Peter Lynch´s checklists for finding 10-baggers
A few weeks ago, I wrote about a study of ten baggers, and the week after, I wrote about how to find new cases with the ten baggers in mind. See my previous articles, How to find 10-baggers and 6 ways to find a new case!.
Let us dive into the creator of the 10-bagger investing philosophy, Peter Lynch’s two checklists from his book “One up on Wall Street.”
But first, for those who don’t know who Peter Lynch is. Peter Lynch is widely recognized as one of history's most successful fund managers. He spent over 25 years as the manager of the Fidelity Magellan Fund, which grew from $18 million to over $14 billion under his leadership. Lynch is known for his unconventional investing approach and ability to spot undervalued companies with significant growth potential. He also popularized investing in what you know and encouraged individual investors to do their own research and not rely solely on Wall Street analysts. Lynch's investment philosophy has influenced generations of investors, and his success has cemented his place as a legendary figure in the world of finance.
Lynch's approach was to invest in companies with strong growth potential and a track record of success. However, he was also known for his ability to spot opportunities in unconventional places. Here is his 13-point checklist:
It sounds dull or, even better, ridiculous
Peter Lynch did not shy away from investing in companies others found unappealing or uninteresting. A notable example was when he invested in a company that specialized in manufacturing chicken soup.
It does something dull
Dull companies that provided essential services were overlooked by other investors, resulting in a love valuation. For example, he invested in Waste Management, which provides garbage disposal services.
It does something disagreeable
Lynch was not afraid to invest in companies that were involved in controversial industries. For example, he invested in Philip Morris, a tobacco company.
It's a spinoff
He looked for opportunities in companies that were spun off from larger corporations. For example, he invested in the spinoff of General Motors' defense unit, which became known as General Dynamics.
The institutions don't own it, and the analysts don't follow it
Lynch looked for opportunities in companies that were undiscovered by the majority of the market, resulting in lower valuations. When institutions and analysts got around to looking at the company usually did result in a rapid share price increase.
The rumors abound: It's involved with toxic waste and/or the Mafia
He was not afraid to invest in companies that were the subject of a negative status, which some investors were too fancy to invest in. Also, such a business is nothing a Harvard MBA student dreams of disrupting.
There's something depressing about it
Lynch brought up Service Corporation Inc, funeral homes. Can it be more depressing? And the name gets an A on the first point.
It's a no-growth industry
Contrary to what many investors look for, high-growth markets, Lynch looks for no-growth industries. A no-growth market will keep investors out of its offering attractive valuations and keeps competition out.
It's got a niche
A niche can give a company a unique position in the market. Lynch exemplifies this with the gravel pit company. Essentially the gravel pit’s work gives it a small monopoly. It only needs to keep the prices to a certain level, so the nearest gravel pit has no profitability to compete in the same geographical area.
People have to keep buying it
Repeated purchases like drugs, soft drinks, razor blades, and cigarettes are a great business dynamic. With one-time purchase products, the company always needs to find new customers and invent new products to attract the old ones. Repeated purchases create higher stability and visibility in a company; therefore, SaaS companies are popular.
It's a user of technology
Lynch looked for opportunities in companies using technology to gain a competitive advantage. Technology companies often fall into a price war, undercutting each other until no profits are left in the market. Instead, buy companies that benefit, such as Automatic Data Processing, when the price of computers gets cheaper and thus increasing the profit margins.
The insiders are buyers
To quote Lynch:
There`s no better tip-off to the probable success of a stock than that people in the company are putting their own money into it.
Sitting in the same boat as the ones running the company is always a good position.
The company is buying back shares
Share buybacks can signal that a company believes its shares are undervalued and will result in higher earnings per share in the future, even if the profits stay the same.
In addition to his list of investment opportunities, Peter Lynch had a list of things to avoid. These were the types of investments that he believed were not likely to result in profitable returns for individual investors.
The hottest stock in the hottest industry
Lynch cautioned against investing in the hottest stock in the hottest industry because these investments are often overvalued when individual investors hear about them.
Beware the next something
Lynch also warned against investing in companies that were touted as the "next big thing," or the "next Microsoft," or the "next Google." These companies often fail to live up to the hype and can be risky investments.
Avoid diworseifications
The term "diworseification" was coined by Lynch to describe companies diversifying into unrelated industries to grow. He believed that such companies were often not well-managed and could end up losing money for investors.
Beware the whisper stock
Lynch cautioned against investing in recommended companies based on rumors or whispers. He believed these investments were often not well-researched and could result in losses for investors.
Beware the middleman
He did not like investing in companies acting as middlemen, such as distributors or wholesalers. He believed these companies often had low profit margins and could be easily disrupted by changes in the market.
Beware the stock with the exciting name
Finally, Lynch cautioned against investing in companies that had exciting or trendy names. He believed these companies were often not well-established and could be risky investments.
Conclusion
Peter Lynch stayed away from the stock discussed on CNN, social media, and the financial newspapers. He looks for undiscovered companies with boring names in industries that don´t invite more competition. He likes companies that are a spinoff from a bigger company, that have a niche, a repeatable purchase behavior, and are active in a no-growth market. Ha avoids companies that are the “Next X,” companies that diworseify and are recommended based on rumors or whispers.
It is a solid list of actionable points to bring to your investment strategy; I myself have a natural instinct to look away from a popular company. Sometimes it has helped me, and sometimes not.
What do you take with you? Have you read One up on Wall Street? If not, do it! I can’t recommend it enough!
As always, happy hunting!
P.S. a reminder for my readers in Stockholm. I have an event tomorrow, the 16th, at 18:00 at RoboMarkets office. I will present two investment cases, RoboMarkets will talk about their newly released ISK with USD, and there will be food and drinks.