This article is an excerpt from the Shortform book guide to "One Up On Wall Street" by Peter Lynch. Shortform has the world's best summaries and analyses of books you should be reading.
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What is Peter Lynch’s One Up on Wall Street about? What is the key message to take away from the book?
In One Up on Wall Street, Peter Lynch describes a no-nonsense approach to the stock market. Rather than following the complex predictions of so-called professionals or leaping on the latest and greatest overpriced stock, he advises you to keep your own counsel, be self-reliant, and see yourself as your greatest resource.
Below is a brief overview of the key takeaways from One Up on Wall Street by Peter Lynch.
One Up on Wall Street: How to Use What You Already Know to Make Money in the Market
Have you always wanted to invest in the stock market but felt too uninformed or inexperienced to do so? In One Up on Wall Street, Peter Lynch argues that you not only have all the tools you need to become a savvy investor but that you actually have a better chance of investing successfully than professionals and firms: You can act independently and based on your own good information.
In One Up on Wall Street, Peter Lynch describes a no-nonsense approach to the stock market that involves examining your daily life for investment opportunities, doing your research, and diligently monitoring your portfolio over time. Rather than following the complex predictions of so-called professionals or leaping on the latest and greatest overpriced stock, he advises you to keep your own counsel, be self-reliant, and see yourself as your greatest resource.
Reasons to Invest on Your Own
Lynch insists that you already have everything you need to do well in the stock market and that you don’t need the services or guidance of a professional investor. He believes this is the case because:
- Professional investors and firms aren’t flawless.
- You’re usually a better source of knowledge than professional investors.
Professional Investors and Firms Aren’t Flawless
Lynch argues that professional investors can lead you astray because they’re often misguided or operating from high-minded theories, rather than on-the-ground experience.
In part, this is because professional investors face the following obstacles, according to Lynch:
Delays: Most professional investors only buy stock once other investors or firms have done so, and it’s therefore a proven good investment. This means they’re not free to leap on early opportunities, when the stock price is low.
Reputation management: Professional investors have a greater incentive to stick to safe, established companies because they risk less professionally. Investment firms also often like to prioritize parity over profit, spreading investment success somewhat equally among clients so clients don’t become upset if others’ portfolios do better than theirs. The result is that when you allow an investment firm to make investing decisions for you, you’ll likely only ever make moderate gains.
Restrictions on what they can buy: Many investment firms don’t invest in companies that have unions, operate in certain industries, or follow other relatively arbitrary rules. Further, the SEC imposes restrictions on what firms can buy. This limits the range of companies they’ll invest in for your benefit.
You’re Usually a Better Source of Knowledge Than Professional Investors
When you invest yourself, you have the advantage of being a consumer who can learn about and test a company’s products or services on a daily basis, either in your personal life or at work. This gives you first-hand knowledge of a company’s output.
You’re also an independent entity who can make your own choices on your own timeline, continues Lynch. This lets you potentially make more money on small yet promising companies you come across long before investment firms learn about and act on them.
Understand Five Truths Before You Invest
Even though you’re equal to or better than any professional investor, you must be aware of certain key truths to have success and feel in control on the stock market, stresses Lynch.
Truth #1: There’s Inherent Risk Involved in Investing
Investing is inherently risky—if you’re not OK with that risk, you probably shouldn’t invest, writes Lynch. You may not make a huge return each year, and some years, you may even lose money. However, if you understand this, you can develop the discipline and resilience to stick with your stocks through their ups and downs (rather than selling at the first sign of a downturn), thereby increasing your chances of making a good return on your investment.
Lynch notes that you can further reduce the risks you’re exposed to by educating yourself about the market and developing good investment skills. You might do this by reading books, scouring the financial section of the newspaper, or talking with people who are already savvy investors. You’ll then better understand what qualifies as a successful portfolio and not aim for impossible gains by making unsound investments.
Truth #2: You Want to Nab the Tenfold Increaser
According to Lynch, as an investor, your goal should be to find a tenfold increaser (what he calls a tenbagger): a stock that makes you back 10 times what you invested. A tenfold increaser dramatically improves your return and helps erase the effect of a bad investment. You can find such companies anywhere and probably encounter two to three a year in daily life.
Truth #3: Only Invest Money You Won’t Miss
Only invest money whose loss won’t negatively affect your day-to-day comfort, stresses Lynch. This is because you can’t predict how stocks will perform in the short term (though you can typically predict over 10 to 20 years) and may temporarily lose money you need to survive.
Truth #4: Pay Attention to the Company, Not the Market
When you find a company you like, disregard what the market’s doing and just buy stocks now, insists Lynch. This is because 1) the market will always be in flux and will eventually reverse itself, and 2) any pundit or acquaintance who thinks they know how the market will perform is likely wrong: It’s virtually impossible to predict the market’s future movements accurately. Therefore, it doesn’t make sense to act based on the market—instead, act based on how you think the stock will do. If the company’s strong, it will do well in the long term, regardless of what the market’s doing right now.
Truth #5: There Are Different Types of Stocks
Companies fall into one of six stock types and often change type over time, says Lynch. How you invest in a stock depends on what type of stock it is, and it’s important to understand the type before you invest. This ensures you have correct expectations of that company’s performance and won’t sell a stock in a company type prematurely.
Here are the stock types Lynch lists:
Slow-growth companies: Most companies that start out as fast growers eventually become slow growers. Lynch doesn’t particularly recommend investing in slow-growth companies because you won’t make money fast.
Dependable companies: These are large, established companies that grow more quickly than slow-growth companies but still maintain a relatively slow pace. It’s good to have a few dependables in your portfolio because they’ll keep you afloat in market downswings since they generally aren’t as strongly impacted by such swings as smaller companies are.
Fast-growth companies: These companies are small and grow aggressively, at 20 to 25% per year. Such companies also tend to be tenbaggers or higher. These companies are riskier than dependable companies.
Cycle companies: These are companies that grow and contract in cycles. Such companies can be dangerous for inexperienced investors if they don’t understand when’s the best time to invest and that a downswing will be followed by an upswing.
Underdog companies: These are companies that are experiencing a low-growth moment but will soon make a rapid comeback and are therefore worth investing in when stocks are low.
Hidden-treasure companies: These are companies that have an asset you happen to know about but which professional investors have overlooked. An asset might be cash, real estate, a subscription model, or some other hidden advantage. It takes inside knowledge to know this advantage.
Most companies change stock types over time. Fast-growth companies eventually slow down or might become cycle companies. Alternatively, a slow-growth company might become an asset play when clued-in investors recognize it owns good real estate. Any slow-growth company might become an underdog.
Truth #6: Plan to Be in the Stock Market for Life
Lynch advises you to put a fixed amount of money in the market and behave as though that money will always be invested. This assumption will keep you from unwisely withdrawing money from the market in a panic.
Where and How to Encounter Strong Investment Opportunities
Now that you understand how to regard and interact with the stock market, start looking for investment opportunities. Lynch believes you’ll find the best investment opportunities in the places most familiar to you: daily life and work. Familiar companies are best to invest in because you have the greatest odds of understanding them and how well they’ll perform.
For instance, if you regularly order house plants from a great online plant store, you have a strong knowledge of that company, which might make its stocks worth investigating. Similarly, if at work, you deal often with a great printing company, you have inside knowledge of that company—an advantage in deciding if you should invest.
Conversely, Lynch strongly warns against investing in companies you don’t understand, trendy companies everyone else is investing in, companies that are diversifying, or companies that supply to only a single buyer. Such companies are likely to fail sooner or later.
When on the lookout for good investments in your daily life and at work, pay particular attention to companies with the following positive attributes, writes Lynch:
Companies that are—or sound—mundane or unappealing: Unglamorous companies (like waste removal or pest control companies) often do well but don’t attract investor attention until stocks are high. For this reason, investigate companies with boring or unappealing names, as this may indicate the company is uninteresting to most investors and therefore attractive.
Companies that have branched off from larger companies: When a subsidiary becomes its own company, it’s often successful because the parent company ensures the subsidiary is in good financial standing beforehand.
Companies in no-growth industries: Seek out companies in industries that seem not to be growing at all because this indicates there’s little competition in such industries, and strong companies can flourish.
How to Assess and Research a Company
Lynch advises that once you’ve discovered an interesting and viable company, don’t invest right away. First, conduct sound research. This should only take a few hours per stock.
Do this in several steps:
Step 1: Determine What Type of Stock It Is
The first step of your research is to determine what type of stock you’re looking at, writes Lynch. This is because you might only want to buy a certain type of stock now based on your needs and risk tolerance—for instance, you might reduce risk by investing in a dependable company.
Step 2: Gather Pertinent Data
The stock type you determined in the last step tells you what information you need to gather on the stock to evaluate its future success and assure yourself that it’s a worthy investment, writes Lynch. Certain data will only be helpful in evaluating the potential of certain stock types.
While the task of data collection can seem daunting to a novice investor, it’s simpler than you might think. You just need a few pieces of information and a general understanding of how well the company is performing. You can obtain this from the investor-relations department of the company, your broker, company reports, or by visiting the company itself if you can.
Here’s the data you should find, says Lynch:
The P/E Ratio
The P/E ratio is the stock Price to company Earnings ratio. You obtain this by dividing the company’s stock price by the company’s earnings per share (essentially how much the company makes per share; this is net profits divided by the number of shares issued).
For instance, if a stock price is $4.00 and the company’s earnings per share are $1.00, the P/E ratio will be ($4.00 : $1.00 =) 4.
Lynch writes that the P/E ratio is helpful for several reasons: You can think of it as the number of years it will take the company to earn back your initial investment. Therefore, a high P/E ratio (20 or 30, for instance) may be unattractive while a low one (say 6 or 7) may be attractive.
Lynch also notes that by comparing the P/E ratio to the P/E ratios of other companies in the industry or to that company’s previous P/E ratios, you can see if a stock is priced fairly, too high, or too low. For instance, if a company’s stock currently has a P/E of 20 (stock price of $100/earnings per share earnings of $5) and last year had a P/E of 5 (stock price of $10/earnings per share earnings of $2), you can tell that the stock price is very high now. You might therefore wait until it falls before investing.
When looking at P/E ratios to help guide your investing decisions, take into account what type of company it is. You can’t expect the same ratios for dependable companies, fast-growth companies, and slow-growth companies.
Assets and Liabilities
It’s also worth looking at a company’s assets and liabilities on company reports, writes Lynch. You want to see that a company’s assets are growing and that its liabilities (debt) are shrinking over time. It’s also a good sign when the company’s assets are currently greater than its debt—if this is true, the company likely isn’t about to go out of business.
Assets and liabilities won’t give you a detailed view of the company’s financial standing because they only indicate what the company owns and what it owes. However, when you subtract liabilities from assets, the result will tell you if the company is generally doing well or badly: If the result is positive, the company has greater assets than liabilities, and it’s in good shape. If the result is negative, its liabilities are greater than its assets, and it’s not in good shape.
Dividends
A dividend is the money a company regularly pays to shareholders, explains Lynch. (It’s different from capital gains, which is the profit you make from selling a stock at a higher price than the price at which you bought it.) Not all stocks pay dividends, so you may prefer stocks that do if you like receiving a regular payout. Conversely, you may prefer stocks that don’t pay dividends because these companies can invest that money into growth, which might result in greater capital gains later. Lynch himself prefers to invest in fast-growing companies that don’t pay dividends over slow-growing companies that do.
Once you’ve examined the company’s P/E ratio, assets and liabilities, and dividends, find answers to these additional questions about the company:
Does the Company Have Special Assets?
Identify if the company has certain types of valuable special assets because this can make the stock more valuable, writes Lynch. Special assets can be natural resources (precious metals, oil, land, and so on), brand recognition (think of Starbucks or Tesla), real estate, patents on drugs, ownership of TV and radio stations, or tax breaks.
Has the Company Recently Diversified?
Lynch warns that you should be wary of companies that recently acquired another company. Often, a large company will do this hoping to increase its profits, but the resulting merger often fails to improve the parent company’s finances. This may be because 1) the parent company overpays for the deal, or 2) the parent company doesn’t understand the company it just purchased. The result is that the company often ends up selling off unprofitable acquisitions by restructuring. This cycle tends to repeat itself and is bad for investors.
Are the Company or Its Employees Buying Back Its Own Shares?
It’s a good sign when a company buys back its own shares, asserts Lynch. By doing this, they take shares off the market. When there are fewer shares, demand drives the share price up—a boon for those already or soon-to-be invested in the company.
Similarly, when employees buy their own company stock, it means they have faith in the company—another good sign.
Does the Company Have a Large Inventory?
If a company—especially a retailer or a manufacturer—has a large inventory, it usually means it isn’t selling as much as it would like to, contends Lynch. Further, this inventory will depreciate in value and can’t be sold for as much in the future—think about clothing, which rapidly depreciates because it goes out of style. Consider avoiding such companies.
Step 3: Craft a Speech Explaining Why The Company’s Worth Investing In
Lynch recommends that if you’ve answered the above questions and satisfied yourself that the company’s financials are sound, the final step of assessing and researching a stock is to devise a two-minute monologue describing why the company’s worth investing in, which you can say to yourself or to someone else. This practice firms up the reason for buying the stock in your mind or helps you question that reason if it’s unsound.
After you’ve created your monologue about why to invest in a company and then actually invested, periodically check that the reasons you invested still stand, insists Lynch. Monitor your stocks carefully, and adjust your investments depending on your stocks’ fortunes.
How to Manage a Stock Portfolio Over Time
You may by now have purchased your first stock, which means it’s time to begin thinking about building a long-term stock portfolio. Let’s look at Lynch’s advice on how to manage a portfolio over a lifetime.
Buy as Many Stocks as Companies You Understand
Lynch believes you should buy as many stocks as you feel you have special knowledge in or which you’ve thoroughly researched and have faith in. For instance, if you work in the automotive industry, you might have special knowledge about a car manufacturer, or you’ve done extensive research on a new coffee shop chain that’s opened in your area, and you feel confident about its prospects. You’d thus buy stocks in both.
If you want a specific number, Lynch recommends acquiring between three and 10 stocks. It’s advantageous to own multiple stocks because the more you own, the more likely you are to snag a tenfold increaser. Further, when you own multiple stocks, you can shift your money around between them, which we’ll talk about in a coming section.
Build Your Portfolio Based on Your Risk Tolerance
To create a portfolio you feel comfortable with, take into account the risk and gain associated with each stock type, recommends Lynch. Then, acquire stock types that give you a risk vs. gain ratio you can live with. The risk versus gain ratio for each company type is:
Low risk, low gain: Slow-growth companies
Low risk, moderate gain: Dependable companies
Low risk, high gain: Hidden-treasure companies (provided you’re sure of the company’s assets) and cycle companies (provided you understand the company’s cycles)
High risk, high gain: Fast-growth companies or underdog companies
Always Reevaluate Stocks and Shift Money Sensibly Between Them
Lynch recommends that you sensibly move funds between stocks as company situations change, and that you maintain approximately the same distribution of stock types in your porfolio.
For instance, you might wish to maintain three dependable, two fast-growth, and one slow-growth company in your portfolio. Then, if you believe a cycle company has hit its financial peak and that its fortunes will soon reverse, sell that stock and buy stock in a different cycle company that’s about to be on the upswing.
Understand When to Buy and Sell
Lynch claims you should buy stocks when you feel 1) the company’s strong and 2) that you’re paying a fair price for what you’re getting.
Additionally, there are specific occasions when stocks come at a bargain. The first is at the end of the year, when companies sell off many of their stocks and you can snap them up cheap. The second is whenever the stock market’s doing badly. Though you might be tempted to sell at such times to minimize your losses, counteract your instincts and buy while stocks are cheap.
When it comes to selling stock, try to avoid selling too soon whenever possible. Lynch lists many instances in which he took poor advice and sold a stock that continued growing.
Take Your Own Counsel on How to Manage Your Portfolio
Lynch’s final advice on managing your portfolio is to avoid selling just because prognosticators recommend it. Instead, rely more on your research and your continued check-ins on the company to inform your selling decisions. Only when you know specifically that an external circumstance will negatively affect the company should you do something about it.
Similarly, don’t heed platitudes or beliefs about when to buy and sell (things like, “It’s always darkest before the dawn,” or “If it’s this low, it can’t possibly go any lower”). There simply is never a single rule that works in every circumstance, so you’re better off using your knowledge of the company acquired through research.
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- Why individuals fare better in the stock market than professionals and firms
- A no-nonsense approach to the stock market
- Why you shouldn't follow the complex predictions of so-called professionals
