How to choose a company stock?

Even a 10 year old could do this..

Another great lesson from “One up on wall street” by Peter Lynch on how he identifies companies that he wants to invest in. His approach is so simple that even a 10 year old could do it. Let’s look at it in 5 minutes.

(If you want to buy the book, the link is HERE. I personally love it! ♥)

Disclaimer: This is just step 1. You need to do a lot more analysis to finally decide where to invest.

But this framework acts as a great first step to shortlist companies which can give 10-20 or even 50X returns.

Let’s look at it:

Peter says that once you have an eye on a company, there are 6 categories in which it can be placed. Let’s look at them one-by-one:

1. The slow growers

These are large, stable companies that are expected to grow slightly faster than a nation’s GDP. These companies were typically fast-growing companies when they started, but have now stabilized, typically because the industry as a whole has stabilized.

Peter says that sooner or later, all fast growing companies will eventually slow down and come in this category.

Another sign of a slow-growing company is that it pays a generous and regular dividend (ITC, remember?)

While the category has “slow” in its name, don’t let it fool you. These are still decent companies to invest in. You could invest in them for getting regular payouts (dividend) or simply if you want safer companies.

2. The Stalwarts

These are companies that grow faster than the slow growers. Typically, younger MNCs would fall in this category - think Coca Cola, P&G etc. These companies can give good returns to investors, and in terms of finances, earnings of such companies typically grow by 10-12% every year. Peter says that historically, these companies have been protected during recessionary periods, so he always holds some such “stalwarts” in his portfolio.

3. The fast growers

These are smaller companies that grow rapidly - about 20-25% every year. This is the category where you have fundamentally good companies that can give you the 50-100x returns that you’re looking for.

But holding stocks of such companies has its own risks:

1. These are small companies, so small blips can cause large problems because they are typically under-financed

2. When smaller companies stop growing (and are still small), stock prices plummet heavily

So as investors, it’s always prudent to keep track of such companies and figure out when they’re going to stop growing (and that’s easier said than done).

4. The cyclicals

These are companies whose stock prices rise and fall in cycles. Cement, auto, airlines etc are cyclical stocks, which means they perform (and underperform) in cycles.

For example, auto stocks do poorly in recessions. But when the country is coming out of a recession, they flourish and their stock prices rise.

These companies could be small sized ones or blue-chip ones too. Doesn’t matter if it’s Tata Motors is a blue-chip company. In a recession, car sales will fall (and so will stock prices, generally). So you need to understand this while buying blue-chips that belong to this category.

5. Turnarounds

These are companies that have not been growing, but suddenly rebound due to some reason (could be internal or external). Identifying such companies is very difficult, but if you’re able to do that while the stock has stayed low, you’ve hit the jackpot.

These are the ones that can give some amazing returns. It’s like betting on an injured horse who eventually wins the game 😉

A simple search on screener shows this list of companies that were poor performers, but suddenly had a good quarter. You need to obviously further analyze such stocks, because this could have happened due to various reasons. But like I said, identifying them is the first step.

6. Asset Plays

This is a company that’s got huge assets (but the general public or analysts aren’t aware of it). Assets could be in the form of land, IP, cash or anything tangible/intangible.

These companies may or may not be in the news. It’s even better if they’re not, because then not many people know about them. But they’re good companies to invest in, according to Peter.

---

Of course, like I said, after categorizing the companies, you need to analyze them further. But this gives a good framework to find companies that could match your expectations in terms of returns.

And since this newsletter is supposed to be under 5 minutes, we’ll call it a wrap today!

But before we end..

If you found this insightful, why don’t you share this on Twitter, LinkedIn or WhatsApp with someone who you think will benefit from it? We’re trying to grow the community, and want to spread financial literacy to more and more people! One small share from you will help a lot! 🙂

See you next week!