Peter Lynch's 6 Types of Businesses
Just as important as understanding the company you are investing in is understanding what kind of stock it is (or rather, what kind of stock you expect it to be).
Peter Lynch, one of the greatest investors of our time, categorized stocks in six ways, depending on what industry they were in and what you should expect as an investor in terms of returns.
1. The Slow Grower
Slow growers are usually large-cap companies that are still growing, but slower than say a high-risk small-cap. Slow Growers might not sound appealing at first, but investing in a range of different companies is a good way to balance out your portfolio. A company that grows slowly in the good times will likely fall slowly in the bad times, and that provides some downside protection to investors. Slow Growers typically have some source of recurring revenue that might grow a few percentage points a year. They also typically pay out a regular dividend.
Stalwarts are companies that tend to remain stable even through the toughest economic conditions. Again, these companies are unlikely to make you rich anytime soon, but because of the intrinsic nature of the business, customers will still buy their products even when times are tough. A good example would be Colgate. No matter what is happening in the economy, people still need to brush their teeth. Consumer staples like this are typically referred to as “recession-proof” — a term I’m not a fan of, but which broadly speaking, is true.
3. Fast Growers
This is Lynch’s favorite category — companies that are growing fast, gobbling up market share, and posting solid revenue growth. Fast growers tend to be smaller, younger companies. After all, it’s far easier for a company making $1 billion a year to double their revenue than a company making $10 billion a year. Lynch believes these are the best investments for getting those 10 and 20 baggers that will seriously add to your long-term wealth. Of course, they are the riskiest form of investment as well.
These are companies whose profits and sales rise and fall at regular intervals. They tend to exist in the automotive and airline industry as well as a few others. If you can correctly predict the cycles, then you can make some good returns off these stocks. However, that can be harder than you think. In recent years, I believe hardware infrastructure companies have also shown a cyclical nature. Big businesses tend to invest heavily in hardware in a year and then cut back on that spending until the next upgrade cycle.
Turnarounds are companies that are in trouble that could potentially be turned around — possibly by new management, or a new product. Turnarounds have the potential to make investors some serious returns, but you are taking a bigger risk with these than with any other category. That’s because with turnaround stocks you are holding a depreciating asset, so time is not on your side. If the company can’t turn itself around, it may be forced into bankruptcy, and that leaves you with nothing.
6. Asset Plays
These are probably the hardest of the six categories to identify and it will take some serious digging and due diligence on the part of an investor. Asset Plays are companies that have some assets that are perhaps not being properly reflected in the company's valuation. For example, the retail sector is currently experiencing a very difficult time and stocks like Macy’s have taken a serious hit. But these companies also own some incredible real estate in some of the most expensive cities in the world. An Asset Play investor might look at Macy’s and think their business is in trouble, but they have all this real estate they could potentially sell that the market is overlooking.
Before you invest in a company, take some time to think about what kind of stock you are buying. If you buy a Slow Grower or a Stalwart expecting a 50% gain in the first year, you’re likely to be disappointed. That’s not to say that it won’t happen, but managing your own expectations is an important part of the investing journey.