Peter Lynch, the most celebrated and successful fund manager, identified 13 attributes of a great stock to buy in his book, “One Up on Wall Street”.
1) Dull names
The company should have a dull name. This is one of the weirdest criteria that Peter has, why does a name got to do with the stock? His point is that a boring name will gather little interest from analysts. It is not attractive or professional to recommend a stock with a stupid name to a rich clients. Hence, it is likely to be lower priced. Peter pays attention to stocks that have dull and ridiculous names and invest in them provided they fulfil the other criteria.
2) Dull business
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It will be a bonus if the company runs a dull business too. The point is the business should be so simple that it is dull and boring. He quoted “Crown, Cork, and Seal” who manufacture cans and bottle caps as an example.
3) Unglamorous business
A business can be unglamorous and yet making increasing profits. The reason maybe that the business is something that no one wishes to compete in. Peter Lynch quoted 2 businesses fulfilling these characteristics, a grease removal company and a plastic cutlery company.
4) Spin offs
Based on history, numerous companies that were spin offs from their parent companies, became very profitable on their own. One of the main reason is that the parent company must be confident of the division before allowing it to gain independence. Strong balance sheets and good management must be in place as part of the consideration.
5) No institutional investment and no analyst coverage
Peter Lynch prefers stocks that institutions are not interested in. In fact, he loves stocks that were once-popular to the professionals, as they tend to bottom when Wall Street starts to lose interest in them. He is particularly not interested if a company is heavily covered or recommended by analysts. Quoting him, “When I talked to a company that tells me the last analyst showed up three years ago, I can hardly contain my enthusiasm.”
6) Rumored that Mafia is behind it
There are rumors or impressions that Mafia runs Italian restaurants, newstands dry cleaners, garbage business and casinos. Respectable investors were not interested to get “tainted” in these businesses.
7) Dealing with depressing things
Businesses that have to take care of the sad side of life, eg. death. This an area Wall Street will ignore even though it can be a profitable business.
8) Low growth industry
Avoid the hottest industry and invest in low-growth industries like plastic forks and knives. High growth industry attracts competition, and soon profitable businesses would lose out to cheaper competitors. In low growth industries, there are minimal competition to begin with.
Businesses with niches do not succumb to competition. In fact, they become so profitable because they are so good in their niches. Focus the attention in one product or service beats a diversified group of products and services.
10) Regular consumption
Peter Lynch prefers to invest in products or services that people consume on a regular basis. Drugs, soft drinks, razor blades, cigarettes, etc. Invest in steady businesses.
11) Use technology to improve business
Look out for businesses that utilise technology to improve their processes or reduce operating costs. A scanner can help a supermarket save 3% of the costs and this would double the earnings.
12) Insiders buying
Insiders know how well the business fare better than anyone else. Insiders buy when they have faith in the business and believe in its potential. If the management holds substantial stocks of the company, it would be safe that their interest would be aligned to the shareholders. On the contrary, insider selling in most cases are normal, as the reason may be to diversify to other investments. It would be a concern when the stock price rises significantly, and many insiders start selling majority of their shares.
13) Company buy back
Company buy backs decrease the supply of shares in the market. If demand stays the same, by law of economics, the price would go up. Earnings per share would go up as well. Alternative ways to deal with profits are 1) raise dividends, 2) develop new products, 3) starting new operations and 4) making acquisitions. Especially with 2, 3 and 4, the company may lose focus of its niche and profitability as well.
It seems like I can summarize these points into 1 big point – Look for stocks that have no hype, as little attention as possible. Prices are always determined by demand and supply. Hot stocks are fueled by high demand and buying them would mean paying a high price. To profit from anything, you have to buy low and sell high. Hence, stocks with low demand gives you the opportunity to buy low.