Insights after Peter Lynch’s book “One up on wall street…”
Every now and then I read, hear or see the surprising (not!) message saying everyone should cut daily expenses, save part of their monthly check and once having some amount saved build somehow additional incomes (passive or not).
Don’t get me wrong, what bores me is the constant bombing of the message and not the idea of doing it. You bet it sounds easier than it really is!
I don’t consider my self someone who dominates the Personal Finance topic, rather one who’s constantly working on it… so talking about my experiences about expenses efficiencies, money management, and building savings could be something for other moment.
Instead, I’m going to talk about when we had managed to save a certain amount of money, that very moment when we face a new difficulty… WHERE DO I PUT MY MONEY?!
Certainly, there are tons of places where we could potentially put our savings, most of the times choosing where depends on our level of knowledge, experience, and our risk profile.
For some reason most people I know, even when they studied something related to business or finance, buying stocks seems out of their minds or even worst, they have the perception of being something reserved for the “big boys” (or better said, big wallets).
That’s why I think it’s important to talk about stock trading as an option for our savings and try to clear some doubts that could be around there.
Before going any further it is important to know, at least in Mexico, you would not have too much problem finding some sort of financial service or platform to buy/sell stocks with less money than you might be thinking right now… and with several fee conditions to choose from.
Having said this, this article summarizes some insights and notes from a book that started as a gift but ended an exchange with an audit poetry book. And yes, you have read it right, I’m not a poetry fan and still for some reason had that book on my bookshelf. Long story short, I saw this exchange as a good way to introduce me (and you) to a very good and recommended “stock trading” book.
The first concept to acknowledge is the very concept of stock, how could we think about trading stocks if we don’t understand what we’re buying and selling? Not going very sophisticated, if we look the definition in places like Google or Investopedia, we’ll find that a stock is a type of security that signifies ownership in an entity and represents a claim on part of its assets and earnings.
Continuing with very simple ideas (and not necessary book concepts), we usually find two types of stocks, ones representing the owner’s shares, with the capacity of influencing in the business decisions and the others as a result of fundraising, ideally to capitalize a project or some sort of business growth. These last ones don’t have influence in the business decisions but instead share part of the earnings and dividends.
The second concept to master is market capitalization, which is the number of shares outstanding times the current stock price. In plain English, we could understand it as the value of a company that is traded on the stock market, calculated by multiplying the total number of shares by the present share price. When investing we should be looking for the market cap to rise.
In a more ground level, one problem we usually confront as a beginner is our approach gathering information, for instance, we will hear every day in the news how the S&P 500 or the IPC close in “x” day. But this information would not tell us very much about a stock, even if we know the stock we’re looking is part of the S&P or the IPC, this last one if we’re looking into the Mexican stock market.
A better approach is to look inside those indexes the stocks ended rising and the ones that not. With this simple example, something we need to have crystal clear is to deepen the news we read and question ourselves on what kind of information we need to bring the most value into our decisions.
Another problem when starting is deciding where to buy a stock. We need to think about the stock environment as a “market” place. In general speaking, a market is a place where we buy things, and like many other things we could find different types of markets. For example, if we look at the US stock market, we can potentially be choosing from around four thousand public companies, compared to Mexico’s stock market which has only around a hundred and forty public companies.
The good thing about this is that luckily for an entry level investor, market size doesn’t matter that much, in almost any market we choose can be found some good companies with stocks worth buying. Most of the times and from my personal experience, the market size only would be influencing the number of services/platforms we need to use in order to be able to gather information and trade the stock.
Everyone could find a good stock to buy, we’re constantly interacting with products and services, we just need to look at home, in the office, stores or any other place and see good products or services representing a company and sometimes a public company. As we mentioned before, a stock is a share of a company.
But and here is a very big “BUT”, not because we like the product or service of a public company means we should buy their stock, finding a good company just means the starting point and where the story begins.
This story starts by knowing the company. What does it do? what are their market cap and bottom line numbers? how the product or service we liked affects their bottom line? and how big/small is the company?
It’s important to understand these starting questions because they give us the ground information, such as, depending on their industry and size we could understand their capacity to move faster or slower in certain environments. Another example within the company size, the bigger the company, usually the less influence a single product or service can make in their results.
As we go deepen understanding the company’s results and operations, when reading their financial statements, another powerful set of tools we could use is the ratio analysis. I strongly recommend anyone to Google it, or even better, read about it in any corporate finance book, this is something could really spurt your company comprehension.
Once we understand the company, it is convenient to categorize our pick with other similar companies to better understand how similar are in their business environments, what pros and cons can we learn from them as a group and based on similar characteristics when is convenient to buy or sell their shares.
For this, Peter Lynch in his book recommends six categories; slow growers, stalwarts, fast growers, cyclical, asset plays, and turnarounds:
· Slow growers, big companies that don’t have much movement in their company and usually neither in their stock.
· Stalwarts are big companies that are currently moving, slow but still moving, because of their size usually they serve as protection on recessions or difficult times.
· Fast growers, small aggressive new enterprises, that grows 20–25% a year.
· The cyclical are companies whose sales and profits rise and fall in the regular and predictable matter, this is the most misunderstood of all six. Something important to have in mind is picking a cyclical stock in the wrong part of the cycle can quickly lead to losing value on our portfolio.
· Turnarounds are companies that can’t promise anything and barely read themselves… in other words, these are no growers.
· Asset plays stocks are ones sitting on something valuable that you know about, these are where the local edge can be used to greatest advantage.
Summarizing, the best way to choose a stock is to know the company and their industry. Sometimes, the simpler or less complex the company/industry the better or saying in the book words, “it’s better when even an idiot could run the company because chances are that at some point an idiot will be running that company”.
When choosing the so-called “hot stocks” or “hot industry stocks” (in our previous category usually fast growers) not by rule, but usually are ones bringing rapid increases with high returns. But also, requiring a deep and continuous tracking, as well as, knowing where the selling points are since they could be leading to false signals with rapid falls.
Some important questions when deciding on hot stocks could be, how much could it last being hot? how much more do the consumers would be needing their products? and how much time until the industry would need to evolve or change?
When gathering information some important ideas to get the facts accurately include asking the right questions to our broker, consult with the companies investor relationship area, depending on the company we could visit the headquarters offices, read their reports and taste or try their products.
Going back on the numbers side, let’s not forget that owning a stock is not like owning a lottery ticket, but rather a piece of the business capital, so earnings and assets are two numbers to be aware of. A quick way to see if the stock price is overpriced is to compare the price line with the earnings line.
Also, the ratio of the market price of the company’s stock to its earnings per share (p/e), and future earnings, although these are complicated subjects, are another two key indicators to keep close.
Some other common indicators worth analyzing when reviewing a stock are:
Finally, once we choose a stock, it’s a good idea every few months to recheck the company story and all the main indicators described above.
This process should be repeated when choosing each stock in our portfolio. When doing this, it’s important to consider being patient and consistent with the investment strategy we choose (but always analyzing the stocks behaviors), also that it’s important to diversify but not pulverize our portfolio, as well as to continuously recheck numbers and our stories.
The next most important thing to know is when to sell and how much to sell. With this, we need to avoid reacting when hearing others say it’s heated or that it is time to sell… Instead, as I mention before review the fundamentals.
Another aspect to be aware, economic variables constantly mentioned on the news or in other places. Do I really know what a weak or strong Mexican Peso (MXP) does to my portfolio? When is bad a high or low oil price? How does this and other variables really affect my portfolio? … Again, some homework needs to be done.
Lastly, it’s very important to have in mind that the stock markets, like individual stocks, are not risk free and could move in opposite direction of the fundamentals or relevant events over the short term. This summarizes, trying to predict the direction of the market over one year or two is practically impossible (at least in my experience).
I hope you found these first insights useful, not forgetting the risk assumed in the activity, trading stocks could be an incredible and fun way to earn some money while learning about the why’s and how’s of companies/industries.
Please keep in mind that the ideas mentioned are not to be taken as final words or in any case some sort of advisory and must include commitment, deep learning, and building experiences, as well as practice, practice and practice.
If you have any comment, please don’t hesitate to write and I would answer as soon as possible.