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Stepan Lavrouk
Stepan Lavrouk
Articles (292) 

Peter Lynch's 6-Step Investing Checklist

Simplify your decision-making process by asking these questions

October 08, 2019

My old trading boss used to say, “There are always a million reasons not to get involved,” meaning that there are always good and bad reasons for putting on a trade, or not doing so. Unlike their ancestors, who were starved for information, today’s investors suffer from the inverse problem: too much data. One of the primary goals of the value investor should be to separate what is important from what it not. Checklists can assist greatly in this endeavor.

In his book, "One Up on Wall Street," legendary value investor Petery Lunch provided six broad questions that all investors should be asking themselves when deciding whether or not to purchase a stock.

The price-earnings ratio

“Is it high or low for this particular company and for similar companies in the same industry?”

There are many different quantitative metrics that investors can, and should, be using when analyzing stocks, and I certainly don’t mean to suggest they should rely solely on price-earnings ratios (in fact, I have frequently advised against relying on this metric). The price-earnings ratio, however, is a good preliminary filter that can disqualify companies that you don’t need to consider any further, which can save you lots of time.

Institutional ownership

“The percentage of institutional ownership. The lower, the better.”

Lynch emphasized that companies with a high degree of institutional ownership are likely to be overvalued. First, because the institutions themselves bid up the stock price. And second, because they are more extensively covered by analysts, which attracts other buyers.

Insider activity

“Whether insiders are buying and whether the company itself is buying back its own shares. Both are positive signs.”

Executives who spend their own money to buy a piece of the company they manage have a strong personal incentive to do well by shareholders.

Earnings growth

“The record of earnings growth to date and whether the earnings are sporadic or consistent”.

Generally speaking, growing earnings suggests the company is increasing in value. Of course, earnings should be taken with a pinch of salt, as they are much easier to game than other numbers like, for example, cash flows. Nevertheless, earnings growth is a good "filter" that you should consider adding to your own checklist.

Balance sheet strength

“Whether the company has a strong balance sheet or a weak balance sheet (debt-to-equity ratio) and how it’s rated for financial strength.”

A company with excessive leverage is poorly-positioned to survive the bad times. As such, a high debt load suggests you have a narrow margin of safety.

Cash positions

“The cash positions is the floor for the stock.”

The net cash of a company represents the lowest the stock should drop, even in the worst of circumstances. As such, it is a representation of how risky the investment is.

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

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