for instance, within their own business or trade, or as consumers of products.
Research The next step is to familiarize yourself thoroughly with the company so that you can form reasonable expectations concerning the
future. However, Lynch does not believe that investors can predict actual growth rates, and he is skeptical of analysts’ earnings
My dissertation estimates.
Instead, he suggests that you examine the company’s plans--how does it intend to increase its earnings, and how are those
Other intentions actually being fulfilled? Lynch points out five ways in which a company can increase earnings: It can reduce costs;
raise prices; expand into new markets; sell more in old markets; or revitalize, close, or sell a losing operation. The company’s
CSULB plan to increase earnings and its ability to fulfill that plan are its "story," and the more familiar you are with the firm or industry,
the better edge you have in evaluating the company’s plan, abilities, and any potential pitfalls.
CBA
Categorizing a company, according to Lynch, can help you develop the "story" line, and thus come up with reasonable
Department of expectations. He suggests first categorizing a company by size. Large companies cannot be expected to grow as quickly as
Finance, Real smaller companies.
Estate, and Law
Next, he suggests categorizing a company by "story" type, and he identifies six:
Virginia Tech
Slow Growers: Large and aging companies expected to grow only slightly faster than the U.S. economy as a whole, but
Roanoke often paying large regular dividends. These are not among his favorites.
College Stalwarts: Large companies that are still able to grow, with annual earnings growth rates of around 10% to 12%; examples
include Coca-Cola, Procter & Gamble, and Bristol-Myers. If purchased at a good price, Lynch says he expects good but
Personal not enormous returns--certainly no more than 50% in two years and possibly less. Lynch suggests rotating among the
companies, selling when moderate gains are reached, and repeating the process with others that haven’t yet appreciated.
Family pictures These firms also offer downside protection during recessions.
and links Fast-Growers: Small, aggressive new firms with annual earnings growth of 20% to 25% a year. These do not have to be in
fast-growing industries, and in fact Lynch prefers those that are not. Fast-growers are among Lynch’s favorites, and he says
that an investor’s biggest gains will come from this type of stock. However, they also carry considerable risk.
Cyclicals: Companies in which sales and profits tend to rise and fall in somewhat predictable patterns based on the
economic cycle; examples include companies in the auto industry, airlines and steel. Lynch warns that these firms can be
mistaken for stalwarts by inexperienced investors, but share prices of cyclicals can drop dramatically during hard times.
Thus, timing is crucial when investing in these firms, and Lynch says that investors must learn to detect the early signs that
business is starting to turn down.
Turnarounds: Companies that have been battered down or depressed--Lynch calls these "no-growers"; his examples include
Chrysler, Penn Central and General Public Utilities (owner of Three Mile Island). The stocks of successful turnarounds can
move back up quickly, and Lynch points out that of all the categories, these upturns are least related to the general market.
Asset opportunities: Companies that have assets that Wall Street analysts and others have overlooked. Lynch points to
several general areas where asset plays can often be found--metals and oil, newspapers and TV stations, and patented
drugs. However, finding these hidden assets requires a real working knowledge of the company that owns the assets, and
Lynch points out that within this category, the "local" edge--your own knowledge and experience--can be used to greatest
advantage.
