Types of Stocks
Market Cap
As you may already know many of our investment philosophies are derived from Peter Lynch. Considering that Lynch compiled astounding returns of 29 percent a year while running the mutual fund Fidelity Magellan, we feel confident that following in Mr. Lynch’s foot steps gives us a great chance at to achieve market beating returns. This section comes straight from Lynch’s playbook.
When first analyzing a company it’s important to determine the size of the company that you’re dealing with. The best way to find the size of a firm is to look at market capitalization or market cap for short. The market cap can be found on most stock quotes but you can calculate it yourself by using the following formula: market cap = # of shares times the share price. For example if company XYZ has 100 shares outstanding and a share price of $15, then the market cap equal $1500 (100 times 15 = 1500). The larger the company harder it is for a company to increase its value substantially. For example, a company with a 50 billion dollar market cap has to increase its value by 50 billion dollars to double while a company with just a 100 million dollar market cap just needs to increase its value just by 100 million dollars to double.
Different Categories of Stocks
After finding the size of a company you can place the firm into one of six categories that Lynch describes in One Up on Wall Street: Fast Grower, Medium Grower, Slow Grower, Cyclicals, Turnarounds and Asset Plays.
Fast Growers: These are usually smaller companies with high growth rates. Usually these companies have growth rates greater than 20 percent a year and trade at high earnings multiples (i.e. high p/e ratios) compared to other companies in different categories.
Medium Grower: These are medium size companies that grow between 10 and 20 percent a year such as Pepsi. Often times you won’t find big winners in these companies, but if you buy them at the right price you could make a solid gain.
Slow Growers: Slow growers are companies such as public utilities that grow at the rate of the national economy. Often times, investors buy these companies for the large dividends they pay and don’t expect large appreciation in the share price.
Cyclicals: Cyclicals are firms that fluctuate with the business cycle. As the economy expands and contracts, cyclicals grow and falter. The classic example of cyclicals are auto companies. As the economy is good more people buy cars, but when the economy dips into a recession very few people buy cars. Cyclicals are a tricky business but a lot of money can be made (or lost) with this category of companies.
Turnarounds: These companies usually are coming out of bankruptcy or a long slump that can provide great returns to shareholders if “turnaround plans” work out.
Asset Plays: These are companies that have an asset, such as land or a subsidiary company that is worth more than the actual company. The game here is to find a company with this sort of “hidden” asset and wait for the market to realize its value. Asset plays are usually hard to find, but it’s possible to make solid returns with these types of companies. Most of the time, the best play is to conduct normal research activities and keep an eye out for potential asset plays instead of just searching for asset plays directly.
It is possible for a company fall in multiple categories. For example, a small company might have great growth rates and a hidden asset which would allow us to classify this type of company as a fast grower and an asset play. Also, it’s possible for a company to switch categories. For example, when Starbucks was first starting out it was definitely a fast growing company. Now that there is a Starbucks on every corner in America the firm is probably a medium grower.