A while ago, I wrote a piece about the best finance books for young adults and couldn’t resist rereading this absolute gem of a book.
The idea behind this summary is that I was taking notes of the book for myself and decided that I might as well publish my notes for the convenience of others.
One Up on Wall Street is written by the famous fund manager, Peter Lynch. Lynch is famous for his down-to-earth investing style and extremely successful run as a manager of the Magellan Fund.
The book is divided into three sections.
The first section is about preparing to invest, the second section is about picking the right company, and the third one is about a long-term mindset.
Part 1: Preparation
One of the first things Lynch teaches is that an amateur investor can beat the professionals. In fact, investing is actually easier as an amateur since you’re only responsible for yourself and have no regulations to follow.
Institutional investors often lack in performance due to regulation and the sheer size of their funds. Because they have to invest in bulk, they tend to miss the greatest opportunities in smaller companies.
While there are endless investing opportunities, Lynch focuses on stocks. Usually, the conversation revolves around stocks and bonds. In the long term, stocks are preferred over bonds because of superior returns and controllable risk.
When you invest in stocks, you can control the risks by doing your homework and analyzing the companies you invest in. If you don’t know what you own, you’re basically gambling.
The Mirror Test
The first part also includes a so-called mirror test you should take before investing in stocks. The idea is that depending on your answer, stocks can be a great or a terrible investment.
- 1) Do I Own a House
- 2) Do I Need The Money
- 3) Do I Have the Personal Qualities It Takes to Succeed
The idea behind the first question is that houses are, according to Lynch, almost always a great investment. This depends, of course, on a lot of things like the tax system, location, and the type of house or apartment you buy – if you don’t mind me adding.
The second question is there to ensure you don’t invest the money that you need for your everyday expenses. You should never invest money you can’t afford to lose.
Third and the most important question includes things like patience, self-reliance, common sense, tolerance for pain, etc. Overall, you need to be able to make decisions without perfect information and be able to resist your human nature and gut feelings.
The heart of Lynch’s investing philosophy is a long-term focus. A successful investor holds his investments for a long time and ignores short-term fluctuations.
With the long-term mindset comes also the fact that the market is, in the end, irrelevant. It’s the companies that matter. Anticipating market movements is impossible while making forecasts of individual companies is somewhat doable.
Even if the market is going up, it doesn’t mean that all stocks do well, and vice versa.
Takeaways
- An amateur investor can beat the professionals
- Stocks are a superior asset class in the long run
- Focus on the long term
- Invest only what you can afford to lose
- Be honest with yourself
- Invest in companies, not in the stock market
Part 2: The Process
Part one was all about laying down the ground rules of investing and seeing whether you should be investing in the first place.
Part two focuses on picking the right companies.
Lynch is famous for his everyday approach to analyzing companies. He believes you can achieve great results by exploring your environment and paying attention to where you shop and what people are buying.
One of the most useful things I’ve picked from Lynch over the years is that one successful product might not make a big difference. You should always compare the sales of a new product to the overall size of the company and see whether it has a big impact on the company’s revenue as a whole.
The Six Categories of Companies
According to Lynch, you can divide companies into six categories: The slow growers, the stalwarts, the fast growers, the cyclicals, turnarounds, and the asset plays.
The idea is that when you sort companies into different categories, you can treat them accordingly and thus adjust your expectations.
For example, there’s no point in expecting massive short-term returns from a massive company. Big companies tend to have small moves, and small companies often have big moves.
Then again, if you’re a dividend investor, it might not do you much good to own an aggressive grower that’s not going to pay out a decent dividend for the next 10 years.
Diworseficiation
Sometimes companies want to spend their excess cash on purchasing other companies from completely different fields.
On planet Lynch, this is called diworseficiation because these maneuvers have a tendency to fail.
There are, of course, exceptions. One of the greatest diversifications happened with a little Finnish firm called Nokia. While you probably remember Nokia from their iconic phones, a somewhat forgotten fact is that Nokia originally made rubber boots and car tires.
There’s a long way from rubber boots to mobile phones, and the success they achieved before the era of smartphones was exceptional.
The problem is that these are rather exceptions than rules, which is why you should be careful when a company decides to purchase something.
Attributes of a Promising Company
Lynch has listed the thirteen most important favourable attributes of a company:
- It Sounds Dull or Ridiculous
- It Does Something Dull
- It Does Something Disagreeable
- It’s a Spinoff
- The Institutions Don’t Own it, And the Analysts Don’t Follow it
- The Rumors abound: It’s Involved with Toxic Waste and/or the Mafia
- There’s Something Depressing About It
- It’s a No-Growth Industry
- It’s Got a Niche
- People Have to Keep Buying It
- It’s a User of Technology
- The Insiders Are Buyers
- The Company is Buying Back Shares
Stocks to Avoid
If Lynch would absolutely avoid a certain stock, it would be the hottest stock in the hottest industry. He also listed other types of stocks he usually avoids:
- The Next Something (almost never is the next something)
- Chronic Diworseifiers (rarely works)
- The Whisper Stocks (longshots that rarely succeed)
- Middlemen Companies (a company that sells 25 to 50 percent of its wares to a single customer – too much risk)
- Stocks With Exciting Names (victims of hype and therefore prone to be bad investments)
Takeaways
- There are great investment opportunities everywhere
- Categorize companies
- Beware the diworseifications
- Boring is often good
- Avoid the hot stocks
Part 3: The Mindset
The last part of the book is all about the long-term view, rationality, and patience.
First of all, it’s important to have realistic expectations of your returns. It’s probably not the most realistic idea that you’d get a 30% annual return for the rest of your life, but you also shouldn’t settle for a return you’d get from investing in bonds.
Lynch also recommends avoiding constant trading, especially with small capital since the transaction fees start to eat away at your returns.
While you shouldn’t put all your money in just one or two companies, it’s not wise to own too many either. If you own too many companies, you’re almost better off just investing in index funds.
The best way to minimize downside risk is to own companies from all the six categories. This way you get the low-risk larger companies with a high dividend yield as well as the fast growers with tremendous profit potential.
Part 3 also goes through when to REALLY sell a company. Bear markets are usually the places where most people sell their stocks. Fund managers are often forced to do so, and individual investors tend to sell because of psychological reasons (and tax planning).
Usually, the real reason to sell a stock is when there’s a change in the company’s fundamentals. A great way to check whether it’s time to sell a stock is to think about why you bought the company in the first place and see if the reason still holds.
There’s also a magnificent list of the 12 stupidest things people say about stock prices. These include sayings like “It’s only $3 a share: what can I lose?” and “It’s gone this high already, how can it possibly go higher?”
Takeaways
- You can’t predict the market
- Market corrections are great opportunities for a long-term investor since you can purchase great companies with a discount
- Different categories of stocks have different risks and rewards
- Market movements aren’t a reason to sell a great company
