Wednesday, June 20, 2018

On investing principles (Peter Lynch)

Over the course of my learning in stocks investing, I have a few people that I look up to a lot in understanding their investing methods.

Today's post will be about Peter Lynch and a brief summary of parts of his investment strategy.

As an investor, one should definitely learn about Peter Lynch and his Megallen Fund, which during his management between 1977 and 1990, had an annualized return of 29.2%. By the rule of 72 (it takes you 72 over %returns = number of years for initial investment to double), your money with him would have doubled every 2.5 years. He has thus gone down history as one of the legendary investors of our time.

Lets take a look at some of his core investing principles.

#1: Buy what you know.

Peter Lynch believed in purchasing stocks you will know about well. Inherently, he believes, that if one was working in a company, such as in logistics, for example, one would be better suited in understanding a logistics/3PL company and hence would have an advantage over other investors in this sector. Alternatively, if one uses Netflix, per say, one would probably understand the product well and benefit from it. I will expound on this a bit, as Peter Lynch, of course, did not just meant this in the most basic of terms.

#2 The "Story" behind the company.

Another aspect of his investing principle was that of tackling every nuance of the company to understand what is their appeal over another company. Each company has a story to tell, in terms of its product, its sales, its managers, even the target segment. In line with this, he believed that one's stock investments can be divided into different segments, namely:

The slow growers, the stalwarts, fast growers, cyclical companies, turnarounds, and asset opportunities.

Slow Growers : Large and aging companies, likely to be paying large dividends as growth has become stagnant. I would give an example of Singtel in the Singaporean context. Lynch is not particularly fond of these types of companies.

Stalwarts: Large companies that are still able to grow at 10-20%, in large because the companies have great products but have penetrated the market very well. I would consider a company like Alphabet as a company to put here.

Fast-Growers: the feisty small to mid-cap companies that grow fast, and may not always need to be in fast growing industries. In fact, Peter Lynch prefers that they are not, mostly because attention on a company can push prices up to unreasonable rates (more on this in awhile).

Cyclicals: companies that have cyclical stock prices. An example I would have thought of was that of Micron, but the stock gains by the company in recent months may have relegated it more to that of Stalwart.

Turn-arounds: companies that have battered stock prices, due to many reasons that might or might be temporary. The ability of the stock to turn around may cause the stock price to shoot up. I would consider Design Studio as a company that is in this area, in my own personal opinion.

Asset Opportunities: companies that have great asset opportunities that is hidden from a Wall Street analyst, perhaps found in medical drugs, metals, etc. Lynch has opined that this is where the "buying what you know" comes in best, as one may know about the opportunities inside a company that might help one to benefit from it.

On top of the above, Lynch also believes in finding out more about the opportunities, the pitfalls and to investigate a single stock as much as possible until the story is fleshed out. Even if it is, one has to consider whether the story is able to be played out, or there could be possible problems that will make the story an awful one.

#3 Reasonable prices
Truth be told, as much as the story can be perfect and all that great, there needs to be the right environment for an investment to enter. While Lynch may be considered by some as a growth investor, one can see when reading further that people tend to look at #1 and #2 that they forget that Lynch looks heavily into value as well. As much as he is much more of an active investor than Warren Buffett, both of them agree on the need to find reasonable stocks at reasonable valuations. Even if the story of Amazon may sound amazing, even if the story of Netflix, Tesla, may be so, one has to consider the aspects of earnings and be wary of buying in too late. Never forget the 2000s, when highly valued tech stocks ended up crashing due to unreasonable valuations. As much as I personally am a fan of Elon Musk, for example, I am reluctant to invest in Tesla due to its valuations.
Ultimately, as much as one may understand how Starbucks can sell their coffee, or its atmosphere, we should never just take that as a reason to buy a stock. There needs to be a bigger in depth look into the company, even for a layman investor.

Boring stocks are a favorite of Lynch as well. There is an added benefit to buying boring stocks, such as companies selling cement, elevator manufacturers and etc, as "ugly ducklings" tend to have that reflected in their stock prices, allowing for cheaper bargains.

Ultimately, when one choose to invest in stocks, whether you may be a fan of Buffett or Lynch, always remember that price is what you pay, value is what you get.

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