One Up on Wall Street

Summary

Never gonna read the actual book, but I can manage to sit through a commentary + summary. One Up on Wall Street is a book by Peter Lynch (who was a nice independent trader). The goal of this book is to produce “tenbaggers” and to turn your portfolio into a star performer.

Using this summary

Here I’ll take notes on notable chapters and what I can learn from them.
Chapter 2 The Wall Street Oxymorons

• Professional institutional/fund managers are restrained by cultural, legal and social barriers.
• Many institutions are held back by various written rules and regulations. We are not. Some bank trust departments simply won’t’ allow the buying stock in any companies/unions (think environmental and ethical limitations).

Chapter 3 Is This Gambling, or What?

• Investing in bonds, MM, CDs are different forms of debt
• Investing in debt yield < 5% gains
• Essentially when you lend someone money, the best you can hope for is the money back plus some interest
• Investing in stocks is more risky but return closer to 10% gains

Chapter 4 Passing the Mirror Test

• The mirror test is:
  • 1. DO YOU OWN A HOUSE
    • If not put money into saving for that investment, kind of a weird rule (don’t we want to invest our money to save for the house?)
  • 2. DO I NEED THE MONEY
    • The idea is to keep money that you will NEED liquid
  • 3. DO I HAVE THE PERSONAL QUALITIES IT TAKES TO SUCCEED
    • Basically, patience, common-sense and the ability to ignore general panic

Chapter 5 Is This a Good Market? Please Don’t Ask

• Its impossible to tell if we’re in a good market, people smarter than have tried and failed

Chapter 6 Stalking the Tenbagger

• Keep an eye in your own industry for value picks. I work in tech, keep ears out for tech stocks that I understand and see value in.

Chapter 7 I’ve Got It, I’ve Got It - What Is It

• If you think a company’s product is going to grow, how much of their revenue does that product account for? Make sure the impact is large enough that the companies market position increases a reasonable amount.
• You’ll get the biggest moves in smaller companies, you don’t expect large companies to quadruple in price.
• Once you have established the size of a company relative to the others in an industry, try to categorize them…
  • 1. The Slow Growers
    • These are large and aging companies. They grow slowly but grow slightly faster than gross national product
  • 2. The Stalwarts
    • Multi-billion dollar companies that are expected to grow faster than slow growers
    • Expected 10-12% growth
    • This category should offer protection and reliability in recessions
    • For ex. people will still eat cornflakes in a recession and Kelloggs will still grow
  • 3. The Fast Growers
    • Small and aggressive enterprises that grow 20-25% per year
    • These do not need to be in fast growing industries
    • Risk in fast growers is over-confident and under-financed young companies
  • 4. The Cyclicals
    • In cyclical industries, companies’ sales and profits are expanding and contracting regularly
    • Examples include auto, airlines, tire companies, steel companies, chemical companies
    • These companies exaggerate the economy
    • You need to buy these at the right time otherwise it would be years until you see another upswing
  • 5. Turn Arounds
    • These stocks have been depressed in a down cycle, good candidates are poorly managed cyclicals
    • Since the stock was down, major gains can be made when prices rise
    • Turn arounds that rise are one’s that focus on their core business and drop other business they entered for diversifications
  • 6. The Asset Plays
    • A company that is sitting on something valuable that you know about but the crowd has overlooked
    • Check company assets and compare it to the price you are willing to pay
• Companies don’t stay in the same category forever, but we need to categorize companies so that we know their story

Chapter 8 The Perfect Stock, What a Deal!

• Its easier to develop a company where its business is simple
• These attributes make it easy to find valuable companies
  • The company sounds boring, or ridiculous
  • It does something dull
  • It does something disagreeable
  • Its a spinoff (of a larger company)
  • The institutions don’t own it (think black rock and other large investment funds)
  • Companies surrounded by rumours
  • There’s something depressing about it
  • Its in a no-growth industry
  • It has a niche
  • People need to keep buying it (this is a branch of my philosophy “people are addicted to it“)
  • Its a user of technology
  • The insiders are buyers
  • The company is buying back shares

Chapter 9 Stocks I’d Avoid

• Hot stocks in a hot industry, these rise quick but fall just as fast
• Don’t invest in the “next _”, ex. there is no next McDonalds
• Avoid “whisper stocks” (random word of mouth stocks)
• Beware stocks with exciting names

Chapter 10 Earnings, Earnings, Earnings

• This is what makes a company valuable
• After categorizing companies look at these categories
  • P/E Ratio
    • Relationships between the stock price and the earnings of the company
    • This is a useful measure for a stocks value (look for a ratio of 20:1-25:1 where smaller ratios indicate undervalued companies)
    • This is calculated as the $\frac{\text{Current Price}}{\text{Earnings per share for the last 12 months}}$
    • Qualitatively, this can be thought of as the number of years it will take the company to earn back the amount of your initial investment
  • Future Earnings
    • An educated guess based on current earnings
    • See how a company plans to grow its earnings and check to see if plans are working out
    • The five basic ways to increase earnings are
      • Reducing cost
      • Raising prices
      • Expanding into new markets
      • Sell more of its products in old markets / to existing customers
      • Dispose of a losing operation

Chapter 11 The Two-Minute Drill

• After categorizing your company and using the p/e ratio to determine value, you need to develop a story about
  • Why you are interested
  • What has to happen for the company to succeed
  • The pitfalls that stand in its way

Chapter 12 Getting the Facts

• Read annual reports
• Read balance sheets
  • Make sure cash and marketable securities exceed long-term debts
  • Debt reduction is a sign of prosperity

Chapter 13 Some Famous Numbers

• Percent of Sales
  • If you like a company because of a product, what percentage of sales does that product account for?
• P/E Ratio
  • You have found a bargain if the p/e ratio is less than the growth rate of earnings
• The Debt Factor
  • Compare debt to equity in terms of percentages
  • Ex. we want 1% debt and 99% equity
• Dividends
  • Slow growers paying dividends is a good sign since if they don’t pay dividends, slow growers have a history of of blowing that money
  • Young companies won’t pay dividends since they are piling that money into expansion
• Does It Pay?
  • Do the dividends rise regularly?
• Book Value
  • Book values are misleading
  • Look at hidden assets or implied value (brand names, things that will be worth something in the future)
• Cash Flow
  • If companies need to spend cash to make cash, they likely won’t get too far
  • Invest in companies that don’t depend on capital spending to generate cash
• Inventories
  • This is the “managerial discussion of earnings” in an annual report, inventories piling up is a bad sign
  • This is not as applicable to the auto industry
• Pension Plans
  • Make sure there isn’t an overwhelming pension obligation, especially in turn arounds. This could bankrupt a company
• Growth Rate
  • The ability for a company to increase earnings by cutting cost and reliably raising prices is the only growth rate that really counts
• The Bottom Line
  • Put simply, profit after taxes
  • Compare this to other stocks in the same industry

Chapter 15 The Final Checklist
This is a summary on what to look for

• Stocks in General
  • P/E ratios should be comparable to other stocks in an industry
  • We want low institutional owerships
  • Company buy backs and insider buying is good
  • Weak debt to asset ratios
• Slow Growers
  • Buy for dividends
  • Check for dividend payout ratio (low here is less risk)
• Stalwarts
  • Look for big companies not likely to go out of business
  • The key is the check the P/E ratio
  • Check for unrelated acquisitions (bad)
  • Check for how the company has previously performed in recessions
• Cyclicals
  • Keep a close watch on inventories
  • Look out for new entrants
  • Its easier to predict an upturn in a cyclical industry than a down turn
• Fast Growers
  • Ideal recent annual growth rates are 20-25%
  • Can the company duplicate success in multiple locations
  • Is expansion speeding up or slowing down
  • Few institutions should own the stock and few analyst should have heard of it
• Turn Arounds
  • Check the equity debt ratio
  • Is business coming back?
  • Are costs being cut?
• Asset Plays
  • Is the company taking on new debts that reduce asset value
  • Check debt to equity ratio
  • Hidden assets?

Chapter 17 The Best Time to Buy and Sell

• Stock prices are typically down between October and December as portfolios are cleaned for the new year’s upcoming evaluations. This is a good time to buy.
• Selling depends on the stock category
  • Slow Grower
    • Company is loosing market share
    • Nothing new is being developed
  • Stalwart
    • P/E ratios are straying
    • Company vesting is on the decline
    • A major division (25% of earnings) is susceptible to an economic slump
    • Growth rate is slowing
  • Cyclical
    • At the end of an up-cycle
    • Rising inventories
    • New entrants to an industry
  • Fast Grower
    • The end of a second phase of rapid growth
    • The company is entering a maturing phase
    • Wall street analysts and institutions are snatching the stock up
    • It turns into a Chapter 9 stock
    • Key employees are leaving
  • Turn Around
    • Too much debt
    • Declined for 5 straight quarters
    • Inventories are rising at twice the rate of sales growth
  • Asset Play
    • When it has brought on too much debt

Chapter 19 Options, Future, Shorts

• Futures is gambling x 100
• Options is a zero-sum game and have nothing to do with company ownership
• The stock owners gets all the dividends when you short
• You need to maintain sufficient balance if your account to cover the value of a shorted stock

The Summary of the Summary

When reflecting on this investment strategy, review:

• Chapter 7
• Chapter 8
• Chapter 9
• Chapter 15