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Niche Investing. Some advice from Peter Lynch
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Niche Investing. Some advice from Peter Lynch

created Natalia Bojko29 Września 2022

Peter Lynch is one of the most outstanding managers of investment funds from the second half of the 13th century. He is one of those people who focused on investing in the value of the enterprise in their capital investment strategies. The fund he managed, the Magellan Fund, increased every thousand dollars invested to XNUMX thousand during the XNUMX years of his operation.

What rules or guidelines could he serve us Peter Lynch? You will learn this and other valuable advice by reading this article.

Common sense is the foundation

Lynch's approach to investing is, in fact, not that different from that of other famous and successful investors. Nevertheless, how he sees and recognizes opportunities to invest capital is quite simple and, as he has repeatedly emphasized in interviews - typically common sense. What's more, it assumes that by spending some time on analyzes and buying companies whose business model is clear to us, an individual investor has a greater chance of success than a professional one. Why? His publications and speeches to date show that he considers financiers from Wall Street (or other stock exchanges) to be people with a mentality similar to philosophers who, instead of testing something empirically, will assume that they will manage to come up with some things.

Niche Investing - small is beautiful

Studying Lynch's philosophy a bit, we often come across criticisms of ignoring small and medium-sized enterprise stocks. The world of big finance has its own rules. If we think the greatest Wall Street financiers are looking to relentlessly buy exciting stocks, we are, unfortunately, largely wrong. Often the funds themselves impose such "standards" for purchasing shares that inevitably disqualify small and medium-sized companies. Of course, Peter Lynch does not say that it is wrong to choose a large and well-known company for the portfolio. His thought explains well what he once said "prices of large companies do not change much".


READ NECESSARY: Peter Lynch - invest in what you understand and don't overpay!


Taking this advice into account, it should be understood as looking for opportunities for more substantial profits, apart from classic, stock exchange giants. What's more, Peter places great emphasis on understanding the potential investment.

Boring and unpleasant investments

According to Peter, industries that are beyond the interest of analysts. The current trend on gaming companies, IT, or those in which innovation and the pace of product change is horrendously high, are beyond Lynch's interest. The more boring the industry or the economy, the better. Where the best analysts do not issue recommendations or where the company is completely bored, the investor should look for opportunities.

Lynch's message is essentially simple. You should buy stocks of companies "oiled" by large institutions, not following fashionable sectors. Why? The pace of changes, as the former managers of the Ministry of Finance indicate, are too high in them, and innovative technologies or processes are too difficult to understand, which makes it difficult to assess their attractiveness.

A good niche company. So what?

Choosing companies for the fund Magellan FundLynch was driven by six different action categories. They consisted of: slow development, reliability, rapid growth, cyclicality, undervalued assets, complete change. It is difficult to describe all six types. Therefore, we will take to the workshop Peter's favorite category of securities, i.e. a dynamically developing small / medium company.

What should an enterprise of this type be like? Very broadly speaking, it must run a niche business with high growth potential. The main factors we should take when evaluating an action are:

  • strong market position
  • good financial condition
  • shareholder-oriented management
  • low valuation

Competitive position

One of the important elements mentioned by Lynch is a strong market position. Importantly, the company should operate in an industry with a low growth rate, which, according to Peter, favors the use of a strong position among competitors.

Lynch repeated that:

There's nothing exciting about exciting industries with high growth potential… well, except perhaps seeing prices fall. […] As soon as a company designs the best processor in the world, ten other competitors spend $ 100 million working on something better - and the better processor hits the market within eight months. Nothing like this is the case with bottle caps […] or motel chains. In industries with low growth potential, in particular those that are boring or evoke unpleasant associations, the problem of competition does not exist..

I think that our Polish market is also full of many examples of fast-growing enterprises in slowly growing markets. It is also not difficult to notice that popular sectors are attracted a lot of attention from analysts and investors willing to buy "innovations of tomorrow".

It should also be borne in mind that the gold rush in a given sector often attracts new competitors, also willing to profit from the ongoing trend. Now it would be worth asking yourself additional questions, on what basis to assess the company's market position? It is worth taking into account factors such as a stable increase in earnings per share, a clear monopoly on the market, territorial expansion and whether the company is not dependent on, for example, one large recipient.

The office demonstrates the approach to shareholders

According to Lynch, it is extremely important that the managerial staff run the enterprise with the owners' interests in mind, not only their own (where the tendency is usually the opposite). Executive and managerial staff should not waste too much money in the display of their office. Peter wrote that "the degree of extravagance of a corporate office is directly proportional to the reluctance of management to reward shareholders".

What about the company's cash retention or management stock ownership? The answer to the first question is mismanagement. If the company has a financial surplus, which arose after the company's investment needs are fully satisfied, it should be distributed among shareholders in the form of a dividend. This is not the only way to "reward" stockholders. A company might as well buy some of its securities out of the market. This may have a very good effect on the market price of these assets.

In answering the second question, a positive signal is the fact that the management staff holds shares in their employer. The mere fact that managers hold securities (in reasonable amounts) encourages them to adopt a more active dividend policy. What about the reverse? Therefore, is the sale of shares a wake-up call? Not necessarily. The sale of shares by the managerial staff does not necessarily mean that the company's condition is deteriorating. People sell their shares for various reasons. However, if it is an "avalanche" phenomenon, it is worth looking for the reasons for this state of affairs.

Solid foundations

For many investors, good financial condition is still a topic of the river. Everyone pays attention to other components of the balance sheet important in their assessment and strategy. On the other hand, the golden rule should be not to acquire shares of companies whose financial condition is unknown. If we are a beginner investor, it is worth paying a little attention to financial analysis in order to be able to correctly assess, for example, the company's solvency. In this respect, Lynch chose companies that had little debt and large cash resources. The structure of the incurred liabilities is also important. If the majority are short-term debts, and the increase in them is not justified and represents a large proportion of the cash held, this would not be an enterprise that would appeal to Peter Lynch.

Simple pricing

According to Peter Lynch, making a stock valuation is as simple as estimating the value of a local pharmacy or real estate. The whole point of specifying it is to rationally determine how much we are able to pay for the enterprise. The key element of the evaluation is here price to profit ratio (C / Z). This raises the question of when can it be judged to be too high? Lynch sought answers to these issues in the company's growth rate calculated on the basis of profit. If the c / z ratio is lower than the company's growth rate, it is probably a good investment opportunity. Taking into account the times in which Peter invested, the pace of enterprise development should be counted in the medium term.

An additional advantage of the purchased company will be signals about the (rational) increase in prices, cost reduction, entering new markets, better exposure to the current ones and closing those areas of operating activity that bring losses.

Diversification in moderation

A few paragraphs of this article are not enough to summarize all the points that Peter Lynch was guided by in the purchase of the companies. At the end, it is worth adding information, how many companies in the portfolio indicate rational risk management? The manager of the Magellan Fund argued that excessive diversification was detrimental to investment. In his opinion, twelve companies were the maximum a rational investor should have. The golden tip at the end would be his words "having stock is like having children - don't give yourself more than you can manage."

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About the Author
Natalia Bojko
Graduate of the Faculty of Economics and Finance, University of Białystok. He has been actively trading on the currency and stock markets since 2016. It assumes that the simplest analyzes bring the best results. Supporter of swing trading. When selecting companies for the portfolio, he is guided by the idea of ​​investing in value. Since 2019, he has held the title of financial analyst. Currently, he is the co-CEO & Founder in the Czech proptrading company SpiceProp. Co-creator of the Podlasie Stock Exchange Academy project (XNUMXrd and XNUMXth edition).