This book is probably the most known work of investor and former portfolio manager of Fidelity Investment Management, Peter Lynch. Lynch is known for having championed the GARP method (Growth at Reasonable Price) in Equity Research.
This book is a good read for beginners and/or retail investors. It might not be an exciting read for practitioners for its apparent simplicity, but it can still be a good refresher for most, especially for the ones willing to explore different and new points of view on high-level stock research.
Another "negative" of this book is that it is quite outdated, as it was written in 1989 and only got a partial update in 2000. Nevertheless, it is still interesting to see how equity research has evolved over time and most importantly how a great investor like Lynch was thinking back then about stock picking.
The most useful take away from the first part of the book is probably the one that says that the "layman" will start talking about stocks at the moment when the market starts to become overvalued. This is a useful suggestion to keep in mind. This "rule of thumb" stems from behavioral finance, which suggests that individuals tend to look for confirmation of their own beliefs in other like-minded people and they tend to reinforce those beliefs in a feedback loop (also known as confirmation bias).
The most important tips come from Chapter Eight, where Lynch lays down his main investment philosophy for stock picking. For Lynch, a stock should have the following characteristics to be considered:
- It sounds dull. This means that management is not trying to impress potential investors by choosing an over-hyped name (i.e. some years ago a company changed its name to Long Blockchain Corp from Long Island Iced Tea Corp. at the top of the Bitcoin Bubble of 2018, with the sole purpose of getting more investors in from the hype).
- It does something dull. The rationale here is that investors often overlook boring businesses that have the potential to develop in a niche industry. AN example could be a vacuum cleaning company or a company specialized in the snow removal business.
- It does something disagreeable. This is actually the opposite of modern ESG investing trends, and readers should keep in mind that ESG concepts were non-existent before the 2010s. Lynch argues that some of the best deals are found in stocks associated with disagreeable businesses, like tobacco or funeral services, which might be overlooked by investors for moral reasons or just because there is social pressure to dislike the business itself.
- It is a spinoff. This is also a valid point these days. Lynch, who was wary of the merger frenzy of the sixties, saw spin-offs as a way to unleash hidden value in corporations, which could then specialize in their core business. Recently, Valuation guru Aswath Damodaran also argued against investing in companies dedicated to growth through acquisitions.
- It is ignored by institutional investors and analysts. This characteristic might be very difficult to find in stock in the overcrowded financial markets of our times, but the takeaway here is that the best deals are found away from the “hot stocks” of the moment.
- It can be in a no-growth industry. The rationale here is that companies in no-growth industries are pushed to improve themselves through cost-cutting and process improvement, rather than being lifted by the overall performance of their segment. Moreover, it is likely that companies in no-growth industries face considerably less competition with respect to companies in popular industries.
- It got a niche: a company focusing on a niche is more likely to have a “moat”, which is a competitive advantage that makes it difficult to be challenged by new entrants.
The customer needs to keep buying the product. With this suggestion, Lynch foresaw the appeal of subscription-based services and their impact on companies’ profitability and relative stability of earnings that we are witnessing in some companies (Netflix, Amazon Prime, low-cost annual Gym memberships).
Lynch argues that a company with steady cash flows coming from a loyal customer base, which keeps buying the product with consistency over time (in the book he makes the example of cigarette manufacturer Philip Morris) is preferable as an investment over a company with a fancy product that boosts sales in the short term but cannot keep up the hype over time.
This is just the first half of Lynch's useful stock-picking suggestions. Stay tuned for part II, which will further investigate Peter Lynch’s investment philosophy.
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