Peter Lynch’s “One Up On Wall Street” talks extensively about what kind of stocks to pick. In general, Peter believes that larger companies tend to make smaller moves and vice versa. So when you spot what he called a ‘ten bagger’, or stocks that have increased tenfold in value, it’s more likely to happen in a smaller company with a market capitalization of, say, less than $10 billion. .
Peter Lynch also divided companies into six general categories, which each have their own unique characteristics. Based on these six categories, investors will be able to know the reason why they invest in said companies and, consequently, the expected return in each type of company. The six general categories are: slow growth, stalwarts, fast growth, cyclicals, asset plays, and turnarounds.
slow growers – As its name indicates, this is the type of company that grows slowly, barely above the national Gross Domestic Product. Slow growth exists for two reasons. First, they expanded rapidly during their first few years and had either saturated the market or second, they did not take full advantage of their opportunities. The book names utility companies as slow growing. However, during the period 1950-1970, they grow rapidly. As the consumption of electricity increased (people installed air conditioners, electric heaters, refrigerators, etc.), the energy consumption increased and thus its growth rates. That no longer happens. Therefore, a company will inevitably become slow growth. A fast grower of the past will be a slow grower of tomorrow. Examples of industries in this category include: rail, aluminum, steel, chemicals, soft drinks.
unconditional- These are not fast growing, and yet they grow faster than the slow growing ones. Most of the stalwarts are large companies with high cash flow production. Due to his huge size, the stalwarts don’t move much and Peter always tries to make a profit whenever he has gone up 30-50% in value in a short period of time. Some stalwarts include: Procter & Gamble, General Electric, Bristol Myers, and Kellogg.
fast growers- The name says it all. These categories are for companies that have high growth rates. This is where the potential of the ten baggers lies. Another five categories won’t give you as many chances to find your next ten baggers. Fast Growers does not necessarily belong to the fast growing industry. You may be growing fast in a slow growing industry. For example: WalMart in the boring retail industry, Marriott in the 2% growing hotel business, Anheuser-Busch in a slow growing beer market, or Taco Bell in a not so fast fast food industry. However, there is great risk in investing in fast-growing producers. The trick is to calculate how much to pay for them and when they will stop growing because in the end, the party comes to an end.
cyclical – Not all companies can make a profit consistently all the time every time. Typically, cyclical benefits rise and fall in a predictable manner and, in most cases, move with the economy. Businesses that can be considered cyclical are: airlines, automobiles, defense companies, or even chip industries. For defense companies, it’s cyclical not with respect to the economy but rather with White House policy. For chip industries, it is cyclical with the computer upgrade cycle. Timing is everything in cyclicals. Unlike other categories, Peter avoids cyclicals trading at a low P/E, which usually means the cycle is currently at its peak. While this rule of thumb doesn’t work 100%, it works quite well to avoid choosing cyclical companies that fall further down.
Deliveries – These are high risk, high reward prepositions. In general, there are specific problems that affect the company. Also, if the company doesn’t fix this particular problem, it will likely end up in bankruptcy court. Despite this, there are several compelling reasons to invest in a radical change. One, of course, is the reward. Once the issue is fixed and resolved, the share price will rise sharply to trade in line with peer valuation. The other beneficial factor of investing in a trend reversal is that it is less likely to be affected by the general condition of the market. The market goes up, the exchange can stay down and vice versa. A recent example of a turnaround might be Altria (MO) in the early 2000s. Facing millions upon billions of lawsuits from smokers, the stock price fell so low that you can buy it at 5 times earnings and a 10% dividend yield. Altria also owned a stable subsidiary of Kraft and Miller (later sold). Exchange investors will see if the demand problem can be solved, then investing in Altria will be handsomely rewarded. Sure enough, the lawsuit issues subside and its share price has quadrupled since then. Of course, changes are not always successful. The K-Mart bankruptcy is another example from the past.
Asset Plays – These are the type of companies that typically have a hidden asset that is obviously not on their balance sheet. All assets must be listed on the balance sheet, of course. But the asset game company many times does not list its assets at market value. For example, the value of a real estate holding that depreciates under current accounting rule. In the meantime, the land itself is most likely worth more than its purchase price. Also, the company that has a large accumulated tax loss qualifies as asset sets.
That’s all. The six categories of actions according to Peter Lynch. I hope that didn’t put you into a deep sleep. As boring as it sounds, this will be a valuable lesson that will make your investment journey that much more exciting and worthwhile.