Peter Lynch argues in the book “One Up On Wall Street” that individual investors have several advantages over professional investors. Selecting unknown stocks is one of them, and to improve our chances of success using these advantages, check out the 13 attributes of a perfect company by Peter Lynch.
Some of the advantages of individual investors are related to knowing companies before analysts. To select companies, Peter lists 13 important attributes of a perfect company.
13 Attributes of a Perfect Company by Peter Lynch
According to the author, “the ‘any idiot can run this business’ aspect is a characteristic of the perfect company, the kind of action I dreamed of. You will never find the perfect company, but if you could imagine it, you would know how to recognize favorable attributes”, of which the 13 most important are listed below.
(1) This sounds boring – or rather: ridiculous
“The perfect action would have to be associated with the perfect company, the perfect company would have to be engaged in a perfectly simple business, and that perfectly simple business would have a perfectly boring name. The more tedious, the better.”
The author cites examples such as Automatic Data Processing, Bob Evans Farms, and Pep Boys – Manny, Moe, and Jack which have tedious names. He comments that these are the companies you’ll never hear about at a barbecue, as the names are ridiculous. The author mentions that companies that have beautiful names are more likely to be in the news.
“If you find an opportunity early enough, you’ll probably get a few dollars off the price just because of the weirdness or vulgarity of the name, which is why I’m always on the lookout for a Pep Boys – Manny, Moe, and Jack.”
(2) “The company does something boring
“I get even more excited when a company with a boring name also does something boring”
If a company with excellent earnings and a strong balance sheet also engages in tedious activities, that gives you plenty of time to buy the stock at a discount because of the general market’s lack of interest in it. The Author cites companies such as Crown, Cork, and Seal manufacture cans and bottle caps.
This unpopularity for doing something boring according to the author is a good thing, given that you can get it for good prices.
(3) The company does something unpleasant
“Better than just being boring is a company action that is boring and unpleasant at the same time. Something that makes people dismissive, feel nauseous, or distance themselves as a sign of displeasure is ideal.”
The author cites Safety-Kleen, a company that visits gas stations and offers them equipment to clean greased car parts, and Clear Shield, which makes plastic forks and straws, as examples. The idea again is that companies that do nasty things are unlikely to appear on investment funds’ shopping lists and so will not be very popular.
(4) The company is the result of a spin-off
“Spin-offs of divisions or parts of a company into separate and independent entities often result in tremendously profitable investments”
According to the author, spin-off companies usually have good financial balance sheets and are well prepared to be successful as independent entities.
“Spun-off companies are often misunderstood and receive little attention from Wall Street. Investors receive shares in newly created companies as government bonds or dividends for holding shares in the parent company, and institutions tend to regard them as insignificant, extraordinary additional contributions or found money. These are favorable signs for the shares of spun-off companies.”
(5) Financial institutions do not own and analysts do not follow them
“If you find a stock that has little or no ownership in the hands of institutions, you have found a possible winner. Find a company that has never been visited by any analyst or that no analyst would admit to having visited and you have a doubly winning stock.”
The author comments that he likes companies that were once popular and are no longer, and that is why they are no longer covered by analysts.
(6) Rumors multiply: the company is involved with toxic waste and/or the mafia
“It’s hard to imagine a more profitable industry than waste management. If there’s anything that disturbs people more than wrappings made of animal matter, grease, and used oil, it’s waste and toxic waste dumps.”
The example cited by the author was Waste Management, Inc. which rose more than 100 times.
(7) There is something disheartening about this
The author cites the example of Service Corporation International (SCI) which deals with death, that is, performs burials.
For being a very discouraging sector, the author considers good the opportunity when good companies in this sector.
(8) It is a non-growth sector of activity
“Many people prefer to invest in a high-growth sector where there is a lot of turmoil. It’s not my case. I prefer to invest in an industry with slow growth, like plastic knives and forks, but only in case, I can’t find a non-growth industry like funerals. This is where the big winners are generated.”
The author says to avoid sectors with high growth due to high competition and the great publicity that companies attract because they are in a growth sector.
(9) The company has a niche
“I would rather own shares in a local quarry than own shares in Twentieth Century-Fox, as one studio competes with another studio while the quarry has a niche.”
Certainly, having a quarry is much safer than having a jewelry business. If you’re already in the jewelry business, you’re in competition with other jewelers across the city, state, and even abroad, as travelers can purchase them anywhere and bring them home. But if you own the only quarry in Brooklyn, you have a virtual monopoly, plus you have the added protection of the unpopularity of the quarrying industry.
The closest rival, which has more than two tons, will not deliver its products to your region because the transport costs will eat up all your profits.
In the case of quarries, you could raise prices to a point just below the level needed for the owner of the nearest quarry to start thinking about competing with you.
(10) People must continue to buy the product
“I’d rather invest in a company that makes medicines, soft drinks, shavers, or cigarettes than invest in a company that makes toys.”
According to the author, the toy sector needs to innovate frequently to be able to sell, since shavers and cigarettes are items that demand frequent consumption by consumers.
(11) The company uses technology
“Instead of investing in computer companies that struggle to survive in an infinite price war, why not invest in a company that benefits from the price war”
The author cites the example of ADT, which uses computers for payroll processing that benefits from the computer price war.
(12) People who are part of the company buy its shares
“There is no better clue regarding the likely success of a stock than the members of the company itself putting their own money into the business.”
The author cites that better than CEO buying shares, it is the employees of the lower echelons.
“When managers in a company own their stock, shareholder compensation becomes a priority, whereas when managers simply receive their salaries at the end of the month, raising salaries becomes the priority.”
(13) The company is buying back shares
“Buying back shares is the best and simplest way for a company to reward its investors. If a company has confidence in its own future, then why shouldn’t it invest in itself, just like its shareholders?
Summary
These were the 13 attributes of a perfect company by Peter Lynch, in a nutshell, Lynch prefers good companies that fulfill basic needs and are unknown. This, according to him, brings a huge advantage to the individual investor.
Lynch in his fund, Fidelity Magellan had up to 1,400 shares in his fund, almost 4 more shares than we have on our stock exchange.
Happy investing!
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