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Stocks Peter Lynch would love but would not touch...

Jun 13, 2015

In this issue:
» Why are the Chinese obsessed with Buffett?
» Coming soon: A new bourse for tech startup IPOs
» Roundup on the markets
» ...and more!

Editor's Note: My colleague Rahul Shah is all set to reveal his "Money Multiplier" formula. And I strongly recommend that you don't miss it! After all, it isn't every day that we get to hear an astute research analyst reveal his secret formula behind his most profitable recommendations. So block your calendar for 5PM on 15th June for this mega event! And yes, if you have any questions for Rahul, just post them here!

 Chart of the day
As I wrote the other day, the trick in hunting for the 10 bagger is not just in finding high growth stocks. But also knowing at what valuations to buy them and when to sell.

Now if you are looking for stocks that will make the biggest difference to your portfolio, they cannot be ordinary. They have to be companies growing at extraordinary rates and at the same time sporting excellent fundamentals. And when we think of such criteria we defer to the learnings from Peter Lynch.

Rest assured we are not going to repeat his oft repeated sermons like 'buy what you know' and 'keep your eyes and ears open'. Instead, we would assume that you are already doing so. And what we will tell you is stocks Lynch would avoid buying currently despite loving them!

'Why so?', you may ask.

Well these are stock that would fulfill almost all of Lynch's buying criteria. They are high growth stocks with little debt on their books, fantastic businesses and excellent return ratios. But their valuations would not really tempt the legendary investor.

How much is too much to pay for these stocks?

Mind you stocks which show signs of perpetual growth with excellent fundamentals are not 100% resilient to risks. In fact Lynch would tell you that here too there are some key alarm signals to watch out for. Heavy spend on marketing and sales is one of them, as such spend may not be sustainable. Relying heavily on top executives and the risk of their joining a rival firm could be a big risk to valuations. Cyclicality can deal a big blow to turnaround companies that are basking in the glow of low debt and high earnings. Similarly companies posting high growth in profits on the back of sale in assets are unlikely to be growth stocks for long.

Thus while you can love and keep a watch on companies that seem to be the best 10 baggers in the making, you would rather be patient to buy them. Only if their fundamentals seems sustainable and when valuations seem reasonable.

Would you want to pay any price to buy solid high growth stocks? Let us know your comments or share your views in the Equitymaster Club.

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That Warren Buffett is the world's greatest investor is probably inarguable. Indeed, his wisdom in the field of investing has not only helped him amass huge wealth, but has been devoured by ardent value investors the world over. The latest country which has taken active interest in Buffett is none other than China. The dragon country has emerged as a country to reckon with and one of the reasons for this has been the stupendous growth in its economy in the past few years.

The Chinese stock market has also reflected this. As the aspirations rise, Chinese investors are considerably interested in Buffett's investment nuggets to help them build wealth over the long term. Consider this. As reported in an article in Moneynews, a Chinese company that develops online games bid more than US$ 2.3 m to win a private lunch with Buffett. Interestingly, whether Buffett's principles of value investing can be applied to Chinese stocks remains to be seen. Especially since China does not win brownie points for transparency and accuracy of information.

Raising money is likely to get easier henceforth as regulators are contemplating setting up a separate bourse for companies, especially tech start ups which are hungry for capital. Under present capital raising rules, these companies have to meet stringent criteria relating to promoter lock ups and profitability. Inability to comply with these norms means they remain devoid of capital required to fund growth. And in the process seek funding from venture capitalists (VC) and private equity (PE) investors. However, that seed money is not sufficient for large scale expansion and there was a need to have some platform whereby these companies could raise money easily.

To give you an idea how big the tech start up opportunity is fathom this. As per news reports, about 3,100 start ups in India have raised US$ 7.2 bn through VC and PE funding since 2013. But very few have made debut on the bourses so far. Thus, if there is a new exchange or a platform, their requirement for growth capital can be met domestically. And they won't have to turn their heads towards foreign markets. Many capital hungry start ups which were not able to raise money in India have explored the possibility of raising money from abroad in the past. However, getting the desired valuations turned out to be a problem in foreign markets. Hence, they were a bit apprehensive to try this option.

Thus, the idea to set up a new platform/exchange is unique in a sense as it would help start ups meet their capital needs domestically at better valuations. However, having less stringent rules for listing also increases the probability of companies with poor track record/practices making it to the bourses. This is one area where prospective investors should pay attention.

Barring stock markets in China and Brazil, majority of global indices remained under pressure for the week gone by. Uncertainty over the timing of rate hikes by the US Fed and Greek's debt saga continued to weigh on the markets. All eyes are now on the US Fed meet which is scheduled next week.

Major European markets remained under pressure. Greece's bailout agreement with its creditors is set to expire soon this month. Greece has already delayed one payment and is now into negotiation for a new deal to avoid defaulting on its massive debts. On the other hand, few equity markets in Asia notched some mild gains. China was the leading gainer (up 2.8%) for the week.

Back home, Indian markets continued to remain under pressure for the third consecutive week. The BSE Sensex was the top loser in the pack. Persistent selling activity was witnessed across the indices. Most of the sectors witnessed selling pressures led by realty and consumer durables stocks for the week. Worries over economic recovery and deficient monsoon forecast have been the prime factors.

Performance during the week ended June 12, 2015
Data source: Yahoo Finance

 Weekend investing mantra
"Behind every stock is a company. Find out what it's doing" - Peter Lynch

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst).

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2 Responses to "Stocks Peter Lynch would love but would not touch..."

vijay s

Jun 15, 2015

I won't buy until valuations are cheap and about 20% safety margin is there, this is I've learned it from your recommendation methodology.



Jun 13, 2015

If you had given PEG ratio along with PE ratio, and Intrinsic value it would have given better insight whether the high valuations are sustainable.

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