Saturday, May 10, 2008

Book reflections on Peter's Lynch "One Up On Wall Street"

What a prolific day today! I had one of the free-est saturday that I can recall from recent memories. I managed to finish Peter Lynch's One up on wall street today in the library.

One up on wall street is really a great reading! His style is more informal. Coupled with his wit and humor AND his enlightening advice, I think this is really a page turner for me. It mentioned on the front cover, "More than 1 million copies sold" - I think it is really that good to have sold a million copy.

There's so much information in this 300 page book that I do not know where to begin reflecting. I'm thinking of adding this book to my wish list of investment book that I would read again and again. Let's just start by reflecting on the points which lit up my proverbial light bulb.

1. I learnt the importance of placing the price of the chart against the earnings of the companies. This is not primarily to see how the market reacts to earnings, but to see how the earnings fluctuates. I 'practiced' this by Prime Success and Hongguo, but atlas, their earnings are too stable so it didn't show much. It'll be interesting to place a cyclical stock against the price.

2. Peter classifies stock into 6 general categories:

a. Slow growers

These are large and aging companies, with low earnings growth and usually large, regular dividends. I immediately think of yellow page. After thinking further, perhaps Singpost fall under here too.

b. Stalwarts

These are the 'blue-chip' quality stocks, with earnings around 10-12% growth. Risk is rather low for this type. Coca-cola, P&G from US side are quoted examples. I'm hard pressed to give an example in the local stock market. Help?

c. Fast growers

Smaller, aggressive companies growing 20-25% annually. Possibly a multi bagger, but with higher risk. Hongguo and China milk springs straight to mind.

d. Cyclicals

Companies whose sales and profits rise and fall in regular cycles. Construction plays come to mind. Tech stocks too.

e. Asset plays

Asset plays are companies that are sitting on a valuable asset but the rest of the crowd do not know. Hongfok (sitting on Concourse at Beach road), SPH (Paragon) are possible asset plays. Am I obsessed with singpost? Singpost might be possibly asset play too (sitting on Paya lebar site which they could dispose for a huge one-off gain).

f. Turnabouts

Those that have been depressed and battered, poised for a turnabout. Osim, creative comes to mind.

The book then goes on to list the pointers to look out when buying these 6 categories. There's even a section to tell you when to sell these 6 categories. All great stuff.

3. I think this is the most enlightening part. Peter's view on the growth of a stock and the PE struck me off as highly sensible. PE of any company that's fairly priced will equal to its earnings growth rate. That means that with a PE is 10x, then the earnings growth should be 10% growth. Some stocks are trading at breakneck 60x PE, so the question one needs to ask is that is the earnings growing at 60% too?

Peter suggests a more complicated formula to include dividends. Take the long term earnings growth rate, add the dividend yield, then divide by PE ratio.

If ratio < 1 ---- bad
If ratio around 1.5 ----okay
If ratio >= 2 ------- good

But if Company A grows at 10% with a PE of 10x is compared to Company B that grows at 30% with PE of 30x, even though both have a ratio of 1.0, Company B should be a better bet. Of course, this assumes all else being equal, which is ideal and never the case in practice.