[Image]
What's the best way to invest
$1
million? Tip one: Don't buy
stocks on tips alone. If
your
Amateurs
only reason for picking a
stock can beat
is that an expert likes it,
then the Streat
what you really need is
paid
because, well,
professional help. Mutual
funds they're
amateurs.
are a great idea (I ran one
once) for folks who want
this
Look around
sort of assistance at a you for
reasonable price.
good stocks. Down
the road, you
Still, I'm not convinced
that
won't regret it.
having 4,000 equity funds in
this country is an
entirely
You didn't
positive development. True,
most need a
of the cash flooding into
these Ph.D. to
figure
funds comes from retirement
and out that
Microsoft
pension contributions,
where
was going to be
people can't pick their
own
powerful.
stocks. But some of it also
has
to be pouring in from
former
If you
stock pickers who failed
to missed the
invest wisely on their
own
boat on Microsoft,
account and have given up
there are still
trying.
other technology
stocks you can buy
--------------------------------- into.
One of the oldest
sayings on
Wall Street is "Let your
winners There are
run, and cut
your losers." ways you
--------------------------------- can keep yourself
from gaining on
When people find a
profitable
the good growth
activity -- collecting stamps
or companies.
rugs, buying old houses and
fixing them up -- they tend
to
Sometimes
keep doing it. Had more depressed
individuals succeeded at
industries can
individual investing, my
guess
produce high
is they'd still be doing it.
We returns.
wouldn't see so many converts
to
managed investment care,
Retail and
especially not in the
greatest restaurants
bull market in U.S.
history.
haven't been
Halley's comet may return
ten
performing well --
times before we get
another
but they're two of
market like this.
Lynch's favorite
areas.
If I'm right, then large
numbers
of investors must have
lost
You can
money outright or badly
trailed even find
a market that's up
eightfold
bargain stocks in
since 1982. How did so many
do this
market that
so poorly? Maybe they traded
a have
been
new stock every week. Maybe
they overlooked.
bought stocks in companies
they
knew little about,
companies
Wondering
with shaky prospects and
bad when you
balance sheets. Maybe
they
should exit the
didn't follow these
companies
market? Use
closely enough to get out
when
Lynch's rule of
the news got worse. Maybe
they thumb.
stuck with their losers through
thin and thinner, without
Stocks do
checking the story. Maybe
they well for a
bought stock options.
Whatever
reason, and poorly
the case, they failed at
for a reason.
navigating their own course.
Amateurs can beat the
Streat
because, well, they're
amateurs.
At the risk of repeating
myself,
I'm convinced that this type
of
failure is unnecessary --
that
amateurs can not only succeed
on
their own but beat the Street
by
(a) taking advantage of the
fact
that they are amateurs and
(b)
taking advantage of their
personal edge. Almost
everyone
has an edge. It's just a
matter
of identifying it.
While a fund manager is more
or
less forced into owning a
long
list of stocks, an
individual
has the luxury of owning just
a
few. That means you can
afford
to be choosy and invest only
in
outfits that you understand
and
that have a superior product
or
franchise with clear
opportunities for expansion.
You
can wait until the
company
repeats its successful
formula
in several places or
markets
(same-store sales on the
rise,
earnings on the rise) before
you
buy the first share.
If you put together a
portfolio
of five to ten of these
high
achievers, there's a
decent
chance one of them will turn
out
to be a 10-, a 20-, or even
a
50-bagger, where you can
make
10, 20, or 50 times your
investment. With your
stake
divided among a handful
of
issues, all it takes is a
couple
of gains of this magnitude in
a
lifetime to produce superior
returns.
One of the oldest sayings on
Wall Street is "Let your
winners
run, and cut your
losers." It's
easy to make a mistake and do
the opposite, pulling out the
flowers and watering the
weeds.
Warren Buffett quoted me on
this
point in one of his famous
annual reports (as thrilling
to
me as getting invited to the
White House). If you're lucky
enough to have one golden egg
in
your portfolio, it may not
matter if you have a couple of
rotten ones in there with it.
Let's say you have a portfolio
of six stocks. Two of them are
average, two of them are below
average, and one is a real
loser. But you also have one
stellar performer. Your
[Image]Coca-Cola, your
[Image]Gillette. A stock that
reminds you why you invested
in
the first place. In other
words,
you don't have to be right all
the time to do well in stocks.
If you find one great growth
company and own it long enough
to let the profits run, the
gains should
more than offset
mediocre results from other
stocks in your portfolio.
Look around you for good
stocks.
Down the road, you won't
regret
it.
A lot of people mistakenly
think
they must search far and wide
to
find a company with this sort
of
potential. In fact, many such
companies are hard to ignore.
They show up down the block or
inside the house. They stare
us
in the face.
This is where it helps to have
identified your personal
investor's edge. What is it
that
you know a lot about? Maybe
your
edge comes from your
profession
or a hobby. Maybe it comes
just
from being a parent. An entire
generation of Americans grew
up
on [Image]Gerber's baby food,
and Gerber's stock was a
100-bagger. If you put your
money where your baby's mouth
was, you turned $10,000 into
$1
million. Fifty-baggers like
[Image]Home Depot,
[Image]Wal-Mart, and Dunkin'
Donuts were obvious success
stories to large crowds of
do-it-yourselfers, shoppers,
and
policemen. Mention any of
these
at a party, though, and you're
likely to get the predictable
reaction: "Chances like
that
don't come along
anymore."
Ah, but they do. Take
[Image]Microsoft -- I wish I
had.
You didn't need a Ph.D. to
figure out that Microsoft was
going to be powerful.
I avoided buying technology
stocks if I didn't understand
the technology, but I've begun
to rethink that rule. You
didn't
need a Ph.D. in programming to
recognize the way computers
were
becoming a bigger and bigger
part of our lives, or to
figure
out that Microsoft owned the
rights to MS-DOS, the
operating
system used in a vast majority
of the world's PCs.
It's hard to believe the
almighty Microsoft has been a
public company for only 11
years. If you bought it during
the initial public offering,
at
78 cents a share (adjusted for
splits), you've made 100 times
your money. But Apple was the
dominant company at the time,
so
maybe you waited until 1988,
when Microsoft had had a
chance
to prove itself.
By then, you would have
realized
that [Image]IBM and all its
clones were using Microsoft's
operating system, MS-DOS. IBM
and the clones could fight it
out for market share, but
Microsoft would prosper
regardless of who won. This is
the old combat theory of
investing: When there's a war
going on, don't buy the
companies that are doing the
fighting; buy the companies
that
sell the bullets. In this
case,
Microsoft was selling the
bullets. The stock has risen
25-fold since 1988.
The next time Microsoft might
have got your attention was
1992, when Windows 3.1 made
its
debut. Three million copies
were
sold in six weeks. If you
bought
the stock on the strength of
that product, you've
quadrupled
your money to date. Then, at
the
end of 1995, Windows 95 was
released, with more than 7
million copies sold in three
months and 40 million copies
as
of this writing. If you bought
the stock on the Windows 95
debut, you've doubled your
money.
If you missed the boat on
Microsoft, there are still
other
technology stocks you can buy
into.
Many parents with children in
college or high school (I'm
one
of them) have had to step
around
the wiring crews as they
installed the newfangled
campuswide computer networks.
Much of this work is being
done
by Cisco Systems, a company
that
recently wired two campuses my
daughters have attended. Cisco
is another opportunity a lot
of
people had a chance to notice.
Its earnings have been growing
at a rapid rate, and the stock
is a 100-bagger already. No
matter who ends up winning the
battle of the Internet, Cisco
is
selling its bullets to various
combatants.
Computer buyers who can't tell
a
microchip from a potato chip
still could have spotted the
intel inside label on every
machine being carried out of
the
computer stores. Not
surprisingly, [Image]Intel has
been a 25-bagger to date: The
company makes the dominant
product in the industry.
Early on, it was obvious Intel
had a huge lead on its
competitors. The Pentium scare
of 1994 gave you a chance to
pick up a bargain. If you
bought
at the low in 1994, you've
more
than quintupled your
investment,
and if you bought at the high,
you've more than quadrupled
it.
Physicians, nurses, candy
stripers, patients with heart
problems -- a huge potential
audience could have noticed
the
brisk business done by
medical-device manufacturers
Medtronics, a 20-bagger, and
Saint Jude Medical, a
30-bagger.
There are ways you can keep
yourself from gaining on the
good growth companies.
There are two ways investors
can
fake themselves out of the big
returns that come from great
growth companies.
The first is waiting to buy
the
stock when it looks cheap.
Throughout its 27-year rise
from
a split-adjusted 1.6 cents to
$23, Wal-Mart never looked
cheap
compared with the overall
market. Its price-to-earnings
ratio rarely dropped below 20,
but Wal-Mart's earnings were
growing at 25 to 30 percent a
year. A key point to remember
is
that a p/e of 20 is not too
much
to pay for a company that's
growing at 25 percent. Any
business that can manage to
keep
up a 20 to 25 percent growth
rate for 20 years will reward
shareholders with a massive
return even if the stock
market
overall is lower after 20
years.
The second mistake is
underestimating how long a
great
growth company can keep up the
pace. In the 1970s I got
interested in
[Image]McDonald's.
A chorus of colleagues said
golden arches were everywhere
and McDonald's had seen its
best
days. I checked for myself and
found that even in California,
where McDonald's originated,
there were fewer McDonald's
outlets than there were
branches
of the Bank of America.
McDonald's has been a
50-bagger
since.
These "nowhere to
grow" stories
come up quite often and should
be viewed skeptically. Don't
believe them until you check
for
yourself. Look carefully at
where the company does business
and at how much growing room
is
left. I can't predict the
future
of Cisco Systems, but it
doesn't
suffer from a lack of
potential
customers: Only 10 to 20
percent
of the schools have been wired
into networks, and don't
forget
about office buildings,
hospitals, and government
agencies nationwide.
[Image]Petsmart is hardly at
the
end of its rope -- its 320
stores are in only 34 states.
Whether or not a company has
growing room may have nothing
to
do with its age. A good
example
is [Image]Consolidated
Products,
the parent of the Steak &
Shake
chain that's been flipping
burgers since 1934. Steak
&
Shake has 210 outlets in only
12
states; 78 of the outlets are
in
St. Louis and Indianapolis.
Obviously, the company has a
lot
of expansion ahead of it. With
160 continuous quarters of
increased earnings over 40
years, Consolidated has been a
steady grower and a terrific
investment, even in a lousy
market for fast food in
general.
Sometimes depressed industries
can produce high returns.
The best companies often
thrive
even as their competitors
struggle to survive. Until
recently, the airline sector
has
been a terrible place to put
money, but if you had invested
$1,000 in [Image]Southwest
Airlines in 1973, you would
have
had $460,000 after 20 years.
Big
Steel has disappointed
investors
for years, but [Image]Nucor
has
generated terrific returns.
[Image]Circuit City has done
well as other electronics
retailers have suffered. While
the Baby Bells have toddled, a
new competitor,
[Image]WorldCom,
has been a 20-bagger in seven
years.
Depressed industries, such as
broadcasting and cable
television,
telecommunications,
retail, and restaurants, are
likely places to start a
research list of potential
bargains. If business improves
from lousy to mediocre,
investors are often rewarded,
and they're rewarded again
when
mediocre turns to good and
good
turns to excellent. Oil
drillers
are in the middle of such a
recovery, with some stocks
delivering tenfold returns in
the past 18 months. Yet it
took
a decade of lousy before they
even got to mediocre. Readers
of
my column in Worth learned of
the potential in this
long-suffering sector in
February 1995.
Retail and restaurants haven't
been performing well -- but
they're two of Lynch's
favorite
areas.
Retail and restaurants are two
of the worst-performing
industries in recent memory,
and
both are among my favorite
research areas. I've taken a
beating in a number of retail
stocks (some of which I still
like and have continued to
buy),
but the general decline hasn't
stopped Staples,
[Image]Borders,
Petsmart, [Image]Finish Line,
and [Image]Pier 1 Imports from
rewarding shareholders. Two of
my daughters and my wife,
Carolyn, have continued to
shop
at Pier 1, reminding me of its
popularity. The stock has
doubled in the past 18 months.
A glut in casual-dining
outlets
didn't hurt [Image]Outback
Steakhouse, and a surplus of
pizza parlors didn't bother
[Image]Papa John's, whose
stock
was a double last year.
[Image]CKE Restaurants --
whose
operations include the Carl's
Jr. restaurants -- has been a
profitable turnaround play in
California.
You can even find bargain
stocks
in this market that have been
overlooked.
So far, we've been talking
about
growth companies on the move,
but even in this so-called
extravagant market, there are
plenty of bargains among the
laggards. Of the nearly 4,000
IPOs in the past five years,
several hundred have missed
the
rally on Wall Street. From the
class of 1995, 37 percent, or
202 companies, are selling
below
their IPO price. From the
class
of 1996, 33 percent, or 285,
now
trade below their offering
price. So much for the average
investor's never having a
chance
to profit from an offering. In
more than half
the cases, you
can wait a few months and buy
these stocks cheaper than the
institutions that were cut in
on
the original deals.
As the Dow has hit new records
week after week, many small
companies have been ignored.
In
1995 and 1996, the Standard
&
Poor's 500 Stock Index was up
69
percent, but the Russell 2000
index of smaller issues was up
only 44 percent. And while the
Nasdaq market rose 25 percent
in
1996, a lot of this gain can
be
attributed to just three
stocks:
Intel, Microsoft, and Oracle.
Half the stocks on the Nasdaq
were up less than 6.9 percent
during 1996.
That's not to say owning these
laggards will protect you if
the
bottom drops out of the
market.
If that happens, the stocks
that
didn't go up will go down just
as hard and fast as the stocks
that did. I learned that
lesson
in the 1971Ð73 bear market.
Before the selling was over,
companies that looked cheap by
any measure got much cheaper.
McDonald's dropped from $15 a
share to $4. I thought Kaiser
Industries was a steal at $13,
but it also fell to $4. At
that
point, this asset-rich
conglomerate, with holdings in
aluminum, steel, real estate,
cement, fiberglass, and
broadcasting, was trading at a
market value equal to the
price
of four airplanes.
Wondering when you should exit
the market? Use Lynch's rule
of
thumb.
Should we all exit the market
to
avoid the correction? Some
people did that when the Dow
hit
3000, 4000, 5000, and 6000. A
confirmed stock picker sticks
with stocks until he or she
can't find a single issue
worth
buying. The only time I took a
big position in bonds was in
1982, when inflation was
running
at double digits and long-term
U.S. Treasurys were
yielding 13
to 14 percent. I didn't buy
bonds for defensive purposes.
I
bought them because 13 to 14
percent was a better return
than
the 10 to 11 percent stocks
have
returned historically. I have
since followed this rule: When
yields on long-term government
bonds exceed the dividend
yield
on the S&P 500 by 6
percent or
more, sell stocks and buy
bonds.
As I write this, the yield on
the S&P is about 2 percent
and
long-term government bonds pay
6.8 percent, so we're only 1.2
percent away from the danger
zone. Stay tuned.
So, what advice would I give
to
someone with $1 million to
invest? The same I'd give to
any
investor: Find your edge and
put
it to work by adhering to the
following rules:
With every stock you own, keep
track of its story in a
logbook.
Note any new developments and
pay close attention to
earnings.
Is this a growth play, a
cyclical play, or a value
play?
Stocks do well for a reason
and
do poorly for a reason. Make
sure you know the reasons.
Stocks do well for a reason,
and
poorly for a reason.
*Pay attention to facts, not
forecasts.
*Ask yourself: What will I
make
if I'm right, and what could I
lose if I'm wrong? Look for a
risk-reward ratio of three to
one or better.
*Before you invest, check the
balance sheet to see if the
company is financially sound.
*Don't buy options, and don't
invest on margin. With
options,
time works against you, and if
you're on margin, a drop in
the
market can wipe you out.
*When several insiders are
buying the company's stock at
the same time, it's a
positive.
*Average investors should be
able to monitor five to ten
companies at a time, but
nobody
is forcing you to own any of
them. If you like seven, buy
seven. If you like three, buy
three. If you like zero, buy
zero.
*Be patient. The stocks that
have been most rewarding to me
have made their greatest gains
in the third or fourth year I
owned them. A few took ten
years.
*Enter early -- but not too
early. I often think of
investing in growth companies
in
terms of baseball. Try to join
the game in the third inning,
because a company has proved
itself by then. If you buy
before the lineup is
announced,
you're taking an unnecessary
risk. There's plenty of time
(10
to 15 years in some cases)
between the third and the
seventh innings, which is
where
the 10- to 50-baggers are
made.
If you buy in the late
innings,
you may be too late.
*Don't buy "cheap"
stocks just
because they're cheap. Buy
them
because the fundamentals are
improving.
*Buy small companies after
they've had a chance to prove
they can make a profit.
*Long shots usually backfire
or
become "no shots."
*If you buy a stock for the
dividend, make sure the
company
can comfortably afford to pay
the dividend out of its
earnings, even in an economic
slump.
*Investigate ten companies and
you're likely to find one with
bright prospects that aren't
reflected in the price.
Investigate 50 and you're
likely
to find 5.
Peter Lynch owns shares in the
following companies mentioned
above: Outback Steakhouse,
Pier
1 Imports, Consolidated
Products, Staples, and
WorldCom.
Read "How to Invest a
Million"
in its entirety in the March
1997 issue of Worth (on
newsstands today), or in the
Worth archives on this site.
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