Readers might already have noticed that our articles frequently quote famous investors/authors like Peter Lynch and Jeremy Siegel and their investment books. Since the previous article focused on the art of selling, this article is exclusively about 5 Peter Lynch techniques to evaluate buys. So let's dive into the details:
Insider buying: While insiders sell for various reasons, like having to buy a new home, they buy for just one reason; they believe and almost know the stock is going up. High flying stocks usually do not have many insider purchases, while there is plenty of selling. Take a look at insider transaction of Netflix (NFLX) before it crashed. You will find zero purchases and a lot of direct sells. Though it might be a faulty premise to argue that insider selling or the lack of insider buying is bad (Even Apple (AAPL) doesn't have much insider buying to show) it is very very safe to assume insider buying is a big plus. Philip Morris International (PM), in spite of its recent run up in price, had a recent insider buy at around $81. Nothing can be more bullish than that.
Buy what you know: It can't get simpler than that. Lynch suggests taking a hard look at things happening in your industry of work. You must have a two minute drill or the elevator speech for each of the stocks you own. If you do not have the "story" you do not have a reason to own the stock. Some examples are "This is a dividend champion, hasn't cut its dividend in the past 50 years" and "The growth in China is going to consume a lot of this metal." What good is a "cloud computing" stock to someone who struggles to do basic things on a computer and doesn't understand the industry?
PEG ratio: While a lot of people focus on the PE ratio and do not buy stocks if PE is too high, Lynch advocates buying high PE stocks if the expected growth rate is high as well. This is called the Growth at Reasonable Price [GARP]. PEG ratio is calculated as the PE divided by the growth rate. PEG greater than 1 means the company is overvalued, and less than 1 is undervalued relative to its growth prospects. Familiar names with PEG less than 1 as of this writing include: Apple and Baidu (BIDU), the chinese internet giant.
Buy Spinoffs: Spinoffs usually do well on their own. Lynch's logic is that the parent company will not let down the spinoff to bite the dust, as it would reflect badly on the parent as well. Fair enough. It's like saying you as a parent will try your best to leave your kids in the best possible shape. Some of the best spinoffs in the history are the AT&T's (T) "baby" bells and the Altria (MO) "kids" Philip Morris and Kraft Foods (KFT). Ironically, Kraft will soon be split into two companies (this makes Altria a grandparent by the way).
No growth industry with negative rumors: People chase growth stocks, and yes, some have been really successful. There are these rare gems like Apple and Bidu that make the shareholders rich. Those companies have done well because they survived cut throat competition. But Lynch would rather pick a company with little to no competition, has a niche, and drives out new companies because of negative rumors about the industry. When you have too many companies competing to win the consumers, guess who the end winner is? It is the consumers and not the shareholders of these companies. A "boring" example without too many competitors would be your local utility company.
As always, use these recommendations and tips to do your own research. This article is intended to provide more ideas to the investors.