Saturday, May 17, 2008

Peter lynch's checklist

Here's a checklist from Peter Lynch's book, One up on wall street:

Stocks in general:
  1. P/e ratio – is it low or high for this particular company and for similar companies in the same industry
  2. The percentage of institutional ownership
  3. Whether insiders are buying and whether the company itself is buying back its own shares. Both are positive signs
  4. The record of earnings growth to date and whether the earnings are sporadic or consistent (the only category where earnings may not be important are asset plays)
  5. Whether the company has a strong balance sheet or a weak one (debt-to-equity ratio) and how it’s rated for financial strength)
  6. The cash position. With $16 in net cash, I know Ford is unlikely to drop below $16 per share – floor of the stock

  1. These are big companies that aren’t likely to go out of business. They key issue is price, and the p/e ratio will tell you whether you are paying too much
  2. Check for possible diworseifications that may reduce earnings in future
  3. Check the company’s long term growth rate, and whether it has kept up the same momentum in recent years
  4. If planning to hold the stock forever, check to see h
  5. How the company fares during previous recessions and market drops

Slow growers
  1. Since you buy these for the dividends, check to see if the dividends have always been paid, and whether they are routinely paid
  2. When possible, find out the percentage of the earnings being paid out as dividends. If it’s a low %, then the company has a cushion during hard times. If it’s higher %, then it’s riskier than the company can continue paying the dividends.

  1. Keep a close watch on inventories, and the supply-demand relationship. Watch for new entrants into the market, which is usually a dangerous development
  2. Anticipate a shrinking P/E multiple over time as business recovers and investors look ahead to the end of the cycle, when peak earnings are achieved
  3. If you know your cyclicals, you have an advantage in figuring out the cycles. The worse the slump in the cycle, the better the recovery will be. Vice versa.

Fast growers
  1. Investigate whether the product that’s supposed to enrich the company is a major part of the company’s business
  2. What the growth rates in earnings has been in recent years. Favourites ones are in the 20 to 25% range. Wary of companies growing faster than 25%. Those 50% usually are found in hot industries, a nono
  3. That the company has duplicated its successes in more than one city or town, to prove that the expansion will work.
  4. That the company still has room to grow.
  5. Is the stock selling at P/E ratio at or near the growth rate? In fair valuation, the P/E should be the same as the earnings growth rate.
  6. Whether the expansion is speeding up or slowing down. For companies selling products which customers buy only once, a slowdown can be devastating. Not so much for companies selling product which customers have to keep buying
  7. That few institutions own the stock and only a handful of analysis ever heard of it. With fast growers on the rise this is a big plus.

  1. Most important, can the company survive a raid by its creditors? How much cash does the company have? How much debt? What is the debt structure? And how long can it operate in the red while working out its problems without going bankrupt? If the company have to issue shares to turnabout, the company may turnabout, but the stock might not
  2. If it’s bankrupt already, then what’s left for shareholders?
  3. How is the company going to turn around? Has it rid itself of unprofitable divisions?
  4. Is the business coming back?
  5. Are costs being cut? If so, what will the effect be?

Asset plays
  1. what’s the value of the assets? Are there hidden assets?
  2. How much debt is there to detract from these assets? Creditors will get the share first
  3. Is the company taking on new debt, making the assets less valuable?
  4. Is there a raider in the wings to help shareholders reap the benefits of the assets?

When to sell?

Slow growers
  1. Company lost market share for 2 consecutive years and is hiring another advertising agency
  2. No new products are being developed, spending on research and development is curtailed. Appears to be resting on its laurels
  3. Two recent acquisitions of unrelated business look like diworseifications and the company announces it is looking for further acquisitions “at the leading edge of technology”
  4. The company has paid so much for its acquisitions that the balance sheet deteriorated from no debt and millions in cash to no cash and millions in debt. No surplus funds to buy back shares
  5. Even at lower price, the dividend yield is not high enough to attract buyers

  1. New products introduced in the last 2 years have mixed results, others still in testing stage and are a year away from marketplace
  2. The stock has a p/e ratio of 15, while similar quality companies in the industry have p/e ratio of 11-12
  3. No officers or directors have bought shares in last year
  4. A major division that contributes 25% earnings is vulnerable to an economic slump that’s taking place
  5. The company’s growth rate has slowed down, though maintaining profits by cutting costs, future cost cutting opportunities are limited

  1. Sell towards end of cycle. Look for inventories building up/falling commodity prices/new competition.
  2. demand for product is slowing down
  3. Compnay doubled its capital spending budget to build a fancy new plant, as opposed to modernizing the old plants at low cost
  4. Company tried to cut cost but can’t compete with foreign producers

Fast growers
  1. Watch out for the end of second growth phase of company
  2. When a lot of analyst are looking into it, giving highest recommendations, 60% held by institutions and coming out in magazines
  3. P/E gets bigger and reaches illogical levels. When p/e reaches 50, can the company still grow at 50% earnings?
  4. Same store sales are down 3% in the last quarter
  5. new store results are disappointing
  6. Top executives join rival firm
  7. Company returned from a show for intuitional investors
  8. Stock is selling at p/e of 30, while most optimistic projections of earnings growth are 15-20% for next 2 years

  1. Sell when it’s turned around
  2. Debt, which has declined for 5 straight quarters, just rose by 25 million in latest quarterly results
  3. Inventories are rising at twice the rate of sales growth
  4. P/e is inflated relative to earnings prospects
  5. Company’s strongest division sells 50% of output to one leading customers, and that customer is suffering from slowdown in own sales

Asset plays
  1. Wait for raider to come
  2. Although the shares sell at a discount to real market value, management announced it will issue 10% more shares to help finance a diversification program division expected to be sold for $20 million only brings $12 million in actual sale
  3. Institutional ownership risen from 25% to 60%.