Learn to Earn by Peter Lynch #3
Young people have the time to invest, but they don’t always have the cash. It’s just not any cash that can safely be put into stocks: it’s cash you can afford to live without for many years while it compounds.
The scenario we’ve seen in the case of Sandy Cartwheel would be the best and easiest place to start — Read the scenario here -> Learn to Earn by Peter Lynch #1
THE PERKS OF OWNERSHIP
Stocks are very democratic. If you want to buy a share and become an owner of the public company of your choice, the can’t stop you. And once you’ve become a shareholder, they can never kick you out. After all, they’re public.
If you own 1 share of a public company, you enjoy the same basic rights and privileges as the owner of a $1 Million shares. These are subject to change depending on which stock class you own — But this all has to be disclosed in the company’s filings to the SEC — The Securities and Exchange Commission.
As the owner of a public company, you get to vote on important matters such as deciding on who will get to sit on the board of directors.
These directors are not employees, but they make strategic decisions, and they keep tabs on what the bosses are doing. Ultimately, the company exists for the shareholders, and the directors are there to represent the shareholders’ interest.
THE DIRTY WORD — PROFIT
We all know what profit means, but there’s still a mistaken idea floating around that people who do things for profit are being greedy or underhanded, and they’re trying to pull a fast one on the rest of society because whenever one person make a bundle, it’s at the expense of everybody else.
Innovation is a great example of where profit and capitalism shines. With innovation came technology like PCs and Robotics or Artificial Intelligence (AI). Investors have poured billions of dollars into these technologies and as a result, we have better, cheaper and faster computers. With AI and Robotics, machines are doing the hard work in warehouses around the clock instead of humans and, this is only the beginning. With fierce competition in these important industries, the costs are kept down but the competition has also put a lot of companies out of business and the ones that survived made the best products at the lowest prices, using and creating the best technology.
Over the long term, profitable companies with good management are rewarded in the stock market.
In a poorly managed company, the results are mediocre, and the stock price goes down, so bad management is punished. A decline in the stock price makes investors angry, and if they get angry enough, they can pressure the company to get rid of the bad management and take other actions to restore the company’s profitability.
When all is said and done, a highly profitable company can attract more investment capital than a less profitable company. With the extra money it gets, the highly profitable company is nourished and made stronger, and it has the resources to expand and grow. The less profitable company has trouble attracting capital, and it may wither and die for lack of financial nourishment.
The fittest survive and the weakest go out of business, so no more money is wasted on them. With the weakest out of the way, the money flows to those who can make better use of it.
People who buy shares in Amazon, Tesla or any other private company do it for the simple reason that overtime these companies will increase their earnings, and they expect that a portion of these earnings will get back to them in the form of higher stock prices.
This simple point — that the price of a stock is directly related to a company’s earnings power — is often overlooked, even by sophisticated investors. The candlestick watchers begin to think stock prices have a life of their own. They track the ups and downs, the way a bird watcher might track a fluttering duck. They study the trading patterns, making charts of every zig and zag. They try to fathom what the “Market” is doing when they ought to be following the earnings of the companies whose stocks they own.
If earnings continue to rise, the stock price is destined to go up. Maybe it won’t’ go up right away, but eventually, it will rise. Remember:
In general, the faster a company can grow its earnings, the more investors will pay for those earnings. That’s why aggressive young, innovative companies have P/E ratios of 25 or higher. People are expecting great things from these companies and are willing to pay a higher price to the shares.
HOW TO CATCH A TWELVE-BAGGER
If you’re going to invest in a stock, you have to know the story. Confusing the price with the story is the biggest mistake an investor can make. It causes people to bail out of stocks during crashes and corrections when the prices are at their lowest.
The story tells you what’s happening inside the company to produce profits in the future.
The Story of NIKE
Let’s take a look at Nike during the 1980s. Nike was a simple business, still is today. It makes sneakers. It’s the kind of business anybody can follow. There are three key elements: First, is Nike selling more sneakers this year than last year? Second, is it making a decent profit on the sneakers it sells? Third, will it sell more sneakers next year, and the years after that? In 1987, investors got some definite answers, which in the quarterly reports and the annual report sent to every shareholder.
Since going public in 1980, Nike stock had been bouncing all over the place: jumping from $5 in 1984 to $10 in 1986, falling back to $5, rebounding to $10 in 1987. Looking at the scenery for this story, the prospect for sneaker couldn’t been brighter. Everybody was wearing them. It was obvious the demand for sneaker was growing, and Nike was a big supplier.
Yet the company has run into a rough stretch where its sales, earnings, and future sales were all declining in 1986. This was not a good time to buy more shares of Nike.
But, in the fourth-quarter report of 1987, there was a positive note. Sales were still down, but only by 3%; earnings were still down; but future orders had turned up. This meant that stores around the world were buying more Nike sneakers. They wouldn’t be doing that unless they thought they could sell more Nike sneakers.
By reading the 1987 annual report, you would also have learned that in spite of several quarters of declining earnings, Nike was still making a nice profit. That’s because sneakers are a very low-cost business. Nike has plenty of cash on hand and was in excellent financial shape.
In the 1988 1st quarter report, the Sales were up 10%, earnings up 68%, and future orders up 61%. You were happy the company had turned itself around, but you weren’t rushing out to buy more stock. You were worried about the price, which had moved up sharply from $7 to $12.50.
So you awaited further developments, and this time you got lucky. Stock prices came tumbling down in the Crash of October 1987. Investors who confuse the stock price with the story were selling everything they owned, including their Nike shares. They heard commentators on the nightly news (like CNBC, Bloomberg or on YouTube today) predict a worldwide collapse of the financial markets.
In the midst of this pandemonium, you kept your head, because you realized the Nike story was getting better. The Crash gave you a gift: the opportunity to buy more shares of Nike at a bargain price.
The stock dropped to $7 after the Crash and sat at that level for 8 days, so you had plenty of time to buy in. From there, it began a 5-year climb to $90, while the story kept getting better. By the end of 1992, Nike shares were worth 12 times more that you’d paid for them in 1987. That’s your twelve-bagger.
Obviously, everything seems easier in this hindsight view. But, there are a few aspects to understand:
- Know the business (how it makes profits, etc.)
- Separate the stock ticker from the business
- Be patient and stay up to date with the company news
- Don’t get caught up in the Crash — Ride the wave, Keep your head
- Finally, don’t pay too much
Even if you missed buying Nike for $7 a share after the Crash, you could have bought it 3 months, 6 months, or a 1yr later as the quarterly reports you received in the mail continued to show good numbers. Instead of making 12 times your money, you would have made 10, 8 or 6 times of money. Still, next time you see a crash remember this quote from Warren Buffet:
