【Book Summary】 One Up on Wall Street by Peter Lynch

Details

Title: One Up on Wall Street
Author: Peter Lynch
ISBN-13: 978-0-7432-0040-0
Published Date: 1989

Author

Peter Lynch (born January 19, 1944) is an American investor, mutual fund manager, and philanthropist. As the manager of the Magellan Fund at Fidelity Investments between 1977 and 1990, Lynch averaged a 29.2% annual return, consistently more than double the S&P 500 stock market index and making it the best-performing mutual fund in the world. During his 13-year tenure, assets under management increased from US$18 million to $14 billion.

Source: Wikipedia

One Up on Wall Street

Introduction

The Advantages of Dumb Money

Stop listening to professionals! Any normal person using the customary three percent of the brain can pick stocks just as well, if not better, than the average Wall Street expert. This include listening to Peter Lynch himself because:
1. he might be wrong;
2. even if he’s right, you’ll never know when he’s changed his mind about a stock and sold;
3. you’ve got better sources, and they’re all around you.
Nothing wrong with mutual funds. Mutual funds are a wonderful invention for people who have neither the time nor the inclination to test their wits against the stock market, as well as for people with small amounts of money to invest who seek diversification.
People seem more comfortable investing in something about which they are entirely ignorant.
Finding a promising company is only the first step. The next step is doing the research.

Part 1: Preparing to Invest

How to assess yourself as a stock picker, how to size up the competition (portfolio managers, institutional investors, and other Wall Street experts), how to evaluate whether stocks are riskier than bonds, how to examine your financial needs, and how to develop a successful stock picking routine.

Before you think about buying stocks, you ought to have made some basic decisions about the market, about how much you trust corporate America, about whether you need to invest in stocks and what you expect to get out of them, about whether you are a short or long-term investor, and about how you will react to sudden, unexpected, and severe drops in price. It’s best to define your objectives and clarify your attitudes (do I really think stocks are riskier than bonds?) beforehand, 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. It is personal preparation, as much as knowledge and research, that distinguishes the successful stock picker from the chronicle loser. Ultimately it is not the stock market nor even the companies themselves that determine an investor’s fate. It is the investors.

1. The Making of a Stockpicker

Peter Lynch’s life story of how he started investing and that he was not a born stock market picker.
One can find and receive stocks from anywhere and that best education is not necessary.

2. The Wall Street Oxymorons

Important for amateurs to view a profession with a properly skeptical eye.
The concept of “Street Lag” is professionals wait for others to make the first move; a stock isn’t truly attractive until a number of large institutions have recognized its suitability and an equal number of respected Wall Street analysts have put it on the recommended list.
Whenever fund managers do decide to buy something exciting, they are held back by various written rules and regulations.
You don’t have to invest like an institution. If you invest like an institution, you’re doomed to perform like one, which in many cases isn’t very well. Nor do you have to force yourself to think like an amateur if you already are one.
You can find terrific opportunities in the neighborhood or at the workspace, months or even years before the news has reached analysts and the fund managers they advise.
Maybe you shouldn’t have anything to do with the stock market, ever. The stock market demands conviction as surely as it victimizes the unconvinced.

3. Is This Gambling, or What?

After the Hiccup of Last October (Black Monday-Monday, Oct. 19, 1987), some investors have taken refuge in bonds. When the stock market is dropping and people rush to the banks to sign up for CDs.
Investing in bonds, money-markets, or CDs are all different forms of investing in debt-for which one is paid interest.
Long-term U.S. Treasury bonds (T-bonds) are the best way to play interest rates because they aren’t “callable”-or at least not until five years prior to maturity. Many corporate municipal bonds are callable much sooner, which means the debtors buy them back the minute it’s advantageous to do so. As soon as interest rates begins to fall, causing bond investors to realize they’ve stuck a shrewd bargain, the deal is canceled and they get their money back.
Historically, investing in stocks is undeniably more profitable than investing in debt. You’ll never get a tenbagger in a bond-unless you’re a debt sleuth who specializes in bonds in default.
Stocks are embraced as investments or dismissed as gambles in routine and circular fashion, and usually at the wrong times. Stocks are most likely to be accepted as prudent at the moment they’re not.
If seven out of ten of my stocks perform as expected, then I’m delighted. If six out of ten of my stocks perform as expected, then I’m thankful. Six out of ten is all it takes to produce an enviable record on Wall Street.

4. Passing the Mirror Test

Before you buy a share of anything, there are three personal issues that ought to be addressed:
1. Do I own a house?
2. Do I need the money?
3. Do I have the personal qualities that will bring me success in stocks?

Do I Own a House?

Consider buying a house, since a house, after all, is the one good investment that almost every-one manages to make. In 99 cases out of 100, a house will be a money-maker.
It’s no accident that people who are geniuses in their houses are idiots in their stocks. A house is entirely rigged in the homeowner’s favor. The banks let you acquire it for 20 percent down and in some cases less, giving you the remarkable power of leverage.
Houses, like stocks, are most likely to be profitable when they’re held for a long period of time.
No wonder people make money in the real estate market and lose money in the stock market. They spend months choosing their houses, and minutes choosing their stocks.

Do I Need the Money?

Stocks are relatively predictable over ten to twenty years. As to whether they’re going to be higher or lower in two or three years, you might as well flip a coin to decide.
Only invest what you could afford to lose without that loss having any effect on your daily life in the foreseeable future.

Do I Have the Personal Qualities it Takes to Succeed?

Patience, self-reliance, common sense, a tolerance for pain, open-mindedness, detachment, persistence, humility, flexibility, a willingness to do independent research, an equal willingness to admit to mistakes, and the ability to ignore general panic.
Important to be able to make decisions without complete or perfect information. Things are almost never clear on Wall Street, or when they are, then it’s too late to profit from them.
It’s crucial to be able to resist your human nature and your “gut feelings.”

5. Is This a Good Market? Please Don’t Ask

The stock market is in in some way related to the general economy, one way that people try to outguess the market is to predict inflation and recessions, booms and busts, and the direction of interest rates. True, there is a wonderful correlation between interest rates and the stock market, but who can foretell interest rates with any bankable regularity?
If professional economists can’t predict economies and professional forecasters can’t predict markets, then what chance does the amateur investor have?
I don’t believe in predicting markets. I believe in buying great companies-especially companies that are undervalued, and/or underappreciated.

Part 1 Following Points

Don’t overestimate the skill and wisdom of professionals.
Take advantage of what you already know.
Look for opportunities that haven’t yet been discovered and certified by Wall Street-companies that are “off the radar scope.”
Invest in a house before you invest in a stock.
Invest in companies, not in the stock market.
Ignore short-term fluctuations.
Large profits can be made in common stocks.
Large losses can be made in common stocks.
Predicting the economy is futile.
Predicting the short-term direction of the stock market is futile.
The long-term returns from stocks are both relatively predictable and also far superior to the long-term returns from bonds.
Keeping up with a company in which you own stock is like playing an endless stud-poker hand.
Common stocks aren’t for everyone, nor even for all phases of a person’s life.
The average person is exposed to interesting local companies and products years before the professionals.
Having an edge will help you make money in stocks.
In the stock market, one in the hand is worth ten in the bush.

Part 2: Picking Winners

How to find the promising opportunities, what to look for in a company and what to avoid, how to make use of the various numbers (p/e ratio, book value, cash flow) that are often mentioned in the technical evaluations of stocks.

In this section we’ll discuss how to exploit an edge, how to find the most promising investments, how to evaluate what you own and what you can expect to gain each of six different categories of stocks, the characteristics of the perfect company, the characteristics of companies that should be avoided at all costs, the importance of earnings to the eventual success or failure of any stock, the questions to ask in researching a stock, how to monitor a company’s progress, how to get the facts, and how to evaluate the important benchmarks, such as cash, debt, price/earning ratios, profit margins, book values, and dividends. etc.

6. Stalking the Tenbagger

The best place to begin looking for the tenbagger is close to home-if not in the backyard then down at the shopping mall, and especially whenever you happen to work. The average person comes across a likely prospect two or three times a year, sometimes more.
One is a professional’s understanding of the workings of an industry; the other is a consumer’s awareness of a likable product.
Professional’s edge is especially helpful in knowing when and when not to buy shares in companies that have been around awhile, especially those in the so-called cyclical industries. You’ll be in a position to know that no new competitors have entered the market and now new plants are under construction. All this means higher profits for existing companies that make the product.
There’s the consumer’s edge that’s helpful in picking out the winners from the newer and smaller fast-growing companies, especially in the retail trades.
Whichever edge applies, the exciting part is that you can develop your own stock detection system outside the normal channels of Wall Street, where you’ll always get the news late.

7. I’ve Got It, I’ve Got It-What Is It?

However a stock has come to your attention, the discovery is not a buy signal. Treat the initial information (whatever brought this company to your attention) as if it were an anonymous and intriguing tip. This will keep you from buying a stock just because you’ve seen something you like, or worse, because of the reputation of the tipper.
Investing without research is like playing stud poker and never looking at the cards.
The size of a company has a great deal to do with what you can expect to get out of the stock. Big companies don’t have big stock moves. In certain markets they perform well, but you’ll get your biggest moves in smaller companies.
Once I’ve established the size of the company relative to others in a particular industry, next I place it into one of six general categories:
- Sluggards (Slow Growers)
- Stalwarts (Medium Growers)
- Fast Growers
- Cyclicals
- Asset Plays
- Turnarounds
Companies don’t stay in the same category forever.

The Sluggards (Slow Growers)

More or less in line with the nation’s Gross National Product (GNP), which lately has averaged about three percent a year.
Usually large and aging companies are expected to grow slightly faster than the GNP. When an industry at large slows down (as they always seem to do), most of the companies within the industry lose momentum as well.
Sooner or later every popular fast-growing industry becomes a slow-growing industry, and numerous analysts and prognosticators are fooled.
Another sure sign of slow growers is that is pays a generous and regular dividend. Companies pay generous dividends when they can’t dream up new ways to use the money to expand the business.
Won’t find a lot of two to four percent grower in my portfolio, because if companies aren’t growing anywhere fast, neither will the price of their stocks.

The Stalwarts (Medium Growers)

10 to 12 percent annual growth in earnings.
Multi Billion-dollar hulks are not exactly agile climbers, but they’re faster than slow growers.
Stalwarts are stocks that I generally buy for a 30 to 50 percent gain, then sell and repeat the process with similar issues that haven’t yet been appreciated.
I always keep some stalwarts in my portfolio because they offer pretty good protection during recessions and hard times.

The Fast Growers

Sometimes as much as 20 to 30 percent a year or more. That’s where you find the most explosive stocks.
A fast-growing company doesn’t necessarily have to belong to a fast-growing industry. All it needs is the room to expand within a slow-growing industry.
While the smaller fast growers risk extinction, the larger fast growers risk a rapid devaluation when they begin to falter.
I look for the 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

A company whose sales and profits rise and fall in regular if not completely predictable fashion. It expands and contracts, then expands and contracts again.
Timing is everything in cyclicals, and you have to be able to detect the early signs that business is falling off or picking up.

The Turnarounds

Have been battered, depressed, and often can barely drag themselves into Chapter 11. These aren’t slow growers; these are no growers. These aren’t cyclicals that rebound; these are potential fatalities.
Turnaround stocks make up lost ground very quickly. The best thing about investing in a successful turnarounds is that of all the categories of stocks, their ups and downs are least related to the general market. Occasional major success makes the turnaround business very exciting, and very rewarding overall.
There are several different types of turnarounds:
- bail-us-out-or-else: whole thing depended on a government loan guarantee
- who-would-have-thunk-it: who would ever have believed you could lose this much money
- little-problem-we-didn’t-anticipate: a minor tragedy perceived to be worse than it was, and in minor tragedy there’s a major problem
- perfectly-good-company-inside-a-bankrupt-company: spun out on its own, away from its less successful parent
- restructuring-maximize-shareholder-values: company’s way of ridding itself of certain unprofitable subsidiaries it should never acquired in the first place

The Asset Plays

Any company that’s sitting on something valuable that you know about, but that the Wall Street crowd has overlooked.
The asset plays is where the local edge can be used to greatest advantage. 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.

8. The Perfect Stock, What a Deal!

If it’s a choice between owning a stock in a fine company with excellent management in a highly competitive and complex industry, or a humdrum company with mediocre management in a simpleminded industry with no competition, I’d take the latter.

(1) It Sounds Dull-Or Even Better, Ridiculous

The perfect stock would be attached to the perfect company, and the perfect company has to be engaged in a perfectly simple business, and the perfectly simple business ought to have a perfectly boring name, the more boring it is, the better.
If you discover an opportunity early enough, you probably get a few dollars off the price just for the dull or odd name.

(2) It Does Something Dull

A company that does boring things is almost as good as a company that has a boring name, and both together are terrific. Both together are guaranteed to keep the oxymorons away until finally the food news compels them to buy in, this sending the stock price even higher.
If a company with terrific earnings and a strong balance sheet also does dull things, it gives you a lot of time to purchase the stock at a discount. Then when it becomes trendy and overpriced, you can sell your shares to the trend-followers.

(3) It Does Something Disagreeable

Better than boring alone is a stock that’s boring and disgusting at the same time. Something that makes people shrug, retch, or turn away in disgust is ideal.

(4) It’s A Spinoff

Spinoffs of divisions or parts of companies into separate, freestanding entities-often result in astoundingly lucrative investments.
Large parent companies do not want to spin off divisions and then see those spinoffs get into trouble, because that would bring embarrassing publicity that would reflect back on the parents. Therefore, the spinoffs normally have strong balance sheets and are well-prepared to succeed as independent entities. And once these companies are granted their independence, the new management, free to run its own show, can cut costs and take creative measures that improve the near-term and long-term earnings.
Spinoff companies are often misunderstood and get little attention from Wall Street. Investors often are sent shares in the newly created company as a bonus or a dividend for owning the parent company, and institutions, especially, tend to dismiss these shares as pocket change or found money. These are favorable omens for the spinoff stocks.
If you hear about a spinoff, or if you’re sent a few fractions of shares in some newly created company, begin an immediate investigation into buying more. A month of two after the spinoff is completed, you can check to see if there is heavy insider buying among the new officers and directors. This will confirm that they, too, believe in the company’s prospects.

(5) The Institutions Don’t Own It, And The Analysts Don’t Follow It

If you find a stock with little or no institutional ownership, you’ve found a potential winner. Find a company that no analysts has ever visited, or that no analyst would admit to knowing about, and you’ve got a double winner.

(6) The Rumors Around: It’s Involved With Toxic Waste And/Or the Mafia

If there’s anything that disturbs people more than animal casings, grease and dirty oil, it’s sewage and toxic waste dumps.

(7) There’s Something Depressing About It

If there’s anything Wall Street would rather ignore besides toxic waste, it’s mortality.

(8) It’s A No-Growth Industry

Many people prefer to invest in a high-growth industry, where there’s a lot of sound and fury. Not me. I prefer to invest in a low-growth industry like plastic knives and forks, but only if I can’t find a no-growth industry like funerals. That’s where the biggest winners are developed.
In a no-growth industry, especially one that’s boring and upsets people, there’s no problem with competition. You don’t have to protect your flank from potential rivals because nobody else is going to be interested. This gives you the leeway to continue to grow, to gain market share.

(9) It’s Got A Niche

Drug companies and chemical companies have niche-products that no one else is allowed to make. Once a patent is approved, all the rival companies with billions in research dollars can’t invade the territory. They have to invent a different drug, prove it is different, and then go through three years of clinical trials before the government will let them sell it.

(10) People Have To Keep Buying It

I’d rather invest in a company that makes drugs, soft drinks, razor blades, or cigarettes than in a company that makes toys.

(11) It’s A User Of Technology

Instead of investing in computer companies that struggle to survive in an endless price war, why not invest in a company that benefits from the price war? Or instead of investing in a company that makes automatic scanners, why not invest in the supermarkets that install the scanners?

(12) The Insiders Are Buying

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.
When insiders are buying like crazy, you can be certain that, at a minimum, the company will not go bankrupt in the next six months. When insiders are buying, I’d bet there aren’t three companies in history that have gone bankrupt near term.
Long term, there’s another important benefit. When management owns stock, then rewarding the shareholders becomes a first priority, whereas when management simply collects a paycheck, then increasing salaries becomes a first priority.
Every time an officer or a director buys or sells shares, he or she has to declare it on Form 4 and send the form to the Securities and Exchange Commission advising them of the fact.

(13) The Company Is Buying Back Shares

Buying back shares is the simplest and best way a company can reward its investors. If a company has faith in its own future, then why shouldn’t it invest in itself, just as the shareholders do?
When stock is bought in by the company, it is taken out of circulation, therefore shrinking the number of outstanding shares. This can have a magical effect on earnings per share, which in turn has a magical effect on the stock price. If a company buys back half its shares and its overall earnings stay the same, the earnings per share have been doubled.
The common alternatives to buying shares are:
- (1) raising the dividend,
- (2) developing new products,
- (3) starting new operations, and
- (4) making acquisitions.

9. Stocks I’d Avoid

If I could avoid a single stock, it would be the hottest stock in the hottest industry, the one that gets the most favorable publicity, the one that every investor hears about in the car pool or on the commuter train-and succumbing to the social pressure, often buys.
Hot stocks can go up fast, usually out of sight of any of the unknown landmarks of value, but since there’s nothing but hope and thin air to support them, they fall just as quickly. If you aren’t clever at selling hot stocks (and the fact that you’ve bought them is a clue that you won’t be), you’ll soon see your profits turn into losses, because when the price falls, it’s not going to fall slowly, not is it likely to stop at the level where you jumped on.
High growth and hot industries attract a very smart crowd that want to get into the business. Entrepreneurs and venture capitalists stay awake nights trying to figure out how to get into the act as quickly as possible.
When people tout a stock as the next of something, it often marks the end of prosperity not only for the imitator but also for the original to which it is being compared.
Instead of buying back shares or rising dividends, profitable companies often prefer to blow the money on foolish acquisitions. The dedicated diworseifier seeks out merchandise that is:
- (1) overpriced, and
- (2) completely beyond his or her realm of understanding.
These frequent episodes of acquiring and regretting, only to invest and acquire and regret once again, could be applauded as a form of transfer payment from the shareholders of the large and cash-rich corporation to the shareholders of the smaller entity being taken over, since the large corporations so often overpay.
If a company must acquire something, I’d prefer it to be a related business, but acquisitions in general make me nervous. There’s a strong tendency for companies that are flush with cash and feeling powerful to overpay for acquisitions, except too much from them, and then mismanage them. I’d rather see a vigorous buyback of shares which is the purest synergy of all.
Often the whisper companies are on the brink of solving the latest national problem the oil shortage, drug addictions, AIDS. The solution is either:
- (a) very imaginative, or
- (b) impressively complicated.
IPOs of brand-new enterprises are very risky because there’s so little to go on. I’ve done better with IPOs of companies that have been spun out of other companies, or in related situations where the new entity actually has a track record.
Companies that sell 25 to 50 percent of its wares to a single customer are in a precarious situation. Short of cancellation, the big customer has incredible leverage in extracting price cuts and other concessions that will reduce the supplier’s profit.
As often as a dull name in a good company keeps early buyers away, a flashy name in a mediocre company attracts investors and gives them a false sense of security.

10. Earnings, Earnings, Earnings

Although it’s easy to forget sometimes, a share of stock is not a lottery ticket. It’s part ownership of a business.
If you were a stock, your earnings and assets would determine how much an investor would be willing to pay for a percentage of your action.
Any serious discussion of earnings involves the price/earnings ratio-also known as the p/e ratio, the price-earning multiple, or simply, the multiple. This ratio is a numerical shorthand of the relationship between the stock price and the earnings of the company. Like the earnings line, the p/e ratio is often a useful measure of whether any stock is overpriced, fairly priced, or underpriced relative to a company’s money-making potential.
The p/e ratio can be thought of as the number of years it will take the company to earn back the amount of your initial investment-assuming, of course, that the company’s earnings stay constant.
Before you buy a stock, you might want to track its p/e ratio back several years to get sense of its normal levels.
A company with a high p/e ratio must have incredible earning growth to justify the high price that’s been put on the stock.
The stock market as a whole has its own collective p/e ratio, which is a good indicator of whether the market at large is overvalued or undervalued.
Interest rates have a large effect on the prevailing p/e ratios, since investors pay more for stocks when interest rates are low and bonds are less attractive.
Earnings, after all, are supposed to grow, and every stock price carries with it a built-in growth assumption.
There are five basic ways a company can increase earnings: reduce costs; raise prices; expand into new markets; sell more of its product in the old markets; or revitalize, close, or otherwise dispose of a losing operation.
- A company’s earnings is what it makes every year after all expenses and taxes are taken out. A dividend is what it pays out to stockholders on a regular basis as their share of the profits. A company may have terrific earnings and yet pay no dividend at all.

11. The Two-Minute Drill

Before buying a stock, I like to be able to give a two-minute monologue that covers the reasons I’m interested in it, what has to happen for the company to succeed, and the pitfalls that stand in its path. Here are some of the topics that might be addressed in the monologue:
- If it’s a slow-growing company you’re thinking about presumably you’re in it for the dividend. Therefore the important elements of the script would be:
  
  This company has increased earnings every year for the last ten, it offers an attractive yield, it’s never reduced or suspended a dividend, and in fact, it’s raised the dividend during good times and bad, including the last three recessions. it’s a telephone utility, and the new cellular operations may add a substantial kicker to the growth rate.
- If it’s a cyclical company you’re thinking about, then your script revolves around business conditions, inventories, and prices.
  
  There has been a three-year business slump in the auto industry, but this year things have turned around. I know that because car sales are up across the board for the first time in recent memory. I notice that GM’s new models are selling well, and in the last eighteen months the company has closed five inefficient plants, cut twenty percent off labor costs, and earnings are about to turn sharply higher.
- If it’s an asset play, then what are the assets, how much are they worth?
  
  The stock sells for $8, but the videocassette division alone is worth $4 a share and the real estate is worth $7. That’s a bargain in itself, and I’m getting the rest of the company for a minus $3. Insiders are buying, and the company has steady earnings, and there’s no debt to speak of.
- If it’s a turnaround, then has the company gone about improving its fortunes, and is the plan working so far?
  
  General Mills has made great progress in curing its diworsification. It’s gone from eleven basic businesses to two. By selling off Eddie Bauer, Talbot’s, Kenner, and Parker Brothers and getting top dollar for these excellent companies, General Mills has returned to doing what it does best: restaurants and packaged foods. The company has been buying back millions of its shares, The seafood subsidiary, Gortons, has grown from 7 percent of the seafood market to 25 percent. They are coming out with low-cal yogurt, no-cholesterol Bisquick, and microwave brownies. Earnings are up sharply.
- It it’s a stalwart, then the key issues are the p/e ratio, whether the stock already has had a dramatic run-up in price in recent months, and what, if anything, to accelerate the growth rate. You might say to yourself:
  
  Coca-Cola is selling at the low end of its p/e range. The stock hasn’t gone anywhere for two years. The company has improved itself in several ways. It sold half its interest in Columbia Pictures to the public. Diet drinks have sped up the growth rate dramatically. Last year the Japanese drank 36% more cokes than they did the year before, the Spanish upped their consumption by 26%. That’s phenomenal progress. Foreign sales are excellent in general. Through a separate stock offering, Coca Cola Enterprises, the company has bought out many of its independent regional distributors. Now the company has better control over distribution and domestic sales. Because of these factors, Coca-Cola may do better than people think.
- If it is a fast grower, then where and how can it continue to grow fast?
  
  La Quinta is a motel chain that started out in Texas. It was very profitable there. The company successfully duplicated its successful formula in Arkansas and Louisiana. Last year it added 20 percent more motel units than the year before. Earnings have increased every quarter. The company plans rapid future expansion. The debt is not excessive. Motels are a low growth-industry, and very competitive, but La Quinta has found something of a niche. It has a long way to go before it has saturated the market.

12. Getting The Facts

Investors continually put their ears to the walls when it’s the handwriting that tells everything. Perhaps if they stamped the annual report and quarterly reports “classified” or mailed them out in plain brown wrappers, more recipients would browse through them.
If you use the broker as an advisor (a foolhardy practice generally, but sometimes worthwhile), then ask the broker to give you the two-minute speech on the recommended stocks.
Professionals call companies all the time, yet amateurs never think of it. If you have specific questions, the investor relations office is a good place to get the answers.
For the most part, companies are honest and forthright in their conversations with investors. They all realize that the truth is going to come out sooner rather than later in the next quarterly report, so there’s nothing to be gained by covering things up the way they sometimes do in Washington.
When I visit a headquarters, what I’m really after is a feel for the place. The facts and figures can be gotten by the phone.
Visiting headquarters also gives you a chance to meet one or more of the front-office representatives. Another way to meet one is to attend the annual meetings, not so much for the formal sessions, but for the informal gatherings. Depending on how serious you want to get about this, the annual meeting is your best chance to develop useful contacts.
I’ve continued to believe that wandering through stores and tasting things is a fundamental investment strategy.
The balance sheet lists the assets and then the liabilities. That’s crucial to me.
- Adding the company’s cash and cash items with marketable securities, you get the overall-cash position; which is the sign of prosperity.
- Debt reduction is another sign of prosperity. When cash increases relative to debt, it’s an improving balance sheet. When it’s the other way around, it’s deteriorating balance sheet.
- Subtracting the long-term debt from the cash, you get the “net cash” position.
Reduced shares outstanding means that the company is buying back its own shares, another positive step.

13. Some Famous Numbers

When I’m interested in a company because of a particular product, the first thing I want to know is what that product means to the company in question. What percent of sales does it represent?
The p/e ration of any company that’s fairly priced will equal its growth rate. In general, a p/e ratio that’s half the growth rate is very positive, and one that’s twice the growth rate is very negative. We use this measure all the time in analyzing stocks for the mutual funds.
A slightly more complicated formula enables us to compare growth rates to earnings, while also taking the dividends into account.
- Find the long-term growth rate, add the dividend yield, and divide by the p/e ratio.
- Less than a 1 is poor, and 1.5 is okay but what you’re really looking for is a 2 or better.
It’s always advisable to check the cash position (and the value of the related businesses) as part of your research.
A normal corporate balance sheet has 75 percent equity and 25 percent debt. An even stronger balance sheet might have 1 percent debt and 99 percent equity. A weak balance sheet, on the other hand, might have 80 percent debt and 20 percent equity.
Among turnarounds and troubled companies, I pay special attention to the debt factor. More than anything else, it’s debt that determines which companies will survive and which will go bankrupt in a crisis. Young companies with heavy debts are always at risk.
- Bank debt is due on demand. It doesn’t have to come from a bank. It can also take the form of commercial paper, which is loaned from one company to another for short periods of time. The important thing is that it’s due very soon, and sometimes even “due on call.” That means the lender can ask for his money back at the first sign of trouble. If the borrower can’t pay back the money, it’s off to Chapter 11. Creditors strip the company, and there’s nothing left for the shareholders after they get through with it.
- Funded debt can never be called in no matter how bleak the situation, as long as the borrower continues to pay the interest. The principal may not be due for 15, 20, or even 30 years. Funded debt usually takes the form of regular corporate bonds with long maturities. Corporate bonds may be upgraded or downgraded by the rating agencies depending on the financial health of the company, but whatever happens, the bondholders cannot demand immediate repayment of principal the way a bank can. Sometimes even the interest payments can be deferred. Funded debt gives companies time to wiggle out of trouble.
Stocks that pay dividends are often favored over stocks that don’t pay dividends by investors who desire the extra income. But the real issue, is how the dividend, or the lack of dividend, affects the value of the company and the price of its stock over time.
- One strong argument in favor of companies that pay dividends is that companies that don’t pay dividends have a sorry history of blowing the money on a string of stupid diworsification.
- Another argument in favor of dividend-paying stocks is that the presence if the dividend can keep the stock price from falling as far as it would if there were no dividend.
If you plan to buy a stock for its dividend, find out if the company is going to be able to pay it during recessions and bad times.
- If a slow grower omits a dividend, you’re stuck with a difficult situation: a sluggish enterprise that has little going for it.
- A company with a 20- or 30-year record of regularly rising the dividends is your best bet.
The flaw is that the state’s book value often bears little relationship to the actual worth of the company. It often understates or overstates reality by a large margin. When you buy a stock for its book value, you have to have a detailed understanding of what those values really are.
Just as often as book value overstates true worth, it can underestimate true worth (aka hidden assets).
- Companies that own natural resources-such as land, timber, oil, or precious metals-carry those assets on their books at a fraction of the true value. There’s also hidden value in owning a drug that nobody else can make for seventeen years, and if the owner can improve the drug slightly, then he gets to keep the patent for another seventeen years. In the books, these wonderful drug patents may be worth zippo.
- There can be hidden assets in the subsidiary businesses owned wholly or in part by a larger parent company.
- There are hidden assets when one company owns shares of a separate company.
- Finally, tax breaks turn out to be a wonderful hidden asset in turnaround companies.
Cash flow is the amount of money a company takes in as a result of doing business. All companies take in cash, but some have to spend more than others to get it.
- But if cash flow is ever mentioned as a reason you’re supposed to buy a stock, make sure that it’s free cash flow that they’re talking about. Free cash flow is what’s left over after the normal capital spending is taken out. It’s the cash you’ve taken in that you don’t have to spend.
There’s a detailed note on inventories in the section called “management’s discussion of earnings” in the annual report. I always check to see if inventories are piling up. With a manufacturing or a retailer, an inventory buildup is usually a bad sign. When inventories grow faster than sales, it’s a red flag.
As more companies reward their employees with stock options and pension benefits, investors are well-advised to consider the consequences. Companies don’t have to have pension plans, but if they do, the plans must comply with federal regulations. These plans are absolute obligations to pay-like bonds.
That “growth” is synonymous with “expansion” is one of the most popular misconceptions on Wall Street, leading people to overlook the really great growth companies.
- If you find a business that can get away with raising prices year after year without losing customers (an addictive product such as cigarettes fills the bills), you’ve got a terrific investment.
Profit before taxes, also known as the pretax profit margin, is a tool I use in analyzing companies. That’s what’s left of a company’s annual sales dollar after all the costs, including depreciation and interest expenses, have been deducted.
- What you want, then, is a relatively high profit-margin in a long-term stock that you plan to hold through good times and bad, and a relatively low profit-margin in a successful turnaround.

14. Rechecking The Story

Every few months it’s worthwhile to recheck the company story.
There are three phases to a growth company’s life:
- the start-up phase, during which it works out the kinks in the basic business;
- the rapid expansion phase, during which it moves into new markets;
- and the mature phase, also known as the saturation phase, when it begins to prepare for the fact that there’s no easy way to continue to expand.
Each of these phases may last several years. The first phase is the riskiest for the investor, because the success of the enterprise isn’t yet established. The second phase is the safest, and also where the most money is made, because the company is growing simply by duplicating its successful formula. The third phase is the most problematic, because the company runs into its limitations. Other way must be found to increase earnings.
As you periodically recheck the stock, you’ll want to determine whether the company seems to be moving from one phase into another.

15. The Final Checklist

Stocks in General

The p/e ratio. Is it high or low for the particular company and for similar companies in the same industry?
The percentage of institutional ownership. The lower the better.
Whether insiders are buying and whether the company itself is buying back its own shares. Both are positive signs.
The record of earnings growth to date and whether the earnings are sporadic or consistent. (The only category where earnings may not be important is in asset play.)
Whether the company has a strong balance sheet or a weak balance sheet (debt-to-equity ratio) and how it’s rated for financial strength.
The cash position. With $X in net cash, I know Company Y is unlikely to drop below to drop below $X a share. That’s the floor on the stock.

Slow Growers

Since you buy these for the dividends (why else would you own them?) you want to see if dividends have always been paid, and whether they are routinely raised.
When possible, find out what percentage of the earnings are being paid out as dividends. If it’s a low percentage, then the company has a cushion in hard times. It can earn less money and still retain the dividend. If it’s a high percentage, then the dividend is riskier.

Stalwarts

These are big companies that aren’t likely to go out of business. The key issue is price, and the p/e ratio will tell you whether you are paying too much.
Check for possible diworsification that may reduce earnings in the future.
Check the company’s long-term growth rate, and whether it has kept up the same momentum in recent years.
If you plan to hold the stock forever, see how the company has fared during previous recessions and market drops.

Cyclicals

Keep a close watch on inventories, and the supply-demand relationship. Watch for new entrants into the market, which is usually a dangerous development.
Anticipate a shrinking p/e multiple over time as business recovers and investors look ahead to the end of the cycle, when peak earnings are achieved.
If you know your cyclical, you have an advantage in figuring out the cycles.

Fast Growers

Investigate whether the product that’s supposed to enrich the company is a major part of the company’s business.
What the growth rate in earnings has been in recent years.
That the company has duplicated its successes in more than one city or town, to prove that expansion will work.
That the company still has room to grow.
Whether the stock is selling at a p/e ratio at or near the growth rate.
Whether the expansion is speeding up or slowing down.
That few institutions own the stock and only a handful of analysts have ever heard of it. With fast growers on the rise this is a big plus.

Turnarounds

Most importantly, can the company survive a raid by its creditors? How much cash does the company have? How much debt? What is the debt structure, and how long can it operate in the red while working out its problems without going bankrupt?
If it’s bankrupt already, then what’s left for the shareholders?
How is the company supposed to be turning around? Has it rid itself of unprofitable divisions? This can make a big difference in earnings.
Is business coming back?
Are costs being cut? If so, what will the effect be?

Asset Plays

What’s the value of the assets? Are there any hidden assets?
How much debt is there to detract from these assets? (Creditors are first in line.)
Is the company taking on new debt, making the assets less valuable?
Is there a raider in the wings to help shareholders reap the benefits of the assets?

Part 2 Following Points

Understand the nature of the companies you own and the specific reasons for holding the stock. (“It is really going up!” doesn’t count.)
By putting your stocks into categories you’ll have a better idea of what to expect from them.
Big companies have small moves, small companies have big moves.
Consider the size of a company if you expect it to profit from a specific product.
Look for small companies that are already profitable and have proven that their concept can be replicated.
Be suspicious of companies with growth rates of 50 to 100 percent a year.
Avoid hot stocks in hot industries.
Distrust diversifications, which usually turn out to be diworsification.
Long shots almost never pay off.
It’s better to miss the first move in a stock and wait to see if a company’s plan are working out.
People get incredibly valuable fundamental information from their jobs that may not reach the professionals for months or even years.
Separate all stock tips from the tipper, even if the tipper is very smart, very rich, and his or her last tip went up.
Some stock tips, especially from an expert in the field, may turn out to be quite valuable. However, people in the paper industry normally give out tips on drug stocks, and people in the healthcare field never run out of tips on the coming takeovers in the paper industry.
Invest in simple companies that appear dull, mundane, out of favor, and haven’t caught the fancy of Wall Street.
Moderately fast growers (20 to 25 percent) in non-growth industries are ideal investments.
Look for companies with niches.
When purchasing depressed stocks in troubled companies, seek out the ones with the superior financial positions and avoid the ones with loads of bank debt.
Companies that have no debt can’t go bankrupt.
Managerial ability may be important, but it’s quite difficult to assess. Base your purchases on the company’s prospects, not on the president’s resume or speaking ability.
A lot of money can be made when a troubled company turns around.
Carefully consider the price-earnings ratio. If the stock is grossly overpriced, even if everything else goes right, you won’t make any money.
Find a storyline to follow as a way of monitoring a company’s progress.
Look for companies that consistently buy back their own shares.
Study the dividend record of a company over the years and also how its earnings have fared in past recessions.
Look for companies with little or no institutional ownership.
All else being equal, favor companies in which management has a significant personal investment over companies run by people that benefit only from their salaries.
Insider buying is a positive sign, especially when several individuals are buying at once.
Devote at least an hour a week to investment research. Adding up your dividend and figuring out your gains and losses doesn’t count.
Be patient. Watched stock never boils.
Buying stocks based on stated book value alone is dangerous and illusory. It’s the real value that counts.
When in doubt, tune in later.
Invest at least much time and effort in choosing a new stock as you would in choosing a new refrigerator.

Part 3: Long-term View

How to design a portfolio, how to keep tabs on companies in which you’ve taken an interest, when to buy and when to sell, the follies of options and futures, and some general observations about the health of Wall Street, American enterprise, and the stock market.

In this section I add my two cents to important matters such as how to design a portfolio to maximize gain and minimize risk; when to buy and when to sell; what to do when the market collapses; some silly and dangerous misconceptions about why stocks go up and down; the pitfalls of gambling on options, futures, and the shorting of stocks; and finally what’s new, old exciting, and perturbing about companies and the stock market today.

16. Designing A Portfolio

Nine to ten percent a year is the generic long-term return for stocks, the historic market average. You can get ten percent, over time, by investing in a no-load mutual fund that buys all 500 stocks in the S&P 500 Index, thus duplicating the average automatically. That this return can be achieved without you having to do any homework or spending any extra money is a useful benchmark against which you can measure your own performance, and also the performance of the managed equity funds such as Magellan.
Nor is it fair to judge a fund for a single year’s performance. But if after three to five years or so you find that you’d be just as well off if you’d invested in the S&P 500, then either buy the S&P 500 or look for a managed equity fund with a better record.
Given all these convenient alternatives, to be able to say that picking your own stocks is worth the effort, you ought to be getting a 12-15 percent return, compounded over time. That’s after all the costs and commissions have been subtracted, and all dividends and other bonuses have been added.
In my view it’s best to own as many stocks as there are situations in which:
- (a) you’ve got an edge; and
- (b) you’ve uncovered an exciting prospect that passes all the tests of research.
That said, it isn’t safe to own just one stock, because in spite of your best efforts, the one you choose might be a victim of unforeseen circumstances. In small portfolios I’d be comfortable owning between 3 and ten stocks. There are several possible benefits:
- (1) If you are looking for tenbaggers, the more stocks you own the more likely that one of them will become a tenbagger. Among several fast growers that exhibit promising characteristics, the one that actually goes the furthest may be a surprise.
- (2) The more stocks you own, the more flexibility you have to rotate funds between them. This is an important part of my strategy.
Spreading your money among several categories of stocks is another way to minimize downside risk. Assuming that you’ve done all the proper research and have bought companies that are fairly priced, then you’ve already minimized the risk to an important degree.
Finally, your portfolio design may change as you get older. Younger investors with a lifetime of wage-earning ahead of them can afford to take more chances on ten baggers than can older investors who must live off the income from their investments. Younger investors have more years in which they can experiment and make mistakes before they find the great stocks that make investing careers. The circumstances vary so widely from person to person that further analysis of this point will have to come from you.
I’m constantly rechecking stocks and rechecking stories, adding and subtracting to my investments as things change. But I don’t go into cash-except to have enough of it around to cover anticipated redemptions. Going into cash would be getting out of the market. My idea is to stay in the market forever, and to rotate stocks depending on the fundamental situations.
A price drop in a good stock is only a tragedy if you sell at that price and never buy more. To me, a price drop is an opportunity to load ip on bargains from among your worst performers and your laggards that show promises.
If you can’t convince yourself “When I’m down 25 percent, I’m a buyer” and banish forever the fatal thought “When I’m down 25 percent, I’m a seller,” then you’ll never make a decent profit in stocks.

17. The Best Time To Buy And Sell

The best time to buy stocks will always be the day you’ve convinced yourself you’ve found solid merchandise at a good price-the same as at the department store. However, there are two particular periods when great bargains are likely to be found.
The first is during the peculiar annual ritual of end-of-the-year tax selling. It’s no accident that the most severe drops have occurred between October and December. It’s the holiday period, after all, and brokers need spending money like the rest of us, so there’s extra incentive for them to call and ask what you might want to sell to get the tax loss.
The second is during the collapses, drops, burps, hiccups, and freefalls that occur in the stock market every few years. If you can summon the courage the presence of mind to buy during these scary episodes when your stomach says “sells,” you’ll find opportunities that you wouldn’t have thought you’d ever see again.
It’s normally harder to stick with a winning stock after the price goes up than it is to believe in it after the price goes down. These days if I feel there’s a gander of being faked out, I try to review the reasons why I bought in the first place.
Lately we’ve had to contend with the drumbeat effect. A particularly ominous message is repeated over and over until it’s impossible to get away from it.
As it turns out, if you know why you bought a stock in the first place, you’ll automatically have a better idea of when to say good-bye to it.

When To Sell A Slow Grower

I sell when there’s been a 30-50 percent appreciation or when the fundamentals have deteriorated, even if the stock has declined in price.
The company has lost market share for two consecutive years and is hiring another advertising agency.
No new products are being developed, spending on research and development is curtailed, and the company appears to be resting on its laurels.
Two recent acquisitions of unrelated businesses look like diworsification, and the company announces it is looking for further acquisitions “at the leading edge of technology.”
The company has paid so much for its acquisitions that the balance sheet has deteriorated from no debt and millions in cash to no cash and millions in debt. There are no surplus funds to buy back stock, even if the price falls sharply.
Even at a lower stock price the dividend yield will not be high enough to attract much interest from investors.

When To Sell A Stalwart

There’s no point expecting a quick tenbagger in a stalwart, and if the stock price gets above the earning line, or if the p/e strays too far beyond the normal range, you might think about selling it and waiting to buy it back later at a lower price-or buying something else, as I do.
New products introduced in the last two years have had mixed results, and others still in the testing stage are a year away from the marketplace.
The stock has a p/e of 15, while similar-quality companies in the industry have p/e’s of 11-12.
No officers or directors have bought shares in the last year.
A major division that contributes 25 percent of earnings is vulnerable to an economic slump that’s taking place (in housing starts, oil drilling, etc.).
The company’s growth rate has been slowing down, and though it’s been maintaining profits by cutting costs, future cost-cutting opportunities are limited.

When To Sell A Cyclical

To play this game successfully you have to understand the strange rules. That’s what makes cyclicals so tricky.
Other than at the end of the cycle, the best time to sell cyclical is when something has actually started to go wrong. Costs have started to rise. Existing plants are operating at full capacity, and the company begins to spend money to add to capacity.
One obvious sell signal is that inventories are building up and the company can’t get rid of them, which means lower prices and lower profits down the road. I always pay attention to rising inventories.
Falling commodity prices is another harbinger. Usually prices of oil, steel, etc., will turn down several months before the troubles show up in the earnings. Another useful sign is when the future price of commodity is lower than the current, or spot, price.
Competition businesses are also a bad sign for cyclicals. The outsider will have to win customers by cutting prices, which forces everyone else to cut prices and leads to lower earnings for all the producers.
Two key union contracts expire in the next twelve months, and labor leaders are asking for a full restoration of the wages and benefits they gave up in the last contract.
Final demand for the product is slowing down.
The company has doubled its capital spending budget to build a fancy new plant, as opposed to modernizing the old plants at low cost.
The company has tried to cut costs but still can’t compete with foreign producers.

When To Sell Fast Grower

If the company falls apart and the earnings shrink, then so will the p/e multiple that investors have bid ip on the stock.
The main thing to watch is the end of the second phase of rapid growth.
Same store sales are down 3 percent in the last quarter.
New store results are disappointing.
Two top executives and several key employees leave to join a rival firm.
The company recently returned from a “dog and pony” show, telling an extremely positive story to institutional investors in twelve cities in two weeks.
The stock is selling at a p/e of 30, while the most optimistic projections of earnings growth are 15-20 percent for the next two years.

When To Sell A Turnaround

The best time to sell a turnaround is after it’s turned around. All the troubles are over and everyone knows it. The company has become the old self it was before it fell apart: growth company or cyclical or whatever. The shareholders aren’t embarrassed to own it again. If the turnaround has been successful, you have to reclassify the stock.
Debt, which has declined for five straight quarters, just rose by $25 million in the latest quarterly report.
Inventories are rising at twice the rate of sales growth.
The p/e is inflated relative to earnings prospects.
The company’s strongest division sells 50 percent of its output to one leading customer, and that leading customer is suffering from a slowdown in its own sales.

When To Sell An Asset Play

With so many raiders around, it’s harder for an amateur to find a good asset stock, but it’s a cinch to know when to sell.
Although the shares sell at a discount to real market value, management has announced it will issue 10 percent more shares to help finance a diversification program.
The division that was expected to be sold for $20 million only brings $12 million in the actual sale.
The reduction in the corporate tax rate considerably reduces the value of the company’s tax-loss carryforward.
Institutional ownership has risen from 25 percent five years ago to 60 percent today-with several fund groups being major purchasers.

18. The Twelve Silliest (and Most Dangerous) Things People Say About Stock Prices

If it’s gone down this much already, it can’t go much lower

They continued to reassure themselves that if “it’s gone down this much already, it can’t go much lower”, and probably also threw in “good companies always come back,” “you have to be patient in the stock market,” and “there’s no sense getting scared out of a good thing.”
There’s simply no rule that tells you how low a stock can go in principle.

You can always tell when a stock’s hit bottom

Trying to catch the bottom of a falling stock is like trying to catch a falling knife. It’s normally a good idea to wait until the knife hits the ground and sticks, then vibrates for a while and settles down before you try to grab it.

If it’s gone this high already, how can it possibly go higher?

The point is, there’s no arbitrary limit to how high a stock can go, and if the story is still good, the earnings continue to improve, and the fundamentals haven’t changed, “can’t go much higher” is a terrible reason to snub a stock.
Frankly, I’ve never been able to predict which stocks will go up tenfold, or which will go up fivefold. I try to stick with them as long as the story’s intact, hoping to be pleasantly surprised. The success of a company isn’t the surprise, but what the shares bring often is.

It’s only $x a share: what can I lose?

Lousy cheap stock is just as risky as a lousy expensive stock if it goes down. If you’d invested $1000 in a $43 stock or a $3 stock and each fell to zero, you’d have lost exactly the same amount. No matter where you buy in, the ultimate downside of picking the wrong stock is always the identical 100 percent.

Eventually they always come back

When you consider the thousands of bankrupt companies, plus the solvent companies that never regain their former prosperity, plus the companies that get bought out at prices that are far below the all-time highs, you can begin to see the weakness in the “they always come back” argument.

It’s always darkest before the dawn

There’s a very human tendency to believe that things that have gotten a little bad can’t get any worse.
Sometimes it’s always darkest before dawn, but then again, other times it’s always darkest before pitch black.

When it rebounds to $x, I’ll sell

In my experience no downtrodden stock ever returns to the level which you’ve decided you’d sell. In fact, the minute you say, “If it gets back to $x, I’ll sell,” you’ve probably doomed the stock to several years of teetering around just below $x before it keels over to $y (much lower than $x), on its way to falling flat on its face at $z.
Whenever I’m tempted to fall for this one, I remind myself that unless I’m confident enough in the company to buy more shares, I ought to be selling immediately.

What worries me? Conservative stock don’t fluctuate much

Companies are dynamic, and prospects change. There simply isn’t a stock you can own that you can afford to ignore.

It’s taking too long for anything to ever happen

Here’s something else that’s certain to occur: If you give up on a stock because you’re tired of waiting for something wonderful to happen, then something wonderful will begin to happen the day after you get rid of it. I call this post divestiture flourish.
It takes remarkable patience to hold on to a stock in a company that excites you, but which everybody else seems to ignore. You begin to think everyone else is right and you are wrong. But where the fundamentals are promising, patience is often rewarded.

Look at all the money I’ve lost: I didn’t buy it!

Regarding somebody else’s gain as your own personal losses is not a productive attitude for investing in the stock market. In fact, it can only lead to total madness. The more stocks you learn about, the more winners you realize that you’ve missed, and soon enough you’ve blaming yourself for losses in the billions and trillions.
The worst part about this kind of thinking is that it leads people to try to play catch up by buying stocks they shouldn’t buy, if only to protect themselves from losing more than they’ve already “lost.” This usually results in real losses.

I missed that one, I’ll catch the next one

The trouble is, the “next” one rarely works. A great company that continues to go up, and a mediocre company that went down, then you’ve compounded your error. Actually you’ve taken a mistake that cost you nothing and turned it into a mistake that cost you plenty.
In most cases it’s better to buy the original good company at a high price than to jump on the “next one” at a bargain price.

The stock’s gone up, so I must be right, or… the stock’s gone down so I must be wrong

If I had to choose a great single fallacy of investing, it’s believing that when a stock’s price goes up, then you’ve made a good investment.
If you sell quickly at the higher price, then you’ve made a fine profit, but most people don’t sell in these favorable circumstances. Instead they convince themselves that the higher price proves that the investment is worthwhile, and they hold on to the stock until the lower price convinces them the investment is no good.
A stock’s going up or down after you buy it only tells you that there was somebody who was willing to pay more-or-less-for the identical merchandise.

19. Options, Futures, and Shorts

There’s no point describing how futures and options really work, because
- (1) it requires long and tedious exposition, after which you’d still be confused,
- (2) knowing more about them might get you interested in buying some, and
- (3) I don’t understand futures and options myself.
Option is a contract that’s only good for a month or two, and unlike most stocks, it regularly expires worthless-after which the options player must buy another option, only to lose 100 percent of his or her money once again.
Another nasty thing about options is that they are very expensive. They may not seem expensive, until you realize that you have to buy four or five sets of them to cover stock for a year. You’re literally buying time here, and the more time you buy, the higher the premium you have to pay for it.
The worst thing of all is that buying an option has nothing to do with owning a share of a company. When a company grows and prospers, all the shareholders benefit, but options are a zero-sum game.
Shorting is the same thing as borrowing something from the neighbors and then selling the item and pocketing the money. Sooner or later you go out and buy the identical item and return it to the neighbor, and nobody is the wiser. It’s not exactly stealing, but it’s not exactly neighborly, either. It’s more like borrowing with criminal intent.
What the shorters hope to do is to sell the borrowed item at a very high price, but the replacement item at a very low price, and keep the difference.
The person from whom you borrowed the shares originally will never know the difference.
During all the time you borrow the shares, the rightful owner gets all the dividends and other benefits, so you’re out some money there. Also, you can’t actually spend the proceeds you get from shorting a stock until you’ve paid the shares back and closed out the transaction.
The scary part about shorting stock is that even if you’re convinced that the company’s in lousy shape, other investors might not realize it and might even send the stock price higher.
None of us is immune to the panic that we feel when a normal stock drops in price, but that panic is restrained somewhat by our understanding that the normal stock cannot go lower than zero. If you’ve shorted something that’s going up, you begin to realize that there’s nothing to stop it from going to infinity, because there’s no ceiling on a stock price.

20. 50,000 Frenchmen Can Be Wrong

The market, like individual stocks, can move in opposite direction of the fundamentals over the short term, which, in the case of the embargo, involved rising gasoline prices, long gas lines, escalating inflation, and sharply higher interest rates.
If there is a Monday effect, I think I know why. Investors can’t talk to companies for two days over the weekend. All of the usual sources of fundamental news are shut down, giving people sixty hours to worry.
When you invest in stocks, you have to have basic faith in human nature, in capitalism, in the country at large, and in future prosperity in general.

Part 3 Following Points

Sometime in the next month, year, or three years, the market will decline sharply.
Market declines are great opportunities to buy stocks in companies you like. Corrections-Wall Street’s definition of going down a lot-push outstanding companies to bargain prices.
Trying to predict the direction of the market over one year, or even two years, is impossible.
To come out ahead you don’t have to be right all the time, or even majority of the time.
The biggest winners are surprises to me, and takeovers are even more surprising. It takes years, not months, to produce big results.
Different categories of stocks have different risks and rewards.
You can make serious money by compounding a series of 20-30 percent gains in stalwarts.
Stock prices often move in opposite directions from the fundamentals but long term, the direction and sustainability of profits will prevail.
Just because a company is doing poorly doesn’t mean it can’t do worse.
Just because the price goes up doesn’t mean you’re right.
Just because the price goes down doesn’t mean you’re wrong.
Stalwarts with heavy institutional ownership and lots of Wall Street coverage that have outperformed the market and are overpriced are due for a rest or decline.
Buying a company with mediocre prospects just because the stock is cheap is a losing technique.
Selling outstanding fast growers because its stock seems slightly overpriced is a losing technique.
Companies don’t grow for no reason, nor do fast growers stay that way forever.
You don’t lose anything by not owning a successful stock, even if it’s a tenbagger.
A stock does not know that you own it.
Don’t become attached to a winner that complacency sets in and you stop monitoring the story.
If a stock goes to zero, you lose just as much money whether you bought it at $50, $25, $5, or $2-everything you invested.
By careful pruning and rotation based on fundamentals, you can improve your results. When stocks are out of line with reality and better alternatives exist, sell them and switch into something else.
When favorable cards turn up, add to your bet, and vice versa.
You won’t improve results by pulling out the flowers and watering the weeds.
If you don’t think you can beat the market, then buy a mutual fund and save yourself a lot of extra work and money.
There is always something to worry about.
Keep an open mind to new ideas.
You don’t have to “kiss all the girls.” I’ve missed my shares of tenbaggers and it hasn’t kept me from beating the market.