Do Your Research and Set Reasonable Expectations

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Do Your Research and Set Reasonable Expectations

A key principle in Peter Lynch’s investment philosophy is that you should do your homework and research the company thoroughly. Lynch remarked, "Investing without research is like playing stud poker and never looking at the cards." He recommends reading all prospectuses, quarterly reports (Form 10-Q), and annual reports (Form 10-K) that companies are required to file with the Securities and Exchange Commission. If any pertinent information is unavailable in the annual report, Lynch says that you will be able to find it by asking your broker, calling the company, visiting the company, or doing some grassroots research, also known as "kicking the tires." After completing the research process, you should be familiar with the company’s business and have developed some sense of its future potential.

Once you have done your research on a company, Lynch believes that it is important to set some realistic expectations about each stock’s potential. He usually ranks the companies by size and then places them into one of six categories: slow growers, stalwarts, fast growers, cyclicals, turnarounds, and asset plays.

Slow growers

Large and aging companies that are expected to grow slightly faster than the Gross National Product but generally pay a large and regular dividend. Lynch doesn’t invest much in slow growers, because companies that aren’t growing fast will not see rapid appreciation in their stock price.

Stalwarts

Large companies that grow at a faster rate than slow growers, with annual earnings growth rates of about 10–12%. Lynch believes that stalwarts offer sizable profits when you buy them cheap, but he doesn’t expect to make more than a 30–50% return on them.

Fast growers

Small, aggressive, new companies that grow at 20–25% a year. These companies don’t have to be in fast-growing industries per se, and Lynch favors those that are not. Lynch thinks that fast growers are the big winners in the stock market, but they also have a considerable amount of risk.

Cyclicals

Companies whose sales and profits rise and fall in a regular fashion. Lynch states that cyclicals are the most misunderstood stocks, and they are often confused for stalwarts by inexperienced investors. Investing in cyclicals requires a keen sense of timing and the ability to detect the early signs in a cycle.

Turnarounds

Companies that have been battered and depressed, and are often close to bankruptcy. Lynch notes that such "no growers" can make up lost ground very quickly, and their upswings are generally tied to the overall market.

Asset plays

Companies with valuable assets that Wall Street analysts have missed. While Lynch says that asset opportunities are everywhere, he points out that you will need a working knowledge of the company and a healthy dose of patience.