6 CATEGORIES OF COMPANIES

It is funny, for me, how investment knowledge is only useful when it it useful. When @Bear77 posted on Peter Lynch’s One Up on Wall Street book, must have been back in April 2023-ish, I bought the book immediately, read the first chapter, then did not touch it again until a month ago. Similar to the Cassel essays which I posted about some weeks back, I am not sure what prompted me to pick up the book again, but I did. And this time, it is clearly resonating, and I am mid-way through it.

Here are my TLDR notes on Chapter 7 of One Up on Wall Street, where Lynch sets out how he categorises companies into 6 Categories. While none of this is really new, re-reading the framework in full was really helpful in crystallising how I see the companies I own, and most importantly, WHY I still hold them. As I review my portfolio post reporting season, I suspect I am now going to use this categorisation more rigorously as a means to step back and review the overall portfolio mix and make adjustments, particularly when I am looking at new additions to the portfolio.

Hope this is useful to others. Words are verbatim from Lynch - I like his wit and graphical choice of words.

SLOW GROWERS

• Usually large and ageing companies expected to grow slightly faster than Gross National Product
• Started out as fast growers, eventually pooped out. Either because they had gone as far as they could, or else the got too tired to make the most of their chances
• When an industry at large slows down (as they always seem to do), most of the companies within the industry lose momentum as well
• The chart of a slow grower .... resembles the topographical map of Delaware, which, as you probably know, has no hills
• Another sure sign of a slow grower is that it pays a generous and regular dividend .... companies pay generous dividends when they can’t dream up new ways to use the money to expand the business. This doesn't mean that by paying a dividend the corporate directors are doing the wrong thing. In many cases it may be the best use of which the company’s earnings can be put.
• .... if companies aren’t going anywhere fast, neither will the price of the stocks

STALWARTS

• The multibillion-dollar hulks are not exactly agile climbers, but they’re faster than slow growers .... as you can see in the chart .. It’s not as flat as the chart of Delaware, but its no Everest, either.
• When you traffic in stalwarts, you’re more or less in the foothills: 10 to 12 percent annual growth in earnings
• Depending on when you buy them and at what price, you can make a sizable profit in stalwarts
• In the market that we had since 1980 the stalwarts have been good performers, but not the star performers. Most of these are huge companies, and it’s unusual to get a tenbagger out of a Bristol-Myers of a Coca Cola
• Stalwarts are stocks that I generally buy for a 30 to 50 percent gain, then sell and repeat the process with similar issues that haven’t yet appreciated
• I always keep some stalwarts in my portfolio because they offer pretty good protection during recessions and hard times

FAST GROWERS

• These are among my favourite investments: small, aggressive new enterprises that grow at 30 to 25 percent a year. If you choose wisely, this is the land of the 10- to 40-baggers, and even the 200-baggers. With a small portfolio, one or two of these can make a career
• A fast growing company doesn't necessarily have to belong to a fast growing industry. As a matter of fact, I’d rather it didn’t .... all it needs is the room to expand within a slow-growing industry
• There’s plenty of risk in fast growers, especially in the younger companies that tend to be overzealous and underfinanced.
• Wall Street does not look kindly on fast growers that run out of stamina and turn into slow growers, and when that happens, the stocks are beaten down accordingly.
• So while the smaller fast growers risk extinction, the larger fast growers risk a rapid devaluation when they begin to falter. Once a fast grower gets too big, it faces the same dilemma as Gulliver in Lilliput. There’s simply no place for it to stretch out.
• But for as long as they can keep it up, fast growers are the big winners in the stock market. I look for the ones that have good balance sheets and are making substantial profits 
• The trick is figuring out when they’ll stop growing, and how much to pay for the growth

THE CYCLICALS

• A cyclical is a company whose sales and profits rise and fall in regular if not completely predictable fashion ... in a cyclical industry it expands and contracts, then expands and contracts again
• Charts of the cyclicals look like the polygraph of liars, or the maps of the Alps, as opposed to the maps of Delaware you get with the slow growers
• Coming out of a recession and into a vigorous economy, the cyclicals flourish, and their stock prices tend to rise much faster that the prices of the stalwarts ... But going in the other direction, the cyclicals suffer, and so do the pocketbooks of the shareholders. You can lose more than fifty percent of your investment very quickly if you buy cyclicals in the wrong part of the cycle, and it may be years before you’ll see another upswing
• Timing is everything in cyclicals, and you have to be able to determine he early signs that the business is falling off or picking up

TURNAROUNDS

• Turnaround candidates have been battered, depressed, and often can barely drag themselves into Chapter 11. These aren’t slow growers, these are no growers. These aren’t cyclicals that rebound; these are potential fatalities ...
• Turnaround stocks make up lost ground very quickly ...
• The best thing about investing in successful turnarounds is that of all the categories of stocks, their ups and downs are least related to the general market
• There are several different types of turnarounds ... 
• There’s the bail-us-out-or-else such as Chrysler or Lockheed, where the whole thing depended on a government loan guarantee.
• There’s the little-problem-we-didn’t-anticipate kind of turnaround such as Three Mile Island. This was a minor tragedy perceived to be worse than it was, and in minor tragedy there’s major opportunity ... You just had to be patient, keep up with the news, and read it with dispassion ... I try to stay away from the tragedies where the outcome is unmeasurable, such as the Bhopal disaster at the Union Carbide plant in India.
• There’s the perfectly-good-company-inside-a-bankrupt-company kund of turnaround, such as Toys “R” Us.
• There’s the restructuring-to-maximise-shareholder-values kind of turnaround. Restructuring is a company’s way of ridding itself of certain unprofitable subsidiaries it should never have acquired in the first place. The earlier buying of these ill-fated subsidiaries, also warmly applauded, is called diversification. I call it diworseification.... the only positive aspect is that companies that diworseify themselves into sorry shape are future candidates for turnarounds.

ASSET PLAYS

• An asset play is any company that’s sitting on something valuable that you know about, but that the Wall Street crowd has overlooked
• The asset play is where the local edge can be used to the greatest advantage
• The asset may be as simple as a pile of cash
• There are asset plays in metals and in oil, in newspapers and in TV stations, in patented drugs and even sometimes in a company’s losses (via huge tax-loss carryforward)
• Asset opportunities are everywhere. Sure they require a working knowledge of the company that owns the assets, but once that’s understood, all you need is patience

OTHER POINTS

• Companies don’t stay in the same category forever.
• Basing a strategy on general maxims, such as “Sell when you double your money, “Sell after two years” or “Cut your losses by selling when the price falls ten percent,” is absolute folly. It’s simply impossible to find a generic formula that sensibly applies to all the different kinds of stocks.
• Putting stocks in categories is the first step in developing the story. Now at least you know what kind of story its supposed to be. The next step is filling in the details that will help you guess how the story is going to turn out.