The first investing book I read was One on Wall Street. I was in college when I first read it, and to this day it remains my favorite investing book. Written by Peter Lynch in 1989, many examples in the book may seem outdated. But the central ideas remain as strong as ever.
Lynch advocated basic observations coupled with fundamental financial analysis. Let’s take an in-depth look at how Lynch’s approach has worked in practice and apply it to three companies that have recently made the financial headlines: Shopify (STORE 2.55%), Target (TGT 4.32%)and walmart (WMT -0.61%).
Originally, Lynch was a growth investor who sought companies that could grow in size over time and generate monster profits. Lynch was known for living a business to the fullest: he would talk to his employees, call the investor relations offices, and do whatever he could to gauge the pulse and health of the underlying business.
From there, Lynch reviewed the financial statements to determine if an asset was mispriced or had hidden value. If the business looked promising in person, sounded solid from what others were saying, and had its finances checked, he considered it a good buy.
Apply Lynch’s Lessons Today
In today’s relentless bear market, it’s more important than ever to take calculated risks and ask important questions. With Lynch’s investment philosophy in mind, we might start by asking ourselves:
- Does this business have cash on its balance sheet or the free cash flow (FCF) needed to survive a period of negative growth?
- In a weak environment, will this company gain or lose market share?
- How has this company performed during past economic downturns?
Many companies that have recently suffered a stock price drop of more than 80% are weak on all three counts. They don’t have a lot of money relative to their planned expenses and are negative FCF, which means there’s more money going out of the business than it’s coming in. For the second point, many of these companies may be swallowed up or lose their competitive advantages. during the current downturn to larger players with more resources. Finally, many struggling new businesses have not been around long enough to prove themselves in a rising interest rate environment; rather, they enjoyed most of their growth when interest rates were low, financing was cheap, and growth was easy.
So how do you find a good buy in today’s market? The real bargains right now are companies that have seen their stock prices tumble due to broader market conditions, but are only failing on one — maybe even two — of those issues.
The creative movement: Shopify
Shopify fits that bill. The e-commerce company isn’t always FCF positive, but it has plenty of cash on its balance sheet and is well positioned to take market share even during a recession. However, it doesn’t have a reputation for persevering through past downturns.
In terms of basic Lynch-style recognition, Shopify definitely checks. Shopify has great reviews and feedback from people who use its services. Whether on message boards or social media platforms, Shopify stands out as a fan favorite among small and medium-sized businesses. It also has an excellent 4.1-star rating on Glassdoor, which means that its employees are generally satisfied. Shopify is also a founder-led company, which suggests that its management has a significant stake in the company’s success.
Shopify’s business model is structured to benefit the same as its customers. The majority of revenue comes from gross merchandise volume, a fancy way of referring to sales that go through Shopify. Therefore, it is in the company’s interest to help its customers increase their sales and achieve their goals.
All told, Shopify is the kind of 10 potential high-risk, high-reward bags that Peter Lynch says are probably worth a look.
The Easy Way: Target and Walmart
Risk-averse investors might be better off applying Lynch’s methods to companies with which they are more directly familiar. Let’s take a look at household names Target and Walmart, which both released their first quarter results earlier this spring.
Both of these big-box retailers are easy-to-get-together businesses. Since they are discount retailers, their margins are inherently low, leaving little room to raise prices in times of high inflation. In their recent earnings calls, both management teams said they had absorbed much of the cost pressures from rising freight and fuel costs, supply chain constraints and higher costs. goods. The result of this, however, is billions of dollars of headwinds that these companies normally couldn’t handle. It’s no wonder the two stocks took a beating after posting weak guidance following the release of their first quarter results.
But applying what we’ve learned, let’s find out: would Peter Lynch view the stock declines of these companies as threats or opportunities? The famous investor would likely approach the situation by visiting stores and taking a close look at factors such as service quality, consumer habits, available inventory, employee sentiment and discounted products. Lynch then followed by reviewing each company’s financial statements.
Especially as inflation persists, Target and Walmart stocks could continue to decline. But both companies have positive FCF and large cash positions as well as low price/earnings ratios. They are well positioned to take market share from smaller retailers during a recession, have been through several economic downturns in the past, and are both dividend aristocrats, meaning they have paid and increased their dividends for over 25 years. years (50 years for Target and 46 years for Walmart).
In sum, it doesn’t take a financial expert to realize that Walmart and Target are big companies caught in a time when it’s hard to offset inflation with price increases. It’s not the end of the world for either company. It just means that they will probably report bad quarters at the moment.
Think long term
As a long-term investor, Lynch was famous for finding troubled companies and snapping them up at a good price. Shopify relies on small and medium-sized businesses which are more vulnerable to a recession than larger businesses. Therefore, its growth is likely to slow, which is reflected in the fall in its share price. But nothing has changed in the company’s long-running thesis.
Seeing companies in action for yourself instead of just looking at a stock chart reminds investors that there are real companies behind the stock price. Going on message boards, forums, reading reviews, and talking to people who use Shopify, it becomes clear that most people love the service. When it comes to Target and Walmart, it’s easy to walk into these stores and use their e-commerce services to see that both are doing perfectly well and aren’t going away anytime soon.
I would expect the short term situation to get worse before it gets better for these three companies. But thinking long-term, all three stocks seem like good buys right now that Peter Lynch himself would be proud of.