• Jalal Ali

13 Filters to Find the Perfect Stock

Updated: Jun 8, 2021

Peter Lynch, as the manager of the Magellan Fund at Fidelity Investments between 1977 and 1990, averaged a 29.2% annual return, making it the best-performing mutual fund in the world


In his book "One Up on Wall Street", Peter Lynch shares his 13 filters that he used to find the perfect stock:


1. IT SOUNDS DULL—OR, EVEN BETTER, RIDICULOUS

“The perfect stock would be attached to the perfect company, and the perfect company has to be engaged in a perfectly simple business, and the perfectly simple business ought to have a perfectly boring name. The more boring it is, the better.”


2. IT DOES SOMETHING DULL

“I get even more excited when a company with a boring name also does something boring.”


“A company that does boring things is almost as good as a company that has a boring name, and both together is terrific. Both together is guaranteed to keep the oxymorons away until finally good news compels them to buy in, thus sending the stock price even higher.”


3. IT DOES SOMETHING DISAGREEABLE

“Better than boring alone is a stock that’s boring and disgusting at the same time. Something that makes people shrug, retch, or turn away in disgust is ideal.”


4. IT’S A SPINOFF

“Spinoffs of divisions or parts of companies into separate, freestanding entities—such as Safety-Kleen out of Chicago Rawhide or Toys “R” Us out of Interstate Department Stores—often result in astoundingly lucrative investments.”


A large parent company doesn’t want its spin-off to get into trouble as it reflects poorly on the parent company. Hence, spin-off usually gets independence with a strong balance sheet.


“...spinoffs normally have strong balance sheets and are well-prepared to succeed as independent entities. And once these companies are granted their independence, the new management, free to run its own show, can cut costs and take creative measures that improve the near-term and longer term companies.”


5. THE INSTITUTIONS DON’T OWN IT, AND THE ANALYSTS DON’T FOLLOW IT

“If you find a stock with little or no institutional ownership, you’ve found a potential winner. Find a company that no analyst has even visited, or that no analyst would admit to know about, and you have got a double winner.”


6. THE RUMORS ABOUND; IT’S INVOLVED WITH TOXIC WASTE AND/OR THE MAFIA

A company surrounded by rumors trades at a steep discount and wall street and other institutional investors usually stay away from it. For example, a company rumored to be involved with toxic waste or the Mafia may be an excellent opportunity.


7. THERE’S SOMETHING DEPRESSING ABOUT IT

The mortuary business is a good example.


“If there’s anything Wall Street would rather ignore besides toxic waste, it’s mortality.”


8. IT’S A NO-GROWTH INDUSTRY

“That’s where the biggest winners are developed.”


“In a no-growth industry especially one that’s boring and upsets people, there’s no problem with competition. You don’t have to protect your flanks from potential rivals because nobody else is going to be interested. That gives you the leeway to continue to grow, to gain market share...“


“There’s nothing thrilling about the thrilling high-growth industry, except watching the stocks go down. Carpets in the 1950s, electronics in the 1960s, computers in the 1980s, were all exciting high-growth industries, in which numerous major and minor companies unerringly failed to prosper for long.”


9. IT’S GOT NICHE

“I always look for niches. The perfect company would have to have one.”


“Drug companies and chemical companies have niches—products that no one else is allowed to make.”


“Chemical companies have niches in pesticides and herbicides. It’s not any easier to get a poison approved than it is to get a cure approved.”


“Brand names such as Robitussin or Tylenol, Coca-Cola or Marlboro, are almost as good as niches. It costs a fortune to develop public confidence in a soft drink or a cough medicine. The whole process takes years.”


10. PEOPLE HAVE TO KEEP BUYING IT

“I’d rather invest in a company that makes drugs, soft drinks, razor blades, or cigarettes than in a company that makes toys. In the toy industry, somebody can make a wonderful doll that every child has to have, but every child gets only one each.”


“Why take chances on fickle purchases when there’s so much steady business round?”


11. IT’S A USER OF TECHNOLOGY

“Instead of investing in computer companies that struggle to survive in an endless price war, why not invest in a company that benefits from the price war.”


“Instead of investing in a company that makes automatic scanners, why not invest in the supermarkets that install the scanners? If a scanner helps a supermarket company cut costs just three percent, that alone might double the company’s earnings.”


12. THE INSIDERS ARE BUYERS

“There’s no better tip-off to the probable success of a stock than that people in the company are putting their own money into it.”


“When management owns stock, then rewarding the shareholders becomes a first priority, whereas when management simply collects a paycheck, then increasing salaries become a first priority”


“There’s only one reason that insiders buy: They think the stock price is undervalued and will eventually go up.”


13. THE COMPANY IS BUYING BACK SHARES

"Buying back shares is the simplest and best way a company can reward its investors. If a company has faith in its own future, then why shouldn’t it invest in itself, just as the shareholders do?"


“When stock is bought in by the company, it is taken out of circulation, therefore shrinking the number of outstanding shares. This can have a magical effect on earnings per share, which in turn has a magical effect on the stock price. If a company buys back half its shares and its overall earnings stay the same, the earnings per share have just doubled. Few companies could get the kind of result by cutting costs or selling more widgets.”

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