6 Types of stock to avoid : Stock market for beginners.
Peter Lynch is a famous fund manager who managed Magellan Fund at Fidelity Investments who gave 29.2% return over a period of 13 years; his assets under management increased from $18 million to $14 billion at the end of his tenure.
He is also the author of three famous investing books which according to me everyone should read
1. One up on Wall Street.
2. Learn to earn.
3. Betting the street.
Peter lynch was the person who coined the word multi-bagger. He used simple & profound method for picking stocks for his fund.
Types of stock to avoid – by Peter Lynch
1. Hottest stock in hottest industry.
This are the companies which are favorites of the markets
whose revenue are growing at astonishing pace like technology stock in USA
& finance stock few months back in India. They sale at such an extravagant
price that it’s difficult to even rationalize the valuations. Even though they
have a good future prospectus ahead on them, still it is difficult for them to
achieve their goals as new competition will surely entire which will destroy
the profitability of the industry.
Peter lynch says
“Hot stocks can go up fast, usually out of sight of any of the known landmarks of value, but since there’s nothing but hope & thin air to support them, they fall just as quickly”.
Peter Lynch Example: - Philip Morris & Xerox.
Xerox is one of the famous company known for its photocopy
machines. Xerox was one of a kind company of 1960 which had a huge growth ahead
of it. It was also one of the Nifty 50 companies, which were the 50 hot stock
of that time. Phillip Morris a cigarette marker on the other hand, a company
operating in a negative growth industry in USA but they were expanding in other
countries.
After a period of time Xerox in its photocopy business
attracted a huge competition from Japanese companies & other American firms
as well; which resulted in a huge fall in earning’s & that translated to
share price of the company .But in the case of Phillip Morris very there was a
negative growth the stock outperform Xerox many times over.
2. Beware the next
something.
This are the company who people or the management itself
assume that it will the next big thing. This type of company fall in two ways
first they bring down profits of the entire industry & eventually they fail
to the present leader. In the book Peter Lynch have discussed about few companies.
In Indian context:-
A. Before the fall of IL&FS there were many
small banks who were sort to be the next HDFC bank but when the crises came
everybody know what happened, their NPA increased, they had to raise additional
funds, etc.
B. When HUL tried to take on Marico in its hair oil
business. HUL spend a lot of money as it was a huge MNC but Marico ultimately
won & HUL sold its hair oil business to Marico.
3. The whisper stock.
This are the stock tips which people receive via phone
calls, SMS, E-mails, etc. Usually brokers do this because their main earning
source is brokerage & when you buy and hold they don’t earn money. Sometime
you may receive phone calls, asking you to buy a stock which also be a pump and
dump scheme.
Peter Lynch explain it as follows
“Often the whisper companies are on the brink of solving the latest national problem: the oil shortage, drug addiction, AIDS. The solutions is either (a) very imaginative, or (b) impressively complicated”.
What is common besides the fact that you lost money on them
is that the great story had no substance. That’s the essence of a whisper
stock. The stock picker is relieved of the burden of checking earnings & so
forth because usually there are no earnings.
Instead of buying this hot stock in a hurry, one can wait
until this companies establish themselves in terms of profitability as well as
its competitive advantage. For example: - Apple Inc. was once a successful
startup but Warren Buffett bought the stake in the company only after when it
established its competitive advantage & profitability.
4. Avoid
Diworsification.
This are the
company who wants to expand their business left and right, by using debt,
internal cashflows, financial engineering, etc by ignore profitability. They spend
a huge amount of money on buying unrelated businesses or assets; which in
return creates a loss of net worth over a long period of time. The example of
long history of diworsification is Coco-Cola. Over a period of many decades
they have bought unrelated business & sold them at a loss.
In the Indian
context :- In case of Anil Ambani Group, they tried to diversified in every
possible industry & in the end all the business didn’t perform as expected which
resulted in huge losses for the whole group.
Peter Lynch
explains that many a time’s businesses succeeded due to diversification because
of a concept called synergy. ‘“Synergy” is a fancy name for two-plus-equals-five
theory of putting together related businesses & making the whole thing work’.
For example: - When Mothersonsumi Systems buy same or related auto ancillary
business in India & all around the world.
According to
him it is better of company just buy-back its own shares incase there is no
growth ahead in the existing business. Which will reduce the number of shares
over a period of time & increase the per-share earnings.
5. Beware the Middlemen.
Middlemen
here means a single seller or single buyer of a company. If a company for
example is a supplier of auto ancillary & its only customer is a single
auto maker it can be dangerous for the company’s future. Same applies in case
of single buyer.For example: - When Mothersonsumi System Ltd started it had
only one customer than was Maruti Suzuki Ltd, but now they have wide range of
clientele.
Peter Lynch “Short
of cancellation, the big customer has incredible leverage in extracting price
cuts & other concessions that will reduce the supplier’s profits. It’s rare
that a great investment could result from such an arrangement”.
6. Beware
the stock with the Exciting name.
Many a time’s
companies with fancy name go up in terms of share price but in reality the
fundamental don’t support it. For example: - When a sector is hot like during
the tech bubble the companies with name related to tech went up. In case of
India few months back finance was a hot sector where all names with finance or
related business went up.
Peter Lynch
explains it, as often as a dull name is a good company keeps early buyers away,
a flashy name in a mediocre company attracts investors & gives them a false
sense of security.
Book recommendations
Amazon.in (For India)
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