Peter Lynch has a very effective way to categorize his stocks. As a successful fund manager holding shares of thousand over companies, it serves to follow his method. By categorizing the stocks, he can identify the companies that would potentially become big winners.
1) The Slow Growers
These are usually the large companies that have gone past the growing stage. Now, they are only growing slightly faster than the gross national product. The dividends given are generous and regular. You should not have many slow growers in your portfolio. This is because their potential earnings growth is small and earnings plays a large part in increasing the share price in the future.
2) The Stalwarts (Medium Growers)
Stalwarts are big and strong companies. Examples are Coca Cola, Kellog’s, Proctor and Gamble. Their earnings grow faster than that of the slow growers, but not too impressive. There is a chance to double your money, but you probably have to hold for a considerable period of time, and highly dependent on the price that you paid for the stocks. The advantage of Stalwarts is that they are recession proof. In fact, they rarely have a down quater to report. Peter Lynch looks for a potential gain of 30%-50% when he buys Stalwarts.
3) The Fast Growers
These are the biggest winners that you can probably get out from stocks. Potential gain can be 10 to 40 times your investment, or even 200 times. They need not be from the hottest industry, hence scout for them in lagging industry. There are plenty of risks in these small companies and newcomers. Peter Lynch look for those with good balance sheets and having substantial profits. As these companies will eventually grow to an extent that no further growth is possible, the key is to figure when they will stop growing and how much to pay for this growth.
4) The Cyclicals
Cyclical comapnies have their profits and share price rising and falling regularly. They are usually luxury goods or service providers. Examples are Ford, American Airlines. These are goods (cars) and services (travel) that people will hold back their spending on during a recession. That being said, cyclicals perform much better than stalwarts when the economy comes out of recession. The key to invest in cyclicals successfully is to be able to determine when the business is falling off or picking up.
5) Turnarounds
Turnarounds are companies that almost went bankrupt but became profitable again. There are several types of turnarounds basing on the reasons they recover. The most recent example is AIG, who was bailed out by the government. Turnarounds are likely what Warren Buffett would described as temporal bad news affected companies. Another likely type of turnaround is successful restructuring. These companies eliminates losses by getting rid of their unprofitable divisions or subsidiaries and generate more profits through focus on their core business.
6) The Asset Plays
Companies that have rich assets often go unnoticed. This is becuase their business is not obviously linked to the assets that they owned. For example, a farming company has a large plot of real estate that can worth more than the business itself. Likewise for retail stores and railway stations and tracks. Look out for businesses that own real estate. The key is to evaluate the price of the asset and compare to the stock price. If the price of asset is equal or more than the stock price, there is very little to lose.
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