One Up on Wall Street

My key takeaways from this book on how to build a ‘Multibagger’ stock portfolio

Photo by Olia Gozha on Unsplash

This book is one of the highly recommended books for those who are stock market enthusiasts and let’s dive deeper into why is it so. So firstly the author of the book, Peter Lynch who averaged a 29.2% annualised return making his fund one of the best performing mutual funds in this world. He shares with us his experiences and takes from the market and how to pick up value stocks. Here are my few takeaways and learnings:

• First and foremost, do not believe in stock news and advisors, it is highly probable that they might be wrong. Avoid the hottest stock in the industry. Do your own analysis.
• Next, make sure to pass the mirror test before you invest which says: 1) Do I own a house? 2) Do I need the money and what are my short term and long term goals? 3) Do I have the personal qualities it takes to succeed?
• You and I can never time the markets.
• He has divided the companies into 6 major types: 1) Slow growers: Companies with a spurt in growth and have now slowed down. These offer low risk and low gain. 2) Stalwarts: Companies faster than slow growers but you make sizeable profits depending on entry and exit points. These offer low risk, moderate gains. 3) Fast growers: Companies with aggressive growth rates with around 20–25% growth. 4) Cyclicals: Companies that are directly dependent on cyclical commodities. These offer low risk, high gain or high risk, low gain. 5) Turnaround: Companies with huge turnaround potential. 6) Asset plays: Companies sitting over huge unrealised assets. These offer low risk, high gains.
• Often there are winning stocks around you, you just need to be observant.
• Don’t invest in things you don’t understand. (If I don’t really understand the banking business, I will stay away from it)
• Often small companies might be able to give you sizeable profits.
• Avoid companies with high institutional holdings.
• If a good company is buying back its own shares, it's a good sign. Also if insiders are buying, it also signifies a good sign. On the other hand, dilution is not a good sign.
• Watch out for company growth and not stock price growth.
• If some other company can replicate the products well, start paying extra attention and head out.
• Emphasise whether a company is diversifying its prospects or “diworseifying” (investing in subsidiaries with no good potential or stepping and continuing with the business that isn’t performing well).
• Now coming to a few important financial ratios to be checked. Check if the P/E (Price to Earnings Ratio) isn’t too high and compare it with competitors as well. See if the company is working on increasing future earnings (there can be several ways such as closing down non-profitable stores, it need not be a bad sign at times). P/E ratio can be thought of as the number of years taken to earn back the initial investment. P/E tends to get high for fast growers and slow for stalwarts and slow growers.
• The best way to learn about a company is to call up their Investor Relations and bombard them with your questions, ask them about the future prospects, talk about positives, negatives and anything & everything you want (Highly possible that they won’t lie).
• Next, compare sales and check if the most loved products have a sizeable contribution to revenue. Also, compare if the Same Store Sales is increasing or decreasing. Growth and expansion are two different concepts. (Fast expansion doesn't always signify high growth)
• If the P/E ratio is half the growth then it is at a very attractive value

• If 1 then poor, if 1.5 then it is good and if it is above 2, it is at a very attractive valuation.
• Check the Debt to Equity ratio and see the type of debt a company has. High debt is very risky.
• Check how the dividend is distributed, how often it is distributed and if it is consistent. (If you are buying a stock for dividend purposes)
• Compare book value with the actual value of assets. (At times book value may value the assets at a higher price than they actually value, say if the assets have depreciated tremendously during bankruptcy, there is a high chance of you losing the capital, overvalued assets are treacherous if the debt is high)
• Always calculate FREE CASH FLOW to get the actual cash position of a company. More the free cash flow, the better it is.
• Avoid companies with high capital expenditure.
• Check Profit Before Tax. (compare within industries and not one industry with another)
• Stay away from companies with growing debts.
• Make sure to check quarterly, half-yearly and annual reports.
• Check how the companies fared during tough times such as recessions, wars and so on.

Now moving on to an important aspect. Each company goes through 3 phases 1) Startup phase- Companies work around their basic business model, it is highly risky because most of the companies go bankrupt during this time. 2) Rapid expansion: A company successfully replicates its success. 3) Mature phase: Here a company faces limitations and can’t expand that easily. Looking through this phase, you can analyse the companies’ position at a better level.

Moving on to the next part, we often get too emotionally connected to a winner and at times we are in denial to let go of a loser. Think rationally, observe the fundamental situation of a company before taking a stand.

Identifying the perfect stock or a perfect company isn’t an easy process, it’s a long process and a tedious task which requires a lot of patience. But with a fair judgement and right call, one can eventually make a strong winning portfolio.