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One Up on Wall Street

In __One Up on Wall Street__, America’s number one money manager Peter Lynch discusses his unique strategies for investing in the stock market. His book is a guide not for professional investors but rather, for the common, every-day shareholder. Lynch’s book is divided into three sections in which he discusses how to prepare for purchasing stocks, how to pick winning stocks, and finally, what to do with your stocks in the long run. At the beginning of the book, Lynch warns that stock before you enter the stock market, you had best define your objective and clarify you purpose before hand. If you are in any way undecided or lack conviction, you are very likely to end up a loser. To make money in the stock market consistently, you have to be in it for the long run. Inevitably, the market will experience a sharp decline while you are invested and you have to ignore it. You have to retrain your intuition and console yourself with the fact that the market WILL go up in the long run. If you abandon all hope and reason when the market has fallen, you stand to lose a huge amount of money. That being said, Lynch moves on to discuss how to prepare to buy a stock In the beginning of the book, Lynch compares buying stocks to buying houses. When you invest in a house, you will undoubtedly check into the neighborhood, schools, public services, taxes, drainage and even the septic tank. You hire professional to inspect the house for any hidden flaws or faults. According to Lynch, buying a stock is no different. It requires the same rigorous inspection to insure that the stock is, in fact, a winner. In the stock market, when everyone has access to the same periodicals, the same expert advice, and basically the same general information about a company, it is almost impossible to find a stock that the market hasn’t already accounted for. Lynch advocates that savvy investors must be willing to do their homework before they invest in order to make money. You have to research things like cash holdings, debt, price/earnings ratios, profit margins, book values, and dividends. Only after you have sufficiently researched things like these should you invest in a stock. Otherwise, you might as well just throw a dart at the financial section and hope to hit a winner. When preparing to invest, Lynch warns not to overestimate the skill and wisdom of professionals. They often are utilizing no more information that you already know and can often mislead you with their advice. Additionally, Lynch argues that predicting the stock market in short run is impossible and so the only way to win is to do research and to find an edge. Look for opportunities that haven’t yet been discovered or certified by Wall Street. Invest in companies not in the stock market. Basically, use all the resources available to you in make informed decisions about investments. In the next section of __One Up on Wall Street__, Lynch discusses ways to find and to exploit an edge in the stock market. To describe the ideal investment, Lynch coins the term ‘tenbagger’ meaning any stock that has produced ten times its initial investment. The goal of investors to find as many tenbaggers as the possibly can and the best place to find them is not in the stock market. Lynch explains that some of the largest companies today started as small, local business. Companies like Staples, Mcdonald’s, Jimmy John’s, and Southwest airlines all started out as local business. If you can manage to get in with one of these companies early, your profits would be astronomical. Small companies, Lynch explains, grow fast. You cannot expect to triple your investment in one year with a stock like Coca-Cola. Lynch goes on to introduce his classification system for companies in the stock market. According to Lynch, there are six kinds of companies: slow growers, stalwarts, fast growers, asset plays, cyclicals, and turn-arounds. The slow growers are almost self-explanatory. They are usually large companies that can reasonably be expected to grow slightly faster than the gross national product. They start out as fast growers but eventually plateau. Slow growers are usually safe investment although one cannot expect very large gains. Stalwarts are companies whose growth is relatively slow. They are usually not a good investment decisions as they are prone to downward swings and cannot offer lucrative profits. Fast growers, on the other hand, are companies that can grow 20 or even 30 percent a year. Companies like Apple, Wal-Mart, and Taco Bell were all fast growers. These are companies to watch out for. If you can get in early with these companies, you will no doubt end up with a tenbagger in very short amount of time. The next two types of companies experience downward swings. The first type is known as a cyclical. Industries like auto makers, steel companies, and airline makers are all good example. The usually have large growth periods followed by downward shifts (obviously we are now in one of those downward shift…a //very// downward shift). These companies, while highly volatile, are good investments in the long run as they ultimately have a net increase. In the short run through, they are highly volatile and thus highly risky. There are also companies known as turn-arounds. These companies experience no or even negative growth. They often have to drag themselves out of bankruptcy. After they hit rock bottom, some companies such as Chrysler turn around and become successful corporations again. These companies, Lynch explains, are risky because often bankrupt companies go out of business and any stock you hold in them will be utterly worthless. If, however, you can spot the turn-around at its lowest point, you will no doubt come out with exorbitant amount of money. The last type of company on Lynch’s list is perhaps the most simple but also the most difficult to spot. It’s known as an asset play, and this is a company that is simply sitting on something highly valuably or in high demand that Wall Street has overlooked. Clearly finding a company that has been overlooked by thousands of professional investors is no easy task. Usually these types of companies are local or even in your professional field (other than investing) where you may have special knowledge or expertise. While finding companies like this can be hard, Lynch outlines six things that you should research before investing in a company. First, look at the p/e ratio. This is the ration between share price and annual earning per share. The lower the ratio is, the better. Low-cost shares that have high annual returns are ideal investments. Also, look at the percent of institutional ownership. Ideally, this percent should be low indicating that a significant portion of the company is owned by shareholders. Next, look at whether insiders are buying or whether the company is buying back its own shares. This is a good indicator of how the company will do in the future. If executives and insiders are buying back stocks, you should too. After that, look at the record of earnings to see if the are sporadic or consistent. Consistent earnings are ideal as the offer steady, predictable growth. Make sure you note the strength of the balance sheet of a company as well. According to Lynch, you want to be sure a company has a high earnings to debt ratio. Companies with high debt and low earning are prone to downward swings and even bankruptcy. Lastly, look at the net cash behind each stock. If a company has a net cash of 15$, then you know that the share price is very unlikely to drop below 15$. The stock has bottomed out and it is very unlikely that you will loose money if you buy at the bottom. Lynch ends the book in a discussion about the long run and when you should know to sell your stocks. Investing for the long-run, according to Lynch, is a safe and lucrative way to make money. The market will inevitably go up in the long run and you stand to make a lot of money if you leave your money in for an extended period of time.