Guest Post by Aditya Tendulkar (@AdityaTendulka4)
Like any finance buff and an aspiring investor, some books become your bible and people you start admiring. Warren Buffet is someone who everyone talks about, but I was introduced to Peter Lynch in my college days when I read his book, "One up on Wall Street."
I would give a lot of credit to this book for giving me a jump start in finance. It taught me how an amateur could use what I already knew in investing. In the last few days, I read Lynch's second book, "Beating the Street," and I could see myself going through the same learning journey I went through in my college days. "Beating the Street" took no time in getting into the very specifics of investment, and I would rightly call it an analyst's workbook.
During Lynch's 13 years as a portfolio manager at Fidelity's Magellan Fund, the fund achieved 29% per annum. The S&P500 gained less than half of that during the same period (between 1977 & 1990). In this book, Lynch gives away his investment style and how he undertakes investment research. I will discuss some of the things I learned during this reading and some quotes that influenced me.
1) St. Agnes. School Investment club
The book starts with this chapter, and it makes you think that if a bunch of school kids could do it, what stops you? This chapter can undoubtedly be called the highlight of this book, and for that matter, what "One up on Wall Street" represents. It talks about how a bunch of 7th graders produced a winning portfolio. The St. Agnes Portfolio thus consisted of companies such as Walt Disney, PepsiCo, Nike, and Gap. What kept me inspired the most is the idea that Lynch illustrates about "Never investing in any idea you can't illustrate with crayons" and "If you like the store, chances are you'll love the stock." In other words: Invest in businesses you understand and whose products you're crazy about yourself.
2) Portfolio Building
What is different from the previous book is that Lynch uniquely explains the step by step process of portfolio building.
While he worked with Magellan, he focused on 5 categories:
* Small and midsize growth companies
* Companies whose future outlooks are anticipated to improve
* Depressed cyclical stocks
* Companies with a high and increasing dividend yield
* Companies whose assets are undervalued by the market
What he stresses is not overpaying for any stock. Peter Lynch feels that any growth stock that sells at a price to earnings level of 40 and beyond are typically in the extravagant territory. However, he says a company with a high P/E ratio that grows at a high rate will typically outperform a slow-growing company available at a lower P/E ratio. He explains, one interesting thumb rule is to look for stocks that sell at or below its earnings growth rate. This can be thought of as a hurdle rate or margin of safety for selecting stocks with upside relative to its purchasable price. He says if we can find a 25% grower at a P/E ratio of 20 or less, it is most likely a buy. The story is even better if the company is well placed to navigate industry downturns and has a long runway for expansion.
In subsequent sections, Lynch gives an overview of how one can invest in Exchange funds and Mutual funds and how they could be diversified. Diversity not just for the type of fund but also the fund manager's style. His view on sector-wise diversification surprisingly came to me as something new. He believes that one should not diversify by sector unless you have good knowledge of a particular industry.
He also speaks about "weekend warriors." Those people who each Saturday and Sunday spread thousands of reasons about why the economy will tank and the world is bound to end. He claims that those who disregard market swings and simply acquire stocks at regular intervals regardless of the world's state will perform much better than market timers. .He also insists that rather than searching, and engaging in researching new businesses, stick to the ones you already know and buy more!
Peter uses one of the terms "Flowers in the Desert" for good businesses in bad industries. The problem with good industries is that they attract competition. Peter's eyes are thus directed at terrible industries. He attempts to find the 'winner' with the highest margins and lowest costs, enabling them to ride-out cyclical waves. One way Lynch suggests you can check its financial strength is to analyse a company's financial instruments. In case of bankruptcy, bonds are the first ones to be liquidated, and thus a lot of junk bonds are the first sign of decreasing financial strength.
Off all the things, one that really stood apart is Lynch's advice to fund managers. He is of the firm opinion that fund managers should do their own research and not depend on the analyst. This way, there is more ownership of the decision, and also the work gets reviewed multiple times (Analyst and manager)
In the last few chapters of the book, he talks about analysing specific sectors such as Savings and Loan’s, Restaurants, Cyclicals etc. He dwells into the specifics of the sectors and some of the warning signs and also shares some great research tips.
Overall, I was quite impressed with this book as it didn’t seem like a repetition of “One up on Wall Street" but more like season 2 of the series. I would recommend this book to all the budding investors.
