A great book that breaks down how one of the masters (remember that whole begetting stuff) mastered wall street, is Peter Lynch’s
One Up On Wall Street : How To Use What You Already Know To Make Money In The Market
Check it out … available at Amazon.
Peter Lynch’s success (and he did have lots of it) in the 80s and 90s came from the investment strategies he used while at the helm of the Fidelity Magellan fund. One of his biggest stipulations is that you invest in something you know – you become familiar with the product. Although he goes into more depth about getting to really know your company before buying its stock (which is recommendable) here is a breakdown of his more salient and screen-able points:
1) Institutions don’t own it, analysts don’t follow it.
This is a hard one to meet but if you can find a stock that has 50% institutional ownership and little analyst coverage, you’re in business. What he is going for here is that if not enough people are following the stock there might be a market, price discrepancy and thus a opportunity but don’t let this be a deal-killer – it’s hard to find low institutional ownership on decent stocks.
2) People have to keep buying it (drugs, cigarettes, razor blades)
3) Insider Buyers are present – management within the company is buying shares. Sellers don’t matter.
This is a very interesting point. Where I shop for stocks on Fidelity.com there is a graph showing insider buyer purchases. The buys on the graph are represented by green dots. The bigger the green dot the bigger the buy. I love seeing big green dots when I am researching a stock. This means insider buyers believe that their company is undervalued, perhaps it is due for a turnaround and perhaps they know something that we don’t.
4) The company is buying back shares.
You can see this on the company’s balance sheet under Shares Outstanding. If the number is decreasing then the company is buying back shares.
5) Is it trading at or near its 52 week low?
This is one I like to see in order to tell if it’s likely a good value or not. Of course it could always go lower but (like to zero) but if I see a company with that is trading at $11 and its 52 week low is $10 and its 52 week high is $42, then I know there is a good chance this stock is at a bargain price. Compare this to a stock that is trading at $20 and its 52 week low is $10 and its 52 week high is $22 – out of the two which one do you think has a better chance of being a bargain?
5) The P/E is low.
Ah, the good old P/E ratio – price to earnings. Generally thought of as how long it takes you to get your money back out of a stock. If the P/E of a stock is at 7, theoretically it should take you 7 years to get a 100% return on investment. The lower the better. You can compare this to three numbers – the S&P 500 average, the industry average and the stock’s 5 year P/E average. If the 5 year average is 10, the industry’s is 15 and your stock is at a 2, guess what, it might be on sale. You’re paying cheap price for the amount of earnings the company is generating.
6) The PEG is < 1
This, as far as I am concerned, is the greatest indicator of value. In general, analysts consider a PEG less than 1 to equate to an undervalued stock. This is the price of the stock divided by its earnings growth potential which although at times can be a very theoretical number, it is still a great indicator of where the company's earnings are headed. Analysts consider a PEG of less than 1 to equate to value in the stock. When I see a PEG below 1 along with giant green dots, I know this stock has great buy potential.
7) On the Balance Sheet, Current Assets + Marketable Securities covers LTD.
This starts giving you a health snapshot of the balance sheet. The stock is on sale but can they cover the debt?
8) Future Earnings.
What is their projected future earnings growth? Remember that number that is sometimes more theory than reality? The one under the P in PEG? Well this is it. How much will earnings grow in the next 5 years – 5, 10, 15%? Usually a healthy 10 – 15% is a good sign. A 20% might be a flop.
9) The debt off of the balance sheet – is it increasing or decreasing?
Again, we want to grab a snapshot of the balance sheet’s health. A company paying down debt is fiscally smart and can weather a setback.
10) Are earnings on the upswing? Have dividends always been paid?
We want to see a solid performer in both earnings and dividends, especially on our part of the plate dedicated to dividends, next to the mashed potatoes and gravy. We don’t want them to yank the dividends out from under us anytime soon, or to not pass the salt for that matter.
11) A little formula:
Add the long term growth rate to the dividend yield. Divide this by the P/E ratio. Less than 1 = poor. 1.5 = okay. 2 = great. Don’t ask, just do.
12) The debt to equity should be below 33%.
Again, this is a snap of the balance sheet health.
13) If they pay a dividend are they always raising it?
Very important to us.
14) Price to book value is low.
Compare this guy to industry average. I also take a peak at P/S – the lower the better as far as value goes.
16 ) The P/CF is 10 to 1 or 10.
The lower the better. A company that doesn’t have to spend a lot to make a lot is copacetic with us.
15) Inventory buildup is a bad sign – it’s baaaad Wilbur!
If it’s retail, they can’t move the inventory without a big markdown.
Finally …
16) Profit after taxes off of the Income Sheet.
What’s left over after all costs including depreciation and interest expenses? Are they still making money?
Well, there you have it. A quickie Fundamental Analysis from the man who put the Mag in Magellan. This is not an all inclusive Lynch Fundamental Analysis but it does include a lot of his key points from One Up On Wall Street : How To Use What You Already Know To Make Money In The Market
. I strongly urge you to read through the company’s statements – shareholder’s reports, earning’s statements and whatnot. Make sure to check out Lynch’s One Up On Wall Street : How To Use What You Already Know To Make Money In The Market as well so you can flesh out the points covered here.Also, there are other ways to go about Fundamental Analysis. Check out these books available at Amazon. Let me know what you think.
Getting Started in Fundamental Analysis (Getting Started in)
Mastering Fundamental Analysis
Fundamental Analysis: A Back-to-the-Basics Investment Guide to Selecting Quality Stocks, Revised Edition
The Fundamentals of Fundamental Analysis
Alrighty, that puts the “F” in DIFCCO so now, in our little hangman game, we have DIF which I still promise does not stand for difficult. So far we have found a great optionable, dividend stock that delivers a 10 – 15% yield. We have performed a decent Lynchese Fundamental Analysis and found a bargain deal with a sound balance sheet. Now it is time to kick up our earnings. It is time for the CCO in DIFCCO – or Writing Covered Call Options – which really makes DIFCCO stand for DIFWCCO or DIF- WRICCO for short. But I’m not changing it at this point.
Stay tuned.
One Up On Wall Street : How To Use What You Already Know To Make Money In The Market
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