Thoughts on Investing---20
insights from Peter Lynch (16-20)
16.
About selling
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.
17. WHEN
TO SELL A CYCLICAL
The best
time to sell is toward the end of the cycle, but who knows when that is? Who
even knows what cycles they’re talking about? Sometimes the knowledgeable
vanguard begins to sell cyclicals a year before there’s a single sign of a
company’s decline. The stock price starts to fall for apparently no earthly
reason. To play this game successfully you have to understand the strange
rules. That’s what makes cyclicals so tricky. In the defense business, which
behaves like a cyclical, the price of General Dynamics once fell 50 percent on
higher earnings. Farsighted cycle-watchers were selling in advance to avoid the
rush.
One
obvious sell signal is that inventories are building up and the company can’t
get rid of them, which means lower prices and lower profits down the road. I
always pay attention to rising inventories. When the parking lot is full of
ingots, it’s certainly time to sell the cyclical. In fact, you may be a little
late.
18. WHEN
TO SELL A FAST GROWER
Here,
the trick is not to lose the potential ten-bagger. On the other hand, if the
company falls apart and the earnings shrink, then so will the p/ e multiple
that investors have bid up on the stock. This is a very expensive double whammy
for the loyal shareholders. The main thing to watch for is the end of the
second phase of rapid growth, as explained earlier. If The Gap has stopped
building new stores, and the old stores are beginning to look shabby, and your
children complain that The Gap doesn’t carry acid-washed denim apparel, which
is the current rage, then it’s probably time to think about selling. If forty
Wall Street analysts are giving the stock their highest recommendation, 60
percent of the shares are held by institutions, and three national magazines
have fawned over the CEO, then it’s definitely time to think about selling.
There’s
simply no rule that tells you how low a stock can go in principle. I learned
this lesson for myself in 1971, when I was an eager but somewhat inexperienced
analyst at Fidelity. Kaiser Industries had already dropped from $ 25 to $ 13.
On my recommendation Fidelity bought five million shares— one of the biggest
blocks ever traded in the history of the American Stock Exchange— when the
stock hit $ 11. I confidently asserted that there was no way the stock could go
below $ 10. When it reached $ 8, I called my mother and told her to go out and
buy it, since it was absolutely inconceivable that Kaiser would drop below $
7.50. Fortunately my mother didn’t listen to me. I watched with horror as
Kaiser faded from $ 7 to $ 6 to $ 4 in 1973— where it finally proved that it
couldn’t go much lower.
19. The
biggest winners are usually a pleasant surprise
The
point is, there’s no arbitrary limit to how high a stock can go, and if the
story is still good, the earnings continue to improve, and the fundamentals
haven’t changed, “can’t go much higher” is a terrible reason to snub a stock.
Shame on all those experts who advise clients to sell automatically after they
double their money. You’ll never get a ten-bagger doing that.
Frankly,
I’ve never been able to predict which stocks will go up tenfold, or which will
go up fivefold. I try to stick with them as long as the story’s intact, hoping
to be pleasantly surprised. The success of a company isn’t the surprise, but
what the shares bring often is.
20.
Picking bottoms – If they don’t scare you out, they will wear you out
Bottom
fishing is a popular investor pastime, but it’s usually the fisherman who gets
hooked. Trying to catch the bottom on a falling stock is like trying to catch a
falling knife. It’s normally a good idea to wait until the knife hits the
ground and sticks, then vibrates for a while and settles down before you try to
grab it. Grabbing a rapidly falling stock results in painful surprises, because
inevitably you grab it in the wrong place. If you get interested in buying a
turnaround, it ought to be for a more sensible reason than the stock’s gone
down so far it looks like up to you. Maybe you realize that business is picking
up, and you check the balance sheet and you see that the company has $ 11 per
share in cash and the stock is selling for $ 14. But even so, you aren’t going
to be able to pick the bottom on the price. What usually happens is that a
stock sort of vibrates itself out before it starts up again. Generally this
process takes two or three years, but sometimes even longer.
How many
times have you heard people say this? Maybe you’ve said it yourself. You come
across some stock that sells for $ 3 a share, and already you’re thinking,
“It’s a lot safer than buying a $ 50 stock.” I put in twenty years in the business
before it finally dawned on me that whether a stock costs $ 50 a share or $ 1 a
share, if it goes to zero you still lose everything. If it goes to 50 cents a
share, the results are slightly different. The investor who bought in at $ 50 a
share loses 99 percent of his investment, and the investor who bought in at $ 3
loses 83 percent, but what’s the consolation in that?
The
point is that a lousy cheap stock is just as risky as a lousy expensive stock
if it goes down. If you’d invested $ 1,000 in a $ 43 stock or a $ 3 stock and
each fell to zero, you’d have lost exactly the same amount. No matter where you
buy in, the ultimate downside of picking the wrong stock is always the
identical 100 percent.
Sometimes
it’s always darkest before the dawn, but then again, other times it’s always
darkest before pitch black.
BONUS
READ: Thoughts on asset allocation (medium):
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