Top 15 Stocks To Buy Applying Investing Principles Of Peter Lynch (Prabhudas Liladhar Research Report)

Peter Lynch

Investment Strategy Research Desk

THE INVESTMENT LYNCHPIN

No matter markets fall or rise, investing legends have sailed through trying times. In fact, in bear markets, learning from legends like Peter Lynch help in filtering and coming up with our own set of investable companies. Peter Lynch’s simple yet practical Bottom Up approach to investing involved 5 broad steps that common investors could pursue to pick stocks albeit KEEPING A LONG TERM VIEW in such bear markets :-

1) Identify good companies

“Know what you own & know why you own it”

To know what you own, you need to start looking at companies in the industry you work in or have experience in and can understand. You can get valuable fundamental information even from non-market related work/outings/ meetings, etc – that may not reach the professionals for months or even years. Hence, he advised the common investor to filter good companies based on industry one understands or works in. In fact, most of his successful investments were bought based on his or his friends’ firsthand experience/knowledge of products/services offered by the company.

2) Classify the stocks

“By putting your stocks into categories you’ll have a better idea of what to expect from them.”

Once he identified the companies, Lynch classified them into any of the 6 categories: Fast Growers, Stalwarts, Slow Growers, Turnarounds, Cyclicals and Asset Plays. As a thumb rule he suggested a portfolio of 10 stocks comprising of 4 fast growers, 4 turnarounds and 2 stalwarts mainly to reduce the risk attached to the other 8. However, this should be followed by individuals who have the ability and capacity to take high risk.

3) Value the companies

“What makes a company valuable, and why it will be more valuable tomorrow than it is today.
To me, it always comes down to earnings and assets. 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.”

To get a rough idea for valuation, Peter Lynch used the PEG ratio. He compared a stock’s P/E ratio to its earnings growth. A bargain is in store if a fundamentally good company trades at a P/E less than its projected earnings growth rate. He also factored in sustainable dividend yield in the denominator of the PEG ratio considering dividends are reinvested leading to accelerated returns. He also cautioned investors to avoid investing in companies that trade at very high P/E levels and have high (unsustainable) earnings growth rates.

4) Develop a story

“Invest at least as much time and effort in choosing a new stock as you would in choosing a new refrigerator.”
The next step is to gather as much information as possible about the company for the growth prospects or any favorable/unfavorable event expected to occur. This is known as the “story.” One must not waste time guessing future earnings and rather focus on factors that will drive the earnings growth. As shareholders, we can call the investor relations, listen to con-calls, do on ground research or simply read analyst reports of our full-service brokers. Other than this, if one has an edge in the company / industry they can develop their own investment rationale. Lynch suggested that investors must be able to perform a ‘2-Minute Drill’ to explain their investment decision with significant clarity to have enough conviction to hold the stock through volatile markets.

5) Stick to the story

“People who succeed in the stock market also accept periodic losses, setbacks, and unexpected occurrences. Calamitous drops do not scare them out of the game.” “The real key to making money in stocks is not to get scared out of them.”

This is the most underrated point causing most investors to fail by exiting a good story too early and holding on the wrong one for too long. For instance, you might have sold some good stocks at low prices in this market panic. So the approach is, you must keep a regular tab on the story to check for any substantial changes in the fundamental paradigm of the business and stay invested in the company until the original story alters.

If you don’t have the time to do so, you could always avail the services of your full-service broker or advisor. Most importantly, no matter what, you stick to your company if the fundamentals (you had bet on initially) haven’t changed! You could obviously average down in fundamentally good companies. Patience is virtue. This results in extra ordinary rewards.

So now let’s directly dive into the process of classifying stocks into 6 baskets. To provide better understanding of classification, we describe each category and have covered a few Indian companies that we think fit into those categories based on earnings trajectory, asset value, etc and the prerequisite characteristics of a category.

These do not qualify as investment recommendations but we intend to provide our readers with examples which will in turn help them in classification of stocks. So say in this market turmoil you have funds to invest, this report could help you in adopting the right approach to think and have your own selected basket of stocks to invest in with proper knowledge of their risk-reward profile. Of course, it’s best to consult your advisor if you have no investing experience.