Part I.V.I - Stock in Nature / As a Company (2/2)
In the first section of this part (I.V.I) we covered the characteristics of the 6 stock categories (created by Lynch). This second part, we'll elaborate some details including, what to expect, when to buy, and sell each of them.
1. Fast Grower 🚀
- ■What To Expect :
These stocks (SAWAD, PTG, COM7 as examples in the previous section) are where you can expect multi-bagger that could change your life for good. However, this blessing comes with costs. Fast Growers carry more risk compared to other categories. If such a stock underperforms against market expectations, the penalty can be very nasty.
- ■When To Buy :
If you are not the lucky one who spots a Fast Grow at its very early stage, most of the time it is traded at premium. It's very common to see their P/E x20 up to x50 times or in some cases even x100 times. If you are to wait for a better deal, when their prices become "cheap" (P/E < 10) something might not be right. What you need to do is not to buy it but start your investigation.
Considering that these stocks are projected to have a brilliant future, what you should be looking at is not what they are today. Hence, if P/E ratio is to be used, it should be the forwarded one, with their future earnings. With this new set of figures, the ratio becomes more reasonable and easier to justify.
Understand their business plan, targeted markets/customers enables you to estimate the total addressable market (TAM), a proper market capitalization, and therefore earnings at their maturity stage.
- ■When To Sell :
The obvious indication for selling is a noticeable slowdown in growth. Although it might sound straightforward, spotting it can be challenging. Some potential signals could be the emergence of formidable competitors and earnings growth declining to the market's average level.
2. Slow Grower 🚂
- ■What To Expect :
Investing in Slow Growers gives you peace of mind. Due to their lower risk level, the returns are somewhat comparable to corporate bonds. While significant growth might not be the case, these stocks are primarily held for their reliable dividend payouts. For instance, RATCH has consistently offered a dividend yield around 5%, while EASTW's stands at approximately 4% (until they experienced significant changes in 2022)
- ■When To Buy :
Their share prices are usually stable. The perfect time to buy these stock is during the market panics causing all stocks to fall down. This is when you can find great discounts.
- ■When To Sell :
Since these stocks are mainly held for their dividends, a clear sell signal is a dividend reduction. Indicators such as declining earnings and decreasing payout ratios could also be used.
3. Stalwarts 🌟
- ■What To Expect :
These companies (ADVANC, HMPRO, CPALL in the previous example) exhibit consistent performance across various circumstances. During the bull market, you may not expect their growths to be as much as the Fast Growers, at the same time, during the bear one they won't let you down.
- ■When To Buy :
Due to their solid characteristics, Stalwarts are often traded at a premium. Buying them should be at the right time, similar to Slow Growers, during market panics or errors. Unlike Slow Growers, their share prices can be more fluctuate. Buying-the-dip can also a good option.
- ■When To Sell :
It's wise to sell Stalwarts out when you could make an unexpected gain, say 50%. In another case that their fundamentals deteriorate by some reasons. The classic one would be when the company begins to 'diworsify'.
4. Turnaround 🛫
- ■What To Expect :
Investing in these companies carries immense risk. As their stocks are traded based purely on expectations of their better future. Any deviation from that outcome can lead to significant loss.
- ■When to Buy :
Buying a Turnaround stock is not a straightforward process. The standard valuation like P/E can't be applied in this case. Because when these ratios become pretty, it often indicates that you're already entering the scene too late.
The entry point is when you ‘start’ to see the signs of recovery such as noticeable improvement in sales, and/or profit margins, reduction in inventory, shifts in business model (DISTAR/KAMART) or product/service mixes, or even the alleviation of circumstances that used to negatively impact their businesses (AOT as an example in the previous section).
- ■When To Sell :
Selling these stocks can be quite challenging. Basically, you might consider selling once the companies' earnings return to their previous levels. Alternatively, you could continue to hold onto them until there's a significant shift in their new fundamentals.
5. Cyclicals 🎡
- ■What To Expect :
Buying Cyclicals comes with great risk, particularly for those who are unaware of the existence of the cycle. Even worse are those who are aware of it, yet still misunderstand the nature of the stock.
A company achieving remarkable growth above 30% for a few consecutive quarters can be either a Fast Grower or, in many cases, just a Cyclical enjoying its good time.
It's not at all about that we call the stock's category correctly. The reasons for buying, holding, and selling them are totally different.
One of the sacred rules when you invest in a Cyclical is that you don't get attached to it no matter how great it seems. And as I did mention in the previous section that the company itself usually has very little control on their fate.
During downturns, the management will try their best to convince the shareholders, mitigate the situation, for instance by coming up with new higher-profit products, or adjusting product mixes, or any other brilliant ideas that they should have done long time ago. Most of the time, they are not going to change a thing.
Unlike other companies in different categories that you can hold onto during their bad times because they can probably make a comeback real quick. Cyclicals' bad times can be much longer. Their cycles can span years, or sometimes even a decade.
- ■When To Buy :
Buying Cyclicals is perhaps the trickiest one compared to the others. Entering these stocks when everything looks nice is probably the worst idea. At this point, it's very likely that they are reaching or surpassing their peak. What lies ahead is only the bottomless long way down.
Similar to the Turnarounds, the P/E ratio couldn't be applied here. Or, if it is, the interpretation will be upside-down. The kind of P/E you should seek is the highest one; a negative one (indicating losses) is even more favorable. This signifies that the company is somewhat at or near its bottom.
Another ratio you can consider is P/B. This one is straightforward, the lower is the better. Especially when you find one below x1. It's unlikely that things can go wrong. Nevertheless, most importantly, you need to ensure that the company won't go bankrupt. Barely surviving is good enough in this case.
- ■When To Sell :
A lower profit margin can be a good signal to sell these stocks. This is because at the peak of each cycle, Cyclicals' products/services begin to match the demand from the market. Soon after, in order to maintain their market share, they will start selling at a discount.
Another sign is an increase in their production capacity; this is usually the beginning of the end. The consequence will be a buildup of inventory, leading to a further reduction in profit margins. Subsequently, the excessive supply from them and their peers floods the market. The next cycle begins...
6. Asset Plays 🏭
- ■What To Expect :
The reason that a company becomes Asset Plays is because most people have not known about the true value of their assets. And for this very reason, it can keep such a company undervalued for a long time.
- ■When To Buy :
The buying point for these stocks is perhaps the simplest yet involves the most sophisticated process among all categories. You buy Asset Plays when their asset values are higher than the company's itself (market capitalization). However, to find the hidden assets you may have to flip many rocks. The hints may be written in some little corners in their financial reports, often within the notes/remarks section.
In case the assets need to be reappraised, you may compare them with the similar ones available in the market (lands, real estates, etc.). And in case of the subsidiaries, things will be quite easy if they are listed also in the stock market. You may just use their market capitalization and do sum-of-the parts calculation.
- ■When to Sell :
As simple as buying, you sell them when their actual value becomes known to the public and unlocked, which is their market capitalization being equal to their true asset value.
At this point, putting together what we've covered in the first section, I'm confident that you have much clearer understanding of stocks. This 6-Catagories of Stock is now your compass that help guiding you to invest in the right thing and sell it at the right circumstance.
From now one, before you buy any stock, remind yourself about the category it falls into!
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