One up on Wall Street – Investing Done Right!

One up on Wall Street, written by Peter Lynch, erstwhile manager of the Fidelity Magellan fund ($3 Billion at that time – that’s like if the entire world put in 50 cents each, the corpus was be managed by him!) is a timeless classic on investing. One of my personal favorites to facilitate mindset conditioning for investing (stock investing is what is targeted in the book). I would put it in the league of ‘Rich dad poor dad’ & ‘The intelligent investor’. Below is my interpretation of the book –

(The way I’ll structure this is to cater to our basic questions/apprehensions)

Who, ME? How could I possibly be better at investing as a beginner than my professional consultant?

• The average common investor has the edge over the professional investor as he can sight multibagger from the beginning of the business in his day to day life. The business reaches the professional investor after it has already taken multi-fold leaps – Imagine a new store opens in your neighbourhood that is always flooded with customers, you must wonder who owns this & is it listed?
• Stock doesn’t get traction by professional houses as a lot of times the business doesn’t get classified into existing industry categories. Other times they just take too long to put it on their watchlist. It’s a choice between chance of making a large profit on an unknown company and the assurance of losing a small amount on an established company. Fund managers generally choose the latter. You’ll never lose your job losing money on IBM. If IBM stock does not rise, fund managers won’t question the buy decision of the manager. Instead they’ll ask “What is wrong with IBM”?
• Fund managers too, just like you, spend a quarter of their working hours explaining what they just did – to their immediate bosses and ultimate bosses (shareholders). Both who can be very critical to the fund as well as to his career!
• The SEC (SEBI in our case) also poses a lot of well intentioned restrictions on holdings of funds that may rule out a lot of Multiple baggers – I remember just recently all the small cap crashed without anything wrong with their fundamentals. I could only link it to the reason that most Large/Mid Cap mutual funds were asked by SEBI (with good intentions) to get their Small Cap holdings within prescribed %. Now all of them sold their small cap holdings sending the stock prices nosediving!

OK, I may have an edge, but I don’t understand the numbers or any industry in depth. Do you want me start learning it from the scratch now?

• Investing in stocks is an art. Not a science. All the math you need in the stock market you get in fourth grade – Always remember the stock market is a Voting machine & not a Weighing machine. But here the votes favour the one with strong fundamentals in the long term!
• Most dot coms (start-ups in today’s reference) cannot be rated on the p/e yardstick. There’s no ‘e’ in the all important P/E ratio. There’s no track of ‘e’ but people always keep a track of ‘p’ which gives absolutely no information. EDS once sold for 500 times it’s earnings. This means it would take you 5 centuries to make back your money, if EDS earnings stayed constant
• If you don’t understand any industry/technology (eg internet), look for industries that indirectly benefit from it. In the gold rush, the would-be miners lost money, but the people who sold them picks, shovels and blue denims made a lot of money – Instead of manufacturer of technology (highly competitive), better invest in a company that is a user of technology

Fair Enough, but there are huge number of companies out there. Where do I start or how do I filter?

• Step 1: Possess these virtues – Patience, self reliance, common sense, tolerance for pain, open minded ness, detachment, persistence, humility, willingness to do independent research and admit mistakes.
• Try & classify the companies into 6 broad categories – Slow growers, Stalwarts, Fast growers, Cyclicals, Asset plays and Turnarounds
• “Any idiot can run this business” is one characteristic of the perfect company, the kind of stock I dream about!
• A no growth industry is where winners are developed. Whenever the next breakthrough arrives in an industry, there are hundred companies working to make it cheaper in Taiwan. This does not happen with bottle caps, oil drum retrieval or motel chains
• Invest in companies that have products that people have to keep buying – Well, clothes & basic hygiene/packaging is here to stay till the time humans walk this planet!

Well this seems easy, anything nuances that I MUST take care of?

• Before you own a share of anything, answer 3 questions for yourself –
  1. Do I own a house? If no, stop!
  2. Do I need the money in the near term? If yes, stop!
  3. Do I have the personal qualities that’ll bring me success in stocks? (remember point 1 in last section) – If no, duh! STOP!
• Once you have the tip or identified a good business, it does not mean you simply buy it. Investing without research is like playing stud poker and never looking at the cards
• It is easy to forget sometimes, a share of stock is not a lottery ticket. It’s part ownership of a business. Value will eventually catch up with the earnings. Always keep an eye on earnings and assets – Compare growth to earnings – (long term growth rate + dividend yield)/ P/E
• Learning on each stock that you must possess – p/e, % institutional ownership (lower the better), insider buying/buyback, trend of earnings (keep in mind the asset play), debt-equity ratio, cash position
• 5 basic ways in which companies can increase earnings – Reduce cost, Raise price, Expand into new market, Sell more in old market, Dispose losing operation
• When in doubt, tune in later. Have patience. Most importantly, invest at least as much time and effort in choosing a new stock as you would in choosing a new refrigerator

OK got it! Anything that I need to be wary of?

• You don’t need to make money on every stock you pick. 6/10 winners in a portfolio can produce satisfying results
• If there were a way to avoid the obsession with the latest ups and downs, and check prices every six months or so, the way you’d check oil in the car, investors might be more relaxed. Day trading is a casino that supports a lot of accountants & brokers!
• Humans go through 3 emotions that make them bad timers of the market –
  1. Concern (when market is low) which keeps him from buying good companies
  2. Complacency when he buys at higher prices and stocks are going up (so he gets complacent and doesn’t check fundamentals)
  3. Then when stock falls below the price he actually paid, he Capitulates and sells
• Perhaps a winning investment seems unlikely in the first place that people can imagine the best happening as far away as possible, somewhere off in the great beyond, just as we all imagine that perfect behaviour happens in heaven and not earth
• If inventories are increasing faster than sales, it’s a red flag. People may talk about FIFO or LIFO as accounting principles. But mostly it’s GIGO (Garbage in Garbage Out) and FISH (First In Still Here)
• Regarding somebody else’s gains as your own personal losses is not a productive attitude for investing in stock market. It leads to try and play catch up by buying stocks they shouldn’t buy. This generally leads in real losses.
• Short term gains or losses don’t tell much about the prospect. Most people keep the winner and dump the loser. This is further from the truth. It just tells you someone else is willing to pay more /less for the same merchandise
• The mindset has to change from – when I’m down 25%, I’m a seller to when I’m down 25%, I’m a buyer

Ah! Got it. Last question, I know how & when to buy, but when do I Sell?

• CHECK FUNDAMENTALS!! Some signs are as follows:
  1. Slow grower – losing market share for 2 consecutive years and it is hiring another advertising agency
  2. Stalwart – growth is slowing down and maintaining profits by cutting costs
  3. Cyclical – inventories go up and company is increasing capital budget instead of modernising current plants
  4. Fast grower – when p/e reached absurdly high levels and at least 3 national magazines have fawned over the CEO, same store sales are decreasing
  5. Turnarounds – we’ll, when they’ve turned around and you’re able to reclassify them, debt suddenly goes up
  6. Asset play – assets were marked down, institutional ownership goes up

Do share your views/feedback in the comments section