Tag Archives: Investing

Peter Lynch’s Investing Maxims

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Here are several investing maxims that every investor should memorize and insight repeatably to pick winning stocks, according to Peter Lynch:

  1. A good company usually increases its dividend every year.
  2. You can lose money in a very short time; it takes a long time to make money.
  3. The stock market really is not a gamble; as long as you pick good companies that you think will do well and not because of the stock’s price.
  4. You can make a lot of money in the stock market; but then again, you can lose a lot of money.
  5. You have to research the company before you put your money into it.
  6. When you invest in the stock market, you should always diversify.
  7. You should invest in several stocks becasue for every five you pick, one will do very great, one will be very bad, and three will be okay.
  8. You should never fall in love with a stock…you should always have an open mind.
  9. You shouldn’t just pick a stock: you should do your homework.
  10. Buying stocks of utility companies is good because it gives you higher dividends, but you will make more money in growth stocks.
  11. Just because a stocks goes down doesn’t mean it can’t go lower.
  12. Over the long term, it is better to buy stocks in small companies.
  13. You should not buy a stock because it is cheap, but because you know a lot about it.

Look for shares that offer “growth at a reasonable price” which helps you to avoid two common investment mistakes:

  1. Either paying too much for fast-growing companies;
  2. Or buying seemingly cheap firms without realizing that they have stopped growing.

https://youtu.be/hKdtS_0vQ48

References:

  1. https://www.safalniveshak.com/value-investing-course-peter-lynch-way
  2. https://sites.google.com/site/changechina2050/investment/learn/peter-lynch-s-investment-rules

Financial Metrics for Evaluating a Stock

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“If you don’t study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards.” Peter Lynch

Anyone can be successful investing in the stock market. But, it does take thorough research, patience, discipline and resilience. And, it’s important to appreciate that “Behind every stock, there is a company. Find out what it’s doing”, says Peter Lynch, who managed the Fidelity Magellan Fund from 1977 to 1990 and achieved an impressive return which reportedly averaged over 20% per year.

With a long-term view to investing, Lynch would patiently wait for the company to become recognized by Wall Street for its growth, which subsequently unleashed an explosive rise in its stock price as smart money and institutional investors rush to buy stock.

In his book “One Up On Wall Street”, he reveals his principles and metrics for successful investing. Here are 11 financial metrics investors can utilize to evaluate a company’s value:

  1. Market Cap – Shows the current size and scale of the company. “If a picture is worth a thousand words, in business, so is a number.” Peter Lynch
  2. Strong Balance Sheet (Cash on Hand / Long Term Debt to Equity) – Shows how financially sound a business has become and its capacity to withstand an economic downturn. Determine if the company’s cash has been increasing and long term debt has been decreasing?
  3. Sales and Earnings Growth Rates – Shows if the business model works & current growth rate
  4. Free Cash Flow – Shows if company generating or burning through cash
  5. Returns on Capital (ROE / ROIC / ROA)- shows capital efficiency of business
  6. Margins (Gross Profit Margin / Operating Margin / Profit Margin / Net Income) – Shows current profit profile of products, spending rates, & potential for operating leverage
  7. Total Addressable Market – What is market size and long term growth potential for the company.
  8. Long Term (5+ years) Stock Performance vs. market – has the stock created or destroyed value for shareholders. “In the long run, it’s not just how much money you make that will determine your future prosperity. It’s how much of that money you put to work by saving it and investing it.” Petere Lynch
  9. Current Valuation (Price to Sales / Price to Earnings / Price to Book / Price to FCF) – How expensive or inexpensive is the stock price.or is the company reasonably priced. “If you can follow only one bit of data, follow the earnings (assuming the company in question has earnings). I subscribe to the crusty notion that sooner or later earnings make or break an investment in equities. What the stock price does today, tomorrow, or next week is only a distraction.” Peter Lynch
  10. Mission and Vision Statement – Understand why the company exist.  What is it doing. “Behind every stock is a company. Find out what it’s doing.” Peter Lynch
  11. Insider Ownership – Do insiders have skin in the game. SEC Filings. Information available on proxy statement.

Additionally, it is important to figure out:

  1. What is changing
  2. What is not changing
  3. Is there an underappreciation for either. “Your investor’s edge is not something you get from Wall Street experts. It’s something you already have. You can outperform the experts if you use your edge by investing in companies or industries you already understand.” Peter Lynch

Do that well, move on #3, you’re the best investor in the world.

As an investor, unless you understand the underlying business of a company, you will not be able to hold its stock when the price is falling. You could end up selling a great company out of fear – even though its price will recover in the future and give you great returns in the years to come. The ability to hold a good company even when its stock price is falling or undergoing a time correction – will play a crucial role in you becoming a successful investor.

In the long run, the stock price will go up only if the business of the company does well.

In Peter Lynch’s own words “I think you have to learn that there’s a company behind every stock, and that there’s only one real reason why stocks go up. Companies go from doing poorly to doing well or small companies grow to large companies”

If you like a stock, buy small quantity of shares. Study the company in more detail. Buy more shares if you like its business. As your understanding of the business increases, your conviction (confidence) will also increase, this will allow you to give higher allocation in your portfolio.

Categories of Stocks in the Stock Market

Peter Lynch divided different stocks into six categories

Slow Growers – Slow growers are those stocks that have a slow growth rate i.e. a low upward slope of earnings and revenue growth.These slow growers can be characterized by the size and generosity of their dividend. According to Peter Lynch, the only reason to buy these stocks are dividends.

The Stalwarts – The Stalwarts have an average growth rate as that of industry and are usually mid to large companies. They have an earnings growth between the 8-12 percent CAGR range. According to Peter Lynch, investors can get an adequate return from these stocks if they hold these stocks for a long time.

The Fast Growers – The fast growers are generally aggressive companies and they grow at an impressive rate of 15-25% per year. They are fast-growth stocks and grow at a comparatively faster rate compared to the industry average and competitors. However, Peter Lynch advises that one should be open-eyed when they own a fast grower. There is a great likelihood for the fast growers to get hammered if they run out of steam or if their growth is not sustainable.

The Cyclicals – Cyclical are stocks that grow at a very fast pace during their favorable economic cycle. The cyclical companies tend to flourish when coming out of a recession into a vigorous economy. Peter Lynch advises investors to own the cyclical only on the right part of the cycle i.e. when they are expanding. If bought at the wrong phase, it may even take them years before they perform. Timing is everything while investing in cyclical stocks.

The Turnarounds – The turnarounds are characterized as potential fatalities that have been badly hammered by the market for one or more of a variety of reasons but can make up the lost ground under the correct circumstances. Holding turnarounds can be very profitable if the management is able to turn the company as these stocks can be bought at a very low valuation by the investors. However, if the management fails to bring back the company on track, it can be very troublesome for the investors.

Asset Plays – Asset Plays are those stocks whose assets are overlooked by the market and are undervalued. These assets may be properties, equipment, or other real assets that the company is holding but which is not valued by the investors when there has been a general market downturn. The real value may be worth more than the market capitalization of the company. Peter Lynch suggests owning a few of these stocks in your portfolio as they are most likely to add a lot of value to your portfolio. However, the biggest significant factor while picking these stocks is to carefully estimate the right worth of the assets. If you are able to do it, you can pick valuable gems.

“Average investors can become experts in their own field and can pick winning stocks as effectively as Wall Street professionals by doing just a little research.” Peter Lynch

Infinity income – When your income from investments is higher than your expenses, you might be able to live off those returns for 10 years, 30 years, 50 years… or forever!

References:

  1. https://stockinvestingtoday.blog/the-investing-style-of-peter-lynch?
  2. https://www.thebalance.com/peter-lynch-s-secret-formula-for-valuing-a-stock-s-growth-3973486
  3. https://goldenfs.org/wp-content/uploads/2020/12/summary-One-Up-On-Wall-Street-Peter-Lynch-2-scaled.jpg

Four Secret to Investing Outperformance – Motley Foolo

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“The average investor’s portfolio lags the performance of the S&P 500 by nearly 4 percentage points.”

The average retail investor’s portfolio lags the performance of the S&P 500 by nearly 4 percentage points, a DALBAR study shows. The lag is a result of bad behaviors by investors because investors jumped into funds when they were already at a high mark—with lower returns in their future—and dumped funds when they were on the way down, without waiting for a rebound.

The returns received by investors vs. returns earned by funds based on Morningstar data

There are four secrets to outperformance, according to Motley Fool, and the secrets are simpler than you might expect.

  • You take market returns – According to a 2020 study by financial research company Dalbar, average investors earned about 5% annual growth in their accounts over the last 30 years. That’s roughly half the average growth rate of the S&P 500 in the same time frame. You can avoid lagging the S&P 500 index by 4% to 5%. If you invest in S&P 500 index funds, you should see performance that’s only a fraction below the index.
  • You stay calm – The Dalbar report finds that 70% of the average investors’ underperformance occurred in volatile markets. Specifically, most of the investors who performed the worst sold their securities when the market was in crisis. Had they held on to those investments, they would have ultimately fared better. The takeaway here is it’s usually best to stay calm and stay invested.
  • Selectively, you do the opposite of the crowd – When everyone else is selling, it’s often a good time to buy. By following best practices such as not investing in a downturn unless your finances are in order; not expecting a quick return; and investing in a “quality” stock of an established company with low or manageable debt, experienced leadership, and consistent cash flows and profits.
  • You buy and hold  – The Dalbar report also concludes that a buy-and-hold strategy with the S&P 500 would have returned more than the average investor’s portfolio. Buy-and-hold investing is the practice of investing in stocks and funds that you intend to keep for years or decades. To implement this approach, pick quality stocks or funds and hold them indefinitely. You might sell if the company changes in some fundamental way, but you won’t sell because the market’s having a temporary crisis.

Hopefully, these four secrets to beating the average investor sound easy. They are, as long as you can resist making emotional decisions.

The average investor can get anxious about market volatility, and that’s often when shortsighted decisions are made. Even investors who can tune out market noise sometimes find it hard to avoid tinkering with a portfolio that doesn’t seem to be growing as anticipated.

When it comes to investing, patience is a virtue.

References:

  1. https://investor.vanguard.com/investing/portfolio-management/performance-overview
  2. https://www.fool.com/investing/2021/07/22/4-secrets-to-beating-the-average-investor/

Loss of Purchasing Power: Is $1 million enough for retirement?

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“One million dollars doesn’t buy as many Cadillac Escalades as it used to.”

Today, $1 million no longer buys as many McDonald’s Big Mac sandwiches or Rolex Submariner watches or Ford F150 trucks as it once did thirty years ago.  There’s a good reason for that called ‘loss of purchasing power’ which is a byproduct of inflation. That’s because $1 million of purchasing power in 1970 was the equivalent of nearly seven million dollars today, according to Motley Fool. And as recently as 1990, a million dollars has lost half its buying power since then, meaning you’d need two million today to have the same buying power as you did in 1990.

As a result of normal inflation and loss of purchasing power, $1 million retirement nest egg today definitely will not offer you as comfortable a retirement lifestyle as it did a few years ago or a few decades ago.

Retirement is not an age, but a number

Financial preparedness is more important than reaching a certain retirement age. And, to answer the question of whether $1 million or any amount of money is enough for retirement, the answer depends on what you want your retirement to look like.

It’s important to ensure you have enough savings and income to sustain your spending and lifestyle in retirement. If you don’t have enough money set aside to pay for your retirement, then you may have to delay retiring. And no matter where you are on your retirement journey, you can make your financial number. No matter how little you have or how much time you have left until you want to retire, you can always improve your financial situation. Getting started and creating a retirement plan can carry you a long way.

A 2018 Northwestern Mutual study found that one in three Americans has less than $5,000 saved up for retirement, and 21% of Americans have no retirement savings at all. Overall, Americans are feeling underprepared and less confident regarding the financial realities of retirement, according to the data.

Despite these findings regarding the woeful retirement savings rate by Americans, it’s still not too late to enjoy the kind of life you’ve worked so hard for… and the retirement you deserve.

One of the most important goals for Ameriocans facing retirement is knowing that they can sustain their desired level of spending and lifestyle throughout their lives, with a sense of financial peace of mind and without the fear of running out of money.  For our purposes, financial peace of mind is the knowledge that, no matter your level of savings or degree of market volatility, you are confident that you are unlikely to run out of money during retirement to support your level of spending and  lifestyle.

Taking the financial road less traveled

Conventional wisdom recommend that older Americans should reduce their stock allocation in retirement and move into more safe investments such as bonds and cash.  Although this may seem the less risky road to take in your retirement years, a few experts do not agree.  If you expect to maintain your purchasing power into future, you must stay invested in stocks.

“The idea that a 60-year-old retiree should be investing primarily in conservative investments is an antiquated way of approaching personal finance”, says Jake Loescher, financial advisor, at Savant Capital Management in a 2017 U.S. News article. “Historically, the rule of thumb stated that an individual should take the number 100, subtract their age, which will define the amount of stocks someone should have in their portfolio. For a 60-year-old, this obviously would mean 40 percent stocks is an appropriate amount of risk.”

“A better approach would be to perform a risk assessment and consider first how much risk an individual needs to take based on their personal circumstances,” Loescher says.

According to the article, there are five circumstances when retirees should eskew conventionl wisdom:

  1. The likelihood you’ll live into your 90s or beyond. Since life expectancy is much longer these days and in today’s low-interest environment, you face an increase risk of your nest egg not keeping up with inflation over the long haul.
  2. If you don’t have enough cash for retirement. If you didn’t accumulate enough retirement assets to sustain an expected lifestyle, it becomes essential to decide how much capital in a retirement portfolio you’re willing to risk for the potential upside appreciation.
  3. When interest rates are low. Low interest rates makes the capital risk seem greater than the value bonds might provide due to a loss of purchasing power.  Taking a total-return approach, using low volatility, dividend-paying stocks to replace part of our typical bond component seems the best approach.
  4. If you have estate planning needs. If you don’t depend totally on your investments for income, then your money may be providing a bequest for charity or an inheritance for children.
  5. For historical purposes. The stock market has outperformed all other asset classes over the last century.

In retrospect, retirees will need to allocate a certain portion of their assets to higher-return equity investments to achieve long-term retirement objectives – be it longevity of assets, a desired level of sustainable income, the ability to leave a legacy, etc.

Essentially, the stock market has outperformed all other asset classes over the last century. And studies continue to show that unless you are within three years of retirement, the average variability of stocks relative to their returns is superior to that of Treasurys, municipal and corporate bonds.  Thus, the right course of action is for older Americans to stay invested in the stock market past age 60 which will provide you at least 20 years, on average, to ride out the long-term volatility inherent in equities.

References:

  1. https://www.fool.com/ext-content/is-1-million-enough-for-retirement/
  2. https://www.pimco.com/en-us/insights/investment-strategies/featured-solutions/worried-about-retirement-pimcos-plan-to-help-retirement-savings-last-a-lifetime
  3. https://money.usnews.com/investing/articles/2017-07-24/5-reasons-to-stay-in-the-stock-market-in-your-60s
  4. https://www.pimco.com/en-us/insights/investment-strategies/featured-solutions/income-to-outcome-pimcos-retirement-framework
  5. https://money.usnews.com/money/blogs/on-retirement/2011/03/22/why-retirement-is-not-an-age

Staying Invested in the Stock Market

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“The stock market is the only market where the goods go on sale and everyone becomes too afraid to buy.”  Nerd Wallet

When the market dips even a few percent, as it often does, many retail investors become fearful and sell in a panic, according to Nerd Wallet. Yet when stock prices rise, investors beomce greedy and plunge in headlong which is the perfect definition for “buying high and selling low.”

Here are the three popular fairytales investors tell themselves regarding investing:

  1. Wait until the stock market is safe to invest – This excuse is used by investors after stocks have declined, when they’re too afraid to buy into the market. But when investors say they’re waiting for it to be safe, they mean they’re waiting for prices to climb. So waiting for (the perception of) safety is just a way to end up paying higher prices, and indeed it is often merely a perception of safety that investors are paying for. Fear drives the behavior and psychologists call this behavior “myopic loss aversion.” That is, investors would rather avoid a short-term loss at any cost than achieve a longer-term gain.
  2. Buy back in next week when the stock market is lower – This excuse is used by would-be buyers as they wait for the stock to drop. But as the data shows, investors never know which way stocks will move on any given day, especially in the short term. Both fear and greed drive this behavior. The fearful investor may worry the stock is going to fall and waits, while the greedy investor expects a fall but wants to try to get a much better price.
  3. Bored with this stock, so I’m selling – This excuse is used by investors who need excitement from their investments. But smart successful investing is actually boring. The best investors sit on their stocks for years and years, letting them compound gains. All the gains come while you wait, not while you’re trading in and out of the market. Investor’s desire for excitement drives this behavior.

The key to long term investment success is creating a plan, sticking to the plan and remaining in the stock market through “thick and thin”. Your length of “time in the market” is the best predictor of your investing performance. Unfortunately, investors often move in and out of the stock market at the worst possible times, missing out on performance and annual return.

“The secret to making money in stocks? Staying invested long-term, through good times and bad.”  Nerd Wallet

In a nutshell, more time in the stock market equals more opportunity for your investments to increase in value. The best companies tend to increase their revenue and profits over time, and investors reward these greater earnings with a higher stock price. That higher price translates into a higher total return for patient and disciplined investors who own the stock.

References:

  1. https://www.nerdwallet.com/article/investing/make-money-in-stocks

The Biggest Mistakes Individual Investors Make

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“The public’s careful when they buy a house, when they buy a refrigerator, when they buy a car. They’ll work hours to save a hundred dollars on a roundtrip air ticket. They’ll put $5,000 or $10,000 on some zany idea they heard on the bus. That’s gambling. That’s not investing. That’s not research. That’s just total speculation.” Peter Lynch

For the 13 years, Peter Lynch ran Fidelity’s Magellan® Fund (1977–1990). During his tenure, he earned a reputation as a top performer, increasing assets under management from $18 million to $14 billion. He beat the S&P 500 in all but two of those years. He averaged annual returns of 29% which means that $1 grew to more than $27.

Additionally, Lynch has authored several top-selling books on investing, including One Up on Wall Street and Beating the Street. He has a plain-spoken manner and offers wisdom on investing that can help you become a better investor.

To become a successful investor, you really need to “have faith that 10 years, 20 years, 30 years from now common stocks are the place to be”, according to Lynch. “If you believe in that, you should have some money in equity funds.”

Yet, “there will still be declines”, Lynch says. “It might be tomorrow. It might be a year from now. Who knows when it’s going to happen? The question is: Are you ready—do you have the stomach for this?”

Long term, the stock market has been a very good place for investors to employ their money and capital. But whether the market will be 30% higher or lower in 2 years from now…nobody knows. “But more people have lost money waiting for corrections and anticipating corrections than in the actual corrections”, according to Lynch. “I mean, trying to predict market highs and lows is not productive.”

“In the stock market, the most important organ is the stomach. It’s not the brain.” Peter Lynch

Theoretically, in Lynch’s opinion, the individual investor has an edge versus the professional in finding winning companies (“10-baggers”) that will go up 4- or 10- or 20-fold. They have the opportunity to see breakthroughs, company’s fundamentals get better, and analyze companies way ahead of most people. That’s an edge and you need an edge on something to find the hidden gems.

“The problem with most individual investors is people have so many biases. They won’t look at a railroad, an oil company, a steel company. They’re only going to look at companies growing 40% a year. They won’t look at turnarounds. Or companies with unions.” Thus, individual investors miss great opportunities in overlooked industries or unjustly beaten down companies to chase hot growth stocks.

“But my system for over 30 years has been this: When stocks are attractive, you buy them. Sure, they can go lower. I’ve bought stocks at $12 that went to $2, but then they later went to $30.” Peter Lynch

“You have to really be agnostic” to pick winners and to invest in a company poised for a rebound, according to Lynch.

“Stocks aren’t lottery tickets. Behind every stock is a company. If the company does well, over time the stocks do well.” Peter Lynch

Peter Lynch’s eight simple investing principles for long term investors are:

  1. Know what you own – Few individual investors actually do their research. And, almost every investor is guilty of jumping into a stock they know very little about.
  2. It’s futile to predict the economy and interest rates (so don’t waste time trying) – The U.S. economy is an extraordinarily complex system. Trying to time the market is futile. Set up a financial plan that allocates your assets based on your risk tolerance, so that you can sleep at night.
  3. You have plenty of time to identify and recognize exceptional companies – You don’t need to immediately jump into the hot stock. There’s plenty of time to do your research first.
  4. Avoid long shots – Lynch states that he was 0-for-25 in investing in companies that had no revenue but a great story. Make sure the risk-reward trade-off on an unproven company is worth it.
  5. Good management is very important; good businesses matter more – “Go for a business that any idiot can run – because sooner or later, any idiot is probably going to run it.”
  6. Be flexible and humble, and learn from mistakes – “In this business, if you’re good, you’re right six times out of 10. You’re never going to be right nine times out of 10.” You’re going to be wrong. Diversification and the ability to honestly analyze your mistakes are your best tools to minimize the damage.
  7. Before you make a purchase, you should be able to explain why you’re buying – You should be able to explain your thesis in three sentences or less. And in terms an 11-year-old could understand. Once this simply stated thesis starts breaking down, it’s time to sell.
  8. There’s always something to worry about. – There are plenty of world events for investors to fear, but past investors have survived a Great Depression, 911 terrorist attack, two world wars, an oil crisis, 2007 financial crisis, and double-digit inflation. Always remember, if your worst fears come true, there’ll be a heck of a lot more to worry about than some stock market losses.

Finally, in the words of Peter Lynch…”You can lose money in the short term, but you need the long term to make money.”

References:

  1. https://investinganswers.com/articles/51-peter-lynch-quotes-empower-your-investing
  2. https://www.fidelity.com/viewpoints/investing-ideas/peter-lynch-investment-strategy
  3. https://www.fool.com/investing/general/2010/05/21/how-peter-lynch-destroyed-the-market.aspx
  4. https://www.fidelity.com/viewpoints/investing-ideas/peter-lynch-investment-strategy

The Psychology Behind Your Worst Investment Decisions | Kiplinger Magazine

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“When it comes to investing, we have met the enemy, and it’s us.” Kiplinger Magazine

Excited by profit and terrified of loss, we let our emotions and minds trick us into making terrible investing decisions, writes Katherine Reynolds Lewis of Kiplinger Magazine.

Most individual investors allow their emotions to dictate their investment decisions. Effectively, there are two types of emotional reactions the average investor can experience:

Fear of Missing Out (FOMO). These investors will chase stocks that appear to be doing well, for fear of missing out on making money. This leads to speculation without regard for the underlying investment strategy. Investors can’t afford to get caught up in the “next big craze,” or they might be left holding valueless stocks when the craze subsides.

  • Fear of Missing Out (FOMO) can lead to speculative decision-making in emerging areas that are not yet established.
  • Fear of Losing Everything (FOLE) is a more powerful emotion that comes from the fear that they will lose all of their investment.

Acording to a 2021 Dalbar study of investor behavior, Dalbar found that individual fund investors consistently underperformed the market over the 20 years ending Dec. 31, 2020, generating a 5.96% average annualized return compared with 7.43% for the S&P 500 and 8.29% for the Global Equity Index 100.

“As humans, we’re wired to act opposite to our interests,” says Sunit Bhalla, a certified financial planner in Fort Collins, Colo. “We should be selling high and buying low, but our mind is telling us to buy when things are high and sell when they’re going down. It’s the classic fear-versus- greed fight we have in our brains.”

Avoiding these seven “emotional and behaviorial” investing traps will allow you to make rational investments.

  1. Fear of Missing Out – Like sheep, investors often take their cues from other investors and sometimes follow one another right over a market cliff. This herd mentality stems from a fear of missing out.  The remedy: By the time you invest in whatever is trending, it’s too late because professional investors trade the instant that news breaks. Individual investors should buy and sell based on the fundamentals of an investment, not the hype.
  2. Overconfidence – Some investors tend to overestimate their abilities. They believe they know better than everyone else about what the market is going to do next, says Aradhana Kejriwal, chartered financial analyst and founder of Practical Investment Consulting in Atlanta. “We want to believe we know the future. Our brains crave certainty.” The remedy: To combat overconfidence, build in a delay before you buy or sell an investment so that the decision is made rationally.
  3. Living in an Echo Chamber – Overconfidence sometimes goes hand in hand with confirmation bias, which is the tendency to seek out only information that confirms our beliefs. If we think an asset holds promise for riches, news about people making money sticks in our minds more than negative news, which we tend to dismiss. The remedy: To counteract this bias, actively seek out information that contradicts your thesis.
  4. Loss Aversion – Our brains feel pain more strongly than they experience pleasure. As a result, we tend to act more irrationally to avoid losses than we do to pursue gains. The remedy: Stock market losses, however, are inevitable.If seeing the losses pile up in a down market is too hard for you, simply don’t look. Have faith in your long-term investing strategy, and check your portfolio less often.
  5. No Patience for Sitting Idly By – As humans, we’re wired for action. That compulsion to act is known as action bias, and it’s one reason individual investors can’t outperform the market — we tend to trade too often. Doing so not only incurs trading fees and commissions, which eat into returns, but more often than not, we realize losses and miss out on potential gains. The remedy: Investors need to play the long game. Resist trading just for the sake of making a decision, and just buy and hold instead.
  6. Gambler’s Fallacy – “This is the tendency to overweight the probability of an event because it hasn’t recently occurred,” says Vicki Bogan, associate professor at Cornell University. Over time, the probability of equities having an up year or a down year is about the same, regardless of the previous year’s performance. That’s true for individual stocks as well. The remedy: When stocks go down, don’t just assume they’ll come back up. “You should be doing some analysis to see what’s going on,” Bogan says.
  7. Recency Bias – Past performance is no guarantee of future results. Yet, our minds tell us something different. “Most people think what has happened recently will continue to happen,” Bhalla says. It’s why investors will plow more money into a soaring stock market, when in fact they should be selling at least some of those appreciated shares. And if markets plummet, our brains tell us to run for the exits instead of buying when share prices are down.The remedy: You can combat this impulse by creating a solid, balanced portfolio and rebalancing it every six  months. That way, you sell the assets that have climbed and buy the ones that have fallen. “It forces us to act opposite to what our minds are telling us,” he says.

It is wise to always keep in mind that the market is volatile as a result of investors’ emotions and behaviors, and thus does not move logically.

References:

  1. https://www.kiplinger.com/investing/603153/the-psychology-behind-your-worst-investment-decisions

by: Katherine Reynolds Lewis – July 22, 2021

Price Line vs. Earnings Line

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“A quick way to tell if a stock is overpriced is to compare the price line to the earnings line. If you bought familiar growth companies – such as Shoney’s, The Limited, or Marriott – when the stock price fell well below the earnings line, and sold them when the stock price rose dramatically above it, the chances are you’d do pretty well.” Peter Lynch

As the former head of Fidelity’s flagship Magellan Fund, Peter Lynch produced an annualized rate of return of 29.2% over his 13-year stint at the helm. This track record has arguably placed him as the best mutual fund manager of all time.

In his best-selling book, “One Up On Wall Street,” Lynch revealed a powerful charting tool, called the “Peter Lynch chart,” that greatly simplified his investment decisions. This simple graph plots the stock price against its “earnings line,” a theoretical price equal to 15 times the earnings per share.

When a stock trades well below its earnings line, you should buy, according to Lynch’s theory. When it rises above its earnings line, you should sell. For example, the Wal-Mart Stores (ticker: WMT ) share-price line fell below the Lynch line at about $55 in March 2010. It didn’t climb back over the Lynch line until June 2012, when shares were $67.50. Had you bought the first crossover and sold the second, you would have gained $12.50 a share, or about 23%.

The idea behind this technique is simple. Lynch believe that mature, stable companies are worth roughly 15 times their annual earnings. And over the last 135 years, this has proven to be the mean valuation of the S&P 500 index.

This is known as a the P/E ratio. It is merely the price of the stock divided by its earnings per share. The resulting multiple represents how many times you are paying for last year’s earnings at today’s stock price.

All things being equal, the lower the number the better. Low P/E ratios mean that you are getting more earnings for your investment dollar. And since most large cap stocks eventually trade for at least 15 times earnings, you are more likely to see your shares appreciate as they return to the 15 P/E level.

This simple idea was the basis of Lynch’s investment approach and the reason he created the chart whichconsists of only two lines. The first is the stock price. The second is the hypothetical stock price if it were to trade at a P/E of 15 (the earnings line).

It is a well-known fact among experienced investors that a stock’s price follows its earnings. Over multi-year periods, stock prices move in sync with changing company earnings.

But over the short term, stock prices are unpredictable. This is what creates valuable opportunities for savvy and patience investors.

Furthermore, a good rule of thumb is that the P/E ratio of any fairly valued company will equal its earnings growth rate. A company with a P/E ratio that is half its growth rate is very positive. A company with a P/E ratio that is twice its growth rate is deemed negative.

Thirteen attributes you should investigate for in a stock with the potential for 10x growth, according to Peter Lynch:

  1. The company name is dull or ridiculous.
  2. The company does something dull and boring
  3. The company does something disagreeable or disgusting.
  4. The company is a spin-off like the Baby Bells.
  5. Institutions don’t own it and analysts don’t follow it.
  6. There are negative rumors about it, like Waste Management.
  7. There is something depressing about it such as SRB, which provides burial services.
  8. That it is a company in a no growth industry, since it’s in a non competitive business.
  9. It has a niche such as drug companies.
  10. People have to keep buying the products such as drugs, food and cigarettes.
  11. The company is the user of technology such as Domino’s.
  12. The company insiders are buyers of the stock.
  13. The company is buying back its shares.

Best stocks to avoid is the hottest stock in the hottest industry. Negative growth industries do not attract competitors. Additionally, avoid companies with excessive debt on its balance sheet and invest in companies that have little or no debt.

The debt must always be lower than the equity. If the company has a debt lower than 50% of the equity, it is considered to be in a good financial position. If it is lower than 25%, it’s excellent. When the debt is above 75% of the equity, it is recommended to avoid that company.

References:

  1. https://finance.yahoo.com/news/peter-lynch-earned-29-13-231636799.html
  2. https://tofinancialfreedom.co/en/one-up-on-wall-street-summary-book/
  3. https://www.forbes.com/sites/investor/2021/04/16/lynchs-one-up-on-wall-street-inspired-screening-strategy/

Investing Truths by Peter Lynch

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“Wisdom acquisition is a moral duty. It’s not something you do just to advance in life. Wisdom acquisition is a moral duty. As a corollary to that proposition which is very important, it means that you are hooked for lifetime learning. And without lifetime learning, you are not going to do very well.”  Charlie Munger

Peter Lynch stressed the importance of looking at the underlying business enterprise strength, which he believed eventually shows up in the company’s long-term stock price performance. Also, pay a reasonable price relative to the company’s market value.

Here are important investing truths from Peter Lynch:

  1. Know what you own and be able to explain why you own it.  Only buy what you understand. ” Never invest in any company before you’ve done the homework on the company’s earnings prospects, financial condition, competitive position, plans for expansion, and so forth.”
  2. Compounding of capital and principal takes time. Be patient, because most great wealth from the stock market is built over decades. “Often, there is no correlation between success of a company’s operations and the success of its stock over a few months or even years. In the long term, there is 100% correlation between the success of the company and the success of the stock. This disparity is the key to making money; it pays to be patient and to own successful companies.”
  3. Simple is usually better than complex and smart. “If you’re prepared to invest in a company, then you ought to be able to explain why in simple language that a fifth grader could understand, and quickly enough so the fifth grader won’t get bored.”
  4. Volatility of the stock market is guaranteed. “You’ve got to look in the mirror every day and say: What am I going to do if the market goes down 10%? What do I do if it goes down 20%? Am I going to sell? Am I going to get out? If that’s your answer, you should consider reducing your stock holdings today.”
  5. Finding undervalued companies selling below their intrinsic value is a lot harder today. “A stock-market decline is as routine as a January blizzard in Colorado. If you’re prepared, it can’t hurt you. A decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm in panic.”
  6. Start early and at a very eary age. Invest for the long term…stocks are relatively predictable over 10-20 years. “Time is on your side when you own shares of superior companies. You can afford to be patient – even if you missed Walmart (WMT, Financial) in the first five years, it was a great stock to own in the next five years. Time is against you when you own options.”
  7. Focus on the company behind the stock. Do not become overly attached to a stock. “Although it’s easy to forget sometimes, a share is not a lottery ticket…it’s part-ownership of a business.”
  8. Don’t try to predict the market. “Nobody can predict the interest rates, the future direction of the economy, or the stock market. Dismiss all such forecasts and concentrate on what‘s actually happening to the companies in which you’ve invested.”
  9. Study history. Market crashes are great opportunities. “During the Gold Rush, most would-be miners lost money, but people who sold them picks, shovels, tents, and blue-jeans (Levi Strauss) made a nice profit. Today, you can look for non-internet companies that indirectly benefit from internet traffic (package delivery is an obvious example); or you can invest in manufacturers of switches and related gizmos that keep the traffic moving.”
  10. It’s very tough for a company to go bankrupt if a company has more cash than debt or if they do not have debt. “The real key to making money in stocks is not to get scared out of them.”
  11. When you own stocks, it will alwalys be scary due to volatility and there is always something to worry about.  Everyone is a long term investor until stocks go down. “There is always something to worry about. Avoid weekend thinking and ignore the latest dire predictions of newscasters. Sell a stock because the company’s fundamentals deteriorate, not because the sky is falling.”
  12. When yields on long-term government bonds exceed the dividend yields of the S&P 500 by 6% or more, sell stocks and buy bonds. ““In the long run, a portfolio of well-chosen stocks and/or equity mutual funds will always outperform a portfolio of bonds or a money-market account. In the long run, a portfolio of poorly chosen stocks won’t outperform the money left under the mattress.”

Emotions can be a real performance killer according to Lynch, if market drops get you selling out in a panic, or market surges have you greedily snapping up overvalued shares. The best investors will do the opposite.

“The single greatest edge an investor can have is a long-term orientation.” Seth Klarman

References:

  1. https://www.investopedia.com/articles/stocks/06/peterlynch.asp
  2. https://www.fool.com/retirement/2020/04/07/9-investing-tips-from-peter-lynch-that-you-shouldn.aspx
  3. https://www.gurufocus.com/news/341584/peter-lynch-golden-rules-for-investing-
  4. https://www.valuewalk.com/2015/07/peter-lynchs-investing-principles-and-25-golden-rules/
  5. https://www.suredividend.com/peter-lynch-investing-lessons/

The Importance of Return on Equity

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ROE measures how much profit a company generates per dollar of shareholders’ equity.

Return on equity (ROE) is a must-know financial ratio. It is one of many numbers investors can use to measure return and support investing decision. It measures how many dollars of profit are generated by a company’s management for each dollar of shareholder’s equity.

The metric reveals just how well the company utilizes its equity to generate profits.  It reveals the company’s efficiency at turning shareholder investments into profits and explains, mathematically, the ratio of a company’s net income relative to its shareholder equity.

ROE is very useful for comparing the performance of similar companies in the same industry and can show you which are making most efficient use of their (and by extension investors’) money.

Billionaire investor Warren Buffett uses ROE as part of his investment decision making process. Buffet cares deeply about a company that uses its money wisely and efficiently. He believes that a successful stock investment is a result first and foremost of the underlying business; its value to the owner comes primarily from its ability to generate earnings at an increasing rate each year.

Buffett examines management’s use of owner’s equity, looking for management that has proven it is able to employ equity in new moneymaking ventures, or for stock buybacks when they offer a greater return.

What is ROE

Return on equity is a ratio of a public company’s net income to its shareholders’ equity, or the value of the company’s assets minus its liabilities. This is known as shareholders’ equity because it is the amount that would be divided up among those who held its stock if a company closed.

The basic formula for calculating ROE simply is to divide net income from a given period by shareholder equity. The net earnings can be found on the earnings statement from the company’s most recent annual report, and the shareholder equity will be listed on the company’s balance sheet. The specific ROE formula looks like this:

ROE = (Net Earnings / Shareholders’ Equity) x 100 or EPS / Book Value

“ROE tells you how good or bad management is doing with your investment,” says Mike Bailey, director of research at FBB Capital Partners in Bethesda, Maryland. “Higher ROEs generally stem from profitable businesses that enjoy competitive advantages within a given industry.”

A high ROE doesn’t always mean management is efficiently generating profits. ROE can be affected by the amount that a company borrows.

Increasing debt can cause ROE to grow even when management is not necessarily getting better at generating profit. Share buybacks and asset write-downs may also cause ROE to rise when the company’s profit is declining.

On the other hand, idle cash in excess of what the business needs to continue operations reduces the apparent profitability of the company when measured by return on equity. Distributing idle cash to shareholders is an effective way to boost its return on equity.

Key Takeaway

Return on Equity measures how efficiently a company generates net income based on each dollar invested by company’s shareholders.

A steady or increasing ROE is a company that knows how to successfully reinvest their earnings. This is important because most companies retain their earnings in the equity of the business.

A declining ROE is symbolic of executive management that is unable to successfully reinvest their capital in income producing assets. Companies like this should elect to pay most of their earnings to shareholders as dividends.

References:

  1. https://smartasset.com/investing/return-on-equity
  2. https://www.forbes.com/advisor/investing/roe-return-on-equity/
  3. https://www.nasdaq.com/articles/5-ways-improve-return-equity-2015-01-21
  4. https://money.usnews.com/investing/articles/what-is-return-on-equity-the-ultimate-guide-to-roe