Advice that any investor would love to follow would be ‘Sell before the next economic downturn’ or ‘Sell before the company hits a bumpy patch’. If only it was as uncomplicated as that!
The golden rule on selling can be simply stated: the investor does his research, buys his investment and keeps it so long the story remains sound. If the evidence you have gathered tells you the company performance is going well and the share is not vastly inflated, then it’s a shame if you sell. This however is much easier said than done.
Two difficulties occur, both psychological according to Peter Lynch: first, the share price rises; second the share price is static or falls!
If the share price rises, then it can be very tempting to cash in on the shares before it is too late. It can be harder to stick with a winning share after the price has risen than it is to believe in it after the price goes down. But, if you sell at the first decent rise you will never have a ten-bagger.
Just because a share has risen it does not mean it is due for a fall. Many shares keep rising from one period to the next – the reason being that the underlying business just keeps getting better and better at producing profits for shareholders as the company grows and takes market share.
One good piece of advice is to avoid following what Lynch calls the drumbeat effect when undue influence is given to opinions in the financial world and media. Thus an investor might be panicked in to selling: ‘If you flip around the radio dial and happen to hear the offhand remark that an overheated Japanese economy will destroy the world, you’ll remember that snippet the next time the market drops 10 percent, and maybe it will scare you into selling your Sony and your Honda, and even your Colgate-Palmolive, which isn’t cyclical or Japanese.’ (Peter Lynch)
Incomprehensible (to the person on the street) rum.... To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Do not automatically sell the shares that have risen in price, while holding on to those that have fallen hoping to come out even. Equally silly is the automatic selling of losers and holding onto winners.
These two strategies don’t make sense because they use the current movement of the share price as an indicator of the company’s fundamental value.
We know that recent share price movements often have little to do with the future prospects of a company.
A falling price is only a tragedy if you sell at the lower price. If the prospects for the firm remain good then a fall presents a wonderful opportunity to buy at bargain prices.
To make decent profits as an investor you need to train your mind to accept that when a good share has fallen 30 percent after purchase you buy more because it is even more of a bargain than you originally thought.
Just because everyone else is abandoning the company, it does..... To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
All the great value investors from Benjamin Graham to Peter Lynch and Warren Buffett agree that the short term movements (over a few months) are irrelevant to good investing except that they might offer the opportunity to buy at a bargain price if other investors are being foolish.
The investor must concentrate on the underlying business of the company in question and not waste time trying to achieve the impossible.
Buying and selling on the prediction of market movements is likely to result in very poor performance, as the investor is likely to be optimistic and pessimistic at precisely the wrong times.
On top of which there are the additional costs of frequent trading – transaction costs and taxes.
‘Every year I talk to the executives of a t…To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
The obvious answer to the question ‘When should I buy?’ is when all the painstaking research stacks up, and the company looks a good bet. The problem is, there are investors who buck the trend and act contrary to the general consensus. These contrarians zig when everyone else is zagging, but the true contrarian does not simply take the opposing view just to be different. He is actually acting intelligently by choosing to zig when he understands that the stock market has got it wrong and zagged.
He can succeed by waiting for the excitement to die down, and then investing in companies that nobody is interested in any more, especially those companies that have begun to bore the analysts.
Investors should not rely on their gut feelings; they should learn to ignore them, and continue with trying to understand the fundamentals of the company under investigation.
Investing without research is like playing stud poker and never looking at the cards.
Shares should not be bought because they are the next of something, such as the next Microsoft or the next Disney: they almost never are what they promise.
Nor should investors be influenced by compani
The amateur investor should develop their own particular method of investing, a tried and proven investment strategy that suits them, and should stick with it, ignoring transitory but probably insubstantial trends in the stock market.
There will be occasions when the temptation to act rashly is overwhelming, but strength of character is needed here. Losses within the chosen strategy have to be tolerated; they are bound to occur and must be accepted, and should not cause the investor to be panicked into buying or selling unnecessarily.
Remaining consistent and faithful to a strategy will minimize losses and maximize long-term profitability.
As Peter Lynch says, in some years you will make a 30 percent return, but there will be other years when you’ll only make 2 percent, or even lose 20 percent.
That is way things are in the stock market, and you have to learn to accept it.
If you raise your expectations such that you are looking to make 30 percent year after year, the end result will be frustration with shares for defying you. Impatience will follow, which may cause …To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
The investor should not be drawn into investing in the latest hottest shares, the “whisper” shares. These frequently turn out to be no more than hope and thin air These shares rise in value astonishingly quickly, but there is nothing astonishing about their subsequent spectacular drop in price.
There are constant whispers circulating about the latest craze, whether it be jungle remedies to cure all ills, high-tech start ups, or bio-technological miracles, lithium or blockchain, and it can be very tempting to join in.
On the face of it, these new companies are on the brink of solving the world’s major problems. Often, or more accurately usually, however there is no substance behind all these rumours and the stock-picker can leave his brain outside because he does not have to spend time checking earnings and so forth because usually there are no earnings.
Figuring whether the PER is acceptable is no problem because there is no PER ratio. But there will no shortage of microscopes and high hopes.
These fads are always with us – just look at market history. For example, in the 1980s Peter Lynch’s favourite story is a company called KMS Industries, which between 1980 and 1986 engaged upon various technological ‘miracles’, such as ‘amorphous silicon photovoltaics’, ‘video multiplexer’, ‘optical pins’, ‘material processing using chemically driven spherica.…To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Investors should limit themselves to researching companies where they have an edge, and they have time and knowledge to ensure each company passes all the tests of prudent value investing. If you are only going to take on shares where you have devoted enough time to have a complete grasp of the company’s situation, eight to twelve companies is probably the most that a part-time stock-picker could follow.
All shares in the portfolio have to pass some stiff tests and you will not know if they pass the tests unless you spend time analysing them. The private investor will lose the analytical edge over the professionals if he/she spreads intellectual resources thinly.
Even a portfolio of 8 – 12 shares requires a lot of work if you are to spot new opportunities and not let the portfolio atrophy: `I’ve always believed that searching for companies is like looking for grubs under rocks: if you turn over 10 rocks you’ll likely find one grub; if you turn over 20 rocks you’ll find two’ (Peter Lynch)
The investor must accept that the stock market fluctuates. Peter Lynch said that, despite learning in graduate school that the market goes up 9% a year he found it impossible to predict, nor could.…To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
The Discipline of the Two-minute Monologue: Peter Lynch, a great value investor, expected his staff to be able to be as disciplined as he was, and be able to expound the merits of a company in a ‘two-minute monologue’. The salient facts about any company should be extracted from the morass of information, then the decision could be taken.
It was vitally important that the essence of a company could be understood and explained concisely. Thus the details of the strength of the economic franchise, management quality, financial structure and low price need to be boiled down to the key deciding factors.
If more than two minutes is needed then this is an indication that the investment is too complicated and carried too much uncertainty to be considered further.
Don’t think the two minute rule lets you off the hook – the briefer you have to be the more expert you need to be, so you’ll have to really understand the business to explain it accurately and concisely. That requires quite a lot of hard graft. That brings onto another Lynch principle, know the facts.
Know The Facts
Among the criteria Lynch sets out for investing, first and foremost is understanding the chosen companies, and continued monitoring of them.
A buy-and-forget policy is asking for trouble; constant attention is required for pursuing a profitable strategy.
By learning enough about shares held, the mistake of selling too early can be avoided. It can be very tempting to sell when the value of shares has doubled or trebled, but if the company is strong and in a competitive position, and the management is of high quality, there is every possibility that it could be a 10- or even a 20-bagger.
To retain a portfolio’s profitability take sufficient time, at least every few weeks, to maintain a high standard of knowledge about each company and check on its progress.…To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Niche companies are Peter Lynch’s preferred type of value investments. He requires a number of factors to be in his favour before committing: (a) strong economic franchise, (b) owner-oriented managers, (c) a low price, and (d) financial strength.
Strong economic franchise
Lynch is firmly of the belief that a company is better able to exploit its superior competitive position sustainably in a slow growing industry, ideally a no growth industry, such as funeral services.
High-growth industries have a tendency of letting you down.
For example, over the last twenty years personal computer and flat TVs demand has grown well, but shares in these sectors have struggled. Every time a company comes out with an innovation rival manufacturers, whether in China, the US or Finland, put thousands of engineers on the task of figuring out how to make it cheaper and better; and a new product will be on the market in six months.
This doesn’t happen in industries with more mundane growth, say bottle caps, coupon-clipping services, oil-drum retrieval, or motel chains.
If the industry is not growing at all (especially if it is one that is boring and upsets people) you generally find less of a problem with new competition allowing the best firm in that industry to gain market share.
Niche companies are generally successful in one geographic area, and are then able to duplicate their winning strategy over and over again, and take it further afield.
This can lead to extremely rapid expansion and profits, largely ignored by professional analysts and newspapers, who are too busy following the struggle for superiority between the well-known ‘industries of tomorrow’ (e.g. bio-technology, social media, internet).
Meanwhile the highly competent niche companies continue on their way and get to dominate their particular area. The imaginary pot of gold at the end of the exciting fast-growing sector’s rainbow is a magnet to many ‘wannabe’ rivals, but in the unexciting humdrum sector competitors drop out, leaving the competent companies to dominate their market.
Lynch thinks it preferable to hold shares in companies that are able to capture an increasingly large part of a stagnant market than to have shares in companies that are fighting to protect a dwindling portion of a seemingly exciting market. Total domination in business is always more healthy for shareholders than competition.
It is apparent that some investors confuse two concepts of growth. The first is growth in sales for the industry. This will lead to growth in the more important form – growth of earnings and shareholder value for a particular firm in that industry – only if certain conditions are present, the most important of which is that high profits are not competed away.
Indeed, in most high growth industries there is great uncertainty as to the potential for translating the growth of sales into earnings growth. This uncertainty alone should put off investors, especially when they consider that there are simpler, more predictable industries where the competitive threats are easier to assess.
There are a number of clues to the strength of the economic franchise, e.g. if the company is able to raise prices year after year without losing customers; earnings per share have risen steadily; the company has duplicated its success in city after city; it is not selling a high proportion of its output to one customer; the firm has a clear local monopoly.
It is difficult to overstate the importance to companies of an exclusive product or franchise. Possession of this exclusivity puts them in a strong economic position, enabling them to raise prices year on year yet retaining their customers. Often the cost to would-be rivals of entering this exclusive market is prohibitive, as in the case of quarries.
Lynch is a fan of quarries: he says that he would far rather own a quarry than a jewellery business. The jewellery business is vulnerable to competitors, both those that have already set up and potential new entrants. These days high street jewellers even have to compete with online operators. The result of all this competition is that the customer is free to shop at dozens of alternative places.
A quarry near a big city, on the other hand, can find itself the only one for a hundred miles giving it a virtual monopoly. On top of that you are unlikely to find new entrants setting up in the near future because quarries are so unpopular with local residents that gaining planning permission is fraught.
Drug companies and chemical companies are also good examples of straightforward niche businesses that are protected from rivals by high cost of entry and cost of competing, but have plenty of room for expansion.
The ideal niche company would be engaged in a simple business. It is much easier to understand the ‘story’ of the simple business and draw conclusions on the strengths of the firms. Also, the management are less likely to make mistakes.
For investors it is vitally important that the management is interested in the progression of the company for the benefit of shareholders and not their own personal aggrandisement.
Lynch favours companies that do not squander company resources on plush offices finding an inverse relation between rewards to shareholders and the extravagance displayed at head office.
He was suitably impressed when he visited company headquarters that were shabby and unimposing, such as those of Taco Bell or Crown, Cork & Seal (a 280-bagger over 30 years). Taco Bell’s headquarters was a ‘grim little bunker’ stuck behind a bowling alley. At Crown, Cork and Seal the president’s office had faded linoleum and shabby furniture. The office did not overlook areas of green lawn, but the production lines.
As an investor look for the combination of rich earnings and a cheap headquarters. Far more important than an imposing executive suite is the capability of the management to run their business efficiently and engage in good labour relations, thereby increasing profitability.
Staff should be treated with respect and fairness; no corporate class system with white-collar Brahmins and blue-collar untouchables. Workers should be well paid and have a stake in the future prosperity of the company.
He disapproves of companies that use surplus cash flow to diversify unnecessarily (and often disastrously). He calls this process ‘diworseification’, and gives the example of Gillette, a company which had a spectacularly profitable razor business but diworseified into cosmetics, toiletries, ballpoint pens, cigarette lighters, curlers, blenders, office products, toothbrushes and digital watches – to name but a few! – before realizing the error of its ways and emphasising its niche business, shaving.
‘It’s the only time in my memory that a major company explained how it got out of a losing business before anybody realized it had gotten into the business in the first place.’ (Lynch)
A sure sign of a healthy company is when those on the inside are buying their own company’s shares. If employees are putting their own money into it then you should regard that as a useful tip-off to the probable success of the share.
This insider buying is reassuring, especially when lower-ranking managers use their salaries to increase their holding on the company. If people earning a normal executive salary are spending a fair chunk of that on the company’s shares then you can take it as a meaningful vote of confidence.
So factory managers and vice presidents buying 1,000 shares is to be read as being highly significant – more so than when the CEO buys. Owning shares encourages managers to reward shareholders (themselves) rather than pay increases in salaries or use the spare cash on pointless or ineffective expansion.
However, insiders selling shares should not necessarily be seen as a negative sign; there could be many reasons for selling – purchasing a house, school fees etc. – which are totally unrelated to the performance of the company.
Lynch is wary of com…………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Small aggressively-run companies offering earnings growth of at least 20% per year can be 10- to 40-baggers, and even the 200-baggers, if you can buy them when they are unrecognised by Mr Market and therefore still cheap. If you get things right in this area, one or two of these can make a career.
Niche companies are Peter Lynch’s preferred type of value investment. He looks for companies which are strong in their balance sheets and profits while they are growing.
The difficult thing when valuing them is to figure out is when growth will fall to more pedestrian levels. This is where the amateur can have a distinct advantage over the professional, who dares not take the initiative and make the first move - they wait for someone else to take the plunge.
Wall Street analysts and managers all watch each other thereby losing out by jumping on the bandwagon too late. Dunkin’ Donuts was a 25-bagger for Lynch between 1977 and 1986, but not until 1984 did any professional analyst turn their attention to it.
When Stop and Shop was about to grow its share price from $5 to $50, there was only one analyst taking any interest in it, yet IBM had 56 analysts following its progress.
Boring and unpleasant is attractive
One of Lynch’s favourite places to look for multi-baggers is in boring or unpleasant industries; these types of industries attracted little attention, and could be severely under-priced as a result.
If everything about the company seems boring – it name, its activities and its management – then it may be overlooked.
The oxymorons, labelled “professional investors”, will simply not see it until finally the flood of good news compels them to start taking an interest. As the crowd starts to do this it becomes trendy and overpriced. Then you can sell your shares to the trend-followers.
The key criteria
Lynch focuses on certain ele
Prof. Glen Arnold
I'm a full-time investor running my portfolio from peaceful Leicestershire countryside. I also happen to be UK´s best selling investment book author and a Financial Times Best selling author.
Originally, I wrote all my ideas out in full on this website. Now that ADVFN publish them they are entitled to display the full version for six months – you can see them here. Thus can I only post the first few paragraphs here for anything younger than six months.
I write 2 to 3 newsletters per week - investing is about making the right decisions, not many decisions.