Book Review: One Up On Wall Street by Peter Lynch

The book One Up On Wall Street distills author Peter Lynch’s knowledge and expertise into a coherent investment strategy that can be used by the average investor. It contains golden nuggets of theoretical gems on how to pick winners, when to sell what you own and especially what to avoid.

If you can’t convince yourself when I’m down 25 per cent, I’m a buyer and banish forever the fatal thought: When I’m down 25 per cent, I’m a seller, then you’ll never make a decent profit in stocks.

Peter Lynch, One Up On Wall Street

But perhaps the most important are the author’s unique insights into how the typical investor thinks, invests and reacts. He gives plenty of anecdotally funny examples of the follies committed by the naïve investor.

Who’s Peter Lynch?

Peter Lynch was one of America’s number-one fund managers. He ran the Fidelity Magellan Fund from 1977 until 1990.  During his time, the Magellan Fund averaged a 29.2% annual return, the best 20-year return of any mutual fund ever (as of 2003). 

He also authored and co-authored many books on investing and business alike. It includes books such as Beating the Street, Learn to Earn, and One Up On Wall Street.

If I were to try to summarise his investment philosophy in one sentence, I would say it is value investing modified to target high-opportunity stocks or ten-baggers as he likes to call it. A ten-bagger is a stock in which you’ve made ten times your money.

What is the book about?

One up on Wall Street is mostly about opportunities and challenges an investor will come across in his lifetime. Peter Lynch uses his experience and wit to educate readers on how to find ten-baggers and when to say goodbye to your winners.

The common thread that connects all the knowledge in this book can be best summarised with a aphorism: Know what you own. He posits that if you don’t know why you bought the stock of a company in the first place, you’ll panic when the stock is down 30%? What do you do when that happens? Do you flip a coin? Do you pray? Go for a walk maybe?

Similarly, what do you do if the stock is up 30%? Do you sell or hold? You’re liable to sell your ten-bagger for a small return. If you don’t know the story you wouldn’t know what to do.

The trick here he says is to stick to your stocks as long as the fundamentals of the story haven’t changed.  The idea is here not to listen to your gut but rather to shut out the natural human tendency to panic and discipline yourself. 

One Up On Wall Street: Summary

The book is divided into three equally insightful and enjoyable parts:

  1. Preparing To Invest
  2. Picking Winners
  3. The Long Term View

1. Preparing To Invest

Peter Lynch had this to say to beginner investors:

It is personal preparation, as much as knowledge and research, that distinguishes the successful stock picker from the chronic loser. Because if you are undecided and lack conviction, then you are a potential market victim, who abandons all hope and reason at the worst moment and sells out at a loss. Ultimately it is not the stock market nor even the companies themselves that determine an investor’s fate. It is the investor.

Before investing, you want to answer three questions for yourself:

  • Do I own a house?
  • Do I need the money?
  • Do I have the personal qualities that will bring me success in stocks?

Firstly, he posits that a house is one investment where investors come ahead 99 times out of 100. The same cannot be said of stocks. So before you start investing in stocks consider buying a house.

The second thing to consider he says is to ask yourself when you need the money. If you need it within say two or three years, you may be better off holding it in a fixed or savings account. This is because even the best blue-chip stocks underperform for years especially if the market hits a downturn. Stocks are almost certain to work out over ten to twenty years but no one knows what the stock will do in a shorter timeline.

And finally, he believes that the qualities required of an investor that are most predictive of success in the market are patience, self-reliance, common sense, open-mindedness, persistence, humility, a tolerance for pain, detachment, a willingness to do independent research, an equal willingness to admit to mistakes, and the ability to ignore general panic.

2: Picking Winners

Winners are stocks in which you’ve made many times your money. For example, if you bought shares at NPR 100 and they increased to NPR 400, that would be considered a four-bagger. He says people will come across many ten-baggers (10x purchase price) in their lifetime and you don’t need a lot of them to be successful in the stock market.

He begins by saying that the best place to begin looking for the ten-baggers is close to home. These are companies you come across in your daily life and if you were paying attention, a few of them would turn out to be ten-baggers.

The core of idea here is to invest in things you know about. If you understand banking, then invest in bank stocks instead of chasing after hydro companies. Also, if you work in computers and you got a tip on a new computer stock, then you are better placed than most to analyse the stock and its future performance. That’s the professional’s edge. It also works in the opposite direction, if you’re a computer guy, you have no edge in the oil industry.

The next step is figure out what’s the story behind the stock? Once you come across a company, it’s time to investigate.

He suggest that most stocks fall under six categories:

The slow growers 

Slow growers are big established companies that grow along with the GDP at the GDP growth rate. Basically, mature companies that grow at 2 to 4 per cent a year.

His suggestion on slow growers is simple, avoid it because if companies aren’t going anywhere fast, neither will the price of their stocks. If growth in earnings is what enriches a company, then what’s the sense of wasting time on sluggards? 

These established companies usually pay a regular dividend and were fast growers of yester years. 

The Stalwarts

These would be your Coca-colas, Procter & Gamble or in Nepal’s context, CIT, NTC, BNL etc. would be considered stalwarts.  They are not exactly agile climbers, but they’re faster than slow growers. You can expect growth rates of around 10 to 12 per cent in gross earnings. Depending on when you buy and sell them, you can make a sizeable profit on stalwarts. 

Always keep some stalwarts in your portfolio because they offer good protection during recessions and hard times which are inevitable. 

The Fast Growers

Fast growers are small aggressive new enterprises that can grow 20 to 25 per cent a year and are the land of the 10 to 40 baggers. 

He argues that fast-growing companies don’t necessarily have to belong to a fast-growing industry. For example Marriot hotel grew 20 per cent when the hotel business only grew 2 per cent a year. They did this by capturing market share from their competitors. 

The same thing happened to Taco Bell in the fast-food business, Wal-Mart in the general store business, and The Gap in the retail clothing business.

Of course, they represent risk, fast growers go extinct or if they slow down a rapid devaluation of their stock is seen. As long as they can keep it up, fast growers are the big winners in the stock market. He suggests to look for ones that have good balance sheets and are making substantial profits. The trick is figuring out when they’ll stop growing, and how much to pay for the growth.

The Cyclicals 

He defines cyclicals as companies whose sales and profits rise and fall in a cyclical fashion.

Cyclicals are the most misunderstood of all the types of stocks. It is here that the unwary stockpicker is most easily parted from his money, and in stocks that he considers safe. Because the major cyclicals are large and well-known companies, they are naturally lumped together with the trusty stalwarts. You have to know that owning stalwarts is different from owning cyclicals.

He argues that timing is everything in cyclicals, and you have to be able to detect the early signs that business is falling off or picking up. If you work in some profession that’s connected to steel, aluminum, airlines, automobiles, etc., then you’ve got your edge, and nowhere is it more important than in this kind of investment.

The Turnarounds

Turnarounds are basically stocks that have managed to fixed their issues, increase earnings and are on the up and up. There are several different types of turnarounds.

The Asset Plays

An asset play is any company that’s sitting on something valuable that you know about, but that the crowd has overlooked. The asset may be as simple as a pile of cash. Sometimes it’s real estate or a monopoly. 

Asset opportunities are everywhere. Sure they require a working knowledge of the company that owns the assets, but once that’s understood, all you need is patience.

Highfliers to lowriders 

Companies don’t stay in the same category. Fast growers lead exciting lives and burn out or settle down into a comfortable stalwart or a sluggard. 

It’s time to sell you favourites when their stories start to change for the worse. 

Putting stocks into categories is how you start to develop a story. At least now you know what the story is supposed to be. The next step is filling in the details that will help you guess how the story is going to turn out.

3. The Long Term View

How much return do you expect to get?

Can you achieve a return of 30% every year? Yes, you may be able to get that return in some years, but most years, you’ll get returns in the 10%-15% and in some years negative returns. The idea is to be realistic of the returns one can expect to get in the stock market.

An investor who manages to make, say, 15 per cent over ten years when the market average is 10 per cent has done himself a considerable favour. If he started with NPR 100,000, a 15 per cent return will bring a NPR 404,550 result, and a 10 per cent return only NPR 259,370.

How many stocks is too many?

There are two schools of thought; one says to put all your eggs in one basket (concentration), the other says don’t put all your eggs in one basket, it may have a hole in it (diversification). 

The fund manager from Massachusetts recommends that it isn’t safe to own just one stock because, in spite of your best efforts, the one you choose might be the victim of unforeseen circumstances. In small portfolios, try owning between three and ten stocks. There are several possible benefits to doing this:

  • If you are looking for ten baggers, the more stocks you own the more likely that one of them will become a ten bagger. Among several fast growers that exhibit promising characteristics, the one that actually goes the furthest may be a surprise.
  • The more stocks you own, the more flexibility you have to rotate funds between them. This is an important part of his strategy.
Spreading it around

One way to minimise downside risk is spreading your money around several categories of stocks. Own a couple of stalwarts, slow growers to go with your fast growers and turnarounds. 

The way you build your portfolio will also depend on your age. Younger people with most of their income-earning years ahead of them can afford to take more chances on high growth and turnarounds while older people need the stability of the income from their investments.  

When to sell stocks from your portfolio?

For stocks in your portfolio, constantly check and recheck the stories, and add or subtract your investment accordingly. 

Instead of holding on to losers and selling your winners, or holding on to your winners and selling your losers, both of which has nothing to do with the future prospects of a company. He recommends a different approach: Rotate in and out of stocks depending on what has happened to the price as it relates to the story. 

For instance, if a stalwart has gone up 40 per cent which is all I expected to get out of it and nothing wonderful has happened with the company to make me think there are pleasant surprises ahead, I sell the stock and replace it with another stalwart I find attractive that hasn’t gone up. In the same situation, if you didn’t want to sell all of it, you could sell some of it. By successfully rotating in and out of several stalwarts for modest gains, you can get the same result as you would with a single big winner: six 30-per cent moves compounded equals a four-bagger plus, and six 25-per cent moves compounded is nearly a four-bagger.

For fast growers, keep them as long as earnings are growing, expansion is ongoing and no impediments have shown up. Check the story every few months or quarterly just as if you were hearing it for the first time. If between two fast growers you find that the price of one has increased 50 per cent and the story begins to sound dubious, rotate out of that one and add to your position in the second fast grower whose price has declined or stayed the same, and where the story is starting to sounding better.

On a final note, he argues that if you practice the approach of ‘sell when it’s double’, you would have never benefited from a big winner. Instead, he recommends investors to stick around as long as the original story continues to make sense or gets better, you’ll be amazed at the results in a few years. 

One Up On Wall Street: Strengths and Weaknesses

Among its strengths lies the fact that it is written keeping in mind how a typical investor makes investing decisions. The book does not dive into details on how to do valuations, calculate the intrinsic value or predict future earnings of stock, there are plenty of other resources that can help you do that. The retired fund manager instead focusses on what winning stocks all have in common, how to know when a winning streak is coming to an end, and more importantly how to block out the noise. In other words, what’s the story behind the stock. As an added bonus, the book is written in an easy to follow manner with plenty of real-life examples.

Many have argued that the book’s investment philosophy is outdated, but I disagree strongly. The book has never been about anything but a framework of thinking for investors. His unique insights into how an average person thinks about the stock market coupled with his own working framework for stock selection is what it’s all always been about. That is to say, until and unless, there is a monumental shift in how investors think, feel and react, this book will stay relevant. 

However, there is a point to be made against the book on how it lacks practical application of his theories. The book was never meant to be that. Nonetheless, he covers the practical application more extensively in his follow-up book, Beating the Street. 

Those who read this book expecting to find a prescriptive how-to invest will be disappointed as there’s no substitute for developing your own story.



Additional suggested reading:

Leave a Reply

Your email address will not be published. Required fields are marked *