'One Up on Wall Street:' Search for Multibaggers Among the Boring, Ridiculous and Disagreeable

As Peter Lynch told us in chapter seven of "One Up on Wall Street," there are six categories of stocks, and knowing in which category your stock is in gets you off to a good start. In chapter eight, he takes us somewhat deeper into the story by urging us to find companies we understand:

“Getting the story on a company is a lot easier if you understand the basic business. That’s why I’d rather invest in panty hose than in communications satellites, or in motel chains than in fiber optics.”

And then there was the famous phrase, “When somebody says, 'Any idiot could run this joint,' that’s a plus as far as I’m concerned, because sooner or later any idiot probably is going to be running it.”

What’s more, he said he would rather own a humdrum company with mediocre management in a simpleminded industry with no competition that a fine company with excellent management in a highly competitive and complex industry.

How to find those simple businesses? Lynch has 13 suggestions that take us away from the mainstream:

1. The business sounds dull and if it sounds ridiculous, that’s even better. His favorite in this category was Pep Boys — Manny, Moe and Jack (PBY, Financial): Who on Wall Street would invest in a name that sounded like the Three Stooges (an American slapstick comedy group from the mid-1900s).
2. The company does dull things. For example, Crown Cork and Seal (CCK, Financial) did nothing but make cans and bottle caps. Very dull stuff, but the company’s financial performance was far from dull.
3. A firm that does something disagreeable also fits the mold. For example, Lynch really liked Safety Kleen (now owned by Clean Harbours Company (CLH, Financial)), a company that provides auto mechanics with a machine that cleans dirty parts and more. He said, “This company has had an unbroken run of increased earnings. Profits have gone up every quarter, and so has the stock.”
4. Spinoffs. Lynch cites several lucrative spinoffs from his time and generalizes to say such firms are normally well-financed and well-prepared, because their parent companies do not want embarrassing public failures.
5. The company is not owned by institutions and not followed by analysts. He also likes stocks abandoned by professionals and just before they rebound. His favorites of this kind were Chrysler (FCAU, Financial) and Exxon (XOM, Financial) when they were in the dumps.
6. There are rumors about toxic waste or the mafia. Lynch liked the Waste Management (WM, Financial) company because it combined toxic waste with the mafia’s reputation for involvement in the garbage business. The company was not associated with the mafia, but it turned toxic waste into a hundredbagger for those who got in early and stayed.
7. It does something depressing. One of his ongoing favorites was Service Corporation International (SCI, Financial), an aggregator of funeral homes. “Now, if there’s anything Wall Street would rather ignore besides toxic waste, it’s mortality. And SCI does burials,” he said.
8. It is in a no-growth industry. Lynch said, “Many people prefer to invest in a high-growth industry, where there’s a lot of sound and fury. Not me. I prefer to invest in a low-growth industry like plastic knives and forks, but only if I can’t find a no-growth industry like funerals. That’s where the biggest winners are developed.”
9. It's a niche player. In his own words, “I’d much rather own a local rock pit than own Twentieth Century-Fox, because a movie company competes with other movie companies, and the rock pit has a niche.”
10. There is consistent, ongoing demand, such as drugs, soft drinks and razor blades to cite a few of Lynch’s examples. He also named cigarettes, which are toxic, but addictive. And while fewer people in the Anglo-American countries smoke, worldwide demand remains solid.
11. It is a user of technology: By this, Lynch means companies that can benefit from price wars or similar situations. For example, he argued it would be foolish to invest in computer companies caught up in endless price wars when you could buy the beneficiaries of such pricing. Automatic Data Processing (ADP, Financial), for example, increases its profits with every price cut by computer companies.
12. There is insider buying: The people who know the company best are increasing their commitments, and at the same time, this signals that shareholders will be the first priority, rather than management. Insider selling, Lynch noted, usually “means nothing, and it’s silly to react to it.”
13. It is making share repurchases. Lynch called this “the simplest and best way a company can reward its investors.” Less attractive alternatives are: increasing dividends, developing new products, launching new businesses and making acquisitions.

Lynch dreamed of creating the perfect company, one which would combine all the “worst elements” of the companies and situations listed above. He called this fictitious company Cajun Cleansers, a recent spinoff from Louisiana BayouFeedback, which is in the obscure business of removing mildew stains from furniture, rare books and draperies.

Its headquarters are on a remote bayou in Louisiana, no analysts have ever been there, no institutions have bought its stock and so on. Theoretically, at least, this is a growing and profitable business that is perfect for an investor such as Lynch.

Conclusion

While Lynch’s entry situations provide a fine list of opportunities, they certainly are not enough in themselves. Each of the 13 situations also provides opportunities to get into trouble, as sometimes there are good reasons why there is no analyst coverage or no institutional ownership and so forth.

In future chapters, Lynch will provide more information that helps potential investors narrow the field, but it still feels that something is lacking.

At this point I try to imagine Benjamin Graham reading this chapter. I imagine him saying, “That’s all very well, but what about their margins of safety?”

The Peter Lynch chart below shows Automatic Data Processing and the relationship between the earnings line (blue) before non-recurring items (NRI) and the price line (green) over the past 28 years. The red line shows a variation of the earnings line. Normally, a stock is considered a good prospect when the price line is well below the earnings line, and a selling candidate when the earnings line gets above the price line:

GuruFocus provides the Peter Lynch Screen tool for quickly finding companies that meet his criteria. Members can access the screener here, and non-members can get started here.

This review is based on the Millennium Edition (2000) of “One Up on Wall Street.” More chapter-by-chapter reviews can be found here.