Peter Lynch, the author of One up on wall street and the former manager of the Magellan Fund. In just 13 years of running the fund, he beat the market and earned an annualised return of 29.2% by buying the common stocks that did not have any unique tech and nothing fancy about them.
He believes that investing is buying companies you frequently deal with because you already have a basic understanding of the business. But, you still have to do your analyses before you buy. Peter Lynch has classified companies into six types to help for better understanding of the stock:
1- Slow Growers
Companies started as fast growers, but they lost momentum and stopped growing. The slow can result from slowing down in the industry. These types of companies usually pay dividends. Utility companies make an excellent example of slow growers.
2- Stalwarts
Giant companies that grow faster than slow growers. Stalwarts such as Coca Cola are good to have companies in recessions and hard times because they have a distinct advantage that ensures that they will not go bankrupt any time soon.
3- Fast Growers
Small and new aggressive companies that grow 20-25% a year. Such companies do not necessarily need to belong to a fast-growing industry. For example, restaurant chains that succeed in one place and successfully duplicate the business to other areas. Fast growers are also the ones with the highest risk, especially for new companies. However, the successful ones can be highly profitable.
4- Cyclicals
Companies that do not have a moat. Unlike typical companies which experience growth, Cyclicals expand and contract in cycles. Airline companies are Cyclicals that expand and contract in rounds. The issue with Cyclicals is that no one can predict the end or beginning of a cycle. Therefore, you can lose a high percentage of your stock value if you invest in the wrong part of the cycle.
5- Turnaround
Companies that can be futile due to bad management or aggressive competition. Companies as such can make a comeback from their desperate situation resulting in a turnaround. Turnaround companies can be risky investments, especially if the outcome is unpredictable. If a turnaround was successful, the stock should be classified into a new category.
6- The asset plays
Companies that are sitting on something valuable that everyone else has overlooked. Such companies can be everywhere, and assets can be anything such as land, buildings, materials … etc. People who work in a specific industry can identify the asset players better than stock analysts.
The Bottom Line
It is essential to know that putting stocks into categories are just a guideline to understand the stock, and it is not a rule. Therefore, it is crucial to know the following according to Peter Lynch:
- Some companies does not necessarily belong to a category.
- Some companies can be classified into two categories at once.
- Companies can change categories throughout its life.
- Smaller companies do have the potential to grow quicker than large companies.
- There is still a potential for large companies to grow even more.
