PDF Summary:One Up On Wall Street, by Peter Lynch

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, legendary investor 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.

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.

Alongside Lynch’s investing advice, we’ll present the varied and sometimes opposing recommendations of other investors and experts, 21st-century updates to some of his ideas, and clarifications on certain concepts.

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(Shortform note: Aside from the missed gains Lynch alludes to, when you withdraw from the market, you must also pay a capital gain tax on your withdrawal. That tax rate can be as high as 20%, making it important to think carefully about withdrawing.)

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.

(Shortform note: Not everyone agrees with Lynch about investing in companies you know. In Benjamin Graham’s The Intelligent Investor, financial journalist Jason Zweig writes in commentary that you must never buy stock in a company merely because you like its products. Instead, decide first if the stock is over- or undervalued and then buy or hold off accordingly. While Lynch doesn’t claim that you should buy stock in a company you like without looking into its financials (and in fact advises you to conduct three research steps, which we’ll examine next in this guide), he does think you should only research companies you already know and like. Zweig, on the other hand, seems to think personal preference should matter little or not at all.)

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.

(Shortform note: This recommendation may no longer apply in today’s tech-saturated business world. Some argue that every company—no matter what it does—is now a tech company because tech has simply become a necessity for staying competitive. This means that companies that might once have seemed mundane or unappealing 1) can use tech to modernize their operations (like a plumbing company using the latest technology to complete jobs more effectively) and 2) can use tech to easily reach the eyes of more investors (a pest control company might create a flashy social media campaign).)

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.

(Shortform note: Why would a parent company spin off a new independent company in the first place? One reason may be that the parent company wants to dedicate its resources to only the highest-performing areas of its business and allow a subsidiary to take care of the other areas. Additionally, parent companies expect the spinoffs will be profitable, as these can narrowly focus on one service or product. This is in line with Lynch’s belief that parent companies set up spinoffs for success—parent companies want the spinoff to succeed.)

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.

(Shortform note: While it may seem difficult for any company to grow in a slow-growth industry, business experts agree with Lynch that savvy companies can find ways to excel in even the slowest industries. For instance, they might offer a product that’s superior to all others in quality, cost, or functionality.)

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.

(Shortform note: Others feel you might need to spend more time than a few hours on each stock: To become a true home-grown stock analyst, you might also wish to research a company’s suppliers, customers, and competitors—a process that could take days or weeks.)

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.

(Shortform note: Rather than letting your current needs and risk tolerance determine what type of stock you buy, investment expert Benjamin Graham proposes determining if you’re an aggressive investor or a defensive investor and letting that identity inform your stock buying decisions. An aggressive investor is eager to obtain better-than-average returns on their investments while a defensive investor simply wants to obtain decent returns. Consider deciding which type of investor you are and then steering toward appropriate stock types (an aggressive investor might favor fast-growth companies while a defensive investor might prefer dependable companies).)

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.

(Shortform note: Gathering the data you need to make an intelligent investing decision may seem tedious or boring, if not superfluous. But Benjamin Graham provides a compelling reason to do your due diligence: When you purchase a stock, you become a part-owner of a company. That means you have both the responsibility and the privilege to pay attention to your company’s progress and speak up when you see management making poor decisions. When you take on the perspective of a company owner, gathering data on your business seems critical.)

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.

(Shortform note: Another way to think about the P/E ratio is that it’s an indicator of what investors are willing to pay today for a stock based on its past earnings or projected future earnings. So if a company has a high P/E today, it might mean that investors expect the company to grow significantly in the future and are willing to pay a high share price now. Therefore, while you can sometimes take a high P/E as a warning sign and a low P/E as an invitation to buy, as Lynch indicates, a high P/E can also be a sign of future growth.)

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.

(Shortform note: What exactly does it mean for a stock to be “priced too high or too low?” When a stock is priced too high—or overvalued—the company’s projected future earnings don’t justify the high price. In such cases, the stock is expected to drop to more accurately reflect company earnings. In the same way, a stock that’s priced too low—undervalued—sells for less than what it should sell for, based on the company’s performance.)

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.

(Shortform note: It’s true that you can’t expect to find the same P/E ratios for different types of companies, as the rise of fast-growth technology companies illustrates. Tech companies can have P/E ratios in the hundreds or thousands: The mobile payments company Square recently had a P/E of 1052.75.)

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.

(Shortform note: Lynch advises reviewing a company’s assets and liabilities but doesn’t provide a formal definition of these. Assets are resources or goods a company can use to reduce expenses, generate cash, or provide future economic benefits. For instance, your car is a personal asset because you can sell it to generate cash. A patent might be an asset for a company because it provides future economic benefits. Liabilities, on the other hand, are financial obligations to other parties. These include loans, mortgages, accounts payable, deferred revenues, and more. For instance, a company’s payroll is a liability: It’s money it owes its employees.)

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.

Companies’ Changing Approach to Dividends

Lynch’s preference for investing in fast-growing companies that don’t pay dividends reflects the change in how companies approach dividends that occurred over the 20th century. According to Graham in The Intelligent Investor, companies used to pass on most of their profits to shareholders in the form of dividends. This meant that you could tell a successful company by its large dividend payments.

However, later in the century, companies paid less in dividends and retained more of their profits to pour into growth. This meant that investors started considering a company paying dividends to be a bad sign—a signal that the company wasn’t growing.

Still, there’s reason to be cautious when a company pays no dividends: They might not be investing their profits in growth, but rather in poorly conceived projects or acquisitions. View dividends merely as a piece of the research puzzle, and don’t invest simply because a company does or doesn’t pay dividends.

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.

(Shortform note: A different way to consider whether a company has special assets is to identify what experts call its unique selling proposition—what makes the business unique among competitors. Ask, Is this company doing something no other company can easily do? What about this company’s business model, product, or operations can’t easily be duplicated and therefore makes the company valuable? If you have positive answers to the above questions, you can consider the company to have a special asset.)

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.

(Shortform note: It’s likely also advisable to pay attention when a company is in the planning stages of an acquisition or merger. In 10% of cases, such deals fall through, which can have undesirable consequences for both the companies and the shareholders. In fact, 3% of the time, activist investors (usually hedge funds) bring the deal to a standstill, showing that investors often view acquisitions as dangerous.)

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.

(Shortform note: Why would a company buy back its own stocks? There are several reasons, one of which is that the company feels its stocks are undervalued and wants to drive up that value. Another reason is that, by buying up stocks and reducing the number of outstanding shares, the company’s earnings per share (which we mentioned in our discussion of the P/E ratio) increases, making it look more appealing to investors—without the company actually having to increase its earnings. So while Lynch points to companies buying their shares as a good sign, it might also simply be the company’s way of making itself look better without making significant changes.)

Similarly, when employees buy their own company stock, it means they have faith in the company—another good sign.

(Shortform note: While employees purchasing company stock may well be a good sign for you as an investor, surveys show that few employees participate in such employee stock purchase plans. Therefore, it’s probably best not to rely too much on this metric.)

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.

(Shortform note: Since the book’s publication, product life cycles have become even shorter, which means inventory becomes obsolete faster than before. This is due in part to technological advancements and rising consumer expectations. What’s more, some tech companies, like Apple, implement planned obsolescences—making new operating systems incompatible with older devices. This forces consumers to constantly upgrade to the latest models and makes old models valueless.)

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.

(Shortform note: Lynch’s logic here is that by creating a speech about why you should invest in a company, you force yourself to carefully think through and justify those reasons. If this is the main point of crafting a speech, you could also simply write down the monologue without reciting it. This is because writing something down forces you to think deeply about the topic and aids recall—no recitation necessary.)

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.

(Shortform note: If you don’t see yourself periodically checking on your investments, consider investing not in individual stocks but in index funds: stock portfolios that are designed to perform the same as a financial market index—for instance, the Standard & Poor’s 500 Index. According to Burton G. Malkiel in A Random Walk Down Wall Street, this is the best and safest strategy for any investor.)

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.

(Shortform note: There’s another compelling reason to buy stocks in only companies you have special knowledge about: Advisors and analysts who claim to understand more than you do about a company usually obtain their information from the company itself. These company performance forecasts are 1) often merely estimates and 2) often inflated to make the company look good.)

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.

(Shortform note: Others disagree with Lynch’s stock quantity recommendation, instead advising you to acquire at least 20 stocks. While Lynch argues you should own multiple stocks to increase your chances of finding a tenfold increaser, others argue your actual goal should be to diversify your portfolio to mitigate risk, and therefore the more stocks you own, the more likely you are to end up profiting.)

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

Building a Low-Risk Stock Portfolio

Lynch recommends building a portfolio that reflects your tolerance for risk. Indeed, in I Will Teach You to Be Rich, Ramit Sethi recommends doing the same thing—what he calls diversifying your portfolio: distributing risk among various types of stocks. He adds that distributing your assets intelligently to mitigate risk is more important than finding perfect companies to invest in. Therefore, you might spend more time thinking about the risk distribution of your portfolio than researching a particular company.

Sethi also breaks stocks into different categories than Lynch and recommends investing not in slow-growth or dependable companies, for instance, but rather in domestic or developed-world international stocks. He specifically recommends using the following asset distribution:

• Invest 30% in domestic stocks

• Invest 15% in developed-world international stocks

• Invest 5% in emerging market stocks

• Invest 20% in real estate development trusts

• Invest 15% in government bonds

• Invest 15% in treasury inflation-protected securities

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.

(Shortform note: Lynch recommends manually monitoring your stocks, but in I Will Teach You to Be Rich, Ramit Sethi argues you should also create automated systems that invest in the stock market regularly for you. This eliminates the need to think about investing every day yet ensures you continue to grow your wealth. Lynch’s and Sethi’s approaches should be seen as complementary, rather than mutually exclusive, though: You can initially determine the stock type breakdown of your portfolio and then set up automatic payments that continue to invest in them. Finally, check on how well your portfolio’s doing and shift funds around as necessary.)

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.

(Shortform note: Lynch advises you to buy and sell when you feel is best based on the company’s financial performance—in other words, to not buy or sell based on the emergence of bull or bear markets, as many investors do. A bull market is a market in which stock prices rise and the economy performs well. Many investors wish to buy stock in bull markets. Conversely, in bear markets, stock prices decline and the economy experiences a downturn. Investors withdraw money from the market, fearing loss.)

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.

(Shortform note: Lynch notes that you should avoid selling early, but how can you tell when it’s too early and when it’s the right time to sell? One metric is media attention: If a company is garnering significant attention in the media, more investors will likely be drawn to the stock, which will drive the price up and eventually may cause it to collapse. You might thus consider selling just when you start reading about the company in the press.)

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.

(Shortform note: Lynch’s advice to ignore hype and go your own way as an investor was largely ignored in the lead-up to the 2007 and 2008 financial crisis. According to Michael Lewis in The Big Short, major Wall Street investment firms fell prey to the contagious excitement about mortgage-backed securities and suffered tremendous losses when the housing bubble burst. Meanwhile, a few iconoclasts who did their basic research and refused to follow the herd profited from Wall Street’s greed and ignorance. In this case, the iconoclasts knew not about an external circumstance that would profoundly affect the stock market, but about an internal circumstance: the risky behaviors of countless Wall Street firms.)