One Up on Wall Street
The small investor can have the upper hand against the ‘professionals’
That said, here are the 6 main lessons from this book.
Lesson 1: Why the individual investor can beat the pros
Surely the amateur doesn't stand a chance against the might of Wall Street?
Doesn't Wall Street have a ton of analysts from the fanciest Ivy League schools working 80 hours
every week to find bargain stocks?
Surely there can't be any left for the amateurs, right?
According to Peter Lynch this assumption is dead wrong.
In fact, the professional investor has many disadvantages compared to the amateur.
Here are a few of them:
Disadvantage 1: Size
A successful money manager will naturally attract a lot of capital, and more capital means less opportunities.
For instance, a $10 billion fund cannot invest in a company with a market cap of $10 million and expect the investment to have a meaningful impact on the fund's overall performance.
Disadvantage 2: Willingness to be average
There's a saying on Wall Street that "you'll never lose your job losing your clients money in an IBM."
Meaning that, they are more focused playing it safe to keep their job than they are willing to take risks to outperform.
Remember that fund managers have their own agendas, and that they too are employees with jobs that aren't guaranteed.
Disadvantage 3: There's a lot of explaining.
Fund managers tend to spend about 25% of their time explaining to various stakeholders about why they made certain decisions.
Unfortunately, stocks aren't sympathetic enough to yield an extra 25% for this increased effort.
Disadvantage 4: Capital is dependent on clients.
As a fund manager is investing other people's money, other people are also deciding how much money the manager has at disposal.
The issue is that these other people aren't savvy investors themselves.
They tend to pull back their money during bear markets and put in more of it during bulls, which is exactly the opposite of what one should do.
This leaves the manager with the following dilemma: he has a lot of money to invest when everything is expensive, and too little of it when everything is cheap.
Does the individual investor have any of these disadvantages?
In fact, the amateur investor often has a great advantage over the professionals, which we'll discuss in the next lesson.
Lesson 2: If you like the store, chances are you'll love the stock
If you're a software engineer, a cashier at the local mall, a professional musician, a surfer,
a fast-food addict or a crazy cat lady, you have an edge over Wall Street.
We all have certain industries, products and services that we know more about than the average person does.
Perhaps we know more about the fashion industry because we work at a local clothing store.
Or perhaps we know more about the gaming industry because we consume games ourselves as our primary leisure activity.
The point is that we all have valuable information about publicly listed companies through our everyday life, and this is information that Wall Street either doesn't know of yet, or had to spend hundreds of hours of market research to realize.
Peter Lynch famously said that "if you like the store, chances are that you'll love the stock."
Think about it! Which products do you enjoy and use from publicly listed companies?
When you're looking for investment opportunities this way you must always remember to check how much the product or service that you enjoy affects the bottom line for the company.
Lesson 3: The 6 categories of stock investments
All investment opportunities aren't created equal.
To lump them all together and treat them accordingly would be a foolish and not so profitable a strategy.
Peter Lynch argues that there are 6 different categories of stock investments:
Category 1: Slow growers
This company is typically large and operates in a mature industry.
The growth of the company is expected to be in the low single digits of percentages.
If you invest in such a company, you typically do it for the dividends.
Peter Lynch doesn't like this category of stocks too much, as he thinks that if the company isn't going anywhere fast, neither will its stock price.
Category 2: Stalwarts
The stalwarts are the inbetweeners.
They're not exactly the stock market's equivalent of cheetahs, but they are no snails either.
An earnings growth rate of 10-12% per year is standard for this category.
Under normal conditions you want to sell these companies off if they make a quick 30-50% gain.
Category 3: Fast growers
These are aggressive new enterprises, growing at 20% or more per year.
They're often priced much higher, but if you can conclude that a company is likely to be able to keep up the growth for several years, it can be a great investment.
Always remember to verify your assumptions regarding the growth rate though.
For instance – if Amazon can keep up its revenue growth rate of 30% per year for the next 10 years,
its revenue will be equal to the GDP of France in 2029!
Is this reasonable?
Category 4: Cyclicals
Cyclicals are companies whose revenues and profits rise and fall with the business cycle.
Typically, they produce services and/or products that the consumers will postpone consumption of in times of financial uncertainty.
An example are car companies.
People don't necessarily have to switch cars every 6 years or so, even if they prefer to.
Timing is everything here.
If you can identify early signs of a booming or busting cycle, you'll have the advantage.
Category 5: Turnarounds
The turnarounds are potential fatalities – companies with declining earnings and/or problematic balance sheets.
If the company doesn't go down and instead manages to flourish once again, stock owners are rewarded.
An interesting characteristic about turnaround companies, is that their ups and downs aren't as related to the market in general as the rest of the categories.
A situation where a company has gotten a temporary bad reputation is usually a profitable turnaround case.
Category 6: Asset plays
Situations where the value of the company indicates that the market has missed out on something valuable that the company owns are asset plays.
Such undervalued assets could be real estate, patents, natural resources, subscribers, or even company losses (as these are deductible from future earnings).
Benjamin Graham was a strong advocate of this approach.
He famously looked for companies where the value of the assets were higher than the market cap of the stock.
Then you just wait until the stock market realize its mistake and corrects itself.
When using these categories one must understand that companies can belong to more than one of them at once.
Also, companies don't stay in the same category forever. Take McDonald's for example. It's gone from being a fast grower ,to a stalwart, to an asset play to slow grower.
Lesson 4: 13 traits of the tenbagger
A tenbagger is the expression that Peter Lynch uses to describe a stock which has appreciated to ten times your purchasing price.
If you have a few of these you in you're investing lifetime, you'll become a legend.
Different types of stocks must be treated differently, as stated in the previous takeaway, but there are also similarities.
Here are 13 positive signs for a stock, regardless if it's an asset play or a fast grower:
- Sign 1: “It seems dull or ridiculous.”
- Sign 2: “It’s doing something boring.”
- Sign 3: “It’s doing something unpleasant.”
- Sign 4: “The institutions don’t control it. The market analysts don’t chase it.”
- Sign 5: “There’s something not good about it.”
- Sign 6: “It’s from a no-growth sector.”
- Sign 7: “It has a niche.”
- Sign 8: “People need to continue purchasing it.”
- Sign 9: “The buyers are insiders.”
- Sign 10: “The firm is doing share buy-backs.”
- Sign 11: “It’s a by-product”.
- Sign 12: “The rumors are many. For example. it’s involved with Mafia or toxic waste.”
- Sign 13: “It uses technology”.
Lesson 5: 5 traits of the reversed tenbagger
And of course, there are also general don'ts, that you don't want to see in any type of company that you are investing in.
Sign 1: It's in a hot industry
As previously mentioned, everyone is looking for ways to get into the hot industries.
Competition is typically a bad omen for profits as people will be willing to pay more in order to be a part of that industry and cmopany.
Sign 2: It's "the next" something
Beware when someone expresses that It's the next Amazon! The next Facebook! The next Google! Or similar.
Usually, it's not.
Sign 3: The company is diworseifying
Some call it diversification, but Lynch likes to refer to it as diworseification.
If the company is acquiring other companies in unrelated industries, stay away!
Sign 4: It's dependent on a single customer
Some companies are relying on one customer for a significant share of profits.
Usually, this is a weak bargaining position to be in, and the company can potentially be squeezed by this only customer.
Sign 5: It's a whisper stock
These are the long shots, often thought of as being on the brink of doing something miraculous, like curing every type of cancer, completely removing any addiction or creating world peace.
Lesson 6: The 12 main misconceptions people have about stocks.
The 12 main misconceptions people have about stocks include:
Myth 1: “It is already so down; it won’t go any lower”
You can never know the lowest point of stock like you can never know its pinnacle.
People who think they can are foolish.
Myth 2: “You can tell when a share hits rock-bottom”
Only because a stock has fallen to enormous levels, doesn’t imply it will not drop any further.
Myth 3: “If the stock is this high, then it won’t go any higher”
No artificial limit decides how high a stock may go.
Myth 4: “It is just $3 per share; how much can I lose?”
The clear answer is $3 per share.
Such a mindset is not right.
A loss, regardless of its size, is a loss.
You do not want to invest in losers.
Myth 5: “They will come back ultimately”
Some companies never return.
Myth 6: “The time before the dawn is always the darkest”
You require more solid grounds because things can get even darker.
Myth 7: “When it gets back to $10, I’ll sell”
You should try to sell immediately.
By setting artificial targets like this, the stock is unable ever to achieve it.
You may end up with under-performers for a long time.
Myth 8: “I don’t worry. Conservative stocks do not swing much”
It is possible for anything to swing these days.
There are no guarantees.
Don’t be content about your portfolio.
Myth 9: “It’s been so long, but nothing has happened”
The day after you are fed up with waiting and sell is going to be the day the prices soar.
Myth 10 “Look how much I’ve lost: I should have bought it earlier!”
You’ll not lose money if you postpone buying.
If you think like this, you’re likely to turn desperate and err.
Myth 11: “I should not have missed it. I’ll try to get the next one."
If you miss it, let it go.
Myth 12: “The stock’s high, so my predictions are right.”
Don’t ever decide on swings. Just because a stock changes, doesn’t imply your predictions were right or wrong.
Only time can tell this.
One up on Wall Street recap
The individual investor can beat the pros at their own game because the game is rigged in the favor of the amateur.
Use your consumption habits and your 9-5 to identify investing opportunities in companies where you have an edge over the rest of the investing community.
All investment opportunities aren't created equal.
You can usually categorize them into one or more of the following 6: slow growers, stalwarts, fast growers, cyclicals, turnarounds and/or asset plays.
There are general positive traits of a stock, such as a dull business, recurring revenues and insider buying.
Our Thoughts from More Money Malaysia
Although we do believe that investing in stocks yourself can be a very profitable thing to do, it can also be a very emotional thing to do.
It also requires a really good understanding of the company, but more importantly, yourself.
One Up on Wall Street does a great job showing you just how much basic information you will need in order to begin learning how to become a value investor.
However, if you're not interested in spending all the time and energy learning this, we suggest you go with investing in index funds or with a robo advisor.
Now that you know what the main lessons are in One Up on Wall Street, here is the only next steps.
- Determine whether you will spend the time required to learn value investing.
Learning value investing will take hours each day for the next year before you are ready to invest like a pro.
Are you willing to put that time in or would you rather spend your time doing other things?
If you are interested in learning value investing, then go through all our videos around investing and start reading the books.
Otherwise, invest using robo advisors or by yourself with index funds.