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6 Types of Stocks to Strengthen Your Portfolio, According to Peter Lynch
How did Peter Lynch, one of the world’s greatest fund managers, achieve an average annualized return of 29.2% for 13 years straight?
He turned a million dollar into 27.9 million in just 13 years…
How did he do it!?!?
Peter Lynch’s mastery transformed a million into 20 million in just a decade.
Lynch was able to accomplish the feat partly by categorizing stocks into 6 groups. That helped him tackle the risks inherent in each type of stocks properly, so he could produce such phenomenal returns.
For us ordinary investors, his idea could help you pick stocks that align with your investment goals and acceptable risk level, on top of investing in good companies at a fair price.
For example…
When you’re middle aged with a bit of money set aside for investment, you’d be willing to risk more for higher returns.
But when you’re retired, you might be willing to risk very little, so you’d be satisfied with returns just slightly above inflation rates.
Knowing which stock-group a company belongs to means you can pick the right investment that will propel you toward your goals.
Here are the 6 types of stocks you should pay attention to, according to Peter Lynch.
1. Slow Growers
Slow growers are large-cap companies whose earnings are, if not stable, growing at a lower rate than that of the economy. Their market prices don’t fluctuation much, thus aren’t very lucrative when it comes to capital gain. But they do offer high dividends, sometimes as high as 7-10%, rendering them suitable for low-risk investors who don’t expect sky-high capital gains.
Basic ratios for analysis
– Low price-to-earnings ratio (P/E) and price-to-book value (P/BV) ratio
– High dividend payout ratio
– Dividend yields might be as high as 7-10% per year
– High market capitalization
Caution
If a company is part of a sunset industry, there’s a high chance its performance is slowing down, too.
2. Stalwarts
These are large companies with strong fundamentals, making them very resilient to economic uncertainties. Despite their modest profit growth of around 10%, they are well-known and respectable companies in the eyes of the public, are relatively low-risk and can quickly recover from recessions.
Basic ratios for analysis
– Earnings per share growing steadily at the rate slightly above that of the market
– Low debt-to-equity ratio
– Big market capitalization
Caution
These can sometimes can be mistaken with cyclical stocks. So make sure your Stalwarts’ operations aren’t affected heavily by volatile resources such as the prices of oil, petrochemical and coal.
3. Fast Growers
These companies may not be as large or fundamentally as strong as the other two, but they have a potential to grow at least 15-20% or even higher each year. Some of them could produce a return of 100-200% in just a few years. But such growth should be driven by revenues and profits generated by business expansion, not from buying and selling assets. One advantage of investing in these stocks is that you can hold them for as long as they can keep their growth rates up.
Basic ratios for analysis
– High and consistent price-to-earnings ratio
– Earnings per share grow at the rate of 15-20%
Caution
Growth should not come from unusual income like sales of assets irrelevant to the core business.
4. Cyclicals
Cyclical stocks are companies whose sales and profits rise and fall in a more or less predictable fashion. They go through episodes of expansion and contraction as their ability to generate profits are highly sensitive to certain external factors. Most are related to oil, petrochemical, coal, commodities, agricultural products and real estate, which are the majority of stocks in Thailand. For example, oil companies should see their sales and profits surge when oil prices go up and vice versa.
Basic ratios for analysis
– Price to earnings ratio and earnings per share tend follow a pattern of peaks and plunges—3 years of profitability and 2 years of losses, for example.
Caution
Make sure you really understand their business cycle, including the cycle of the resources needed to operate their businesses. Otherwise you could buy in the wrong part of the cycle.
5. Turnarounds
These are companies that have suffered severe losses or nearly went bankrupt due to unprofitable investments or lack of liquidity, but are in the process of turning themselves around. If these companies repay their debts or successfully restructure their businesses and turn a profit, you’ll be benefiting hugely from that, too.
Basic ratios for analysis
– Price to earnings ratio and earnings per share follow a pattern of peaks and plunges
– Net profit becomes positive
– Debt to equity ratio continues to fall
Caution
These are highly risky investments as they could go bankrupt anytime.
6. Asset Plays
These companies usually own high-value assets such as real estate or shares in other companies, like Berkshire Hathaway, Warren Buffett’s holding company that own shares in a number of different businesses.
If you put money in an Asset Play company that invests in profitable businesses or in prime real estate, the value of the Asset Play company will also increase as well. That means you have a chance to enjoy huge capital gain when the market realizes the real value of the assets the company is holding.
Basic ratios for analysis
– Searching for Asset Plays won’t require much ratio analysis, but more digging through company financials to see what assets are they holding, how much did they spend to acquire those assets, and how much are those assets today. You can find such information in public statements released by the companies.
Caution
No one knows when the market will realize the real value of these companies, especially those that own the real estate. That might prevent their stock prices from going up for quite some time.
The quickest way to identify stock type
Peter Lynch invested in these 6 types of stocks to create a well-diversified portfolio, keeping the risk manageable while maximizing the returns.
You don’t have to invest in more than 1,000 stocks like him to make use of his technique. Just start by reading financial reports, identifying the trends of key financial ratios relevant to each type of stocks, and you will know if a stock fits in your portfolio.
For example, if you’re middle aged with a sum of money for investment, you’d be more willing to take a bit of risk. So you might pick the Fast Growers, Cyclicals and Turnarounds to make your portfolio grow at the rate of 15-20% per year.
But if you just retired and can’t take much risk—your main goal is to maintain the principle investment—investing in the Slow Growers, Stalwarts, Asset Plays and a small portion of Fast Growers could help you achieve a return of 5-8%, which is higher that the inflation rates.
Jitta FactSheet can help you save a lot of time, as you can put the most important ratios at the top, or group ratios together for easy reading.
Here are some ratios you could add to your Jitta FactSheet to speed up financial analysis:
- Market cap
- Price to book value ratio
- Earnings per share
- Net profit margin
- Debt to equity ratio
- Return on equity
- Dividend payout ratio
- Free cash flows
- Dividend yield
Not only will these ratios help you identify the type of each stock, but will also help you spot the growth and performance trends of each company in a fraction of the time.
Just follow these 3 easy steps to add and customize your Jitta FactSheet:
1. Click CUSTOMIZE
2. Type the name of the ratio you’re looking to add, then drag-and-drop it to reorder
3. Click UPDATE FACTSHEET
Now you can categorize stocks the way Peter Lynch does. But don’t forget to set your investment goals and acceptable risk level. Doing so will help you devise an investment plan with specific KPIs, which will help you optimize your investment strategy going forward.
If you’re determined and focused on improving your investment skills, the goals you set are just within reach!