You can’t become a successful stock investor overnight, but you can reach the same level of expertise as the world’s most successful investors. It’s all within your grasp and in this video will show you how.
Peter Lynch, a highly regarded investor, served as a fund manager and philanthropist for Fidelity Investments’ Magellan Fund
Assets under management for the fund increased from $18 million to $14 billion during Lynch’s tenure and also achieved superior performance compared to the S&P 500 index and became the top-performing mutual fund globally, with an average annual return of 29.2%.
According to Lynch, there are 5 categories of stocks that can be used as a guide to help you make informed decisions when choosing a stock.
But before we go into details, it is worth noting that companies may not always fit neatly into a specific category, and may transition between categories at different points in time.
These categories include fast growers, slow growers, cyclicals, asset players, and turnarounds.
Let’s dive in and see what are the major characteristics of each category.
Number 1. Fast Growers
According to Lynch, investors should seek out stocks with companies that have a track record of steady earnings growth and rising dividends, which he refers to as Fast Growers.
He notes that companies that expand at a rate of over 25% per year are relatively rare, but are known for finding innovative ways to continue growing earnings and provide investors with ample opportunities to get involved.
The advantage of investing in these successful companies is that there is often a long window of time during which they continue to grow, sometimes for several years or more.
Characteristics of a fast grower include rapid revenue and earnings growth. As an example, Lynch cites Microsoft, which he categorizes as a fast grower.
He notes that in the 3 years since it went public, the company has made a 20-fold return on investment and experienced significant growth over its 20-year growth cycle.
Number 2. Slow Growers
Slow Growers are companies that have the potential to grow consistently over time, without being affected by external factors, such as wars, elections, and rising interest rates.
As an example, he cites Service Corporation International, a company that provides funeral goods and services and has demonstrated steady growth of 15% per year.
Number 3. Asset Players
Asset Players are companies that have assets that are not always reflected in their stock price but can become valuable when they are recognized by the stock exchange.
As an example, he cites Walt Disney as an Asset Player. When Disney World and Epcot were first opened, they were not performing well.
But the company later discovered that its hidden asset was its established brand name, which went on to be a major success. A hidden asset can be a well-known name or reputation that a company has built up over time, and while it may not appear on the balance sheet.
It can be a valuable asset when the company introduces new products. Lynch notes that patents also play a role in protecting the unique products of these companies.
Number 4. Cyclicals
Investors should be cautious when purchasing stocks of companies that are closely tied to a country’s economy, which he refers to as Cyclicals.
These companies may experience fluctuations in their earnings depending on the performance of the economy, with the potential for spectacular results in one quarter and poor performance in another.
Lynch advises investors to choose strong companies with good cash flow and low debt when investing in cyclicals, as these companies may be better able to weather downturns in the economic cycle.
And number 5. Turnarounds
Turnarounds are companies whose stocks have suffered significant declines in the past and have been overlooked by investors, but have the potential to improve their fortunes.
Lynch suggests that investors can examine the balance sheets of these companies to determine their likelihood of reversing their trends.
If a company is implementing changes such as introducing new products, undergoing new management, or reducing costs, it may be a sign that it has the potential to recover. However, it is important to wait for concrete evidence of a turnaround before taking action, as many turnarounds do not succeed and there are often more failures than successes.
As an example, Kresge Store which was in poor shape until it launched K-Mart, leading to a fifty-fold increase in its stock price.
Important Keys to Look for Before Buying a Stock
You should assess a company’s potential for growth when evaluating it for investment including a long history of increasing earnings and dividends, the introduction of new products, cost-cutting measures, a strong balance sheet, and a well-recognized brand name.
You should also consider the company’s products, sources of revenue, and competition when evaluating a stock. If a stock is performing differently than expected, it may be helpful to investigate the reason for this deviation.
Pick the right time to buy a stock
Lynch emphasizes the importance of selecting the appropriate time to purchase a stock and seeking out situations where the potential for gain is high and the potential for loss is low.
He advises investors to consider both the risks and rewards of a stock pick and strive to minimize risk while maximizing reward.
He notes that a balanced approach is crucial to successful stock investing, and that the skill lies in understanding the potential consequences of being wrong and right.
- Peter Lynch’s 4 Simple Rules to Outperform Most Investors in The Stock Market
- Warren Buffett’s 6 Greatest Rules of Stock Investing