One up on Wall Street Written by Peter Lynch

One up on Wall Street

One up on Wall Street is a book written by Peter Lynch who at the time was the vice chairman of Fidelity management and research company, the investment arm of Fidelity investments. Throughout the years Peter Lynch became an icon in the investment world as he grew $18 million in assets to $14 billion. In the book Peter Lynch gives investment advice classified into two categories: descriptive advice and quantitative advice. We will be explaining descriptive advice in brief and mainly focusing on quantitative advice since they’re purely mathematical.

Peter Lynch starts the book with part one “Preparing to invest” where he explains the most important step in investing; “Only invest in what you can afford to lose without that loss having an effect on your daily life in the foreseeable future”, Lynch advises people to put financial safety as priority number one. Moving on to part two “Picking winners”, this chapter teaches us the process of searching and finding the potential “Tenbagger” (ten times an investment). Part three “Long term view” of the book explains the long term view as Lynch teaches us how principles of investing in the long term view.

Moving on, We take a look at the quantitative advice that Peter Lynch explains throughout the book in nine main points;

1. A. Interpreting a stocks price-to-earnings Ratio

• Peter Lynch explained P/E ratio about a high level evaluation of a firm's investment possibility.
• The formula is as follows;

• P/E ratio= current stock price/ earnings per share

• The P/E ratio of any company that’s fairly priced will equal its growth rate.
• If the P/E of Coca-Cola is 15, you’d expect the company to be growing at about 15 percent a year. But if P/E is less than the growth rate, you may have found a bargain.

B. Lynch PEG ratio

• Peter Lynch developed the PEG ratio as an attempt to solve a shortcoming of the P/E ratio by factoring in the projected growth rate of future earnings.
• The formula is as follows;

• PEG ratio = P/E ratio / company’s earning growth

• To interpret this ratio, a result of 1 or lower says the stocks either at par or undervalued based on growth rate. If the ratio results in a number above 1, conventional wisdom says the stock is overvalued relative to its growth rate.
• Many investors of today's world use PEG ratio as a way to get a more complete picture of a company’s value rather than P/E ratio only.

C.The Dividend-Adjusted PEG Ratio

• The dividend-adjusted PEG ratio is a unique metric that takes the PEG ratio and attempts to improve through factoring the dividends.
• The formula is as follows;

• Dividend-adjusted PEG ratio = P/E ratio / (earnings growth + dividend yield)

• Peter Lynch’s point was a higher ratio is better than a lower ratio, which would be the opposite in how earnings ratio is used today.

1. Free cash flow

• Peter Lynch made it a point to analyze free cash flow in his book as cash is much harder to manipulate than earnings, making it a much better tool to evaluate companies.
• Free cash flow (FCF) is the cash management tool that is used to create value for a company and as well as for its shareholders
• The formula is as follows;

• FCF = Cash from Operations – CapEx

• In other words;“Free cash flow is what’s left over after the normal capital spending is taken out.” – Peter Lynch explains also "Dedicated asset buyers look for this situation: a mundane company going nowhere, a lot of free cash flow, and owners who aren't trying to build up the business."

1. Netcash per price

• Peter Lynch suggests looking at the cash and cash equivalents and then deducting the long-term debt to gauge liquidity levels. He warns, however, as sometimes it doesn't make any difference, having a lot represents increased pressure to assign it.
• The formula is as follows;

• Netcash per price = (cash+ cash equivalents - long term debt ) / total stocks outstanding

1. Debt and Debt/Equity ratios

• Peter Lynch likes his companies to be in a robust financial position with little or no debt on their books.
• Lynch's explains the debt/equity ratio as quick way to determine the financial strength of a company, Whereas also he mentions that “The company’s balance sheet should be strong, with low levels of debt relative to equity financing, and be particularly wary of high levels of bank debt.”
• The formula is as follows;

• Debt/Equity Ratio = Total Liabilities / Shareholders' Equity

• Lynch suggests taking a look at the debt/equity ratio as he explains “It's just the kind of thing a loan officer would want to know about you in deciding if you are a good credit risk”

1. Inventory and Sales growth

• Inventory and sales growth are important figures for cyclicals, Peter Lynch mentions that, for manufacturers or retailers, an inventory buildup is a bad sign, and a red flag is waving when inventories grow faster than sales. On the other hand, if a company is depressed, the first evidence of a turnaround is when inventories start to be depleted.
• Peter Lynch explains in the book "I always check to see if inventories are piling up. With a manufacturer or a retailer, an inventory buildup is usually a bad sign. When inventories grow faster than sales, it's a red flag."

1. Pension Liabilities

• Peter Lynch explains in the book that; "Even if a company goes bankrupt and ceases normal operations, it must continue to support the pension plan. Before I invest in a turnaround, I always check to make sure the company doesn't have an overwhelming pension obligation that it can't meet."

1. Percent of Sales

• Peter Lynch explains how a specific product catches our attention and how it is worth finding the product as a percentage of total sales. While at stores our perception might be that the product is a killer,which could just turn out to be just an illusion and represent only a small fraction of the company's sales

1. Profit and profit margins

• Peter Lynch discusses how a company with smaller profit margins would benefit in a greater way whenever the industry tide goes up in terms of prices. Moreover, this means that a company with lower margins would be able to translate these increases into double-digit growth in net profit

1. Dividends  vs  Earnings

• Peter Lynch tends to prefer smaller growth firms. However, Lynch suggests that investors who prefer dividend-paying firms should seek firms with the ability to pay during recessions and companies that have a 20-year or 30-year record of regularly raising dividends.

We have discovered that Peter Lynch indeed an icon in the investment world as he explains criteria and characteristics of choosing the right stock. Peter Lynch philosophy and style is well grounded and is famous for his ten baggers and growth investment style meanwhile not eliminating dividend paying stocks or steady cash flow generators like Coca-Cola for example.