In today’s Money Morning…how ‘date night’ could be your next great investment opportunity…three rules for better investing…you may have already stumbled across your next great investment…and more…
I remember when Friday night used to be cinema night. My wife (then girlfriend) and I pretty much caught every major blockbuster film release.
Boy have things changed.
I can’t quite put my finger on when this habit died. I don’t even know if it was a gradual thing, or a sudden stop.
But I don’t even remember the last time I actually set foot in a cinema.
No, these days it’s all about Netflix [NASDAQ:NFLX] and the latest TV series.
I don’t know about you, but the quality of series like House of Cards, Stranger Things and Big Little Lies far exceeds the average Marvel comic film remake, in my opinion.
In hindsight I wish I’d paid more attention to this change of habit.
Because I could have made some big money from it! You probably could have too.
Over the last five years, Netflix [NASDAQ: NFLX] has risen from US$10 to US$170. Meanwile, shares in cinema operator Village Roadshows [ASX:VRL] have gone from $3.20 to $3.80.
In fact, a legendary investor identified this way of investing three decades ago.
Let me explain…
Peter Lynch became famous in the 1980s as manager of the Fidelity Magellan Fund.
His story is worth re-telling here, as it explains why my changing cinema habits were a missed investment opportunity that I should have cottoned onto.
In 1977, Lynch took over the Fidelity fund. It only had $20 million worth of assets. It was his first portfolio manager job.
Over the next decade he proceeded to turn it into the largest mutual fund in the world, by outperforming the market a mind boggling 13.4% per year annualised.
What was his secret? Did he have some superior mathematical model? Or some unique underlying view on the economics of the markets?
No, it was a lot simpler than that. He had just three rules. Rules that he was happy to share with anyone who listened.
Rule 1: Buy what you understand
According to Lynch, our greatest stock research tools are our eyes, ears and common sense.
Lynch was proud of the fact he discovered many of his great stock ideas while walking through the shops or chatting casually with friends and family.
This is something we can all do.
Have I noticed I am buying more from Aldi than Coles these days? Are my friends getting sick of Apple iPhones and buying Samsung Galaxys instead? (Note: they aren’t, by the way!)
These could be important investment triggers.
Most of the stock market is in the business of serving you, the individual consumer. If something attracts you as a consumer, it should also pique your interest as an investment.
That then leads to his second rule…
Rule number 2: Do your homework
Rule number 1 is just a tool for idea generation.
From there, fundamental research is important.
The key figures to look out for are a potential new trend in things like sales growth or cash-flow, and below average debt-to-equity ratios.
Crucially, Lynch also look at the Price Earnings Growth (PEG) ratio. This is a tool to measure how much value is already priced into a stock. The PEG ratio expands upon the price/earnings ratio by factoring in earnings growth.
If for example a company had a PE ratio of 30 (which seems high) but was growing Earnings at 30% per year, the PEG ratio would be 30/30 = 1.
A result of 1 suggest the stock is fairly valued, given its growth rate.
If the same stock had an earnings growth rate of 10%, a value of 3 would result, and suggest it’s overvalued. A growth rate of 50% resulting in ratio of 0.6 would imply the stock was undervalued.
The PEG ratio simplifies the valuation decision by concentrating analysis on the earnings growth rate versus the current PE ratio.
It can help you avoid stocks that may already have a lot of hype priced in.
Like Lynch, you want to seek out companies with strong earnings growth and reasonable valuations. A strong grower with a PEG ratio of two or more has that earnings growth already built into the stock price, leaving little room for error.
Rule number 3: Invest for the long run
On this point I think Lynch might have had it a bit easier than today’s investor.
We live in an age of disruption, when every sector seems to be under threat from technological improvements.
Whether that is financial tech, mobile health, electric cars, or something even newer.
However, there are still plenty of stocks with sustainable competitive advantages to invest in. Underlying demographic trends can provide strong tailwinds for these types of companies.
And in Australia we have less turnover in the top 100 stocks than in, say, the US. So that supports more of a long term view.
This weekend I want you to ask yourself these questions.
What am I doing this weekend? How am I spending my leisure time?
Perhaps you have you tried something new recently that has struck a chord? Or multiple friends have all brought up the same brand or shop in conversation recently? Maybe a new smartphone app is all the rage?
My cinema-going habits turned out to be the best kind of investment indicator. If only I had paid attention to it at the time…
Habits are slow to change, but when they do, the results can be explosive.
Every demographic, whether it’s the baby boomers, or the millennials tends to go through various phases of life together.
This provides the disruption effect that is so often talked about. Most often after the fact, though!
So this weekend, be like Peter Lynch. You never know, perhaps you’ve already stumbled across the next million dollar investment idea?!
It’s worth thinking about…
Editor, Money Morning
PS: Small companies that are just starting to get consumer interest can grow very fast, very quickly. Like Netflix, some of these are simply small changes in habit. While others are revolutionary developments that will change the world. Get a heads up on these hidden gems by reading this report…