Peter Lynch stock categories: a six-part framework

0:00Wall Street wants you to think investing is complicated. Peter Lynch and Winston Buffett disagree. And here is his dead simple system that's crushed the market for 13 years straight. Peter Lynch grew the Magellan Fund from $18 million to $14 billion and famously delivered those marketing results. Yet his message is clear. Regular US investors can have an edge over Wall Street.

0:28And in a market drowning in hype cycles and headlines, most investors are taking risks they don't actually understand and they're missing the simple opportunities right in front of them. So get this wrong and you could spend years watering the weeds in your portfolio. Get it right and you tilt the odds back in your favour. I promise you this. By the end of this video, you'll have Peter Lynch's complete practical system, your hidden advantages, how to classify stocks, and a free workbook you can use right now.

0:54I'm Felix Prehn. I'm an ex-investment banker who's seen how Wall Street banks work from the inside. I'm also the founder of Goat Academy. We have over 20,000 students. I'm also the co-founder of Trade Vision where we make data accessible to everybody.

1:09And my mission is to teach regular investors how to spot opportunities, avoid the landmines, and make better decisions. So today, I'll compress Lynch's three books into an actionable framework for regular investors. No hype, just process.

1:25And for those of you who are actually serious about investing, I have something even better than these frameworks here. Imagine having Wall Street's own rules in your pocket. I'll gift those to you. I will give those to you as my gift at a live training that I'm holding at felixfriends.org/training. All you got to do is grab yourself a free seat and for about an hour and a half, I will teach you. I will deliver to you the actual system, the actual structures that I learned from my mentors. And that'll take us way beyond what we can cover in this video here.

1:57But let's get started with the Peter Lynch rules. Here's your hidden advantage as a non-banker. The shopping mall strategy that literally changed everything. Let me tell you a story here that completely flips how you think about stock picking. In the late 1970s, Lynch's wife Caroline came home from a grocery shop and she is absolutely raving about these new pantyhose called L'eggs. Not just nice, she's genuinely excited about pantyhose.

2:27Now, most husbands, and I know most of my viewership is male, would probably nod politely and just forget about it, right? But Lynch, he starts paying attention. These weren't just better pantyhose. They had a very unique packaging, a plastic egg container, and they were displayed right at the checkout counter at a grocery store where women couldn't miss them. So the revolutionary packaging in the most boring industry imaginable is what caught the attention here.

2:53So what does Lynch do? He bought Hanes stock, which is the company behind that product, and the stock went up 6 times. But wait, it gets better. Lynch noticed the lines at his local Dunkin' Donuts getting longer every morning. Not just busy, but consistently packed. So he'd get his coffee and he'd think, "This place is printing money."

3:12So Lynch discovered doing some research that Dunkin' was expanding like crazy, had great unit economics, so high margins on coffee and donuts and that sort of thing. And the customer loyalty was insane. People didn't just like their coffee, they were kind of addicted to this routine of going there. So the result, another massive winner in his portfolio.

3:33And here's the kicker. These weren't complex biotech plays or emerging market strategies or the latest AI whatnot. These were businesses Lynch encountered in his normal suburban life. Products his family was already using and loving.

3:49Now, why Wall Street can't do what I've just told you. You might be thinking, "Come on, these Wall Street guys, they're smart. They've got MBAs from Wharton and Bloomberg terminals that cost $30,000 a year and all that stuff." Well, Lynch says that's exactly what the problem is. And my experience correlates exactly with that. Your disadvantages are actually your superpowers.

4:09And the first thing is that banks are run by committee. So picture this. You see Chipotle packed every lunch hour, you see it's packed three months straight. So you want to buy the stock, right? So what do you do? Well you walk to your computer or you get your phone and you buy 100 shares. Done.

4:33What do you think happens on Wall Street? Well there's an analyst who says, "I'm going to schedule a committee meeting. I'm going to get compliance approval. I'm going to write a 47-page report justifying why Mexican fast casual dining is a sustainable competitive advantage in the post-pandemic restaurant landscape." And by the time they're done with all those meetings, Chipotle is already up 40% and the opportunity is gone.

4:53And then you have the second problem here that these guys face. I call it the career risk problem. Fund managers get fired for being wrong. They do not get fired for missing opportunities. So they buy the same safe stocks everybody else owns because no one's ever gotten fired for owning Apple, even if it underperforms. But if you buy some weird local restaurant chain that doesn't really work out, well, you're going to be out of the door and you're going to be updating your LinkedIn profile.

5:26And then we got a really interesting one, and I can definitely attest to that. Lynch calls it the geographic blindness problem. And this one's kind of funny. Where do most Wall Street analysts live? In Manhattan, maybe in Greenwich, Connecticut. And that's about it.

5:50So Lynch tells this amazing story about Walmart. For years, Wall Street was writing reports about how discount retail was dying and department stores were the future. Meanwhile, every American outside of Manhattan was shopping at Walmart and was absolutely loving it. The analysts, they'd never set foot in a Walmart. They didn't even know where the nearest Walmart was.

6:08So Lynch's Walmart discovery. Well, he visited family in small-town America and he saw these massive Walmart stores absolutely packed and realised Wall Street had just missed the biggest retail revolution in history. The stock went up 50-fold after he bought it, 50x.

6:25And you might have seen the same thing with Tesla. Wall Street was like, "Sounds like some weird technology thing," and everybody in California was driving them. So it became a huge product, became a huge success story. Wall Street missed the beat. And there are many, many of these examples.

6:42Now, next we also have what Lynch calls the fifth grade explanation test. And this is going to save you from making daft investments. If you can't explain why you own a stock to a fifth grader in 2 minutes, you probably shouldn't own it. And I don't mean another investor. I don't mean your broker. I don't mean some smart whiz kid. I mean a 10-year-old child.

7:06So I'll give you a good example. This is a Lynch example. He says, "I own McDonald's because they sell hamburgers that cost them a dollar to make and they sell them for 4 bucks or whatever." So they're opening new restaurants in countries where people have never heard of American fast food before. That's pretty simple.

7:25What is a bad example? If you say, "Well, I own this biotech company because their phase 2 clinical trials for the monoclonal antibody therapy is showing promising efficacy in treating inflammatory cytokine responses and the FDA fast-track designation could accelerate the regulatory pathway." Just stop it. Right? You have no idea what you're talking about unless you are one of the 1 in 100,000 who's some sort of bio scientist.

7:51So Lynch isn't saying dumb things down. He's saying have clarity of thinking. If you can't explain it simply, you don't actually understand it well enough to risk your hard-earned money on it.

8:01Let me give you a real example. His Dunkin' Donuts example. He says, "Americans are addicted to coffee and donuts." This company sells both. It has the best locations. It's opening new stores faster than anybody else. People will drive past three other coffee shops to get to Dunkin'. Fifth grader gets that. Harvard MBA gets that. An analyst will probably even get that. Well, I wouldn't count on it. And this is literally what made Lynch rich.

8:39So think about your daily life for a second. You probably have insight Wall Street would pay a lot of money for. Maybe you're a parent. Maybe your kids are obsessed with certain toys way before it ever shows up on Wall Street. Maybe you work in retail. Well, you see what products fly off the shelves, right? You see those hot cakes.

9:03Maybe you work in construction or some sort of engineering thing, right? Well, you probably know what tools actually work, which companies make them. Maybe you work in healthcare. Well, you can see what equipment comes in, right? What's the software that works? What's the stuff that always gets bought and saves time and money? It's the simple observations like that.

9:26But, and here's a big warning. Don't extrapolate from one data point. So one data point as in "my child likes this toy" isn't quite enough because your child might be special or your local Target store might be busy, but doesn't mean the whole chain is thriving, right? So you got to check some data. So you got to confirm with real numbers.

9:53And the beauty of the internet is that you have access to all those numbers nowadays basically for free. Say here's a restaurant chain and you absolutely love it. Well, maybe their maths doesn't add up. Maybe they make no money. So just go out and check the balance sheet, right? So what I want you to do, and I'd love it if you shared it with people, be generous here, right? What products or services are getting more and more popular in your daily life? Something you think, "Wow, this is

10:22"Better than what I came for," or "everyone's now using this." That's your starting point. That's your actual edge. Wall Street should figure it out eventually, usually about a year or two later after you already know. You don't need to find the next Apple or Google. You just need to find the next thing regular Americans will consistently spend money on before Wall Street's algorithms catch on.

10:46And that takes us very nicely to the next section, which is Lynch has six stock categories. I'm going to take a screenshot of this or just download the workbook down below at felix.org/peterlynch. Little tricky to spell always, but there's a link down below you can click on.

11:02So before you buy a single share, you need to know what game you're playing. And Lynch discovered that every stock fits into one of six categories and each one has very different rules for when to buy and hold and sell. So we got the slow growers, your utilities, your major companies. Just don't touch them. Just don't bother. You can get some dividends and stability, but they can be a dividend trap. They're very rate sensitive and these are boring. They grow 2 to 5% a year. Who really wants it, right?

11:31So most companies start as fast growers and eventually they become the slow growers, at which point you're no longer interested. And then we have the stalwarts, the portfolio anchors, the reliable blue chips who are chugging along at that 10 to 12% growth which is the kind of baseline that we want, right? And what do we do with these? We look for dips, pretty big dips, 20 or 30% dips that are temporary. Temporary bad news, some recall, they're poisoned a chihuahua and Utoxitor or something and therefore they had to recall 10 million bottles of Coca-Cola. People are still going to drink the stuff afterwards, right? Very sorry about the chihuahua.

12:13Now so these are basically your dependable companies and again they keep you through rough markets. Philip Morris is one of those, again that's a Peter Lynch stock, right? And he waited for it to rise 30 to 50% and then he sells it, but he then waits for bad news to knock it back down 20 or 30%, then he buys it back again. And he did that 5 times at Philip Morris. I do it all the time. I literally do it all the time. I keep buying the same companies and selling the same companies again and again and again. And people are like, "Why do you do that? It would have just gone up." Like, "Yeah, but we made way more money in the process."

12:41What's a good example right now? I would argue UNH is a good example right now. CEO got shot. They got criminal investigations against them for some sort of Medicare fraud. I mean really, you really can't make this stuff up, right? And stock's down, I don't know, 50, 60% or something, right? No, UNH will still be there tomorrow. They've revised their numbers back up and all that stuff. So you can do some research on that.

13:05And then we have the fast growers. And I know a lot of you guys are just in the fast growers. These are companies that are growing 20% or more, right? Lynch loves these. He says this is where you want to be. This is where the compounding really kicks in. Lots of growth. But you got to really verify these because these are also higher risk, right? So you kind of want companies that are growing 20 to maybe 30%. That's typically where Lynch says are your biggest winners. They grow much faster than that, they often screw things up. Management can't handle it.

13:37And I mean look at Microsoft. You could have bought Microsoft pretty much anytime and you're still very likely to make money because this industry just gets bigger and bigger and bigger. So how do we pick a fast grower? Let me write it out for you. So the fast grower, first of all you want that 20 to 30% growth and you want to buy it before your dentist starts talking about it, because at that point it's probably a little late.

14:12So the business should be early in the expansion cycle. Think McDonald's when they had 100 stores, not 30,000, because it's kind of hard from 30,000 to go to 90,000, is probably impossible. So you want to know that they can grow for 5 years or more. That's important.

14:29And then you have your cyclicals. And I often warn about these because they're riskier, right? These are much riskier because cyclical implies you got to get the timing right. So you got to understand the industry a little bit. So when do we buy cyclicals? Buy when the sector or the industry is hated and we sell into optimism, right? So you want to be a little early on those.

15:10So what are examples of those? Good examples of those are auto companies, steel, housing. We've been buying home builders last couple of weeks before the interest rate story really became mainstream, right? And I think that was working out very well. And then everyone's going to catch on to this in the next couple of weeks and months and then we'll sell them.

15:34But most people get the timing wrong, right? They just buy it when everyone's like, "Oh my god, everyone's building houses, interest rates have just gone down, let's go and buy the home builders." At that point it's too late. So you need to see the cycle a little bit further advanced. That's a little bit harder to do. So you might want to skip this one. Literally you might want to skip this one. It's harder to do because you just need to buy when everyone hates it and just sell it when everyone loves it. It's a tough thing to do.

15:58And then we have the turnarounds. And turnarounds are beautiful, but again a little bit more challenging to do. Now the thing with turnarounds, write this down, this is a really good rule. Turnarounds rarely turn around. That's the first rule, right?

16:24So these are beaten down companies that might make a comeback through new management, operational fixes, debt reduction, and so on. Think Apple in the late '90s. Apple was left for dead. Steve Jobs returned and well, you know what happened, right? But it rarely happens. So you make money on some, but you're also going to get them wrong, right?

16:43So to me an example where I got it wrong was PayPal. PayPal just hasn't turned around. New CEO came in, he's not a fast guy. He's not a communicator. He does not convince Wall Street. So PayPal isn't turning around. So what do you want to wait for? Not the story. You want evidence of a turnaround. And the way I look at that actually, to save you from digging much deeper, we look on the chart and on the chart there are a couple of things that tell us that the evidence is already there, rather than running through all their financials. And I'll teach you that if you come to the live training, Felix training, because that'll make your life a lot easier rather than running through their sales numbers or something like that.

17:25Now lastly we have asset plays. What the heck is an asset play? Hidden treasures. These are undervalued companies. And that might be cash. That might be real estate. Maybe it was an industrial company that owns a great big piece of somewhere valuable. And the sum of its parts are actually worth more than the business. And people haven't noticed that yet.

18:01An example that Lynch gives is Disney. After Disney opened Disney World, their growth slowed, but Lynch realised they were sitting on a massive hidden asset, the Disney brand name, which is worth billions and billions and billions. And they also own thousands of acres of Florida real estate. They have licensing rights to Mickey Mouse and every Disney character. And their content libraries are fortunes that Disney used. So these are hidden assets that launched the Disney Channel. They started merchandising and they started to develop more of their land. Huge winner, right?

18:31And what Lynch looks for is companies with real estate that is on their books at historical cost. So what they paid for it, say they bought some land 30 years ago and they never ever revalued that land and now it's worth 10 times more. Or brand names that are worth more than their book value. You also occasionally see cash rich companies that trade below cash value. Crazy stuff, right?

19:05But sometimes cheap companies are cheap for good reasons and the catalyst to unlock the value might never come. So one of the rules that one of my mentors told me, he was an old Wall Street goat, he said, "Felix, you got to promise me one thing. You're never going to buy a stock because you think it's cheap." And I said, "Okay." And I did it a few times. You have to learn sometimes. But it was small and it was painful and it's seared in and I'm like he was completely right. Much cheaper to listen to other people's experience than to go and do it yourself.

19:40So what does the portfolio mix look like? So this is Lynch's portfolio, that's meant to be a circle. You have about a quarter that is those stalwarts. Not a word I use very often. The stable stuff. You have about 30%. You have about 40% in fast growers. You're not going to make money if you're not going to take risks. And then

20:16You have a little bit, maybe 10 to 20%. That's cyclicals and that's about 10 to 20%.

20:25And then you have your turnaround stories here. They're not always there, but if they are there, that's your zero to 20%. So that adds up more or less, right? So you get the idea. It's a mix. The stalwarts and the fast growers are the core, you could ignore the rest. You could ignore the rest and just not deal with those at all.

20:47Now, let me know which of these 6 categories sounds most like you. Just put a 1 to 6 in the comments down below. Is it the fast growers? Probably for most people, right? Is it the slow growers? I doubt it. Let me know down below.

21:00Now, I want to teach you one more thing because this is a real core to this man's life's work. And it's one formula that Lynch says you need to know. And it's what most people associate Lynch with nowadays. And it's this. It's the PEG ratio. People often ask, is it expensive? Is it cheap? And I always say it doesn't really matter. But this is actually a pretty decent way of looking at what the pricing is.

21:26So most people look at PE ratio, right? Complete nonsense. Never ever look at the PE ratio. It really is just the most useless thing in the world. So this thing here is not what you want to be looking at. So he's come up with this PEG ratio, which is the PE ratio. It's profit over earnings divided by earnings growth. Now earnings growth is much much much more important but he brings it back to a measurable number.

21:51So you have a PEG of 1, fair value. PEG of greater than 1, potentially overvalued. Now note the potentially, right? So stuff can go up and be overvalued for quite a long period of time. And then you have the stuff that's below 1 and that's potentially cheap. Now, I said never buy something because it's cheap, but you then want to look at is there an opportunity here? Are they actually growing faster?

22:15Now, I'm going to give you some real market data here, more or less. Double check always the numbers obviously, which looks at some of the popular stocks out there and tells you what the PEG ratio is, right? So Apple is 1.3, Nvidia's 1.1, Meta is actually looking pretty undervalued, Eli Lilly looking pretty decent, Tesla is looking crazily overvalued, but then that's because they haven't got any growth, but maybe you see the growth in the future. So you can see the limitation here, right?

22:43Netflix looks insanely overvalued. I'm not sure it's necessarily the case, but there's that. And then actually, I don't know why because the growth rate for Johnson and Johnson and Coca-Cola is negative. I actually just bought some Johnson and Johnson stock because I think there's an opportunity there.

23:02But so no single number is ever going to be the answer. And I know people always look for that. Give me one number. If that's right or wrong, I'm going to buy it or sell it. Sadly, the investing world is a little bit more complex than that. It just is.

23:12So if you don't want to learn that, well, you can always just buy an ETF and you'll get average. Average is better than below average. I don't think it's what we want, certainly not what I want. And if you consider how much time you spend working, you might be thinking, "Oh, now I have to manage the money too." Yeah. Because the only reason you go to work is to get money. So to respect the money in yourself, you need a little bit of learning.

23:36And so if you're a newbie or you're just wanting to get organised, this is a very good way of getting started. So phase 1, this week, get yourself a low cost broker. I use Schwab. You can use anything. Set yourself up some screening tools. Yahoo Finance is free. Make sure you use your tax advantage account. So Roth IRAs for example are amazing in the US.

24:01Do a little bit of research. Screen for some PEG ratios. Analyse a couple of companies per category and then build out a watch list of some stocks. And then phase 3, start with the solid businesses, the stalwarts. The ones who are growing that 10 to 12%. And once you've done that, you might want to add a couple of fast growers to it. I give you some ideas most weeks, but you also want to have a little bit of cash opportunities on the side.

24:27And the most important thing is risk management. And that's what most people just completely ignore is risk management. So, if you want to get some good risk management on a platter, I'll give it to you. Just come and join me live at felixfriends.org/training.

24:51Okay? And my promise is to train you and to open your eyes to how risk management actually works. And if you do that, you'll be in a much much better position because you'll understand you're not just buying stuff and you're not just hoping. And that's in reality what most people are doing, right? They're just sitting there and they're hoping.

25:07So, I hope this has been useful. Now, would I suggest you read these 3 books? Honestly, no, because it's going to take you quite a lot of time and I think you can learn a lot faster than reading books. They're great books. They're a fun read. So, if you ever like on holiday on a plane or something, they're a fun read. And I think he's a genuinely nice guy, which is quite rare on Wall Street.

25:31But I would just focus on me. And I think the best way to learn is to focus on you, not to read all the strategies from everybody else out there. So there's a lot of wisdom in someone like a Peter Lynch who actually shares quite openly what he's done. But the McDonald's story is only going to be so useful because McDonald's is over, right? So you're thinking, well, how can I apply this? What are the rules? How do I actually structure this?

25:52And my goal is to give that to you at Felix/training. It's live. It's free. And it's part of our mission to make a million people financially free. That's where I would start because I think that hour and a half or so is much much better spent than reading a bit of a book that is just going to send your mind running. If you got some value out of this, check out all the other videos on the channel. And I wish you tremendous success.

26:11There are 3 massive trends creating a once in a decade opportunity right now. That's what Winston just told me. You just had to lie down on the news. And what have we got? We've got gold breaking records because governments are printing money and central banks are buying gold. Healthcare equipment is booming as baby boomers now age and need healthcare equipment.