By Ee Hsin Kok. Edited by Arjun Chandrasekar.
Stock categories are a great way for us to divide our investment portfolios and assess how diversified and/or volatile we can expect our portfolios to be. Peter Lynch, widely considered to be one of the greatest fund managers of all time, has 6 different stock categories which he classifies companies into slow growers, stalwarts, cyclicals, fast growers, turnarounds and asset plays. Let’s review each one in-depth!
The Slow Grower
The slow grower company is one that grows around 1-4% a year, often just right at the pace of the US GDP. Often these companies are very well established in their respective industries and therefore don’t have any room to grow. Modern-day examples include 3M, IBM, and Coca-Cola. Peter Lynch is not a fan of slow growers and argues that the only reason to buy these companies would be for their dividends. If you are buying them for their dividends, ensure that dividend payments have always come out on time and that the company has consistently raised dividends over the years.
Stalwarts are well-established companies that are still growing faster than the US GDP. They have wide economic moats and are very unlikely to go out of business. Modern-day examples include CostCo, United Health, and Lockheed Martin. Peter Lynch says that the most important factor when buying these is their price. Many of these companies are ‘hold forever’ stocks, so if you can buy them when they’re undervalued, they will make you a lot of money in the long run.
Cyclicals are companies that traditionally outperform when the economy is good, and underperform when it’s not. Modern-day examples include General Motors, Exxon Mobil, JP Morgan, and Bank of America. Peter Lynch says that many investors will be anticipating the end of the cycle, so there will be times where despite earnings increasing, prices on cyclicals will stagnate, and so the P/E ratio begins to shrink – a telltale sign the cycle is ending. Cyclicals are not companies you want to ‘hold forever’. Instead, look to buy low at the bottom of the cycle, and to sell at the top of the cycle.
Fast growers, like their name suggests, grow fast. Modern-day examples include Facebook, Nvidia, and Amazon. These companies have projected growth rates from 20 to 35%. Additionally, Lynch says that projected growth rates over 40% should be seen with skepticism as they are often unrealistic, and it typically means that the company is in a ‘hot’ industry (a major red flag to Lynch). Fast growers should also have a good track record of success. If a company hasn’t been able to grow its earnings at a rate greater than 15% for the past 5 years, you probably should not be confident at a projected growth rate over 20%.
Turnarounds are companies that have fallen from their previous highs due to some unfortunate factors. A modern-day example would be Boeing. During the recent covid crash, due to complications with its 737 Max and the downfall of the aviation industry, Boeing plummeted from around $300 to a low of $95. However, when you consider the size of Boeing’s economic moat, Boeing’s recovery has not been unexpected. As of 24th July 2021, Boeing sits around $220, a 130% return from its low of $95. Lynch also states that once a turnaround has rebounded, it is no longer a turnaround, so Boeing might have to be reclassified soon.
Asset plays are found when the market has missed out on something valuable that a company owns. When you are looking for an asset play, ask yourself the following questions:
- What’s the value of the assets? Are there any hidden assets?
- Assets can come in the form of land, patents, and even losses that can carry over as tax write-offs
- How much debt is there to detract from these assets? And is the company taking on new debt? Because that will make the assets less valuable.
- Is there another company looking to buy the asset play? Check if there are because the raiding company will be the one that helps you reap the benefits of the assets.
It is important to note that not all stock categories are created equal. Just because there are 6 categories, does not mean each should be 1/6th of your portfolio. You weigh each category differently according to your risk tolerance. For example, an aggressive portfolio would be 5% slow growers, 30% stalwarts, 5% cyclicals, 50% fast growers, 5% turnarounds, and 5% asset plays.
According to Peter Lynch, there are 6 main stock categories: slow growers, stalwarts, cyclicals, fast growers, turnarounds and asset plays. To dive deeper into each of the categories introduced to you today, I recommend you read Peter Lynch’s “One Up On Wall Street”. And if you’re feeling overwhelmed, don’t worry! As you make your way through your investing journey, these will come more naturally to you.