Something that I always remind myself when I am starting to fall in love with a stock. Hope this is useful for the newbies. PETER LYNCH AND HIS FAMOUS 2-MINUTE DRILL
Assuming you have already done a great deal of research on a potential investment--determined what type of business it is (a slow grower, a stalwart, a fast grower, a turnaround, an asset play, or a cyclical),and you have looked at the earnings compared to the stock price (PE ratio: and as Lynch says, \"If you remember nothing else about PE ratios, remember to avoid stocks with excessively high ones, so you know of the business is relatively expensive or cheap compared to current earnings and expected growth. Next, you need to think about the story.\" With the possible exception of the asset play (where you can sit back and wait for the value of the real estate or the oil reserves or the TVF stations to be recognized by others), something dynamic has to happen to keep the earnings moving along. The more certain you are about what that something is, the better you will be able to follow the script. The analyst reports on the company you get from you broker give you the professional version of the story, but if you have got an edge in the company or in the industry, you will be able to develop your own script in useful detail. Before buying a stock, I like to be able to give a two-minute monologue that covers the reasons I am interested in it, what has to happen for the company to succeed, and the pitfalls that stand in its path. The two-minute monologue can be muttered under your breath or repeated out loud to colleagues who happen to be standing within earshot. Once you are able to tell the story of a stock to your family, your friends, or the dog, and so that even a child could understand it, then you have a proper grasp of the situation. Here are some of the topics that might be addressed in the monologue: If it is a slow-growing company you are thinking about, then presumably you are in it for the dividend, (Why else own this kind of stock?) Therefore, the important elements of the script would be: \"This company has increased earnings every year for the last ten, it offers an attractive yield; it is never reduced or suspended a dividend, and in fact it has raised the dividend during good times and bad, including the last three recessions. It is a telephone utility, and the new cellular operations may add a substantial kicker to the growth rate.\" It it is a cyclical company you are thinking about, then your script revolves around business conditions, inventories, and prices. \"There has been a three-year business slump in the auto industry, but this year things have turned around. I know that because car sales are up across the board for the first time in recent memory. I notice that GM new models are selling well, and in the last eighteen months the company has closed five inefficient plants, cut twenty percent off labor costs, and earnings are about to turn sharply higher.\" If it is an asset play, then what are the assets, how much are they worth? \"The stock sells for $8, but the videocassette division alone is worth $4 a share and the real estate is worth $7. That is a bargain in itself, and I am getting the rest of the company for a minus $3. Insiders are buying, and the company has steady earnings, and there is no debt to speak of.\" If it is a turnaround, then has the company gone about improving its fortunes, and is the plan working so far? \"General Mills has made great progress in curing its diworseification. It has gone from eleven basic businesses to two. By selling off Eddie Bauer, Talbot, Kenner, and Parker Brothers and getting top dollar for these excellent companies, General Mills has turned to doing what it does best: restaurants and packaged foods. The company has been buying back millions of its shares. The seafood subsidiary, Grotons, has grown from 7 percent of the seafood market to 25 percent. They are coming out with low-cal yogurt, no cholesterol Bisquick, and microwave brownies. Earnings are up sharply.\" If it is a stalwart, then the key issues are the PE ratio, whether the stock already has had a dramatic run-up in price in recent months, and what, if anything, is happening to accelerate the growth rate. You might say to yourself: \"Coca-Cola is selling at the low end of its PE range. The stock has not gone anywhere for two years. The company has improved itself in several ways. It sold half its interest in Columbia Pictures to the public. Diet drinks have sped up the growth rate dramatically. Last year the Japanese drank 36 percent more Cokes than they did the year before, and the Spanish upped their consumption by 26 percent. Thatââ¬â¢s phenomenal progress. Foreign sales are excellent in general. Through a separate stock offering, Coca-Cola Enterprises, the company has bought out many of its independent regional distributors. Now the company has better control over distribution and domestic sales. Because of these factors, Coca-Cola may do better than people think.\" If it is a fast grower, then where and how can it continue to grow fast? La Quinta is a motel chain that started out in Texas. It was very profitable there. The company successfully duplicated its successful formula in Arkansas and Louisiana. Last year it added 20 percent more motel units than the year before. Earnings have increased every quarter. The company plans rapid future expansion. The debt is not excessive. Motels are a low-growth industry, and very competitive, but La Quinta has found something of a niche. It has a long way to go before it has saturated the market.\" Those are some basic themes for the story, and you can easily adapt Lynch process to the local Singapore Asian markets and fill in as many details as you possibly can. The more you know the better. You might often devote several hours to developing a script, though that is not always necessary. The Lynch two-minute drill is presented in his bestselling 1989 book One Up On Wall Street, Chapter 11
NextInsight
a hub for serious investors
