Novice Investing - Learning From Peter Lynch

Date: Monday 01st 2008f December 2008 05:47:21 PM

Learning From Peter Lynch - Part IV - 10/09/2006

By: Hari Wibowo

How to find your next ten baggers? This article will explain how the legendary Peter Lynch made himself wealthy by buying stocks that return him 1000% or more. The criteria that he set was rather illogical at a glance. However, he does have his own reasons. Without further delay, here is the thirteen criteria he is looking for in a ten-bagger.

It sounds dull - or even better, ridiculous. How could this be? A good business will have a simple business plan with a boring name. He mentioned names such as Pep Boys, Bob Evans Farms that will enduce laughter every time you mention it, let alone own it. When you find some unknown companies with boring name, chances are Wall Street analyst won't recommend it unless it is wildly profitable and has risen ten fold already. Thus, companies with boring name is a fertile field of finding your next ten baggers.

It does something dull. Peter Lynch will get excited if the companies does something boring such as Crown, Cork and Seal ( making cans and bottle caps) or Seven Oaks International (processing coupons). Similar reasoning as above, Peter wants his company to be away from Wall Street radar's screen until it is already profitable and compel them to buy, thus propelling the stock even further. In fact, companies with ridiculous name and do something dull is an even better deal than individual traits.

It does something disagreeable. Again, you must be familiar with the scenarios by now. You would want to buy the company that Wall Street ignores, let alone loves. Company that fits in this category include Safety-Kleen that provides a machine that washes greasy auto parts, Envirodyne which makes plastic forks and straws

It is a Spinoff. At first, I can't quite digest why Peter set this as a criteria. However, he explains it brilliantly. For starter, the parent company of the spin off does not want to see their spinoff to be in trouble. That would bring them unwanted bad publicity. As a result, the parent company always give them with strong balance sheets to weather the storm. Further, once the spin off becomes independent, they can then cut cost and is more flexible in taking creative measures to increase long-term earnings.

The Institutions don't Own it, The Analyst do not follow it. This is what most of the above reasons are leading to. When a company is heavily followed, you will not find a good bargain. Why? When two or three analysts are bearish, the other analysts may be bullish, thus providing support for the stock price. As a result, the stock will not move much, let alone reward you with a ten baggers.

The Rumors Abound: It is involved with toxic waste and/or the mafia. I cannot quite get the reasoning right here. Peter uses Waste Managements (WMI) as an example on how the waste business is somehow rumored to be controlled by a mafia. With its mafia rumor depressing the stock price, I believe that Peter can buy this company for a much cheaper price and reap a bigger profit later when the rumor of a mafia connection has waned.

There is something depressing about it. What is more depressing than companies dealing with burials? Service Corporation International is it. Nobody will be happy at a burial, unless of course, you are Service Corporation International.

It is in a no-growth industry. Again, the point for this is to avoid Wall Street's overexcitement which will drive the stock price expensive. High growth industry will attract Wall Street's analyst and the masses. Not so, with the low growth industry. For every glamour that a high-growth industry brings, it will also bring thousands of competitors, each with a better product each month. That does not happen in a boring slow-growth business such as coupon-clipping services or bottle caps.

It's got a niche. I think that this does not apply to a ten-baggers but to any successful investment for that matter. Another word for companies with niche is 'moat'. Niche is much harder to imitate and protect your business with moat. Several examples of niche products are: pharmaceuticals and the newspapers business.

People have to keep buying it. This is the type of businesses with have lots of repeat purchase. this will instill brand royalty. Coca Cola is one example, a razor blade and toothpaste is another example. When you only buy certain products once every five years, chances are, you already forgot the name of similar product you were buying five years ago. On the other hand, if you bought your toothpaste once every month, you will surely remember the name of your toothpaste pretty soon. Repeat purchase will also create steady cash flow for the company. Thus, it will be less likely to go under.

It is a user of Technology. Rather than buying computer stocks, Peter advocates buying companies that benefit from computers. The reason is that the technology landscape is changing fast. Remember when IBM still sell typing machine and then computer? It doesn't sell that anymore. You could buy companies that benefits from the internet (such as credit card company) instead of investing in ISP (Internet Service Providers). Internet will saves major credit card companies more money than it saves an ISP.

The Insiders are buyers. Who would know a company better than insiders? No Wall Street analysts will get to understand the company better than insiders. They breathe the company day in and out. When insiders buy shares of a company, that signals the vote of confidence.

The Company is buying back shares. Another closest thing to insider buying is a company buying back its own shares. If a company has got to thing that its share price is cheap, then it should invest on itself, just like shareholders do. By buying back shares, the company is shrinking the number of shares available and thus, making the remaining shares more valuable.

That is the thirteen criteria of finding your next ten-baggers. If you look at all the criteria carefully, you realize that the companies in question need to be profitable and undervalued as well. With high wall street following, you will not find a deeply undervalued stocks. Also, if a company is not profitable, it cannot afford to buy back its own shares.

END

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding any securities.

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