Owning good stocks is one thing—knowing when to buy and sell them is another. And that’s what Peter Lynch took on in chapter 17 of "One Up on Wall Street." Not that he was a market timer, but rather used his experience to offer broad suggestions about stocks and the market.
Buying
Lynch started the chapter with a couple of suggestions for buyers:
“After all that’s been said, I don’t want to sound like a market timer and tell you that there’s a certain best time to buy stocks. The best time to buy stocks will always be the day you’ve convinced yourself you’ve found solid merchandise at a good price—the same as at the department store. However, there are two particular periods when great bargains are likely to be found.”
The first of those periods of good hunting is late in the year, with selling to collect tax losses on stocks that went in the wrong direction. Retail investors are joined in the year-end selloff by institutional fund managers who need to clean up their portfolios before their annual evaluations. Lower priced stocks are more likely to drop more than pricier ones because of cost-per-share thresholds. Patient investors will keep a list of stocks they would like to own if the price were lower.
The second time of opportunity is during market slumps and plunges, when most other investors are headed for the exits. Lynch notes it takes “courage and presence of mind” to buy at such times. However, those who do may “find opportunities that you wouldn’t have thought you’d ever see again.”
False selling signals
Lynch began the “When to Sell” section by warning investors not to be influenced by “skeptics who yell 'Sell' before it’s time to sell. I ought to know. I’ve been talked out of a few tenbaggers myself.” He went on to give a couple of examples in which he had sold too soon, based on someone else’s wrong opinion.
The guru also cited specious rules of thumb, such as selling once a stock doubles in price. In particular, he warned against taking such advice from stockbrokers who would profit twice if an investor sold prematurely and then bought a different stock (Lynch was writing before discount brokers became well established).
Watch out for “experts” on television and elsewhere who proclaim that one industry is in fashion and another is out. Also avoid selling based on the comments of experts on macroeconomic trends. For example, Lynch referred to what he called the “drumbeat effect,” in which an “ominous” message is repeated so many times it becomes impossible for an investor to avoid it. In the mid-1980s, that message was the M-1 money supply:
“Anyway, for months there was something in the news about the M-1’s growing too fast, and people worried that it would sink our economy and threaten the world. What better reason to sell stocks than that 'the M-1 is rising'—even if you weren’t sure what the M-1 was.”
Then, as suddenly as it appeared, discussion of M-1 disappeared, replaced by talk of the discount rate the Federal Reserve charged member banks.
Real sales signals
Perhaps the best piece of advice, in a book full of advice, is this statement:
“As it turns out, if you know why you bought a stock in the first place, you’ll automatically have a better idea of when to say good-bye to it.”
With that, Lynch began a category-by-category set of rationales for selling:
- Slow growers: He said he had little experience in this category, but generally sold when the price had gone up by 30% to 50% or when the fundamentals became less attractive.
- Medium growth (stalwarts): These were stocks he commonly rotated within the category. He usually sold when the stock price got ahead of the earnings line or the price-earnings ratio diverged too far from its normal range.
- Cyclicals: The name of this category almost begs an investor to sell at the top (and buy again at the bottom), but of course few investors know where the cycle is at any given time and where it is headed. Lynch said he could not predict cycles, so he advised selling when something had “started to go wrong.” A couple of examples include rising costs and companies spending to expand plants that have hit full capacity. Another example: falling commodity prices.
- Fast growers: In this universe of potential 10-baggers, investors need to be careful. Lynch advised investors that the main flag to watch for was “the end of the second phase of rapid growth.” For example, had The Gap (GPS, Financial) quit building new stores while the old stores were looking shabby, and customers complained their favorite products were unavailable, it would have been time to consider selling.
- Turnarounds: After the turnaround seems complete, the troubles that caused the problem are resolved and everyone knows the company is back on its feet, it’s time to sell. Lynch pointed to Chrysler (now Fiat Chrysler (FCAU, Financial)) as an example. He called it a turnaround play at $2 and even at $10, but by the time it hit $48, the debt had been paid, the “rot was cleaned out” and it had become a regular, cyclical auto company, it was time to sell.
- Asset plays: At the time Lynch was writing this book, corporate raiders were prominent, and he normally recommended holding on until the raiders arrived. One such case in the 1980s included Disney (DIS, Financial), which had been a “sleepy company” until billionaire Harry Weinberg took a material position and challenged management to generate more shareholder value. In contemporary times, we would watch activist investors, especially if they are working in tandem with a big institutional investor.
Conclusion
For those of us who have trouble knowing when to buy or when to cut ties with a stock, chapter 17 of "One Up on Wall Street" is a refreshing read. Lynch made several points that help us know which types of signals should lead us to consider buying and selling.
First, he offered several suggestions for buying, including the value perspective: when you find “solid merchandise at a good price.” Lynch also explained that while he was not a market timer, good values might be found at year-end and during market slumps.
Second, he warned against false selling signals. Such signals included other investors yelling “Sell” even though a company’s fundamentals did not justify an exit, and basing decisions on abstract economic issues such as the M-1 money supply and actions of the Federal Reserve.
Third, he provided that general piece of advice, which we will repeat here:
“As it turns out, if you know why you bought a stock in the first place, you’ll automatically have a better idea of when to say good-bye to it.”
Finally, Lynch took readers through a category-by-category set of guidelines for each of six stock categories.
Peter Lynch screen tool
GuruFocus provides the Peter Lynch screen tool for quickly finding companies that meet his criteria. Members can access the screener here, and non-members can get started here.
(This review is based on the Millennium Edition (2000) of “One Up on Wall Street.” More chapter-by-chapter reviews can be found here.)
